Are S corps advantages destroyed by some state laws?

[docnews]

Here is my situation: new independent contractor physician with about $300k/yr expected income and I was looking into the advantages of incorporating my single person business.

From my research an S corporation can save you the medicare tax 2.9% (3.8% at surtax levels) on the amount you dare pay yourself in dividends. The reasonable salary for a physician I would argue would at least be $150k/yr, so the dividend amount would be 50% / the other $150k, saving about $5k/yr. But ambiguous accounting costs and maintenance fees could easily reach $2k/yr. So net $3k/yr is nothing to scoff at as long as it takes less than 1 day of work per year.

But then I did more research and learned that every state handled an S corp pass-through differently. Some respect, some place fees, some ignore. Well in Tennessee it appears that they ignore ... then place you under state corporation tax law with an excise tax of 6.5%! So in a sense I would be penalized 3.6% of all dividend income through a S corp!! So who would setup an S corp in Tennessee? I guess some interstate commerce would be forced to follow TN law but am I correct in stating that whoever sets up an S corp for a single person corporation is harming themselves?

I guess in some ways I'm glad that my conclusion thus far is the easy way (sole proprietorship) might be the best way.

Any doctors incorporating just themselves and seeing large savings/benefits for their troubles? Has anyone set-up an S corp only to find out they actually pay more in taxes?

[jfoxcpacfp]

For practical purposes, the rule of thumb for income versus distributions (not exactly dividends) from an S-corp that has been used in the past by the IRS is 50:50. iow, the IRS will typically not challenge a business owner for abusive distributions if you take at least as much salary as you do in distributions. I don't know if you nailed that by luck or you did some research, but you got it. However, when the business owner is the sole income producer (i.e. - if you quit working, your business would cease to bring in revenue), you can expect the IRS to challenge that ratio in an audit. I would lean toward 25% dist's and 75% salary and I would put my recommendations in writing.

Yes, you will potentially save some taxes as an S-corp, but I would also question that a $150k salary would be accepted as "reasonable" given similar salaries for similar work in your profession. If the typical salary for your specialty is $150k, though, then you would have a better argument.

The reason to choose a corporation or LLC has more to do with liability protection than saving taxes. This is an often-misunderstood point. For you to be a sole proprietor may not be as big a risk today since you are just starting out and likely have more debt than assets, but it will be a future concern. Your malpractice policy will cover claims on your work as a professional but not if you kill a child crossing the street on your way to work. And not if an employee makes an error that causes loss or harm to someone while he/she is on the clock. The way to cover these and other risks are with adequate insurance, including a sizable umbrella policy, along with a business structure that shields your business from personal assets.

As for state taxes, relatively speaking, TN is a business-friendly state but you will have to pay TN Excise taxes on certain profits at 6.5% if you are incorporated or are a SM-PLLC. You also pay Franchise tax on your net worth (probably minimal for your biz) + your real and tangible property at 25 cents per $100 with a minimum $100. There are adjustments in the calculations so I can't comment on what you would end up paying but you would probably be paying more. Again, though, the liability issues far outweigh the tax differential (imo).

Too much to cover here in depth; this is a serious discussion to have with your financial advisor. Hope this helps.

[docnews]

Johanna Turner wrote:

 

The reason to choose a corporation or LLC has more to do with liability protection than saving taxes. This is an often-misunderstood point. For you to be a sole proprietor may not be as big a risk today since you are just starting out and likely have more debt than assets, but it will be a future concern. Your malpractice policy will cover claims on your work as a professional but not if you kill a child crossing the street on your way to work. And not if an employee makes an error that causes loss or harm to someone while he/she is on the clock. The way to cover these and other risks are with adequate insurance, including a sizable umbrella policy, along with a business structure that shields your business from personal assets.

 

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Isn't the liability protection overblown? I'm setting up an umbrella insurance policy for personal protection and in my state it is unheard of for there to be a malpractice claim higher than the limit. This s corp accounting/fee/taxes costs a few thousand a year which makes it a questionable expensive "insurance policy" on the rare likelihood that I would be sued successfully for greater than my umbrella insurance limit AND that my state would allow my s corp income to remain out of the grabs of the lawyers. Plus these pass-through entities pass the money right through to your personal bank accounts that have no extra protection, correct?

