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How to Compare Your Tax Rate to Other Dentists – Episode 107

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Are you sick of surprise tax bills? How do you know if you’re paying a fair amount for your level of income? In this episode of Dentist Money™, Reese & Ryan cover all things taxes including income calculations, common deductions, entity structure implications, and how tax reforms at the end of 2017 might impact conversations with your CPA. They also explain why it’s not always easy to compare your tax rate to your peers’.

Podcast Transcript:

Speaker: This is Dentist Money. Now, here’s your host, Reese Harper.

Reese Harper: Welcome to The Dentist Money Show, where we help dentists make smart financial decisions. I’m your host, Reese Harper, and excited for a new episode with my trusty old co-host, Sir Ryan Isaac.

Ryan Isaac: Good afternoon.

Reese Harper: Sir, it’s a great day to be with you, on this tax preparation Wednesday.

Ryan Isaac: Don’t we call that every Wednesday in the office? No.

Reese Harper: I’m excited to release this episode, because we get a lot of calls year end around taxes, and we’ve decided to do … We’re going to try and do an episode a month around benchmarking and this happened because … We decided during the … We do a show every week, as our listeners know, and we decided to try to take one episode each month and focus it on the benchmarking that we’re doing that month, so that our listeners can understand a little bit how their situation might compare to hundreds of other dentists that we’re tracking.
And, maybe how other people’s feedback might affect the way they’re thinking, because we get a lot of questions, and we have a lot of concerns that come up during these months around these subject, and taxes is the thing we cover in December.

Ryan Isaac: Yeah, and the big question being, everyone wants to know, do I pay too much in taxes? How do I compare to the guy who makes the same amount of money as I do? That’s what everyone wants to know, and that’s where this began.

Reese Harper: Yeah, and so we were upstairs, and the thing that we’ve been trying to figure out is, we have a big sample, but it’s impossible to get people with identical incomes, right? Everyone’s income is within dollar … Their dollar’s different. Two people with a million dollars in collections have very different incomes at the end of the day. It’s really hard to get a hundred people with exactly $592,432 of income to compare it identically.

Ryan Isaac: Well, spread it out an even 50 grand, and it could bump you into another bracket, you cut of some deduction, or some exemption, and then …

Reese Harper: Yeah. So, the, I guess, big picture, we found that it’s harder and harder over time to compare effective tax rates, or the actually percentage of your income that you pay in taxes to other people because everyone’s situation is so, so different that it’s … We found some different ways that we feel like are more effective to compare taxes that we think will be insightful today. But let’s talk about the first problem you’re had, Ryan, in this month as you’ve been working on tax rate, which is how to calculate income accurately across all of the clients.

Ryan Isaac: Yeah, the only thing I was going to say real quick is that the question that comes up is we look at, let’s take two people with $400,000 of income, and one person was paying 10% less tax overall than the other person. Then we noticed that was kind of a trend among any income group. The bigger the spread to an income, the bigger the disparity in those tax rates. So, like you said, the first thing that we’ll talk about is how do we actually calculate income? What is income?
One of the things that we need to distinguish too for everybody listening, is how is this method of calculating income going to be different than what you might see on your actually personal tax return? Because we get those questions too. We’re trying to arrive at a number that represents the actually cash flow that a client gets their hands on every year, right?

Reese Harper: Yeah.

Ryan Isaac: The gross amount of dollars that they can use for taxes and debt, and spending, and savings, and all that kind of stuff. That’ll be a different gross income number than the one that’s calculated for personal tax returns. We’ll talk about the difference though. But, we’ll start with that. How do we calculate income?

Reese Harper: Let’s start, why do you want to calculate income the way you calculate it?

Ryan Isaac: Yeah, so like I was just saying, we want to know what is the total gross amount of dollars that someone even had available, because throughout the year, we’re trying to calculate things like what percentage of your money goes towards savings, or how much goes towards taxes, or debt, or personal spending.
And so, to be able to have the accurate picture, we have to know how much really came in the door. The personal tax return doesn’t always tell the whole story, that’s why when we ask people, “What do you think you make in a year?” Most people under estimate it by a good margin.

Reese Harper: Exactly, so if I’m going to add up someone’s income, what are the things that I might take into consideration, besides the obvious stuff? Because, the obvious stuff you think of is I got to look at my salary-

Ryan Isaac: Yeah, W2.

Reese Harper: … and I have to have my profits that are on the bottom of my … That I take my business profits and then any distributions I might pull out, which are also included in those profits, typically on the tax return. But people think of it that way like, “Well, it’s whatever I took out plus whatever my salary is, then there’s some business profit.” It’s hard for an average dentist, and I can totally understand why, it’s really hard to know what you actually make, but that’s not what you think your total is.

Ryan Isaac: Those are the two big ones. What’s interesting about that though is if you’re an S corp, and you take your S corp tax return, and you take your personal return, if you have a retirement plan that reduces your salary at the business, the W2 on the S corp won’t match the W2 on the personal return.
If you take a 179 deduction, or you have losses that you’re deducting on your personal return on schedule E, then the net income at the bottom of the corporate won’t match the net income on the bottom of the personal, so it’s hard.

