Case Studies On How Incorporation Can Cut Your Taxes In Half

This post originally ran on Dr. Inc. June 4, 2023

The Pain of Taxes For High-Income Earners

Your average tax bill for your household is nearly $100,000 annually which places you in the top 10% of all taxpayers according to research with the tax foundation, and as documented in a recent Medscape survey on doctors and taxes.

You were likely reminded of this large tax bill when you filed your taxes last year—and you know it’s coming soon this year. It’s even worse if you are a W-2 earner due to the shrinking number of options to reduce your tax burden. For modern W-2 employees who receive direct deposits and rarely see their paycheck, taxes can often feel indolent and mostly invisible. However, when it's all added up at tax time, the total can be strikingly large.

As if that wasn’t enough President Biden has vowed to target you to pay more taxes when he explicitly stated he was coming after those who earn over $400,000 a year.

How Can You Pay Fewer Taxes?

It brings up the invertible question that most doctors ponder at least once a year: “How can I pay fewer taxes and keep more of my money”.

With up to 70% of you now working as employees, the real question is how a you can reduce his or her taxes while working as a W-2 employee. The options for high-income earners, such as you, are becoming limited when it comes to tax deductions. However, there are still some available options, including:

1. Maximize retirement contributions: Contributing to retirement accounts like 401(k)s and IRAs can help reduce taxable income.

2. Take advantage of medical expense deductions: Many medical expenses not covered by insurance may be deductible on your federal return. Any medical expenses that exceed 7.5% of your adjusted gross income may be deductible from your taxes.

3. Make charitable contributions: Donating to qualified charities is an easy way to lower your taxable income without having to itemize deductions. My wife and I like to use a donor-advised fund from fidelity for sharing our resources with those in need. According to Medscape's 2023 "Physicians and Taxes" report, charitable donations is the number 1 method that doctors use to reduce their tax burden.

4. Claim dependents: Claiming dependents on your taxes can help reduce your tax burden significantly.

5. Take advantage of state-level tax credits and deductions: Different states offer different types of tax breaks for physicians, so make sure you research what’s available in your state

6. Take advantage of mortgage and student loan deductions. For example, if you have student loans, you may be able to deduct up to $2,500 in interest payments each year from your taxable income.

What Else? Start A Business by Incorporating Yourself

There are a lot of creative and convoluted actions that high-income earners will take in order to reduce their tax burden. Some of the maneuvers are questionable and others are just frankly illegal.

The one that I find the most compelling is to start a business.

For you, the easiest way to start a business is to incorporate yourself as a professional micro-corporation. Your medical license provides you the special power to do this—as you are among a small group of service professionals who a granted the option. A micro-corporation will allow you to take advantage of additional tax benefits available to businesses—that are unavailable to individual taxpayers— such as lower self-employment tax rates, corporate fringe benefit plans, and various business expenses.

In response to this, a lot of you will reflexively shoot down this idea because: “I chose to be an employee so that I didn’t have to run a business”, or “I don’t want to go into private practice, it’s too complicated and risky”.

Both are legitimate mindsets, but neither applies to the formation of “Dr. You, Inc.”—which is a professional micro-corporation that is virtual and has only one employee— you.

A single-member professional corporation taxed as an S-Corp is my favorite foundational business structure that will work for most doctors. However, you can choose from a host of other business structures that provide tax advantages to your professional income—structures that range from sole proprietor, single-member LLCs, Professional Corporations (PC), and Professional LLCs (PLLC).

Which is best for you should be based on a careful analysis of your personal and professional life with a professional who can coach and support you.

I would love to provide you with a business analysis determining which professional business structure would work best for your situation. Schedule an appointment here for us to discuss things.

A Case Study

I recently had a physician meet with me through SimpliMD as he had read my new book “Doctor Incorporated: Stop The Insanity of Traditional Employment and Preserve Your Professional Autonomy”. Through the book, he was inspired to view his professional life outside of the framework of traditional employment. He was also stinging from filing his prior year taxes when he realized that he and his wife had paid $129,000!

His current employment contract was up for renewal, and he had two offers on the table to consider. Both would lead to greater compensation than the previous year. But one hospital, which was his current employer, would only offer him a traditional employee contract (W-2 worker). The other hospital was willing to offer him the same compensation but do it via an employment lite contract through his yet-to-be-formed, professional corporation.

