By Dr. James M. Dahle, WCI Founder
From time to time I hear doctors talk about incorporating in order to decrease liability and taxes. Almost without fail, the doctor overestimates the decrease in liability and taxes to be paid, especially once the costs of incorporation are taken into account. We'll try to set the record straight here.
Should You Incorporate to Reduce Liability
Incorporating doesn't decrease your malpractice liability one iota. The only way to do that is to practice good medicine, have good risk management techniques, and to carry adequate malpractice insurance. Obviously, this is the greatest liability issue for most doctors.
Incorporating your business also won't really help with other liability concerns, such as accidents on your property, auto accidents, or issues with other businesses you may be involved with. The best way to reduce these is to carry high liability limits on your auto and property policies, and to add on an umbrella policy. Other businesses with significant liability (such as rental properties) should be placed into limited liability companies so that your maximum liability will be limited to the value of the business.
However, there can be other liability issues, such as your employees suing you for discrimination or other issues in which incorporation can help protect your personal assets. You need to balance this decreased liability with the increased complexity and cost of incorporation.
For many doctors, incorporating probably doesn't decrease your overall liability enough to justify the trouble.
Should You Incorporate to Save on Taxes
Remember that tax avoidance is legal and good, and that tax evasion is illegal and bad. A wise physician does many things to avoid taxes, such as funding 401Ks, keeping track of write-offs throughout the year, and giving to charity. Only a fool gets involved in tax evasion schemes.
There are basically three types of corporations as far as taxes are concerned.
C Corporations
C corporations pay corporate tax rates. The C corporation tax schedule is pretty similar to the personal tax schedule, so there is really no significant benefit for a doctor to use this structure. In fact, it introduces double taxation on money.
Consider a physician that makes his business a C corporation and earns $300,000. First, he pays $100,000 in corporate tax. Then, he distributes the money to himself as a dividend which is taxed at 15%, the dividend rate, for another $30,000 in taxes. If he hadn't been structured as a C Corp, his tax bill would have only been $85,000 in taxes (even less if he were married), instead of $130,000. This just doesn't make sense for most doctors, who actually want to be able to have what they earn for their services.
S Corporations and Limited Liability Companies (LLCs)
As an employee, you make a salary. Your income taxes and your payroll taxes (social security and medicare) are taken out of your pay. You'll always pay the employee portion of the payroll taxes, and either you (if you're a sole proprietor) or your employer will pay the employer portion.
As an S Corp shareholder, you will be paid both a salary AND dividends. On the salary, you pay income tax and both halves of the payroll taxes. However, on the dividends, you do not pay the payroll taxes. This is a significant tax, as high as 15.3%, so not having to pay it can be pretty advantageous. This makes your incentive, obviously, to pay yourself a tiny salary and a huge dividend each year.
This is a big difference between an LLC and an S Corp. With an LLC, all of your income is subject to payroll taxes. (Although technically, an LLC can choose to be treated as a corporation, and an LLC with multiple members is taxed as a partnership.)
The IRS, of course, understands the incentive to form an S Corp to save some taxes. So they have a rule that requires your salary to be “reasonable” for the services rendered:
“Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”
There are no specific guidelines as to what reasonable compensation is, but various courts have had rulings that help to define this, so you'll need to tread carefully in this area, probably with some qualified legal advice. The IRS has suggested the following factors should be considered when determining what reasonable compensation is
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Training and experience
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Duties and responsibilities
Time and effort devoted to the business-
Dividend history
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Payments to non-shareholder employees
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Timing and manner of paying bonuses to key people
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What comparable businesses pay for similar services
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Compensation agreements
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The use of a formula to determine compensation
So how much can you reasonably save in taxes in this situation? Well, let's use an example from my own field.