Reese Harper: Yeah, your business returns and your personal tax returns show different numbers, so what’s the real number? And for financial planners like us, our concern is if we don’t know the true economic benefit that a client got from their dental practice, their true real cash flow income, then it’s hard for us year after year to measure whether they’re making progress.
So using our elements, as you guys know, the second row of our elements table measures where you income goes. Do you spend it? Do you save it? How much do you pay in taxes? How much goes towards debt? If we don’t have a good accurate annual income number, it’s hard for us to really make good forecasts, and know what’s going on, and if your overall situation’s healthy as it should be.

Ryan Isaac: So going back to your question, what are the categories we have? The two big ones, W2 salary, net income-

Reese Harper: What are some we don’t think about?

Ryan Isaac: Yeah, so a couple we don’t think about. We add back in for gross income, what money did you actually get your hands on kind of purposes. We add back in two categories that are actual deductions on the corporate return, one of them being amortization, which is when you slowly write off the … you deduct the good will of the business that you purchased.
Then the other one is depreciation. Amortization shows up usually in statements towards the bottom third of the tax return in list where you’ll see supply cost, and labs, and things like that. Depreciation is, I think it’s line 14 on an S corp return. It’s right in the middle on the front page, and that’s the deduction you take slowly over time for buying stuff, if you’re doing a build out, buying equipment, things like that. Why do we add that back in, I guess is the important question.

Reese Harper: Yeah. Well, we add those things back because those aren’t’ real cash expenses that you incurred. They’re government allowed write offs that you get for things that have happened, things you’ve purchased. So when you buy a practice, you’re going to put a loan on a certain schedule, and you’re going to pay it off. You’ll either pay cash, or you’re going to pay it off in seven years or 10 years.
But, the amortization that you get is going to be written off over a much longer period of time, more longer than your payments on your loan. It’s not a real cash expense, and either is depreciation. If you buy a computer and … or let’s say you refinish your space and you put in a bunch of new TIs and four new chairs, some of that stuff will be 179 depreciation-

Ryan Isaac: Which is where you just take the depreciation, do it in one year instead of spread it out.

Reese Harper: Some will be spread out over five to seven years, and sometimes more. And so, you have to add back depreciation in order to get a sense of what someone’s real income was, because it’s not a real cash expense.

Ryan Isaac: Yeah. So those are a little less known. Then there’s a few smaller ones that-

Reese Harper: They can add up.

Ryan Isaac: They can add up, and it depends on the situation. One would be a dentist who owns the building they practice in, and owns it in a separate LLC, and then makes a rent payment from the corporate entity to the LLC that owns the practice, and sometimes you’ll over pay on that. Then, they’ll take the overpayment out of the LLC that owns the building as a net income distribution. It’s more net income from another entity.

Reese Harper: Yeah, they pay money to the entity that holds their building and then they just take the money out of there that they don’t need.

Ryan Isaac: Yeah, so if they make 50 grand of payments in a whole year, but they pay 100 grand to this entity, then we have to add some of that back in as income, because it is taking income just in a different spot, that’s one.

Reese Harper: It’s hard to … That’s a really tricky issue because a lot of people don’t … People chose to pay different amounts of rent to themselves based on their tax planning. So what we try to do is we try to normalize that a little bit, and we try to say how much of this is just to cover what rent would normally be in that situation?
How much of it is for building payments and how much of it is really just excess rent that you’re paying that should count towards income? Because a lot of people wipe out a large portion of their income by paying over to an entity where they have their property, but that still needs to be accounted for in your personal income as cash flow that you could have earned.

Ryan Isaac: Yeah, and sometimes there’s depreciation on those entities too, with the building. And so, you have to take that into consideration. Another one that’s similar is there are some practices that where the owners also have their own management corporation. They might have multiple locations and then have a central management corporation that maybe employs some people or has some services or pays for some things, and they’ll pay a management fee out to that.
But, if there’s net income from the management company as well, then you have add that back in. So those are some of the smaller ones.

Reese Harper: If you’ve never heard about that, don’t worry about it, because you don’t need one.

Ryan Isaac: Yeah, I’m not giving you advice on what to go do, I’m just saying some people-

Reese Harper: You don’t necessarily need one.

Ryan Isaac: Yeah.

Reese Harper: That’s something that-

Ryan Isaac: You’re not missing out on something.

Reese Harper: Yeah.

Ryan Isaac: Another smaller one would be there could be some … I was saying this before. The W2 on your corporate return might be different than the W2 income on your personal return, if you have a 401K or a simple IRA, something that’s reducing your pretax deductions off of your W2 income. That’ll be reduced before it even hits your tax return, so you have to take that into account.

Reese Harper: So all the money you’re putting into a retirement accounts, that’s technically money you could have just taken home, so it counts as income in our calculations.

Ryan Isaac: Yep.

Reese Harper: Then, you could also add back any personal expenses. I think it’s this last one that’s probably the … If you go to-

Ryan Isaac: Yeah, it varies a lot too.

Reese Harper: You take a big trip, and you justify it as a business expense, is that really a business expense, or was that just money that you could have taken out personally and just chose to write it off through the business to save a little bit on tax?
What about things like some of your meals and entertainment, some of your travel-

Ryan Isaac: Vehicles.

