I was recently reading Incorporate and Grow Rich, a book which I'll review in a separate post. The more I read the more excited I got about C corporations and their benefits. Then I started realizing that there were specific rules that kept me from using a C-corp for just about anything I could
use it for. Once I got over the disappointment, I decided I'd share a few things about C-corps that you may not know.
You Don't Have to Incorporate to Go into Business
Many people don't realize that being self-employed, or going into business, doesn't require you to incorporate at all, much less start a C-corp. You can just be a “sole proprietor.” It is quick and easy. This blog is currently a sole proprietorship. It provides no asset protection b
enefits (my business is the same as me) and I do my taxes for the business on my personal tax return (Schedule C.) You can also be in business as a partnership, as many doctors are. Again, no asset protection benefits (in fact you take on additional liability due to your partner's actions), and you do your taxes on your own 1040 (Schedule K-1.) Many of the tax breaks available to corporations are available to you as a sole proprietor. You get to deduct all your business expenses and travel from your profits, and then pay taxes on the difference.
You Don't Have to Form a C-Corp in Order to Incorporate
There are other corporations that provide asset protection benefits to you, such as an S-Corp, Limited Liability Company (LLC), or, in some states like mine, a professional corporation designed specifically for doctors and lawyers. All of these are separate entities from you individually. That protects you from liabilities associated with the business, and protects the business from your liabilities. But tax-wise, these are all very similar to a sole proprietorship. They are “pass-through entities” and you end up paying tax at your personal tax rates. There is an opportunity to get out of some of your payroll taxes by incorporating yourself as an S-Corp, but that's about the extent of it. Tax-wise, these corporations are pretty much the same thing as you.
A C-Corp Pays Its Own Taxes
A C-Corp, however, pays taxes completely separate from you. It even has its own tax brackets. Here they are:
| 15% | <$50K |
| 25% | $50-$75K |
| 34% | $75-100K |
| 39% | $100-335K |
| 34% | $335K-$10M |
| 35% | $10-15M |
| 38% | $15-18.3M |
| 35% | >$18.3M |
Weird huh. It doesn't make much sense to me either. But there are some real benefits available there. Let me see if I can illustrate them. Imagine you make $450K. I know. You don't. Neither do I. But let's just imagine it. On that last $50K you made, you paid 35% in federal income tax, let's say 5% in state tax, and 2.9% in Medicare tax. That's 42.9%. If you could somehow have gotten your corporation to make that dollar, instead of you, it is possible that you would only pay 15% tax on it. That would save you 0.429*$50K – 0.15*$50K = $13,950 in taxes. Excited yet? Yea, I was too.
Avoiding Double Taxation
The problem now is that the money belongs to the corporation, not you. You can't just go blow it on a new car or a vacation. Or can you? At this point, you have a few more options available to you. First, you can have the corporation buy the car or the vacation. Of course, you have to be able to justify it as a business expense. But a CME trip would qualify (unless it's a foreign cruise), as would a car (actually the rules pretty much require it to be a truck if you want it to be new) used to commute you around to your various work sites (again, this gets tricky for a doc without any other business interests).
A better option might be that the corporation can pay you the money and you can buy the car or the vacation yourself. It can do this several ways. First, it could provide you a retirement account of some kind, such as a profit sharing plan. Now, you can take the money you would have put toward retirement and buy a car with it. The retirement account contribution is deductible to the corporation, just like it would have been to you.
Second, the corporation can pay you a salary. This salary is totally deductible to the corporation. Of course, it is fully taxable to you, including payroll taxes. That kind of defeats one of the purposes of the corporation, but at least you get the money out and can get that Geo Metro you've had your eye on. Even if it is paid as a bonus, you still pay your full marginal tax rate including payroll taxes on it.
Third, you can endure the double taxation problem. Corporate dividends to you are taxable at capital gains rates, currently 15% for most docs. Unfortunately, those are not deductible to the corporation. So the corporation pays taxes at 15%, then you pay taxes at 15%. 30% is better than 42.9%, but still not great.
