Physician, you have arrived.
Your practice is beginning to make more money than it spends, and you can afford your student loan payments with money left over to live on.
At this point, you have possibly already started a family, or else are in the process of doing so.
Life is good, made all the better by our federal government’s willingness to provide you with the child tax credit for all your little precious carpet crawlers.
If you and your spouse together make less than $400,000 in adjusted gross income (AGI), and the kids are all less than 17 at the end of the year, that means a tax credit of $2,000.
Credits vs. Deductions
There is a difference between credits and deductions in tax language, and it is hugely important to understand if you don’t already.
A deduction reduces your gross income to a lower net income amount, after which your tax is calculated. Therefore by the mighty power of mathematics deductions save you money on taxes.
Less income = less taxes. Life continues to be good.
But if you’re grasping this concept carefully you are probably realizing that means that deductions do NOT reduce your tax dollar for dollar.
You’re right!
When you think about deductions, as many of us often joke around about when we’re taking colleagues or prospective business relationships out to lunch, you’re thinking something along the lines of, “it’s all good, I’m writing it off!”
Well, true, but listen closely to this. It may change your perspective about freely unlimbering the plastic from your wallet to spring for a meal.
Deductions reduce gross income.
When you divide taxable income (which is gross income adjusted for the standard or itemized deduction and the qualified business income deduction ((QBID)) into the tax from the IRS table you get a percentage called the effective tax rate.
Put that phrase in your head next time you’re out to lunch.
Effective tax rate.
Because that is all you’re actually writing off on that meal, with the further deep cut of dividing it in half!
Example: you spend $100 to take yourself and 3 others out to lunch. Let’s say your effective tax rate has been around 15% the past couple years.
You’re only writing off, or reducing your tax by $7.50 for that meal.
What? Darn you, evil math!
That is how a deduction works (take heart, meals are really the only deduction that only allows 50% currently).
Credits, on the other hand, reduce tax on the back page of 1040.
You should like deductions, but be madly in love with credits.
The Child Tax Credit was increased to $2,000 after the big tax reform that kicked in 2018, and it went absolutely bonkers in 2021 and 2022 post-COVID, but it’s back down to earth again and holding steady at $2,000.
You should love the Child Tax Credit. Millions do, and it makes life easier for all of my family men and women on the client roster, but…
There is a poisonous reptile hiding in the weeds for those who rely on this credit in their year-end and estimated tax calculations.
I’m about to drop the dime on these pesky critters and reveal them in all their hideous reality.
The Snake in the Grass
What I’m about to share with you comes from bitter experience.
What did they say at the beginning of Fargo the movie as well as the TV series?
“At the request of the survivors, the names have been changed. Out of respect for the dead, the rest has been told exactly as it occurred.”
Now, I’m in Colorado, along with a little over half of my client roster.
We’re not in Fargo or Minnesota, but the story you’re about to hear is specific to my colorful little mountain state.
Pay attention, America, because you have a better-than-normal chance of this affecting you, too.
You see, most states do not follow suit with the child tax credit, including Colorado.
Here in Colorado, we have a fairly straightforward tax calculation: it’s 4.5% of the federal taxable income, with some nice little adjustments for local charitable giving, retirement income, and state sales tax, but no love for the kiddies.
You may ask yourself, “How does this rise to the level of a poisonous reptile?”
Simple. People tend to view the IRS as the larger obligation come tax season, and the state as an incidental annoying additional amount. But!
If you have kids, there’s a strong possibility you’re actually going to pay less (or even nothing) in federal taxes after withholdings and payments but get smacked across the face openly with an unexpectedly high state tax bill.
Here is where the poison is, specifically in Colorado. But the rest of you states listen up, nasty things are coming to a tax return near you.
Colorado has been getting downright draconian in their assessment of the underpayment penalty for our state income tax.
They do calculate it based on payments (or lack of payment) for all 4 of the same quarters the IRS expects an estimated tax payment, and to make matters worse they will not waive penalties or interest.
What to Do About It
Starting this year with the very first Estimated Tax Payment deadline for both the IRS and Colorado, and probably for most of the other 40 states with a state income tax, we need to take the state estimated tax more seriously than ever.
If you are my client, here is your first heads-up. I’ll be reminding you again at the end of March, and in the April newsletter too!
Now, like a rattler, getting bitten usually doesn’t mean you’re going to die, but you are going to suffer financially if you fail to heed this friendly advice.
Calculating estimated tax quarterly for those of you with multiple children just needs to get a little more serious if you want to keep every single dollar of your own money possible in your own wallet.
Physician entrepreneurs, if you would like to discuss how having a non-equity financial partner guiding your practice’s business future can increase your wealth, reduce your taxes, and provide the peace of mind that will allow you to put 110% of yourself into your patient care goals?
We would like to talk to you as well.
We are still accepting one new business advisory clients in the month of February.
Use the link I’m providing below now to choose a time to talk most convenient for you.
You will also receive your own copy of 5 Mistakes Physicians Make That Hurt Cash Flow, just for booking a call.
Imagine having a financial coach and compliance expert by your side, so that you can focus your professional clinical time where it belongs: on patient care.
Does that sound good?
Then reach out to me, and let’s talk: Free Profit & Cash Flow Analysis