It’s 2018, and the new tax law is in place (affecting your private practice). The new law’s lower tax brackets help all of us, and those of us with less than $315,000 taxable income (if married filing jointly) even get to deduct an extra 20% of the portion of our practice profits that aren’t deemed a salary. However, if like me you live in a high-tax state, you’re suffering the huge impact of the $10,000 limitation on deducting state and local taxes plus property taxes.
Now I get that reading about taxes is about as delightful for most of us as going to the dentist for a root canal job. Just seeing the tax form above may have triggered overwhelm or even panic. In fact, when I asked my wife to review this article before I published it, it caused her to feel waves of anxiety and the thought “Ugh! I don't want to read this!” started swirling in her head. You may well feel the same, but if you’re not diligent about maximizing your business deductions, you’re leaving a ton of money on the table which will be even more painful. If anything, the long laundry list that seems so overwhelming is actually good news because it lets you deduct more expenses and pay less taxes. So, grit your teeth (bad pun intended) and read on to avoid the pain of needlessly paying more taxes than you must…
As a disclaimer, I’m not a tax pro and even if I was, I don’t know your personal tax situation, so the following is for informational purposes and is not tax advice. The best way to use the following is to ask your accountant about the deductions I mention, so she can help you minimize your taxes. Your bank account and future self will both thank you. Having said all that, my CPA has reviewed this article and says there aren't any error in it, so I guess my understanding of tax stuff isn't too far off the mark :).
A Ton of Money? How High Are Your Taxes Really?
If you divide your total taxes by your total income, you’re likely paying less than 20% average tax. That’s very tame compared to many other developed countries. However, that’s not the point here. For the purpose of this article, what we care about is your marginal tax rate. It’s the taxes you pay on your last dollar of income that you save by deducting $1 of business expenses.
Say you’re married filing jointly reporting a taxable income between $165,000 and $315,000. Your federal tax bracket is now only 24%, but that’s just the first tax bite. In most states you then have to add state and local taxes. For residents of NYC, the tax rate is over 10%. In California, state tax for our example is 9.3%. In Maryland, including local taxes, rates for our example are as high as 8.7%. Since we live in Maryland, I’ll use that to illustrate the bite of income taxes. With property taxes likely eating up more than half of the $10,000 deductibility mentioned above, your last dollar of income gets double-taxed by the IRS and the state. This brings our example rate to 32.7%.
But wait, there’s more! There’s that little thing called self-employment (SE) tax, which tacks on another 15.3%! You can deduct most of the employer half of SE tax, but even so, your actual rate for our example is 46.3%. That’s right, if you increase your income from $165,000 to $165,001 that extra buck of income will be split almost evenly between you and the tax man! When we realized this was the situation with my wife’s practice, that was a real downer.
Conversely, if you deduct an extra $216, your taxes get reduced by $100 and you get to keep that extra $100! That’s why being diligent about deducting every bit of legally allowed business expenses is the simplest way to avoid leaving more of your money than absolutely required on the tax-man’s table.
If you make enough from your practice, ask your accountant if changing your practice business entity to an LLC taxed as an S corp wouldn’t be a good way to save you even more.
What Business Deductions Can You Claim as a Therapist in Private Practice?
The 2018 Schedule C is not out yet, but the 2017 version (above) is a good approximation, except that we lost the ability to deduct entertainment expenses. The other types of business expenses are still deductible, and the following lists them and gives some examples of what private practice expenses might fall into each.
Advertising/Marketing: Do you pay for a Psychology Today listing (about $30/month)? That’s deductible. Google Adwords? Facebook ads and/or boosting posts? Newspaper ads? Yup, yup, and yup again.
Car and Truck Expenses: You can deduct tolls and parking for business-related drives. More important for most of us, you can also deduct the standard mileage rate ($0.54/mile in 2018) for business-related drives if you keep a contemporaneous log of those miles. This doesn’t cover commuting from home to your office, unless you have a home office which turns that drive into a deductible drive between business locations. Driving to buy office supplies is deductible too, and if you don’t think that amounts to much, think again. Driving 10 miles each way to Staples, Walmart, etc. to buy supplies a couple of times a month adds up to a $259 deduction (in 2018) which is worth $120 in the above example. Since you don’t pay taxes on this, it’s probably more than you get for a therapy session!
