Exploring Taxes with a Friend of WCI - WCI Podcast #403

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This is the White Coat Investor podcast episode 403 exploring taxes with a friend of WCI. Today's episode is brought to you by SoFi. Helping medical professionals like US Bank, Borrow and invest.

You know, not only are they getting an employee deferral, but there's also an employer contribution that can come into the mix depending upon the type of retirement plan. So, you know, and they could also be eligible for health coverage as well and you know, other benefits such as, you know, dental or vision, you know, dependent care benefits. But one of the main reasons why I like it, not just for obviously the retirement plan purposes, but you can also start writing off some of their, some personal expenses that as business deductions, such as like any of their travel expenses if they need like a new computer or if they, you know, writing off their cell phone. There's just things that you're able to take from being personal expenses to being legitimate business deductions as well. So, you know, those are definitely kind of the top reasons to do it. But you just have to make sure that you're obviously treating like them, like a legitimate employee as well. And so all of those benefits obviously add up to big deductions and will save you a lot more than what you're paying in that Social Security and Medicare. But that's also good. You're making them eligible for Social Security benefits later. They're also providing a steadier flow of taxable income which can help you qualify for loans and mortgages and all those other things.

Yeah, well, here's the issue, right? Everyone's like, I should hire my spouse. The truth is, the person you should hire is your minor child. Your minor child is a way better deal. Not only are they probably not making enough that you're going to have to pay any income taxes on their earned income if they're a minor child and the business isn't a corporation, they don't pay any payroll taxes on their earnings. It's earned income, so it can go into a Roth IRA and never be taxed again. I mean, it is a fantastic deal to hire your child such a great deal that the big problem there is, is people want to pay their kids too much, you know, more than the kids really deserve to be paid for whatever work they're doing. And it does have to be a legit job, as you mentioned, you know, you got to treat them like every other employee. They got to have a W2, W3, W4, and I9. They've got to have an employment contract and all those things. But the real deal is hiring your kids, not hiring your spouse. The problem is your kids aren't nearly as good of a worker as your spouse usually is. Your spouse is usually a lot more beneficial to the business. But I think everybody thinks about these great deductions. And it's true. Paying your spouse a salary, that salary is a deduction to the business. But you just got more taxable income on the personal side. So that's kind of a wash there. It's not a wash if it's an S Corp though, right? Cause if it's an S corp and you're just gonna take that as a distribution instead of paying salary, you know, there's payroll tax savings on doing that. And of course, you got to pay the payroll taxes, the Social Security tax and the Medicare tax. And don't Forget, it's not 1.45%, right? It's 2.9%. You're the employer, you own this business. You got to pay both halves of the Medicare tax. It's not 6.2%, right? It's 12.4% for Social Security. You got to pay both halves of it. So altogether it's about 15% you're paying in taxes that you don't get back. You don't get that back. Yes, your spouse gets a little bit more Social Security benefit, and maybe for a few years, they're actually getting to where they qualify for their own benefit. But for many doctors with non working spouses, your spouse is going to get more of a benefit from 50% of your Social Security benefit than they are from having their own Social Security benefit. So you might not be getting anything beneficial from paying those extra payroll taxes. I mean, they're likely gonna qualify for Medicare anyway through your benefit. And so you might be very limited in the extra benefit you're getting for paying those payroll taxes, but that money's gone. That money's not coming back. And on the reverse side, when you're putting money in a retirement account, you know, if it's a tax deferred retirement account and you put 22,000 in there, then maybe you're saving, what, something like $8,000 that year in taxes, right? You're paying $15,000 in payroll and you're saving 8. And the truth is, you're not even saving that 8. You're just deferring it. Some of it you're going to be paying back later. So I just think it's dramatically overstated. Whoever's telling these people to do this. The benefits are way more overstated than they actually are for lots of people. You just got to sit down and run the numbers for your situation and make sure it's actually smart for you to do this because there's a good chance you'll actually come out ahead not paying your spouse to work in the business.

Yeah, I a hundred percent agree with you about kids. The that's definitely the best one of my favorite strategies because and I have all four of my kids on on payroll. And that's because you can do so much with saving on payroll taxes as well as you know that that tax free income to them, but they're not able to do as much as your spouse. And so if you can be paying your spouse getting those benefits, being able to write off a lot of the expenses that were normally going to be personal expenses that can be now business expenses. I find that especially if you just start paying them a 30, $50,000 salary, the Social Security on that really isn't a ton when you also take off the the amount of tax savings that you get for deducting their salaries, et cetera and payroll taxes. So I still encourage it as long as the math works out. Of course. And having a spouse being able to do a lot more complicated tasks for the business, you're essentially having to pay other benefits to to other employees or having to hire a completely separate person to do that same job.

