A couple months ago I had the honor of recording a BackTable VI Podcast with a couple of my friends regarding locums work. If you haven’t listened to it yet check it out here or the podcast app of your choice. These guys are getting some serious sponsors now which is great to see, though I don’t plan on drinking green fluid for breakfast just yet. Going to stick to my Costco protein powder.
I hope a lot of you found that podcast episode helpful. I felt like we could have easily gone on for another couple hours talking about being an independent contractor, particularly to those misinformed and misguided individuals who view us as “part-timers” or “hired-guns.” I can personally attest to the fact that I have had a far more satisfying existence as an independent contractor than I ever had working as an undervalued monkey for some hospital, radiology group or OBL shark. I would argue that many of my clients would contend that the relationships I have established have been mutually beneficial as independent IRs have the potential to alter the clinical landscape of both hospitals and outpatient centers. It’s ok to doctor differently and just because it’s a foreign concept to closed-minded academic luminaries who define success by one’s ability to win power struggles in a broken system doesn’t mean that independent contractor work isn’t a valid path forward for well-intentioned physicians.
When discussing the locums game, it’s hard to not avoid the topic of money. Part of being an independent IR is achieving your worth, both professionally and financially, in any given setting. Feeling valued is a key factor in ensuring career longevity and avoiding burnout which is so ubiquitous and something I have now experienced not once, but twice in a very short 4 years.
For many of the reasons I’ve laid out on this blog, finding professional satisfaction in IR is rather challenging. So challenging, that I actively and vocally question our leadership, recruitment efforts and other factors which have effectively created a future generation of disgruntled early career IRs. But more importantly, my anger has fueled a desire to educate and help others on their mission to achieve success in a path which is uncommon, and that is the journey of the independent IR physician.
For me, going down this road was a culmination of three big decisions since my fellowship:
1. Choosing to not do academic medicine even though I enjoy teaching, research and the sound of my own voice. Some faculty thought I was a sellout.
2. Choosing not to partake in a traditional IR/DR private practice partnership despite the financial safety net it provides. My IR colleagues thought I was crazy.
3. Choosing not to continue as a minority partner in an OBL instead opting for the more difficult road of establishing my own practice and identity distinct from any senior colleague. At this point most people thought I should be institutionalized.
Part of the second and third decision involved educating myself about finances just as much as I educated myself about medicine. Going into a new-build OBL practice involved an introduction to the small business world, valuations, partnerships, exits and more. These decisions which I have made have forced me to learn about some things that many physicians never learn about. I’ve had to learn these things out of necessity. I’ve been burned and have made some financial mistakes in the process, but the learning from that and the subsequent pivoting has yielded financial success beyond what I thought was possible since leaving training. Many are now reconsidering their decision to commit someone like me to a mental institution and are now asking me for advice. Funny how that works.
Part of being intentional with your life is being intentional with your finances and striving for a future where you don’t need to be dependent on a job. I’ve already accomplished this for myself in 4 years through maintaining my lifestyle from training, making quick pivots to escape crappy situations and subsequently increasing my revenue generation each time, working a lot utilizing the full range of my IR and DR training and investing as much as possible into income generating assets which now spin off tax-advantaged profits to allow me to buy back my time and pursue my career on my own terms. This is particularly important in medicine and even more so in a professional landscape as messy and ill-defined as interventional radiology. I’ll save the rant about the dumpster fire that is American medicine for another day, but today I want to talk about taxes as this will reflect the biggest expense for most physicians. Apologies to my foreign readers as the details of this discussion which are US centric will not be relevant to you.
Here’s a question that I’ve been asked a lot:
Do you file as an S-Corp or an LLC?
