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The Benefits of Micro-Incorporation For Retirement Plans for Self-Employed Doctors and Their Spouses

coast fire fat fire micro-corporations retirement tax issues wealth Nov 25, 2023

In my last post we addressed the benefits of a solo 401(k) + Defined Benefit Plan through a professional micro-corporation. This was based on a recent conversation that I had with a physician who was job stacking. Both here and her husband are high income physicians who work W-2 jobs. They both max out their retirement plans as W-2 employees, and she was curious about whether her 1099 side income is best received as a sole proprietor or micro-corporation—especially in the context of taxes and retirement funding. She is currently set up as a sole proprietor for her >$100,000 in side income.

Today I am going to break down the answer to her question.

The decision between being a sole proprietor or an micro-corporation taxed as an S-Corporation (S-Corp) in conjunction with a solo 401(k) and a defined benefit plan involves various factors, including your income, business structure preferences, and tax considerations. Let's explore both options:

Sole Proprietorship:

Pros:

  1. Simplicity: Operating as a sole proprietor is straightforward and involves minimal paperwork.

  2. Flexibility: Sole proprietors have flexibility in decision-making and business operations.

Cons:

  1. Tax Implications: As a sole proprietor, your income is subject to self-employment taxes, which can be higher than the combined employer and employee payroll taxes of an S-Corp.

  2. Limited Retirement Contributions: While you can contribute to a solo 401(k) as a sole proprietor, the contributions are limited compared to what you can contribute in an S-Corp with a defined benefit plan.

Micro-Corporation as S-Corp:

Pros:

  1. Tax Savings: S-Corps allow for the distribution of income as salary and dividends, potentially reducing overall tax liability.

  2. Retirement Contributions: With an S-Corp, you can establish a solo 401(k) and a defined benefit plan, allowing for higher retirement contributions compared to a sole proprietorship.

Cons:

  1. Complexity: Operating an S-Corp involves more administrative tasks and may require professional assistance.

  2. Stricter Regulations: S-Corps have stricter compliance requirements than sole proprietorships.

Comparison:

1. Income of $100,000:

  • Sole Proprietorship:

    • Subject to self-employment taxes.

    • Limited retirement contributions.

  • Micro-Corporation as S-Corp:

    • Potential for tax savings by distributing income as salary and dividends.

    • Higher retirement contributions through a solo 401(k) and a defined benefit plan.

2. Retirement Contributions:

  • Sole Proprietorship:

    • Limited contributions to a solo 401(k).

  • Micro-Corporation as S-Corp:

    • Higher retirement contributions possible with a solo 401(k) and a defined benefit plan.

3. Administrative Burden:

  • Sole Proprietorship:

    • Less administrative burden.

  • Micro-Corporation as S-Corp:

    • More administrative tasks and compliance requirements.

Conclusion:

Given the potential for higher retirement contributions and potential tax savings, an Micro-Corporation as S-Corp with a solo 401(k) and a defined benefit plan is more advantageous if she is earning $100,000. However, her decision should consider her overall business goals, willingness to handle administrative tasks, and the advice of a tax professional or financial advisor who can provide personalized guidance based on your specific circumstances.

Why A Professional Micro-Corporation is Best

Now I want to circle back to the question that I was asked on which is better for retirement funding with 1099 job stacking income.

You have to understand that when you operate as a sole proprietor and contribute to a solo 401(k), there are specific limitations on the contributions you can make. Those contribution limits for a solo 401(k) are determined by two components:

  1. Employee Salary Deferral: As an employee of your own sole proprietorship, you can make contributions to the solo 401(k) up to a certain limit. For 2024, the limit is $23,000.

  2. Profit-Sharing Contribution: In addition to the employee salary deferral, as the employer, you can contribute a percentage of your business profits to the solo 401(k). The total employer and employee contributions combined cannot exceed certain limits. For 2024, the total contribution limit (employer plus employee) is $66,000. If you are 50+, you also get an extra $7,000 as an employee catch-up contribution.

Comparing with Professional Micro-Corporation as S-Corp. and Defined Benefit Plan:

In contrast, an professional micro-corporation as an S-Corporation (S-Corp) offers additional retirement planning flexibility, especially when coupled with a defined benefit plan. Here's how it works:

  1. Solo 401(k) Contributions: Similar to the sole proprietorship, an S-Corp allows you to contribute to a solo 401(k) as both an employee and employer. The same contribution limits apply.

  2. Defined Benefit Plan: An S-Corp can also establish a defined benefit plan. Unlike a solo 401(k), a defined benefit plan promises a specific benefit at retirement, usually based on salary and years of service. This can lead to higher contribution limits compared to a solo 401(k) alone.

Why Contributions May Be Higher in S-Corporation with Defined Benefit Plan:

  1. Leveraging Defined Benefit Plan: The defined benefit plan allows for potentially larger contributions, especially for those with higher income, as it calculates contributions based on factors like income and years until retirement.

  2. Combined Contribution Limits: By combining contributions from both the solo 401(k) and the defined benefit plan, individuals operating through an S-Corp can achieve higher overall retirement contributions compared to a sole proprietorship using only a solo 401(k).

Conclusion:

In summary, the statement "Limited Retirement Contributions" for a sole proprietorship refers to the specific contribution limits imposed on solo 401(k) plans. In contrast, a professional micro-corporation as an S-Corporation, particularly when coupled with a defined benefit plan, may provide a more robust framework for retirement savings due to the potential for higher overall contribution limits. However, the decision should be made considering individual circumstances and with advice from financial and tax professionals. Additionally, contribution limits and tax regulations may change, so it's advisable to consult the latest information or seek professional advice.

If you are receiving 1099 income either through your primary employment or your side work, don’t make the mistake of settling for receiving it as a sole proprietor when you could have significant tax and retirement savings through a professional micro-corporation.

If you are currently receiving your 1099 income income as a sole proprietor, and recognize for retirement funding it would be better to receive it through a micro-corporation, let us help you. You can work with our legal network to help create a highly personalized professional micro-corporation in any state, go here and the SimpliMD legal network will be happy engage with you to begin the process.

If you have questions about this, you can schedule a meeting with me here for a free 45 minute discussion about your specific situation. While I am not a tax or or legal professional, I can help assess, coach and connect you to those who can help you within our SimpliMD network.

If you would like to work with our legal network to help you create a highly personalized professional micro-corporation in any state, you can get started now by going here and the SimpliMD legal network will be happy engage with you to begin the process.

Our SimpliMD community is set up to work exclusively with physicians—and since I am a practicing doctor as well—I understand your unique life and needs.

 

Tod

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