Yeah, I mean I think you might be overstating the benefits part of it too. Right. Cause yeah, you could give them health insurance, but you've already got a policy for yourself through the business and they're covered on that. Right. It's a family policy. You've got an hsa, but you've already got a family hsa. Cause your spouse is already on that plan. It's not like there's additional HSA you can get there dental and vision. Again it could be on the family plan. Life insurance that you can buy through a business is not a huge benefit. You can't buy that much life insurance typically. And dependent care stuff you could get just with you working there. And the other thing is with converting personal expenses to business expenses, I mean technically only the portion of whatever that is that you're using for business is deductible. Now granted there's a lot of gray here. A lot of people go pretty far into the gray. But technically, if you are writing off their cell phone use, it's only supposed to be the percentage of their cell phone use that is actually business related, which for most of us is not that much, let's be honest. So I think that part's not huge. I think the real benefit is the retirement plan, right? Being able to use the retirement plan. This is the big benefit. And one way you can make that bigger, that I think this works better than it otherwise does, is if you've got a retirement plan that allows for mega backdoor Roth IRA contributions. So now instead of only getting 23,500 in there, maybe you're getting 70,000 in there and it's Roth, it's never taxed again, et cetera. And obviously you have to pay them more. You can't pay them $10,000 and put $70,000 into a mega backdoor Roth IRA contribution. You got to pay them 80,000 DOL or $90,000 and the correspondingly higher payroll taxes that go along with that higher salary. But I think there's a lot of bang for your buck when you kind of get as much as you can out of that retirement plan benefit. Because that's really the benefit. That's what you're weighing everything else against. I just don't think the, you know, the legitimate business expenses, the dental vision, you know, cell phone, computer, et cetera, I don't think that all adds up to much. The real benefit here is, is more money in a retirement plan. And it's not that you can't invest for retirement outside of retirement plan, it's just that the money grows faster. So it's the additional benefit of being able to put that money into a retirement plan. And that comes down to, well, what's the arbitrage you're going to get between your contribution now and your rate later? It's how much does the money grow? So it's really hard to calculate exactly how much that's going to be. But obviously the more you can put in there and the longer you can leave it in that retirement plan, the more benefit you're going to get for doing that.

Definitely.

Now what, what I mean, a spouse can obviously do more, so you can justify paying them more than you can pay your kids. You know, if you have your kids do some filing for you or sweep up the office afterward or something, you can only pay them so much. But what are some of the things you've seen, doctors, practices, physicians, dentists, whatever that the spouse is actually doing without any particular professional Training to do.

Yeah, you know, usually they'll start out doing more administrative type support. So they can help with scheduling, checking in and checking out, helping with the, you know, I know when. I mean, I was a child, when I did this in my. My own father's neurological practice, you know, they're helping with, you know, medical record management, filing away things. Everything is obviously electronic now, but they can learn that. They can be answering phones, but they could, you know, if they are very creative types, they can be helping with marketing and, you know, your office's online presence, social media, the website, et cetera, or even just creating those marketing materials and, you know, patient outreach events even. And, you know, or it could just be just overseeing the normal daily operations. Maybe you're like, hey, you know what? I don't want to deal with the staff right now, and I don't want to handle the HR roles that well. They can definitely be doing that or even helping with the bookkeeping. Maybe they're very proficient with the budgeting and the payroll and the accounts receivable, accounts payable. But most spouses don't have experience when it comes to dealing with the insurance, but some of them, they may. So it's just really finding out one thing, what your spouse is willing to do. Because I definitely ran into instances where they're like, I don't want to be doing X or Y or Z, but so you have to find something that they're interested in and then obviously pay them a reasonable salary for someone that you would be paying for those same sort of skills off the street and treating them again, like, as you mentioned earlier, in a legitimate employee with an employment agreement, they're on timesheets, and you've really defined that role for them. And definitely ChatGPT can be a friend when helping to help you define these roles or even when you're trying to figure out, hey, what can I do for my kids? If you want them on payroll, it's a very helpful resource to be like, hey, create a job description for my spouse with these responsibilities, and it can pop something else out nice that you then put aside in case the IRS were to ever ask for it.

Yeah. And, you know, the truth is, it's the key there when hiring. Family is legitimate job, legitimate business. You know, I mean, I saw a company the other day that came across my desk where basically what they're trying to do is get you to pay your kids for doing their household chores and then using that money to go into Roth ira. And I'm like, whoa, whoa, Whoa, whoa, whoa.

No bueno.

This isn't gonna fly with the irs, you know, so it's gotta legitimate work. And maybe the best reason to hire your spouse is because your spouse is the best person to do that job. For example, Katie works at the White Coat Investor, and guess who cares more about the success of the White Coat Investor than anybody else on the entire planet, right? Katie does. And so she's an incredibly dedicated employee with a whole different set of skills than I've got, and so has been working with us for more than a decade now and some years. I don't know if we're coming out ahead on all the tax benefits and what we're paying for her for payroll taxes and all that, but we're definitely coming out ahead on hiring her because she's the right person to be doing that job. And so that's the kind of sorts of things I'd be thinking about when I hired my spouse. Your spouse might care so much about your business that they're going to be better at customer service, they're going to go the extra mile, they're going to work unpaid overtime. They might be the best employee you ever had. And that's a great reason to hire your spouse. You know, when you're getting that sort of a work ethic and that sort of those sorts of attributes, you know, there's a reason you married them is because you like being with them and you know, because probably a hard worker and a great person to share that work with. So. And you might really enjoy working together. That's another reason to hire your spouse. All right, what are the. What are the big red flags here? What should people watch out for? How do people screw this up when they hire their spouse?