Fourth, the corporation can buy you a tax-deductible (to the corporation) benefit you may want . For example, a term life insurance policy up to a face value up to $50K is deductible to the corporation. So is health insurance (including dental, vision, and a Flex Savings Account), up to $5K in child care, educational assistance up to $5250, moving expenses, a “physical fitness facility”, and “de-minimis fringes” (drinks in the fridge and other small value items).
Fifth, the corporation can give achievement awards. Each year the corporation can give a fully tax deductible (to you and the corporation) award for longevity and one for safety up to $1600 each to your family member or other employee, or a $400 “non-qualified” award to you. If you make the award golf clubs or a TV you don't even have to pay payroll taxes on it. There are a few small catches, and it isn't much money, but it is a tax-free way to get it out of the company.
Sixth, the corporation can buy something from you. Sell the corporation a computer, a car, or some other equipment. It's an expense (and thus deductible from profits) for the corporation, and you don't have to pay taxes on it either (unless you somehow managed a capital gain on it.)
Seventh, the corporation can give “business gifts.” These can be up to $75 per recipient per year. There's supposed to be a business purpose, but that can be as simple as “building goodwill.” In fact, if you put your logo on it, it's advertising and doesn't count against the $75 limit. I'm not sure I'd try buying your employee spouse a new Mercedes with a tiny business logo by the license plate and call it an advertising expense, but there's clearly plenty of gray in this area.
Now, most of these corporate benefits are just as available to an S Corp as a C Corp (except the dividends taxed at capital gains rates and the achievement awards given to corporate shareholders).
Reduced Dividend Taxation
There is one other huge benefit available to a C-Corp that initially got me super excited. Dividends the corporation receives from other corporations are mostly non-taxable (up to 20% may be taxed.) That sounds an awful lot like an extra tax-protected retirement plan to me.
Change Fiscal Year End
The C-Corp is also the only entity that can have a different year end than December 31st. This allows for great flexibility and some unique tax strategies that can allow you to defer taxes for up to a year. Not to mention you can get a lot more attention from your accountant in June than you can in April.
Now that I've got you all excited about C-Corps, I'm going to use the next post to dash your hopes, and show you that the government not only hates doctors, but also only wants real businesses to be able to benefit from incorporation.
Photo Credit: David Wright CC-SA, Wikimedia
I’m sorry, but from talking to physicians that have set up C-corporations, you can invest all (or a large amount) of your gross income into tax-deferred or tax-exempt investment vehicles. That is, everything that you don’t need to live on.
I’m a lowly medical student right now, but say I have 200,000 coming in as an attending, for example. If I dedicate 40,000 gross to my student loans and only need 30,000 gross to live on, I could write put the 130,000 remaining in tax exempt/deferred investments, right?
There is one thing that I do not agree with on the website, although it is a great resource for doctors. In the S and P 500’s HISTORY, including stock market crashes, depressions, and recessions, it has yielded an annual 10.5% or so pre-tax. If somebody has a loan accruing at 3%, for example, it really does benefit them to pay the loan off extremely slowly. This is assuming that they have an emergency fund of 3-6 months for living expenses and that they CAN afford to lose that money.
I don’t have the expertise nor energy to buy individual stocks, but I’m a big proponent of getting low expense-ratio, passive Vanguard index funds instead of paying for commissions and capital gains. Vanguard has a bunch of Target funds that automatically adjust the asset allocation depending on one’s estimated retirement age. I don’t really think it’s that radical to employ the standard 120-your age to determine the percentage of your total investment that will be put into stocks. Then as you get older, you switch more toward bonds and less volatile stocks/funds.
In other words, as long as your yield is greater than your loans, your net worth is increasing, which is the main point of investing.
However, if one has a loan growing at 7.9% (grad plus), I could see how it could be a solid choice to pay it off quickly since paying it off is a guaranteed 7.9% yield.
Of course, when I’m investing I’m doing it for a LONG-haul, like 30 years. I don’t have the stats right now, but I’m pretty sure that the lowest 30 year annualized return for the stock market large-cap indexes is like 8.5% or so.
