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A Physician's Guide To Understanding Taxes
(Marginal tax rates, tax credits versus tax deductions, withholdings & more)
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There are few things in life that are guaranteed. Before we get to death, we have to deal with taxes. Until you finish training, your taxes were likely pretty straightforward - one W-2 form from your training program. However, as you progress through your career and life, diversify income streams, build a family, and look for ways to save on taxes, things can get overwhelming quickly. As such, it’s no surprise that taxes are a question that come up routinely in our physician communities.
This page is intended to walk you through some of the basics of taxes, as well as address commonly asked questions.
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Disclosure: This page contains information about our sponsors, as well as affiliate links, which support the group at no cost to you. These should be viewed as introductions rather than formal recommendations - please do your own due diligence before making decisions based on this page. We are not formal financial, legal, or otherwise licensed professionals, and you should consult these as appropriate. To learn more, visit our disclaimers and disclosures. Please also note that tax laws can change, and while we will try hard to keep this page up to date, we can not guarantee it.
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Quick Links
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Resources
Tax Strategy For the W2 Physician
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Tax Deductions for the 1099 Physician
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Self Employed Finances for Physicians
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Several software exist to help you calculate and file your taxes. Some are free for less complicated returns and others charge a fee for add-ons such as self-employed income, business income, and state returns. If you have a complicated situation, it’s important to get professional help to avoid a nightmare audit situation with the IRS.
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While Quicken is not specific tax-preparation software, it is a robust accounting package for self-employed individuals and to help keep track of your finances so you are ready come tax time. We've partnered to offer PSG members 50% off Quicken's entire suite of products using our affiliate link.
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How Are Income Taxes Calculated?
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Your taxable income is not the same as the income you bring home. Here’s how you calculate your taxable income:
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Determine Your Total Income
Start with your total income, including (but not limited to):
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W-2 wages
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Self-employment income
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Investment income (interest, dividends, stocks/investments sold, etc.)
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Business income
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Partnership income
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S corporation income
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Rental income
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Social security benefits
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Retirement income
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Unemployment compensation
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Calculate Your Adjusted Gross Income (AGI)
Determine your above-the-line deductions to arrive at your adjusted gross income (AGI), including (but not limited to):
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Educator expenses
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Self-employment expenses (including health insurance premiums)
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Self-employed SEP, SIMPLE, and qualified plans contributions
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Traditional IRA contributions
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Early withdrawal of savings (from a certificate of deposit or savings account) penalty
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Alimony payments
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Student loan interest
Note that some of these deductions, such as the student loan interest, have caps for a maximum deduction or phase out at different income levels.
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Determine Your Deduction
There are two options when calculating your deduction: using the standard deduction amount the IRS sets annually or itemizing. With the standard tax deductions at $13,850 for single/married filing separately and $27,700 for married filing jointly for 2023, only about 10% of American households itemize their deductions. If you have a lot in the following categories, however, it’s worth double checking your itemized deduction amount versus the standard deduction limit. Take whichever deduction is higher. Expenses that may be included in an itemized deduction include (but are not limited to):
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Medical expenses
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Taxes paid
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Mortgage interest
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Charitable donations
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Investment interest
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Casualty and thefts
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Finally Arrive
Once you have your AGI and have subtracted your deduction, you get your taxable income, which is the amount you are actually taxed on for the year.
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Calculate the Amount of Taxes Owed
Once you know what your taxable income is, you can determine the amount of tax owed using the progressive tax brackets.
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How Do Tax Brackets Work?
In the United States, income taxes are calculated using a progressive tax structure. The marginal tax rate increases as income increases. These marginal tax rates are applied incrementally to different portions of your income, based on the tax bracket thresholds the IRS sets every year. Marginal tax rates increase as the tax bracket thresholds increase.
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In English?
Let’s take a look at the marginal rates for tax year 2023 by taxable income, and then look at an example.
Now let’s say you are a single physician whose taxable income is $200,000 for the 2023 tax year.
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Your taxes would be calculated under each marginal tax bracket “bucket” as:
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10% of the first $11,000: 0.10 x 11,000 = $1,100
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12% of $11,001 – $44,725: 0.12 x (44,725-11,000) = $4,047
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22% of $44,726 - $95,375: 0.22 x (95,375-44,725) = $11,143
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24% of $95,376 - $182,100: 0.24 x (182,100-95,375) = $20,814
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32% of $182,101 - $200,000: 0.32 x (200,000-182,100) = $5,728
Adding each bucket together gives you your total tax amount for the year:
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$1,100 + $4,047 + $11,143 + $20,814 + $5,728 = $42,832
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For an income of $200,000, your taxes would be $42,832. You do not owe the 32% tax rate for your entire income, which would have equaled $64,000, significantly more.
