My lazy ass finally sat down to do my taxes and I’ll share the numbers with you guys here. Since 2006 I’ve always looked forward to doing taxes; something about numbers and strategizing clicks with me. 2019 has been rather somber with California’s medical board investigation looming and legal expenses but glad I got my taxes done with.
Here are some basic numbers to wet your whistle:
- Total gross income – $100,500
- Business expenses – $23,800
- Net profit (net income) – $76,000
- Adjusted Gross Income (AGI) – $77,400
- Taxable income – $48,000
- Federal taxes – $12,100
- State taxes – $5,700
As a sole proprietor I tabulate my gross income on a Schedule C. All the income I earn as an independent contractor by doing telemedicine and consulting gets added on the profit side of the business income. This is sometimes referred to as Gross Receipts or Gross Profits.
This value is rather useless. Ironically it’s the number many will claim when they characterize their income. As me how much I earned in 2014 and I’ll say $430,000. True. That’s how much I earned in gross wages as an employee for Kaiser Permanente. But I also paid over $100,000 in income taxes.
I earned income mostly from doing telemedicine and consulting. The work was great – I gotta say that I greatly enjoyed it. Get this, I had 8 income sources. That’s a lot to keep track of but I learned a lot from it and made some solid connections.
My business expenses came out to $23,800. Just like any business I have expenses which I incur in order to earn a profit. Think of it like this, if you had a business where you sold cell phones, if each cell phone cost you $250 and you sold each for $300, your $250,000 of gross income would only amount to $50,000 of potential profit.
Your business expenses will include those 1,000 cell phones you had to buy in order to profit that $50k. In my situation I had to spend $23,800 in order to make my $100,500 in gross profits.
My $23,800 business expenses included the following:
- legal/professional contracting
- business travel
- cell phone/internet
- home office expenses
It’s a good idea to know where you fall as an entrepreneur on the spectrum of writing off your business expenses. For someone like myself who did so many different things $23,800 is rather small. If I put in more effort then I could have written off more but I got a little lazy this year.
You get to write off expenses for starting a new business and you get to write off expenses for R&D. You can even get very creative by leasing a shared office space as I’ll demonstrate below. The point isn’t to defraud the IRS but the more complex the tax code gets the more ways we can come up with saving on taxes.
Shared Office Space
The IRS no longer allows you to write off meals or beer or coffee when conducting business. The exceptions are when you purchase meals for your employees or catering an event for clients. The IRS underestimates the ingenuity of entrepreneurs.
Let’s say I spend $200 on dining out and $100 on coffee every month and another $200 on drinks. That’s $500/month that I cannot claim on my taxes. However, if I rent a shared office space for $250/month I get a desk, WiFi, coffee, and alcohol. In fact, some shared office spaces allow you to “bill” under them. This way if I buy food on their property or have food delivered to me then I can one bill for my shared office space and write the whole thing off as an expense.
In the past I used to itemize my deductions but with a standard deduction of $18,000 what’s the point? This works out in my favor because I don’t have any mortgage interest to write off and no other expenses as an employee.
I get to deduct this from my total income before calculating my taxes. So guess what, if I earned only $18,000 in 2018 – or $1,500/month – I would owe no federal income taxes because of the standard deduction. This would take my taxable income down to $0.
Qualified Business Income Deduction
The Godfather just wrote a great novel about this topic, the QBI. It’s referred to as Section 199A and allows the business owner to potentially deduction 20% of their Qualified Business Income. I would recommend reading his post a couple of times because it’s pertinent to physicians.
In my case I had $56,000 in Qualified Business Income and 20% of this is $11,400. Since I landed only in the 12% tax bracket this equates to $1,368 back into my pocket. Still, it managed to lower my Adjusted Gross Income.
The US tax system penalizes higher income earning individuals. Understanding these rules and regulations has been instrumental in my tax planning. Intentionally lowering my income has allowed me to keep more of my income to myself.
Federal Taxes – $12,100
My total federal income taxes came out to $12,100. This is made of 1) income taxes ($0), 2) health insurance penalties ($1,250), and 3) Self-Employment taxes ($10,700).
1. Income Taxes – $0
My tax based on my income was actually $0. Yeap, $0. How is that possible? Because I had a “Tax Loss Carryforward Credit” from 2017. That’s a loss that I had that was too big to take fully in 2017. This allows me to carry that amount forward to the next year and gives me a tax credit. I still have another $12,000 to carryforward. Seem odd? Check out this blurb below from Investopedia which explains it really well through an example from President Trump’s taxes:
He had such a large loss in 1995 that he can essentially wipe off $50 million dollars of taxes each year for 18 years. That’s the Tax Loss Carryforward in action.
Our tax system is a progressive one which means I fall into different tax brackets based on my income. You can use this online calculator to figure out which tax bracket you will fall into. The number you want to enter there is your ‘taxable income’ and not your gross or overall income. The taxable income is your gross income minus deductions, business expenses, and tax credits.
