[Editor's Note: Today's guest post is from Robert Lindstrom, CFP and Founder of Provision Financial Planning, a fee-only financial planning firm. We have no financial relationship.]
Solopreneurs who are also practitioners have a unique set of challenges and opportunities. You have to both work in the business as a professional and on the business as an entrepreneur. Your personal and business lives are more likely to be intertwined and “busy” is probably an understatement.
The topics in this article can apply to doctors, attorneys, accountants, and other professionals. The key point is that you must be self-employed and not have any employees.
Let’s take a look at a few of these unique topics.
Tax Considerations
Business Entity
Some of the specific tax recommendations will depend on your company’s entity structure and income. If you’re already established and expect a high income, consider whether or not an S-Corp can make sense for you.
QBI Deduction
There is a good chance you are considered a Specified Service Business, which means you can be phased out of the Qualified Business Income deduction. This phase-out begins when taxable income hits $160,700 for taxpayers filing Single and $321,400 for taxpayers filing Joint in 2019. You should pursue strategies to get below this number if possible. For example, you can maximize business and personal deductions because the phaseout is based on your taxable income, which is affected by personal deductions.
Retirement Accounts
An overlooked opportunity for solopreneurs to reduce taxable income is the Solo401(k), discussed in the benefits section below.
If you expect your business to lose money or not make a lot early on, now is the time to consider Roth conversions and/or capital gain harvesting. You may be able to do these tax-free depending on which tax bracket you end up in.
Estate Planning
Life Insurance
First things first here. DO NOT count on the sale of your business to take care of your family if space debris falls on you. This should be done with life insurance and probably with term life insurance.
Buy/Sell Agreement
The next thing to determine here is whether or not your business would have any value if you were no longer a part of the equation. If you think there is, you can enter into a buy/sell agreement. You can try to find a peer that is in a similar situation so you’ll be helping them do the same.
Have a Contingency Plan in Place
Even if you don’t think your estate can sell the business, you need a plan of some kind. You do estate planning to reduce the burden on your family. You should do the same for your clients or patients.
For this contingency plan, consider partnering up as before with someone in a similar situation. You’ll want to carefully consider your industry’s rules around privacy and confidentiality.
At the very least you’ll want to prepare communication ahead of time to send to your clients or patients. You’ll also want to keep a list of all vendors that should be notified, especially vendors that have personally identifiable information. Ideally, the person that agrees to help transition your clients or patients will be able to help them find a good replacement.
These are the types of things you should discuss with an attorney for legal advice.
Insurance and Benefits
Health Insurance
Common benefits that you get as an employee are now up to you to tackle. Health insurance is the first one. If your spouse works, this will often be the best option. If your spouse doesn’t work, you need to plan for this to be one of your major expenses.
Don’t overlook the HSA if you end up with a High-Deductible Health Plan. The triple tax benefits make this type of account one of the best deals for taxpayers in the Internal Revenue Code. Get the tax deduction as you contribute, let it grow tax-free by paying current expenses out of pocket if you can afford it, and use the funds tax-free on qualifying medical expenses.
Robert Lindstrom, CFP
Life Insurance
Of course, there are always exceptions, such as poor health, but it generally doesn’t make a whole lot of sense to keep any Group Life Insurance from an old employer. If you are healthy and purchasing additional Group Life Insurance, you were probably overpaying anyway. You can get individual term insurance that is less expensive than group. Try to always get the new policy in-force before canceling any existing life insurance if possible. If you have any health issues, it can make sense to purchase Group Life Insurance and convert it when leaving an old employer.
Disability Insurance
Chances are you already needed individual disability insurance. If you don’t have it, it’s now time to get it. The bad news? This type of insurance has a financial component of underwriting or when you make a claim. If you’re just starting out, then your income is probably going to be lower so you won’t qualify for as much coverage.
First, check-in with any associations you are a member of to see if there is group coverage available. This may be your best option for now. As mentioned, there is a good chance you need to protect more income than a group policy will cover anyway so you may want to go ahead and purchase an individual policy. Adding benefit increase riders may be wise in this situation.
Retirement
We’ve talked about some downsides of self-employment when it comes to replacing common employer benefits.
Individual 401(k)
Not so with retirement. You now have a bonanza on your hands. Enter the Solo401k or i401k.