Let's say as a partner in my emergency medicine group I generate income of about $225 an hour, and after working 1500 hours for the year, I have an annual income of $337,500. Let's also say that in our emergency department, we pay our prn, employee, or moonlighting physicians $150 an hour. If a moonlighting physician worked 1500 hours at that rate, he would have an income of $225,000. So “reasonable compensation” could be defined as $225,000 and you could pay yourself $112,500 as a dividend.
What would the tax savings be? Well, federal and state income taxes would be equal, and with a salary of $225,000, you've already maxed out your social security tax for the year. So that leaves Medicare tax. Both halves of medicare are equal to 2.9%, so 2.9% times $112,500 equals $3262.50. You would then have to subtract the costs of incorporation from that.
You can quickly see that there isn't a huge tax savings to be had here by incorporating. It might be worth it, depending on your circumstances, but you'd have to run your own numbers.
[Update 2020: As we republish this post that originally ran in 2011, one notable update is the 199A deduction included as part of the 2018 TCJA. Although it really doesn't apply to physicians and other specified service businesses, an S Corp has wages for its owner-employees which are often necessary for there to be any significant 199A deduction. But for a physician business, there is still no real tax benefit to incorporating other than saving payroll taxes.]
Incorporation Cost
You should plan on paying at least several hundred dollars to incorporate, although you may be able to find packages on the internet that will help you do it yourself for less than $200. There are also additional legal and accounting compliance costs that will vary (you have to file a corporation tax return each year). Only you can decide how much the hassle to do it yourself is worth. Otherwise, you'll need to pay a highly trained professional such as an attorney or accountant to take care of those tasks. You'll probably want to incorporate in Delaware or Nevada to save on incorporation fees.
In summary, incorporation isn't the financial boon that many uninformed doctors think it will be. The tax savings are generally pretty limited, and it won't decrease your main liability issues a bit.
Agree or disagree? Do you think it's worth it for doctors to incorporate to lower liability and their tax bill? Comment below!
What are your thoughts on the fact that incorporating results in a much lower chance of being audited?
As I understand it, S corp returns are very rarely audited. Of course, you’ll still have your personal return which I imagine gets audited just as often whether you incorporate or not.
Could you comment on something I am considering? I was considering incorporating and having a portion of my income stay as a W-2 (so I can keep my clinics insurance, retirement etc.) and have a portion be sent to my corporation. With the portion from the corporation, I could then pay my spouse a salary and contribute significantly to her retirement. That seems to be a good way to save more for retirement and defer taxes. Is this a workable/good plan?
What does she do for your corporation? How much do you pay her to do that? Is that a reasonable rate? Is the IRS going to view that as legitimate work? IRS agents aren’t stupid, so you’d better have good answers to those questions before doing something like that.
Thanks for the excellent read. I’m making partner in a group next month where I’ll be earning about 200k in California before profit sharing and earn about an additional 30k in 1099 moonlighting. Pre profits my total income should be around 230k. I was looking at incorporating as a s-corp for a few reasons:
1) to clearly separate business and personal expenses and accounts
2) have the flexibility to hire a spouse or family member as an employee and pay in to SS for them (with legitimacy of course)
3) Lower my personal tax bracket significantly
After reading this article and a few others, I think I’ve settled on a s-corp. I realize it won’t net me tons of tax savings but will hopefully clearly separate business accounts from my personal account. I also realize I could do this without incorporating but would like a clear line drawn between business and personal assets. I also realize that I’m adding more work on to myself by doing this.
With that background, my question for you:
Why do you mention incorporating in nevada? From my reading, if I incorporate in Nevada but my business occurs in Ca, I still will be paying Ca tax, etc. So how does that yield any benefit?
Thanks for your time!!
You’re right, there is not a lot of benefit to incorporating in Nevada in your situation.
http://www.pahl-mccay.com/should-california-businesses-incorporate-in-nevada.aspx
I have finished residency and am in a high income tax state. I must disclaim that I am not a tax professional, but I have been doing some research on this topic. My current structure is a 1099 and I have been trying to decide between an S-corp and remaining a sole proprietor. To summarize additional expenses for an S-corp in my state, I see the following:
-S-corp state tax 1.5%. (and incorporating in delaware or Nevada won’t help if I still earn income in my state)
-Payroll accounting fees are around $25/month to do yourself or about $150-250/month for the expert to do it.