Reese Harper: Some of your vehicle expenses. There’s a lot of things that could be-

Ryan Isaac: Those are smaller.

Reese Harper: They’re smaller but we may choose to add them back in order to give people a better reflection of their income. So why do we do this? I mean, I think a lot of people are like … Okay, it’s a really complicated way to calculate income, I mean to …
I think we said it in the beginning, if we have two people that are both collecting 100,000 and one’s tax return says 300 and one says 500, it’s not always because they’re actually making different amounts of personal cash flow. Their incomes might be similar, it’s just one person might have a lot more tax deductions that year-

Ryan Isaac: What gets reported.

Reese Harper: … then another person. We want to be able to say, “We need to …” It goes to the heart of why we do financial planning this way. We want to be able to say, “Does this person save enough money for what they make? Do they spend too much for what they make? Are they financing their debt the right way? Are they paying a fair amount of tax?”
Especially as it relates to Tay’s conversation around tax rate, it’s important to really understand what someone’s gross income is, their true gross income before you can start to understand what their effective tax rate really is.

Ryan Isaac: Yeah, and how is this different? I mean, so some of the questions we’ve gotten back are how is this number different from what my accountant will calculate? What an accountant’s trying to do is kind of the opposite of what we’re trying to do.
Accountant wants to get the smallest number possible to get reported as your final adjusted gross income that you’re going to pay tax on.

Reese Harper: Which is great that they’re trying to do that.

Ryan Isaac: Yeah, that’s really good, but that’s why those numbers will be different sometimes. Usually, the difference will be some of those less common things that we add back in, amortization, depreciation, retirement plan contributions. If you put those back in, then our number will match the accountant’s number that gets on your personal tax return.

Reese Harper: Yeah. So before we get into the meat of our discussion today, let’s just hit really quickly how you calculate taxes that you pay. I just want to summarize that in one minute.

Ryan Isaac: Wow. [inaudible].

Reese Harper: Taxes are paid in a … Think of a chart that has different rates at different levels of income, and this is going to get turned upside down in the next two weeks.

Ryan Isaac: So listen to this podcast before January 1st.

Reese Harper: Yeah, next January 1st, 2018. This will probably be the first time that we’ll see a big change in our tax code, and if you want to know one of the things that’s changed is there’s still going to be seven different tax rates. So right now there are seven rates of tax. There’s 10, 15, 25, 28, 33, 35 and the last one’s 39.6.

Ryan Isaac: I like how at the end they’re like, “Let’s not do a round number.”

Reese Harper: Yeah, “Let’s just go to point six.” I’m like, “Who came up with that? Just go to 40, or at least go to 30-

Ryan Isaac: Go to 39.

Reese Harper: 39.99.

Ryan Isaac: Yeah.

Reese Harper: That would be better.

Ryan Isaac: Isn’t that funny though?

Reese Harper: Yeah, 39.99. I always think about that. Why do you-

Ryan Isaac: Government. Ahh, you IRS.

Reese Harper: So you got seven brackets, there’s still going to be seven, but they’re going to change the amount of income that goes into each bracket. So right now the lowest rate is a 10% rate, that means between zero and 20 grand, you pay 10%. Then the highest rate is at 39.6, so anything above 470,000, you’re going to pay 39.6 on.
This is just federal income tax, and that’s different than your state income tax. So just keep in mind that about, call it every 50 grand to every 100 grand of your income, your taxable income, you pay a different rate at those, and the higher your income gets, the higher the rate you pay.
It’s not the rate you pay on all of your income. It’s the rate you pay on that specific amount.

Ryan Isaac: It’s called marginally.

Reese Harper: That marginal is a confusing word, I hate it.

Ryan Isaac: Yeah.

Reese Harper: Yeah.

Ryan Isaac: My marginal rates. I paid 40% taxes.

Reese Harper: Every incremental amount of income pays at a different rate. And so, different states, we won’t get into this too much today, but different states pay different-

Justin Copler: Let’s go through all 50 states, and just talk about their tax rates.

Reese Harper: Okay, all right.

Ryan Isaac: What’s the first one in the states song? Is it Alabama?

Justin Copler: Let’s start with Texas.

Reese Harper: Oh, you guys. Okay, so think about your state, you probably have a flat … You could have a flat state like we do here in Utah. You could have zero state income tax and just pay just a lot of property tax, or you could have a really high state income tax like New York, and it could be varied in tiers, just like federal.
They you have your payroll tax, and you have your AMT tax. AMT tax is an extra federal tax, and payroll tax is you pay on the salaries that you pay yourself.

Ryan Isaac: Payroll tax you’re paying for social security and Medicare.

Reese Harper: Yes.

Ryan Isaac: Social security, the portion of social security ends when your payroll, your W2 hits just under 130 grand, and then the Medicare, you keep paying for Medicare, smaller chunk.

Reese Harper: Yeah, I think it’s important to note too that AMT … It looks like AMT will no longer be part of the new tax.

Ryan Isaac: I think it’s going to.

Reese Harper: They’re going to change how it’s calculated.

Ryan Isaac: Go to Twitter right now. It’ll have been changed, but …

Reese Harper: Yeah, right now the point of next year’s tax proposal is supposed to make it simpler and from what I can tell, we still have seven rates. They went down a teeny bit, like two percent on some of them.

