By Dr. James M. Dahle, WCI Founder
It's become a bit of a tradition the last few years for me to do a post about our taxes. Like many of you, I do my own tax preparation. I do this not only to save money (I'll bet my tax returns would cost me between $2000-3000 if prepared professionally) but mostly to learn the tax code. Knowing the tax system is useful not only to know what I need to keep track of during the next year, but most importantly to teach me how to tweak my financial life to minimize Uncle Sam's take. I practice tax avoidance, but not tax evasion. I pay the federal and Utah state governments every penny I owe, but I refuse to leave a tip.
New Schedules
Without fail, every year it seems I need to learn a new schedule or two. This year was no different and in fact was a major pain in the rear. Since I gave away part of my business (see recent post) I had to learn how to do a partnership return (Form 1065). Previously, since I was the only member of the LLC, I just did the WCI return on a Schedule C. This year, instead of a Schedule C for WCI, we had two K-1s. Instead of just getting K-1s, I also had to give them. However, doing the WCI return this way did have the nice benefit of not having to input dozens of 1099s, so it was really a wash effort-wise. Since I hired my kids as models in 2015, I also had to issue W-2s and W-3s in addition to the 1099 to my business manager. None of that was really too bad. I could issue the 1099s, W-2s, and W-3s using Turbotax Home and Business. Unfortunately, I would have had to pay another $130 to get Turbotax business to do a very simple partnership return. I cheaped out and just did it by hand. It was no big deal.
What was a big deal this year, however, was dealing with the disposition of my rental property (for a huge loss). That was all new to me. To make matters worse, while in the midst of doing that I realized that Turbotax had carried forward a figure for the previous 3 years that basically said I was only renting out the property 2% of the time, limiting my depreciation deductions. So I had to go back and correct my 2012, 2013, and 2014 taxes, submitting 1040Xs for each year. I'll get a few hundred bucks back overall, but mostly it just straightened everything up so I could maximize my tax loss for 2015, which was my real goal.
I was also pleased to learn that I didn't have to file a 1040 for any of my new employees. The Social Security Administration did send me a letter asking me to clarify what job the two youngest ones were doing. Apparently they think it's weird to have a 6 year old employee but not an 8 year old employee.
Adding Up the Damage
As my financial life and thus my e-file returns have become more complicated, it makes it harder to compare my effective tax rates from one year to the next. I don't just take what Turbotax says my rate is. I subtract my legitimate business expenses, but not my losses to get my total income. Then I subtract my losses and deductions. As you all know, my income was significantly higher this year and we were expecting to be in the top bracket. However, thanks to savvy tax planning, we ended up with a taxable income well below the cut-off. Our taxable income was around 55% of our total income plus the above mentioned losses. (I see all you out there trying to calculate our income in your heads. It's not that hard. I publish what WCI makes and all you have to do is add that to a typical emergency physician partner income and that'll get you in the ballpark.)
2015 Effective Tax Rates
- Federal 14.8%
- Payroll 6.7%
- PPACA 0.6%
- State 3.2%
- Total 25.3%
That's not too bad, and much better than I had feared. I was worried we would hit an effective tax rate of 30% this year. Of course, the total taxes paid was about five times my salary as a resident, and about 38% more than we paid last year. I don't even want to think about adding property and sales tax to that total. By way of comparison our overall effective tax rate was 23.9% last year and 15.5% in 2011, the year I started WCI and my last year before making partner. I find it interesting that despite quadrupling our income over those four years, our effective tax rate has only increased by 9%.
