When you’re a self-employed therapist, tax planning has the potential to save your business time and money, giving you more resources to devote to helping clients.
Here are eight steps you can take to reduce your tax bill, avoid penalties and late fees, and spend less time crunching numbers when tax season rolls around.
Open separate personal and business bank accounts
First things first: As soon as you get serious about running your own therapy practice, it’s time to open a separate business checking account.
Why? When you use one account for all your personal and business expenses, your personal and your business transactions become intermingled. It’s easier to make mistakes.
However you do your bookkeeping—whether you do it yourself with software, or have Heard or a bookkeeper handle it for you—your bookkeeping data is going to be based on information from your business bank account.
It used to be that a small business owner would bring a stack of receipts and a handwritten list of transactions to their bookkeeper, and the bookkeeper would categorize each transaction and enter it in the general ledger. Then the information could be used to generate financial reports—which, in turn, included most of the information needed to file and pay taxes.
Today, software does the heavy lifting:
- If you use accounting software to do your own bookkeeping, it will import a list of transactions from your online banking data and then allow you to categorize them.
- If you hire a bookkeeper, they’ll use the same software to import the data from your bank and categorize the transactions themselves.
- If you use Heard, your data will automatically be imported and categorized by your bookkeeping team.
In all these scenarios, if your personal and business expenses are intermingled, it will add an extra step to the process of bookkeeping. Each transaction will need to be categorized as either personal or business, then categorized based on your chart of accounts.
If you do your own bookkeeping, it means more time sitting at your computer crunching numbers, and greater potential to make mistakes. If you pay a bookkeeper to do it for you, it means a bigger bill each month.
As soon as you open a separate banking account for all your business spending and earning, you reduce the cost of bookkeeping—and, eventually, filing your taxes.
Set aside a portion of your income for taxes
When you’re someone else’s employee, they withhold a portion of your income and remit it to state and federal governments for the sake of paying taxes. The paycheck or direct deposit you receive every two weeks is your take-home pay. You don’t need to worry about paying income tax yourself.
When you’re self-employed, on the other hand, it’s up to you to withhold taxes from all the income you earn, and use that cash to pay your taxes.
Exactly how much you withhold depends upon your tax bracket, as well as the income tax rate in your state. See our list of tax brackets for therapists.
As a general guideline, you should expect to withhold 25% – 35% of all business income to cover taxes.
There are a couple of ways to do that:
- Each time you receive income, set aside a portion in a separate savings account
- Every predetermined period of time—one week, two weeks, or each month—add up all the income you earned for the period and set aside a portion
Whichever approach you use for setting aside income, the important thing is to do it consistently: At a consistent rate, and according to a consistent schedule. If you don’t set aside enough, you could come up short when it’s time to pay taxes, leaving you scrambling to cover the difference.
Heads up: If you pay quarterly taxes, you’ll calculate your withholding in advance based on how much you paid the previous year, and pay that amount to the federal government every three months. You can learn more from our guide to quarterly taxes for therapists.
Educate yourself in self-employment taxes
When you own your own business, you pay self-employment taxes in order to cover the cost of Federal Insurance Contributions Act (FICA) payments.
FICA payments are your contribution to Medicare and Social Security. You contribute 2.9% to Medicare, and 12.4% to Social Security—a total charge of 15.3% of your net income.
If you’re someone else’s employee, they withhold half that 15.3% from your pay, and cover the other half themselves. When you’re self-employed, you cover all of that 15.3%.
Keep in mind, that applies to your net earnings, ie. your income after business expenses. Also, typically only 92.35% of your net earnings is taxed.
Finally, for 2023, only the first $160,200 of your net earnings is taxable. That number changes each year. For the latest cutoff, check the IRS website.
If you’re setting aside a portion of your income to cover taxes, make sure to take self-employment tax—not just income tax—into account.
