These items certainly are not all-inclusive, and I am not an accountant or financial advisor. I am simply a PA-C with a desire to share financial independence concepts with current and future PAs. This information is for educational and informational purposes only. You should definitely do your own research and consult with a professional if you have questions!)
Tax Day, which is usually April 15th, is a day that many do not necessarily look forward to. However, the IRS recently announced that Tax Day was pushed back to May 17th, 2021, for 2020’s taxes. Many new PAs will be surprised how much of their income goes towards taxes, and many experienced PAs still cannot believe how much of their income seems to vanish because of taxes. For some, it can seem as though the more income they earn, the more money seems to disappear towards taxes. So is it even worth it to try to earn more income? What can you do to try to reduce your tax burden?
Some of these tax tips and tidbits would only pertain if you decide to itemize your deductions versus taking the standard deduction. I encourage you to review your taxes each year to decide which option between itemizing or taking the standard deduction works out better for you for the year.
I recognize that all of this tax stuff may be a bit boring and dry, but it’s really important for PAs to understand! So grab a cup of a caffeinated beverage of your choice, find a comfy area to sit, and digest this information!
You Can Deduct Student Loan Interest, but Only up to a Certain MAGI
This tidbit of knowledge was presented to me by our “financial advisor” right out of PA school. I place the quotes around financial advisor as he really was a life insurance salesman with the title of financial advisor with whom we eventually parted ways. (This is a story for another time). He suggested that instead of trying to pay off my student loans quickly, we instead purchase overly expense, and dare I say, unnecessary whole life insurance, because I could deduct my student loan interest, which would help with our taxes.
HOWEVER, he failed to point out (and granted, we didn’t do our own research because we were young, naive, and not financially literate at the time) that this is only true up to a certain MAGI (modified adjusted gross income). MAGI is defined as either an individual’s or household’s adjusted gross income with any tax-exempt interest income and certain deductions added back. MAGI is the basis for determining whether you qualify for certain tax deductions, and is the sum of your adjusted gross income (AGI), your tax-exempt interest income, and specific deductions added back. For single filers, the income to qualify for this is less than $70,000, with a gradual phase out up to $85,000, and for married filing jointly filers, the income to qualify for this is less than $140,000, with a gradual phase out up to $170,000. So once our joint MAGI surpassed $170,000, we no longer qualified to deduct our student loan interest. Honestly the income limits for both single and joint filers are not that difficult to reach with a PA income. If you qualify for this deduction, you can deduct up to $2,500 of the amount that you paid in student loan interest.
Please note: With the current pause to federal student loan payments and interest accrual due to the COVID-19 pandemic, you may decide to hold off on making some federal student loan payments until this is no longer in effect.
You Can Contribute to Tax-Deferred Accounts to Help You in the Current Tax Year
When you contribute to tax-deferred accounts, you will pay taxes in the future when you withdraw from them, but contributing to them now allows you to save on your current tax year, because it helps lower your taxable income. Examples of these types of accounts include the following: traditional 401(k), traditional 403(b), traditional 457(b), HSA, and traditional IRA. Therefore, contributing to a tax-deferred account benefits you by allowing you to invest, but also may help to lower how much you may need to pay in taxes. Read more here about why HSAs are such great accounts as they are trip tax advantaged!
You Can Contribute to Tax-Exempt Accounts to Help You in Future
When you contribute to tax-exempt accounts, you will pay taxes on them now, but never again in the future! Examples of these types of accounts include Roth IRA, Roth 401(k), Roth 403(b), and Roth 457(b).
You Can Give Money or Donate Items to Charity to Help Lower Your Taxes
Donating money to charities helps both you and them out! You not only help with financial assistance for the charity of your choice, but you will also help save on your taxes. Donating items to charities can also help others while helping you save on your taxes. You could also start a donor advised fund, which is a charitable investment account.