Ryan Isaac: Yeah, all the deductions are still there. Exemptions are still there.

Reese Harper: All the deductions are still there. It’s …

Ryan Isaac: The accountants that I’ve seen on Twitter are actually really excited. So this is better for our business.

Reese Harper: Yeah, it’s actually going to be … It’s going to take a year or two before anyone even knows what really is going on, and tax strategies start to be developed, and then people are like, “Oh, now we’re going to do this.” I’m like, “Great.” Last night I was watching-

Ryan Isaac: Man, I had my tax postcard ready. I was going to do the whole thing on a postcard.

Reese Harper: I was watching Steven Mnuchin last night give an overview of this, he’s the treasury secretary, and he’s like, “Well, you know, now the beauty of this,” if you’ve ever seen him speak, he’s deadpan and he looks like a mannequin. Mnuchin sounds like mannequin to me, so that’s why I always think that when I see him.
He’s like deadpan look in the camera and he’s like, “Well, the beauty of this tax plan is that we get 92.4% of the county will finally be filing it on a postcard.” I’m like, “Do you realize that that’s actually not a thing?” It’s such a marketing pitch. I’m just like, “Ugh.”

Ryan Isaac: So put your postcards away is what you’re saying?

Reese Harper: Yeah. Look, I’m all for trying to fix the tax system and make it simpler, at this juncture, I just cannot feel like it’s any simpler than it was.

Ryan Isaac: It doesn’t seem so.

Reese Harper: It doesn’t.

Ryan Isaac: Yeah, but let’s wait. He’s wait, let’s see.

Reese Harper: What do you mean? We know what it’s going to be. They just released it. It’s so fricking complicated.

Ryan Isaac: Surprise me. Surprise me.

Reese Harper: Anyway, so we’ll just-

Ryan Isaac: So the point is, all these things that we just described are going to be slightly different but they’re all going to still be there and applicable.

Reese Harper: Yes.

Ryan Isaac: When you calculate your taxes, you just add all that stuff up. On a miscellaneous note, sometimes we will show our … We’ll calculate … We’ll put on the reports property tax as well. We like to show people how that, where they live, how it affects some of the taxes they end up paying.

Reese Harper: Yeah, so in our case, I think what we’re going to get to now is if you want to know do you pay more of less than someone else-

Ryan Isaac: Yeah, here’s the meat of all of it, right?

Reese Harper: You want to know if you pay more or less than somebody else, well-

Ryan Isaac: It seems easy, like an easy question.

Reese Harper: It seems you could just say, “Well, I made this. You made this, how much did you pay? How much did I pay?” Well, by living in the State of California, and making a really high income compared to living in the State of Texas, I mean, you’re automatically adding-

Ryan Isaac: Your condo in California cost two million dollars and the Texas ranch was 400 grand.

Reese Harper: Well, I’m just saying your state taxes alone, you’re double digits.

Ryan Isaac: Yeah. I was going to even … So yeah, totally.

Reese Harper: There’s a lot of things that make each person’s tax due that they owe very different, and I think people don’t realize that one person paying 50% of their income might not be unheard of, I mean, nearly that much, where someone else might be at 35% and they’re making a similar amount of money.
I just think before you blame it on your tax preparer, or before you fell too frustrated, it’s helpful to go through some of these things we’re about to discuss and understand that even if your time feels like it’s … Even if right now you feel like you’re in a situation where you’re getting the short end of the stick. Next year or the year after, you might go through some of these things we’re about to discuss and find that your taxes are a lot lower than the person you were comparing yourself to before.
I think this will be helpful. So talk to me about a few things that are surprising to your clients, Ryan, around taxes that people pay and how they vary so much person to person.

Ryan Isaac: Yeah. Well, let’s just start with number one on the list was depending on the type of entity structure that somebody has, could affect the way that they get to deduct certain things, or the way that … Some people have practices where the income just flows through on schedule C, on their personal tax return. They don’t have a S corp, or something that they’re filing it through.
They’ll pay different amounts of self employment tax versus the person who chooses to put their practice in an S corp, and has a W2 salary and net income. Again, this is not you should or shouldn’t do this. These are just examples of some one chose to have a different entity structure than one other person and that right there could make a little bit of difference.

Reese Harper: Yeah, whether it’s a C corp, an S corp, an LLC, or a schedule C, and how much payroll you actually pay yourself is a huge factor.

Ryan Isaac: Yeah, you could have two guys with the same collections in an S corp and one guy pushes twice as much money through payroll for whatever reason, it could be a good reason for it, maybe a retirement plan or something, but that’ll affect the amount of payroll taxes. It’ll make these tiny little changes that after a while it can end up to two, three, five, seven percent difference in overall tax rates.

Reese Harper: Yeah. I think what is important about this take away is that there are better and worse entity structures for your state, and your own personal growth plans, and level of complexity-

Ryan Isaac: Asset protection.

Reese Harper: And collections level. And so, if you’re not having a regular conversation with your tax adviser on entity structure, we recommend that you have that conversation periodically, because years like this, I mean this tax proposal that’s coming out could change people’s perception of C corporations in a substantial way, where before C corporations really were an overly complex stogy for services business, especially they’re kind of unheard of, where now you’ve got …
That particular entity is getting the most favorable tax treatment of any of the entity types.