[Update 4/15/2016: A few brief comments on how I calculate the effective tax rate. First, you should note that this is different from how Turbotax does it. Turbotax takes line 55 (federal income tax) and divides it by line 38 (adjusted gross income). Under that, I owe 22.8%. That's a dumb way to do it in my opinion. A much more sensible way is to use your total income (line 22) as the denominator and line 63 (total tax) as the numerator. And if you're in a state with an income tax, add your total state tax to the numerator. But even that can be adjusted. For example, I add back in my tax loss harvesting (-$3K on line 13) and my real estate loss (-$29K on line 14) to the total income. If you're an employee, you may wish to add your 401(k) contributions to your total income, since they don't show up on your 1040. You may also wish to add in the employer's half of your payroll taxes to the numerator and denominator. You're paying those, whether you see it or not. ]
The Marginal Tax Rate
Tax software is great for figuring out your marginal tax rate. All you do is add $100 to your earned income and see how much your tax bill goes up by. In my case, my federal tax + payroll tax due goes up by $36 and my state tax due goes up by $5. So my marginal tax rate is 41%. However, we stayed out of the top tax bracket this year. If I add $100K to my income to get us well into the top tax bracket, and then add another $100, my tax bill for that extra $100 is $46.
Estimated Tax Payments
In 2014, we paid a very minor penalty for underpaying our taxes throughout the year. In an effort to avoid that happening, we decided to just take last year's tax bill, divide it by four, and multiply it by 110% and pay that much each quarter. That guarantees we'll avoid penalties by keeping us in the safe harbor. However, by midway through the year, it became clear that WCI was doing very well and we were dramatically underpaying our taxes. That caused quite a bit of worry and difficulties with cash flow planning as I wasn't really sure how much we were going to owe. This year we're going to do things a little bit differently. We're still going to make quarterly payments of 110% of what we owed for 2015, but this year I'm paying 27% of whatever we make into a side account each month to cover the tax bills. Why 27%? I figure we'll make a little more this year and we won't have that rental property loss, so that's why it's more than the 25% we paid this year. Hopefully that'll eliminate the cash flow concerns we had this year.
How We Did It
I'm often asked how we can possibly keep our effective tax rate so low. It's really not that complicated. The truth is our effective tax rate is usually even lower than this post states. That's because a great deal of our income occurs in our retirement accounts, which we have been maxing out since residency. All that interest, all those dividends, and all those capital gains are not taxed. Even if our portfolio doubled in a single year, we wouldn't owe any significant amount of additional taxes due to using retirement accounts to invest. Ignoring that, there are seven keys to our relatively low tax bill.
#1 Learn the Tax Code
More than anything else, I know how taxes work. I read a few books about it, but mostly, it comes from the experience of just doing my own taxes for 20 years. There are minor changes each year, but it's basically the same code year to year and once you learn how it works, you can carry that knowledge with you the rest of your life and apply it to your advantage.
#2 Retirement Account Contributions
Retirement accounts can be a little bit complicated. But it became very obvious to me early in my career that learning how they work would be beneficial to my finances. I was later asked to write the IRA chapter for The Bogleheads Guide to Retirement Planning. So as I've gone through life, I've made decisions that caused me to have more and more retirement accounts available to me. Those decisions include using Backdoor Roth IRAs, using a high deductible health plan so we could use an HSA, going into a partnership where I had a 401(k)/profit-sharing plan and a defined benefit plan, starting a side business, and then this year, adding my spouse as an owner of that side business. Each of those decisions increased the availability of tax-protected accounts. For 2016, we expect to be able to contribute the following amounts to retirement accounts:
- His Backdoor Roth IRA $5,500
- Her Backdoor Roth IRA $5,500
- Partnership 401(k)/Profit-Sharing Plan $53,000
- Partnership Defined Benefit/Cash Balance Plan $30,000
- His WCI Individual 401(k) $53,000
- Her WCI Individual 401(k) $53,000
- Health Savings Account $6,750
- Total: $206,750
- Total Deductible: $195,750
Want to pay less in taxes? Figure out a way to avoid paying taxes on $195,750 of your income. Retirement accounts are truly the best tax deduction out there. Not only do you get the tax break, but you still have the money! While it is true that we will eventually have to pay taxes on that money before spending it, chances are very good we will be able to access it at an average rate far lower than our current 46% marginal tax rate.
As discussed in a previous post, we did dramatically increase how much we're paying in SS taxes this year, but the overall effect of adding another individual 401(k) was to lower our current tax bill, even with the added SS taxes.