Now let’s say you are a married physician. Between working in your own private practice, your real estate dealings, and your investment earnings, your household is crushing it with a taxable income of $750,000 for the 2023 tax year.
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Here, we are going to use the married filing jointly marginal tax rates.
Your taxes would be calculated under each marginal tax bracket “bucket” as:
10% of the first $22,000: 0.10 x 22,000 = $2,200
12% of $22,001 – $89,450: 0.12 x (89,450-22,000) = $8,094
22% of $89,451 - $190,750: 0.22 x (190,750-89,450) = $22,286
24% of $190,751 - $364,200: 0.24 x (364,200-190,750) = $41,628
32% of $364,201 - $462,500: 0.32 x (462,500-364,200) = $31,456
35% of $462,501 - $693,750: 0.35 x (693,750-462,500) = $80,937.50
37% of $693,751 - $750,000: 0.37 x (750,000-693,750) = $20,812.50
Adding each bucket together gives you your total tax amount for the year:
$2,200 + $8,094 + $22,286 + $41,628 + $31,456 + $80,937.50 + $20,812.50 = $207,414.00
For an income of $750,000, your taxes would be $207,414.00. You do not owe the 37% tax rate for your entire income, which would have equaled $277,500.
To summarize this math so you don’t have to calculate each bracket separately:
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Marginal tax brackets for the tax year 2023
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Single individuals
Married filing jointly
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Alternative Minimum Tax (AMT)
Once you determine your tax due from the bracket, you have to check to see if you fall under the rules for alternative minimum tax (AMT), which adds to your tax bill.
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Alternative minimum tax is a tax system imposed by the US government that requires taxpayers to calculate their tax liability twice. Once, under ordinary income tax rules and then under the AMT and pay whichever amount is highest. The AMT is the excess of the tentative minimum tax over the regular tax. It is owed only if the tentative minimum tax for the year is greater than the regular tax for that year.
How to calculate AMT?
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Compute taxable income eliminating or reducing certain exclusions and deductions
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Subtract the AMT exemption amount
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Multiply this by the appropriate AMT tax rates
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Subtract the AMT foreign tax credit
Purpose of AMT
AMT is designed to prevent taxpayers from escaping their fair share of tax liability through tax breaks. The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.
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Take Any Additional Tax Credits
Once you have your tax amount for the year, there are certain tax credits that are excluded from the AGI but still reduce your taxable income. These may include (but are not limited to):
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Child tax credit and credit for other dependents
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Foreign tax credit
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Education credits
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Home energy credit
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Earned income tax credit (EITC)
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Adoption credit
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Electric vehicle credit
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Done, Done
Subtracting your additional tax credits from your calculated tax burden yields your total taxes due for the year. Once you compare it to the taxes withheld throughout the year, you arrive at either your tax return or tax amount due.
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Understanding Tax Deductions vs. Tax Credits
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Tax deductions and tax credits both reduce the total that you’ll pay in taxes, but they do so in different ways. A tax credit is a dollar-for-dollar reduction of the money you owe, while a tax deduction will decrease your taxable income, leading to a slightly lower tax bill.
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Tax Deductions
Tax deductions reduce the amount of your taxable income that is subject to taxes.
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These deductions lower your taxable income by the percentage of your highest federal income tax bracket. Thus, tax deductions lead to a slightly lower tax bill.
Example: If you’re in the 10% tax bracket, a $1,000 deduction would only reduce your taxable income by $100.
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Tax deductions lead to a slightly lower tax bill. There are two ways to claim deductions.
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Standard Deduction
This is the kind of deduction that any taxpayer can claim automatically. How much you can deduct depends on your filing status. The largest standard deduction is set aside for married couples filing a joint tax return.
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Itemizing Deductions
Itemizing involves listing out individual expenses that you want to write off on your return. Itemizing your deductions generally makes the most sense if your total deductible expenses are higher than the standard deduction. See the list above for example deductible expenses
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Tax credits
Tax credits directly reduce the amount of taxes you owe, giving you a dollar-for-dollar reduction of your tax liability.
