Well, another tax year come and gone. Thankfully lots of first world problems for us this year. In some ways, a higher income eliminates a lot of the complexity in our taxes. We qualify for almost no credits, get no exemptions, and are phased out of many deductions. We don't have to deal with the AMT either. The downside? Well, we PAID more in tax than we MADE in any year prior to 2013, my first year as a full-partner in my practice. Seriously, it was a lot of tax. Basically, everything I made in my practice went to the taxman. In April alone I wrote tax checks for more than a year's worth of our spending. Very painful, but I now take special pride when I see pictures of aircraft carriers knowing who is paying for them.
Every year it seems I get to learn a new schedule. I thought this year was going to be the first year I didn't have to do that, but no, I ended up having to do a 5500-EZ. This is the form you file when your individual 401(k) has >$250K in it at the end of the year. It's just an informational return, like the partnership return we did for WCI and the 1099s, W-2s, and W-3s we do. It's only two pages and Vanguard sent me everything on one page that I needed to fill it out. No big deal, but be sure you do it as there is a penalty associated with it. Since that was the only new thing I had to do, and since I did it back in January along with the W-2s, W-3s, and 1099s, I put off my taxes until the week before April 15th. Over two days I spent around 7 hours total doing them using Turbotax. That's really good for me, not only the total time but the short amount of time between start and finish. Next year we'll be substituting a corporate return for a partnership return, but hopefully it won't be much worse. It's the same number of pages anyway.
Our Tax Rates
Our marginal tax rate this year was 45.8%. (If you're not sure how to calculate that, add $1000 to your earned income with your tax software and see how much your taxes go up. Mine went up $458, so my marginal rate is 45.8%.)
Our effective tax rate ended up being:
- Federal Income: 21.7%
- Payroll (including PPACA) Taxes: 6.1%
- State: 3.8%
- Total: 31.6%
I mostly just use the total income on my tax form (line 22) for that but I cheat a little in that I add back in what I pay my kids and the losses I got for tax loss harvesting into the denominator since I feel those are just smart tax planning decisions. It doesn't change things much since neither amount is very large in relation to my income or my tax bill.
Looking Back
How does that compare to other years?
As you can see, as our income has risen dramatically, so have our effective tax rates. There will never be another tonight and there will probably never be another 2007 (when we paid less than 5% as a total effective tax rate thanks to a deployment to the Middle East.) But you know what? Even Americans who make a lot more than doctors still don't pay 50% of their income in taxes unless you start including stuff like property and sales tax.
The increase in rates over that six year period is impressive, but the increase in total tax burden is even more impressive. To make things easier for this chart, I didn't go back and dig through all my paystubs to sort out how much I paid in payroll taxes as an employee, I just took the numbers off my tax forms, so for 2012 and earlier it slightly understates my tax burden.
This goes all the way back to the year I left residency. When I speak to residents, I often tell them “I know you think you pay taxes, but you don't actually pay taxes.” This chart demonstrates what I mean. Most attendings are going to find themselves paying more in tax than they made as a resident. But even an attending, I managed to keep my taxes very low for a long time, which certainly contributed to us becoming millionaires 7 years out of residency. Note also the benefit of being in a flat tax state instead of a progressive tax state. It's not quite as good as being in an income-tax-free state, but imagine if the slope of my federal line looked like my state line.
I thought it might be interesting to graph the percentage change of total tax burden from the prior year as well. Here's what that looks like:
I wish I could get an investment that performs like that. Sure, the first year is kind of rough, but it's all gravy after that. I'm apparently one of Uncle Sam's best investments! Increases in your tax burden like these do make tax planning and projections pretty hard. If you have similar income fluctuations, be sure you have the safe harbor rules down cold. Despite my final Turbotax screen looking like this:
I didn't owe any penalties or interest on my taxes.
Lessons Learned
That's all fun and stuff, but let's get into something useful. Despite my tax burden changing in the last year, my tax situation didn't change much. There were few revelations for me this year, but it's worthwhile to emphasize a few things.