-s-corp start up fees
-additional end of year tax fees for a more complicated filing situation.
If you pay yourself less than the limit for payroll taxes every year (<~113K for 2013) then you could save quite a bit with an S-corp despite the additional expenses listed above because you would not have to pay the employer portion of payroll taxes on the difference between your salary and the $113K limit. However, this would not end up being a "reasonable" salary for most physicians. Thus, for high income earners, defined here as those that will pay themselves a salary of more than $113K, the additional costs don't really make it worth it in my opinion. I will remain a sole proprietor for now.
I’m on the fence about it as well. I’m going to look at my taxes this year (my first year of peak earnings) and calculate how much I could save for the hassle and then decide. I agree that trying to get under the SS limit is a bad idea for a doc.
I too must confess that I am not a tax professional. However, the benefit of incorporating seems to be the ability to sock away more for retirement in the form of a Solo 401k. When one is an employee one can only sock away a max of 17k or so. The place you are “employed” by can then match you up to about 55k total, they rarely do. In addition to rarely matching you to max they also require you to use there 401k setup. When you are an Scorp you can do both yourself. In addition, instead of giving some fatcat your money to play with AND paying him to play with it usually in a volatile stock market, you can do a self directed Solo 401k. With that being said the benefits are endless then. Let’s say you do work for a company that max matches. Your 55k (a little less actually) max in and then you pay the fees and MAYBE get 10% back if you are lucky. You then pay taxes on anything you take out later. If you do this yourself, you can invest in anything you want, including real estate, stock market, or private loans – whatever. You are only obligated to pay taxes on that which you cash out. Not on investment income. In addition, you can still borrow against it. Now I just started doing this about 6 months ago and am by no means an expert but to me it just makes sense to NOT give someone else your money to play with.
The ability to use an Individual 401K has nothing to do with incorporating. A sole proprietor can do the exact same thing. I don’t know of any individual 401Ks with quite the investment flexibility you’re talking about, but you could use a SEP-IRA, roll it out to a self-directed traditional IRA, and then invest in things like real estate and private loans if that was your main goal.
Great post WCI! New grads will have a chance at a one time big savings with an S-corp and I unfortunately learned the hard way! The reason is, you only have a max of 6 months to make attending money. So imagine you pay yourself something reasonable like $10k/month. Lets say you do really well your first 6 months out and make $140k. If you pay SE only on 60K, you save the SE of 15.3% for 113k-60k = 53K or $8109 in tax savings! You will also save 2.9% on the remaining 27K. Also, with the new Obamacare 0.9% Medicare tax for S/MFJ above 200k/250k, if your spouse is already making that much, then I think you would save an additional 0.9% on all of it? I’m not sure about this last part, but if the 0.9% is considered an additional payroll tax, then you should be able to save on it too. Unfortunately, I called my franchise tax board and they told me I can’t retroactively incorporate for 2013. Also, expenses such as $800 franchise tax fee and 1.5% state tax on the dividends, payroll, increased tax prep costs would probably take away at least 2K in savings, but still, it a LOT of cash to just give away for a brand new attending. If anyone knows differently about retroactively incorporating, please let me know!
Never thought about it for the new grad. But you’re right, if you can somehow save Social Security taxes, that’s a much bigger deal. I’ll have to look into the additional Obamacare tax, but I do think it is a payroll tax, so this could be more profitable than I estimated for a high earner.
The other category that may see more flexibility in the assignment of salary vs distributions is in a startup practice. Since the doc is not seeing even remotely close to a full patient schedule, they would not expect a full physician salary either.