Commissions/Fees: This is on the Schedule C, but unlikely to be relevant for therapists.
Contract Labor: If you have independent contractor (IC) associates, deduct whatever you pay them for carrying out therapy sessions that bring your practice revenue. The above is not for salaries paid to employees, as that has its own Schedule C line.
Depreciation: If you bought your office space, you can depreciate it (mostly over 39 years, but some types of expenses have shorter depreciation schedules). More applicable for most of us, if you buy equipment, you can depreciate that too. Your accountant will tell you if you can deduct the full cost in one year, or if you need to split the cost over several years.
Employee Benefits: While most of us would consider pension plans to be a benefit, the IRS splits those apart, so those don’t go on this line. However, if you pay for employee health insurance for example, that’s deductible here.
Insurance: Unless you’re ignoring the law and common sense, you’re paying for malpractice insurance, and hopefully for liability insurance too. Don’t forget to deduct those! Health insurance is already covered under employee benefits, so don’t double-count it here.
Interest: If you bought your office space using a loan, this is where you deduct the interest. If you have a business credit card and made the mistake of not paying the balance in full when the statement arrived, that interest also goes here.
Legal and Professional Services: Did you have an attorney write any contracts or review your lease? Deductible! Do you pay an accountant (if not, consider doing so)? Her fees are also deductible. Bookkeeper? Ditto. Billing service? Yup. Did you hire an interior designer to help design your office for that perfect fung shui? Deductible.
Office Expenses: Think supplies like coffee, tea, and candy for the waiting room; postcards to send your clients, and postage for sending them too.
Pension and Profit-Sharing Plans: This is where you put in your contributions toward employees’ SIMPLE IRA or other retirement plans, but not contributions to your own plan.
Rental Cost of Vehicles and Machinery: If you buy furniture and rent a truck to avoid paying exorbitant delivery fees, that’s deductible. If you have a major water leak and need to rent an industrial-level fan to dry out the carpet… Yup, deductible.
Rental Cost of Other Business Property: If you’re renting office space like most of us, this is where you get to deduct it. Considering this is probably your largest business expense, it saves you the most in taxes. For example, if you’re paying $750/month in rent, deducting it will save you (with the above example income situation) over $4500 in taxes!
Repairs and Maintenance: Did you call in a repairman for the air conditioning? A plumber to get the sink to drain? Did you hire a cleaning service to clean your office? Does Orkin or Terminix come in to control ants, spiders, and other critters? You got it – all deductible!
Supplies: Do you buy books to give out to clients who need to read them to help in their own therapy? Deductible.
Travel and Meals: If you fly to a conference, workshop, or other business-related event, the airfare, cab fare, Uber ride, etc. are all deductible. Same with the cost of your hotel room or the AirBnB place where you stay. Meals when traveling away from home, or when meeting a referral source or colleague to discuss business are also deductible, though only at 50% of what you spent. As of January 2018, business entertainment is no longer deductible, but I suspect few therapists have ever taken clients or referral sources to a ballgame or a show, so this won’t have a big impact on most of you. I know it won’t affect us.
Utilities: If your rent excludes any utilities, be it electricity, water, or even music streaming for the office, your payments for those are deductible.
Wages: If you have full-time or part-time employees, whether therapists, a billing specialist, or a receptionist, you can and should deduct the salaries you pay them.
Other Expenses: Then there’s this catchall line. This covers any other legitimate business expenses. Examples include professional license fees, professional association dues, continuing education, supervision, data processing, merchant card service fees, etc.
A Caution from My CPA
As I mentioned above, my CPA reviewed this article and says it's accurate. However, she wanted me to add the following caution for all of us. You need to get a signed W-9 form from providers (unless they're incorporated) before they start doing any contract labor, maintenance services, or professional services for you. This is because you'll need to send them Forms 1099 if you pay them more than $600 during the tax year. Otherwise, the expenses could be non-deductible.
Bottom Line on Deducting Business Expenses
In 1934, Judge Learned Hand wrote: “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.” Seeing this quote framed in the office of our CPA was part of why we chose to work with him. While we make sure to pay every dollar of taxes we owe, we also do our level best to reduce our taxes to the legally required minimum. Unless you want to leave a ton of money on the table, the above should help you do the same.