By not treating them like a legitimate employee. That's probably the number one thing, as you and I discussed earlier, not putting them on payroll properly, not having a defined role, not having the agreements in place. And so that's really 90% of any fight with the IRS and the state is that documentation. If you treat them like a legitimate employee, they're legitimate. They're not going to argue with you about that deduction and making sure that, that they are just set up properly. Even like, hey, if you're going to be doing the retirement plan with them as well, making sure you understand attribution rules with them too. So then that way, because they're not going to be in the same sort of calculations as another employee would be. So understanding those rules as well is really important.

Yeah, for sure. You could Assume that you're going to get this huge benefit from them having a retirement plan. But don't forget, if you've got other employees working for you, your 401k or whatever plan's got to pass testing and putting your spouse on that plan and making this big contribution for them may force you to make even larger contributions for your employees that you weren't planning to make. So you could very easily come out behind if you don't run those numbers in advance before deciding how much to pay your spouse. And you may end up having to pay them so little that you're definitely not coming out ahead paying all those extra payroll taxes for them. The other thing I think is important to keep in mind is your spouse might have another job, right? They might be having Social Security taxes paid for them at that other job. Well, when you take this new job, you're also going to have to pay the employer half of the Social Security taxes. And even if you can get the employee half back because they've already paid the maximum amount on wages, you're not getting the employer half back. It's the same reason that a W2 job and an S Corp often doesn't mix very well together, because you end up paying more in payroll taxes for no additional benefit. So you got to be a little bit careful about that as well if they have another job. All right, let's move on to our next question. We've talked about hiring your spouse, a little bit about hiring your kids, and let's talk about hiring a nanny. Here's the next Speak Pipe question.

Hello, WCI team, and Jim, I hope you're feeling good and making progress every day. My wife and I recently took on our first household employee, a nanny, to help watch our kids, and we're paying her through a payroll platform that helps with tracking the payroll taxes and all the appropriate withholding. As part of the setup of that platform, they applied for on our behalf and received a new Federal Employer Identification Number, or ein, which is in my name only for context. We are married, we file jointly, and we are Both employed with W2 income. My questions are broadly, what does this mean for our finances? And more specifically, am I a business now? Should I add my wife to the EIN or the business? Do we file taxes for this business separately from our own annual income tax returns? And are there any new advantages or strategies that are newly available to us as a result of these changes? Thank you for all that you do and everything that your team does. All of us out here are certainly rooting for you and wishing you a continued smooth and speedy recovery.

All right, well, thanks for your kind words. To start with. I am having a smooth recovery. It's not as speedy as I would like, but I'm learning a lot about patience as I do physical therapy. All of you out there doing physical therapy or occupational therapy, thank you so much for what you do. It really is important work and it can be a long road for people coming back and regaining function. As I work 23 times a week on my wrist, I'm very much cognizant of that. All right, let's talk about nannies. And I think we're going to get into some schedule H discussions here, but you want to give an overview a little bit, Alexis, on this topic and what we ought to be thinking about as we move to hire a nanny, because this is really common, especially in dual income professional households. Yes, you come out ahead with these two great big huge incomes, but you find your time is very limited and you gotta start outsourcing stuff like crazy. Clearing the driveway and doing the lawn and cleaning the house and somebody watching the kids. At times it can make a lot of sense to hire all these things out and you're still coming out ahead because of your two high incomes. But what should people think about as they move to hiring in?

Yeah, this is near and dear to my heart because, you know, as I'm sure you're aware and a lot of your listeners are aware, my husband is a physician. He's a neurosurgeon. So he's working and I'm working. And so we have a family assistant. And you're 100% right. We needed that help in order to keep things going despite having the two salaries. And so when having this family assistant, you do you have to go out and get a separate ein, or employer identification number. And I couldn't, I don't want to put this through my business, or he doesn't want to put it through his practice. You have to have this separate. And it doesn't mean that, that it's. When you're doing this for a household employee, it doesn't mean that you have a separately formed entity. You're just following labor and tax laws, but you're not operating a formal business entity unless you take additional steps to actually do something like that. But in this case, basically just the IRS is recognizing that you are an employer of a household employee. So doing this, essentially the IRS is just wanting to track your tax withholdings and your payments for your nanny's employment. And so this is a way of just separating your personal finances from your now household employee finances. So you can't write off any additional business expenses for it. You can't, you know, putting your spouse on it's not going to be any, have any beneficial effect on it as well. But, you know, so your EIN is specifically for your household employment tax purposes. And so like I said, doesn't typically open up to additional business deductions. Now, when you are ready to assuming that you're probably using a payroll service that is helping you do all these, pay all the taxes, file all the 941s and all those payroll forms at the end of the year, they'll usually create a packet for you that you can use on your taxes or give to your tax professional that will detail out all of your quarterly estimated payments that they're making on your behalf to the irs, as well as the Schedule H which you put onto your tax return that will report the wages that you've paid, any Social Security and Medicare that you've paid, any federal taxes you've paid, unemployment tax as well, and then any state taxes too. So it's very nice. They basically do that Schedule H for you and you can just kind of copy and paste it into whatever software you're using and so then that way you're able to properly report everything. Now that doesn't I've had a lot of people ask like, hey, well then can I be deducting my nanny taxes?