#3 Saving for College
In addition to retirement, we also save for college in 529 accounts. From a federal tax perspective, that money is after-tax, but if spent on education the gains will never be taxed. From a state tax perspective, all that money is triple-tax-free, like my HSA. We now have 23 529s. There is one for each of my four children, and so far, 19 for nieces and nephews. We have more nieces and nephews than that, but if their parents won't give us their SS numbers, there isn't a lot more we can do. But Utah gives me a 5% state tax credit on up to $4K a year contributed to every one of those accounts. It's not a huge deduction, but it does help. There are lots of ways to give money to family members you care about, but not a lot of ways to deduct that gift. This is one of them.
#4 Charitable Contributions
I'm told by tax preparers that most people give away less than 1% of their income. We give away a lot more than that. As long as the recipients are registered charities, we basically give money on a pre-tax basis. Granted, some of that deduction was phased out thanks to Donald Pease, but it's still a huge deduction for us.
#5 Health Insurance
Not only do we get to deduct $6,750 for HSA contributions, but since we're self-employed, we also get to deduct the premiums paid. Our premiums are about $1,000 a month, so that's a significant deduction, especially at our 46% marginal tax rate.
#6 Paying Taxes
Another huge deduction for us is our taxes. These are deducted on Schedule A, and so get hit by the gradual Pease phaseouts, but they're still significant. We paid about $25,000 in property and state income taxes. In addition, half of our self-employment taxes were deductible (and that deduction is above the line, so not subject to Pease phaseouts).
#7 Losses
As regular readers know, we took a bath when selling our accidental rental property. That gave us about a $50K deduction this year between expenses required to sell and the difference between the purchase price and sale price. We were also able to deduct $3K against our regular income thanks to tax-loss harvesting. Those are huge deductions. Nobody likes losing money, but at least Uncle Sam shares the pain. We did have a few thousand in investment income, but it was almost all at qualified dividend and long-term capital gains rates, which were also erased thanks to my early winter frenzy of tax-loss harvesting.

Not only did this kid cost us $5K, but we get no tax deduction for her AND she keeps trying to destroy this business's most expensive asset using drool and direct trauma
A Few Things That Didn't Help
That were also a few things that many people think are deductions that don't really help us much. For example, we have four kids. They're worthless when it comes to taxes. All of our exemptions were phased out, our child tax credits are phased out, and we don't qualify for any childcare deductions. We paid thousands in out of pocket health care expenses, but those are subject to a 10% floor, and 10% of our income is a lot, so we don't get anything there (other than a future tax-free withdrawal from the HSA).
We also paid quite a bit in tax payment fees since I started making my estimated quarterlies by credit card. But that's subject to the 2% floor, so again, no deduction there (although we did get some rather large credit card rewards). Lots of people think having a big huge house is a great tax deduction. But despite this huge mansion we live in, we only paid $8,357 in interest. Part of that is our 2.75% 15-year fixed mortgage with less than a 50% LTV ratio, but still, that pales in comparison to our big deductions. If mortgage interest and property taxes were our only Schedule A deduction, it wouldn't even be worth itemizing.
Overall, I'm pleased with how low we were able to keep our tax bill. There are very few people at our earning level paying such a low percentage. We're using the savings to spend, invest, and give in ways that make us a lot happier than paying taxes.
What do you think? What was your effective tax rate this year? What are you doing to lower it? Comment below!

Still don’t understand this:
•His WCI Individual 401(k) $53,000
•Her WCI Individual 401(k) $53,000
All employEE contributions are 18k across the board for all jobs. EmployER contributions are essentially profit sharing based on based on 20% x (net business income – 1/2SE tax). So since you made your wife partner, she now can do employEE plus employER (assuming she does not have another job where she contributes 401K employee contributions). You only for employER aka profit sharing of 53K as you are tapped out of your employEE contributions with the ER gig. Am I understanding it correctly?
Do you have now have two different solo 401K setup for each of you?
