I wrote a few weeks ago about how I wasn't all that worried about an increase in the marginal tax rate on income over $250K, and that a lot of doctors shouldn't be worried either. After weeks of negotiations, it looks like we're headed over the fiscal cliff (keep in mind this was written on Saturday, so it's possible a miracle has occurred in Washington prior to publication), which is a lot more worrying to me for many reasons. Let me explain why.
1) Macroeconomic effects
Many economists worry that the rapid increase in taxes for essentially all Americans will dramatically decrease consumer spending and tank the economy, sending us back into recession or worse. I'm not smart enough to know if this is actually true or not, but a bad economy tends to be bad for my income and bad for my investments. A recession would also encourage the government to maintain interest rates at rock bottom levels, which is bad for me since my only debt is a mortgage that has already been refinanced at a ridiculously low rate.
2) No Doc Fix
This week I emailed the president, my two senators, and my representative to quit screwing around with the doc fix. Most importantly, dramatically cutting Medicare payments by 27% will decrease access to care for many patients. My parents already can barely find anyone in their town who takes Medicare. That phenomenon is gradually spreading throughout the entire country. It also makes it harder for me to find people to follow-up on patients after their ED visits.
The effect on my income is also significant. Something like 20% of my patients are on Medicare or Tricare. 27%*20%= 5.4%. I'm about to have my pay cut by 5.4%. That sucks. Many people think Congress will get this fixed in the first quarter of 2013. I guess that's better than not fixing it at all, but even so, it will have rather severe effects on cash flow in physician practices.
3) No Social Security Tax Break Extension
While I'm of the school of thought that it was dumb to cut funding for a program that most people like that already was in fiscal trouble, this change will have a significant effect on most physicians. For 2013, you have to pay Social Security Tax (6.2% from you and 6.2% from your employer) on the first $113,700 of your income. In 2012, that was 4.2% from you and 6.2% from your employer on the first $110,100. If, like most docs, you make more than $113K, your SS Tax will go up by $2524, or a little over $200 a month.
4) Elimination Of The 10% Tax Bracket
Many doctors are worried about the rate in the top tax bracket increasing from 35% to 39.6%. They don't stop to think about how the loss of the lowest bracket will affect them. Right now, the first $17,400 of taxable income (post-deductions) is taxed at 10%. Without changes, that money will be taxed at 15%. That's another $870 in federal income tax for a married doc (using 2012 limits).
5) Increases In Other Tax Brackets
It isn't just the top tax bracket whose rate will increase. The 25% bracket will increase to 28% (increases taxes by $2160 using 2012 married cut-offs), the 28% bracket will increase to 31% ($2243 increase), and the 33% bracket will increase to 36% ($5127 increase). A doc in the top bracket (taxable income over $388K), that's another $9530 in taxes.
6) Increased Investment Taxes
I don't have much of a taxable investment account right now, so this won't affect me much. If you have a taxable investment account, going over the fiscal cliff increases your long-term capital gains taxes from 15% to 20% and your qualified dividend taxes from 15% to your regular tax bracket, which could be as high as 39.6%. For many people, that could increase taxes by thousands per year.
7) Increased Progressivity of Tax Code
Not only will taxes go up (on everyone), but they will become more progressive, hurting a typical doctor much more than a more average earner. It's hard to calculate the effects of this, as everyone will be a little different. Your personal exemption used to be phased out before the Bush tax cuts. That means the $3800 exemption you get for each dependent starts disappearing at a certain income. It isn't entirely clear what income this would occur at, but in 2009 the phase-out started at $250,200 and was complete at $372,700 (married.) That means for someone with a taxable income over $372,700 and 3 dependents, you'll owe another $6019 in federal taxes. But wait, there's more. Your deductions (you know, charitable giving, mortgage interest, property taxes, state taxes etc) also get reduced. Before the Bush tax cuts, this phase-out meant your itemized deductions were reduced by 3% of the total of your income above a certain threshold up to 80% of your total deductions. In 2009, that threshold was $166,800. So if your taxable income were $400K, and you had $50K in itemized deductions, you'd lose $6996 of them. At the 39.6% marginal rate, that'll cost you another $2770.
