Working as a 1099 Physician

Dr. Wright: When I was working as W2, you know, making 420 or so as an ER doctor, I was paying about a close to 30% combined tax rate. After I transitioned to 1099 and I figured out what I was doing, I was making closer to 500 and I was paying about 11 to 12% combined tax rate.

In the company that I run [1099 Tax Doctor], a lot of my clients that are in that ballpark of income level around 4600. They get close to single digits. In fact, some of them have actually gotten single digits. You know, if you’re making more like 7-8 hundred, you should still be paying less than 20% combined federal and state tax. Less if you’re in a no income tax state, obviously.

So yeah, it’s, you know, and in practical terms like that, that meant a $60,000 tax savings for me.

Dr. Wright: An LLC (limited liability company) is what’s called a pass-through entity. These are businesses that are not subject to corporate income tax. Instead, what you do is you take the income that your business earns, you subtract the business expenses, and you get a net profit. And then the net profit passes through to your personal income tax return and you pay income taxes on it. So, an LLC does not actually have any tax benefit at all. It’s disregarded by the IRS. You’re still considered a sole proprietor.

The benefit of an LLC is that it allows you to be taxed as an S-corporation, which is a tax designation that you can elect for an underlying entity which has tax benefits.

Dr. Dalawari: I see. So most of our physicians at VitalSolution would be creating an LLC for themselves and then be taxed as an S-corp. That’s actually what I do as well.

Dr. Wright: The S Corp allows you to save on self-employment tax. Self-employment tax is also called payroll tax. FICA, which is a U.S. federal payroll tax, includes Medicare and Social Security.

As a W2 employee, when you look at your pay stub, you have your federal income tax and also your state income tax (if your state has an income tax.) Then, you have Medicare and Social Security, which is entirely additional to the income tax. As a 1099, you still have to pay those but it’s referred to as self-employment tax although it’s the same thing.

What the S Corp does is it allows you to treat part of your income as a salary from your company and the rest as a distribution. And distributions are not subject to the payroll tax to Medicare and Social Security. So S corps don’t actually save on income taxes. They save on payroll or self-employment tax. So that’s kind of what you use them for.

They’re also the least audited business entity. For deducting expenses, it will look better on an 1120-S, which is the S Corp tax return, than it would on your personal tax return. As an S Corp, you do have some additional responsibilities.

You have to file a separate tax return, so you want to use a CPA that’s knowledgeable about how to do that. The S Corp has to file 1120-S, which is just a corporate tax return. You also pay taxes a little bit differently when you’re an S Corp. Instead of making individual payments, you pay your income taxes through your business.

So there are a few other little nuances that come with it, but overall it’s not a lot of work and it generates a significant amount of tax savings, especially for higher-income earners.

Dr. Wright: It depends. You typically want to take a salary of at least $175,000 because that allows you to max a solo 401(k). And then from there, it depends. You want to be advised by a professional who knows what the IRS is looking for and what to avoid to offer you an estimate. Most of my clients probably take a salary in the ballpark of $200-$250K. That’s across all different specialties.

Dr. Wright: If you’re just doing a little bit of locums work or working a side gig and you’re making maybe $20,000, you don’t need to bother with an LLC. You just report that on your personal tax return. You can still deduct business expenses on a Schedule C on your personal 1040.

Around $100,000 of 1099 revenue is typically when S Corp starts to make sense and where the tax benefit outweighs the cost.

Dr. Dalawari: For most of our physicians at VitalSolution who are probably making in the $550-$600K range of 1099 revenue, this structure would make a lot of sense.

Dr. Wright: Yes, it’ll probably save you close to $10,000 a year in self-employment tax.

Dr. Wright: The main ones to consider for VitalSolution physicians and for a lot of my ER physicians and locums physicians is that they don’t have an office they rent. They work at a hospital and if you don’t have an office that you rent or lease, that is considered your place of business.

It might be justifiable to have a home office. A home office allows you to deduct a portion of the office’s square footage relative to the house and a portion of your utilities.

If you have a place of business you work at, you can’t deduct commuting between your house and your office. But if you’re a local physician or you’re a physician who’s working at a hospital where you don’t have an office–these are job sites and you’re traveling to a job site–you can typically justify a vehicle deduction. There are different ways to do that: the actual expense method versus the mileage method.