As Is/As If

So I worked with him to do a feasibility study that would evaluate what we call an “As Is and As If” analysis. In this study, we involve an attorney, a physician coach-agent, and an accountant to run a doctor’s personal and professional data through proprietary tax software. The analysis involves real data based on the physician’s actual prior year’s tax return (As Is) and then projects the various tax entities that a doctor can use to receive their income—from individual to corporate options (As If).

It provides firm data that is not a sales job, but actually “proves” which option is better financially in a side-by-side spreadsheet. I love doing this because the numbers don’t lie.

For this doctor, we analyzed his prior tax year and then compared that to what his new job offer-compensation data would look like as a professional micro-corporation taxed as an S-Corp, C-Corp, and staying as a W-2 employee.

From a Tax perspective here is what it looked like:

Half The Taxes

As you can see, converting to a micro-professional corporation would cut taxes his in half!

Yes, I said “HALF”. Wow-that is an eye-popping $80,000 in tax savings!

This is all because of the additional tax channels that are made available to small business owners.

In this doctor’s case, the tax savings were translated into an additional $ that enhanced his annual net worth—including:

• additional household income of over $25,000 compared to being a W-2 worker

• TRIPLE the tax-advantaged retirement funding—with the potential for it to be even more through a Cash Balance plan.

In summary, by using an employment lite agreement through his micro Professional Corporation he will be working for the hospital alongside all the other traditional W-2 physician employees, looking just like them, providing the same services, and getting compensated in the same way—yet still maintaining no management responsibilities.

However, invisible to everyone except his employer, he will work as a contractor through his own professional micro-corporation. This arrangement will enable him to reduce his taxes by half and triple his retirement savings.

Why wouldn’t every doctor want this?

Simultaneously, he gains professional autonomy and the ability to layer in side jobs and passive income sources that all additively benefit his household and accelerate the growth of his net worth.

This all catapults him into thinking like a businessman and he now plans to use those extra dollars to fund his next small business venture which includes owning his own airplane and doing aviation medicine on the side.

His professional micro-corporation has now become the foundation for his growing entrepreneurial business enterprise.

Who Can Do This?

By now I hope you are asking yourself is there something special about this doctor that makes this all possible?

The answer is no.

Every doctor in America can do the same thing—and it begins with taking the first step—of incorporating yourself.

I believe every doctor in America should form a micro-corporation as the basis for any and every professional activity that they perform.

The move offers tax advantages, business deductions, and professional autonomy, which help preserve the hard-earned status of professionals like you. It allows you to operate as both an individual tax entity and a single-owner corporate tax entity.

I Did It

How do I know all this? Because several years ago, discovered this hidden option after working as a traditional W-2 employee for 15 years. Here is what my personal case study looked like when I was evaluating whether it would be wise to start a micro-corporation and convert to an employment lite contract:

Like any good scientist, I needed to see the "proof" in the numbers before making the decision. It is worth noting that my analysis was less focused on tax savings and more focused on the financial benefits for the household. Both aspects are important and closely interconnected, as your tax savings contribute to your overall net household benefits. The end result is retained earnings.

Put another way, you get to keep more without having to work more.

As you can see in my case, I started a micro-corporation and converted it to an employment lite agreement. This resulted in a net household financial benefit of $70, 000 (post-tax), or $700, 000 over 10 years.

In essence, choosing to be a W-2 employee was costing me $700,000 every ten years—close to a million dollars!

Translated another way, by keeping that million dollars for 10-15 years, I could achieve Coast FIRE or FIRE much sooner compared to being a W-2 employee..

I call that working smarter, not harder.

And over the past nearly 10 years, this has indeed proved out—and thus I will retire from my primary clinical practice 6months from now— in my late 50s.

Had I known what I know now, I would have reached the stage of financial independence/freedom a decade earlier.

Start Your Own Business!

As these case studies demonstrate, micro-corporation owners who perform1099 work have significantly more options to reduce their tax burden than traditionally employed W-2 doctors.

So, become a small business owner and incorporate yourself!

You can take the next step by scheduling a low cost meeting with me to help you get started with an initial assessment and then connecting you to our preferred professional network.

Tod