Yeah, I mean the problem with a nanny is you really need a nanny, but if you pay them more than a certain amount, it starts getting very complicated very quickly. Right. You mentioned actually hiring a payroll service. Would you recommend that, do you think most people hiring a nanny, most of the audience we have out there, probably a dual income family or maybe a single parent or something. Is it worth it to get the payroll service? Do you think? Is it worth the additional fees to have those services done for you rather than trying to figure out how to do it all yourself?

It depends on how much time you want to put into it. It's all cost benefit, basically. And even for me, even though taxes are my full time, I go and have a nanny agency, payroll agency doing that for me just because I really first off, I hate payroll taxes. I hate want to be dealing with it and things change enough that it's just not worth my time. But yes, can you do it yourself? There are plenty out there that do it themselves, but again, it's just all about that cost benefit.

Yeah, I've done a lot of Form 941s in my life. They're not the worst tax form I ever tried to do myself. I've never actually done a Schedule H. It doesn't look terrible. You know, it looks doable. But I can see how somebody putting that all together for you would be well worth paying for. Do you have any idea what you pay the firm you pay each year?

Yeah, I believe it's about like $50 a month. It's really not that bad.

Yeah, so that's pretty inexpensive. It doesn't take very many hours of physician time to. To make up for $50 a month. I mean, that's only 600 bucks a year. And for lots of docs, that's. That's, you know, two, three hours of time. And. And you could easily blow more than that keeping track of all this stuff. And if you make a mistake and got to refile it all, you know, that doubles the time, of course, and penalties. Not. Not a bad investment to spend a little bit of time. And it's not like you hire them forever either. Right. If you're like, after a year, you're like, I am not getting my $600 a year benefit out of this. You've got all these examples of how they filled it out before. And so that should help you to DIY it moving forward from there. All right, so people want to deduct this, right? They're like, oh, it's an expense. Surely I can deduct this, right? Well, I don't think that's really the case, is it?

I got this question, actually, last night was, hey, I have to send my kid to aftercare in order to work or have the. A nanny. And so in order to work, this is a business deduction because I have to have them in order to work. Right. And unfortunately, no, I wish it was. I so wish it was. There's very, very rare instances where you can actually make it work. But typically, you can't deduct your nanny and household employee expenses as deductions. And so it's considered a personal expense. But you can use it for the child independent care tax credit. And although that, you know, especially, you know, physicians, you know, they have usually a higher income, it starts to threaten. There's a lower threshold for getting the full benefit. You know, you're still able to use your nanny's wages as qualified child care expenses for that Child independent care expense credit. That form 2441, you can also go and use if your employer provides it and they have A Dependent Care fsa. Those native expenses qualify for that Dependent Care Flexible Spending account as well, so you can use it towards that. But, yeah, unfortunately, if you own your own business, unless you're in the daycare industry or you're somehow able to create maybe a separate entity that is like a daycare for your business that allows your other employees to bring their kids into it, you're not able to write off your nanny's expenses through that.

So. So now people start hearing this, and they're like, oh, crap, I hired a babysitter to go out to dinner and a movie last night. How is this different from having a nanny? And what I think a lot of people don't understand is there's a threshold here, right? You have to actually pay one employee more than a certain amount before you got to do all this. Right. And so that amount for 2024 was $2,700. So if you're paying them less than that, you don't have to do all this. Right. I mean, what do you have to do? If you've got a nanny and you only had them for a week or whatever, and you paid them 1,500 bucks, what do you have to do? Anything?

No, you don't. Unless you're trying to write it off as a business deduction, which, again, you can't. You're helping them save for college or have some extra spending money, et cetera.

Yeah. I think there's a secondary rule that if you pay more than $1,000 in cash wages in a quarter, you have to file as well. But, you know, I think the main number people need to keep in mind is $2,700 for the year. If you're paying more than that, you got to do all this stuff. If you're paying less than that to the neighborhood kid to mow your lawn, and you're paying less than that to some other neighborhood kid to watch your kids for a few nights, you don't have to do this. That's okay. The fun thing about that, though, for them is that's earned income for them, and they could use it to put it in a Roth IRA or whatever. Even though you didn't actually have to fill out a bunch of paperwork to demonstrate that income, they just got to claim it as household employee income, right?

Correct. Yep. Yeah. In theory, they're supposed to be going and claiming that on their tax return, and that's why the IRS does have those, like, those thresholds. I would say probably, though, that not, you know, coming from a tax advisor this is probably a little taboo to say, but probably 99% of people don't do that. You know? You know, most people don't even understand that this rule is out there. And it's not like the IRS is going to come beating down your door because you paid Susie down the street $2,000 for, you know, babysitting one year. But realize that if they do find out, they technically could.

