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How To Best Manage $40,000 In Side Income
I am going to circle back to last week’s post when I compared the flow of dollars associated with $40,000 in side income and 3 common tax entity structures that are used by doctors for managing this income:
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individual W-2 income
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1099 sole proprietor income
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1099 professional micro-corporation income
Inspiration From Book
Recently, I had an ophthalmologist from Florida reach out to me with this exact question about how to best manage his $40,000 in side income. After reading my new book he realized there was a much better way to organize himself as a professional micro-corporation in order to retain more of his income. His initial target was his side job income. But after some discussion, he is now in the process of converting his entire job structure to an employment lite contract tied to his professional micro-corporation. That is because he understood that the results were scalable and even more advantageous when his entire income flowed through his professional micro-corporation.
Interestingly enough, he is employed by a small group private practice and has the option to buy into the practice as a shareholder in 3 years. He feared by converting from an employment contract to an independent contractor contract (PSA aka employment lite) would prevent him from becoming a partner in the private practice later.
His reasoning was that his professional micro-corporation was essentially his individual private practice and thus his alignment would have to either be to his own micro-corporation or to the group practice, but it couldn’t be to both. He was wrong that he could not do both. Let me explain.
You Have Small Business SuperPowers
You have the superpower to choose to be an individual, or a single-member micro-corporation and can use either taxable entity interchangeably for the job/work/practice structure that you desire.
Mythbusting Truth
Doctors can use their professional micro-corporation to own shares in another professional corporation such as a group practice corporation (ie: PC, PLLC, LLC, etc..)
Here is a visual of what that looks like:
Thus, our ophthalmologist still plans to buy into the group practice, but will now do it through his professional micro-corporation as the owner of the shares within the group practice. This will be the smartest way to receive and manage his income from the group due to the individual tax and retirement plan benefits that it provides him rather than simply receiving the dollars as an individual.
You Don’t Know What You Don’t Know
This is a good example of a common physician blind spot:
Most doctors just don’t know what they don’t know about their individual business powers.
Using your micro-business powers to own shares in a private practice group is a great example of this blind spot. The option is hidden from your view until you finally can actually see it like in this image.
A similar blind spot for our tribe is that choosing employment means there is no need or value to having a professional micro-corporation. The truth is that employment lite through your micro-corporation is a much better arrangement than traditional employment. Most doctors just don’t know it’s an option. Here is a visual of that arrangement.
That is one of my goals with Dr. Inc.—to inform and inspire you about what is possible due to your innate small business powers.
Comparing 3 Common Paths For Side Income
Now let’s take a closer look at the characters in our social story from last week’s post.
To summarize the story from last week:
I explained why W-2 workers are the biggest loser when it comes to side job income. It included a graphic depicting & contrasting 4 different doctors who are working within a corporate flywheel that generates income for them through their side jobs.
This week, I am going to re-organize the 3 doctors with side jobs into three caricatures, each with their own back story.
We have Dr. W-2
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He likes the ease of employment and takes on side work through his employer because his employer offered him the extra income opportunity. It makes him feel special and more valued by his employer since they deem him capable of managing the extra workload. Besides that, the title of “medical director” looks great on his CV and his LinkedIn profile.
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Getting all of his taxes managed by his employer’s finance department makes it easy to just check his bank account every few weeks to monitor the extra compensation deposits.
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The extra pay in his checks is nice although the extra hospital call and administrative tasks can make him tired, and it can also negatively affect some of his family’s plans at times. But he reasons his family is ultimately the reason he is taking on the extra work—to pay for the boat they all love to use on the weekend. Thus, his extra work and extra income have a justified purpose.
We have Dr. Sole Proprietor
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He likes the predictability of his W-2 position with his hospital employer. The hours and pay are right and his family loves where they live.