# 1 Some Deductions Matter More Than Others
Your biggest deduction is probably your tax-deferred retirement accounts. That was a $189,000 deduction for us this year. Tack on $6,750 for an HSA and $12,062 in insurance premiums paid and that's the lion's share of our deductions. So all that ticky-tacky stuff that you keep track of to try to lower your tax burden–that's just icing on the cake.
# 2 Beware the PEP and Pease Phaseouts
Remember that $4K “personal exemption” you get for everyone in your family? Well, in 2016 that started going away at an income of $259K (single) and was completely gone by an income of $433K (married.) My kids certainly DO NOT give me a tax break.
Donald Pease also hates me. Thankfully the Pease phaseout (reduces your itemized deductions) is very gradual, but I still lost another $15K worth of my itemized deductions (mostly charity) to it. Itemized deductions start phasing out at the same place as the exemptions- $259K single and $311K married. This is one reason why an above the line deduction is more valuable than a below the line (itemized) deduction.
# 3 Consider Foreign Stocks In Taxable
I did get one credit this year- the foreign tax credit. It was worth $205. But since credits are even more valuable than deductions, and since there is no income limitation on the foreign tax credit, this is one reason to consider putting your broadly diversified international index funds preferentially into your taxable account (assuming you have to put something there.) There is a lot more to tax location than the foreign tax credit (and even tax-efficiency for that matter), but it is one consideration. Of course, international mutual funds generally have a higher yield than domestic ones, which may eliminate that benefit. (Total International Stock Index Fund had a yield of 2.75% compared to 1.88% for the all-US Total Stock Market Index Fund.)
# 4 Don't Invest With Companies That Don't Download to Turbotax
It is amazing how much faster you can prepare your taxes when you download your tax forms directly from your bank or investing company to Turbotax. Vanguard does this. So does Lending Club. But Prosper does not. As you'll recall, I've been liquidating my peer to peer loan investments. My form 8949 (Sales of Capital Assets) ran 8 pages this year. It would have been extremely painful to type every Lending Club note I sold in by hand. Thankfully my Prosper account was always very tiny.
# 5 Real Estate Can Be Very Tax-Efficient Or Very Tax-Inefficient
I am amazed at the tax efficiency of my various real estate investments. For example, my debt investments are taxed at, well, 45.8% every year. That property where my partnership manages our business that is giving me such great returns? I actually got a small taxable loss from them even though we sold one building and bought another this year! 1031 exchanges are great!
# 6 State Taxes Can Be Really Easy
No kidding, I spent less than 2 minutes on my state taxes this year. That alone is worth the price of Turbotax. The only thing I have to enter on my state taxes in addition to what it pulls from my federal taxes is my 529 contribution credit.
# 7 Form 8606 Is No Big Deal
Every year between January and April I get literally hundreds of questions about how to do form 8606. The Backdoor Roth IRA Tutorial has over 1000 comments on it. But it's really the same two or three questions over and over again. Want a very, very simple 8606? Do your contribution and conversion one day apart during the regular calendar year. Then every line is either $5,500 or $0. Just double check and make sure line 15 is zero and then you know you did it right.
Well, that's enough about taxes. I'm going climbing. Way more fun and less risk of an audit.
What do you think? What did you learn from doing (or reviewing) your taxes this year? What was your marginal and effective rate? How long did it take you to do your taxes if you did them yourself? How long did you spend on tax-related stuff if you paid someone else to do them? What did you pay? Comment below!
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189k in deductions ? You state your tax deferred retirement accts are your biggest deduction – but how did you get to 189k ?- the max on a sep-ira is 54k – even if you did that for you and your wife and did a hsa – your still short
Many thanks for explaining
I envy the day you’re about to have!
https://www.whitecoatinvestor.com/multiple-401k-rules/
Partnership 401(k): $54K
Partnership DB/CBP: $30K
His WCI i401(k): $54K
Her WCI i401(k): $54K
= $192K this year. Plus HSA and backdoor Roth IRAs and 529s and taxable account and pay off mortgage and if Dr. Gertner gets his way, maybe even another DBP. But probably not this year.