Ryan Isaac: Especially if revenue and income’s high.

Reese Harper: And if you have a large business, a large service business, a multi location practice, this could really change your strategy. I think that’s something that … I think it’s like, “Oh, great. Okay, we’re simplifying the tax code, we’re going to create a conflict of interest now around entity structure by having the rates that people pay be different for a C corp and an S corp.”
Well, the difference between C corps and S corps is in the C corp world, you have everyone from Apple Computer to Tom’s vacuum cleaner store-

Ryan Isaac: Shout out to Tom. Great little vacuum shop.

Reese Harper: Great shop.

Ryan Isaac: Yep.

Reese Harper: … doing the same thing. I mean they have the same entity and they pay the same rates, and so when the IRS is trying to regulate, or when congress is trying to create a tax incentive for large companies to … and make us more competitive globally, I mean, they’re applying a tax rate to businesses that are completely different from one another, and that does create a massive amount of complexity by doing that.
I mean, you just cut tax rates for C corporations and they’re not as competitive for flow through entities like and S corp and LLC-

Ryan Isaac: If you’re a service corporation, especially.

Reese Harper: … and it’s like, “Well, what should I do?” Then your CPA will be able to have a good conversation about this, but there’s not always an easy answer. All I’m saying is that I don’t know that this resulted in less complexity, which was the original intention and it’s just really, really hard to see government fight so hard to do something, and they end up … half of the people feel it’s a victory, half feel like it’s a failure.
The half that feels it’s a victory are claiming it’s much simpler, and the other half’s claiming it’s more complex and a mess. I try not to get too frustrated by the dysfunction in Washington, but it’s interesting to just see how much complexity is going to come out of this tax legislation.

Ryan Isaac: Well, I mean, just this point alone. I mean, that just took five minutes to say that everything that we just said about a corporate entity structure, having it making a difference on your tax return will be different in January 2018.

Reese Harper: And it’s still going to be important to analyze it, more than ever.

Ryan Isaac: Yeah.

Justin Copler: I just tried to look up Tom’s vacuum shop.

Ryan Isaac: Did you Google it?

Justin Copler: It doesn’t exist.

Ryan Isaac: Oh, man. Well, it’s a free name. We just named it.

Justin Copler: Fine.

Ryan Isaac: All right. Another one would be someone who chooses at the business level to put corporately paid benefits, healthcare and retirement plans we’ll do separate.

Reese Harper: We’re just talking about healthcare?

Ryan Isaac: Yeah, some healthcare, maybe some life insurance. Some people do stuff like that, different HSA plans and …

Reese Harper: Yeah, that does, it has a big effect.

Ryan Isaac: So the thing that I’ve noticed is, I’ll look at two returns, it could be same collection, same size of office, one person will have corporate healthcare that they’ll pay for and the other person won’t. Depending on who can get it cheaper, like maybe someone who’s less healthy and has to shop for it because their business doesn’t offer it, pays more for the healthcare but they get a bigger deduction on off of the personal returns on the above the line deductions for self employed health insurance cost.
That decision made a difference of maybe one percent or half a percent in tax rate difference between the two that made exactly the same income. They different tax rates because of that healthcare decision. So another little one.

Reese Harper: Yeah, totally. Retirement plan, you mentioned, and contributions there. I mean, there’s literally people with the same incomes that could have … I mean, you have two people with $500,000 incomes, one person’s doing a 401K of 16,000 to 18,000 a year, and the other person’s doing a profit sharing plan and defined benefit plan, and 401K, all three, and deduction north of 200,000 a year. They’re the same income level, and that has a massive effect on your tax [crosstalk].

Ryan Isaac: People have 401ks and one forgot to fund it fully, and the other one did.

Reese Harper: Two people who have 401ks, same income, someone just screwed up payroll and didn’t put enough in.

Ryan Isaac: Yeah, in fact that’s super common. I’m finding with clients that just the 401k is, on average, it’s reducing someone’s tax rate by two and a half to three percent, just 401K.

Reese Harper: Just to have it there.

Ryan Isaac: Just to have it there and fully funded.

Reese Harper: Yeah.

Ryan Isaac: So, I mean …

Reese Harper: Depending on your income level.

Ryan Isaac: Yes.

Reese Harper: The lower your income is, the more substantial of an effect it will have, it would probably be even larger than that. Talk about the debt payments, how debt and interest effects it.

Ryan Isaac: Well, another one, how big of a business someone chooses to build and how fast they choose to build it will determine, in large part, how much financing they go get, right? The more loans, the more interest expense someone has, the lower their income, because they have higher write offs. So, it’s another one where it’s a very personal … It’s not just apples to apples income. My buddy has the same collections as me, but he pays way less taxes.
Well, he has a ton of financing to finance his growth and he writes off a lot of money in. We don’t have the same net incomes.

Reese Harper: But what you’re saying is interest on loans has a huge effect?

Ryan Isaac: Yeah.

Reese Harper: On mortgages as well.

Ryan Isaac: Yeah, so we’ll get to that. That’s actually … We’ll get that in …

Reese Harper: In itemized.

