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Labor Expenses
Your labor expense including salary and benefits will be the largest expense for your micro-PC. This includes the cost of benefits, malpractice insurance, CME, and other professional expenses.
The beautiful thing about a micro-PC is that you have complete control over setting your reasonable salary and then choosing your individualized benefit structure to surround you and your household.
In order to create your micro-PC budget properly you need to do a little reverse engineering work that has some overlap with your personal finances. This is all part of getting money into your household in the most tax-efficient manner using all the powers you possess as a small business owner.
Here is what is needed:
1. You need to know what your household spending is for each month. This represents the minimum level that you will need to set your salary for, or your combined salary if you employ your spouse as well. Don’t forget payroll taxes must be removed from this as well. The lower this “reasonable” salary is, the less you will pay income tax. This is a fundamental strategy for lowering your effective tax rate.
2. Consider what professional expenses can be deducted from the business such as CME, malpractice, and other professional fees.
3. You should evaluate which household expenses be allocated or shared as business expenses such as phone, internet, transportation, healthcare, and other expenses. Make sure to work with your accounting or tax professional to properly separate, track, and allocate these expenses.
4. You need to calculate the tax-advantaged household income that you can recoup through your small business through strategies such as section 280A(g) of the IRS code often called the “Augusta Rule”
5. Calculate your small business-supported retirement plan for you and your employees including small business options like a defined benefit plan/cash balance plan
6. Determine the potential for a business distribution to yourself based on the projected business revenue and expenses.
After doing all of this, then you will be able to put your shoulder into strategies and decisions that affect one of your largest variable expenses, taxes.
Taxes are not be avoided, but they also don’t need to be overpaid.
In order to dig deeper into this, I want break down some basics about the options you uniquely have as a physician to receive your earnings through various tax entities and why this should be important to you.
Taxable Entities
From the IRS standpoint, there are two primary taxable entities: individuals and businesses.
All US citizens are individual taxable entities. Whether single, married filing jointly, head of household, widow or widower, individuals pay taxes on income earned in the U.S. Even though couples filing jointly involve more than one person, the IRS treats them as one taxable entity.
Sole proprietorship net income is also included in the proprietor’s personal taxable income.
Business owners are required by the IRS to pay taxes on their employees, and they use IRS form W-2 for this. It’s a record of an employee’s compensation, benefits, and taxes withheld for a given tax year. You fill out your W-2 if you are classified as a part-time or full-time employee at any point in a given tax year. The government receives its tax payment on these earnings in real-time as they are earned. Companies pay payroll taxes for each employee. Payroll taxes include Social Security, Medicare, and federal income tax withholdings
In contrast, to form W-2 for employees, 1099-NEC is an IRS form that states how much you are paid as a non-employee worker—such as an independent contractor. It lists compensations you received as a worker in a given tax year, plus any federal, state, and local taxes withheld (likely none). When a company hires an independent contractor, it doesn’t pay these taxes. Independent contractors are responsible for filing their individual income taxes, but they can make business expense deductions that W-2 employees cannot. This is a very important difference for high-income earners in particular because W-2 earners tend to have effective tax rates that are higher than their 1099 peers.
Ordinary business income through your services in a micro-PC is treated as 1099 income and is not subject to withholding. This means that the recipient of the business income or 1099 income is responsible for paying their own taxes. The IRS allows these tax payments to be estimated and paid quarterly.
Taxes
The entity that first receives your hard-earned dollars matters to the IRS because individuals are taxed differently than businesses. In summary, individuals have far fewer options to save on their taxes than businesses. This matters because taxes are one of the largest expenses you will manage in connection with your large income. By receiving your earnings into your micro-business first via 1099 income, you will dramatically expand your tax strategies as the following table summarizes:
In recent years, physicians are flocking to W-2 status from large corporate employers. While there are lots of financial and practice management incentives for this trend. High-income earners like doctors are sitting ducks for the IRS when they become W-2 employees.
Components of A Business Budget?
For the sake of our discussion, I am going to describe the micro-PC budget from the vantage point of a contractor who is a locums, tele-doctor, or has an employment lite agreement like myself.
The components of this lean micro-PC’s budget would not include staffing, medical office building, management, medical office equipment, compliance measures, insurance, electricity or any of the other myriad of budget items associated with having a retail medical office building in private practice or any direct care model.
