Taxes are often the single largest expense of your private practice, second only to payroll if you have employees.
If you’re wondering how to better manage your taxes, or better understand the tax implications of being a W-2 employee, an independent contractor or self-employed, then today’s post is for you.
I love reading... 😍📚
And yet, I think this video 📹 will be a whole lot easier to understand. 👇
(I've included all kinds of fun slides! Ok, they're not THAT fun. But still.)
Did you miss the video? It's right there 👆
Still keen to read?! No worries... here we go!
There are a lot of different taxes out there. Today, we are going to focus on the three different categories of taxes which impact earnings that come from your practice as a therapist. Those three are:
- Income taxes
- FICA taxes
- Payroll taxes
As you can see in the slide below, these 'buckets' of taxes are inter-related. You'll always owe income tax on virtually all income you receive from any source (although there are some special exclusions and deductions). But earned income - which I describe below - is a special kind of income. Because it's special, it has its own type of tax: earned income tax (also known as FICA tax). On earned income you owe both income tax AND earned income (e.g. FICA) tax. Finally, there is income you might receive through a paycheck (e.g. through the running of payroll). Paychecks are a special type of earned income. As a consequence, income from a paycheck incurs income tax, earned income (FICA) tax AND special payroll taxes.
Whew. That's a lot of taxes. As we'll see, it can add up. And the type of work you do (and the way you receive compensation for that work) impacts both which of these taxes you'll pay, as well as how much of each tax type you'll owe.
Income tax is the tax that people are most familiar with. We all know the annual joy that it is to file our tax return. The Federal Government assess tax on our income, as do many states and some local governments (e.g. New York City).
Income tax impacts pretty much any income you receive from any source. There are certain kinds of income that are excluded from income tax, and deductions you can take to reduce your taxable income, but in general, income tax will be assessed on all of your income.
Usually, but not always, income tax is progressive. Progressive taxation means that the higher your income, the higher rate of tax you pay. This means that the rate of tax on your first dollar of income will usually be substantially lower than the rate of tax on your last dollar of income. That makes it important to distinguish between your marginal tax rate and your overall (or effective) tax rate. But that’s a story for another day. For today’s topic, it suffices to know that income tax is a tax your will owe on any and all earnings from your private practice.
FICA tax is a hugely important tax to keep in mind and it’s the one that is most commonly misunderstood. FICA stands for the Federal Insurance Contributions Act. This is the tax that funds Medicare and Social Security, two huge expenses for the Federal Government.
The bad news is that FICA tax is quite high, totaling 15.3%. The good news is that (unlike income tax) you do not owe FICA taxes on all of your income. You only owe FICA tax on what is known as “earned income.” Earned income is income that comes from either owning your own business or performing work which someone else pays you for. In other words, earned income is what you get in exchange for working a job.
As mentioned above, FICA tax is 15.3%: 2.9% of that funds Medicare and the remaining 12.4%. (at least on the first $142,800 in earned income in 2021).
The good news is that that 15.3% is split between the employer and the employee - they each pay 7.65%. But... if you work within your own private practice (or if you're a 1099 independent contractor), that means you're self-employed. And the IRS considers self-employed individuals to be both the employer and the employee. So that means - sadly - that you owe both the employer AND the employee portions of FICA tax: the whole 15.3%.
Paying both portions of the FICA tax is what's called Self-Employment Tax. I think this term is a bit misleading, because it isn't a special tax assessed only on the self-employed. It's simply the FICA tax that everyone owes - it's just that if you're self employed you have to pay both the employee and employer portion yourself.
Looking for more great resources to help you navigate your financial life? Check out my free Guide to Financial Planning for Therapists. Click here to access!
The final and third bucket of taxes that might be assessed on earnings from your private practice are payroll taxes. Payroll taxes are mostly dictated at the state level, so what payroll taxes you owe will depend on what state you're in.
And as I mentioned above, payroll taxes are only owed on earnings you receive from a paycheck (e.g. the running of payroll). If you're an independent contractor, you don't receive a paycheck - so these taxes won't apply to you. Equally, if you work in your own private practice and you don't run payroll for yourself, these payroll taxes won't apply to you. If, however, you work within your own S-Corp, you're required to run payroll for at least a portion of your overall earnings. And the payroll you run for yourself will then be subject to these payroll taxes.
What are these payroll taxes? Well, as I said they are primarily dictated at the state level. And, like FICA, they are split into two categories: employer-paid payroll taxes and employee-paid payroll taxes.
Employer Payroll Taxes
Starting with employer-paid payroll taxes, we first have the the Federal Unemployment Tax, known as FUTA tax. This payroll tax is assessed at the rate of 6.0% on the first $7,000 of annual payroll earned. BUT you can erase up to 5.4% of that tax if you pay an unemployment tax to your state. I live in Los Angeles, so I'll use California payroll taxes to illustrate how they work.
In California, there is unemployment payroll tax which ranges from 3.4% to 6.3% which is due on the first $7,000 of annual payroll earnings. So if we were paying at least 5.4% in California unemployment insurance tax, we only need to pay 0.6% FUTA tax (That's 6.0% less the creditable 5.4% for state payments).
California also assesses employer an employment training payroll tax which is 0.1% on the first $7,000 in payroll wages. The specific payroll taxes assessed employers in your state will vary, but California provides an example of what you might expect.
Employee Payroll Taxes
Finally, states often asses employee payroll taxes. In California, employees are responsible for paying a disability insurance income tax on earnings they receive as payroll. That tax is 1% of the first $122,909 in payroll wages. That cap on income adjusts (e.g. increases) each year. Again, the payroll taxes your state assesses on employees will vary, but California provides an example of the type of treatment you might expect.
How much tax are we talking?! An Example... 📝
Ok, that was all a lot of detail. But what does it all mean? Well, it means you're going to have to plan on paying a pretty big chunk of your annual income in taxes. The below slide lays out an example for a solo-practitioner therapist working in their own private practice in California. In this case, the practitioner wouldn't actually run payroll for themselves, but I've included payroll taxes just to give you a sense of the magnitude we're talking about. Payroll taxes are important to keep in mind if you're considering making an S-Corp election to save on taxes (a strategy I'll explore in a future post).
I explain this example in greater detail in the video above. Here's the net net:
That's a Wrap 🎬
Alright, that’s it for today! I hope this material helped you understand a bit better the taxes your face as a therapist working in private practice.
I’d love to hear how I can improve content like this. What made sense? What was unclear? What else would you like to hear about that would be helpful? Give me a shout and lemme know!
Turning Point is a registered investment advisor in the state of California. Please visit turningpointhq.com for important information and additional disclosures. This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes financial, legal or tax advice; a recommendation for purchase or sale of any security; or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Read the full Disclaimer here.