An Argument For Handling Your Own Income Taxes
I am a busy, young professional with multiple income streams and can think of far better ways to spend my time than sitting in front of a pile of documents at my computer, tabulating my income taxes.
Filing the taxes is actually the easy part. Keeping a running document of every potential tax event over the calendar year is more taxing.
Then comes dealing with the litany of IRS correspondences. I have written in previous posts that I get a letter from the IRS demanding more money about every 3-6 months. This has been the case since 2008.
Let’s delve into the topic of taxes and why I insist on doing them myself.
The filing process is simple. We answer some questions on a piece of software which then tells us what we owe. Usually we can file electronically which makes everything nice and simple.
What matters to me is that I get exposed to the questions that the tax software asks. Every one of those questions is an opportunity for me to lower my taxes. It may not be something I can do that calendar year, but I can possibly plan for it in the future.
With the running ‘tab’ shown on an adjacent window, I know exactly what each move is costing me or profiting me. It’s a very useful feedback system. Exactly because of my years of doing my own taxes, I have learned that I can almost completely avoid paying taxes if I increase my deductions enough and earn the majority of my income from either my own business or from investments.
During the filing process, I learn how my taxes work. I believe that a fair proportion of physicians don’t quite understand their taxes, which is a shame. We are among the highest tax payers, it’s beneficial to know how it works even if we don’t profit from that knowledge immediately.
I have gotten in the habit of looking over the PDF tax document right after filing it – that’s the document the tax software generates. The tax forms are very different from the interactive tax softwares used to create them. Comparing the two together really helps a person understand how the tax system works.
This isn’t moral advice, however practically, it’s easier if you are honest on your taxes. There is a lot of room to lie on your taxes – we’re talking tens of thousands of dollars. The problem is that if you are dishonest then you have to genuinely be worried about the IRS being on your back.
If you are honest, it makes it much easier to push the envelope and welcome those IRS letters.
Having a business
An employed physician pays taxes on the income they receive from their employer, often reported on a W2 document, aka paystub. There are a few things an employee can deduct, though not much. Any major work expense deduction has to meet a floor percentage before it can start counting towards a deduction.
As a business, if I earned $10,000 in one month and needed to spend $2,000 on rent, $2,000 on a laptop, $500 on a car, and contributed $2,000 towards a qualified retirement account – then I would deduct that $6,500 directly from the $10,000 and be taxed on $3,500. The power of this speaks for itself.
Accumulating Tax Information Over The Year
Whenever I am about to make a large purchase I think about whether it’s something that I can write off partially or completely against some income. This is another way I practice my tax muscles in preparation for tax-time.
I keep a digital Word document with every kind of major transaction throughout the year; when I dine out or spend money in a large group, travel or buy a new device. I add some notes next to it so I know in what context I spent that money.
When connecting spending with taxes, it reinforces the behavior of thinking about how one can save on taxes. If I need to replace my laptop and can show that I use it mostly for work then I can write it off against the profits from my business.
Dealing With IRS Audit Letters
I started out doing my own taxes once I entered residency and kept that up for 7 years until I decided that I was a baller and could afford an accountant. He was great, brilliant man, who charged me ~$1,000 a year to do my taxes.
For the past 3 years I decided to bring tax filing in-house. It wasn’t that I minded paying the $1,000, it was money well-spent – I wanted to better understand the process, in order to minimize my taxes as much as I had minimized my expenses.
I started getting audit letters in 2008, once my income surpassed $100k/year. Out of fear, I paid any amount that came in the mail from the IRS – I mean shit, they did that for a living, they must know what they are talking about. And the explanation were insanely over my head, written in a foreign language.
In the recent years, when I have been actually paying attention to the audit letters, I often find that the IRS is incorrect. Maybe back in those years I really was doing things wrong, not so much now.
Addressing IRS audit letters
Sometime in 2011, I got my first letter from the IRS which I could simply forward to my CPA instead of sweating over it. I took a snapshot of it and emailed it to him (after encrypting the email, of course!). The letter stated that I owed an extra $2,500. I was sure I owed it. However, my CPA explained to me why the IRS was incorrect and what I should write in reply.
Man, that was a game changer. How could the IRS send me something that was so obviously wrong? I don’t recall the details but it was actually fairly easy for the IRS to figure it out since I wasn’t doing anything fancy with my taxes back then.
