It doesn’t take long after receiving your first paycheck to realize that your all of your money is not your own. The U.S. government is an active partner in your earnings, and the more money you make, the larger its take. While taxes are a fact of life, physicians have more control over how much of them they pay than they might think. A little knowledge can make physicians’ lives less taxing resulting in hundreds of dollars of savings back into their pocket each year.
Tax planning is not just for the rich. The Internal Revenue code is full of ways that the average taxpayer can use to make life less taxing. Physicians can benefit from taking a little time to understand how the code applies to their situation. Here are just are few important steps anyone can take to get in control of their taxes:
Stop Loaning Money to the Government
The average tax refund, which is the amount of over-paid taxes that the U.S. government returns to taxpayers, is $3,100. While many people become ecstatic when they receive their refund check, they might feel a little less exuberant when they realize that all they did was give Uncle Sam an interest free loan. In essence, a $3,100 refund translates into the loss of over $250 a month that could be used to pay down debt or save for retirement. Over time, those lost opportunities add up to thousands of dollars in additional interest costs or lost interest earnings over time.
If you expect to get a refund each year, you need to have your withholding changed to reflect your current earnings and tax status. Your W-4 form provides you with a guide to determine the number of allowances you should claim so that the right amount of tax is withheld.
Not all Income is Taxed the Same
The first dollar you earn each year is taxed at the lowest rate which is 10% and the last dollar is taxed at a higher rate (up to 28%) depending on your total net earnings. It may be important to know your tax bracket so that you know how much you will pay in taxes. If you find that an earnings increase will bump you from the 25% tax rate to the 28% rate, you might want to consider ways to reduce your income for the current year. For instance, you could make a larger contribution to your 401(k), or consider making a larger contribution to charity.
Know What Income Get’s Taxed
Generally, you are not taxed on your earned income. Rather, you are taxed on your Adjusted Gross Income (AGI) which is your earned income less certain adjustments and deductions. Just because your earnings may increase, doesn’t mean your taxes will necessarily increase. Adjustments include contributions to your retirement plan, so, if your earnings increase you can increase your contributions thereby keeping your AGI lower. The very best and easiest way to lower your AGI is by making a maximum contribution to your qualified retirement plan.
Itemize if You Can
The majority of taxpayers file Form 1040EZ which doesn’t include itemized deductions. If the total amount of your deductions don’t exceed the standard deduction ($5950 for single filers; $11,900 for married filers – 2012), then you would just take the standard deduction. The mistake a lot of people make, is that they don’t at least check to see how many itemized deductions they have. But, as your earnings improve, and your finances grow, so too can your expenses that qualify as deductions.
Expenses such as out-of-pocket medical costs, mortgage interest, state taxes, registration fees, charitable contributions, professional fees, unreimbursed business expenses, can all add up fairly quickly. Maximizing your deductions is the key to keeping a lid on your AGI. Be sure to keep detailed records and copies of your receipts so you can calculate and verify your itemized deductions.