By Dr. Leif Dahleen of Physician on Fire, WCI Network Partner
I’ve not done a tax return reveal before, but 2019 was an interesting year from a tax perspective, and I’d like to share my completed returns with you.
My taxes have become increasingly complicated over the years, and I’ve used a CPA for as long as I’ve been a physician. My CPA happens to be married to a physician, and he’s a seasoned real estate investor and business owner. That makes him a good fit for me and my situation.
I plan to go through my two-page 1040 line by line, detailing what the numbers represent, where they came from, and what can be done, if anything, to modify them with real-life examples.
If you do the math, you’ll see that our taxable income is less than half of our total income. I’ll show you how we made that happen, as well.
I realize that these are big numbers, but I don’t think they’ll come as a surprise so I feel comfortable sharing them. Anesthesiologists are well paid, small businesses can be lucrative, and investment income tends to add up once one is financially independent.
By revealing my return, I hope you’re able to pick up some pearls that you can apply to your own tax situation.
Our 2019 Tax Return Revealed: Total Income $522,662, Taxable Income $253,906
2019 was a big year in our household. It was my final year as an anesthesiologist; I left my job in August of 2019.
It was the first year I earned multiple six figures in online income.
We also had dividend income of just over $50,000 between my Vanguard brokerage account and some passive real estate investments.
If you’re thinking real estate is what allowed us to reduce our taxable income so much, I’d say “good guess!” The truth is that the majority of our deductions came from charitable giving; you don’t pay taxes on donated income.
Line 1: Wages = $188,176
This is where “wages, salaries, tips, etc…” are recorded. The $188,176 comes from Box 1 on my W-2 from my former employer.
That’s what I earned in my final partial year working as an anesthesiologist.
Line 2b: Taxable Interest = $1,448
Interest earned in my savings accounts are recorded here. There’s really no such thing as a high-yield savings account anymore, but I was getting close to 2% on my money back in 2019, which seems high compared to what’s available today.
Interestingly, I had a bit of interest earned in a business savings account from Passive Income MD that was included in this calculation.
I do own a sliver of that business, and that fact will come into play again.
Line 3a: Qualified Dividends = $34,874
Most of this comes from owning Vanguard index funds. I don’t aim for significant dividend income; it’s tax-inefficient to do so when earning a high income.
Nevertheless, the U.S. stock funds I own kicks out close to 2% and the international allocation doles out closer to 3% (with a higher percentage of ordinary, non-qualified dividends as compared to the domestic stocks).
Line 3b: Ordinary Dividends = $50,073
It’s important to note that this is not in addition to the $34,873 noted in Line 3a.
Essentially, the qualified dividends are a subset of the total reported dividends, which the IRS refers to as “ordinary dividends”.
In other words, your ordinary dividends are your total dividends, and are equal to qualified dividends plus ordinary, non-qualified dividends. The nomenclature is really clumsy, I know.
Qualified dividends receive beneficial tax treatment as opposed to ordinary, non-qualified dividends, which are treated basically the same as interest and earned income. I had $50,073 – $34,874 = $15,199 of ordinary, non-qualified dividends in 2019.
Line 4a: IRA Distributions = $12,002
Like we have every year since 2013, we did a pair of backdoor Roth conversions.
Since it’s a conversion of a post-tax, non-deductible IRA contribution, there is no tax on $12,000 converted.
Line 4b: IRA Distributions, Taxable Amount = $2
The money market funds where our money sat for a bit earned a total of $2 before the conversions were finalized.
Line 5: Social Security Benefits = $0
This line will presumably continue to read “0” until I’m 70 years old based on the current Social Security rules. Eventually, it could be a substantial amount, but that’s more than 25 years away.
Lines 4c and 4d were also blank, as I do not have pension or annuity income.
Line 6 = Negative $3,000
I did realize some capital gains in 2019, selling a portion of some lakefront property we had purchased a couple of years earlier.
The potential $32,000 gain was more than covered by the $40,000 in carryover losses from prior years’ tax-loss harvesting and the additional $27,000 in losses I harvested in 2019.