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He was recently approached by a local nursing home and was asked to serve as their assistant medical director. He would be paid an annual salary for this side work. Since he already cares for nursing home patients within his primary job, this seemed like a low-stress and low-time-demand side job. The nursing home planned to pay him as a 1099 contractor. After speaking to his accountant, he was told he could receive the money as a sole proprietor or professional micro-corporation as an S-corp. He really didn’t want the burden of starting and running a micro-business, nor the extra tax filing—so a sole proprietor made the most sense.
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What he really liked is the business deductions that he would be able to capture on his personal tax form, which he previously missed out on as a W-2 employee. His accountant gave him a list of common deductions (listed below) that he would need to track, and also explained the need to pay quarterly taxes on his side job income.
We have Dr. Professional Micro-Corporation
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He read a book during residency that promoted the idea of starting a professional micro-corporation early in his career, so he did it and used the corporation for some moonlighting opportunities during residency. He found the business simple to manage on QuickBooks, and his taxes weren’t too difficult to do on his own—although it helped that his wife was an accountant.
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His first job was as a traditional employee because the financial incentives to go this route was just too high to bypass. Now 3 years later, with his payback window behind him and his first 3-year contract ready for renewal, he is reflecting back on his micro-corporation and how he can use it in the future.
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He did use the professional micro-corporation over the past 3 years to earn some extra 1099 income doing side job telehealth and medical surveys—but nothing major, the income was <$20,000 total.
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Now a local wound center wants him to work a half day a week as a contractor for their company. He figures the $40,000 would be great extra income, and since the wound center is a joint venture with his current employer, they are supportive of the extra hours fitting into his current clinic schedule. He figures this will flow nicely into his professional micro-corporation. This really got his mind thinking—why not scale up the whole thing and convert his primary employment to an employment lite contract as a contractor through his micro-corporation? He plans to ask his employer about it, but for the time being he wants to evaluate what it looks like to use his micro-corporation for something as large as $40,000.
Which Path Is Best?
This brings us to where the rubber meets the road, and how to best manage side job income.
Since side work is increasingly common for all doctors, let’s take a look at how $40,000 in side work income actually affects each of our social story doctors.
This is an impressive reminder that you are far better off activating your small business powers rather than passively disabling them as a W-2 worker.
So let’s take a look at comparing all 3 paths for your side income dollars—and especially note the last two rows on taxes paid and retained household dollars.
You can see from the summary slide that you should try to avoid taking your side income as a W-2 worker. Granted you are netting $30,000 in extra household dollars while earning $40K but as I explained previously you are working harder in the corporation’s fly-wheel while the tax drag is increasing the entire time. Based on the current tax brackets, the more you earn, the more you will pay in taxes. See below for a reminder of how the federal tax system works in a tiered manner. As a high-income earner, the more you earn, the more you pay in taxes.
The Professional Micro-Corporation is the Best
As you can see in the graph, the clear winner is using a professional micro-corporation for flowing your side income. You will pay no taxes on the earnings, will sock away $25K in savings in your 401(k), and end up with $13,500 in household dollars to spend however you want as well as have $2000 in deductible business expenses to cover the operation of your micro-corporation (corporate reports, books, and tax filings). You likely will be able to operate your business for less than $2000. Whatever, you don’t spend on the business expenses will further contribute to the net retained household income and enlarge it past $38,500. It’s also worth noting that a lot of the deductible business expenses actually save you money that you previously just paid out of pocket—your household vehicle mileage and cell phones are great examples of this. It is noteworthy that corporations have more options for deductible business expenses than sole proprietors-including the tax-free dwelling unit rental program. Here is a list of some of those S-corp business deductions:
Sole Proprietor A Respectable 2nd Place
It is notable that a similar logic applies to the sole proprietor model in terms of deductible business expenses and how that impacts spendable household dollars. The business’s access to a solo 401(k) retirement plan is the key, as are its tax-friendly expenditures. As you can see the sole proprietor does much better in comparison to the W-2 earner, but still can’t beat the professional micro-corporation. He will pay $2000 in taxes more than the professional micro-corporation.