Much respect to my friends who have asked me this question before, but when I see this question it becomes apparent that the person asking it really does not have a true framework for understanding basic tax discussions. And of course, nor should they. The vast majority of IRs are W2 employees. I certainly had no idea what any of this stuff was until I got to the OBL and had to come up with a business structure for tax purposes. I then had to change my strategy somewhat recently when I learned that I could further optimize my situation. My goal here is to give you all a high-level overview of taxes as they pertain to us as independent IRs. Even for those of you in academics or private practice radiology groups, some of the information can be helpful if you have any other side-hustles such as locums on off-weeks or industry consulting arrangements. I am not a tax expert, but these are all lessons I learned from my experience and keeping with the theme of this blog, I am being transparent in sharing these lessons with you so you can benefit and prosper.
Legal Structures versus Tax Identities
When we talk about filing taxes as in independent IR, we are talking about how we choose to legally structure our business. In the US there are four recognized tax paying business entities which are the following:
- Sole Proprietorship
- Partnerships
- S-Corps
- C-Corps
So what are LLCs? An LLC refers to a Limited Liability Corporation and is nothing more than a legal entity and is not recognized by the Internal Revenue Service as a taxpaying business structure. So what’s the point of an LLC? It’s really a means to protect one’s personal assets from a business lawsuit. Furthermore, it allows a business to elect taxation as a corporation without certain administrative hassles such annual meetings or associated documentation.
Of the four recognized taxable business entities, the ones most relevant to most physicians will be sole proprietorships and S-Corps. These are known as “pass-through entities” which is a fancy way of saying that these businesses pay tax through the individual income tax code rather than through the corporate tax code.
In the context of locums work, many locums physicians are sole proprietors. This means that instead of a typical W2 one would receive each year to reflect their earnings from a job in which they are an employee, they will be paid on a “1099 basis.” Why does this matter? Two reasons.
- FICA
- Business deductions.
FICA refers to Social Security and Medicare taxes. Here is the breakdown of these taxes per the IRS:
Social Security Taxes
6.2% paid by the employer
6.2% paid by the employee
Medicare Taxes
1.45% paid by the employer
1.45% paid by the employee
The above results in a total of 15.3% FICA tax paid. Above a $147,000 threshold, 2.9% (Medicare taxes of 1.45% paid by the employer and 1.45% paid by the employee) is levied on additional earnings to $200,000 when filing as a single and $250,000 when filing married. Above the $200,000/$250,000 threshold another 0.9% Medicare tax (“Obamacare”) so a total of 3.8% (2.9% + 0.9%) is applied.
In the world of independent IR, whether you own an OBL or work as an independent contractor, you are both the employee and employer of your business. As such, you are on the hook for significant FICA taxes.
What is an S-Corp and how is it helpful?
An S-Corp simply refers to “small corporation” and is an IRS designated business tax entity which allows the corporation to pass taxes onto the shareholder’s individual’s tax returns. In the context of this discussion an “S-Corp” is simply one’s solo IR business and both the employer and employee of this corporation is you the physician.
The main benefit of making an S declaration when filing your taxes is to split one’s income into both salary and distributions. Why is that helpful? Distributions are not subject to FICA taxes. Of course, one would ask, well if that’s the case why don’t we just file as an S-Corp and pay ourselves a ridiculously low salary to maximize the distribution bucket so we can save on taxes? Well a couple reasons. First, the IRS states that one should pay themselves a “reasonable salary” which is of course a huge gray area. More practically speaking, you want to pay yourself enough money to maximize pre-tax retirement contributions to your solo-401k.
Key Solo 401k contribution rules
For the tax year 2022, one can contribute up to $61,000 for their solo 401k. Of this amount, the employee amount is $20,500 and the employer amount is $40,500. Employer solo 401k contributions cannot exceed 25% of salary. Therefore, in order to maximize your Solo 401k, here is the relevant math:
$40,500 / 0.25 = $162,000
Keep in mind that the business (you) must actually make an additional $40,500 to make this contribution
$162,000 (25% salary) + $40,500 (employer contribution) = $202,500
$202,500 after business expenses including employer half payroll taxes (FICA) is what your business needs to make in order for you to max out your Solo 401k.
