1099 Side Job Income: Incorporation vs Sole Proprietor? Part 2

This was originally published on Dr. Incorporated May 13, 2023

Due to it’s length it has been broken down into 2 parts

In part 1 I discussed the rise in 1099 work for doctors, how location independent professional work is fueling this, and reviewed the W-9 tax form that a 1099 employer is going to expect you complete. You can read the blog here.

This week, we will address the question of what your best answers should be for the W-9 Tax form if you are earning 1099 income. More importantly, we will discuss which answers can help you maximize the retention of your side income for your household.

If you want to boil this down to a financial equation, you should read my blog Case Study: How To Pay No Taxes On Your Side Job Income, which points you towards incorporation.

Part 2

What Business & Tax Entity Structure Is Best For Your 1099 Income?

I am going to address the question of the best combined business and tax entity structure for you if you are working as independent contractors-such as earning 1099 side job income. Should you operate as a sole proprietor or consider another professional micro-corporation option? You will need to know this information when completing your W-9 form for your side job employer. Here is what that form will look like:

My goal is to inform you about the best option for managing your 1099 income and then inspire you to take action. I want you to choose to proactively manage your professional life and determine what is best for you.

A plan to optimize your 1099 earnings is much better than simply checking the default individual/sole proprietor box without being informed.

If you have an accountant, I encourage you to discuss things with them. However, understanding the "why" behind their answer is crucial. Ultimately, the decision is yours to make, and their role is to counsel or guide you. Only you know your present and future personal and professional goals, so expecting your accountant to read your mind or predict the future may not always lead to the best answer for you.

My Recommendation

Let me begin by stating that a professional micro-corporation taxed as an S-Corp will likely be the best option for you to channel your 1099 work through. This means you would check the “S-corp” box on the W-9 form. There are several physician-specific reasons for this recommendation, including asset protection, tax strategies, and building larger retirement funds.

If you don't have time to keep reading, you now have the answer to the question of which business structure is best for you as an independent contracting physician who is earning 1099 income.

I encourage you to take the next step by establishing your professional micro-corporation for your independent contracting work. You can sign up for a low cost 45-minute business coaching session with me at SimpliMD to delve deeper into this opportunity and to connect you to our professional network who can help you move forward. Alternatively, you can can sign up for the wait-list for my upcoming course this spring “Doctor, You Are A Business”. I genuinely enjoy helping doctors in our SimpliMD community set up and operate professional micro-corporations efficiently and effectively—because it helps them thrive!

I invite you to continue reading to find out why this is your best option. There are multiple business structure options available, and depending on your individual situation, other options may sometimes be a better fit.

Your Bifurcated Business Decision: TIN

Let's start by breaking things down and examining the most common decision tree for organizing your independent contracting work. This can be found in Part 1 of the Form W-9 and is titled Taxpayer Identification Number (TIN).

Counterintuitively, this section is not at the top of the W-9 form; it's at the bottom. This numerical code is used by the IRS to track who will be responsible for paying income taxes, whether it's an individual (you) or a business (you-incorporated). The choice is yours.

You Are A Business

When you are working as an independent contractor earning 1099 income, you are essentially declaring yourself as a self-employed individual running your own business.

I hope you understood that when you signed that side job contract: It is a business-to-business contract, and the company providing you with 1099 employment views you as a business.

If they see you as a business, it's time for you to start acting like a businessperson and proactively organize your earnings to benefit your household to the fullest.

As a business person, you have a choice between two general tax categories for your bifurcated business and taxpayer identification number (TIN): your social security number or your employer identification number (EIN). Each one has its own set of tax rules associated with it. Which set of tax rules is better for you simply depends...

Here is the general overview of these two options:

1. You work as a business organized under your social security number, which means you will have the choice of designating yourself as a sole proprietor or as a special type of corporation called a single-member LLC.

   -This means you will have one unified checking account where all your income will be deposited. These funds will be allocated for paying your quarterly taxes, business expenses, and personal living expenses. You will set your own salary, which will be used to calculate your quarterly taxes. It is important to track each expense as either personal or business-related. You will only need to complete a single 1040 tax return that includes your business expenses in schedule C.