The fundamental budget items in your lean micro-PC would include:
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Your primary job(s)
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Your side job(s)
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Overhead
Here is the real power of a micro-PC for physicians. A large portion of your overhead expenses is essentially covered by whoever is contracting with you for your professional services. This means you are not responsible for support staff, management, equipment, billing/collections, and the real estate/clinic space.
Don’t get me wrong there are business expenses or overhead associated with your micro-PC, but these expenses are largely shaped to benefit your household in a dance that is very familiar to thousands of small business people throughout our country.
Business expenses
The business expenses that you will be responsible to manage can fit into 4 broad categories:
1. Employee Salaries
2. Taxes
3. Business Expenses
4. Fringe Benefits
The great thing about a micro-PC is that you gain control over the flow of your cash through these elements when you receive your earnings via 1099 rather than as a W-2.
W-2 employees have control over their salaries and that is about it. There are still a few itemized deductions, retirement plans, and child tax credits that can help with lowering your taxes.
Micro-PC owners have complete control over the cash flow through each expense category in your budget. Since I have already discussed salaries and taxes, let’s take a look at business expenses and fringe benefits.
You can creatively personalize these expenses for your household and wrap them around your unique personal and professional life.
Business Expenses & Fringe Benefits In a Micro-PC budget
The following is a list of potential expense and fringe benefit line items that could be included in your budget plans. The decision to include each, and how much can be highly variable from micro-PC to micro-PC.
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Advertising and Marketing
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Website/Social Media
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Charitable Donations
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Internet/cell phone/digital services
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Payroll taxes
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Corporate taxes
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Accounting Services
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Continuing Medical Education
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Professional Dues, Licenses, Memberships, and Subscriptions
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Malpractice insurance
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Legal and professional fees
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Meals and Entertainment
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Home Office/administrative support
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Travel
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Transportation-mileage reimbursement or car lease
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Business space leasing
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Fringe Benefit plans
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Health Insurance/HSA/health care reimbursement program
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Eye/dental Insurance/health reimbursement program
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Life Insurance
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Disability Insurance
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Corporate Meeting home rental program-section 280A(g) of the IRS code often called the “Augusta Rule”
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Meals for the convenience of the employer
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Per Diam Reimbursement program
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Employer-sponsored Retirement plan: 401(k), SEP, Cash Balance Plan
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Corporate profit sharing/distributions
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Company Car
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Assets
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Office equipment
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Professional equipment used as a contractor
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Real Estate and Medical Office Building are usually held under a separate LLC if you are in an employment lite agreement (this is what I do).
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There are many things I love about having total control over my fringe benefit program. The most important is that am only paying for benefits that I need and use for my household.
A personal favorite is being able to expense out CME anywhere in the world that I want to go, as long as my business budget can support it. When I was a traditional physician employee, I really despised the paltry $3000 CME stipend with its various corporate restrictions that included being restricted to the US only.
I really like international travel and also enjoy rubbing shoulders with international physicians due to their unique perspectives that are not so American-biased. For that reason, I especially like Canada-based CME Away by SeaCourses. I also really enjoy the fact that spouses get to accompany for free! This means your business deduction goes further!
Putting It All Together
After working your way through each of these expense categories, not it’s just a matter of crunching all the numbers on a spreadsheet and then adjusting your expenses to match your revenue. This may create a forced rank order of business expenses and fringe benefits that you can afford in any given year. For instance, you may want to lease a car as a business expense, but the budget will only support a Honda lease rather than a Ranger Rover lease. You have will have to make the choice, but the beauty is that you have the full autonomy to make that decision!
As you work through this. the best way to create a budget that works for your company is to use a template from Apple Numbers, Microsoft-Excel or Google Sheet spreadsheet as it allows you to easily input data and manipulate the information. It can then be easily duplicated for the next year with simple adjustments.
Zero Based Budgeting
Most micro-PCs for physicians will attempt to reduce the tax burden for the business owner by coming as near as possible to a minimal business profit each year. In other words, between business expenses, salaries, fringe benefits, and distributions you will want your projected budget each year as close to zero as possible. Thus it becomes a type of zero-based budget due to the confluence of aligning your professional and personal goals with the business expenses.
A micro-PC budget will almost always integrate your personal and professional goals and needs. Thus having a personal household budget and integrated goals is an important underpinning to putting it all together. This is why I really like using my Dare To Dream goal-setting document every year during a short business retreat for my wife and myself. I will dig deeper into this in my next post.
In the end, the alignment of your household with your micro-PC is will empower your sense of autonomy over your personal and professional life as well as enhance your financial well-being.
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