In the example for an S corporation above, you suggest a salary of $225,000 and a dividend of $112,500. I think I’m following the analysis of the social security and medicare tax. What I’m not sure on would be the difference in income tax on that $112,500 at the marginal vs capital gains rates. If it was paid as regular salary then it would be at my marginal tax rate, but since it’s a dividend, isn’t it only taxed at capital gains rate? Or am I wrong about that?
S Corp dividends are taxed at regular income rates, so all you save are payroll taxes.
If I set up S corp, how do I buy a car both for business and personal use? My business miles are about 80% and personal 20%. Do I buy from S Corp money or I can buy from personal account and deduct miles at the end of the year at the IRS rate of 55 Cents/per mile?
You can either deduct mileage or you can deduct actual expenses (80% of your total actual expenses.) That’s a good question as to whether or not you can buy it from your business account (thus making the purchase payroll and income tax free). Certainly if it was 100% business mileage you could, but I’ll have to think about/look up whether or not you can do that for 80% use.
Thanks !!
So, if I buy a vehicle with a down payment of say $10,000, am I correct that 80% of this down payment can be deducted if the split comes out 80/20 between business and personal? Just need clarification.
From the IRS:
To use the actual expense method, you must determine what it actually costs to operate the car for the portion of the overall use of the car that is business use. Include gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments) attributable to the portion of the total miles driven that are business miles.
It doesn’t actually say anything about the purchase price and remember, it’s mileage OR actual expenses, not both. I don’t see that the purchase price is actually deductible, but I’ll keep looking.
Hi Jim,
Do you have an update on your comment above regarding purchase of a vehicle that’s mostly(/almost always) used for business? Husband is now an S-corp shareholder and his car is getting ready to die of old age. Time for another one- can the purchase be a business expense? Thanks a bunch!
You can only deduct the expenses required for business use. So if you use 99% of it for personal use, it’s not going to do much for you as a business expense. Remember commuting is a personal use.
I had friends with a non-medical corporation. They advertised on their vehicles in order to maximize deductions out of it. (Huge stickers blah blah blah LLC) I dont know any of the numbers or specifics on deductions. I do know it was in Florida. Maybe an inkling
I see that a lot as well. It has nothing to do with incorporating (the point of this article). You can buy advertising for any business. I suppose you could charge your business the going rate for it, but what is a deduction for the business becomes taxable income to you personally.
I think what most people are going for though is a deduction. That someone the car becomes a “business expense” if you do this. I think there is a lot of abuse here so it is important to read the rules of what a business car is. If you are driving it around town to primarily acquire business, then sure, write it off. But if you’re taking your kids to soccer practice and commuting to work, those are not business miles.
https://www.whitecoatinvestor.com/business-mileage-the-holy-grail-of-tax-deductions/
Hi WCI,
Sorry for this newbie question but do I have to be on a 1099 to incorporate? Or can I, as a W2 employee open up a S-corp as well? Thanks!
No, employees can’t incorporate.
Good read Jim.
Wondering if you can shed some light on my situation. I am currently employed and get paid via a W2. My employer has a 401K, which I will be maxing out in 2015 for $18K. The match by my current employer happens at the end of the year and it is “discretionary” – so I won’t know till the end of the year.
I am considering doing some stuff on the side like chart reviews, etc. For these I would get paid via 1099.
1. Does it make sense for me to make LLC as a sole proprietorship or S corp?
2. Solo 401K or sep-ira? If go with solo 401K, can I contribute anything since I am already putting away the max 18K from my end into the employee 401K?
3. If I do form LLC, can i incorporate in any state? I currently live in one state and travel to another state as an employee. Most of this 1099 work would be from home.
1. If you choose S Corp, you get more hassle, less payroll tax, small retirement account contributions. Choose sole proprietorship it’s less hassle, more payroll tax, larger retirement account contributions. Your choice.