In 2020, I added another $170,000 in losses harvested, which will more than negate the gains I’ve realized from the sale of a brewery and the rest of the lakefront property.
The IRS allows you to offset up to $3,000 of ordinary income with capital losses annually, and the extra is carried over to future years (after capital gains are also negated).
Line 7a: Other Income = $285,963
As I mentioned above, I had significant online income in 2019. This number also includes income from passive real estate investments and partnership income as a shareholder in both Passive Income MD and The Physician Philosopher.
This is also where alimony and farm income is reported, but I’m a happily married non-farmer so I have neither of those. My AcreTrader farm income gets lumped in with other real estate investment income.
Line 7b: Total Income = $522,662
Add up all the numbers above and this is what you get.
We’ll lower this by more than 50% with retirement contributions, deductions, and tax credits in the following ways:
- Individual 401(k) contributions
- Health Savings Account (HSA) contributions
- Deduction of 1/2 of Self Employment Tax
- Section 199A QBI Deduction
- Foreign Tax Credit
- Partial Child Tax Credit
- State and Local Tax (SALT) Deduction of up to $10,000
- Charitable Giving (exceeds all of the above combined)
Line 8a: Adjustments to Income = $61,185
This is the first number that we subtract from total income. It’s the sum of the first three bullet points above.
My HSA deduction was $6,225. The max deduction for a family was $7,000 in 2019, but I had some employer contributions that I didn’t get to deduct.
The deductible part of my Self Employment tax (Social Security) was $6,225, and I get to deduct half of that.
The remainder came from a $52,057 individual 401(k) contribution. I did not earn enough online income to max this out at $56,000 in 2019, but it was pretty close.
I actually contributed the max, and have asked to have eTrade “recode” the $3,943 amount that was over-contributed to a 2020 contribution. Problem solved, and yes, I’ve had to do this once before.
These are the so-called “above the line” deductions.
What’s not shown on the 1040 is $38,000 in W-2 income that was contributed as $19,000 each to my employer’s 401(k) as my employee contribution and to my non-governmental 457(b) in 2019.
These contributions are not included in Box 1 of your W-2 (it has already been subtracted) so you don’t pay income taxes on that money.
Line 8b: Adjusted Gross Income (AGI) = $460,847
This AGI number is important because a number of credits are based upon this number or the similar and sometimes identical Modified Adjusted Gross Income (MAGI).
The ACA tax credit is based upon your MAGI, and if you’re not careful, you can lose a lot of credit at once when you cross from one level to the next with $1 of additional income. I clearly do not and should not qualify for this deduction.
The child tax credit is also based upon MAGI, and I fall in the phaseout range. It’s a gradual slope without the cliffs of the ACA subsidy, and I’ll cover it in more detail below.
The MAGI also determines whether or not you can contribute directly to a Roth IRA, and the AGI determines whether or not you qualify for the American Opportunity and Lifetime Learning tax credits for those paying for college for dependents.
Line 9: Itemized Deductions = $152,183
This website has a charitable mission, and I donate much of the profit, mostly via our donor-advised fund. We donated more than 50% of our online profits in 2019, knowing that I’d no longer have clinical income to boost how much we’re allowed to donate.
That’s an issue because the IRS limits one to donating 30% of AGI when donating appreciated assets like mutual funds. Without the clinical income, my AGI would have been about $270,000, and I would have been limited to $90,000 in donations, which is less than half of my profits.
$10,000 of our itemized deductions came from paying State and Local Taxes (SALT) on our income and property. We actually paid $15,727 to the State of Minnesota, $6,779 to the State of Michigan, and $11,289 in property taxes, but this deduction maxes out at $10,000.
It used to be that SALT taxes were fully deductible, but that wasn’t really the case for me because I was paying the AMT (alternative minimum tax) for years, and SALT taxes were not deductible under that calculation.
In summary, we were able to deduct $10,000 for SALT and $142,183 for charitable giving.