That year alone, I had made the money I paid to the CPA from that audit letter. However, what I learned from that experience has saved me over $30k thus far.
Of course, my CPA was conservative when filing my taxes. He took whatever information I brought to him and filed my taxes accordingly. I can’t blame him for not wanting to push the envelope – which CPA wants a barrage of IRS audit letters to deal with?
When I started taking over my own taxes again, I remember that’s when the audit letters really started coming in. The first few were frightening, you hear so many stories about the IRS scrutinizing you once they get a hold of you. But soon, it was the norm. Most were incorrect. It was a matter of pointing out why the IRS was wrong and waiting about 6 months for them to reply back to me with their quick 1-pager: “we have reviewed the information you sent us and we have decided to close this inquiry and you don’t owe any money”.
I just wish that the IRS audit letters were as comprehensible as their letters saying that I don’t owe them any extra money.
The explanations that the IRS sends out are vague and though not incorrect, they are often inaccurate. I don’t advise a high earning physician to take on their own taxes without having professional consult available to them, at first.
Though most CPA’s would never take on going over your taxes with you after you filed them yourself and addressing IRS audit letters, there are those who consult in such a fashion.
The tax system is complicated, but it is limited in how it relates to the average physician household. This means that there are a finite number of issues that can be brought up by the IRS for audit reasons. It would be a good investment to pay a CPA an hourly rate to sit down with them F2F or digitally and go over the IRS audit letter and the taxes which you filed.
After a few such sessions you will learn enough that it’s quite likely that you won’t need the help of a CPA any longer.
IRS Tone In Letters
I don’t want to criticize them too much but the IRS makes statements such as “if this tax burden wasn’t yours and believe that it was someone else’s, please send us their contact information and any other pertinent details”.
What they are saying is that “if you want to get off the hook for this amount, tell us who to go after, instead”. The IRS displays so little tact, it’s a shame. They are in the business of collecting taxes, so own it, develop it, become stellar at it! Don’t hide behind the facade of having the monopoly on taxes because that’s how you lose face.
I don’t mind paying taxes, for the most part. I understand that taxes are what make this country run its day-to-day operations. I don’t agree with how some tax-money is spent, but that’s why I am given the option of getting the fuck out to go live somewhere else. I vote with my presence and dollars.
In any good transaction, both parties should look out for each other. That’s why we tip the bartender. They pour us a little more than a shot in our drinks, they slip us an extra maraschino cherry. They let us taste as many beers on tap as we like and they warn us if one tequila brand is not worth the money the bar is charging. They looked out for me, so I will look out for them and tip them well.
I don’t think I want to tip the IRS. And as the tax code gets more and more complicated, it will soon be the norm for most of us to go through a lawyer when paying taxes – similar to what many of the uber-wealthy do now.
We wouldn’t even deal with the IRS directly. We have the lawyer’s CPA assess our taxes which then is negotiated down by the lawyer. The lawyer then will pay that negotiated amount to the IRS and we never have to hear about it again. If it gets contested it will float around in the lawyer’s portfolio of cases for as long as it takes to stall the courts. Whatever the lawyer can win is their margin to keep and whatever they lose, they will pay out of their own pocket. Look for that app.
The Simplest Way To Handle Your Taxes
As mentioned above, if you can find a CPA who is willing to go over your taxes after you’ve done it yourself then you will gain the most benefit. Granted, it’s boring and tedious. Few will enjoy the process the way I sadly do.
Remember how shitty it was learning that Epic EMR? But it’s nice having access to all the labs and PMHx with a few clicks. And with CareEverywhere it’s an even more comprehensive tool. Once the painful learning curve is behind you, it’s a worthwhile skill to have.
The same holds true with handling income taxes. At first it will be a nightmare. In time, it will be eye-opening and a great tool at your disposal.
The workflow can be streamlined:
- Document any major potential tax event on a running document.
- Collect all pertinent tax documents throughout the year.
- Sit down and complete your taxes online.
- Before filing them, print out the PDF and review it according to what you entered in the tax software.
- Sit down with a CPA with 2 copies and go through the entire document.
- If and when you get the audit letter, set up another session with your fav’e CPA and go over that. This can often be done over email quite easily.