What is Tax Rate?
Tax Rate is a key indicator of your financial health. It’s the percentage of your annual gross income that goes to taxes.
Total Annual Taxes Paid / Total Personal Income = Tax Rate
Example: Assume your annual income is $300K. If you pay $87,600 in taxes, your Tax Rate is 29.1%. $87,600 / $300K = 29.1%.
Your Tax Rate focuses on total taxes paid. This is different from your marginal tax rate.
Why is Tax Rate Important?
Once you’re an attending physician, taxes are one of your biggest expenses for life. Don’t pay more than you have to. The IRS is like a restaurant with terrible service. Pay your bill, but don’t leave a tip!
Total Annual Taxes Paid
“Total annual taxes paid” includes federal income tax, state income tax, and payroll tax.
Just add up the following numbers:
- The “total tax” line on your federal 1040 (in 2021, it was line 24).
- State income tax on your state tax return.
- Boxes 4 and 6 of any W-2s you have.
The term “payroll tax” refers to Social Security tax and Medicare tax.
- If you are paid on a W-2, payroll tax is withheld from your earnings, and reported in boxes 4 and 6 on the W-2.
- If you are paid on a 1099 (e.g., locums work), payroll tax is NOT withheld from your earnings. For 1099 work, payroll tax is referred to as “self-employment tax” (SE tax).
- You pay SE tax on your income tax return. The “total tax” line on your 1040 includes your federal income tax and your SE tax.
Improving Your Tax Rate
While you’re working, saving tax now means taking every possible tax deduction. Some deductions are well-known, others less so. A few well-known ideas to save tax now:
- Submit all legitimate business expenses for reimbursement through your employer. Reimbursement is not taxable.
- Use Flexible Spending Accounts (FSAs), if your employer offers them, for medical expenses and dependent care. With FSAs, you avoid taxes on your contributions, and withdrawals are tax-free for qualified expenses.
- Contribute the maximum to all retirement accounts. The most common accounts are a 401(k) with a private employer, or a similar account called a 403(b) at an academic medical center or nonprofit hospital. You can make your contributions pre-tax or Roth.
If you’re retired, project your taxes in advance for the year, and use your tax diversification to stay in a low tax bracket.
For more ways to improve your Tax Rate, see the taxes section of our post, Financial Planning for Emergency Physicians, and check out the taxes category of this blog.
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5 Biggest Financial Mistakes ER Doctors Make & Simple Ways to Solve Them.
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