Same solo 401(k), two $53K limits. Not sure what the difficulty understanding what’s going on is. I make enough with both my partnership and WCI to max out a $53K limit with both without an employee contribution at all. But yes, I can only do one employee contribution between the two of them.
So what I’m hearing is you need a different job that will give you a third 401k/403(b) for that employee contribution 😉
I definitely don’t need a third job!
I have never been able to figure out a way to structure our 8 partner s corp anesthesia practice to convinved my partners to max out our employer contributions of our safe harbor 401k. I of course do my employee contributions, and everyone gets the 3% safe harbor employer contribution. However we have 7 other non partner employees that trend older than the partners. Nondiscrimination rules always mean large contributions would be necessary to our crnas, anesthesia tech, practice managers, ect…
Can Anyone think of any way to make my situation work to max out our employer contributions? I managed to get us switched to employee fiduciary years ago, but my numbers seem to never make sense for the 53k, im stuck with around 18k+ 3% salary
That’s a common problem for many docs, especially dentists. You can either lower the pay (preferably gradually) of your employees (such that it is revenue neutral for you to give them the money for retirement instead of salary), you can hire part-timers or independent contractors that you can exclude from the plan, or you can save in taxable. Of course, be sure to max out any backdoor Roth IRAs and HSAs available to you.
Change corp structure to C corp and then you can discriminate
Discriminate in a 401k plan?
Yes in C-corp you can. I get 53K while our employees get 4 or 5% match
Being a C-corp does not mean you can discriminate. It means your plan passed the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. You have to re-test every year, same as any business.
You are right, I am just not savvy enough to write that way. But as a C-corp we passed those tests and hence can contribute more towards partners 401K, while keeping employees to a match
Exactly. My point was that the C corp (which I believe is outdated for most professional practices today) has nothing to do with it.
Have you had a good independent TPA look at your census and see if there’s a cross-tested platform that would make sense? My accountants have been very impressed with the plan she did for my solo practice (and I came to this person via the WCI website, so you know she’s good)!
Just completed my taxes. My marginal federal tax rate for 2015 was 40%. My average federal tax rate for 2015 was 33% The big numbers hurt but on the other hand I’m paying more in tax than I had ever dreamed of making in a single year. This is a great country!
Painful, but definitely a first world problem! It hurts a lot less once you’re out of debt.
Not sure I understand the reason for paying 27 percent of 110 percent of your taxes four times. That’s a total of about 119% of what you paid last year. You only need to pay 100% to be protected by the safe harbor?
Now if you expect your total taxes to go up 19% in 2016, I see where you’re coming from. But wouldn’t you come out ahead by paying 25% of 100% four times, and just storing that extra 19% in a high-yield money market account until you may need it next April?
First, you need 110% of what you paid last year to be in the safe harbor. So I am taking 110% of what I paid last year, dividing it by four, and paying it to the IRS every quarter.
Second, I am putting 27% of everything I make into savings in order to cover both the quarterly estimated payments and the tax bill next April.
Third, I expect to make more money in 2016 than I made in 2015.
But you have the right idea-pay enough to be in the safe harbor and have enough on the side to pay the bill in April.
Love the site. Just gave my first presentation to fellows about financial planning and your site was on Slide #2. Whole life pitch during residency is the same reason I decided to manage things myself.
Just curious, years back your approach to 529 plans was to take larger risk. Now that you can put more into the funds what’s your current approach?
Same. 100% stocks. 50% TISM, 25% VG SV, 25% DFA SV
I would highly suggest getting an accountant to do your taxes. In my experience you severely overestimate the costs associated with it. I’m a physician with a spouse that is a CRNA. Between our pair of W2s and my 3 separate K1s and schedules that I get from various other streams of income we end up with a near 100 page federal tax return each year.
CPA charges $400 per year total.
For your income level, having an accountant do your taxes decreases your likelihood of an audit and increases your chances of defending yourself in an audit. For such a small cost it’s worth it IMHO. Don’t save pennies by doing it yourself and end up costing yourself dollars down the road.
