By Dr. Jim Dahle, WCI Founder
There was a thread with a poll on Sermo (a doctor-only forum) recently asking what percentage of your income you paid in taxes in 2011. The lowest option was <20%. I thought that was ridiculous (since I make about an average physician salary and paid about 8% in Federal, 3.5% in payroll tax, and 4% in state income taxes), so I spoke up about it. After a few days it became evident that either most doctors have no idea what they pay in taxes, or that they pay far too much in taxes. Out of 58 responses on the poll, I was the only one who was paying less than 20% in taxes. Keep in mind that more than half of doctors make less money than I do.
I found it hilarious that 4 doctors thought they paid more than 50% in taxes. I can't quite figure out how to pull that off, even if you are single, make a ton, take a standard deduction, are self-employed, and pay ridiculous state and local income taxes. Really? More than 50%? You're either mistaken or you're stupid. Hopefully mistaken.
I found it disturbing that 38 of the 58 were paying more than 30% in taxes. No wonder doctors can't get ahead. Where are the doctors who are living in tax-free states? How about the employees (who pay less in payroll taxes)? And what about the poor pediatricians making $100K? Why do none of these doctors have an effective tax rate less than 20%?
Or is the problem simply that doctors have no idea what their effective tax rate is?
Physician Salary After Taxes
Let's run a hypothetical situation. Let's take a single doctor Kaiser employee with no kids who lives in California, rents his apartment, and only saves $15K in his 401(k) each year. Let's say he makes $200K, which is about an average physician salary. What does he pay in taxes? Let's take a look.
- Adjusted Gross Income $185K
- Taxable income $175,500
- Tax due $42,812 (21.4% of his total income)
Now his payroll taxes. Last year it was 4.2% of the first $106,800 and 1.45% of all $200K, or $7386 (3.7% of his total income).
Now his state taxes. Forgive me as I've never paid taxes in California, I'm just picking on you because I know the state taxes are pretty high. I calculate out a tax due of $14,503, or 7.3% of his total income.
Grand total for what I consider an awfully unfavorable tax situation comes out to 32.4%. Could be a bit worse for a self-employed doc who didn't bother with a 401(k), or for someone making a lot more money. But under no circumstances is he ever getting above 50%. You just can't do it.
Now, let's consider a Texas employee pediatrician, married, father of 4, sole provider. He makes $100K and since he reads the White Coat Investor, maxes out his 401(k) at $16,500. He also owns a nice home and paid $20,000 in mortgage interest, property taxes, and contributions to charity. He paid another $3,000 in student loan interest.
His federal income tax looks like this:
- Adjusted Gross Income $80,500
- Taxable income $38,300
- Tax due $899 (<1% of gross income)
He pays another $5,650 in payroll taxes and no state taxes for a total of $6,549, or 6.5% of his gross income.
How to Lower Your Effective Tax Rate
What's the moral of the story? The government pays you for certain activities and not for others. You probably ought to know what they are if you prefer paying less taxes. You might not want to do all of them just to lower your taxes, but you should at least know the rules for how the game is played.
Here's the big rules (a how-to guide to lower your effective tax rate):
- Make less money
- Get married
- Have kids
- Be an employee (the employer pays for half your payroll taxes)
- Buy a huge house with a big fat mortgage and property taxes. Heck, buy two.
- Give money to charity
- Live in a state without state income tax
- Save money for retirement
- If self-employed, try to characterize every expense possible into a business expense