Owning a Home Can Help You Lower Your Taxes
I would first like to start by saying that the decision to purchase a home versus rent has many pros and cons on both sides (which will be covered in the future), and you should not pursue homeownership ONLY to lower your taxes. However, if the decision to own a home is what you have decided is best for you in your current circumstances, then understand that there can be some tax benefits. You can deduct your mortgage interest as well as up to $10,000 of property taxes if you’re married and filing jointly and up to $5,000 if you’re single or married filing separately.
Trying to Aim for $0 Owed and $0 Refund for Your Taxes Is a Good Strategy
I used to look forward to receiving a tax refund because it seemed to be almost like a “bonus”, which I could use for a special treat that I had been wanting. However, if the government owes you money on your tax return, it can actually be viewed as though you’ve been lending the government an interest-free loan for the past year. A tax refund is not some special amount of money that the government owes you; it is in fact YOUR money that is owed you. Instead of hoping for a giant refund, instead try to tax plan so that you have access to your money throughout the year instead of the government!
Now, as my husband and I have earned more over the years, the amount of taxes we have owed has been increasing as well. You also do not want to owe a giant amount of money to the government each tax season, so again, try to plan, adjust your tax withholding on your W4, max out your tax-deferred accounts once you are financially able to, etc.
You Should Not Try to Avoid Earning More to Pay Less in Taxes
Many PAs may have this thought at some point throughout their career: “Should I even try to earn a higher income, if I’m just going to have to pay more in taxes? Is it even worth it?” I have definitely had these thoughts over the years! However, potentially having to pay more taxes should NOT be a reason to try to avoid earning more income, as overall, earning more will help you financially.
One informative tidbit that has helped calm and soothe my thinking in this matter is the following: as your income and tax bracket increases, only the earned amount above the threshold of the last tax bracket is taxed in that particular bracket. So what does this mean? Here are a couple of examples: if your income as a single PA is pretty nice in the year 2021 at $170,000, or if your joint income with your spouse as a married PA filing jointly is $340,000, then you’re just above the income threshold for the 32% federal tax bracket. However, this does NOT mean that your entire taxable income is taxed at 32%. Instead it means that only your taxable income above $164,926 as a single filer and $329,851 as married filing jointly filer are taxed at 32%. The breakdown of your federal taxes for the year 2021 would be as follows:
|Single Filers Tax Rate||Taxable Income Bracket||Tax That You Would Owe|
|10%||$0 – $9,950||10% of taxable income in this range|
|12%||$9,951 – $40,525||$995 plus 12% of taxable income over $9,950|
|22%||$40,526 – $86,375||$4,664 plus 22% of taxable income over $40,525|
|24%||$86,376 – $164,925||$14,751 plus 24% of taxable income over $86,375|
|32%||$164,926 – $209,425||$33,603 plus 32% of taxable income over $164,925|
|35%||$209,426 – $523,600||$47,843 plus 35% of taxable income over $209,425|
|37%||$523,601 or more||$157,804.25 plus 37% of taxable income over $523,600|
|Married Filing Jointly Tax Rate||Taxable Income Bracket||Tax That You Would Owe|
|10%||$0 – $19,900||10% of taxable income in this range|
|12%||$19,901 – $81,050||$1,990 plus 12% of taxable income over 19,900|
|22%||$81,051 – $172,750||$9,328 plus 22% of taxable income over $81,050|
|24%||$172,751 – $329,850||$29,502 plus 24% of taxable income over $172,750|
|32%||$329,851 – $418,850||$67,206 plus 32% of taxable income over $329,850|
|35%||$418,851 – $628,300||$95,686 plus 35% of taxable income over $418,850|
|37%||$628,301 or more||$168,993.50 plus 37% of taxable income over $628,300|
So as you can see, as your income increases, you only pay a higher percentage of taxes on the amount earned that is higher than each tax rate threshold, not the full amount of your earned income. This is called marginal tax rate.
It is important that PAs take the time to educate themselves about taxes to understand how they work, and to try to optimize how to pay taxes while still being able to save and invest on their journeys to financial independence!