Now, the rules are a little bit different if it's like your spouse or your mom or something like that. Right. If it's a family member, how do the rules change? Do you recall offhand or is this rare enough that it has to be looked up every time?

Yeah, it's rare enough. It's most of the time family members are, are just going in and helping out. Most of the time they're getting at some other sort of support. Like you're paying for their meals or some other sort of gift them some money. Yeah, exactly, exactly. Keep it under the gift tax threshold and then you don't even have to worry about it.

Okay. And I would bet there's a whole lot of people flying under the radar out there. What's your sense for how often this is audited?

I have been doing this for over 20 years. I think I'm in my. Oh, my gosh, how old am I now? Good to 23, 24 years. And I have never once heard anybody do it. None of my clients. When I was working for local regional CPA firms before going out on my own, I never once did I have anybody get picked up for this.

Not that that is a tax technique we recommend.

Yes, exactly.

But it ought to relieve your worry about this a little bit if you're super close to it or whatever. All right, well, I think the main message when it comes to nannies, I think some doctors feel guilty hiring people to help. They're like, oh, we could just figure out how to do this ourselves. We could save this expense. I think the main message when it comes to nannies is this is okay to hire some help to help with your household stuff. And yes, it might involve a little bit more expense or a little more tax paperwork, but it's probably worth it to make your life better. Remember, the biggest financial risk in your life is burnout. Right. And this is maybe a type of burnout insurance. Get a little bit of help with stuff on the side that allows you to not feel so burned out when you come home from a 12 hour day and find you have four more hours of work at home waiting for you okay? Anything else we need to talk about that we haven't talked about when it comes to hiring nannies? Alexis.

We can talk about like a little bit about household. Like if you have other household employees, like if you have a cleaning service that comes. Or like, or just a person that comes to clean. Like, there are ways to potentially write off a little bit of theirs, like through the home office and et cetera. So it's not all is lost, basically. Do you want to talk about that?

But that's a good point. But I assume it's based on square footage. Right? You get a deductive portion. That's the home office.

Yeah, exactly. Or if, like you have somebody that comes in directly only just cleans your home, then. Or not your home, sorry, your office, then you can write that off 100%. But hopefully you're having your kids do that and then that's how they're earning their money.

Yeah. Our problem is the office is not that big of a percentage of the house, number one. And number two, it's the easiest thing to clean. Right. Practically doesn't need to be cleaned. So if it was actually by the amount of time the cleaner spent in the office, it would really be a, a minimal deduction.

Well, I think for me it depends because, like, I'm a little bit more. I'm a little bit more of a pack rat, so my kids get to have to organize a little bit more for me. But yeah, for sure.

Okay, let's move on to a new subject. We're going to talk a little bit about the Vanguard Settlement Fund. Let's listen to this speak pipe.

Hi, Dr. Dali. I have a fair amount of money in the Vanguard Settlement fund. And while filing my taxes, I noticed that it's coming across as ordinary dividend. My understanding is the underlying assets are all short 30 day US treasuries, at least most of them are. So typically those are exempt from state and local taxes. But because of the way the statement is reading out, it seems like I would have to pay ordinary dividend income tax for both federal, state and local for this. Is there any way to not pay state and local taxes on this?

Thank you. All right, this is a great question. There's a lot to talk about with this question, though. What should we start with? Should we start with just answering this question?

Yeah, yeah, let's do that. First off, for those that are wondering, hey, well, what's a settlement fund? I had to actually look up and see, well, which is which Vanguard fund do they actually use for most of Their accounts, it seems like most Vanguard brokerage accounts use looks like the Vanguard Federal Money Market Fund or VMFXX as their settlement fund. So that's usually where if you get some earnings from your investments, they'll pop that money into that settlement fund before it's reinvested. So it's not a money market fund. It's a money market fund, but it's not a bank account. It's usually invested in mutual funds like short term high quality debt instruments like U.S. treasury bills. And so they are, they're treated as just ordinary taxable income. But a portion of those funds can be exempt from state and local tax taxes. So at the you'll probably be receiving soon, you know, in, in the mail a Form 1099 dividend from Vanguard that will not only show you your earnings but it will also give you a breakdown of which states have a percentage that's portion that are exempt from state taxes. So they'll publish that percentage in their annual tax information and you need to apply that percentage based on what states you live in against how much is earned and then have that reflected on your state tax return.

Yeah, absolutely. The answer to your question is yes, that income is part of it exemption from state and local taxes. I'm looking up 2024's tax information here from Vanguard and it's 49.3% of income from that Vanguard Federal Money Market Fund, the settlement fund that is exempt from state and local taxes. So all you've got to do now is you or your tax preparer has to reflect that on your tax return. If you ignore it, then you're going to pay the state and local taxes on that. Now obviously in seven states there is no state income tax. So those people don't have to worry about this. In lots of other states it's not that high of a percentage. In my state it's 4.75%. And if you don't have very much income, maybe it's not even worth the hassle to you. I don't know. But you can certainly claim that. So I think that's the bottom line answer to your question is yeah, you can, you just have to report it on your taxes. Right. Is that particularly difficult in tax the tax preparation space? If you know that 49% of your $8,000 of income from this fund is, you know, from U.S. securities. Is that hard to report on the tax return, Alexis?