Your ability to qualify for a particular tax credit depends on several factors, including your income, age and tax filing status.
If you qualify for a $1,500 tax credit and you owe $3,000 in taxes, the credit would reduce your tax liability by $1,500.
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Nonrefundable versus refundable tax credits
If you don’t owe a lot in taxes to begin with, you don’t get the full value of nonrefundable tax credits if the credits take your tax bill below zero.
Example: A $600 tax bill combined with a $1,000 nonrefundable credit doesn’t get you a $400 tax refund check.
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If you qualify to take refundable tax credits — things such as the earned income tax credit or the child tax credit — the value of the credit goes beyond your tax liability and can result in a refund check.
The IRS lays out specific criteria you must meet to qualify for both non refundable and refundable credits.
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Tax Withholdings and Refunds
If you get to the end of your lengthy Form 1040 and you have overpaid your taxes through your withholdings, you’ve loaned your money to the federal government at 0% interest. That’s not a great short-term investment strategy. Check out these short-term investment options instead.
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In this situation, it’s important to update your withholdings on your W-4 to make sure you don’t have the same over withholding issue again for the current tax year. The IRS has a Tax Withholding Estimator that can help you figure out what adjustments you need to make based on your predicted income for this year and the income and taxes you’ve already earned and had withheld so far.
If your income is more variable as a business owner or self-employed individual, the IRS requires you to pay quarterly tax estimates so that you don’t get hammered with a huge bill at the end of the year, which can cause high penalties and fees. Learn more about side gig finances.
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Quarterly Estimated Taxes
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What IRS Estimates Tax Payments Are
Federal income tax is a pay-as-you-go tax. Your income tax can either be paid via withholdings or by estimated tax payments.
For W-2 employees, this is taken care of through your W-4 withholding selections, which you provide your employer at the start of a job so they can withhold taxes from each paycheck. They send the withheld taxes to the IRS on your behalf and report your total income and withholding to the IRS at year end. You then receive your W-2 summarizing what income and withholdings they’ve reported and sent.
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You can also select to have voluntary withholding (typically not withheld by default) on other types of income streams such as annuities, pensions, IRAs, social security income, and dividends.
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When you are working a side gig, are self-employed, or run your own business, you are required to pay as you go on a quarterly basis. If you don’t, you can receive hefty fines and penalties from the IRS when it’s time to file your taxes.
Types of income you should assess when determining if you need to pay quarterly taxes:
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Interest payments outside of sheltered retirement accounts
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Dividend payments outside of sheltered retirement accounts (even if they are reinvested)
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Retirement payouts
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Capital gains outside of sheltered retirement accounts
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Alimony
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Self-employment income
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Business income
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Who Owes Estimated Tax Payments
Sole proprietors (this includes if you are working side gigs and are not considered a part-time employee), partners, and S corp shareholders generally owe estimated taxes and are required to make estimated tax payments if they expect to owe more than $1,000 ($500 or more for corporations) in tax after subtracting their withholdings and tax credits on their return come tax time.
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If you have paid at least 90% of the tax for the current year, or 100% of the tax shown on your return for the previous year (whichever is smaller), then you will not owe a penalty come tax time in April.
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If you or your spouse receive salaries or wages through another employer, you may be able to avoid having to make estimated tax deposits by asking the employer to withhold additional withholding from your W-2 job. To do this, coordinate with the HR department or the online pay platform. You will need to know what additional withholding amount they need to withdraw, so make sure you review the Form W-4 ahead of time or use the Tax Withholding Estimator. This works better if your non-withheld-from income is relatively steady over the entire year or is smaller in total amount. For example, if you are house hacking and know what the general income and expenses are for your steady renter every quarter, you could withhold extra from your W-2 physician job to cover that extra income. But if you are doing a combination of coaching, speaking gigs, and expert witness work, your self-employed income can vary greatly quarter by quarter, making it more difficult to adjust your W-4 to withhold from your wages.
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When Estimated Tax Payments Are Due
To avoid penalties, estimate taxes must be paid by their due date and for the required amount. Estimated tax payments are due on:
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April 15th for income earned between January 1st and March 31st
June 15th for income earned between April 1st and May 31st
September 15th for income earned between June 1st and August 31st
January 15th (of the following year) for income earned between September 1st and December 31st
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If the due date falls on a federal holiday or weekend, the payment is due the next business day.
