The new status symbol for physicians today is not a Rolex – it’s a side hustle. Making some income as an Independent Contractor (“IC”) rather than as an employee can not only speed your pace to FI, you’ll get several tax benefits not available to W2 employees.
As you’re probably aware, you’ll pay twice as much in FICA if you’re self-employed, so why is it a good idea for doctors to be paid as IC’s? Here are six reasons:
- Social Security (“SS”) is paid on only the first $132,900 (2019). Because doctors are HIPs (High Income Professionals), those who earn W2 income in their “day” jobs have already “maxed out” on SS – and their employers split the cost with them. Income earned beyond the SS threshold is taxed at 2.9%, which is what the moonlighting IC doctor will pay, for a savings of 6.2% in taxes. This is critical for HIPs as, otherwise, you would be slicing an extra 6.2% off your IC profits.
- Having IC income means a HIP can have an extra business retirement plan. Assuming you already have a 401k at work, you can contribute another $53k ($59k if age 50+) to a separate Solo-401k based on your IC income. Your contribution is calculated as a percentage of your net profits from your IC income. While you can make only one $19k (2019) employee discretionary contribution no matter how many different streams of income you have, you are also allowed to contribute an extra 20% of the first $280k of IC profits to a separate retirement account. (Note that if you have a 403b instead of a 401k, you are limited to a combined maximum of $56k [$62k if age 50+] deposited into your Solo-k + 403b.)
- Opening a Solo-k through your IC business means that you will have a place to park rollouts from other 401k’s/403b’s. Why is this important? Because pre-tax IRA accounts will cause you to owe pro-rata taxes on backdoor Roth conversions. Since you will probably change jobs several times in your career, a Solo-401k is far better than rolling out to an IRA for your orphan 401k’s and 403b’s.
- You can hire your spouse to work for you (administrative work, marketing, management, etc.) and your spouse can also contribute to a Solo-401k, reducing your taxable income even further. This not only gives your spouse additional tax-advantaged retirement space but it also gives him a place to roll over his 401k/403b accounts when he changes jobs. (Note: if your spouse is not already maxing out SS with a separate employer, this may not make sense. At the most, I’d recommend minimal pay just to get $19k into a Solo-401k.)
- You can write off business expenses that you’re currently losing. Under TCJA 2017, employee business expenses are no longer deductible. If you are self-employed, though, you can deduct at least part of your costs for: CME, business travel, licensing, a legitimate home office, tax and accounting advice, and more. These deductions will reduce your IC income and the related FICA taxes.
- Last but certainly not least, you can hire your children. There are many benefits to hiring your children, both financial and non-financial, but my absolute favorite is to start Roth IRAs for your kids at an early age. Can you imagine the potential tax-free growth of a Roth IRA over 60 years? What can your children do? Help with marketing (website, Twitter, Facebook, Instagram), clean your office, pose for marketing materials, learn to file and do bookkeeping. And you get to keep your Solo-401k because you can limit 401k participation to only full-time employees who are age 21+.