MVP for Professional Micro-Corporation
Knowing that a basic professional micro-corporation can be set up for $2000-$5000, a common question is “What is the minimum value proposition (MVP)” for a doctor to start his/her professional micro-corporation?
This MVP business term basically answers the question:
“At what level of income does the return on investment for the cost of a micro-corporation result in you saving money?”
As you can see it, the professional micro-corporation is a winner at $40,000 of income because after factoring in the cost of starting a professional micro-corporation—which is a deductible business expense—you still come out ahead over the sole proprietor.
How Low Can You Go?
Although everyone’s tax situation is unique, the tipping point for starting a professional micro-corporation vs filing as a sole proprietor vs W-2 income is somewhere between $10,000 to $20,000 in side income.
General Recommendations
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For under $20,000 in side income, the sole proprietor beats both the W-2 and the professional micro-corporation.
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For $20,000-$30,000 in side income, the sole proprietor and professional micro-corporation are equal and thus your individual tax situation will guide your choice—I recommend you speak to your tax professional about this.
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For over $30,000 in side income, while using the SimpliMD physician business structure, the micro-corporation comes out ahead—beating the sole proprietor with an increasing margin as the side income dollars scale upward.
I would add that one can form a professional micro-corporation online for much cheaper than $2,000-$5,000 via Legal Zoom, etc. However, I highly suggest you work with an attorney familiar with doctors to help you—as it will pay off in the long run. A lot of doctors will start their corporation with a basic model and add features/fringe benefit plans later. Working with someone who knows how to do this for doctors like SimpliMD —is important.
Scalability
The tax savings and retained income associated with the professional micro-corporation scale up nicely and ultimately make a huge impact on lowering your annual taxes if you deploy it 100% into all of your professional work. This means you will be working as an independent contractor, which is increasingly common for doctors. That is what I do through my primary job via an employment lite contract and then my side jobs also flow through my professional corporation.
It’s the scalability element that becomes more obvious as you blend a W-2 job with 1099 side income that flows through your professional micro-corporation. From tax savings to retained income to robust and individualized fringe benefit programs, to business deductions, to professional autonomy—all are scalable and even accelerated within a professional micro-corporation structure. Basically, the more professional income that you pour into your micro-corporation, the more you save.
If you are a W-2 earner and were frustrated by your large tax bill this year when you filed your taxes, you need to check out professional micro-corporations as a way to reduce your tax burden.
Summary
If you make <$10,000 in side work income, you should receive it as 1099 income rather than W-2 income. I suggest you receive it as a sole proprietor and this will allow you wisely deduct business expenses that ultimately allow you to retain more of your earnings.
If you make >$10,000 in side work income, you should receive it as 1099 income rather than W-2. I recommend at this level that you should consider starting a professional micro-corporation to help you retain more of those earnings over both the W-2 worker and the sole proprietor. You should work with your tax professional to help you make an informed decision about this.
If you make >$20,000 in side income, it’s clear that you are in the space where starting a professional micro-corporation will help you retain more of what you earn and pay far fewer taxes.
Once you start the micro-corporation, you will be in a position to learn how to effectively use it for your side income and then this can be scaled up to eventually include your primary job or additional side jobs.
FREE Business Coaching Session
I am so passionate about the value of doctors activating their small business powers that I’ll provide you with a free business coaching session worth $500 to help you decide what would work best for you.
Stop giving away your extra income to the government when you don’t have to!
Tax evasion is NOT the goal, legal tax reduction is the goal.
I am reminded of what Federal Judge Learned Hand said about taxes:
“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”
Stated in another way, Judge Hand reminds you that it is ok to arrange your professional affairs in a pattern that allows you to pay the Treasury the lowest amount possible.
The best way to arrange your business affairs is to activate your professional micro-business powers due to the additional tax strategies that it provides you.
So, take the next step of reducing your tax burden by signing up for 45 minutes of free business coaching where I’ll listen to your situation and provide you with some coaching tips on how to best manage your side job income. You can set up this free meeting at the following link.https://calendly.com/drinc/45min.
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