First of all, I just want to thank Dr. Dahle. I am an Emergency Physician and my brother-in-law, who is also an EP forced me to read the White Coat Investor two years ago which changed my life. My question is whether you know anyone who has set up a defined benefit for themselves as a sole proprietor, and if so, whether or not it’s worth it. I am an independent contractor and so is my wife (Family Medicine). We each have a i401k that we max out and we contribute the max to HSA. We still have mortgage @ 2.7% fixed, student loans (max 3.63% variable, most are lower and fixed) and a business loan @5.0% fixed.
Yes.
Whether or not it’s worth it is a value judgement. The fees on a personal defined benefit plan aren’t too high, so if you put a lot in it it’s probably worth it.
But I probably wouldn’t start one in your debt situation. I’d pay all that off first.
I am an ED doc with a DBP I started this year. My fees are $1500 per year and well worth the extra $90K I can save tax deferred each year for the next 5 years. How much you put away is based on your W2 income as well as your age and expected date of retirement. That is the point of the actuary and the fees.
I keep my bonds in my DBP since they are relatively stable with less than 5% expected growth allowing me to contribute a little extra year
Can you please explain how you go about extending a i401K to “her” to the tune of 54K tax deferred? I’m assuming you list your wife as an employee. Do you have other employees and do you have to extend them the same option? Could you potentially do this for all of your kids? What precludes you from adding “her” to your EM practice as an employee and doing the same thing?
My wife actually does real work that generates real money for WCI. And she owns half of it. Pretty easy to justify an i401(k) for her in those circumstances.
But she doesn’t do any work for my EM practice, so I’m not going to make something up and tell the IRS she’s doing work that she isn’t.
My kids were on the WCI payroll the last couple of years as models. But I can’t pay them enough to justify adding them to a 401(k). I can’t even justify paying them enough to max out a Roth IRA. WCI has no other employees. It contracts with some other companies, but it has no other employees.
Hey,
That brings up a good point. I was also thinking about how you and your spouse get those I401Ks which have ~18K in employee distribution.
I really like this idea of multiple 401Ks (thank you for pointing that out!!!)…..but you potentially can take all the money out of your LLC (It looks like you are switching from LLC to a C corp this year but neveretheless) in forms of distributions. Having to do payroll for both of you I believe is a bit more expensive — the self-employment tax etc….
It may be worth to do payroll for asset protection however — in some states wage garnishment is not allowed…etc
So two options: 1. have payroll and have some extra taxes that you pay and then you can do SEP (although given you are doing backdoor roth, that may not be ideal) and solo 401K maximized to $50+K 2. get distributions directly and may be max out the employer portion of the solo 401k.
Given your (and mine) high marginal tax rate, I am trying to understand if doing payroll unless absolutely necessary still puts you ahead or not.
I’m a little hazy on all this — I have a LLC with my wife and I as 50% owners that potentially could be used to establish another 401K — it is used for investments now — so trying to figure out whether I should institute payroll — so that i can gain 108K in tax advantageous space or if the tax hit is not worth it.
Hope that makes sense.
Yes, you’re weighing the extra payroll tax against the value of an additional tax-protected and asset protected account. I discussed this point in detail in this post:
https://www.whitecoatinvestor.com/why-i-gave-my-business-away/
Just to play devil’s advocate, imagine adding 87k for his CBP, and 87k for her CBP. That gets me to 366k. (192+87+87). Looked at another way, 87*2=174k. Tax on 174k comes to $77,604 at the 44.6 percent level (39.6 federal, and 5 percent Utah). Is it worth it to defer $77,640? That represents lots of family trips to Italy. Finally, it is of course all horse play at this point. You have already won the game, and there is nothing wrong with paying tax to support society. It is just the competitor in me supports the WCI versus the IRS concept. Don’t you want to beat the 31.6 percent number? I know at least part of you does, right? Ironically, it might be more than 174k. If markets go down, your company can put in even more money at the low stock prices, and thus lower your distribution profit (and your effective tax rate). The actuary requires a higher contribution if you do not meet the interest credit rate target. Conversely, if markets are high, you don’t have to max out the CBP to achieve your interest credit rate because the markets have worked for you. This is an added zinger that makes it even more favorable.