2018’s tax brackets show that for my taxable income of $48,000 I would fall into the 12% tax bracket. I’ll be using the Head of Household column since I am claiming mommy as a dependent. The first $13,600 will be taxed at 10%. The next $13,601 to $51,800 will be taxed at 12%.
The 10% tax bracket will cost me $1,360. The 12% tax bracket will cost me $4,100. That’s a total federal income tax burden of $4,460. Which, again, got wiped out by my carryforward loss from 2017.
My taxable income (different from ‘income tax’) is only $48,000 even though I earned $100,500. That’s because I got to deduct my business expenses, my standard deductions, and a few other little things.
Federal income taxes are calculated based off of your “taxable income” and not your net profits or your Adjusted Gross Income. Your taxable income is your net profits minus all adjustments and deductions.
This is why we can lower our taxable income by contributing to tax-deferred accounts and traditional IRA’s. We can also take other allowable deductions such as the itemized or standard deduction.
Health Insurance Penalty – $1,250
I got slapped with a $1,250 tax or fine for not having health insurance for 10 months out of the year. I had health insurance but not in the US. Since I didn’t have an ACA approved health insurance plan I had to pay a fine of $125/month for those 10 months to satisfy the individual mandate.
Self-Employment Tax – $10,700
We pay federal income taxes, state income taxes, and also medicare and social security taxes. The last 2 are grouped under self-employment taxes or also referred to as payroll taxes when you’re employed.
While employees are taxed on gross wages, business owners like myself pay medicare and SS tax on the net income. This is the money left over after deducting business expenses from total business earnings.
For the sake of calculating my self-employment taxes the IRS uses my net profits of $76,000. Before doing so they use a multiplier of 92.35% which accounts for the portion of SS tax which is tax deductible. I know, confusing. Just know that the below numbers were calculated off of $70,800 (= 92.35% * $76k) and not $76,000.
My total SE taxes came out to $10,700 ($8,700 + $2,000) as I’ll explain below.
Social Security Taxes – $8,700
Social Security taxes will cost us 12.4% in 2018 for incomes up to $128,400. Any income above this is no longer taxed for SS which is why you cap out at a certain income when you go to collect SS in your old age.
I can claim a deduction for half of this. It’s a weird law and differentiates an employee from a business owner. Since my gross business earning minus expenses (net income) was $76,000 I would owe $8,700 for Social Security taxes. Half of this, $4,300, I can take as a deduction against my net income to further lower my taxable income.
This is how we talk about AGI’s – adjusted gross income. Your AGI is your net income minus these deductions or adjustments.
Medicare Taxes – $2,000
Medicare taxes are set at 2.9% whether you’re a business owner or are self-employed. The employee would only have to pay half of this and their employer remits the other half on their behalf.
If you’re a physician and you have a taxable income of more than $200k then you’ll also pay the Additional Medicare Tax at 0.9%. I’m obviously far from that.
2.9% of my net profit ($76,000) comes out to $2,000. Just like Social Security taxes I can deduct half of this against my net income.
State Income Taxes
This isn’t much different from my federal taxes. I only have to file for Oregon. And though I wish I could file in a state with no income tax I have to file in the state in which my ass resides when I earn my income. Even as a digital nomad physician who isn’t location dependent the rules are strict about your actual residence of a state.
My total Oregon state income taxes were $5,800 for the year. This comes out to $480/month. Which means that I could pocket an extra $480/month by living in a state with no state income tax.
Though recent IRS tax codes have changes for federal income taxes I still get a standard deduction from my state. For me this comes out to $3,570. This lowers my AGI from $77,400 to $73,800.
You don’t see a solo 401k or traditional IRA mentioned because I decided it wasn’t worth the deduction. My tax bracket is so low that the $18,000 I could have contributed to my individual (solo) 401k would have reduced my tax burden by only a tiny amount.
If I was earning $300k a year then it would make sense to max out my retirement accounts because I would be in a higher tax bracket which would allow me a much higher tax savings.
I would rather hold on to that money to either invest in after-tax investments or use it to spend on fun shit such as paying for lawyers.
Roth Solo 401k vs. Roth IRA
For any physician who still wishes to save more for retirement I would recommend contributing to an Roth Solo 401k. I had this option as well but it’s the same issue – why tie up my money until age 59.5?
I qualified to max out a Roth IRA worth $5,500 which I added to my Roth bucket. I invest in REITs in my Roth IRA account and it’s worth about $25k right now. I figure I’ll keep adding to this over the years and eventually start a gradual process of Roth conversions.
Tax Planning 2019
It’s already 2019 so I usually begin my tax strategizing the year before. There are only a few strings to pull on when it comes to optimizing taxes. It’s tough as an employee but you give yourself far more options when you become a business owner, whether an S-Corp, LLC, or Sole Proprietor. If nothing else consider starting a business on the side which will allow for some write offs and gives you more investment options.
There is another layer of tax planning when it comes to living abroad. The FEIE can be an effective method of decreasing your tax burden if you plan for it appropriately.