By Dr. James M. 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.
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
White coat. You know as well as I do most doctors and people do not grasp the difference and importance of effective and marginal tax rates. Since marginal is in everyday in a practical sense what people use to make most tax decisions, that is what they think about first and formost. There many circumstances one can have a marginal rate well over 50% over a large income range. My personal example is a spouse working in a job with an income of $40,000/ year for 48 weeks and 50ish hours a week. I am in amt phaseout range, in a highish income tax state. Thus all her income was taxed at 35% fed, 9% state, 6.4% soc sec, 1.45% medicare for a total marginal rate of 51.85%. I of course had her pump the max into her 403b, but that resulted in a tiny non retirement after tax hourly rate. The tax code incentivized her greatly to quit.
It staggers me that some doctors don’t know their tax rate and how to reduce it.
Another way to reduce , where I live, tax is through investment properties , negative gearing, then tax withholding variation.. Currently tax rate is 22% reduced from. 45.
Btw If your tax rate is 50% then for two and half days of the week your salary is going to the government! If you think of it that way, you will start looking at ways to reduce your tax rate ( legally)…….I recommend doing a tax variation form so that the lump sum you get at tend of financial year is given to you spread out through the year..so that you are not giving the taxman a year long interest free loan!
You are supposed to use the marginal tax rate and include the employer’s share of the the payroll tax when you talk about people working for a living. That how the media do it – Buffett’s secretary, etc.
i have no doubt that many physicians dont know their tax rate, but i imagine many were using rough estimates and “adding in” factors that likely shouldnt be considered. They probably use an estimate for what they paid in sales taxes that is likely a little more than reality. Some probably also considered employer paid taxes on behalf of employees, taxes they paid. Some may even consider state lic and other factors a tax. With all that said, i think many people get suckered into tax reduction schemes which actually arent in their best interest. When you feel like you are losing everything to the tax man, these ideas at first seem good until you finally realize that you still wind up with less money in your pocket. It is common for the insurance agent to prey on physicians using a “tax savings angle”.
Hey Dr. WC,
Do you think that you could ever make a post about the financial and familial implications of pursuing the HPSP? I have heard from others, but would love to hear your POV as well.
-A
Have you seen this?
https://www.whitecoatinvestor.com/personal-finance/should-i-join-the-military-to-pay-for-medical-school/
I have a series coming up on financial tips for military docs too.
In the series in the NYT about tax rates they also reported some extremely high levels. This was in part due to calculating as a percentage of TAXABLE rather than gross or adjusted gross income. Many people also included ALL the taxes they could identify. Not just the employer portion of payroll taxes, and sales taxes, but also real estate taxes, corporate taxes for those running their own companies… It did not seem that the very high rates were achieved by people with primarily wage income. Even without counting all these, I make an average physician income, and, just checked, my total federal, payroll, and state tax rate is approximately 24% of adjusted gross. I would love to see how you get your rates so low.
Dr. WCI,
Great article, I couldn’t ask any follow up questions on the article for some reason though. I am accepted to medical school, and I know I want to do EM. How did you go about obtaining a civilian residency? What is a career in EM like after residency in the service? Did they take into account your wife at all?
Sorry for blowing up the comments on this article, if you would prefer email correspondence, I understand.
-A
I’ll shoot you an email to answer your questions. Feel free to email anytime.
can a professional corporation (or proprietorship) claim as a business deduction the difference between the billed amount and the amount the insurance pays
doesnt the irs at least require that such full billing be customary and usual
insurance folks say bill whatever you want..we only pay what is contracted..
so the professional corp can deduct the difference as loss against income ??
sounds pretty sketchy to me
No, you can’t deduct that.
I really appreciate your website and insight, I’ve been spreading the word to other residents, most I know are so clueless it’s scary. I have a buisness background from before med school so I suppose take to it more than most of my peers. I have a question regarding taxes and ER docs who work at mulitple hospitals as independent contractors, or more broadly for any ER doc that has just one employee position. I’d love if you put up an entire post that discusses how and why setting up an LLC, S or C Corp to “pay” yourself from the company could be beneficial as it relates to paying back student loans and tax protection. Specifically the legal ramifications of appearing to only make say $50k a year that you pay yourself in dividends or salary from the corp when in fact the company you started is pulling in well over that. I get the whole keep the money in corporate account, buy everything you use with that money and claim a loss in the company to balance your gain in personal income. I guess my questions mostly concern the legality of this and is it financially beneficial? Seems complicated to get up and running properly. Can I fill out employment forms with the company name as whom paycheks or direct deposits are paid?
