Dealing with Income Inequality – Optimizing Savings, Taxes and Deductions

The only time my husband out-earned me was during our first 3 years of marriage. This was when I was still in residency, working 80+ hour days (and earning less than minimum wage/hour). Since then,  we have made relocation moves that primarily help with my career growth, to the detriment of his. Here are some ideas on dealing with income taxes when there is a big income disparity among spouses.

In 2015, an NPR article quoted statistics showing that 38% of wives made more money than their husband. In most physician-women breadwinner household, that income disparity can be huge. In my case, I earn (depending on the year) 95-98% of our household salary – my husband have always worked part time to enable me to work full time. This has huge tax implications, as my husband’s part time 20,000 to 30,000 annual salary is now taxed at our higher combined tax rate of 39.6% (plus state income tax of 9.9%). We pay more in daycare and school fees than what he earns after taxes!

Should he Stop Working?

We actually looked into the numbers, and strictly, from a financial standpoint, the answer is a big YES. But just like there are so many other equations in a marriage and partnering: social, psychological – which I will address in other posts here. After taking a one year break from the workforce, we decided it was worth the financial penalty for my husband to return to work.

Optimizing Taxes and Deductions:

For the first 7 years since I started working as an attending physician, we continued doing what when we did when we had no income disparity: we both put up to 20% of our income into our 401K (I maximize my 401K contributions within the first few months of the year), paid more than 50% of my spouse’s income in taxes and went our merry way. It was not until I got more interested in finance and investing (after wasting almost 10 years and lots of $$$), that I realized there are much better ways to get around this.

Our first move was to maximize his 401K contributions to 18K/year. That meant for most of the year, his final paycheck was $0. It also meant that his salary alone minimally increase our household salary, and as such, our tax bill.

To ensure no surprises come Tax Day, I also elected to reduce my dependence limit on my W2 as 1/1 to ensure we don’t get saddle with a large tax bill.

We also maximized the gift tax exemption of 26000 per couple. This past year, we chose to support a local homeless shelter for teenage moms. In the future, depending on our future salary, I am considering a Donor Advised Fund to help off-set our tax bill. Obviously, once it goes into the fund, it will all be earmarked for donation. By opening this, it will allow us to get an immediate tax donation on our contribution, yet grant funding over time.

Depending on the snowball that life sometimes throw at us, it might be beneficial to consider filing taxes separately. While this has not applied to us, if your lower earning spouse incurs high medical or work-related expenses a particular year, it might be worthwhile filing your taxes separately. You can only take the deduction for such expenses if it amounts to > 2% of income, filing separately will lower this threshold.

Another way to lower taxes, if you qualify, is to maximize your Health Savings Account (HSA) deductions. You will qualify for this if you have a high deductible health insurance plan. This generally refers to health insurance with deductible of $1300 or greater.

Financial gurus refer to such accounts as “triple-tax advantaged” – no federal taxes on money contributed (effectively lowering your annual gross income), returns on investment are not taxed, funds roll over annually if not spent and at age 65, it can be withdrawn without penalty. Not all HSA accounts are created equal, so do your research before opening one: going automatically with what is offered at your workplace is not necessarily the best option. You can pick a different HSA provider and have your work send a check directly to them. This move will save you on payroll taxes. If you choose to deposit it directly with your after-tax monies, you will still get a deduction come tax time, but will be subjected to payroll taxes. If you intend to invest with these funds, be sure to pick a HSA company that allows investment in low cost (index) funds. In 2017, you can contribute up to 6650 per family, or 7650 if you (or your spouse) are above 55 years of age.

Another popular option is to open a Flexible Spending Account (FSA) if offered by your employer. Be aware though, that all monies not spent by the end of the tax year (Dec 31st) is lost, so do not put in more than you will spend. Besides healthcare expenses (including over the counter medications), some employers offer dependent-care FSA as well – which you can use to pay for childcare, preschool, summer camps.

Here is a new strategy I heard of recently that I have yet to explore: bunching itemized deductions every other year. This applies to IRS deductions that need to meet a minimum amount (%) of your income before you can take a deduction. Examples are medical expenses, charitable contributions, property taxes and state income taxes.

How will this work?

Basically, you will opt to take an itemized deduction on the year you pay for your property taxes (ie paying the current year and the following year’s property taxes at the same time), maximizing your charitable donations – a Donor Advised Fund will be particularly helpful, and maximize your medical expenses (going for an elective surgery or procedure).

On your ‘off’ year, you minimize your expenses and charitable donation and take a standard deduction (varies yearly, but it is 12700 for married filing jointly in 2017). While this will not help us much at our current income rates, it may be something worth exploring in the future for us.

There are also special tax-exempt bonds, put out by the Treasury Department called I-Bonds and EE-Bonds that may be beneficial under certain circumstances. I am still researching these options – depending on how the stock market is doing, the returns may not be worthwhile (even if tax-free).

Other methods will be to consider setting up a business and using it to deduct business expenses that way.

Another option that is kosher under IRS rules is to consider volunteering both locally and abroad. You are allowed to deduct your airfare, meals, and lodging expenses. As physicians, this may be a good way to do some good while seeing the world and getting a tax deduction as well. Such volunteer trips need to be with registered 503(c) organizations to qualify.

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