A Solo401k is only available to you if you are the sole employee, or only you and a spouse are the only employees. Once you hire someone else you won’t be eligible for this plan anymore and would move on to something like an ERISA 401k or SEP IRA. Plan accordingly.
A Solo401k allows you to put up to $57k away into this plan in 2020. It is also capped at 20% of earned income. For the self-employed, earned income is net income after deducting one half of your self-employment tax.
Just like a normal 401k, contributions for yourself equal the deferral amount, which is $19,500, or $26,000 if you are over age 50. Similarly, you have the option to make contributions to either a Traditional or Roth account.
Depending on the business’s profitability, you’ll be able to put significantly more in as an employer profit sharing contribution. This can be powerful if you’re trying to qualify for the QBI deduction or otherwise lower your AGI.
Mega Backdoor Roth IRA
If you are already getting the full QBI deduction or aren’t trying to, you can consider the Mega-Backdoor Roth. Current rules only allow you to contribute the deferral portion to the Roth account. As we discussed already, this is only $19,000. You can make up the difference by putting the money into an after-tax account just like the standard application of the Mega-Backdoor Roth. The awesome part of doing this in a Solo401k is that there is no discrimination testing because there are no other employees. Make sure the plan documents are friendly to this strategy.
Determining whether the profit-share or the after-tax contributions make the most sense for you depends on current tax rates, future expected tax rates and how your income interacts with the QBI deduction.
There are some ancillary benefits to this as well. For instance, you can consolidate any old traditional IRAs into this account so you can do ongoing Backdoor-Roth IRAs.
Balance/Prioritization
As a “practicing owner,” one of the biggest issues you’ll face is finding balance, and this will manifest itself in two primary ways.
- Balancing working in your business with working on your business. There is no doubt the most important time spent is with patients or clients. As an owner, that doesn’t change. But it does mean the books still need to be reconciled each quarter, your records monitored for compliance, confirming cybersecurity is intact, making sure you’re bringing in new business, etc…
- Balancing business and personal. Keeping this balance right is tough for any business owner, but it only becomes more apparent for the solo business owner. If you’re married, just ask your spouse. You don’t have anyone else to talk to all day about what’s going on in the business, good or bad. So what are you going to do when you go home? Tell your partner all about it.
You will have to experiment to find the right balance for you. You’ll have to accept that sometimes you won’t get work done because your family needs you. Your family will also have to accept that sometimes you need to get certain work done. Joining peer study groups will give you the chance to talk shop.
In this article, I tried to stay focused on those issues applicable to solo practice owners, although there is some overlap. There are many more issues and opportunities you will need to consider that affect all business owners that are not unique to solopreneurs.
What are the biggest challenges you face as a self-employed business owner? What financial advice do you have for other solo-practice owners? Comment below!
Morning, Robert.
Do you know whether children are also permitted as employees for the Solo 401K Plan?
Should they be 1099 contractors? Some other type of arrangement for under 18 YO?
I don’t recall WCI mentioning how his kids are compensated other than he makes the contribution for them to match earnings.
Children should generally be employees so you can avoid payroll taxes there. You can exclude them because they’re part-time.
Hi Chris,
Children that are employed would be considered employees, so the Solo401k would no longer be an option. Paying them as 1099 contractors would preserve Solo401k eligibility, just pay close attention to all the other rules governing contractor vs. employee to avoid mis-classification. The child would then actually be eligible to open their own Solo401k if it made sense.
Hope that helps.
Interesting that you can’t use the solo 401(k) structure even if none of the other employees would be eligible for a 401k.
Doesn’t matter in my case anyway as WCI, LLC doesn’t actually employ my kids. It contracts with the company that employs them.
You’re correct on the part-time aspect. That applies to anyone, not just children.
Thanks, guys.
The replies showed up by email, but the new comments didn’t appear on the website for some reason until I posted this. Weird.
Sometimes they go to the spam folder. You can always email me if you think one is in there and I can search it. But I get hundreds of spam comments a day and I don’t routinely read them.
I started a small practice when I was early in my career. The practice has grown tremendously over the last several years. I now have scores of employees. I am getting to the later phase of my career and a major goal for me in 2020 is to come up with a transition plan.
I am thinking I need to plan for:
1) I get hit by space debris and die
2) I get hit by space debris and become disabled and unable to run the practice
3) I decide to retire
We do have around 14 million in assets fully separate from the practice. My health care savvy accountant says the practice could be worth around 8 million. My kids are now young adults so I really just need to take care of my spouse.