2. Solo 401(k) without a doubt. No larger contributions for you, but you preserve the backdoor Roth option.
3. You either form an LLC (which can pay taxes as a sole proprietor/partnership or as an S corp) or a corporation. You probably ought to form either entity in the state you’ll be working in. The state you reside in isn’t a bad choice either. I don’t think I’d try to do a Nevada or Delaware corp though.
Thanks for the input. I was leaning towards LLC as well.
1. Solo 401k – From what I understand, IRS caps ALL (empoloyer plus employee) 401k contributions to 53,000. Is that correct?
Assuming I put the max 18K into my employed 401K, I have 35K left to be play with. Now let’s say my W2 employer adds 15K. Now the total in ALL of my 401K is 33K. That leaves me a max of 20K that I can potentially add into my solo 401K. The max one can contribute to solo 401K is 20% of all income. In order to capture this 20K “leftover” in my scenario, my income from W2 would have to be a minimum 100K. Am I running the numbers correctly?
2. Should I open a separate checking account for this sole proprietor LLC?
3. Am I able to get EIN for a sole proprietor LLC? I would hate to have to disclose my social security number on the W9 everytime I use it.
I’m in a very similar position to the poster above. I have a w2 with earnings of ~300k, of which I contribute the max employee portion to my company 401 k ~18k this year. I also moonlight on the side and make about 125k, with a solo 401 k set up. I am currently set up as an LLC, but am considering changing it to an LLC taxed as an S corp. My understanding that the max employer/PSP is 20% of net business profits for sole proprietor and 25% for Corporations.
I have been weighing the pros and cons of S corp from your posts, and my main goal is to max out my retirement contributions. My understanding is that SS is only on the first 117k, and this should be covered by my employer w2. I figure I would only be paying medicare and obamacare taxes on the rest of my self employed income
So I am considering doing the S corp, without necessarily paying myself in dividends (max w2), to get that extra 5% (25% vs 20%) per yer retirement contribution to my solo401k. What do you think?
I think you’re missing something. 25% = 20%. Work your way through the forms and you’ll see what I mean. The 25% figure includes the amount used for the 401(k)/SEP contribution. The 20% figure doesn’t. So they’re really the same thing.
I am deciding whether to incorporate in los angeles or in one of the surrounding cities. S-corp ER doc working around the general metro area, lots of locums.
how can I quickly find out where I will pay the least CITY taxes?
Won’t Delaware get us in trouble?
As I understand it, where you incorporate doesn’t affect what city taxes you pay. That’s determined by where the money is earned. I didn’t realize that California cities had an income tax. Can California become any more toxic for docs?
I am a resident in Oklahoma who just started moonlighting in January. My projected income from moonlighting will be around $80,000. I have heard mixed reviews from attendings while some have used a PC. I have considered starting one as I have a wife that I could pay a small salary and invest in retirement for her. Currently I have been saving 40% of my moonlighting income for taxes, but I have heard I could save 15-20% starting a S-corp. Would it be worth the hassle and expense with my $80,000 income from moonlighting.
It wouldn’t be worth the hassle to me, but it might to you. You might even save a little SS tax too at your income level. It takes much less income to get the bang for your buck when you’re saving SS in addition to medicare tax.
I am an independent contractor and recently incorporated (S-corp), mainly to protect my personal assets from any potential litigation. I work minimally, part-time and therefore, my annual salary will be approximately $70K. I have no assets in the corporation (other than salary that I receive), and no employees other than myself. I have two questions:
1. Am I correct that by incorporating, if I were to be named in a lawsuit, only the assets in my corporation would be at risk and not my personal assets?
2. I have personal medical malpractice insurance but do not have insurance for my corporation as I understand it would not be necessary to insure my corporation given that I have no other employees and no assets in the corporation other than my salary. Do you agree?
