Section 199A

[Phantom Spike]

I am potentially going from a salaried position to an independent contractor (long term locums) position in 2021 (meaning going from W2s to 1099s). I expect an annual independent contractor income in the $250-300K range. I'm wondering if I should create an LLC or a PLLC (or some other business entity) so as take advantage of the Section 199A rule (Qualified Business Deductions). In such a case I would be the sole employee of the business entity, and it would only be for tax purposes, not for any form of legal protection. I'm very new to all this, but from what I've read, on the one hand, physicians don't qualify for this deduction, yet some physicians have claimed it. Also, it seems that if your total taxable income (as a single taxpayer) is over $207,500, the deduction gets phased out. While I hope I will earn more than this, I don't know for sure. Has anyone else successfully used Section 199A? It seems very complicated; is it worth doing?

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[SigmaFS]

Independent contractors qualify for Section 199A, so there's no need to form a PLLC for that specific purpose. The total income phase-out is the concern. Participate in a solo/individual 401k and an HSA to lower your taxable income.

 

[RangerBob]

I'm a sole proprietor and use the 199a deduction each year. So do all the other independent docs I know. We are 100% eligible for it--we're just one of the professions subject to the phase out. As SigmaFA points out, there are ways to avoid the phase out (lower your taxable income--participate in solo 401k, buy better/pricier health insurance, etc.).

There are few reasons for solo docs to form LLC/PLLCs over sole proprietorships. As a locums at that price range, the only reason I can think of is if the hospital requires it. There are a few agencies/hospitals that won't do business with docs unless they're a corporation. Otherwise, sole proprietorships are far simpler. S-corps can save you a bit as you can pay yourself distributions and save on some medicare/SS taxes, but they cost a lot more to administer and from my/my accountant's/trusted physician mentors' research, it isn't worth it. Also, from my accountant's reading of the tax code, they can't claim as much of the pass through deduction as a sole proprietor can, at least as a solo physician with just professional income.

The primary reason, in my mind, to form an LLC/PLLC is if you have a partner or employees, or if you have a physical office where you see patients, as it shields your personal assets from some liability claims. If someone trips in your office they can sue the practice. If someone is sexually harassed by your partner they can sue the practice. The business structure can protect you there. If you're a sole proprietor, this means all your personal assets are at risk. If you're an LLC/PLLC, then it's just the business assets, not your own. Since I'm all on my own with no office, there's no benefit for me to have that extra protection--I have liability insurance if I injure someone while driving on the job or if they trip over me. You're always personally liable for medical malpractice, so no business structure helps with that (but certain structures can shield you from a partner's medical malpractice)

 

[Phantom Spike]

Thanks to both of you, very helpful responses! One of the hospitals I am speaking with wanted to know whether to send a written contract in my name or in the name of an LLC (they didn't care either way but seemed to suggest that it would be very difficult to change it later for some reason), which is what initially sent me down this path (as I mentioned, this is all new to me, as I have been primarily employed until this point).

I did some further research since my post yesterday and my next question was indeed going to be about the potential savings on self-employment tax by forming an LLC and having it taxed as an S-corp. If I understand it correctly, it seems like the tax benefits could be substantial if one is earning in the $250-300K range and one chooses to pay oneself a "reasonable" salary of two-thirds of the profits (which seems to be the recommended strategy) with the rest being paid as dividends (at the $300K level, for example, the tax savings could be around $15K), but the whole process seems like such a hassle. Based on RangerBob's input, it also seems not worth the trade-off.

I will probably have to get an accountant if I go down this path, at least for the first year or so, but a quick question: as an independent contractor, would I need to formally create a sole proprietorship to avail of any 199A deductions? Or simply fill out Schedule C as an individual? (And SEP-IRAs are as good as solo401(K)s in reducing pre-tax income, correct?)

 

[RangerBob]

Thanks to both of you, very helpful responses! One of the hospitals I am speaking with wanted to know whether to send a written contract in my name or in the name of an LLC (they didn't care either way but seemed to suggest that it would be very difficult to change it later for some reason), which is what initially sent me down this path (as I mentioned, this is all new to me, as I have been primarily employed until this point).

I did some further research since my post yesterday and my next question was indeed going to be about the potential savings on self-employment tax by forming an LLC and having it taxed as an S-corp. If I understand it correctly, it seems like the tax benefits could be substantial if one is earning in the $250-300K range and one chooses to pay oneself a "reasonable" salary of two-thirds of the profits (which seems to be the recommended strategy) with the rest being paid as dividends (at the $300K level, for example, the tax savings could be around $15K), but the whole process seems like such a hassle. Based on RangerBob's input, it also seems not worth the trade-off.

I will probably have to get an accountant if I go down this path, at least for the first year or so, but a quick question: as an independent contractor, would I need to formally create a sole proprietorship to avail of any 199A deductions? Or simply fill out Schedule C as an individual? (And SEP-IRAs are as good as solo401(K)s in reducing pre-tax income, correct?)

Talk with your accountant regarding savings as a s-Corp. when we did the math it just wasn’t with the hassle. You can save a bunch depending on what your “salary” is defined as, but there are a number of extra costs. My state also taxes a corps. Keep in mind, it could be hard to justify a salary lower than what you’re paid since you’re being paid by the locums company to do a specific job.

I applied for a TIN with the IRS for my sole proprietorship. That’s about all I did.

I have a solo 401k. Whitecoatinvestor goes over thedifferences between the sep and solo 401k. I don’t remember all the specifics but at the compensation range you’re talking about it seemed pretty clear the 401k was the winner.

 

[dpmd]

Thanks to both of you, very helpful responses! One of the hospitals I am speaking with wanted to know whether to send a written contract in my name or in the name of an LLC (they didn't care either way but seemed to suggest that it would be very difficult to change it later for some reason), which is what initially sent me down this path (as I mentioned, this is all new to me, as I have been primarily employed until this point).

I did some further research since my post yesterday and my next question was indeed going to be about the potential savings on self-employment tax by forming an LLC and having it taxed as an S-corp. If I understand it correctly, it seems like the tax benefits could be substantial if one is earning in the $250-300K range and one chooses to pay oneself a "reasonable" salary of two-thirds of the profits (which seems to be the recommended strategy) with the rest being paid as dividends (at the $300K level, for example, the tax savings could be around $15K), but the whole process seems like such a hassle. Based on RangerBob's input, it also seems not worth the trade-off.

I will probably have to get an accountant if I go down this path, at least for the first year or so, but a quick question: as an independent contractor, would I need to formally create a sole proprietorship to avail of any 199A deductions? Or simply fill out Schedule C as an individual? (And SEP-IRAs are as good as solo401(K)s in reducing pre-tax income, correct?)

You don't need to do anything to be a sole proprietorship. Sep ira has the disadvantage of not allowing as much money to be put away unless your income is above a certain level. Also if you decide to do backdoor roth the pro rata rule will get you with a sep ira. Solo 401k does have a special from that needs to be filed yearly with stiff penalties for forgetting (once assets hit a specific number) but lets you roll over old 401k into it for backdoor roth purposes. The form is super easy to fill out, just have to used to doing it.