If you’re flying somewhere, find something work-related to do and then a portion of the travel becomes a tax deduction. It’s not difficult for a physician who is a higher income earner to write off $30-$40K of business expenses related to running their business. When you’re a 1099, you’re essentially self-employed. You’re running your own business.

Dr. Wright: I’ve heard it said that a home office is an audit flag. No, it really isn’t. If you’re someone who can justify a home office, I would take the deduction. Most of my clients qualify for and take a home office deduction.

My advice: if you require a place to do your business, if you do charting from home, which means you’re doing billing from home, you need a home office. And if that office is used exclusively for your business, it’s a deduction.

Dr. Dalawari: Right, I have a home office deduction and I agree, I don’t think it’s a high audit risk for most professionals.

Dr. Wright: The name of the game is lowering your taxable income. You can do this through itemized deductions and business expenses. But, the most impactful way to do this is with a tax-deferred account.

Anything you put into a tax-deferred retirement account comes off the top of your tax bracket because it lowers your taxable income. So, if you’re making $650,000 a year and you put $100,000 into a tax-deferred account, your taxable income falls from $650K to $550K. So in that upper tax bracket, you’re probably paying close to a 40% combined tax rate. So you’re generating $40,000 of tax savings by putting $100,000 into your retirement, and then that contribution and that tax savings allows you to put more money towards your retirement.

So you accumulate wealth faster because you’re essentially shifting the tax burden away from taxes, and you’re shifting that into your retirement. And then, of course, those funds get invested, and you benefit from compound interest, which is the most powerful tool you have. You’re not subject to capital gains tax on your investments.

A defined benefit plan is just a 401(k) with a higher limit–that’s how I tell physicians to think about it. It does all the things a 401(k) does. It’s technically a pension plan. A cash balance plan, which is the plan my company uses, makes sense for most physicians. In a cash balance defined benefit plan, when you’re done with the plan, you close it and the funds roll over to an IRA. So you just get all the money from the plan right into an IRA.

There’s more paperwork involved, and the plans are a little more expensive. You have to have an actuary do calculations every year for you to tell you how much money you can actually fund into your plan. You have to submit a Schedule SB signed off by a licensed actuary or an enrolled agent. You have to submit Form 5500. There are other reporting requirements, but the amount of money you get into the plan is determined in large part by your income. The more money you make and the longer you’ve made that money, the higher your limit goes.

I have VitalSolution cardiologists that I work with who are making anywhere from $500K to $700K. They’re getting close to $200,000 into a defined benefit plan and then they’re layering that with a solo 401(k) and then doing a mega back door off on top of that. So they’re getting close to a quarter million into retirement accounts that are not subject to capital gains tax and knocking about $100K off their tax bill.

Dr. Wright: The maximum contribution to a solo 401(k) is currently $66,000. A professional making six figures can max the plans when you have a defined benefit plan. You can max the defined benefit plan and then use what’s called a non-prototype 401(k). That layers with the defined benefit plan typically. You can put a smaller portion called a profit share as a tax-deferred contribution. It’s not the full $66,000; it’s usually around $20,000. These non-prototype plans allow you to fill the rest of the plan up to the $66,000 max as a Roth contribution. It doesn’t generate any tax savings upfront, but it’s still not subject to capital gains tax. And it’s not taxed when you withdraw it from retirement.

Dr. Wright: 99% of high-earning working professionals should be funding tax-deferred accounts. If you want to get every bit of tax benefit you possibly can, you can do what’s called a backdoor Roth, which is just a way of getting $6,000 or so into a Roth account using a bit of a loophole.

Right now, when you’re working 50-60 plus hours a week and you’re making $600,000, you’re in the highest tax bracket, and using a tax-deferred account allows you to maximize the amount of money you’re able to save for retirement. That allows you to maximize your benefit of compound interest. Then, when you retire, regardless of what happens with tax rates, you’re going to be in a lower tax bracket because you’re now no longer working making $600,000 a year. And you’re probably not withdrawing that much money every year out of your retirement plans.

You need less to live on because you don’t have to factor in savings and taxes and hopefully your home is paid off and what have you. So, there are situations where let’s say you’ve made a lot of passive income and let’s say maybe in retirement you’re making more money than you made when you were a working professional. Well, that’s a great problem to have. In that situation, there actually are things you can do, but you know the vast majority of us are probably not going to be in that position.