[jfoxcpacfp]

(Post removed due to duplicates resulting from bug in forum files)

[GatorMD]

A few of my colleagues have created an S-corp and I looked into it briefly last year. My accountant estimated it might save me around $2k per year after fees, but I couldn't stomach paying myself a "reasonable salary" of $150k when I am paid $350k as an hourly IC. Not sure how you defend that in the event of an audit. It just makes me uncomfortable and not worth the potential savings to me. I'd rather concentrate on other tax savings strategies like maxing out all of my retirement accounts etc.

[Slav4ikMD]

Question on income vs distributions:  so in my situation I have a bunch of W2 income and then have a PLLC for a side business (private practice and consulting), which yields me say 100k a year.  So if I pay myself a salary of 50k off that, does that become a red flag as such a low salary for a physician, or given that they see my other large W2 numbers it would actually be in my advantage as it gets added to what I made as a W2?  I think that 50/50 is reasonable in my case, what do you guys think?  Any other thoughts for my situation?

[litovskyassetmanagement]

docnews wrote:

Here is my situation: new independent contractor physician with about $300k/yr expected income and I was looking into the advantages of incorporating my single person business.

From my research an S corporation can save you the medicare tax 2.9% (3.8% at surtax levels) on the amount you dare pay yourself in dividends. The reasonable salary for a physician I would argue would at least be $150k/yr, so the dividend amount would be 50% / the other $150k, saving about $5k/yr. But ambiguous accounting costs and maintenance fees could easily reach $2k/yr. So net $3k/yr is nothing to scoff at as long as it takes less than 1 day of work per year.

But then I did more research and learned that every state handled an S corp pass-through differently. Some respect, some place fees, some ignore. Well in Tennessee it appears that they ignore … then place you under state corporation tax law with an excise tax of 6.5%! So in a sense I would be penalized 3.6% of all dividend income through a S corp!! So who would setup an S corp in Tennessee? I guess some interstate commerce would be forced to follow TN law but am I correct in stating that whoever sets up an S corp for a single person corporation is harming themselves?

I guess in some ways I’m glad that my conclusion thus far is the easy way (sole proprietorship) might be the best way.

Any doctors incorporating just themselves and seeing large savings/benefits for their troubles? Has anyone set-up an S corp only to find out they actually pay more in taxes?

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You can have an LLC and you can elect to be taxed as S-corp.  With $300k in income that might not necessarily be the best idea.  That is, until you decide to adopt a Defined Benefit plan for yourself.  For best results, you would want to pay yourself a salary ($265k to max out the DB plan) and distribute the rest.  Doing a DB plan with just the 1099 income might be a problem if your 1099 income is lower than $300k. Also, if your income varies a lot, having a W2 is important if you want to adopt a DB plan. With $400k or above you would probably be fine, but if you make more than $400k or so it would make sense to pay yourself the salary (and elect the S-corp status) whether you want a DB plan or not (which would be $265k if you want to max out the DB plan).  For the purpose of maxing out a solo 401k plan, you are just fine in keeping a solo proprietorship/LLC.

[litovskyassetmanagement]

Slav4ikMD wrote:

Question on income vs distributions:  so in my situation I have a bunch of W2 income and then have a PLLC for a side business (private practice and consulting), which yields me say 100k a year.  So if I pay myself a salary of 50k off that, does that become a red flag as such a low salary for a physician, or given that they see my other large W2 numbers it would actually be in my advantage as it gets added to what I made as a W2?  I think that 50/50 is reasonable in my case, what do you guys think?  Any other thoughts for my situation?

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You don't need to pay yourself a salary with $100k 1099 income.  One reason is that you already paid FICA tax on your W2 wages, so paying yourself a salary won't save you as much compared to a situation where you did not have any W2 income. But if you do pay yourself, $50k is just fine.  This becomes a problem when your 1099 is $400k and you pay yourself $50k.  At that point, I'd say $150k-$250k is a reasonable salary.