No, it just depends on the state. And you know, most softwares out there will ask you like hey, is there any portion of this not taxable to the state. And so you just have to, again, look up how much it is based on the information. It's not just Vanguard that provides these annual reports with your tax statements. And so I've seen it with Merrill lynch and Morgan Stanley, et cetera. You just have to know where to find it. If you can't find it, then, like Jim just did, you can go in and Google it, and usually it'll just pop up. You just have to find the fund that your, that you've invested in. So usually the percentage will be different depending upon which fund that you're in. So like you said, depending on how much you actually earn, you want to see if there's a good cost benefit to it, look it up. But each tax software is different, and then where it goes on your state return just depends on your particular state.

Yeah. Now, all I did to find this, and I found this while Alexis was talking and giving the answer to this question, right. I put in Vanguard funds, percentage of income from US Government obligations. And the first hit is a Vanguard form called. It's a PDF called US Government Obligations Income Information. That's it. And it's got every Vanguard fund listed on there and the percentage of their income that comes from government obligations. And so that's the information you need. I'm sure if you swapped Vanguard for Fidelity or iShares or BlackRock or Schwab or whatever, you'd get a similar form from those companies. So you just got to be aware that it's out there, and if you pay attention to it, you can actually save some of your income taxes. However, I think we got to have a little more of a discussion about this, right? I mean, the real question if you're all worried about the taxes from your settlement fund, is why are you in the federal money market fund to start with? Why are you not in the municipal money market fund? Instead of just saving your state taxes, why not save the federal taxes on it and use a municipal money market fund? Now, everybody's got to do the math on that, but typically, most of the time, most of the year, you will come out ahead if you're in a high tax bracket, using the municipal money market fund for your cash rather than the federal money market fund. So I would encourage you to at least run the numbers on that. I don't think most states have a good money market fund that is both federal and state income tax free. But if you do, shoot, use that instead. It'd be even better off. You save even more in taxes. But I think most of the time that municipal money market fund is what high tax people will often consider using instead. I haven't bothered. My cash is sitting in federal. I'm probably coming out a little bit behind. But what I noticed a few years ago, and I wrote a big long blog post about this, is that the rates change a lot more in the municipal money market fund than they do in the federal money market fund. I was surprised. There were big changes around April 15. I saw some changes later in the summer, and there were months of the year when I did not come out ahead using the municipal money market fund. And so it actually required a little more attention to be paid to what the current yields were in the various accounts. And at times, in order to really maximize your benefit here, you actually had to be swapping back and forth a few times a year. What have you noticed, Alexis? Do you use a municipal money market fund when you're using a money market fund or you did not bother with.

The hassle right now? I don't bother with the hassle. Usually my funds aren't. I'm not trying to have them sit too much in cash except for my emergency fund. And then usually with those, I'm trying to find more high yield funds to hopefully earn more interest on.

I think the main message when it comes to cash management is if you're going to be having any significant amount of money sitting in cash for any significant amount of time, make sure it's in something paying interest. Right? So many people are sitting and checking, making 0.01% a year or it's in a savings account at your local credit union or bank and paying nothing. You know, get that money into a high yield savings account. Get that money into a money market fund of some kind. You know, vanguards tend to have the highest yields, but Fidelity and Schwab both have good ones. Get into something that's paying something on cash. So you're making 4% or 5% instead of making 0.05% or something like that. That's the main thing. Or as Alexis does, don't have a lot sitting in cash. Get it invested relatively quickly so you don't have that cash drag on your money. All right, let's do our quote of the day today. This quote of the day comes from Thomas J. Stanley. For those who don't recognize that name. That's one of the authors of the Millionaire Next Door said, before you can become a millionaire, you must learn to think like one. You must learn how to motivate Yourself to counter fear with courage. I like that quote. Okay, let's talk about a low earning year and what that means tax wise. Here's our next Speak pack question.

Hello, Dr. Dali. My question is about tax considerations during a relatively lower earning year. I'm taking a three month unpaid paternity leave this year, so my income will likely be hopefully the lowest of my career. And so I was looking into things like doing Roth conversions, but when I run the numbers, I'm Normally in the 24% marginal tax bracket, and this year we'll probably just dip down to the 22%. That seems like a distinction without a difference. And I'm just wondering if I'm thinking about this correctly or if there's any other considerations I should be thinking about in this year. Incidentally, the only way I'm able to take this unpaid paternity leave is because of the help I've gotten from this community. So thank you to you and everybody else.

My favorite part about this call is the baby sounds in the background.

Oh, yeah, it's so sweet.