8) Child Tax Credit Reduction
The child tax credit is being reduced from $1000 to $500 per child. That's okay. If your taxable income was over $130K you didn't get it anyway thanks to the phase-outs.
9) Marriage Penalty Is Back!
Prior to the Bush tax cuts, it was possible for a married couple with disparate incomes to pay a lot more in tax than a couple with similar incomes, even for a similar amount of income. They would also pay more than if they hadn't ever gotten married at all. The Bush tax cuts fixed this problem. If they're rolled back, the problem returns and will affect many of us, particularly if only one spouse is a high earner.
Putting It All Together
How bad could this potentially be? Let's take a high-earning physician ($400K taxable income) with a large Medicare practice (60%) and 3 dependents. His income will be decreased by 16.2% ($64,800) and his taxes could go up by $21,713 or more. All told, his after-tax income is reduced by $86,513, or about 22%. Even a good saver is going to have a dramatic decrease in lifestyle with a hit like that. Most of us will take less of a hit than this theoretical worst-case scenario, but I would guess that the majority will probably have at least a 10% decrease in after-tax income as we plunge over the fiscal cliff.
What do you think? How will you cope with this drop in after-tax income? Comment below! (Keep comments civil and on-topic.)
You forgot to also mention the increased taxes from Obamacare including and increase in the medicare tax by 0.9% which is a significant increase as well.
Do you have a copy (link) to what the income tax tables are going to revert back to?
A cut in medicare rates will actually affect the take home pay of a private practice physician much more significantly than what was outlined above. A practice has a certain amount of expenses, also known as overhead, in order to see/treat a set number of patients (regardless of what reimbursements are received). If you currently have 60% overhead that means you currently spend 60 cents for every dollar of revenue you receive. If the 27% cuts kick in and 50% of your patients are on medicare, then your revenues drop by 0.27*0.50=13.5%. Unfortunately, your expenses don’t go down by the same percent (they typically go up, if anything), you will still need to spend 60 cents in overhead expenses for what you previously received a dollar, but now you will only receive 86.6 cents in revenue. Your profit margin/take home pay drops from 40 cents/unit (100-60) to 26.6 cents/unit (86.6-60). This revenue cut represents a take home pay cut of 33.5% (much more than the 13.5% drop in revenue), or if you made $400,000 last year (50% medicare population and 60% overhead), then your expected pay this year would be $266,000 without a doc fix and this doesn’t even take into affect any of the other tax consequences outlined by WCI. Reimbursement cuts are magnified in your take home pay cuts due to the fixed (or rising) cost of running your practice. The practices that will be affected most are those that have high overhead and high medicare populations.
The medicare reimbursement cuts will immediately impact the private practice physician. It may not affect the employed physician as much or as significantly since the organization may absorb some of this initially, but it is the same economics working on the organization’s bottom line, which will surely be passed down stream to the employed physician eventually.
Jon im with you and ive mentioned this before, the medicare cuts are what actually scare me the most. Even if you dont take medicare, most other insurance base their pay from medicare rates and i wouldnt be surprised if down the road that leads to either reductions or lack of increases to keep pace with inflation.
Its another nice post by WCI trying to simplify a complex problem that actually affects each of us a little differently.
I struggle with what to do about it. I dont like any of it but im not so sure those letters/emails/etc do much. Im actually thinking that the best defense is to support your lobby. In the past ive been reluctant to support these organizations. I just wasnt sure it was in my patient’s best interests but im to the point now where i think it is in my patient’s best interests to avoid further cuts.
Let me ask a question. Lets say you own the s and p 500 index. When it pays you a dividend, what tax rate are you paying in a taxable account. Is it long term capital gains or qualified dividend? Also, will it be it hit by the 3.8% medicare surcharge on investment income.
I think in your article you need to add the 0.9% medicare surcharge on earned income over 200k single and 250k married.
It’s time to start living like mrmoneymustache.com.
And throw in AMT and you’ve got yourself a party.