I’m still waiting for someone to answer my question about having multiple cash balance plans. Not sure how they’d integrate.
I have the answer. I checked with an actuary that has been in business for 28 years. I will email his name and firm. Yes, you can do it. He cited the essentially the 80 percent rule and the affiliated service group part of the tax code. The sections are 414(m) and 414(b). The profit share on the individual 401k gets adjusted, but the bottom line is that you can put away another 140k (70k for you, and 70k for your wife) into a cash balance plan. As you likely know, you can put the money in a low cost index fund from Vanguard and manage it yourself. Adjusting the 87k number above down to 70k, I come up with an additional 140k that you can tax defer. Multiplied by 44.6 percent I come up with $62,440 that won’t go to the tax collector but will go in your low cost Vanguard Index Funds. The gentleman I spoke with charges 2k in annual fees, and only 1800 dollars in legal fees to set it up.
That takes care of that.
But I still have the 3 year minimum issue. I guess I have at least 6 months to decide and probably 11 before I have to fund it though.
Admittedly, the three year rule is somewhat troublesome, because the WCI structure is rapidly changing. However, the rule is not hard and fast. It is a guideline. I think you would be ok in most circumstances, but 3 years is the rough guideline. The paper work has to be done by December 31st, and most firms give you a drop dead date of around December 15th to decide. You would have to fund it by the due date of your tax return. However, I would argue that it should be funded as early as possible to take advantage of the time value of money. Or, in the words of PoF, “front loading” the account.
That assumes I don’t have something better to do with the money. A defined benefit/cash value plan is pretty low on my totem pole of accounts. I fund my Roth IRAs and HSAs on Jan 2nd. I fund my DBP on March 30th of the next year! I’d try to do the same with this one. You can’t front load everything unless you are moving money from taxable into tax protected accounts and then buying more investments in taxable again each year.
189k is very doable even without WCI’s business advantages.
We’re at 200k
54k my 401k/PSP, 40k spouse 401k with match, 18k 457b, 11k backdoor Roth, 75k cash balance plan, 2k in additional moonlighting deferral under my personal cap as I don’t use the full 18k with my PSP matching formula.
I could push this even higher with cash balance plan up to 150k or solo 401k from 1099 income if I chose to.
Impressive!
Strong work, WCI. It is the perfect segway for your fan club to promote the concept of establishing a cash balance plan for the WCI? Could you imagine a post entitled “Beating the $141,000 limit?” According to this website ( https://www.cashbalancedesign.com/resources/contribution-limits/ ) , that is how much a 41 year old can put away from one business tax deferred. The layer of complexity should not bother you, and I know you will love the competition with the IRS. The main question for the WCI community (Kon, Fox Wealth MGMT, ERISA) would be do the same rules for beating the 53k limit (80 percent rule, 50 percent vote, etc…) apply to a CBP? Since a CBP is a type of defined benefit plan, according to this post ( https://www.whitecoatinvestor.com/multiple-401k-rules/ )things are done per employer, so you should be ok beating the 141k limit, right? Or, is there a regulation that precludes the WCI from establishing a CBP? Other than the view point of complexity (you have done a lot more complex things) and having more money in a taxable account (that will take care of itself after your earnings from this year), what is the argument not to do this? Let’s go for round two, a re-match in 2017: WCI versus the IRS
My tax experience went much the same: highest tax bill ever, paid almost my first year in practice salary in total taxes with state, federal, local, SS, Medicare, and most money put away for retirement, ever.
W2 income: $262,500 Full time psychiatry job
1099 income $156,000 working 20 weekends and 3 holidays
Total federal tax: ~ $80,000
SEP IRA: $28,000
401K: $24000 (I am 53).
Pension at W2 job: $13,500 (5% off the top)
College savings 529: $5000
I have reached a point that the marginal rate is so high that I turn down extra work now. We are downsizing to a cabin in the mountains, selling the McMansion, and I look forward to making less…
My financial literacy goal for the next year is to read a tax book or two and do my taxes by hand next year. Shouldn’t be too complicated while still in residency as you point out, but hopefully will prepare me for the future. As always thank you so much for the valuable information and for sharing your experience!