Yeah, that's awesome. Paternity leave. Bummer that it's unpaid. This has become a lot more generous in the last few years. There's a lot of people out there getting paid parental leave, whether they're male or female. And three months is not uncommon at all with a lot of employers. I mean, it's not France where you get like a year or something of paid leave, but it's a lot different than it used to be. I mean, when I started my career, we didn't even think about asking about paternity leave. Right. I mean, I took a shift off for one of my kids. I think that was about the extent of my paternity leave with four children. But it's a new world out there for sure, and it's probably a good thing. The thing that strikes me the most about this question, though, is it's only three months less earnings, right? You're not dropping your income that much. Yes, it's a lower income year, but it's not a low enough income year to really make a huge difference. I wouldn't say. What do you think? How much lower does your income really have to be for you to score some sweet tax benefits out of that year?

I had the same sentiments. It really wasn't for him in this example. Definitely not a huge drop. You know, I would want to see it at least get down, you know, in maybe to like the 12%, you know, to be considered like a huge drop. I mean, Maybe going down to the 20 would be, would be a nice drop. But you know, if you are able to, you know, what I would really recommend for him in his instance with such a shorter drop is, okay, well, let's look at strategies to help lower your, the percentage even further. Like all the normal tax strategies that you'd be doing, like making sure you're maxing out your retirement and doing your tax loss harvesting things like that. And so then that way, okay, great, now we have a little bit more to work with. And okay, now if you have that lower, you truly have a lower gear or like, let's say you and going to take a full year off or maybe you're going to have a big gap before going from, you know, residency into your tending job, you know, then, yeah, consider Roth conversions, you know, or maybe you want to accelerate some income into the current year. You know, if, you know you're going to have some other big deductions coming through. You could even look at, you know, trying to sell some of your, your securities that maybe have some big capital gains that you want to use and take advantage of trying to get into that 0% capital gains rate if you can get your taxable income low enough. But yeah, you know, what I would say for him is, you know, right now, like, I would kind of treat his current year as he's been currently treating it, despite the fact that he's only losing three months of income.

Yeah. I think you named the three things that can really be done in a low income year. One is make Roth contributions instead of tax deferred contributions. I don't know that dropping one bracket is really going to change the calculus. This is one of the most complicated decisions in personal finance, whether to make Roth contributions or tax deferred contributions. There is so much that goes into that decision. Sometimes it's obvious what you should do. You know, if you're a resident, you're not playing any games with trying to get your student loan payments lower or something. It's almost always going to be Roth. Right. And if you're in your peak earnings years and you're not a super saver of some kind, it's usually going to be tax deferred. But most people don't fall into those careful categories, you know, and so it's a hard decision. Lower income is obviously one thing that you put on the side of the ledger that makes Roth a little bit better. But there's so many other things on the ledger. I don't know that that's enough to really move the needle. The second thing, of course, is Roth conversions. You know, these are typically done in people between the year they retire and when they start taking Social Security, you know, is when people do big Roth conversions. But if you had a big drop in income, you could do them that year. I've got a neighbor who took a one year sabbatical from his job as a radiologist. I'm going to try to sucker him into coming on the podcast to tell us all about it. But his income dropped far more than a quarter percent that year. In fact, he saved up for this year for a while before it started so that he could do everything he wanted to do during that year with his family. He basically took an advance on his retirement in order to do that in his early 50s. So Roth contributions, Roth conversions. And you mentioned tax gain harvesting. You know, if you got a really low income this year for some reason and you could, you know, harvest some of your gains, why not? You might as well, right? Use that zero top of that zero percent, you know, capital gains tax bracket. That's under $100,000 though. It's like 94 or 96,000. Even if you're married, filing jointly, you got to get your income way down. Taking a three month unpaid paternity leave is not going to get you there. The big problem I think people run into when they have a drop in their income of 25% is now they don't have the money to make the contributions they were going to make to their retirement accounts. Right. I think that's the bigger problem if people are only saving 20 or 25% of their income, yes, your tax bill is going to be lower this year, but it's going to be hard for you to max out retirement accounts that you were maxing out before. If you drop your income by 25% unless you drop your expenses dramatically. And in my experience, that doesn't happen when there's a new mouth to feed in the house. Anything else? I can't think of anything else to do in a lower earning year. Just those Roth contributions, Roth conversions and tax gain harvesting.

Yep. Yeah, those were the main three.

Awesome. Well, Alexis, thank you so much for your time being willing to come on the podcast as a friend of WCI and help us to answer these questions for people. Thanks also for your work at Cerebral Tax Advisors and we'll look forward to seeing you at an upcoming conference.

Thank you so much, Jim.