The statistics can be seen here:
https://www.whitecoatinvestor.com/what-can-you-expect-from-the-market-in-the-long-run/
You might be interested to learn that money invested in the stock market between 1960 and 1970 and withdrawn between 2000 and 2010 had a return of less than 3% a year after inflation. That’s 30-50 years. Money invested in 1928 and withdrawn in 2011 also had a real return of less than 3% a year. A guaranteed return of 7.9% (nearly 5% real assuming 3% inflation) is nothing to sniff at.
Sorry, but the total pre-tax return in its history is like 10.5% annualized. And inflation averages roughly 3%, if I’m not mistaken. Thus, the real return would be 7.5% pretax.
I guess if you put the word “like” before it you can use any number you want. Returns are “like” 14%. They’re “like” 7%. In reality, from 1926-2011, not counting inflation, expenses, or taxes, the return of the S&P 500 counting dividends is 9.77%. You couldn’t really invest in it until Vanguard’s 500 Index Fund came out in October 1976. Since inception, that fund has returned 10.76% per year (arithmetic average, not geometric or annualized returns which would be nearly 0.5-1% lower) after expenses but before inflation and taxes. Inflation is about 3% since that time. But all this bickering about whether the historical return is 9.5% or 10.5% is not particularly important. What is important is what it will be going forward, and there are a lot of good reasons to assume the future will not look like the past. If you plan on 10.5% out of your stocks and only get 7% (4% after inflation), then what? You’ll save too little and end up either taking on more risk than you should, working longer than you planned, or living on less than you planned in retirement.
I’m curious how many physicians with C corps you have talked to. I don’t know a single one. Nor am I aware of a way to invest anywhere near all of your income into tax-deferred or tax-exempt investment vehicles, unless you consider a life insurance policy or an annuity as an investment vehicle. An older doc can get a big chunk into a defined benefit plan, but most are limited to $51K, plus perhaps a little more for a catch-up contribution and some backdoor Roth IRAs. Perhaps also an HSA. We’re still talking less than $70K a year.
I love how you envision living on $30K a year as an attending. I also had similar thoughts as a student and even a resident. But you know what? I don’t know anyone actually doing it. Even a guy I know who has a blog that talks about physician personal finance and investing and who saves a higher percentage of his income than anyone he knows in real life doesn’t live on $30K a year. So before you plan on doing this, I suggest you find someone who has actually done it. You might also do a little research into the tax code to see how much a doc who makes $200K, yet only spends $30K, actually pays in taxes. I assure you the answer isn’t zero. In fact, if you’re self-employed, you’ll pay at least $19K just in payroll taxes.
Yes, if your investment returns are greater than the cost of your loans, and you don’t get burned on cash flow, you’ll come out ahead not paying off the loans early. That’s just math. Don’t forget to account for behavior.
Yield isn’t return. That’s an important concept to learn. Some of my partners are really excited about the 8-10% yields they’re getting on an investment. Until I point out the total return on it is zero because it’s decreasing in value each year. To make matters worse, it’s not a return of principal or a qualified dividend, so that yield is fully taxable, and they’re coming out behind after taxes.
The true annualized return of the S&P 500 counting dividends but not expenses or taxes from 1926 to 2011 is 9.77% per year according to this: http://financeandinvestments.blogspot.com/2012/06/historical-annual-returns-for-s-500.html Perhaps increase it to 9.8 or 9.9% due to the last 15 months. But keep in mind there are long periods of time when the return is less than that, especially if you look at real returns in periods of high inflation. It was 5.9% nominal for the 25 year period ending in 1953. If that’s the last 10 years of your career and the first 15 of your retirement you’re kind of hosed if you were counting on 10.5% returns from stocks.
http://dqydj.net/sp-500-return-calculator/
I just put in the January 1900 to January 2013 dates and with the CPI considered, the annualized yield was 6.306%, with dividends reinvested.
Obviously, I don’t advocate being 100% in stocks if one is 5 years away from retirement, but I think people are too risk-averse when investing. I cringe when I see 30 year olds heavily invested in bonds and cd’s for their long-term investments.
