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  • S corp to decrease taxes as 1099?

    First and foremost, forgive my ignorance if I word any of this incorrectly, as this is pretty foreign to me.

    I was speaking to a colleague, and he has just started doing full time locums 1099 work. He is getting paid very well for the travel locums work he is doing, and thinks he will make high 6 figures (lets say 800k) in pure 1099 work this year.

    He mentioned to me he has created an S corp for the 1099 pay, and then is planning to pay himself as a W2 what he believes is a fair market pay for someone in our specialty. He stated about 300k, leaving 800k-300k = 500k left over in the S corp as distributions which he believes will get substantial tax benefits. My understanding is that he would only benefit payroll taxes from it.

    One thing that felt like a grey area was what is designated as a "fair market salary". Sure an average physician in our specialty may make around 300k, but he is clearly not working like an average physician with all the locums work. Does that alter what a market salary would be that he would have to pay himself as a W2?

    I am just trying to gauge how much he is actually saving in taxes by going this route, in order to get a better understanding of how this works.

    Thanks!

  • #2
    He is correct that with net profits of $800K he will save taxes with an S-Corp. You are correct that the savings will only be on Medicare taxes.

    The only question is; what will be appropriate reasonable compensation. In the court cases over the last 10-12 years the rulings have prioritized what the individual would make in W-2 wages at another employer based on their knowledge, skills and experience in the area's job market. They have also modestly increased compensation to factor in management, marketing, financial and tax tasks.

    There is no absolute correct answer. I still like it when total compensation including employer contributions (which are not subject to FICA) are > distributions. This is one area where if the individual is old enough they take full advantage of a defined benefit plan.

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    • #3
      I will tag on that, if I can get a physician to agree to take a $300k salary out of an S-corp, I’m not going to argue about fair market salary. You also should take into account that your colleague is bearing the full cost of operating expenses, such as payroll tax matching, CE, supplies, probably some travel, administrative (taxes, bkk, payroll) costs, retirement plan admin and profit sharing, PTO, etc. So:
      1. He won’t have a full $500k to distribute
      2. The additional OOP expenses raise his “FMV” pay rate closer to par with a doctor employed by a 3rd party practice or institution
      Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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      • #4
        just to tag you on that, im in a very similar situation...
        but will having a cash balance plan be helpful in this situation?

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        • #5
          Originally posted by akmd View Post
          just to tag you on that, im in a very similar situation...
          but will having a cash balance plan be helpful in this situation?
          Be helpful in what way?
          Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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          • #6
            reduce taxable income as it is above the line deduction?

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            • #7
              Originally posted by akmd View Post
              reduce taxable income as it is above the line deduction?
              Well, yes, that will obviously reduce taxes if it is appropriate for you to set one up, and that is the relevant issue.
              Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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              • #8
                Originally posted by akmd View Post
                reduce taxable income as it is above the line deduction?
                I think moving deductions from your 1040 to your 1120S does help with the S corporation gambit.

                Some business-y deductions save only income taxes when you operate as a Schedule C sole proprietorship. But when you operate as an S corporation, in effect, they save both income taxes and payroll taxes. Further, they probably bump up your compensation.

                For example, someone makes $800K, operates as an S corporation, and pays $200K of W-2 wages, $25K of health insurance, and $175K of DB pension benefits. I think their comp in this case is $400K. And they'll save or defer not only income taxes but also payroll taxes on the $25K of health insurance, the $175K of pension benefits, and then on that leftover $400K distributive share they'll save Medicare taxes.
                Stephen L. Nelson, CPA, MS-tax, MBA-finance - Partner
                Nelson CPA PLLC | s[email protected]

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                • #9
                  Originally posted by jfoxcpacfp View Post

                  Well, yes, that will obviously reduce taxes if it is appropriate for you to set one up, and that is the relevant issue.
                  Can you please shed some light on who can qualify for a cash balance plan or not?

                  starting 2023 I will be straight 1099 and this was one of the reasons I opted for that kind of payment arrangement.

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                  • #10
                    Originally posted by akmd View Post

                    Can you please shed some light on who can qualify for a cash balance plan or not?

                    starting 2023 I will be straight 1099 and this was one of the reasons I opted for that kind of payment arrangement.
                    I am not really qualified to do that, but I can provide some general direction:
                    • Age at least late 30s before starting (I prefer even later)
                    • Planned high income stream for several years (varies by the TPA you talk to)
                    • Understanding of the plan mechanics: willing to contribute high amounts of money to investments with lower than necessary return rates solely for the tax breaks. This is a tradeoff and I am making no judgment for or against in this statement.
                    • Understanding also that, if you get a quality TPA, you will be paying several thousand dollars per year for the service.
                      • Note that you must contribute from W2 income, so you will also be paying Medicare taxes in order to make the cash balance contributions.
                    This is not a OSFA arrangement. Appropriate for some, not necessarily for all.
                    Our passion is protecting clients and others from predatory and ignorant advisors. Fox & Co CPAs, Fox & Co Wealth Mgmt. 270-247-6087

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                    • #11
                      Ok thank you

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                      • #12
                        I was going to ask re a similar topic.....for someone who has an S-corp, what is the best mix of salary vs dividend. For instance as mentioned above, taking $300K as W2 income and taking the rest as dividend to myself, what is saved by that? So the savings on this strategy is roughly payroll tax rate which is what, 1.45% once you have maxed out Social Security, or is it more? Thank you

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                        • #13
                          You can't just arbitrarily set a salary. The IRS and the courts require you to pay yourself at least reasonable compensation. However, unless it provides some benefit to you. There is no reason to pay yourself > than reasonable compensation.

                          W-2 Social Security (SS) wages > $250K (married filing jointly), $125K (married filing separately) and $200K (everyone else) are subject to the additional Medicare tax (0.9%). While both employee and employer pay the 1.45% Medicare tax, only the employee pays the 0.9% additional Medicare tax for a total of 3.8%.

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                          • #14
                            Thanks very much - yes for 3.8% almost seems worth the hassle of dealing with the manual withholding - but then today I remembered that every dollar that is distributed instead of W2'ed is then not eligible for the 3% employer salary match for the 401K plan of my company - which puts it back closer to "toss-up" as far as I can tell - am I right on this? So if I W2 $300K salary and distribute $150K, I've saved 3.8%x150K in payroll taxes = $5,700, but lost the ability to pay an employer match on 3%x $150K = $4500 tax deduction. Am I right on this math?

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                            • #15
                              There is a compensation limit for employer contributions (2022 = $305K, 2023 = $330K). You can not receive an employer match and/or non-elective employer contributions on more than the limit.

                              It would make no sense to exceed the compensation limit. You would be paying extra 3.8% Medicare taxes while receiving no extra 3% employer match.

                              While facts and circumstances determine reasonable compensation. I can't see where you aren't already meeting that requirement.

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