[jfoxcpacfp]

Slav4ikMD wrote:

Question on income vs distributions:  so in my situation I have a bunch of W2 income and then have a PLLC for a side business (private practice and consulting), which yields me say 100k a year.  So if I pay myself a salary of 50k off that, does that become a red flag as such a low salary for a physician, or given that they see my other large W2 numbers it would actually be in my advantage as it gets added to what I made as a W2?  I think that 50/50 is reasonable in my case, what do you guys think?  Any other thoughts for my situation?

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Your PLLC income is just gravy - you already have a well-paying day job. As a PLLC, of course, you won't have a "salary" (i.e. paycheck) anyway - you'll be taxed on all of the net profits, whether or not you take your earnings out out or leave it in the PLLC. If you decided to incorporate, then you would take a paycheck, but that would, imo, be a total waste of money for compliance purposes as you would have all of the payroll filing requirements. Keep it simple. Hope this helps.

[docnews]

Johanna Turner wrote:

Not sure what this means: “Plus these pass-through entities pass the money right through to your personal bank accounts that have no extra protection, correct?” The entity does not pass the money through; the member (LLC) or the shareholder (Corp) makes that decision. Naturally, once an asset moves from the business ownership to personal ownership, it is no longer protected by the business. But I’m not sure how that fits into the discussion – perhaps you could clarify?

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An LLC or Corp does not hold the money, correct? Soon after the corp or LLC gets the money, it would be passed on to me. So how does it protect the money from personal liability?

[Slav4ikMD]

Kon and Johanna, thank you for your responses.  So my accountant does it as an S corp and I pay myself a salary from that 100k self-employed income.  I honestly don't know if that is best.  The anticipation is that this 1099 will continue to grow gradually from 100k up, and W2 income will basically remain stable (or maybe slightly less, but still substantial).  My goal for the 1099 income is to be able to use it max for deductions for the business and save max pre-tax for retirement.  For now I set up a solo 401k, so for '15 contributing 18k as employee and around 11k employer's contribution off that 50k or so salary.  I feel like with 100k this is better than doing a sepIRA.  Leftovers basically go for deductions, which are now high, especially as I am expanding my business and there are many expenses.

So basically I am not sure if the PLLC and S corp was the way to go, but that's the set up my accountant recommended.  Do you guys think I should explore other approaches?  I am pretty content with what I do now, but if you feel I can do better, I'd love to hear about it.

(BTW I am not sure what the etiquette of this site is - if these questions are too detailed and personal and shouldn't be answered for free, please feel free to ignore.) 

[litovskyassetmanagement]

I wouldn't recommend doing an S corp for $100k in 1099 income (unless you don't have any other W2 income above $120k), and if you have an LLC you can just elect to be taxed as a sole proprietor.  Also, you can put 20% of the entire $100k in profit into your solo 401k plan, not just 25% from the $50k.  And you already paid the employee portion of FICA, so you don't get the full 15.3% tax savings.  I recommend that you sit down with your accountant and ask them to explain why an S corp makes sense vs. passthrough.

[Slav4ikMD]

Kon, honestly I don't understand S corp vs passthrough too well, but I think his rationale was that I would be able to deduct more aggressively and it is "cleaner."  I am not sure if that is the case or if I understood correctly.  But he did say that if I wanted to be super conservative, then we don't need this whole thing.

To clarify re 401k:  so I just deposited 18k as an employee contribution.  Didn't put in employer contribution yet, was going to put in 11k from the business account.  Are you saying I can put in another 20k as employer contribution?  Thank you!

[litovskyassetmanagement]

He's right - this is much 'cleaner' as he says.  Your employer contribution is 0.25*$50k or $12,500.  If you had $100k in net profit, your employer contribution would be about 0.2*$100k or $20k.  The benefit of the S-corp election definitely grows as your net profit increases.  Your CPA should explain to you the difference in taxation for the two elections so that you understand what the trade-offs are.

[jfoxcpacfp]

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