Line 10: Qualified Business Income (QBI) Deduction = $54,758
This is another big one! Calculating the Section 199A QBI deduction is complicated.
What you need to know is that W-2 employees are not eligible, but most sole proprietors/independent contractors will be as long as your taxable income is under the threshold. Certain professions can qualify with income above the phaseout range if they elect to be taxed as an S Corporation and pay wages.
In 2019, if your taxable income (not including qualified dividends and before the QBI deduction) was under $321,450 for married filing jointly, you qualify regardless of profession. The deduction phases out gradually to 0 over the income range of $321,451 to $421,450. For single filers, divide those income numbers by two.
If your Qualified Business Income is under the phaseout range, you can deduct the lower of either 20% of QBI or 20% of (Taxable Income – Qualified Dividends). The latter was the lesser of the two for us, and it worked out to $54,478.
In the 24% marginal tax bracket, our 2019 QBI deduction is worth 24% of $54,478, or $13,074 in federal tax savings alone.
Line 11a: Add Lines 9 and 10 = $206,941
The itemized deductions and QBI deduction are added together. Next, they will be subtracted from your Adjusted Gross Income to determine your . . .
Line 11b: Taxable Income = $253,906
This is the number we’ll use in the tax tables to determine the baseline number for what we owe. Of course, it will be further modified after that.
Line 12a: Tax = $46,148
This is what we’d owe if we got no child tax credit, foreign tax credit, and owed no self-employment tax. We need to factor in all three before determining what we actually owe.
Line 12b adds in some other miscellaneous taxes from Schedule 2 that I don’t owe, so it’s the same $46,148.
Line 13a: Child Tax Credit = $950
I had kids for ten years before I finally qualified to receive some kind of tax credit for them. We were mostly phased out of it in 2019, but I did get to claim almost half of one of them.
Here’s how this works. If you’re married filing jointly, the phaseout of the $2,000 per child (under 17) credit begins with a MAGI above $400,000.
The credit for each child is phased out by $50 for every $1,000 of additional income, so it works out to a phaseout range of $40,000 per child.
If you have two children as I do, it’s a phaseout range of $400,000 to $480,000. With a MAGI rounding up to $461,000, I lose 61 x $50 or $3,050 of the potential $4,000 credit, leaving me with a $950 credit in 20190.
Note that itemized deductions, including charitable donations, do nothing to lower MAGI and help you qualify for the child tax credit.
Line 13b: Schedule 3, Line 7 + Line 13a = $2,615
In what seems to be an effort to save space, we take the previous line and add some additional credits and payments to it from Schedule 3.
The only additional credit I had was a $1,665 foreign tax credit. I own my international index funds in my taxable brokerage account. Since the funds pay foreign taxes, I get a credit for owning them.
Know that if you hold international funds in a tax-advantaged account like an IRA or 401(k), you will not get to claim this credit for those funds.
The $2,615 is the $950 child tax credit plus my $1,665 foreign tax credit.
Line 14: Subtract Line 13b from Line 12b = $43,533
We’re two steps away from total tax!
Line 15: Other Taxes, Including Self Employment Tax = $10,853
This is $7,065 in Self-Employment Tax, $1,978 in additional Medicare tax from Self-Employment Income, and $1,810 in Net Investment Income Tax (NIIT).
This NIIT is the Affordable Care Act surtax of 3.8% of investment income for couples with a MAGI over $250,000. The number for single filers is $200,000.
Note that tax-loss harvesting does lower your investment income by up to $3,000 per year, saving you an additional $114 for those tax-loss harvesting efforts.
Line 16: Total Tax = $54,386
This is it! That’s what we owe the federal government in income tax for 2019.
The remainder of the 1040 shows what we withheld (too much) and what would be refunded.
In my case, I applied the overpayment to my estimated quarterly payments earlier in 2020.
Lessons Learned from My 2019 Tax Return
When you’re a W-2 employee, there’s not a whole lot you can do to lower your tax bill. You can make charitable donations, but realize that you’re donating $1 to save maybe 24¢ or 32¢ at the federal level.