1. Not if you’re a doctor, which it appears you are. Malpractice is always personal. Bad reason to get an S corp.
2. Yes, I don’t think you need special corporation insurance. You should get an umbrella policy though.
I am currently in a fellowship with a W2 of 55K. I am thinking to do locums with potential income of 50-80k. Should i incorporate as LLC or go as a solo proprietor?
Hi, great article!
I’m a new grad doing 1099 contract work in CA wondering if an S-Corp would allow me to pay myself primarily through dividends (and thus offer me significant tax savings) this quarter because the IRS won’t expect me to make more than 113K in my first 6mos as an IM attending.
I made $49K in August and will be averaging 35K/mo from here on out.
Background info on me/my goals: I have no spouse or kids and am saving to start a franchise practice for a group I currently work for in 2 years (with help from 2 angel investors), for a mortgage downpayment (~650K where I live), retirement & disability coverage since I was declined a policy.
Would love to know your thoughts!
As long as you pay yourself a reasonable salary, the rest can be “distributions” if you are a corporation or LLC paying taxes as an S-corp.
I think the issue here is not what the IRS “expects” you to make, but what is a “reasonable” salary. I’m struggling with the same issue. I’m in a new group and plan to talk to some of them to try and learn more, but there is really very little about this online. Anybody have any examples they can share? Don’t have to use actual numbers if you don’t want, just give rough estimates or percents of what’s occurring in your practice. My main issue is what’s a reasonable doc salary in California or New York maybe be very low or high compared to some other area, even just a different city. How much does geography play into the decision, and how to decide what is fair when there’s obvious incentive for for us to make it as low as possible?
The incentive isn’t to make it as low as possible. The incentive is to make it as low as possible while still being able to max out your retirement accounts, which puts a pretty decent minimum under it. The two guidelines I’ve heard are make sure you’ve at least maxed out your SS taxes (So $118K or so) and don’t declare more than half your income as distribution. But the main thing is having a method by which you determined your salary (salary survey, hourly rate etc) that you can explain to the IRS in the unlikely event of an audit.
Great point regarding the incentive. And also just found your post with comments here: https://www.whitecoatinvestor.com/how-much-should-you-pay-yourself-as-salary/
That’s very helpful as well.
Hi! Thank you, thank you for all of your shared knowledge. I’m a California new grad about to start 1099 contract work. I am married with kids filing jointly, spouse currently not working, renting to save $ for that ridiculously expensive CA mortgage. I’m in a surgical subspecialty but will be working in a new area for this practice, so not sure how the first year will pan out. Regardless, it seems like everyone out here doing 1099 work does an LLC, and after reading this article and others I’m struggling to decide what to do. S corp, LLC or sole proprietor? I also am trying to decide between SEP IRA and solo 401k–another article had me leaning toward SEP but comments on this one seem to recommend solo 401k. Any quick advice would be so greatly appreciated!
Sole proprietor. Solo 401(k).
If you’re making more than perhaps $400K then it may be worth doing an LLC paying taxes as an S corp or an S corp itself.
Why would someone want to do sole proprietor? Doesn’t doing sole proprietor mean your business and personal assets are one, hence if you get sued your personal assets are fair game?
The main liability risk for docs is malpractice, which is always personal whether you are a sole proprietor or a corporation. But for business related risk? Sure, incorporating will help. But otherwise, might as well be a sole proprietor.
Just discovered WCI a couple weeks ago. Fantastic articles/blogs. Thanks very much.
I have been kicking around LLC, S corporation and have the following comments/questions.
CPA said LLC to S corporation conversion very easy but reversing it very difficult. Also below 100 K LLC wins, above $300-400 K, then CPA recommends S Corp.
I am semi retired and will gradually decrease work with estimated income now 200 K. CPA advised hybrid type model where I kept LLC with my wife as “passive investor” allowing her to get 50% of the profits which would not be subject to Social Security tax. What are your thoughts on this?
I am still a little fuzzy on SEP IRA versus 401(k). Which would be better in my situation? My wife already has a 401(k) health benefits etc. at her hospital employee job.