I use a CPA. Costs me $600.
Turbotax was $99 plus 8 hours of my time…
I have seen my income jump in recent years, but went from 15.2% in 2014 to 17% in 2015 and most recently to 19.7% using my AGI. It seems like the taxman cometh as I make more and more money. Hopefully for 2017 I can keep it lower than 20%.
The biggest killer for me going forward is California state taxes. Definitely progressive and definitely expensive.
Last year I broke into the > 21% federal tax rate after all deductions. This year too.
I think taking all the above the line deductions I can afford helps the most. (SEP, 401K, 5% work pension with match, vests at 25% per year after year three).
Welcome to the club, My Friend. I think you are now seeing why so many practicing physicians say they pay a lot of taxes! I pay more in taxes than I ever imagined making in a year. Ultimately it is a blessing to have such abundance. I was helped by state and federal funding in the past as well as continuing to benefit from the social benefits. I am blessed to have so much money left even after a huge tax burden.
My overall tax rate this year dropped to 26.9% from 36.2% last year. One of the few financial benefits of getting divorced!
My ex- and I went through similar income growth to yours, and I remember marveling when our tax bill exceeded $100K, then $200K. This year would have been about the same as yours.
Whenever I hear someone say “the rich don’t pay their fair share” I want to ask them what, exactly, is my “fair share”.
Jim,
Do realize that you do live in a state with a low state income tax rate. I lives in one situation where the state tax rate was 7.5%, the local tax rate in the city of employment was 2.5% and the local income tax rate in the city of residence was 1.5%. The maximum state rates kicked in an income of $50k.
I use TaxAct as I was very dissatisfied with the lack of customer service at Turbo Tax. I strongly recommend that everyone does their taxes at least once to develop an understanding of the tax code, especially those portions which affect my situation.
We paid no federal or state income tax this year as the capital gains rate is 0% at our income level and the State of Arizona offers tax credits for contributions to qualified educational organizations and social service agencies.
Sure, Utah’s state tax is low when compared to California. But it’s high when compared to Alaska.
I ditched TurboTax this year because it was f*’in up my taxes and I couldn’t take the time to figure it out.
http://www.roguedadmd.com/2017/04/the-tax-man-cometh/
I will likely try H&R block or a TurboTax reboot of some kind next year.
However if my blog/future Empire is ever generating 6 figures like WCI I’m not sure what I’ll do
I don’t actually do my own taxes but when I look at the numbers I feel lucky that the government in its infinite wisdom has chosen to give me the breaks that they have. Seems like a pretty sweet deal and I can understand when there is anxiety amongst my colleagues when the government starts talking about revisiting them.
I do my taxes from IRS pdfs of forms and instructions, but I’m a math nerd who should maybe have become an actuary like my brother. But also because Turbo Tax and other programs did not seem to be doing it correctly and especially couldn’t handle foreign income when I worked in the UK whilst husband was stationed there. Not that I am perfect- IRS has corrected my records and even my math a few times- but I dislike the lack of perfect transparency of the programs. All they’d do is keep me from having to enter things multiple times on multiple forms and maybe let me skip my completing a lot of forms to ensure I don’t need to file them- like AMT or late penalty calculations- and avoid the maddening IRS do 97 calculations to come up with the number that one started with and no change in the final result from doing the extra form in the instructions.
While I complain about the IRS, Alabama’s Dept of Revenue actually does on line what turbo tax does/ did for me- enter 30 facts and then all I have to do is proofread/verify that all is correct on the 20 pages of tax forms (half of which don’t apply). Oh, and include photocopies of my IRS forms in the past.
We had a brutal tax year–
Total Effective Tax Rate — 39.1% (as defined above)
Marginal Rate — 46.4%
Mine is similar, unfortunately. Even though I made some changes that lowered my tax burden by 85K comparing 2016 to 2015. I have a ways to go. Maybe I should make the plunge and go part time like POF!