Dr. Wright: The Section 199A deduction, also called the qualified business income deduction (QBI), was part of the tax package that Congress passed in 2017. They lowered the rate of corporate taxes on C corporations, from 35% to 21%, to be in line with the rest of the world and to give a tax break to corporations, sole proprietors, and people that are self-employed.

So what they did was they said you can take 20% of your business income and you can treat that as a deduction. You can essentially write that off against your business income. The downside to that for physicians is that Congress decided to phase it out for service professionals, which would be physicians, attorneys, real estate agents, accountants, and people that don’t build things.

There are income limits to where that phases out, so the income limits are based upon your taxable income. After your itemized deductions, your business expenses, your defined benefit plan, after everything, that’s the lowest number you’re taxed on. If you’re filing married and your taxable income is over $440K, you can’t get any of that deduction. But if your taxable is below $340K, then you get all of it. So if you’re a professional making $600,000, the goal is to put just enough into your defined benefit plan to get your taxable income at or below the threshold to capture that 199A deduction.

Dr. Wright: I get this question a lot. I almost always say do not put your spouse on payroll. People think that there’s some sort of tax benefit or deduction that comes with doing that, and there isn’t. In fact, there’s additional tax you have to pay if you do that.

The reason people consider doing that is to be able to make an employer contribution into a 401(k) for their spouse. It’s about $20,000 or so, and it generates probably $6,000 to $8,000 in tax savings.
But if you put your spouse on payroll, they now have to pay Medicare and Social Security tax that they otherwise would not have had to pay. That basically wipes out the tax savings from using a 401(k) for them.

And if you’re someone who has access to a high-limit defined benefit plan, you don’t really need to
do that for your spouse because you already have this huge tax-deferred account to use.

Dr. Wright: I own a large commercial office building and do real estate investing personally. I see real estate as an investment strategy, not a tax strategy. That’s because as a 1099 making six figures, you have access to a defined benefit plan that accomplishes the exact same thing real estate would accomplish. It’s an investment. It gives a return on investment. It’s even better because it’s not subject to capital gains tax. It directly reduces taxable income. And there’s no upfront capital you’re putting at risk.

Dr. Wright: If you’re a W2, then no. There’s not enough complexity to justify using a professional. It’s good to have a professional look at everything when you start having significant 1099 revenue, such as six figures or more and you’re taking a lot of business deductions when filing your taxes. There’s also some liability protection when your tax return is prepared by a licensed CPA. If you’re running an S Corp, vet CPAs by asking questions like, “How many 1120-S forms have you filed?” and “How many of your corps have been audited?” You preferably want a CPA that has filed thousands of 1120-S forms. You want someone with enough expertise and understanding of business tax law to properly advise you.

Dr. Wright: Usually, there’s not anything you have to do differently. And it depends if you’re doing something like telemedicine versus physically working in another state. So in general, whatever state you have a residency in, that’s where your S Corp or your business will be registered.

Let’s say you live in Georgia. You’re going to form your S Corp or your LLC in the state of Georgia. Now let’s say you do 50% of your work physically in Alabama. Well, then you’re going to have to pay Alabama tax. But states have a system where one state will give you tax credits because you paid money to another state for income earned in that state. So in that situation, you’re going to have to pay some estimated tax payments to Alabama and then you’re going to pay personal income tax in Georgia.

You can’t get away with not paying state taxes because you live in a no-income-tax state. Wherever the money is made, that’s who’s going to tax it.

Let’s say you have your S Corp in Georgia. You live in Georgia, but you do ALL of your work in Alabama. Well, in that situation, you’re going to have to register your S Corp additionally in Alabama so that you can open withholding accounts to pay taxes in Alabama because you’re going to owe all of your income taxes to the state.

Dr. Dalawari: I’ve heard that sometimes, if you work in multiple states, one of the states may take more money out than another, but then you also may get a refund from one state versus another.

Dr. Wright: Yes, every state has different ways of handling that. Most states have kind of like a credit system where you get credits and so you pay one state and you get a credit for your other state. There’s a handful of states that are a little more complicated, but in general, you should not be double taxed. You should only be taxed once by one state and I have had clients that have run into states that are trying to grasp into their wallet and take more than they should. And then we have to push back against that and file grievances and abatements. But again, that’s something a competent CPA should know how to deal with.