I don’t want to sell to private equity, as I already have more than enough wealth. I would rather sell to the hard working and talented docs that work in the practice and have contributed greatly to all of our success. Figuring all of this out seems daunting and complex, but it needs to be done. Actually I should have taken care of this long ago. I was so busy growing the practice that I did not take the time to tackle this issue of transition, despite it being on the agenda for the last couple of years. The younger docs in the practice share generously in the profits despite their status as employees and as a result have been long term and loyal, but they have been asking about equity.
Do you have any advice about how to approach development of a transition plan? What are potential pitfalls to avoid?
I would focus on just treating everybody fairly. Sit down with the potential partners and ask what they would like to see, work out what you want to do, and then bring in the lawyers to formalize everything.
Treating everyone fairly is a given. But there are several first steps, and even those initial decisions feel daunting.
How much is the practice worth?
How many partners should there be?
What would the criteria be for deciding who gets offered a piece of ownership?
How do the potential partners pay for the practice? Take loans? Pay over time from income?
1) Have a third party value it.
2) How many want to be and can they afford it?
3) Who is willing to pay the price? Are they all good with being partners with each other?
4) Their problem, not yours, but either works for you as long as the interest rate they are paying is good enough.
Again, I’d put some feelers out after sitting down with people and gauge interest, then talk to a business attorney.
At the scale you’re talking about (i.e. practice with scores of employees), putting together a succession plan is going to take a considerable amount of work. The handful of questions you brought up are both legitimate and very difficult to answer. It will be different for everyone. I could easily throw another 2-3 pages of open ended questions onto your short list without trying too hard.
This is absolutely the time to get professional advice from multiple sources: business broker, valuation expert, tax planner, et. al. Congratulations on your tremendous success in both building a profitable business and having taken enough out over the years to have a sizable portfolio. It’s surprisingly rare which always depresses me a bit as a champion of entrepreneurship. Most small businesses are running hand to mouth and the only thing keeping it afloat is the business owner working tirelessly without putting aside anything for their own future.
I might have a transition checklist floating around from a local broker when looking to buy something 2-3 years ago.
Hi Chris,
Are you a physician, a financial planner, or something else? It would be great to review a checklist for practice transition. Is there a link you could provide?
At this point, I am going to start with my tax accountant who specializes in health care entities, but not until April when tax season winds down. And I will need the input of my estate attorney as well. Valuing the company is going to be interesting, and I am wondering do I get an offer from private equity? Even though I don’t want to sell to private equity, that could give me one benchmark idea regarding what the practice might be worth.
Thanks,
Ziggy
Ah, they published it online nowadays. Just a starting point for getting you thinking about things.
https://frontrangebusiness.com/sell-a-business/steps-to-selling-a-business/
And a handful of bullet points about valuing any business:
https://frontrangebusiness.com/sell-a-business/valuing-a-business/
Thanks! The checklist is a good start.
@Ziggy Nope, small business owner several times over. Mostly software and real estate.
The money stuff is a side hobby. I spent a few years helping starting startups raise investment capital from VCs and angels. Due diligence is basically the same for investing as buying the the business outright. Actually, it’s usually easier since startups only have one or two years of operating history. Most of the value a good broker will provide is helping you work through the steps to make the business sellable and address any potential skeletons in the closet that are deal killers.
Basic items would include reviewing past tax filings, verifying payroll taxes procedures, using proper corporate formalities, verifying business accounts and credit lines, reviewing employee contracts, etc. Anyone who’s owned a business for awhile has a legacy of decisions that made sense back in the day that would cause problems for the new owners. Assets purchased with a personal signature, past partnerships dissolved with a handshake, litigation that won’t quite go away, personally guaranteed lines of credit, outstanding officer loans – stuff like that.
Don’t be surprised if a potential buyer only wants to purchase the business assets and transfer them to a new entity vs. buying the business entity itself. Buying the assets protects them from having to deal with potential liability from ages ago. It’s a pretty common strategy in this value range. Unfortunately, it usually means losing the benefit of LTCG tax rates on the sale proceeds. Since you don’t need the cash on hand, investing the proceeds into a new or existing business through a 1031 exchange might make sense to defer taxes altogether.