Ryan Isaac: Yeah, in itemized. So when you go to your personal return, there’s a few sections where you’re taking money off of your adjusted gross income before adjusted gross income gets calculated. It’s the front page of your personal tax return. It’s this little section at the bottom. They call those above the line deductions. Above the line meaning above the adjusted gross income line that’s on the next page.
Some of these are individually paid healthcare, HSA contributions, which is another one. I mean, if someone just chooses, they say, “Hey, I’m kind of worried I think my family will go to the doctor a lot. I’m going to choose a low deductible health plan with no HSA,” and the other one says, “I want a high deductible, but I want an HSA,” and then gets to write off the HSA. I mean, that could make a difference too, you know.
HSA’s half of 401K funding. I mean, it’s meaningful. Student loan interest is above the line deduction, personal IRA contributions, if you pay alimony, there’s some other deductions on there that aren’t as common that some dentist’s accountants will take, we won’t go into those, but …

Reese Harper: But I think the things you just listed though, sometimes these are things that you start taking advantage of, these above the line deductions. Sometimes your healthcare premiums are not reported properly. A lot of this has to do with are you giving your tax preparer good data? And, do you know what data you’re giving him and how that affects your tax preparation?
If you don’t give him the information, I mean, how many times, and I’m not trying to throw any CPA under the bus, because if you’re listening to this podcast, most of you are probably doing this properly, but if you are … How many times did you see tax returns prepared slightly differently based on … We don’t know why. Why does someone not have this line item when we know …

Ryan Isaac: Yeah, is that a style thing?

Reese Harper: Yeah, it’s like they don’t have any self employed health insurance on their tax return.

Ryan Isaac: Yeah, but they pay for it.

Reese Harper: Or there’s no IRA contributions here listed, or there’s no student loan interest listed on the tax return.

Ryan Isaac: Right.

Reese Harper: I mean, these are manual things that have to be given to your CPA and transferred over to the tax preparation software, and there’s no way for them to get that information unless it comes from you.

Ryan Isaac: Yeah, good records and …

Reese Harper: Sometimes they’ll ask for it, and maybe you’ll think you gave it to them, but didn’t, or you did give it to them and it doesn’t get put on to the return. And so, I think also in addition to just bad data, there’s the, “Did you really take the time to do all of these things like the maxing your HSA contribution, fully maxing your retirement plan that year, gathering up all your documentation around loans and interest payments, making sure you have acuate amortization schedules so that you’re not miscalculating how much interest you did write off?”
These are not things that are easy to just assume they’re getting done.

Ryan Isaac: Its good organization, and good record keeping. The next section, I was just having a conversation about this this morning, and this is really common. This is where you get a lot of variability in tax rate, and this is your itemized deduction section. What’s interesting about this one, just on the outset, there’s a provision, it’s called The Pease phase out. It’s named after a congressman that wrote this, that says after a certain income limit, your itemized deductions, which we’ll talk about there, they start getting reduced after a certain level of income.
They’re talking about getting ride of The Pease phase out, so now we won’t phase out your itemized deductions. But, here’s where, like you were saying earlier, the personal choice of what kind of house to buy, and what are of the city you live in, what city you choose to live in, what state you’re in, they make a big difference. The person who chooses a bigger house in a more expensive part of the city, a more expensive zip code, maybe higher taxes, maybe you just happen to live in a higher tax state, you will have bigger write offs on your tax return in this itemized section.
You’ll have less cashflow, it’s kind of like a give and a take. Another one too in this itemized section is charitable contributions. You’ll see anything from zero to six figures in charitable contributions in a given year. That’s massive. I mean, somebody gives 10 grand versus $100,000 in charitable is … That’s a big chunk of taxes, so you might have your neighbor who makes the same amount of money, but you gave six figures in charity and he gave $10,000, and thanks everyone for giving to charity, but on taxes that’s going make a difference. You can’t compare the two anymore.

Reese Harper: Yeah, and on your mortgage interest, apparently it looks like they’re going to cap the mortgage balance though that you’re going to be able to write off. As of three days ago, the proposal said it was a $750,000 mortgage that was the cap on allowable mortgage interest write off.

Ryan Isaac: Okay.

Reese Harper: And so, we’ll find out what happens to that. So most of you, like me, who live in a zip code who you can’t hardly get a house for less than that money-

Ryan Isaac: Well, you and your wife and kids would all have to share the same room.

Reese Harper: Yeah, that’s actually fine.

Ryan Isaac: You could do that.

Reese Harper: You can get a garage for that. In San Jose, you can get a garage and if you’re in Northern California or if you’re in Manhattan, you can get a small closet for that, all right? But you could live in it. You could learn how to sleep standing, it’s possible. They do it in NASSA. Okay, Gordie?

Ryan Isaac: Yeah.

Reese Harper: It happens.

Ryan Isaac: You know what’s funny about this though? It’s that I’m willing to be though when people are comparing tax rate with their friend, they’re saying, “He pays less than me.” I don’t know how much they say, “How much did you give to charity?” Are they going there?

Reese Harper: They’re not going there.

Ryan Isaac: Probably not, but it makes a big difference. So that’s the itemized deductions.

Reese Harper: But just a quick … Some math, Ryan. If I don’t give money to charity, don’t I still have more?