Thanks again and please give me any feedback.
I agree with what your CPA is telling you. It’s all about saving payroll taxes and still being able to max out the individual 401(k).
You have to be taxed as an S corp in order to avoid SS tax. Might be better for her to get a retirement account.
The main benefit of a solo 401(k) is you can max it out on lower income and you can still do a backdoor Roth IRA with it. So I almost always recommend the individual 401(k).
Not sure what you’re talking about with your wife being a “passive investor.” What is she investing in- your practice?
What entity structure would you suggest in regards to owning rental income properties (single-family residential), primarily as a passive investment (as opposed to active management). I understand that active management has additional benefits such as the potential for greater deductions through passive activity losses and access to additional business expense deductions, but wasn’t sure if from a tax savings perspective to go one way or another. I know there are other things to consider that may come into play such as acquiring financing through an LLC or corporation is either nearly impossible without making a personal guarantee, or in the event that you can receive financing it is usually at the cost of less favorable terms (or so I have read). Just wanted to get your opinion based on your experiences regarding what the best entity structure would be when considering all things (liability, tax savings, estate planning, etc.).
An LLC. But you’re right that you’ll usually need to guarantee the loan personally.
Would you recommend the LLC to be taxed as an S-corp, or something different?
It doesn’t do you any good to be taxed as an S Corp since it isn’t earned income.
In terms of Starting an S Corp. What have you found to be the most straight forward and yet affordable approach in doing so. I hear that some have been charged upwards of 1k by professionals to start the S corp. Are there any online entities that could do the same at a lower cost?
Thanks
I think there are. Bear in mind that for many businesses you can become an LLC ($70 and 10 minutes online in my state) and then file a form with the IRS so the LLC is taxed as an S Corp. Relatively easy as a do-it-yourself task.
I was talking to a lawyer I know who said you cannot be an LLC in CA as a physician, must be an Scorp…I wasn’t able to conirm that anywhere though. Has anyone else heard differently? CA has a lot of unique laws.
Many states require you to be a PLLC (professional LLC) instead of an LLC. But I don’t recall hearing of one that required you to incorporate to practice medicine. That seems rather strange so I doubt it’s true. But I agree, California can have some weird laws.
Hi,
I am a recent grad working per diem ( W2) in LA and Independent Contractor work (1099) remotely for a company based on east coast. I also travel back and forth between home in FL and CA and working from home in FL. I was wondering if it would be worth it to become and S corp in FL for my 1099 work ( approx $40,00/ yr) and file separately in CA for my W2 clinic work. Thanks
You seem confused on some points.
I’m not hearing a good reason to incorporate anything and I have no idea what you mean by “file separately.” All your income ends up on one tax return whether some of it comes through an S corp or not.
I am in a similar situation (working part time as an independent contractor) and make about $60K/year with this. I incorporated because my income is low enough that with the incorporation, the business expenses that I incur can be deducted again my income, and I self funded my 401K. Because of this, in the past year, I paid only $3K in income taxes. If I didn’t have the cooperation, I would have had to file my entire income on my personal income taxes and would have paid a 40% tax rate (because of my husband’s income, we are in the highest tax bracket). To me, it makes sense in this situation. You would have to determine if it is right in your situation.
Not sure exactly what you’re talking about. Are you an S Corp or C corp? If a C Corp, did you retain a bunch of earnings in the corporation (and are you not mentioning the corporate taxes you paid on that?) If an S corp, how is it that you didn’t file your entire income on your personal income taxes as that is a pass through entity?
Or are you just saying you came up with $50K+ of business expenses and thus really only made $10K or so?
I have an S-corp. My expenses for the year came out to close to $20K. I fully funded by 401K for $18K and another $10K through my company’s profit sharing. I have both an attorney and CPA who guided me through this. I would recommend that anyone considering incorporation or LLC for tax benefit purposes do so under the guidance of both as well to maximize benefits while abiding by the very complicated tax laws.