There are schemes involving conservation easements, captive insurance, and oil & gas partnerships that I’ve avoided. These can be risky and/or highly scrutinized. I have chosen not to let the tax tail wag the dog with any of these, but there are people who swear by them.
However, when you are your own boss, there are significant deductions available to you.
Working the QBI Deduction
I was able to use the “simplified computation” Form 8995 to calculate my 199A deduction because my taxable income was beneath the phaseout range. If you’re in the 24% bracket or lower ($326,600 in 2020 for married filing jointly), you can, too.
However, if I hadn’t made any charitable donations, I would have been nearly completely phased out.
Deciding between Roth and traditional 401(k) contributions also has a significant impact on your calculated QBI deduction, and that’s something I’ll be looking at each year.
Tax-Loss Harvesting Is Really Valuable
In previous years, I’ve been in the 32% to 35% marginal tax brackets, paid 9.85% in state income tax, and was subject to the Pease Limitation. A $3,000 deduction then was worth about $1,300 to $1,400 in tax savings every year.
That’s before factoring in the additional $114 saved from the NIIT (3.8% ACA surtax on investment income) for high earners.
Now that I’m in the 24% federal income tax bracket and paying 4.25% state income tax in Michigan, the same $3,000 is only worth $848 but I still get that additional $114 in savings making it worth close to $1,000 altogether. That’s a pretty sweet deal for a few mouse clicks.
Roth Conversions and Charitable Giving Are Useful in Tax Planning
As I look at the numbers for 2020, I hope to optimize that QBI deduction, which, for those of us under the phaseout range of taxable income, maxes out at $65,320.
If my taxable income will be too low, I could do some Roth conversions to boost it. If taxable income will be too high, I could donate more money or assets.
There is the 30% of AGI limit when donating appreciated assets, but when donating cash, the limit has been lifted from 60% in a normal year to 100% in the year of COVID.
I could also adjust taxable income when choosing between Roth or traditional contributions to my individual 401(k), but I’ll be limited in my ability to do so unless I opt for a self-directed 401(k) that allows tricks like the Mega Backdoor Roth.
I will also have the ability to do in-plan Roth conversions in my old employer’s 401(k) if I formally separate from my employer. I have remained available to the hospital on a casual basis, which has prevented me from doing so thus far.
Tax Planning, in General, Is Useful
When most of my income was W-2 income and the QBI deduction didn’t exist, I didn’t do much tax planning. I worked a lot, saved a lot, and in recent years donated a lot, but there wasn’t much end-of-year planning to do.
Now, it’s more important than ever. I now use the comprehensive tax planning spreadsheet included with the Personal Finance Bundle from CPA Kathryn Hanna. I can dial in my expected QBI deduction, optimal charitable donations, and so much more by plugging in my numbers.
Another place to quickly approximate your taxes due and run through different hypothetical scenarios is with the online tax tools and calculators at Turbotax. I find TaxCaster to be particularly helpful.
Investing a bit of time into understanding the tax code and how the numbers on your tax return are derived can be profoundly beneficial, though, especially for the self-employed.
Calculate the Percentages
I paid $54,386 in federal income taxes, $22,506 in state income taxes, and had $11,755 withheld in Social Security and Medicare taxes from my W-2 job. That adds up to $88,647 in taxes paid.
I am not counting consumption taxes like sales tax, automobile and boat registration, or property taxes. If I did, we’d hit $100,000 and change.
Based on the $88,647 in federal and state income taxes plus FICA taxes, it works out to 34.9% of my taxable income, 19.2% of my AGI, and 17.0% of my total income.
Growing the gap between total income and taxable income is the key to paying less taxes, although it doesn’t make the percentages look any better! Still, I cannot complain about these numbers, and I can only imagine the percentages will increase from the historic lows at which they currently are.
I always learn something when I peruse my tax returns, and I hope you’ve found a takeaway lesson, too. Thank you for taking this deep dive with me.
What valuable lessons have you learned when it comes to your taxes? Comment below!