One of the things I learned from doing my 2016 taxes is that a surprisingly large percentage of the dividends from the Vanguard Total International Index Fund are non-qualified – approximately 30%. In comparison, with the Vanguard Total Stock Market Index Fund, less than 10% of the dividends are non-qualified. Even with the Foreign tax credit (mine was $117), the Total International Index Fund seems less tax efficient than the Total Stock Market Index Fund.
Agree. Shocking large % of VTIAX dividends unqualified. Then there’s the issue that if you exceed $300 ($600 MFJ) you have to fill out form 1116, which I hear is a nightmare even for tax-savvy DIYs.
I will be rebalancing/purchasing more international into 401k and more total US into taxable in the future.
1116 is no big deal if you have Turbotax just pull in your data from Vanguard. All automatic.
Maybe I’ve never exceeded that much but if it is all from mutual funds rather than separate stocks IIRC no 1116 is needed. And luckily for me I’ve never owned over 5 foreign stocks separately- does make one wonder if the paperwork justifies any benefit from such an investment.
Good to know. Assuming form 1116 supported by TT Premiere?
Don’t know. I use TT Home and Business. Upgrading is usually very easy though if you need to.
Dr. Google says yes, form 1116 supported by all TT versions. Will soon cross $600 foreign tax, so hopefully it is easy peasy……
Thank you for tax articles like this. Have only been doing my own taxes for four years, so still learning a bit and fixing minor mistakes each year.
With all these “first year after residency” horror stories I’m wondering what you wished you had done differently? 2017 will be my first complete tax year at my attending salary (~$450k expected). I’m a W-2 only EM doc in CA and taxes are already very high. Other than the obvious (401k, backdoor Roth) I don’t qualify for much else – errr nothing – as I’m single, no kids, minimal property taxes. Paying off my $400k in student loans over 3.5 years. Any tax related advise?
Thanks, long time reader
Not much you can do (although you ought to give very serious consideration to leaving California). There’s just nothing to work with here. You could encourage your group to implement a defined benefit/cash balance plan maybe.
First, be happy that you have that great starting salary. Some of the best advice I received was from an attending when I was a resident. He explained the longer you can live like a resident and save your money, the better off you would be down the road. He said most new docs start raising their expenses right away to match their salary. I followed that advice for many years and it’s really paid off. Yes of course you try to maximize pre-tax savings, but the really great part comes when your post tax savings and investments can cover your living expenses. Don’t rush to pay off your loans, save instead. I was able to save enough for a house then borrow from it to start a practice. I paid off the school loans over 10 years. If you are able to be a contractor instead of W-2, you can set up your S corp and start a SEP IRA or a profit sharing plan-self directed retirement trust. For example, you can buy shares of a surgery center and all the distributions go directly pre tax into the plan. You can then use those funds to buy any self directed investments including stocks, bonds, or real estate. This is even more important if the 2017 tax laws change for S corp pass through income tax rates of 15%. If that happens, just work at 2 ERs as a 1099 and you will come out way ahead. In the long run it’s always better to be your own boss but a great starting salary is nothing to sneeze at so enjoy it while you can!
Please be certain as you start the higher paying job, probably in July or even September after a well deserved vacation, that your first (partial) year, with pay not so high as the 12 months as an attending the year after finishing residency, that you still max out your tax deferred plans (unless your income is still so low it is a bad idea tax wise).
Even long after residency- since I’ve taken a few sabbaticals following my Army spouse around the world- I’ve juggled my 401K (TSP in government jobs) to ensure I max it in the <12 months first calendar year I start the job, then lower it pronto in January to ensure I don't hit max before the following year is over and miss out on employer matching by having $0 deductions going into the pension plan for a few months at year's end.
Ditto if I leave a job before December: last job I resigned in March so had barely any pay coming to put the $17.5 K max into the TSP. (After I verified there's no max percentage ((except 100%!)) in that employment plan so even if my wages were only $18K for the year I could still put $17.5 K into the TSP.)
presumably my 70 year old self will thank my 45 year old self for such planning and ‘sacrifice’
Or it might be your 55 year old self …
Are Medicare/Medicaid and fica and social security taxes included in anyone’s calculations?