2. Work as a business organized under an Employer Identification Number (EIN), which means you are in essence a corporation, although sole proprietors single member LLC’s can have a separate EIN. My pro tip for you is that regardless of which business entity you choose, getting an EIN will be necessary if you employ a family member within the business, or plan to open a solo 401(k) for the business. Choosing the best corporate structure for you is a highly individualized process that considers your professional and personal financial situation and how it aligns with the most tax-advantaged corporate structure and tax codes.

   -Functionally, incorporation means you have separate checking/financial accounts - one for your personal finances and one for the business. It's crucial to keep the money separate. Your income will flow into the corporation, and you can receive a self-determined salary as a W-2 paycheck from your corporation (also known as self-employment). Business and personal expenses are kept separate, and you will need to manage two tax returns - one for yourself and one for the corporation.

Now, let's take a moment to delve deeper and explore this divided choice.

Business Options Tied To Your Social Security #

Sole Proprietors and Single Member LLCs have sections of the tax code dedicated to each of them. Although the income appears on your individual 1040 tax form, the tax code allows you to account for your business expenses through each of these entities using Schedule C. It is all integrated into one tax filing under your individual social security number, with no extra corporate tax return to complete. Many consider this choice "easier" or simpler. There are certainly many advantages to each option in this space—so let's briefly look at each.

What is a Sole Proprietorship?

This represents the default mode as an independent contractor for most of you. You are commonly advised by your tax professional who simply hits the impersonal default button. It’s the lowest expense and the least complex option for you.

A sole proprietorship is the simplest form of business entity, as it is an unincorporated business owned and operated by a single individual. Legally, there is no distinction between the business and the owner, making the owner personally liable for all of the business's debts and obligations.

One advantage of a sole proprietorship is its simplicity. There is no need to file any paperwork to create one. The business owner can simply start operating under their own name or a fictitious name (also known as a "doing business as" or DBA name), making it easy and inexpensive to start this type of business.

Many doctors assume that since their 1099 side income is relatively small (the national average being $37,000) compared to their primary job, it is most efficient to use a sole proprietor structure to pass their earnings through to themselves individually. This is a bad assumption for a number of reasons but especially because a sole proprietorship lacks liability & asset protection. The owner is personally liable for all of the business's debts and obligations. This means that if the business is sued or incurs a large debt, the owner's personal assets may be at risk. This can be particularly concerning for high-net-worth individuals such as doctors.

From a tax perspective, sole proprietors also fall short of incorporating because of the earnings it can help you retain. I explain this in my blog Case Study: How To Pay No Taxes On Your Side Job Income, which points you towards incorporation being the clear financial winner.

What is a Single Member LLC?

It’s worth noting that Form W-9 also lists single-member LLC in the same box as sole proprietorship. Therefore, the taxes from both business entities similarly flow through your personal social security number.

A single member LLC is a special version of an LLC corporate structure that the IRS considers a "disregarded corporate entity." In general, this means it does not need a separate EIN like other corporations, its business expenses can be deducted, it does not have to file corporate taxes, and its funds can be commingled with the individual owner's checking account.

This might be a bit confusing because on the W-9 form, because it's a corporation, albeit a special one, so let me provide further explanation about this business entity option.

A single-member LLC is a type of limited liability company (LLC) with only one owner. Firstly, let's address the advantages of a single-member LLC. This structure offers limited liability protection, separating personal assets from business liabilities. Additionally, it requires minimal formalities, such as annual meetings and extensive record-keeping, making it an attractive option for solo practitioners seeking simplicity in their business operations. Moreover, an LLC provides flexibility in taxation, allowing the owner to choose between pass-through taxation similar to a sole proprietorship or corporate taxation like a S or C corporation.

A Single Member LLC is Good, But A PC is Better For Doctors

However, despite these benefits, a single-member LLC may not be the optimal choice for a self-employed physician doing contractor work compared to a PC structure.

One significant drawback is the lack of specific professional protections offered by a PC. A Professional Corporation is designed explicitly for licensed professionals, such as physicians, and often provides additional safeguards against malpractice claims and professional liability. In some states, certain professions, including medicine, may be required to operate under a PC structure to maintain compliance with regulatory standards.

