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Surveys show that about half of all Americans believe they pay too much in taxes. For many dentists, it can feel like that number is higher. A hatred for paying taxes is something that unites us all.
Part of the reason for this dislike is many people don’t fully understand how federal income taxes work. And this misunderstanding may lead to a myriad of poor tax decisions that can be costly.
The U.S. has a progressive tax system, which is just a fancy way of saying that as your income increases, it’ll be taxed at a higher rate. The government decides how much tax you owe by dividing your taxable income into chunks called tax brackets.
Currently, there are seven tax brackets for ordinary income:
10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The most important thing to understand about tax brackets is that being “in” a certain bracket doesn’t mean you pay that tax rate on all of your income. Each chunk of your income gets taxed at the corresponding rate.
For example: Let’s say you’re a single filer and you have $50,000 of taxable income in 2024. That amount of income would put you in the 22% tax bracket. But you don’t pay 22% on the entire $50,000. You would pay 10% on the first $11,600, 12% on the chunk of income between $11,601 and $47,150, and then 22% on the rest.
Your total tax bill would be $6,052. So even though you’re in the 22% tax bracket, only around 12% of your income is actually going towards federal taxes. That 12% is called your effective tax rate.
We often hear people say something along the lines of, “Well, I don’t necessarily want a raise or to make more money this year because I’ll just get bumped into a higher tax bracket.”
This is flawed thinking. If you want more money in your pocket, it’s always better to make more money. Remember, 70% of something is always better than 100% of nothing.
Tax deductions or “write-offs” are another common misconception. Just because something is tax deductible does not mean it’s free.
If something is tax-deductible, it means that you’ll be able to deduct the cost from your taxable income. This provides a small tax break, but it doesn’t make the purchase free. Depending on your tax bracket, a tax deduction could make a purchase something like 25% off, but that still means it’s 75% “on”.
For example, let’s say you’re in the 12% tax bracket and you give $5,000 to your local church. Donations to charities are tax-deductible so that $5,000 donation would save you $600 in taxes. Which is great if you were planning on giving to your church anyway and weren’t doing it for the tax break.
But if your goal was to preserve as much money as possible and you were donating only for the tax savings, you’d be better off keeping the $5,000 and simply paying the 12% tax bill. In this scenario, you’d keep $4,400 in your pocket instead of giving away a $4,400 donation.
Tax deductions are great for necessary expenses in your life or in your business, but if you’re buying a piece of equipment or donating to charity solely for the tax deduction, it doesn’t make financial sense.
Don’t let the tax tail wag the decision-making dog.
This was one of the mistakes from our complimentary E-guide: “10 Mistakes that Can Cost Dentists $10k or more”. To read all 10 mistakes, download the complete E-Guide here:
10 Mistakes that Can Cost Dentists $10k or More
*For illustrative purposes only. Dentist Advisors does not provide tax related services; please be sure to consult with a tax professional before implementing any investment strategy.