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In partnership with Generational Financial – Ben Yin, MBA.
Contents
It depends! Read more to learn the only two reasons ICs should form a physician LLC.
A lot of independent contractor physicians think they should form an LLC. But the truth is that most don’t understand exactly why, or how to leverage a physician LLC to save thousands of dollars come tax season.
As a financial advisor devoted exclusively to helping physicians build long-term wealth, ApolloMD’s trusted partner Benjamin Yin says there are only two reasons why physicians would need an LLC:
1. Save on payroll tax (Social Security + Medicare)
2. Take advantage of PTE (Pass-through Entity Level Tax)
Contrary to what you might be reading, you don’t necessarily need an LLC to deduct business expenses, fund retirement accounts, add family members to the payroll, or for asset protection (at least in this case).
Still, neither of the above uses is straightforward, and many physicians, even many financial advisers and CPAs, ultimately get the numbers wrong when it comes to maximizing value. Below, we’ll lean on Ben’s expertise to explain the numbers behind each of these, what the best model is for independent physician contractors, and why you might still want to consult with a financial advisor to adapt the strategies to meet your needs.
The Basics
As a physician there are several practice opportunities with different employment statuses available during the job search, with two of the most common being an employee (W2) or an independent contractor (1099). The operations of both are very different and there is no “better” option. Employment status is dependent on what is best for the individual.
For those who thoroughly researched and made the decision to work as an independent contractor, that’s great! Making the change from working under an employed model to working as an independent contractor can be a difficult and sometimes scary decision, but it doesn’t have to be.
Probably the most common question for those starting as independent contractor physicians is, “Do I establish an LLC or S Corp?” The answer could change depending on your circumstances, but we’ll skip to the good part here: for most IC physicians, in most circumstances, the correct move is to form an LLC but elect to tax it as an S Corp.
We’ll explain why in a moment, but first it’s important to review the official IRS definitions:
S Corp: These are corporations that choose to pass corporate income, deductions, credits and losses through the corporation’s shareholders for federal tax purposes. Shareholders of the S Corp report flow-through of losses and income on personal tax returns and are assessed at individual income tax rates which allows for S Corps to avoid double taxation on corporate income.
LLC: This is a business entity created by state statute with regulations differing from state to state. LLCs may have more than one owner, which are referred to as members. The number of members differ with most states not restricting the type of owners allowed. Most states also permit single-member LLCs. The number of members determines if the IRS treats the LLC as a corporation, partnership, or part of the owner’s tax return.
These definitions are long, unclear, and not very helpful for most just starting out as an independent contractor. Depending on who you talk to, some may suggest an LLC and others will suggest an S Corp. Both are correct, to an extent.
Why to Form a Physician LLC, Reason #1:
The first reason a physician should form an LLC is that you can save huge on payroll taxes.
Remember that as an independent contractor, you are both the employer and the employee, meaning you have to pay both parts of the payroll tax (or self-employment tax).
• Social Security:
• Wage cap: $168,600
• Employer contribution 6.2%
• Employee contribution: 6.2%
• Total: 12.4%
• Medicare:
• No wage cap
• First $250k of income (married, filing jointly)
• Employer contribution 1.45%
• Employee contribution: 1.45%
• Total: 2.9%
• > $250k of income:
• Employer contribution 2.35% (Medicare surcharge tax of .9%)
• Employee contribution: 1.45%
• Total: 3.8%
Thus, the basic strategy doctors can follow is this: your physician group pays your LLC, and your LLC pays a portion of that income to you, acting as a W-2 employee of your LLC. The rest will still be income eventually—it can be taken as owner distribution, withdrawal, or dividend directly to your personal bank account—and the great news: not a single dime of that will have any payroll tax (no Social Security, no Medicare).
Here’s a simplified example:
In this example, Dr. Love is paying herself $100,000 via W-2, about 30% of their LLC’s 1099 income. So why do many financial planners and CPAs for doctors often set their clients’ W-2 threshold at a higher amount, more like $169,000, $184,000, or higher?
Why many CPAs get it wrong
The case for $169,000: This caps out the social security wage base and “keeps the government happy.”
The case for $184,000: This amount lets you maximize contributions to a 401k.
• $23,000 employee contribution (assuming you’re under 50)
• $46,000 employer contribution (IRS rule: $184,000 x 25%)
• Total of $69,000 (maxed out for 2024)
According to Yin:
It’s not a best practice to increase your payroll just so you can max fund your 401(k). If you increase your wage from $100k to $184k, your payroll taxes increase by over $10k! If you pay yourself $100k, you can only contribute $48k into the 401(k)… $21k less than the max of $69k. We’re not saying don’t save the $21k, just utilize different vehicles like Back Door Roth IRAs and brokerage accounts. Another way to look at it: that $10k saved in payroll tax can go towards your investments. So instead of putting in $21k, you’re only really putting in $11k.
Wage setting can be controversial. The IRS says you have to be paid “reasonable income.” Some advisors argue that $100k (assuming your LLC makes $300k) is too low. But often these advisors don’t consider the expenses of running your own business:
• $300k to the LLC
• ($48k) 401(k) contribution
• ($40k) Expenses
• ($8.3k) HSA
• ($7.65k) 50% Employer payroll tax
• Adjusted Gross Income: ~ $196k
So, your $100k wage is actually based on $196k, not $300k…making it much more “reasonable.”
Something else that Yin says is very important: “If your wage is set too high, you might be better off forgoing the LLC and just getting paid personally (also known as filing a Schedule C). Why? Because when your W-2 salary increases, your QBI (qualified business income deduction) and PTE (see below) benefits decrease. Plus, you have LLC-related expenses such as paying a CPA to run payroll and handle your LLC tax return. Ultimately, whether or not you utilize an LLC is based on your personal situation. It’s not a slam dunk for everyone, especially if your W-2 salary is too high.”
Why to Form a Physician LLC, Reason #2:
The second reason doctors should form an LLC is to take advantage of the Pass-Through Entity Level Tax or PTE.
The primary benefit of doing this is to further reduce your taxable income by taking state taxes as a federal deduction. Assuming your state qualifies, this could be significant. Here’s how it works, using the same numbers as above:
In states that do not have a state income tax, such as Tennessee, creating an LLC taxed as an S Corp is not a “no brainer” like it is in other states due to the distributions from your LLC incurring an excise tax to make up for the lack of state income tax.
Other states require a Professional LLC or PLLC. Some states, such as North Carolina, require the state medical board to be involved. Thorough research on your individual state requirements, as well as consulting with a financial advisor, will help to establish what is the best fit for you.
Conclusion
At ApolloMD, we work with and refer our physicians to trusted partner Benjamin Yin, MBA, Co-Founder and Principal of Generational Financial Partners. Ben works with a large number of independent contractor physicians and provides customized plans to help them prepare, protect and prosper based on the individual’s goals and needs.
Schedule a complimentary consult with Ben to discuss independent contractor status as a physician and how to get started.
Disclaimer: Described in this blog post are some examples and steps commonly followed by physicians. These scenarios are merely examples common across the industry. Before establishing a business or determining what employment status is best for you, we recommend obtaining the guidance of a trusted, experienced financial advisor/planner and an experienced, knowledgeable CPA.