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Minimizing "reasonable salary" for physician Solo 401k

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  • Minimizing "reasonable salary" for physician Solo 401k

    My spouse is an independent contractor EM physician in Southern CA with a gross income is about $300k. A little over $100k is an "administrative stipend" for being the medical director of one ED, working government compliance issues, representing the physician group to ACEP, and some other related tasks. About $10k comes from telemedicine, and the rest is hourly income from working shifts. The last few years she has taken a salary around $150k, which is enough to maximize pre-tax solo 401k contributions. Net business income after deducting wages etc. has been around $80k, so a 199A deduction around $16k. I'm concerned that our household's large ~$90k/year pre-tax contributions will put us into "super saver" territory with large RMDs and high tax rates down the road.

    My math says that if we can lower her salary to around $100-120k and hire a TPA to make mega backdoor Roth contributions into her Solo 401k, we will be able to contribute to Roth accounts at a very reasonable effective tax rate, considering the payroll tax savings and extra 199A deduction. But the plan will not work without a justification for the lower salary. My thinking has been that because part of her compensation is from management, that could be justified as business profit rather than wages from personal effort. But I don't know how far I can push this. Dropping the salary and switching to MBR will drop the ratio of (W2)/(W2+K1) from ~65% to 45% at $120k or 37% at $100k.

    Is there a more quantitative salary analysis method I can use? Or, does anyone know of a good resource (CPA firm, etc.) who can perform an analysis to see how low of a salary we can justify? Preferably someone who has experience with physician compensation, and the method should be audit-tested, which is of course the concern. I'd be willing to pay a reasonable price. TIA

  • #2
    So she has an s-corp? $100k salary sounds questionable. Just because she isn't working shifts she is still personally earning all that income directly..

    Are you sure s-corp even makes sense at that income? Whether MBD Roth makes sense is another discussion

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    • #3
      Originally posted by childay View Post
      So she has an s-corp? $100k salary sounds questionable. Just because she isn't working shifts she is still personally earning all that income directly..

      Are you sure s-corp even makes sense at that income? Whether MBD Roth makes sense is another discussion
      Yes, she has an S-corp. I think a sole proprietorship would make more sense tax-wise and complexity-wise, but I believe it's required by her physician's group, and state law (CA), to be incorporated. If someone knows differently, please let me know.

      I don't think a MBR would make sense if her salary needs to be ~$150k+, as it wouldn't allow any more contributions, just Roth contributions at a slightly reduced rate, which is already high due to CA income taxes. But if the salary can be lowered below $150k, then the numbers make more sense, and I think the complexity would be justified.

      I should also mention that we're planning on taking 3 months of leave next year, with a drop in income and therefore salary, so if we are going to pull the trigger on a MBR 401k plan, it should be in place by the end of this year.

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      • #4
        I agree with childay an S-Corp is unlikely to be cost effective at this income level.

        It is more likely that the $150K is insufficient to be reasonable compensation than there is any justification to lower it to $120K.

        100% of this income is from the performance of personal services. A direct quote from IRS guidance on reasonable compensation;

        "But to the extent gross receipts are generated by the shareholder's personal services, then payments to the shareholder-employee should be classified as wages that are subject to employment taxes."

        Essentially, the default is that all of such income should be treated as wages and associated payroll costs. The IRS guidance defines 9 factors that can mitigate this.

        In all of the IRS and court determinations over the last 13 years. The single most important factor when determining reasonable compensation for personal services. Is what is a competitive salary for someone with that knowledge, skills and experience in the COL..

        Bottom line: What would be the combined W-2 salaries for her hired to perform the Medical Director, Telemedicine and EM Physician personal services.

        If you and your spouse are concerned about the amount of total traditional pre-tax contributions. Why aren't you both making Roth post-tax employee deferrals instead of traditional pre-tax employee deferrals?

        Comment


        • #5
          Originally posted by spiritrider View Post
          I agree with childay an S-Corp is unlikely to be cost effective at this income level.

          If you and your spouse are concerned about the amount of total traditional pre-tax contributions. Why aren't you both making Roth post-tax employee deferrals instead of traditional pre-tax employee deferrals?
          This is a bit of a tributary, but you asked so here's the answer. It's because of the difference in tax rates. Our marginal tax rate now is 24% fed + 9.3% state = 33.3% total. With all $91k/year of our employer retirement space used as pre-tax, we expect to be in the 32% bracket in retirement, in a tax-free state. So, pre-tax contributions are slightly preferred to Roth (33.3% > 32%).

          But, the marginal rate on business contributions is less due to 199A, only 24%*80%+9.3%=28.5%. So, if we could make Mega Backdoor Roth contributions at 28.5%, it would be a slight advantage (28.5% < 32%). And, the reduction in pre-tax contributions would (I predict) bring us down from 32% to 24% in the future, so it works out nicely. But a MBR plan wouldn't let us actually contribute more, just contribute the same amount as Roth, so it's questionable to me whether the potential tax savings is worth the effort, complexity, and fees to set up a MBR-capable plan and TPA.

          The advantage would be clear we could lower salary below the $154k threshold for maximum contributions. That would lower the allowable business contributions, but it could be made up by employee after-tax/MBR contributions, which would have a very low (<10% or even negative) effective tax rate. And it would help mitigate future RMDs. But the plan doesn't work unless all the pieces work together, and the salary piece is the critical one I'm asking about.

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          • #6
            I honestly don’t think you’re going to find support for the salary you are hoping to use, especially given that you want an “audit-tested” method (whatever that is). I’ve never heard of anyone performing a legitimate compensation study and calculating results anywhere near what you are thinking.

