6 Huge Benefits of IC income
NOVEMBER 09, 2016
Johanna Fox Turner, CPA, CFP
Typically, a worker who has a choice prefers to be classified as an employee rather than an Independent Contractor (“IC”). The reason is that an employer pays “only” half of the FICA tax due on all earned income while IC workers pay 100%.
FICA is made of up Social Security tax (6.2% for employer + employee or 12.4% for IC workers) and Medicare (1.45% for employer + employee or 2.9% for IC workers). Paying 15.3% of your net profits is a heavy burden for a small business owner.
So why is it a good idea for doctors to be paid as IC’s? Here are six reasons:
1. Social Security (“SS”) is imposed on only the first $118,500 ($127,200 in 2017). Because doctors are HIPs (High Income Professionals), those who earn W2 income in their “day” jobs have already “maxed out” on SS. Not only that, but their employers have split the cost with them! Income earned beyond the SS threshold is taxed at 3.9%, which is what the moonlighting IC doctor will pay, a savings of 12.4% in taxes. This is critical for HIPs as, otherwise, you would be slicing an extra 12.4% off your IC profits.
2. 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. That means you can make only one $18k employee discretionary contribution across all retirement accounts, but you can contribute an extra 20% of the first $265k of IC profits to a separate SOLO-401k. (Note that if you have a 403b instead of a 401k, you can contribute only a maximum of $53k [$59k if age 50+] across all retirement plans combined.)
3. 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, if at all possible, you do not want pre-tax IRA accounts in your name. That’s because contributions to back door Roth IRAs are taxable if you own any pre-tax IRA space but not if you have money in a 401k. Since you will probably change jobs several times in your career, a SOLO-401k is far better than an IRA for your 401k/403b’s rollovers.
4. 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 were not already maxing out her SS at her own job, I would recommend minimal pay just to get a SOLO-401k started.)
5. You can write off business expenses that you’re currently losing. You probably have several job-related expenses that could be deductible if it weren’t for that pesky 2% haircut on employee business expenses. If you are self-employed, though, you can deduct at least some 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 Medicare taxes.
6. Last but certainly not least, you can hire your children. There are many benefits to hiring your children, both financial and nonfinancial, 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 employees aged 21+.