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  • Tax Strategies as Independent Contractor

    I am finishing residency soon and would like to do independent contractor work.  What is the best strategy to pay myself and minimize tax burden? (ie start an LLC)

  • #2
    LLC has nothing to do with taxes. Your two options for tax filing are sole proprietor and S-corporation. Both allow for complete deductions of business expenses. An S-corp allows for some of the income to be received as a corporate distribution, which is taxed at the corporate rate and not for Medicare (2.9%), but costs extra in filing fees. Also, if you have additional W-2 income alongside being an independent contractor, then the S-corp will be taxed again on the social security portion of the wages. Both allow you to run expenses through them and to have an individual 401(k).

    So if it is your only job and you are the only employee, unless you make a very large amount (basically if you'd save on corporate taxes an amount greater than the additional taxes/fees), sole prop is probably better...and, if you have an employed job as well, then sole prop is almost certainly better due to SS tax.

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    • #3
      Do not fall into the trap that many new physician's do and think an LLC and/or an S-Corp is always necessary and/or beneficial.

      First, understand that an LLC is a state chartered business entity and has nothing to do with your tax status. By default a single member LLC is considered by the IRS as a "disregarded entity". This means you file your taxes on a Schedule C and Schedule SE as a sole proprietor. An LLC buys you nothing tax wise.

      Next, understand that an LLC provides little to no liability protection for the professional acts of the LLC owner like it does for any employees. Also, a new LLC is unlikely to be able to get any credit such that the LLC's creditor protection matters. In almost all cases an LLC creditor will require a personal guarantee.

      Since you will need the same business liability insurance and malpractice insurance that a sole proprietor will require, there may be little to no liability benefit of an LLC.

      Do not be seduced by the mantra that an S-Corp (whether under an LLC or not), will always save substantial amounts of payroll taxes. Contrary to conventional wisdom an S-Corp is best suited for someone with an income from 1/2  to 1 1/2 times the Social Security (SS) maximum wage base. Currently this is from about $60K - $200K. Once an S-Corp shareholder-employee's W-2 SS wages > the SS max wage base, you are only saving 2.9% on the distribution.

      Finally, do not fall into the trap of using an S-Corp for supplemental IC work when you have primary W-2 employment. It will almost always be counter productive.

      The bottom line. Do not listen to the practitioners, fellow residents, buddies at happy hour or some random guy on a web-based forum. Engage the services of a professional familiar with the particular circumstances of your state.

      P.S. I was referring to myself and not DMFA.

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      • #4
        Well, I mean, I *am* just a random guy on a web-based forum...this is very true. I didn't think for a second you were referring to anyone in particular.
        I think some of us forget that. We *do* agree on the point, though. Much respect

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        • #5
          it is startling how often really smart physicians make non medical decisions based on what they 'heard' from some 'dude'

           

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          • #6
            So can anyone enlighten me on this?

            Several friends I have in PP have an S-Corp. They get paid via a 1099 from their group. They set their salary at the average countrywide salary for the specialty and pay personal income taxes on that. Whatever is above that due to extra shifts, extra work, and such, they take as a distribution and pay lower taxes on that. So in addition to saving the medicare surtax, they save some on taxes that way. How do they structure themselves that way? When I ask they tell me their CPA takes care of it.

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            • #7




              So can anyone enlighten me on this?

              Several friends I have in PP have an S-Corp. They get paid via a 1099 from their group. They set their salary at the average countrywide salary for the specialty and pay personal income taxes on that. Whatever is above that due to extra shifts, extra work, and such, they take as a distribution and pay lower taxes on that. So in addition to saving the medicare surtax, they save some on taxes that way. How do they structure themselves that way? When I ask they tell me their CPA takes care of it.
              Click to expand...


              They just set up an LLC. If the costs are very low and you make a lot, to where the 2.9% difference is worth the cost of set up, maintenance, and filing (needing cpas, etc...) then it could be worth it. Its too costly and too tedious for the small benefit in cali.

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              • #8
                This is another common myth. An S-Corp W-2 shareholder-employee receives distributions, these are not dividends and certainly not qualified dividends. Distributions go on your Form 1040 Line 17 as ordinary income and is taxed exactly the same as your their W-2 wages.

                This is not to say that there isn't a benefit for many physicians to have an S-Corp. To put this in a perspective that a physician in PP might relate to. There is essentially a FICA "Donut Hole" from about $200K - $325K ($350K in CA). This is where the 2.9% Medicare tax savings do not outweigh the payroll costs, extra CPA and tax filing costs, complexity and hassle. Once you get above the upper end it starts to save you money, but even then many Physicians can't be bothered for a couple $K.

                Thus, the admonition to consult with a professional about an individual's particular facts and circumstances, including state law. It may be beneficial, but it really should be considered on a case by case basis.

                Edited to add the second paragraph. Although RosieQ beat me too it and her analogy of a U-Shaped curve is far more correct.