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How to Calculate and File Estimated Taxes
To calculate and file your estimated taxes, you can use Form 1040-ES by mail or you can pay online or via phone via various methods delineated in the How to Pay Estimated Taxes section of this page on the IRS website. A lot of people like using the Electronic Federal Tax Payment System (EFTPS) online which is convenient and provides clear tracking of all payments made.
If you have a more complicated situation, such as several different income sources coming in without withholding, or have high variability in your non-withheld income, it’s also a good idea to work with an accountant at the end of every quarter to make sure you are covered.
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As a very general rule, many recommend setting aside 25-35% of the income that comes in without withholdings depending on your tax bracket. That way, at the end of every quarter, you won't find myself with a huge estimated tax bill due to the IRS and without the money to pay estimated taxes because you've already spent or invested that money. A short-term investment option such as a high-yield savings account or money market account is a great place in which to tuck the taxes away as the money comes in. Just make sure you check account transfer and transaction limits.
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Bonus Withholdings
We hear stories from residents who are so excited to have their first job lined up, especially when it comes with a significant signing bonus. A lot of times, they start allocating the entire amount their future employer has offered them as a signing bonus towards things like moving expenses. They forget to take into account that bonuses are income and thus taxed, and sometimes at higher rates than normal income. (This can be true for other supplemental income, such as commissions, as well.) When the bonus comes in, it’s significantly less than they planned for, and now they have to scramble to cover the expenses they’ve already coordinated under the assumption of a higher amount hitting their bank account.
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Don’t find yourself in this situation. Make sure you know how much you’re going to get in your payment after withholdings before spending the entire bonus in your head. As discussed above, under the progressive tax structure, different buckets of money are taxed at different rates. When bonuses are significant, they can fill your normal marginal tax rate bucket and bump you into a higher rate for part of the bonus amount.
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The default flat rate for withholding on bonuses is 22%, but if you fall into a higher tax bracket due to the bonus, the withholding rate may be higher to account for the increased marginal tax rate. Employers can choose to withhold on bonuses using an annualizing method, which calculates the estimated tax to withhold based on a projection of your entire annualized income for the year. This can lead to a higher withholding rate.
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Quarterly taxes are required to keep your overall tax underpayment come April 15th low enough to avoid penalties. Since bonuses are a one-time, often large lump sum, your employer will likely use one of the above methods as a built-in way to cover the extra withholding and save you the headache of having to calculate and file the quarterly estimate return.
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Filing an Extension
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If you have a complex income and tax situation (such as you are still awaiting your K-1 numbers from your partnership or you have several different rental properties and investments to compile records for) and find yourself up against the clock for the tax filing deadline, you might hear the term extension thrown around.
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It’s important to know that filing an extension gives you additional time to file your tax return. It does not extend the amount of time you have to pay any taxes that are due. If you do not make the quarterly estimate payment by April 15th when it’s due, or don’t pay the taxes you owe with your previous year’s return by the tax deadline, you will be subject to interest and penalties, which can be significant when dealing with the IRS.
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In order to file for an extension, you need to provide the IRS with a completed Form 4868 and send any payment due with the form by the normal filing date. Extensions generally give you a six month extension, and you can file your return at any time during the extension period.
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What To Look for When Hiring An Accountant
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We often have physicians on the communities seeking trusted accountants. Unless you've been very lucky, you know that it's not always easy to find an accountant that meets your needs.
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A few questions to ask yourself during the process of looking for an accountant:
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Do you need an accountant? For many physicians, the answer to this question.
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Should you use online tax preparation tools or an actual accountant?
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What role do you need your accountant to play? This will come down to things including your sources of income, how many states you're filing in, the complexity of your financial life, your desire to explore different tax strategy options, etc.
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What's your budget? What do the accountants you're considering charge? What's included in that price?
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Are you confident they will be responsive? Do they have a team large enough to handle the workload?
The more complicated your situation, the more likely you'll need an accountant and the more you should expect to pay.
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Visit our choosing an accountant page to dive into what questions you should ask when interviewing accountants so that you know you're hiring the right professional for your situation.
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You should also look into the certifications that they have. While CPA is the most common and necessary certification, you may also want someone with additional expertise in tax strategy, financial planning, company accounting management, estate planning, etc).
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There are many other questions you may want to ask depending on your business, such as if they can help with issues such as sales and use tax, entity creation and maintenance, registered agent services, etc. Chances are, if you know about these things, you'll know what you need from them.
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