Ryan Isaac: Yeah, so that’s the thing. There’s a trade off between … This is the argument why some people will say, “Well, it will lower your taxes. Just go buy stuff before the year’s over.” Well, you’ll have more money if you just don’t buy stuff.

Reese Harper: Yeah, it’s not like you get all of the money back. So, I think it’s important to keep that in mind.

Ryan Isaac: Yeah, [crosstalk] tax rate. Tax flow and tax rate are two different things.

Reese Harper: Mm-hmm (affirmative). Let’s talk just really quick about exemptions. So I think that makes a big impact and people don’t realize that.

Ryan Isaac: Yeah, another thing-

Reese Harper: This is something that’s getting increased in the proposal. So now we’re looking at … It used to be about $1000, and now they’re going to $2000 credits, which we’ll hit in a minute. There’s dependent credits that are going to be increasing for people at lower income levels.

Ryan Isaac: Now, this one phases out at a lot lower level than itemized deductions do. But, the size of your family will make a big difference in the taxes you pay. What’s interesting too is some of these things we’ve talked about, like above the line deductions, let’s take two people with really similar incomes, similar family sizes. One person happens to max out an HSA and it puts him just under the limit where their dependent exemptions don’t phase out.
They get to claim their kids on their tax returns, and their neighbor, same amount of income, just had a slightly higher adjusted gross income, they got phased out. Then that’s a big swing in tax rate.

Reese Harper: Yep, and it’s important … I mean, you should know these thresholds. When am I going to lose out on credits? When am I going to lose out on exemptions? Because maybe there is something that year you could do, where buying that care makes sense this year, because not only do I save the money on my tax rate, but I’m also picking up some credits and I’m not going to be phased out of.

Ryan Isaac: Exemptions, yep.

Reese Harper: Anyway, let’s talk a little bit about … We’ve talked about all these differences in tax return preparation. Give us a big takeaway on how you compare people’s rates, Ryan, and say, “I think this person’s actually doing a good job, and this person probably needs some work, or could get a little bit more organized and take advantage of things.” How do you know, just by looking at people, how to make that determination?

Ryan Isaac: Yeah. Well, one of the biggest things that we’re responsible for, that we spend time on about twice a year, is, we talk about this a lot, which is the retirement plan. Just making sure that the retirement plan that’s in place this year, is the most efficient, most cost effective plan that you can actually max out, you have the dollars to max it out, that you could possibly have.
It could change next year. So step one from our perspective, the retirement plans, it’s a huge one. It can range from $10,000 between a couple spouses doing IRAs to multiple six figures in a pension plan. So having the right one makes a huge difference and that’s one of the first places we’ll start, just to make sure it’s the most efficient plan that someone has in place.

Reese Harper: Yeah. What about … We talked a little bit about this, but if I’m trying to look at someone and say, “Who’s done a good job with taking advantage of all of the things for their age and income level?” If I look at two 45 year old productive dentists, both collecting the same, and they both have a similar amount of income, but one person has $250,000 worth of exemptions, credits, deductions, amortization, depreciation, and another person has $75,000. I mean, right away, as a financial advisor, [inaudible] starting to ask the question, “Why is that and why did one person have so much? So many expenses it reduced their taxes where the other person didn’t?”
At least in … At first blush, this may not be the case every time, but if two people have the same income levels, but the volume of these things that I just listed is larger from one person to the next, then I have to look at the person who has more and say, “They seem to be working harder at this, or they seem to be paying more attention to it, or they seem to be addressing it at first glance.”
Now, it might just mean that you have a ton of kids and that-

Ryan Isaac: A really expensive house, and give a lot to charity.

Reese Harper: A really expensive house. But, in most cases, people with larger tax deductions are people who are at least paying attention to their taxes, and it’s not always the wealthiest person, because sometimes just paying the tax and keeping the difference results in a higher net worth.
But, it is a red flag to me when I see two people with the same incomes and if you’re the person at the bottom of the totem pole, in terms of you have no, hardly … You’ve got 10% the deductions and credits and exemptions that anybody else has.

Ryan Isaac: You’re top of the income totem pole and then bottom of the available exemption write off totem pole.

Reese Harper: Yeah, it seems like-

Ryan Isaac: That’s a weird totem pole.

Reese Harper: Yeah, it seems like that’s been helpful for, at least for me, analyzing client by client to just say, “This person doesn’t seem to be taking advantage.” If you’re just going to run a quick benchmark and a number, it’s easier to see that.

Ryan Isaac: Well, this month was a really busy month. This is the thing I would say to people who don’t work with us, or don’t have an advisor that’s communicating this frequently, whether it’s a financial advisor or a tax advisor. I found it to be, just based on the feedback we got, this is definitely one of the highest points of interest for our clients out of almost anything else in the whole year.
People really want to know. We report, here was your income, here was your taxes, and they want to know, is that good or bad? And so, we spend-

Reese Harper: I think everyone wants to know, “How do I make this go lower?” That’s basically what we want to know.

Ryan Isaac: Is this okay? Go lower.

Reese Harper: I want to go down more.