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                • #9




                  Do not be seduced by the mantra that an S-Corp (whether under an LLC or not), will always save substantial amounts of payroll taxes. Contrary to conventional wisdom an S-Corp is best suited for someone with an income from 1/2  to 1 1/2 times the Social Security (SS) maximum wage base. Currently this is from about $60K – $200K. Once an S-Corp shareholder-employee’s W-2 SS wages > the SS max wage base, you are only saving 2.9% on the distribution.

                   
                  Click to expand...


                  I think this is the key point. There is a U shape tax savings curve for utility of S corp. It's highest in the <150k per year  salary range since you can argue to take 1/2 your income as salary and 1/2 as distributions and save the social security taxes on any income under 127k (the amount of income that is subject to the 6.2%x2=12.4% social security tax). You also save 2.9% on medicare taxes as well, so about a 15% tax benefit for any income shifted to distributions at that lower level. It actually works really well if you are just finishing residency and have 6 months of working as an attending. Any additional benefits at higher come from saving on medicare taxes only 2.9% plus the Obamacare 0.9% tax on income over 200k, so about 3.8% of a tax benefit for higher income.

                  However it's not that simple. Many states have a business tax that you have to pay...it's a whopping 1.5% in California, so that eats into the 3.8% benefit for where most physicians are at. However, as you start making more and more, a 2-3% tax benefit of incorporating can start to add up, so $400,000 and above will likely save a few thousand dollars and could consider it.

                  Taxes are more difficult to do and instead of a few hours on Turbotax for $100 yourself you now have to hire a CPA for $1000-1500. It would have ended up saving me about 1-2k to be incorporated with a lot more headache so I'm holding off for now.

                  No real liability benefits so far as I can tell.

                  The final benefit of incorporation as far as I understand after running through this decision process with a CPA was that incorporating allows you to save more towards pre tax retirement accounts at lower income levels. For W2 wages the formula is 18k+ 25% of wages as an employer contribution (which you can control since you are the employer). Hence you can max out the full 55k for 2018 at 148k of income (55k-18k=37k. 37/0.25=148). However if you are all sole proprietor you can only do 20% of income so 55k/0.2= 275k income needed.

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                  • #10
                    RosieQ, a small correction and a context.

                    For 2018, the employee deferral limit is $18.5K, so the maximum W-2 employer contribution is ($55K - $18.5K = $36.5K) / 0.25 = $146K in W-2 wages. For a self-employed individual this would require the same $36.5K / 0.20 = $182.5K in net self-employment earnings

                    However, this is not really any different than an S-Corp. The shareholder-employee needs only to have a W-2 wage of $146K, but the S-Corp has to pay the $36.5K employer contribution out of net business profit. $146K + $36.5K + $182.5K.

                    This one of the reasons why the self-employed individual uses 20% instead of 25%, because the employer contribution comes out of their net self-employment earnings. Where the S-Corp pays the employer contribution in addition to the W-2 wages.

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                    • #11



                      RosieQ, a small correction and a context.


                      For 2018, the employee deferral limit is $18.5K, so the maximum W-2 employer contribution is ($55K – $18.5K = $36.5K) / 0.25 = $146K in W-2 wages. For a self-employed individual this would require the same $36.5K / 0.20 = $182.5K in net self-employment earnings


                      However, this is not really any different than an S-Corp. The shareholder-employee needs only to have a W-2 wage of $146K, but the S-Corp has to pay the $36.5K employer contribution out of net business profit. $146K + $36.5K + $182.5K.


                      This one of the reasons why the self-employed individual uses 20% instead of 25%, because the employer contribution comes out of their net self-employment earnings. Where the S-Corp pays the employer contribution in addition to the W-2 wages.


                      Click to expand...



                      Thanks for the clarification. 

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                      • #12
                        Thanks for the replies. That is how I understand it as well. In the state I live in there is a small (<$100) yearly fee for the S Corp and that is it. Income range is >500k for the specialty so doing an S-Corp is the way to go. But they are also able to do more through their S- Corp than just save the 3.8% surtax. I wish I could talk to their CPAs. I am W2 employed so it does not matter to me, but I am considering switching to a 1099 job and it would be nice to have all the facts. I guess I will just need to schedule a face to face with their accountants.

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                        • #13




                          Thanks for the replies. That is how I understand it as well. In the state I live in there is a small (<$100) yearly fee for the S Corp and that is it. Income range is >500k for the specialty so doing an S-Corp is the way to go. But they are also able to do more through their S- Corp than just save the 3.8% surtax. I wish I could talk to their CPAs. I am W2 employed so it does not matter to me, but I am considering switching to a 1099 job and it would be nice to have all the facts. I guess I will just need to schedule a face to face with their accountants.
                          Click to expand...





                          What can they do with an S-corp that they cant as a sole proprietor? Thats probably their cpa talking and not reality. I was super gung ho about this when I graduated fellowship, ready to get an S-corp and profit, etc...I read several books, and there was no there there. Made no sense. No tax benefit outside distributions and the minimal gain for the headaches doesnt make sense (again, costly CA). What are these benefits?

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                          • #14
                            OP, as mentioned above to determine s-corp or not, you really need to know how much income you will be earning.  Do you have any idea?

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                            • #15
                              Thanks for the replies everyone!

                              I would expect to be earning about 175k

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