Moreover, a PC structure may offer more favorable tax treatment for self-employed physicians, particularly in terms of retirement planning and fringe benefits. PC owners may have access to tax-deductible retirement plans, such as a 401(k) or defined benefit pension plan, which can help maximize tax-deferred savings and reduce taxable income. Additionally, PCs may be eligible for certain fringe benefits, such as health insurance and reimbursement for business expenses, which can provide valuable tax advantages and improve overall financial security.

General Comparison Between Sole Proprietor vs Professional Micro-Corporation

Now let’s circle back around to evaluating whether choosing to be a sole proprietor is best for you. There are numerous reasons why small business owners across the country choose to operate their micro-businesses as sole proprietors—it is a wise choice for many. However, your high income, riskier business activities (such as malpractice claims), and high net worth set you apart from the typical sole proprietor. Take a look at this comparison chart:

I believe the greatest distinction between these two business structure options is asset protection. Your individual high net worth should be protected—and malpractice insurance alone is not adequate. Check out the White Coat Investor’s blog post on asset protection to take a deeper dive.

Asset Protection Priority for Doctors

A single-member professional micro-corporation, such as a single-member LLC or a PC, offers liability protection for the owner. This means that the owner's personal assets are shielded from any legal claims against the business. It is an appealing option for those who wish to protect their personal assets while benefiting from a corporate structure. It is important to note that for physicians, this does not eliminate the need for personal malpractice insurance.

On the other hand, being a sole proprietor means that the business is not a separate legal entity from the owner. The owner is personally liable for any legal claims against the business, putting their personal assets at risk if the business is sued. However, a sole proprietorship is relatively easy to set up and maintain. There are no separate tax returns to file, and the owner retains complete control over the business.

I recently spoke to a cardiologist about his transition from 25 years of employment to working as an independent contractor doing locums. During our conversation about the advantages and disadvantages of being a sole proprietor versus setting up a professional micro-corporation, we discussed asset protection. Two key points stood out to me in our conversation, which I believe reflect common mindsets among many of you:

When I asked him about his net worth, he replied, "I don't know. I'll have to ask my accountant."

When discussing the risk of physicians being exposed to personal asset liability, especially as sole proprietors, he said, "That's what my medical malpractice insurance would cover."

Many of you hold two common mindsets about your assets. You may only have a vague idea of their total net value and whether they are adequately protected. It is common to believe that malpractice insurance and a high income will secure your future retirement. Recent Medscape surveys show that 25% of physicians in their 60s have a net worth of less than a million dollars. Among family doctors, only 25% have a net worth of $2 million or more. To maintain your physician lifestyle in retirement, you may need $3-5 million.

One issue for this cardiologist is his naive understanding of the exposure he faces as a medical provider with a 25-year career's worth of assets. Being seen as the proverbial "rich doctor" makes him a target for others looking to take advantage of his wealth.—which includes “above the policy malpractice judgments.” After 25 years as an employee, his lack of business knowledge has left him unaware that, as an independent contractor, he is essentially operating as an individual business. His status as a doctor also puts his assets at risk through his business dealings.

Asset protection alone is a compelling reason for every physician engaged in 1099 side work as an independent contractor to establish a professional micro-corporation as their business structure, rather than a sole proprietorship.

Choosing Incorporation

When navigating the complexities of 1099 side income as a physician, putting it all together, you'll find that establishing a Professional Corporation (PC) taxed as an S-corp offers distinct benefits such as liability and asset protection, tax flexibility, and robust retirement options.

While the advantages of a PC are compelling, remember that every physician’s situation is unique. Seek guidance from a qualified attorney or tax professional who can tailor advice to your specific circumstances and local regulations. Your journey toward financial well-being and professional success begins with informed decision-making.

Remember, the right structure empowers you to thrive in your medical practice while safeguarding your hard-earned assets. Consulting with knowledgeable people like myself will allow you to weigh your options, and chart a course that aligns with your goals.

The lack of business education in your professional journey puts you in a vulnerable position of not knowing much about this subject. When that happens, you may default to "safe mode" and opt for the cheapest, simplest option, which often leads to choosing to be a sole proprietor. This gap in business education is why I created SimpliMD for you and developed self-guided learning options in our community. I invite you to take the next step in your small business competency journey by becoming a member and unlocking over $2500 in special products only available to our members.