When Tax Deductions Pack an Extra Punch
We tend to love tax deductions. Who doesn't enjoy paying less taxes? An important part of tax planning is aiming to pay as little tax as possible over our lifetimes. A big part of that is taking deductions when and where they can give us the biggest impact.
Beyond Your Marginal Tax Rate
When we take a deduction, we typically think of saving taxes at the same rate as our "marginal" tax rate—the rate your highest amounts of income are taxed at.
For example, if you take a $40,000 deduction, your tax savings based on your bracket would be:
- 32% bracket: $12,800
- 24% bracket: $9,600
- 22% bracket: $8,800
- 12% bracket: $4,800
- 10% bracket: $4,000
However, as I've seen from projecting and planning taxes for clients throughout the year, there are times when a deduction can give you benefits above and beyond just your tax bracket. This is when the magic happens.
When Tax Planning Becomes Magical
This enhanced benefit comes when your income is high enough to either:
- Push you into a higher tax bracket
- Start phasing out important deductions and credits
- Phase you into additional taxes
Some common examples include:
- Moving from the 24% tax bracket to the 32%—that's an 8% bump on additional income!
- Capital gains and dividends being taxed at 20% instead of 15% (or 0%)
- Phasing out of the 20% QBI deduction (which is based on taxable income)
- Losing the Child Tax Credit (based on your Adjusted Gross Income)
- When first starting or buying a practice—losing ACA health insurance premium tax credits
- In retirement—facing additional Medicare premiums or more taxable Social Security
- Triggering the Net Investment Income Tax when income exceeds thresholds
A Real-World Example for Practice Owners
Let's imagine you're a married practice owner who had an exceptional year. Your practice profit is expected to be about $359,530 and projected taxable income is around $445,000. In this scenario, you are:
- Firmly in the 32% tax bracket
- ONLY eligible for a limited QBI deduction (about $16,300)
- NOT eligible for the Child Tax Credit
However, you still have time to make a profit-sharing contribution to your practice's 401(k) plan. You decide to make a $68,000 profit-sharing contribution distributed among employees.
Because you've set your wages strategically with your financial planner and have a good plan administrator, you get an allocation that benefits you as the owner.
The result? This $68,000 deduction doesn't just reduce your taxable income by that amount—it actually brings your taxable income down to approximately $342,800 - a $102,200 drop that affects multiple tax calculations!
The actual tax savings would be around $30,000—nearly a 45% effective return on the amount you contributed to profit sharing!
Why? It brought you out of the 32% tax bracket and into the 24%, it greatly increased your 20% QBI deduction, and it allowed you to get a limited Child Tax Credit.
In other words, magic 🪄.
Strategic Questions for Your Tax Planning
This magnified effect doesn't always happen—but strategic tax planning can save much more than the base tax rate alone would suggest.
As we project taxes and coordinate with clients' tax professionals, we're always asking:
- What types of income are we working with? (Wages, business profit, capital gains, etc.)
- What tax brackets apply, and how close are we to lower or higher brackets?
- What deductions or credits are we phasing out of?
- What extra taxes are being triggered, and why?
- How would additional income or deductions affect all these factors?
Your Next Steps
Take a closer look at your income projections for 2025 (or 2024 if you haven't filed your practice or personal tax returns). Are you approaching any of these critical thresholds? If so, the right moves now could have a multiplier effect on your tax savings.
I'm always here to help you see the full financial picture. If you'd like to discuss personalized strategies for your practice, reach out for a conversation!
Until next time, have a great weekend!
Evon Mendrin CFP®, CSLP®
This newsletter provides general information, not specific advice. All examples are hypothetical. Always consult with a qualified tax professional regarding your individual situation.
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