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
Two physician household, CA, no kids, no house. You know where this is going.
Taxable this year around $680K. Federal effective rate ~28%, state effective rate 9%, plus Medicare, SS, and city tax.
Total effective rate (depends on the denominator) between 40 and 45%.
So….3 times the average physician income…terrible tax situation….and you’re still not paying 50% of your income in taxes.
I’m in similar situation to Bonerphone. About same income 2 physicians in NYC suburb with same bad tax situation. But with 4 kids. I lived in anhattan for years and paid NYC tax as well which put me knocking on 50% taxes. Now closer to 45%. But my property tax is 5% of my gross income as well so between federal state mc ss and my town/village/county/school taxes I surpass 50%. Then my commute costs over $15 a day because NY city bridge and tunnel tolls are out of hand and then in NYC I pay for parking. Bottom line. If I did not live on the east or west coast I would keep far more of my money and not lose over 1/2 of it to income taxes/property taxes/commuting and parking costs into a major city. That all being said I’m not complaining as we do make a very high physician salary. Although I live in an area of wall street investors and corporate attorneys who make far more than me.
Seriously, I don’t understand why people in New York have access to physicians. That’s a serious Broadway (or whatever reason people stay) tax.
My husband just opened a new pediatric office as a solo practitioner. Our accountant just told us that the business is looking at a $60,000 tax responsibility. We had none our first year because the business was not profitable. Any ideas on how we can reduce that tax burden? We thought about purchasing equipment (exam tables, televisions, scales, etc.) because we are expanding our business but she said that would not reduce the tax burden because such items are depreciable. If there is any article or publication you could point us to discussing how can we reduce our tax burden? We would sure appreciate it!
Cindy-
Reducing taxes isn’t exactly the way you seem to think it is. There isn’t a magic way to reduce them that you just don’t know about. When you make money, you pay taxes. All this year you guys have been making money and apparently not paying taxes on it. That’s why you have a significant tax bill. Think of it as a good problem to have, and realize that when you own the business, nobody is going to do your withholding for you. You have to do it yourself and pay quarterly estimated payments. Luckily, since you didn’t owe anything last year, there won’t be a penalty for underwithholding, but you still will owe the taxes.
Also realize that most of the things that lower your taxes also lower how much money you get to spend. So if you’ve already spent all this money, there’s little you can now do to lower your taxes. Plus, many times it’s WORTH IT to pay more in taxes in order to have more money to spend. For example, giving money to charity lowers your taxes, but not by as much as you gave away. Your after-tax/after-charity income is lower. Same with retirement accounts, the very best tax break out there (because you still have the money). But your after-tax/after-retirement income is still lower. Same with any business expense you weren’t going to buy anyway. Sure, if you just pay all your employees $200K more, then you won’t owe any taxes. But your after-tax income will still be lower.
So I guess my recommendation is to max out any pre-tax retirement accounts (401(k), profit-sharing, HSA etc), buy any business expense stuff you are going to buy anyway before the end of the year, and then budget so you can pay the tax bill in full come April. Then make sure you’re paying the right amount of quarterly estimated taxes starting in April next year.
Saying “you’re stupid” in an article is tasteless no matter the intent and it distances readers who are not even in your “stupid” group, because it is just annoying to see in an article like this.
I’m going to assume you don’t read Mr. Money Mustache.
There’s a careful balance to be struck in engaging writing people enjoy reading and not tweaking off too many of them. The last thing I want is a blog that reads like a boring scientific journal.
As has been peripherally discussed (and I would maintain, under discussed!), the MARGINAL tax rate is the important concept, not absolute tax rates. After all, any changes that one makes occur in marginal income.
I am in the top federal tax bracket, in a moderate state income tax state, single, no dependents. Therefore my marginal tax rate is indeed on the order of 50%. Compounding this, I am effectively compensated in a fee for service productivity based manner. If I choose to take time off, I lose income. I must pay all my own benefits and malpractice (granted these are all tax deductible). However – and this is the critical point of my argument and the source of an intense sense of inequity – if I am “forced” to work by call or daily after hours add-on work obligations, it is marginal income and heavily taxed. I do not “voluntarily” do this work or have any choice to not do it. Quite often these patients are the sickest and the work is the most difficult, and given my payer demographics (40% Medicare and 30%[!] Medicaid/Uninsured) very poorly compensated. To then tax it at 50% to boot?! When I hear that physicians are “overcompensated” and the source of excess health care costs, I want to scream! Best I can tell, through below market pay coupled with clawback of half of it, I am heavily subsidizing the system.
A lot of doctors also do a lot of driving between offices and even to patient houses, and they can write off the vehicle mileage for that. It may seem like a pittance, but a lot of these doctors (especially in rural areas where offices can be far apart) easily put 20,000 miles on their cars each year. That’s about $11,000 deduction in mileage alone. But this is all a good thing because legitimate business expenses really should all be deductible.
So as a highly compensated and salaried executive’s wife, I would only take home 52% of my wages if I worked. 33% + 7% state +7% payroll (and .9% medicare surcharge). I only thought this happened in Europe! And it doesn’t include healthcare :(.
Ok, well, this pretty much only applies if your income is below a certain level, as in the two examples given. Also, it does not take into account things like car tags, sales tax, and property taxes. If your income after deductions is 165K to 329K you will pay at least 32% tax. The average state tax rate is about 5%, but for higher incomes this number increases: for instance, Minnesota tops out at 9.85%. Vermont is at 8.75 percent and d/n forget CA, which goes up to 13.3%. Add in sales tax, which averages about 5%(my state is at 7%) and now you are at 42% average. So if your taxable income is 300k in Minnesota you pay $96,000 to the fed, 29,550 to the state, and a 7% sales tax. Unless you are not going to the grocery store, and not paying electric bills, you will lose a bit more on sales tax. Then there are car tags, and don’t forget you don’t deduct mortgage taxes; just interest on the loan. Now you are darn near 50%. Did you renew your drivers license recently or purchase a hunting license? Did you travel on a toll road, or visit the highest point in New Hampshire? Which charges an outrageous 50 dollars to drive to the top. Hard to call these anything other than taxes from my standpoint.