But is that true about the C-corps? Are you only taxed at regular income tax rates for money that you draw out of the corporation? And the rest is shielded from taxes until you use it?
Are you familiar with corporate tax rates?
Taxable Income ($) Tax Rate[27]
0 to 50,000 15%
50,000 to 75,000 $7,500 + 25% Of the amount over 50,000
75,000 to 100,000 $13,750 + 34% Of the amount over 75,000
100,000 to 335,000 $22,250 + 39% Of the amount over 100,000
335,000 to 10,000,000 $113,900 + 34% Of the amount over 335,000
10,000,000 to 15,000,000 $3,400,000 + 35% Of the amount over 10,000,000
15,000,000 to 18,333,333 $5,150,000 + 38% Of the amount over 15,000,000
18,333,333 and up 35%
C corporations pay taxes. Then you pay yourself dividends (taxed again at 23.8% for high earners.) S corps (many docs are S-corps) pass through all their income to be taxed at the individual level. You really only end up saving a little in Medicare tax.
I agree a 30 year old should have a pretty low percentage of his portfolio in bonds.
Yes, I fully understand that one may get burned over a shorter time frame, say 2000 to 2007. But all my current investments are long-term, for retirement and until 59.5 when I can withdraw them. (ROTH IRA)
Well, I grew up living poor and don’t have any expensive tastes, so as a *single* person, 10,000 a year is actually enough for me to live on. It will obviously increase a lot if I have 4 kids, of course!
You have no idea. Multiply that number by 10 and you would be considered a very frugal doc.
I guess that bodes well for me! It also helps having spent time without running water, electricity, nor air conditioning or internet, bathing with bucket showers.
To be fair to most docs, I see people that make 40,000 a year with loans for Toyota Sequoia SUV’s that cost 40,000 new, right? That’s crazy!
Sorry, I misspoke about “yield” and “return.”
The issue I have with your statement that future stock performance will decline is that you are saying that you can predict the market. And really nobody has been able to predictably do so. I’m kind of saying that same thing but saying that the future should be *similar* to the past over a long period of time, but I doubt that it will drop too much.
Did you get a management company to administer your rental property? That is one of the few realistic business ventures that I was thinking of doing. They take, what, 10% of the total rent?
I agree that buying a new Sequoia on a $40K income is stupid. I also agree that future market returns may be exactly the same as past ones. But you need to be prepared for them not to be. I use a management company that costs me 10%. I’m seriously considering firing them. I’ve seen it lower in other places, such as 8%. I think you’re usually better off hiring a manager yourself, especially for an apartment complex. I’m definitely not getting a value from them of 10% of rent. If the property were in my current city I’d manage it myself.
Please come back after residency and let us know you’re living without running water, electricity, air conditioning, or internet. Many of us have done it for short periods of time, but there’s a reason most people have all that stuff in their homes. And why not when you can easily afford it and still save plenty of money for the future.
Thanks for the information and your experience in management companies. Some people I know just do it themselves but sometimes there are headaches.
Oh, I currently do live with running water, electricity, air conditioning, and internet. I just (personally) consider those to be enough for myself to be happy. Living in those conditions made me kind of anti-material. Of course, I don’t care if people spend all their money. I just find it interesting if somebody made 250,000 gross after their yearly loan payments and they complained that they didn’t have money.
The centerpiece of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, is the permanent flat 21% tax rate on C corporations it put into effect as of Jan. 1, 2018.
Pretty cool right?!
Don’t forget about STATE taxes either… In California…”C corporations, or traditional corporations, pay the corporate tax of 8.84% or AMT of 6.65%, depending on whether they claim net taxable income.” -investopedia.com
Ouch!
“The worldwide average statutory corporate income tax rate, measured across 208 jurisdictions, is 23.03 percent. When weighted by GDP, the average statutory rate is 26.47 percent. The average top corporate rate among EU countries is 21.68 percent, 23.69 percent in OECD countries, and 27.63 percent in the G7.” -taxfoundation.org