            As to CA law, doctors have been exempted from the requirements of California’s AB5 law requiring s-corps.
            Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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            • #7
              Originally posted by jfoxcpacfp View Post
              I honestly don’t think you’re going to find support for the salary you are hoping to use, especially given that you want an “audit-tested” method (whatever that is). I’ve never heard of anyone performing a legitimate compensation study and calculating results anywhere near what you are thinking.

              As to CA law, doctors have been exempted from the requirements of California’s AB5 law requiring s-corps.
              Thanks, this is helpful, even if not the answer I was hoping for.

              Around 2018 (TCJA) I had her ask her physicians group about the possibility of becoming a sole proprietor instead of an S-corp due to the the 199A tax savings, and was told it was required by state law, and also her group's policy that providers be incorporated. Might be worth asking again given that AB5 was passed last year.

              Comment


              • #8
                Originally posted by fyre4ce View Post

                Thanks, this is helpful, even if not the answer I was hoping for.

                Around 2018 (TCJA) I had her ask her physicians group about the possibility of becoming a sole proprietor instead of an S-corp due to the the 199A tax savings, and was told it was required by state law, and also her group's policy that providers be incorporated. Might be worth asking again given that AB5 was passed last year.
                She can be incorporated (LLC/PLLC) without electing s-corp status. Unless CA is unusual in some way

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                • #9
                  Originally posted by childay View Post

                  She can be incorporated (LLC/PLLC) without electing s-corp status. Unless CA is unusual in some way
                  That would be even worse than S-corp. C-corp’s have no flow-through and she would have to take all profits as a bonus or be subject to double taxation. I haven’t talked to many doctors who are in C-corp groups since we’ve been doing this and I would say I’ve talked to several thousand. Never met an individual doctor, at least under 60, who set up a sole owner C-corp.

                  fwiw, “C” corp as I use it is a redundancy, but that’s the way it’s referred since people are most familiar today with S-corps. A corporation that has not “elected” to be treated as an “S” corp is, by default, a “C” corporation.
                  Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                  • #10
                    Originally posted by jfoxcpacfp View Post

                    That would be even worse than S-corp. C-corp’s have no flow-through and she would have to take all profits as a bonus or be subject to double taxation. I haven’t talked to many doctors who are in C-corp groups since we’ve been doing this and I would say I’ve talked to several thousand. Never met an individual doctor, at least under 60, who set up a sole owner C-corp.

                    fwiw, “C” corp as I use it is a redundancy, but that’s the way it’s referred since people are most familiar today with S-corps. A corporation that has not “elected” to be treated as an “S” corp is, by default, a “C” corporation.
                    Was not referring to c-corp but rather LLC as default pass-through entity. Correct me if needed of course.

                    Comment


                    • #11
                      Originally posted by childay View Post

                      Was not referring to c-corp but rather LLC as default pass-through entity. Correct me if needed of course.
                      I was referring to your statement “She can be incorporated…” An LLC/PLLC is not, by default, a corporation, but incorporation means electing (via an LLC) to be incorporated. Doctors are not allowed to do business in CA as an LLC, which is what they are if they choose LLC/PLLC and do not elect to be treated as a corporation.
                      Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                      • #12
                        Originally posted by jfoxcpacfp View Post

                        I was referring to your statement “She can be incorporated…” An LLC/PLLC is not, by default, a corporation, but incorporation means electing (via an LLC) to be incorporated. Doctors are not allowed to do business in CA as an LLC, which is what they are if they choose LLC/PLLC and do not elect to be treated as a corporation.
                        Interesting, didn't know that about CA

                        Comment


                        • #13
                          Originally posted by jfoxcpacfp View Post

                          I was referring to your statement “She can be incorporated…” An LLC/PLLC is not, by default, a corporation, but incorporation means electing (via an LLC) to be incorporated. Doctors are not allowed to do business in CA as an LLC, which is what they are if they choose LLC/PLLC and do not elect to be treated as a corporation.
                          So I'm clear on this, to my knowledge, these are the options for an independent contractor in general:

                          1. Sole proprietor
                          2. LLC filing as a sole proprietor
                          3. LLC filing as an S-corp
                          4. S-corp
                          5. C-corp (listed for completeness, doesn't make sense in this case)

                          If that's not accurate, feel free to correct me.

                          Are you saying that doctors are not allowed to take options 1 or 2 in California? If so that would commit my spouse to the tax structure of an S-corp, and the resulting lower 199A deduction. I don't think it would be a fair defense of a low salary in an audit to say "she'd be paying even less taxes if she filed as a sole proprietor."

                          Comment


                          • #14
                            Originally posted by fyre4ce View Post

                            So I'm clear on this, to my knowledge, these are the options for an independent contractor in general:

                            1. Sole proprietor
                            2. LLC filing as a sole proprietor
                            3. LLC filing as an S-corp
                            4. S-corp
                            5. C-corp (listed for completeness, doesn't make sense in this case)

                            If that's not accurate, feel free to correct me.

                            Are you saying that doctors are not allowed to take options 1 or 2 in California? If so that would commit my spouse to the tax structure of an S-corp, and the resulting lower 199A deduction. I don't think it would be a fair defense of a low salary in an audit to say "she'd be paying even less taxes if she filed as a sole proprietor."
                            No, I’m saying that the only options available to doctors in CA are #1, #4, and #5 of your list. I’ve never researched whether a doctor can be an LLC filing as an S-corp, but I doubt it’s allowed.
                            Our passion is protecting clients and others from predatory advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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