Ryan Isaac: But it was very helpful though, even if it felt high and a little painful for someone to explain, “Here’s what makes a difference between you and your peer with similar income that pays less taxes than you. He’s got more kids and he pays twice as much on his house, and he gave more to charity. Or, he did use an HSA, or he did claim this thing on something that you didn’t claim that you could have, and let’s take a look at that.”

Reese Harper: Or his retirement plan contributions were twice as big. So, that’s why we’re recommending that you should look at adjusting your retirement plan.

Ryan Isaac: Yeah, it makes a difference. And so, some of this is just it’s good to know. It’s good to just … We spent a lot of extra time this month explaining to people the 10 categories that can make a 10% swing in a tax rate between two different people with similar incomes, and that was really insightful and helpful to people.

Justin Copler: Isn’t this one of those things too where it’s helpful to look across multiple years, to look how your tax rate’s moving?

Ryan Isaac: Yeah, another point, that’s a perfect question. So, another point to how to compare this is sometimes it’s just good to compare to yourself. Look at trends of collections, of income, of profitability, and total taxes paid, and percentage of taxes paid and see how they’re trending together.

Reese Harper: Yeah, I think let’s just go … A bullet point summary of what you could do to make sure that you’re actually lowering your tax rate as much as possible.

Ryan Isaac: Yeah.

Reese Harper: One, you’ve already said, “Make sure you have a good understanding, I think, a knowledge around all these issues. Don’t go blind into it and just feel emotionally upset, that you feel that you’re being taken advantage of.”

Ryan Isaac: Because your peer said, “Oh, I paid way less than that. You didn’t? What’s wrong?”

Reese Harper: Yeah, or if someone says, “MY CPA’s super aggressive, and I’m not paying hardly any taxes.” Take that with a grain of salt because you need to be able to actually compare apples to apples and understand whether that’s …

Ryan Isaac: It could be true if he just revamped the whole office and took it all in 179 deductions.

Reese Harper: Yeah, and then there’s just good tax planning and then there’s illegal and they’re different, all right?

Ryan Isaac: Someone just said that on the show the other day.

Reese Harper: Let’s talk about legal, and I think there are people that run more through their practices than others in a proactive way.

Ryan Isaac: Yeah.

Reese Harper: I mean, there are people who, we’ll just say, understand the legal limitations of deductions and they try to maximize as much of those as possible.

Ryan Isaac: So when you say that is a product of frequent communication with the person in charge of your taxes, so like have discussions about that like, “Hey, I just spent money on this with my staff. I did this with another practice, another office for marketing. How does this get applied? What are our options for doing this?”

Reese Harper: “Can I call this a business expense? Can this be a business expense?”

Ryan Isaac: Yeah, “Is this marketing or meals and entertainment?”

Reese Harper: Yep, and trying to just understand that each deduction has certain limitations, but man, there’s a lot of gray area with taxes, and a lot of people interpret the tax code very differently. And so, you just need to have a comfort level with your understanding between you and your CPA that you’re actually coming down on the side of a piece of legislation that you can defend, and feel good about. But, having no communication means that it’s never going to happen.

Ryan Isaac: Yeah, if you just wait until the end of the year, then you’ll just get a number and pay it and be mad.

Reese Harper: Yeah. Spreading out depreciation and 179 expenses in a way that’s optimal for your situation is really important, and then thinking about the timing of new purchases and how to pay for those. Also, thinking about retirement plan contributions, like you mentioned.
I think a lot of this just boils down to if you’re maxing your retirement plan contributions and if you’re taking advantage of all the legal deductions possible, if you’re putting money away in all the above the line areas you can, and itemizing as much as possible that you would normally itemize anyway, you’re going to have a lower effective tax rate than the person who just says, “It is what it is.”
We see that a lot. There’s people that just let their CPA prepare their tax return and don’t get that engaged, and then there’s people that really get involved, and those effective tax rates are meaningfully lower.

Ryan Isaac: Well, yeah. I mean, think about it. If you could save one to two percent a year, one percent a year of your whole tax bill for the next 25 years, that’s a meaningful chunk of money that will matter. It will matter in retirement.
All right. All right. Well, thanks to everyone for listening, for joining us today. We really appreciate it. This will all be pretty different discussion in about two weeks.

Reese Harper: Yeah, forget everything you just heard.

Ryan Isaac: Yeah, hurry and listen to the episode.

Reese Harper: All this will be relevant in two weeks, but it’s crazy the changes in percentages and some of the specifics are going to be very different.

Ryan Isaac: It would be interesting to see how it all plays out a year from now when we-

Reese Harper: Maybe everyone’s going to come back with a C corp.

Ryan Isaac: Yeah, I don’t know, maybe. That was not advice, but anyway. Check out The Dentist Money Show on YouTube, now in full Technicolor, and remastered in 3.1 Dolby Digital.

Reese Harper: Yeah.

Ryan Isaac: Yeah, they got the little thing.

Reese Harper: Thank you.

Ryan Isaac: YouTube, Dentist Money Show. If you’d like to talk to us, if you have questions, if you want to know how your tax rate compares to someone else’s tax rate, if you want to know what you might be able to do better to save more money, go to, at the top of the webpage, there’s a little link for our calendar. Just schedule a time at your convince, and we’d love to talk to you, or you can just call us at 833-DDS-PLAN. Love to hear from you.

Reese Harper: Carry on.


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