Not sure what Medicaid tax you’re referring to, but I include all those payroll/self-employment taxes you mention.
We implemented a 401k plan in our small group practice in 2016 and only got to 35k. The cost of matching the rank and file was prohibitively expensive and forced us to abandon the PS piece. Any thoughts?
My thought is that if you have employees you need professional help in deciding what retirement plan to use in your practice.
My other thought is that money is fungible. So one option if a retirement plan match is really expensive is to pay the employees less and give them more retirement matching. But most employees pay far more attention to the salary than the benefits even if it is all the same pot of money to you.
The rank and file are often not aware how much in matching and profit sharing funds they’re receiving annually or fail to make a comparison. If they’re hourly, I translate the total figure into a per hour figure. For example, “the $4K that you received last year equates to $2/hr, etc”
Good idea. Even our employee physicians transitioning to partnership are surprised how much we (the partners) have been paying for their insurance and malpractice.
Basic question: how can anyone exceed a marginal tax rate of 39.6% because that is the highest tax bracket for 2016. What am I missing?
From the post: “Our marginal tax rate this year was 45.8%. (If you’re not sure how to calculate that, add $1000 to your earned income with your tax software and see how much your taxes go up. Mine went up $458, so my marginal rate is 45.8%.)”
The marginal rate includes Payroll tax and state tax in this example.
I like the way he calculated marginal rate as it took an additional $1000 of taxable income and input it in the tax program and the amount of tax/$1000 was right there: $458/1000 = 45.8%.
Be glad you don’t live in Oregon! I’m at 51.9%. 9.9% income tax…
State taxes and Pease phaseouts for me. My state taxes add 5% and my Pease phaseouts add 1%. So I’m at 45.6%. If you’re in California or New York it’s worse.
Actually now that I think about it, mine should have been higher than that since additional income should have cost me more Medicare tax. Not sure why my marginal rate was only 45.6%. Might have to go back and play with that a little more.
Correct me if I’m wrong, but it sounds like the only way to figure out your marginal tax rate is if you do your own taxes and hypothetically increase it by $1000?
Is this the correct logic?
As a sole proprietor, your marginal tax rate = federal tax bracket + state tax bracket + Pease (not sure how you can figure that out) + 1.45 Medicare tax + 13.85 Social security tax (on the first $118,500) ?
Thank you in advance!
I don’t know that it’s the only way, but it’s the easiest way for sure!
Pease basically adds 1%, but you don’t have Pease while you have SS tax. And if you’re self-employed, you pay the employer portion of Medicare tax too (but half of it is deductible.) The tricky parts to predict are the phaseouts and AMT.
For those with rental properties or businesses it might be interesting to look at things from a cash flow perspective. Your effective and marginal tax rates might change a little bit. I would add back to the denominator (gross earnings) things like depreciation (if that was what took you $0 for the rental and you couldn’t deduct losses due to MAGI), and things that had no marginal effect on your cash flow but that you were able to claim as an expense (percentage use of home, phone, internet, etc., assuming those were already purchased and the business wasn’t the reason for their purchase).
I didn’t even know what Pease was until I read this post. I also did not know about the actual amount or income to which it applied as to the added Medicare tax (for the ACA) on AGI> $250,000.
I gave mine over to a CPA last year and this (for $600). I used to use Turbotax. I think you are right BASICS (as is the post) that to get your true marginal rate you need the tax program open and essentially finished and then add $1000 of income and see how much your tax goes up to get this magic number (marginal tax rate) as the tax code is so complicated and changes every year.
I’ll ask my CPA to do it. I had to file an extension again in order to moonlight enough to make my $28,000 SEP IRA contribution by October 15th. I simply didn’t have the $20,000 owed to federal and the $28,000 SEP money by April 15th.
I’ve created an odd situation in which I have to 2/3 of my moonlighting money from January to April to pay the (now $20,000) federal tax burden over and above the “extra” $18,000 I had them take out of my W2 pay for all the moonlighting I did this past year. Then I have to take 1/2 of my moonlighting monies from May to September and put it aside to make the SEP IRA payment (for the previous year).