You’re right about the overhead affecting the drop in income. I thought about trying to adjust for that but decided it would be better to keep it simple. Suffice to say the cut will be bigger for everyone than what I’ve outlined.
I don’t have a copy of tax rates. As soon as I do I’ll post them on the site. I think everyone is just waiting to see what happens this week/month before making them up. But it’ll basically fold the 10% bracket into the 15% bracket, and increase each of the other brackets by 3%. I presume the brackets themselves will be adjusted for inflation. I’ll post them when it’s a little more clear what’s going on.
DCD- Today you’re paying the qualified dividend rate, probably 15% for you. Tomorrow, you’ll be paying your marginal tax rate, perhaps as high as 39.4%+3.8%. The 3.8% Obamacare tax applies only on taxable income over $250K, and then only to investment income.
I didn’t include the Obamacare taxes despite the fact that they’re new on January 1 for two reasons. I’ve discussed them before and they’re not going away in any deal anyone is talking about. You’re stuck with them.
Here is a link to an article that I wrote with Andrew Schwartz, CPA on the fiscal cliff, which includes a table with the tax rates.
http://www.physicianfinancialservices.com/files/7760/Med%20Ec%2Epdf
Larry
While I am not a doctor, I think I am a business person. Nobody wants to take a cut in pay but if you also take a cut in work that might work.
Personally I think everyone should go all cash and require some upfront payment and require mediation for any issues. I don’t expect many to actually do this since they are much nicer than I am.
it’s politics
in the end, even if the go over the cliff, some sort of retroactive compromise will be reached.
why exactly the bush tax cuts were a good idea (during wartime no less) is the better question.
go over the cliff for everyone, fix the AMT once and for all, kill SGR and come up with some way of controlling Mediare costs (tied to quality not procedures) and maybe, just maybe, that would make some sense.
oh I forgot about good old fashioned hedonic adjustment…
Larry-
Anything you write tonight about tax rates might be out of date in 2 hours!
Foss-
There’s great wisdom in your comment, but your suggestions are unpopular, and popularity drives politics.
Your right! In fact, at the time we wrote it, we knew it would have a very short shelf life.
Yes popularity does these days
But even you have noted that the repubs might ‘cave’ on tax cuts. How about this. Before the bush tax cuts tax rates were higher on everyone, so were cap gains and dividends. So why exactly were those rates too high? We have first world problems and act like babies. American exceptionalism is an ironic term now isn’t it?
Has anyone figured out what is in the bill regarding retirement plan conversions to a Roth?
Roth conversions are generally paid at your marginal tax rate. So if you’re at 28% federal and 5% state, you’ll owe 33% of the amount you convert in taxes. It’s usually a little higher than that due to phaseouts too.
In answer to UroMD HR 8 allows you to transfer assets from your 401k or similar plan to a Roth 401k if your employer has such a plan. This is a new provision.
ROTH ACCOUNTS WITHOUT DISTRIBUTION.
(a) IN GENERAL.—Section 402A(c)(4) is amended by adding at the end the following:
‘‘(E) SPECIAL RULE FOR CERTAIN TRANS- FERS.—In the case of an applicable retirement plan which includes a qualified Roth contribu- tion program—
‘‘(i) the plan may allow an individual to elect to have the plan transfer any amount not otherwise distributable under the plan to a designated Roth account maintained for the benefit of the individual,
‘‘(ii) such transfer shall be treated as a distribution to which this paragraph ap- plies which was contributed in a qualified rollover contribution (within the meaning of section 408A(e)) to such account, and
‘‘(iii) the plan shall not be treated as violating the provisions of section 401(k)(2)(B)(i), 403(b)(7)(A)(i), 403(b)(11), or 457(d)(1)(A), or of section 8433 of title
5, United States Code, solely by reason of
such transfer.’’.
(b) EFFECTIVE DATE.—The amendment made by this
section shall apply to transfers after December 31, 2012, in taxable years ending after such date.
CPA will charge hundreds more manage new acounting and to file taxes. Forget government trying to simpufy the tax code.
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Good luck!