A bit of background on me, I’m a 2nd year ER resident who has been moonlighting like a madman and expect my first 6 digit yearly income in 2012. I have ~ $300,000 in student loans, all consolidated to the US Dept of Treasury and I am in Income based repayment. Up till this year I have had to pay $0.00 per month since my wife doesn’t work and we have a child without being put into the interest heavy “forebearance”. But with my jump in income I’ve had to think about alot of other things. I’m already stashing away an emergency fund, locking up disability insurance, buying a $1,000,000 term life policy, have my eye on the Utah 529 through Vanguard for college, and will plan to save 20% of my income towards retirement every year broadly invested in a portfolio of large index funds. But I wonder how important to my overall plan an LLC or similar corp with a big umbrella policy is? I’ve seen your post about starting an LLC but it doesn’t really touch upon the details. I’ve been searching for an impartial financial mentor and so far I really connect with your philosphy and approach via thewhitecoatinvestor. Feel free to contact me directly via email or by a reply to this post. Cheers!
Glad you’re enjoying the site. I’ve blogged about the benefits of incorporating to save some money on taxes. We’re talking about a professional corp, LLC, or other pass-through corporate entity. A C corp is generally a bad idea for docs, as you become subjected to double taxation. The tax benefits are pretty limited, but they do exist. Basically you save 2.9% in payroll taxes on the amount of your income that is considered “dividend” and not earned income. The tricky part is justifying the amount you are calling dividends. You almost surely can’t get away with calling everything over $50K dividend. But perhaps everything over the average wage for an employed physician in your specialty is reasonable. I could do a post on this, but there is little in the way of guidelines from the IRS. You basically pick a figure you can defend to the IRS, and then hope you don’t have to. But we’re talking about saving maybe $3K a year or so, less after incorporation expenses.
It’s no big deal having a professional corporation if you’re an independent contractor or a partner. But I don’t think you can do it as an employee. You need at least one moonlighting job.
You do need a big umbrella policy and probably more life insurance than $1 Million. You don’t need a corporation to do either of those things. Good luck in your career. You’re off to a great start.
How much of an umbrella policy do you recommend? I’ve heard of 4 million. I was considering Geico for that. Any recommendations.
Thanks for your great posts. I’ve been reading through all of them randomly!
I’d say $1-5 Million is the right range. Like term life insurance, it’s pretty cheap so err on the higher side. I’d start with looking into the company that does your property and auto insurance. Sometimes they’ll give you a good deal. You saw my post on umbrella insurance, right?
https://www.whitecoatinvestor.com/umbrella-insurance/
Well just finished up my 2011 return and…
MFJ total gross income of 430k includes 27k of Roth conversions split into two tax years
Total federal tax = 105k
Total state tax = 32k
Payroll taxes + casdi = 15k
Real estate taxes = 10k
Sales taxes = ? Maybe 3k
Total taxes = 175k
175/430k = 41%
Not sure it could have been any worse than that
50% seems impossible
It was the best of times it was the worst of times…
That’s brutal. Although you do have over twice the income of the average doc, and my article was primarily just referring to payroll, federal, and state income taxes.
Out of curiosity, why the Roth conversions at such a high bracket?
The payroll federal and state tax were 37% of total income so they were basically the whole thing. I included the real estate and sales taxes so that no tax was left out! Turned out much more than I expected.
I recently decided on a tax diversification strategy. I should have converted the IRAs at the end of residency – not doing so was a bigggg mistake, but that is a sunk loss.
If all goes as planned I will have a generous low six figure pension after age 60.
Likewise I have a pre tax employer contribution of about 20k per year. My wife puts away 16.5k pretax in her 401k too. So I decided to make my 401k a Roth AND convert all of our trad iras to roths.