It’s a wild game as a LOT of the moonlighting money goes to taxes ($38,000) or the SEP ($28000) of the total $150,000. I’ve spent a large chunk of the rest buying a cabin on 20 acres on top of a mountain to retire to…should I survive…
I’m sure the CPA can sort out estimated tax payments to prevent this or you can just ballpark it like I do. Although the late penalties are always a lot less than I fear, I make an estimated payment any quarter when I’ve made more than usual or if last year’s withholding just wasn’t getting close to what we end up owing. I sure don’t want to have mandatory withholding on all my interest/ dividends/ capital gains but mostly seeing in January we owe $1000s more than I thought or planned for is no good, as you have lived. Just now I even delayed selling some stocks until after March 31 so I could delay that estimated tax payment until June, but for the April 18 due date sent in a (2018) $8K estimated tax payment for my marginal tax rate times a capital gain we took in January.
Anyway if $66K of $150K moonlighting is the amount of extra tax and SEP you’ll owe, I recommend you take another $66K and put it into estimated taxes and making more frequent payments into your SEP. If only because buying all of it once per year puts you at risk of paying the highest price for stocks, when every other IRA/ pension fund last minute purchaser is buying along side you. So how about doing less cabin building and more tax paying/saving this year, to have an easier winter/spring next year. Then next year you can spread your moonlighting over the whole calendar year.
Here’s the rub. I can’t currently afford to make estimated tax/SEP payments that equal $16,500 per quarter, partly due to getting the retirement mountain top acreage BEFORE I sell my big house (the building of which was my largest financial error in life so far).
You are right. The only way out of this game is to reduce my bills and pay more in quarterly amounts. I extended myself to get the cabin (an opportunity too good to pass up). My situation changes when I sell the big house and move in about 15 months.
I’ll fix it this year. No college costs this year. The last two years I paid $60000 in college costs over what we saved. That was another fundamental error in planning.
You’ll gradually catch up a little each year until you’re funding that stuff early in the current year rather than at the last possible moment the next year.
Young physician right out of residency working for Kaiser.
Brutal year for taxes with dual attending and lawyer (wife) salaries. No credits, no exemptions, only mortgage deduction. Backdoor ROTH also. No partnership, profit sharing or HSA at Kaiser.
My question: 2017 – created an LLC to put my rental condo on. My wife and I are only employees. Can I open a i401k or SEP-IRA under the LLC? If so, if there is no profit for the year – how much max can I contribute?
No. Only earned income goes into retirement accounts. Rental income isn’t earned income, at least not unless you qualify as a real estate professional, which you don’t. Plus you didn’t have income from it anyway.
Why’d you create an LLC for it instead of selling it if it produces no profit?
Hi. This is the reality of life, the more you earn the higher taxes that we pay. As the saying goes, Taxes are the lifeblood of the government and without it the government cannot stand. It is also one of the power or sovereignty of a State, the more taxes that it receive, the more powerful the State can be. The government (particularly the legislative) has all the discretion on the matters and guidelines of the subject or nature of taxes. The Tax Code also mandated that all earnings, even from n illegal source, are taxable. I think paying too much taxes is like carrying too much burden because its as if you are only working for the Government. So I think, there must be an exhaustion of legal remedies to lower our taxes and this is called Tax Avoidance. There are also wrong schemes that other may think in lowering our taxes and that is called Tax evasion. Tax evasion is not advisable as it lowers one’s taxes through an illegal or unacceptable mechanisms.
As a prior practice partner of mine pointed out frequently “They can’t tax vacation.” You get 168 hours a week during your finite life. If you trade it for money by working more or harder, the government claims 40-50%+ of it and lets you keep the rest. If instead you simply keep more hours for yourself to enjoy life, you get to keep the full value of all that time.
The choice is sort of obvious when you think about it that way!
I love it. Great quote.
I take all my vacation time…usually, but this year I have asked for six vacation days off to work elsewhere for a weekend, business week, weekend, and a holiday. Most days it is 8AM to 2PM.
It will pay $20,000 of the $28,000 I need for last years SEP contribution (by October). At least I am paying myself this chunk towards a permanent “vacation” in 6 years.