I just got an estimate for my taxes. It was $1500. Still, might be worth it. But that assumes I would still learn and implement the tax code just as well.
Perhaps a second opinion would be worthwhile – I recently provided my last 3 years of taxes (done by a tax CPA highly regarded by my accountant) to a different firm (that provided additional services I was considering) – they actually found an oversight of a small business credit that had not been correctly applied in 2014. I checked back with original CPA, and he filed the amended return (no charge) which resulted in a $2300 refund check I just received. Moral of the story: even professionals make mistakes! I agree with Steve and think you should double-check yourself – any firm would be highly motivated to find something and win your business, and if they don’t then the $1500 confirms your tax skills!
Thanks for an awesome blog! Rich
The moral is not that “even” professionals make mistakes but that “every” professional makes mistakes. We don’t walk on water, but some firms stay closer to the surface than others. I would want to know if the mistake was ingrained due to the culture of the firm (pushing for quick turnarounds, lack of review, inconsistency because different preparers handle your work every year) or a one-off (rush because you turned your information in right at the deadline, your normal preparer was on maternity/paternity leave, software glitch). Unless you are well-versed in the tax code and the various interpretations of sections that apply to your situation, it is unlikely that you (or anybody) will ever find out mistakes on your return without a notice from the IRS. Probably the same in your profession – do your patients learn about every mistake that you or someone else in your practice makes? Doubtful and, in some ways, it’s a good thing because most mistakes are probably irrelevant to the big picture. You just don’t know what you don’t know.
Bottom line is you did the right thing (albeit unwittingly) by getting a 2nd opinion. Does that mean you need to change firms? Not necessarily but I believe some more investigation is in order. The problem is that most clients don’t like to ask uncomfortable questions, but nobody will care more about your money than YOU will.
Certainly I agree that everyone makes mistakes, myself included – my comment was really meant to push WCI a bit in the 2nd opinion direction, as however competent he is in this arena, he is not “even” a tax professional…
In my case although I had been with the same tax CPA for about 5 years, I was looking for more proactive tax advice and better communication in the process of expanding my practice. I did end up switching for these other, customer service related reasons – the $2300 was icing on the cake and evidence of the new firm’s tax competency (and also offsets their higher cost…).
Would you recommend a routine 2nd opinion every few years?
I did get one this year. There will be a post discussing it in a few months.
Yes, I do believe it is a good idea for the client to get a second opinion at least every 5 years, maybe more frequently. Some CPAs may be a bit hostile when they find out, which I think might be a point in favor of seriously considering a move. Any professional who does not want to be questioned has some troubling ego issues, imo.
I can speak from personal experience. One of our clients got a second opinion a couple of months ago and scheduled a meeting to discuss it with us. The reason they did so was that they weren’t getting the quarterly tax planning phone calls they had from another CPA who had left to go into private industry. The 2nd CPA did not find any mistakes but gave them a presentation about what they would do for them. The client brought the presentation in to show us (it was a canned software program report, but looked really good) and then (finally!) explained everything. They told us they really did not want to change and they are now happy clients. Because I was able to have the new CPA in on the meeting, it was a great learning experience for her and allowed us to identify a weakness in our system. I thanked them profusely for taking the time to discuss it with us.
Yes, the first emotion about a meeting like that is to be hurt (maybe a woman thing?) but once that is past, you realize it is good to be questioned and can be a great opportunity to improve your firm. That said, if we have a client who is constantly questioning our judgment, cost, and service, we will suggest that perhaps we’re just not a good fit and perhaps we can recommend another firm for them.
Interesting that the idea of a second opinion would hurt. My competency is questioned at least once a day, maybe because almost all of my patients are brand new to me so there is no long term relationship there. Doesn’t bother me a bit if they want to go down the street to the next ER, and many drug seekers do!
Great article. Question: I don’t understand the difference between the partnership 401 (k)/profit sharing plan and WCI 401(k) contributions, 53k for both?? How does that work?
This post may help:
https://www.whitecoatinvestor.com/multiple-401k-rules/