A recurring theme when speaking with new Independent Contractor Physicians is Taxes, and how to pay less of them. More often than not, the first thing they all do is to calculate how much they think they will make the first year, typically around $300,000, and then they do the math and figure that in the 35% tax bracket, they will pay $105,000 for income taxes, which unto itself is a large number. What they often forget is that they must also pay taxes on self-employed income, also known as FICA/Medicare. If you live in a state with an income tax, this amount gets even higher. There are ways to reduce this number, legally. Keep reading to see how.
Form a Physician Corporation – Establishing your physician corporation will allow you to opportunity to significantly reduce your earned income. The simple math is that you have to pay Medicare taxes on either your salary. If you form a Physician Corporation, you can elect to make this $208,000 (in order to max out your SEP-IRA) versus $300,000 if you simply file a Schedule “C”. The difference between the two is that by forming your Physician Corporation, your dividend payment is not subject to Medicare tax, which immediately saves you 2.9% on $92,000 or $2,668 per year. Simply file your PA or PC, apply for your EIN Number, file your appropriate IRS forms and establish a bank account. You can do this yourself, or you can work with a business manager. This does take some work, but, it will pay for itself many times over with the reduction in annual taxes.
Physician Retirement Accounts – As a physician, there are few better ways to both fund retirement and protect your assets. In most courts, retirement accounts of any type are not able to be attached by civil judgment. If for this reason alone, fund them to the greatest amount possible. The worst thing that can happen is that you will live within your means, and be able to retire early. Below are a couple of vehicles to consider:
1.) Fund your 401(k)/Profit Sharing / SEP-IRA
The type of account is not important, just so long as you do it. If you are part of a practice group, you may have the ability to contribute to a 401(k) up to $17,500 per year, and the practice group may contribute to a Profit Sharing Plan. The total of these two plans can add up to $52,000 per year, PRE TAX. That means that if you are in a 35% tax bracket, you just saved $18,200. Unfortunately, the $17,500 is still subject to FICA/Medicare taxes. If you are an Independent Contractor Physician, you should have a SEP-IRA. This will allow your Physician Corporation to contribute up to $52,000 pretax. This contribution is not subject to FICA/Medicare, as it is an expense of the business, and not part of your salary. A savings of at least $19,000
2.) Cash Balance / Defined Benefit Plan (Physician Pension)
This is one of the most under-utilized retirement options, and it is one of the best when it comes to reducing your tax bill and protecting your assets. The IRS will allow you to create a pension for yourself, and accumulate up to $3 million. While the annual contribution amounts are subject to your annual salary and current age, I currently have clients putting away over $200,000 annually Pre-Tax. If you have the income, you could literally save $100,000 in annual taxes when you take into consideration State/Federal income taxes. These plans work in conjunction with 401(k) and Profit sharing plans.
3.) Make a non-deductible IRA contribution
Many people fail to make an IRA contribution as it may not be deductible due to IRS limitations based on income or participation in company retirement plans. These same limitations prevents them from making a ROTH IRA contribution. What they don’t realize is that by making a non-deductible IRA contribution, you can then convert that to a ROTH IRA, and never pay taxes on those earnings….EVER!! Failure to take advantage of this IRA loophole costs you thousands in unnecessary taxes.
4.) Create a Physician Captive Insurance Company (CIC)
It enables the business owner or business to own a profitable second business. This profitable business can build up loss reserves, helping prevent the total business entity from being hollowed out by excessive taxation. A CIC primarily insures the risks faced by the operating company or related companies. The primary reasons that businesses or their owners form CICs are:
- To manage business risk by formally self-insuring certain risks with pre-tax dollars
- To protect assets from creditors of the operating business and its owners or other risks
- To realize profits and accumulate wealth inside of a separate business entity
When a business owner sets up a captive insurance company to formally insure risk, he or she also benefits by being able to accumulate wealth in a more tax efficient vehicle. The operating company (or parent company) pays tax deductible premiums to the captive insurance company. And, small captive insurance companies may make an 831 (b) tax election. As such, they are taxed at zero percent (0%) on their underwriting profit. Underwriting profit is simply defined as premiums collected less claims paid. Small insurance companies by definition receive $1.2 million or less in annual premiums according to the Internal Revenue Code (IRC). The result is a remarkably efficient vehicle to accumulate loss reserves (and by extension wealth) for the future. This prevents the business and its owners from being hollowed out by excessive taxation.
If you have $200,000 or more that you would prefer not to pay taxes on, let’s talk more.
My Professional CFO, LLC, is a Business Management firm providing the highest level of service in three key areas of importance to Independent Contractor Physicians. We specialize in Corporation filings and ongoing Compliance, Accounting and Payroll, and Investment Management. Our professionals will assist you in forming the appropriate type of company for your situation and work with you to make sure your company remains compliant. We provide ongoing Accounting and Payroll services to make certain all necessary tax forms and withholding payments are made in a timely manner, as well as the set up and management of your retirement accounts. We are not simply a document filing service; we are here to help you with the part of the business that you have to do, so you can focus on what you love to do.
Alan Conner, MBA – President of My Professional CFO, LLC has nearly 2 decades of experience working with professionals and small business during both start-up and ongoing management. He has written countless business plans and has managed assets for both institutions and high net worth clients.
Email us with any questions, or call us at: 1 (800) 517-0236