I have no idea where taxes will be in 30 years. It is entirely possiblemthati should not have converted. Likewise it is entirely possible that rates will rise and my conversions were the right thing to do. By my math the bulk of my retirement savings will still be taxable at distribution but these conversions plus the Roth 401k give me at least a partial hedge against the possibility of higher future tax rates
Yes, it may be worthwhile paying a little more in taxes for some tax diversification later, especially given your relatively high expected income in retirement. I’m getting most of my tax diversification from Roth IRAs I did in residency and during my military time. Since those were my first contributions, they should have more time to grow. They’re still more than 50% of my portfolio.
Intriguing post. Thanks!
An article about AMT would be great. I got ensnared last year and see no hope in sight.
I’ll put it on the list!
Don’t forget to add in Real Estate taxes and sales tax.
After all, every dime you pay any government body is a dime less for you.
I’d say for young singles making under $250K, getting close to 50% is possible in some states.
You should also consider that the 50% of payroll tax that your employer pays indirectly comes out of the employee paycheck. So that should be added as well.
I was shocked to read that you, WCI, paid only 15.5% in federal, state, and payroll taxes. I live in a state without state income tax and I still pay almost 30% tax combined, with probably similar income as you, with similar job as you, after maxing to HSA and SEP-IRA. The math just doesn’t add up. Without state tax, you are saying, you pay 11.5% tax. How is that possible? If I am missing big on some tax deductions, could you let me know? I do my own taxes using Turbo Tax. I don’t have a personal blog like this but I claim full business deductions (e.g. fees paid for DEA renewal, license renewal, journals, CME fees, etc.) as well as HSA and SEP-IRA deductions. I am single but I feel that I can’t be paying 2.5 times the tax as you (taking out your state tax since I don’t pay state personal income tax) just out of single vs. married tax bracket/deduction differences. Please educate me!
4 questions-
1) Are you married?
2) How many kids?
3) How much did you give to charity last year?
4) How much did you make last year?
The difference between my taxes and yours are probably found there. I’ll be paying more this year as I had significantly higher income. It’ll be more yet for 2013. It isn’t that I claim some tiny business expense. It’s the big things that matter- Income, dependents, big deductions like mortgage interest, property taxes, and charitable contributions, and retirement contributions. Remember that our tax code can be very progressive at times, with just a little more income dramatically increasing the tax bill.
WCI –
I’m an EP, almost 2 years out from residency. I have a question regarding tax rates and moonlighting shifts, and how do you calculate the “increased” taxes?
Let me be more specific:
Some co-workers view any income earned from moonlighting as entirely taxed at their MARGINAL rate; e.g. 33%. That’s a big hit, and makes the extra shift less attractive.
Myself, I wonder if it better to view moonlighting income as taxed at the same EFFECTIVE tax rate that the rest of my year’s income is taxed at; e.g. 20% (don’t actually know that number for sure yet). This lower tax rate makes the extra shift accordingly more attractive.
So how do you view this issue? I read an interesting view from a Harvard econ that suggested that we’re nuts for taking moonlighting, but his analysis (http://www.nytimes.com/2010/10/10/business/economy/10view.html) smells off to me…
Great blog!
Unfortunately, I think your co-workers view is more accurate. When you add additional work, it’s taxed at whatever your marginal rate would be. Although it’s possible having that moonlighting income might allow you to use another retirement account which could dramatically lower that. In fact, if it were a solo 401K it’s possible you could defer all of your moonlighting income.
Quick reply on an old thread! I appreciate your thoughts.
By the way, thanks for the post about SEP-IRAs versus the solo 401K. While it doesn’t apply to me just yet, I was able to get my wife (a pulm/CC fellow) on-course with a SEP, based in large measure on your comparison. I’m learning the tax/retirement/investing stuff a little later in life than I would prefer, but your information has been helping!
You’re welcome. It’s easy to see all the new comments for me, so it really doesn’t matter where you put one on the site, it comes right up when I look for new comments.
I actually prefer Solo 401Ks over SEPs despite the additional complexity because of the ability to preserve the backdoor Roth. I’ll probably open one later this year for this blog income.