All right. I hope that was helpful to you. A lot of great topics. I mean, who that owns a practice hasn't thought about hiring their kid or a spouse, right? Lots of docs out there using nannies and other household employees and maybe wondering what the financial ramifications of doing that are. We also talked a little bit about money market funds and other cash options and what to do in a year in which your income is lower. Great topics. Hope you learned something today you didn't already know. If you already knew all this stuff, Congratulations to you. You're probably very financially literate and I bet that's paid some great dividends in your life. As I mentioned at the top of the podcast, SoFi is helping medical professionals like US bank borrow and invest to achieve financial wellness. Whether you're a resident or close to retirement, SOFI offers medical professionals exclusive rates and services to help you get your money right. Visit their dedicated page to see all that SoFi has to offer at whitecoatinvestor.com SoFi one more time, that's whitecoatinvestor.com sofi loans originated by SoFi Bank NA NMLS 696891 advisory services by SoFi Wealth LLC. The brokerage product is offered by SoFi Securities LLC member Finra SIPC investing comes with risk, including risk of loss. Additional terms and conditions may apply. Don't forget about Expert Witness Startup School, right? Enrollment is only open through the 27th. You can sign up whitecoatinvestor.com ExpertWitness and we'll throw in a free WCI online course if you do so. Thanks. For those of you leaving us a five star review and telling your friends about the podcast like it has been from the beginning of time with White Coat Investor, the main way we grow is just Main way we grow is you telling your friends about us. Whether those are your trainees, students, residents, or whether it's students telling their attendings about it. This is how we grow and it's important material we're passing out here that really does make for better doctors, better parents, better partners, et cetera. Another way you can help, though, is sharing 5 star reviews any place you can review podcasts we appreciate. The most recent one came in titled Empowering Physicians. The White Coat Investor podcast, hosted by Dr. Dali, stands out as a beacon of financial education for physicians, offering invaluable insights that has been as influential to my life as my actual medical education. With effortlessly delivered content and a lineup of knowledgeable guest speakers, the podcasts are not only informative, but remarkably easy to listen to and enjoyable on my commute. Since tuning in as a fellow in 2019, I've witnessed remarkable growth in our net worth, surpassing 2 million in less than five years, a feat I attribute to the wisdom gleaned from WCI. Despite having delved into Dr. Daly's books, blog posts, and earlier podcasts, the newly released material continues to provide fresh perspectives and actionable advice, making it an indispensable resource for physicians navigating the world of personal finance. Five stars. Wow. I'm not sure I could have written that better myself. Great review. Thanks for sharing that and I hope that helps others to find this information that has helped you to be so successful. We appreciate you out there. This is not easy work you're doing. Please keep your head up and shoulders back. You've got this. We're here to help. We'll see you next time on the White Coat Investor Podcast.

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A lot of employers, I mean, it's not France where you get like a year or something of paid leave, but it's. It's a lot different than it used to be. I mean, when I started my career, we didn't even think about asking about paternity leave, right? I mean, I took a shift off for one of my kids. I think that was about the extent of my paternity leave with four children. But it's a new world out there for sure, and it's probably a good thing. The thing that strikes me the most about this question question though is it's only three months less earnings, right? You're not dropping your income that much. Yes, it's a lower income year, but it's not a low enough income year to really make a huge difference. I wouldn't say. What do you think? How much lower does your income really have to be for you to score some sweet tax benefits out of that year? It doesn't happen when there's a new mouth to feed in the house. Anything else? I can't think of anything else to do in a lower earning year. Just those Roth contributions, Roth conversions and tax gain harvesting.

Yep. Yeah, those were the main three.

Awesome. Well, Alexis, thank you so much for your time being willing to come on the podcast as a friend of WCI and help us to answer these questions for people. Thanks also for your work at Cerebral Tax Advisors and we'll look forward to seeing you at an upcoming conference.

Thank you so much.

Jim all right. I hope that was helpful to you. A lot of great topics. I mean, who that owns a practice hasn't thought about hiring their kid or a spouse, Right? Lots of docs out there using nannies and other household employees and maybe wondering what the financial ramifications of doing that are. We also talked a little bit about money market funds and other cash options and what to do in a year in which your income is lower. Great topics. Hope you learned something today you didn't already know. If you already knew all this stuff. Congratulations to you. You're probably very financially literate and I bet that's paid some great dividends in your life. As I mentioned at the top of the podcast, SOFI is helping medical professionals like U.S. bank, borrow and invest to achieve financial wellness. Whether you're a resident or close to retirement, SOFI offers medical professionals exclusive rates and services to help you get your money. Right.

I had the same sentiments for him in this example. Definitely not a huge drop. I would want to see it at least get down maybe to the 12% to be considered a huge drop. Maybe going down to the 20 would be a nice drop. But, you know, if you are able to, you know, what I really recommend for him in his instance with such a shorter drop is, okay, well, let's look at strategies to help lower your. That, that, that percentage even further. You know, like all the normal tax strategies that you'd be doing, you know, like making sure you're maxing out your retirement and, you know, doing your tax loss, harvesting things like that. Like, you know, and so then that way, okay, great, now we have a little bit more to work with. And okay, now if you have that lower, you truly have a lower year, or like, let's say you're going to take a full year off or maybe you're going to have a big gap before going from, you know, residency into your attending job, you know, then, yeah, consider Roth conversions, you know, or maybe you want to accelerate some income into the current year, you know, if, you know you're going to have some other big deductions coming through. You could even look at, you know, trying to sell some of your securities that maybe have some big capital gains that you want to use and take advantage of trying to get into that 0% capital gains rate if you can get your taxable income low enough. But yeah, you know, what I would say for him is, you know, right now, like I say, would.