Maximize your tax deductible retirement contributions
Contributions to an individual retirement arrangement (IRA) account are tax deductible. You can contribute extra income you earn over the course of the year to an IRA and have it written off your taxes. Later, when you withdraw the money in retirement, it’s taxed at a lower rate, assuming your income during retirement is lower than your income now.
The contribution limit for a simplified employee pension (SEP) IRA is $66,000 or 25% of your annual income—whichever amount is less.
Start making plans now for how much you’ll contribute to your IRA—and if you don’t have an IRA, set one up. It could mean major tax savings, plus an investment in your future financial security.
You can learn more from our article on how to choose a retirement plan for your therapy practice.
Take advantage of tax deductions
Carefully tracking your business expenses and taking advantage of tax deductions is part and parcel of running your own business.
When you fail to claim deductible expenses on your tax return, you end up paying tax on earnings you don’t really get to keep—that is, on money you spent to keep your practice running.
The more deductions you claim, the less you pay in taxes. It’s as simple as that.
Don’t wait until tax season to start tallying up your expenses. Get familiar with which expenses are deductible and start tracking them now. You’ll be less likely to overlook potential tax savings, and you may be able to plan your spending so you gain maximum advantage from deductions.
Some not-so-obvious tax deductions therapists can take advantage of:
- Professional membership fees. The cost of membership in a professional organization for therapists is 100% tax deductible.
- Travel to conferences. You can deduct most of the expenses incurred in the cost of traveling to a conference for mental healthcare professionals.
- Therapeutic aids: Flashcards, educational toys, weighted blankets, even stuffed animals: If you use them in the course of treating patients, their cost is likely tax deductible.
For a full rundown, check out the Complete List of Tax Deductions for Therapists.
Lower your tax bill up to 20% with the qualified business income (QBI) deduction
One deduction you should definitely not overlook is qualified business income (QBI).
The QBI deduction is available to businesses with pass-through structures—that is, just about any business except C corporations. When you claim it, you can reduce your tax bill by as much as 20%.
There are some complexities involved when claiming the QBI deduction, like an income level cutoff, but not enough to bury you in paperwork. For a deeper dive, read our article on the QBI deduction for therapists.
Consider electing S corporation status
When you go into business as a self-employed individual, the IRS considers you a sole proprietor by default. Your personal and business taxes are one and the same, and you and your business are the same entity in the eyes of the IRS.
The financial professionals at Heard recommend most solo therapists running their own practices elect S corporation status.
S corp status comes with a few benefits:
- Your S corp’s income isn’t subject to self-employment tax (15.3%). Only the money your practice pays you as an employee is subject to FICA
- You have reduced financial and legal liability in the event your practice is subject to a lawsuit or can’t pay its debts
- You can give employees or investors shares in the business, or bequeath ownership of the practice and its assets in your will
When you elect S corp status, your tax filing and bookkeeping becomes a bit more complex, and you’ll need to set up payroll so you can pay yourself a wage. But it can pay off considerably in terms of tax savings. Learn more from our guide to S corporations for therapists.
Get help from professionals
Your list of reasons for launching your own therapy practice probably doesn’t include a love of bookkeeping and accounting.
A quick refresher:
- Bookkeeping is the act of tracking, recording, and categorizing all business transactions so you have accurate data for generating financial reports, budgeting, and paying your taxes.
- Accounting includes generating financial reports from bookkeeping data, as well as using that information to file taxes and make long-term financial plans.
The time and effort needed to keep up with bookkeeping, file your taxes, and follow changes to tax law can become a major burden, eating up resources you’d rather devote to clients and throwing your work-life balance off kilter.
One of the smartest moves you can make as a self-employed therapist is to get the help of financial professionals running your business, so all the work of bookkeeping and accounting doesn’t fall on your shoulders alone.
When you sign up for Heard, you get a team of professionals who do your bookkeeping and accounting for you, file your taxes, and calculate your quarterly tax payments—all for one flat monthly rate. Here’s how it works.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult their own attorney, business advisor, or tax advisor with respect to matters referenced in this post.
Bryce Warnes is a West Coast writer specializing in small business finances.