The Value of S-Corp Tax Savings
Assume an interventional radiology salary of $500,000. This would be a very modest salary for a full-time locums physician, but let’s go with it. Assume this is paid on a 1099 basis. If the doctor decided to create an LLC and file as an S-Corp assuming a reasonable salary of $250,000 and distributions of $250,000. The $250,000 of distributions are not subject to the 3.8% Medicare taxes which they would be if the physician in this case filed as a sole proprietor.
Now to be fair if this person did file as a sole proprietor part of the 3.8% would be tax deductible. Remember the 3.8% consists of the following:
1.45% employer Medicare tax + 1.45% employee Medicare tax + 0.9% “Obamacare” tax.
Ultimately, in this case filing as an S-Corp can save the physician 3.8% in Medicare taxes (2.9% + 0.9%) on the $250,000. The tax savings in this case is $9500. In reality the relative tax savings is somewhat less as the taxes on the employer side of Medicare can be written off as a tax deduction if filing as a sole-proprietor. So at the $500,000 tax bracket of 35%, this write off would be worth $1268.75 (1.45% x 250,000 x 35%) which would bring the relative tax savings to $8231.25 if filing as an S-Corp ($9500 above minus $1268.75).
Now is $8231.25 worth it? There is added complexity in electing an S-Corp including establishing an LLC and paying for a CPA to file for your taxes. Of course, the CPA fees are tax deductible, but the time and expense does eat into the cost savings. Overall, I’d expect to spend at least $3000 a year or more to do this. Practically speaking, I think for the typical interventional radiologist the added expenses are absolutely worth it.
The tax-savings add up when your business revenue increases. For those doing full-time 1099 work, it is not unusual to be pulling in revenue into the low seven figures. The tax savings at this income level could be closer to $25,000 or more. When compounded at an average market return of 7% annually over 30 years, that’s a lot of money.
Confounding Factors
For those with significant W2 sources of income relative to 1099 pay, filing as an S-corp will likely not be in your best interest as you will be paying additional FICA taxes in addition to what you will already be paying as an employed physician (you will be paying the employee side of Social Security taxes for each W2 you receive which you can get back from the government, but you can’t get back the half of social security that is withheld from your paycheck by your employer). This was the case for me the last two years as I still received six figures worth of pay from two W2 positions which I have since scaled back as my 1099 work has significantly increased.
For those of you who work part-time you may benefit from the 199A deduction which phases out over $400,000 when married and filing jointly. In this situation it may be to your advantage to pay yourself a higher salary than you otherwise would as the tax savings from the 199A deduction will outweigh the added FICA taxes you’ll pay from the higher salary you take.
There are several states where S-Corps are taxed like C-Corps. Texas being a notable example. Please look into this and consult with appropriate professionals before making any firm decisions.
Minor Detail on Timing
If you want to file as an S-Corp, you will need a business entity created by the start of the new year or otherwise your ability to file as an S-Corp can only be back-dated to the time of business entity creation. Practically speaking, if you are thinking of filing as an S-Corp in 2023, form your LLC before the end of the 2022 calendar year.
Conclusions
The TL;DR of this is as follows:
1. LLC and S-Corps are like apples and oranges.
2. LLCs allow you the ability to file as an S-Corp, otherwise they really serve no other practical purpose in the context of the physician who is an independent contractor.
3. S-Corps allow you to save some money on Medicare taxes (anywhere from several thousand on the low end to $20,000+ on the high end).
4. If you’re going to file as an S-corp, form your LLC before the tax year in which you file to elect.
5. If you have significant W2 income with a 1099 side gig, it is likely not in your best interest to file as an S-Corp.
6. I am not a tax professional, but I’ve lived this sole-proprietor versus LLC with S-Corp election game so I am passing on knowledge from my own experience. This post does not constitute professional legal or tax advice. Consult with a professional. You will pay money for this, but it’s worth it. Hopefully resources such as this and the ones linked here can make your discussions with a CPA more valuable.
Helpful Resources:
https://www.toptal.com/finance/interim-cfos/c-corp-vs-s-corp
https://www.whitecoatinvestor.com/s-corporations-what-you-need-to-know/
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