You don’t need to incorporate to write off $20K in expenses nor put $28K into 401(k)/profit-sharing. You can do all that as a sole proprietor.
What was the benefit to you of incorporating?
There is an employment tax savings. See explanation below from a legal website:
Corporations offer self-employment tax savings:
Earnings from a sole proprietorship are subject to self-employment taxes, which are currently a combined 13.3% on the first $106,800 of income. With a corporation, only salaries (and not profits) are subject to such taxes. This can save you thousands of dollars per year.
For example, if a sole proprietorship earns $80,000, a 13.3% tax would have to be paid on the entire $80,000. Assume that a corporation also earns $80,000, but $35,000 of that amount is paid in salary, and $45,000 is deemed as profit. In this case, the self-employment tax would not be paid on the $45,000 profit. This saves you over $5,000 per year. Please note, however, that you should pay yourself a reasonable salary.
Also:
The main reason business owners form S corporations is because of the tax benefits. First, an S corporation is a pass-through entity—income and losses pass through the corporation to the owner’s personal tax return. The income taxes you’ll pay on your business income, and the business deductions you’ll be allowed to take, differ little from being a sole proprietor.
Where S corporations shine is in the realm of Social Security and Medicare taxes. When you’re a sole proprietor, all the profit you earn from your business is subject to these taxes. However, this is not necessarily the case if your business is organized as an S corporation.
S corporation tax treatment can provide a way to take some money out of your corporation without paying Social Security and Medicare taxes. This is because you do not have to pay this tax on distributions (dividends) from your S corporation—that is, on earnings and profits that pass through the corporation to you as a shareholder. The larger your distribution, the less Social Security and Medicare tax you’ll pay. The S corporation is the only business form that makes it possible for its owners to save on Social Security and Medicare taxes. This is the main reason S corporations have been, and remain, popular with small business owners.
Right. With an S corp, anything you call distribution instead of salary saves payroll taxes. This is why I have declared WCI an S corp this year. But I didn’t get that from the questioner. There certainly isn’t enough benefit to justify the hassle with a 4 figure distribution like the one being discussed.
“For example, if a sole proprietorship earns $80,000, a 13.3% tax would have to be paid on the entire $80,000.”
Actually, the tax would be not on the gross receipts of $80k, but on the net business income, i.e. $80k – relevant business expenses = net income.
Furthermore, yet another huge benefit with an S Corp is you can deduct the entire $35k salary from the corp’s revenue of $80k as part of business expenses, something you can’t do in a sloe proprietorship.
Correct me if I’m wrong, folks.
Absolutely. You are taxed on your earnings (net business income), not your gross revenue. Sorry if that wasn’t clear.
But deducting your salary is not some huge benefit. Either way you pay taxes on the same money on “salary” whether you are a sole proprietor or an S Corp shareholder. The only savings is on payroll taxes if you make some of your income distribution instead of salary.
I have been hired by a hospital with an income guarantee of 325k for first year, but will need to create my own business structure. First year out of fellowship; income should range between 325-450k per yr. Trying to decide between LLC, S-Corp and Sole Proprietor (most likely using i401k for tax-deferred retirement savings). Considering the fact I have no additional employees, which structure makes the most sense?
Sole proprietor probably. If you want to declare an income of $156K or so (enough to max out an individual 401(k)) then you could save over $5K in Medicare taxes by becoming an LLC and being taxed as an S Corp. But I’m not hearing a reason to be an S Corp.
Thank you very much for the reply. It appears you have given a valid reason (saving 5k in medicare taxes) for becoming an LLC and being taxed as an S Corp, but then state you’re not hearing a reason for an S-Corp. Can you expand?
There’s a certain amount of cost and hassle to being an LLC and filing as an S Corp. If that is worth $5K to you, then go ahead and do it. But that’s the reason to do it.