[Editor's Note: The following guest post was submitted by a regular reader and emergency medicine physician who would like to remain anonymous. We have no financial relationship.]
I clicked the “Continue” button in Turbotax and the numbers started turning. They went from green (refund) to gray and just kept going…and going. It finally settled on $8,000 in taxes owed to the IRS.
I went through the stages of grief in rapid succession, only settling on grief after a futile Google search to figure out how we could owe so much. I have been doing our taxes since the year we got married and we have never owed more than a few hundred dollars. Sometimes we got a refund. We certainly aren’t tax cheats and I thought we had our withholdings properly figured out for the year.
Warning: Don't Fall Into the Same Trap!
Fortunately, we have a large enough emergency fund to cover this unexpected expense but I am writing this as a warning to other physicians to not fall into the same trap that we did. The reason this happened is we now have a large difference in incomes. This is a not an uncommon situation for some physicians, especially if you and your spouse are in different years of training. Also, this post only applies when you and your spouse are both W-2 employees, not independent contractors.
Our Tax Problem
My wife and I moved in the summer of 2016. As of right now we don’t have any kids but we are expecting our first child soon. We have a two-year separation in training. Before we moved, I was working as an attending physician with the military while she was a chief resident in primary care. I made approximately $130K that year while she made approximately $115K. Her chief resident year was an attending position that paid close to what junior faculty at her institution were paid. So for the 2015 tax year and the first half of 2016, we had relatively similar incomes.
I left the military in the summer of 2016 and we moved so she could start a fellowship. This led to a significant raise for me to about $262K but her salary went down to about $60K. When we filed our 2016 taxes we received a refund of about $2K. Therefore, that difference in our income wasn’t a big deal in that first year since we moved in July and the difference in incomes was only present for 6 months.
Miscalculating W-4 Allowances
All was well until that fateful moment in January 2018 when I went to work on our taxes and gulped when I saw that $8K figure. I sat down with an accountant and it took him approximately 5 seconds to tell me that the problem was our large difference in income. We should have withheld a lot more since starting our new positions. We had both written on our W-4s that we were married and claimed 1 allowance each because this is what we had always done. I felt a little better when my accountant said that he has a few clients each year who fall into this trap.
Even though my wife and I work for the same employer, the payroll systems don’t talk with one another when it comes to being married to someone else inside (or outside) your organization. If we were not married, then our withholdings would be completely appropriate for our financial situation. However, with such large differences in income, the lower earner is not being taxed at a high enough rate. When their income is added on top of the higher earner, that income is in a much higher tax bracket with much higher taxes. To be clear, my wife’s income did not bump us up into a new tax bracket when added to mine. However, when my wife’s income was added to my income, her income is entirely taxed at a much higher rate.
Unfortunately, choosing the “married but filing separately” option does nothing to alleviate this. I “forced” TurboTax to do this and it resulted in an even higher tax bill. The reasons behind this are well beyond the scope of this post.
Married But Withholding at the Higher Single Rate
With the caveat that I am not a CPA (but as suggested by my CPA), the way to avoid this is to plan to withhold more money when you start your new job. The absolute safest thing to do would be to list you and your spouse as “married but withholding at the higher single rate” on the first day of your new job with different incomes. With the new tax law coming into effect in 2018, you don’t have to worry about claiming personal exemptions on your W-4 because these were eliminated. Withholding at the higher rate will sting when you get your paycheck but it’s better than having a surprise tax bill, especially if you are new attending.
IRA W-4 Withholding Calculator
The next safest method would be to use the IRS W-4 withholding calculator. You can use this calculator to figure out exactly how much you would owe in taxes and all it requires is a single paystub to do the calculations.
If you have a little more risk tolerance (and have an emergency fund capable of withstanding owing a few thousand dollars at the end of the tax year), you could consider waiting until your January paycheck to increase your withholdings. If you received a refund the year before, this is less risky as you probably have a cushion before you would owe taxes but I would be very cautious with that approach. I hate giving the government an interest-free loan just as much as the next person but do you really want to owe the government thousands of dollars at a single pop just as you are getting on your feet as an attending?
If you and your spouse have a large difference in income (ours was 430%), then make sure to withhold more money when you start your new job or at least with the new tax year. Hopefully, you can avoid the sting of shelling out so much money to Uncle Sam at tax time.
[Editor's Note: This post illustrates an important principle: The taxes you must pay by tax day, the taxes you must pay and have withheld throughout the year to avoid a tax penalty, and the amount you have withheld are three amounts that theoretically should be similar, but are often dramatically different. Some prefer to be as exact as possible in their estimates, while others prefer to take advantage of the safe harbor rules to in effect, borrow money from Uncle Sam for their own needs. Learn the rules and stay out of the penalty box!]
What do you think? Have you dramatically overwithheld or underwithheld? How did you deal with it? Comment below!