Case Study: How To Pay No Taxes On Your Side Job Income

This blog originally was posted on Dr. Inc. April 29,2023 by Tod Stillson MD

How To Best Manage $40,000 In Side Income

I am going to circle back a previous post How To Retain More Income From Your Side Job where I compared and analyzed the flow of dollars associated with $40,000 in side income and explored three common tax entity structures that doctors use to manage this income:

• individual W-2 income

• 1099 sole proprietor income

• 1099 professional micro-corporation income

This isn’t a theoretical idea, rather it’s based on Medscape's 2023 "Physician Side Gigs Report," physicians earn an average of $34,000 in extra income annually from various side gigs. 

This is also consistent with the conversations I have had with doctors across the country.

Inspiration From Book

Recently, I had an ophthalmologist from Florida reach out to me with this exact question about how to best manage his $40,000 in side income. After reading my new book he realized there was a much better way to organize himself as a professional micro-corporation in order to retain more of his income. His initial target was his side job income. But after some discussion, he is now in the process of converting his entire job structure to an employment lite contract tied to his professional micro-corporation. That is because he understood that the results were scalable and even more advantageous when his entire income flowed through his professional micro-corporation.

Interestingly enough, he is employed by a small group private practice and has the option to buy into the practice as a shareholder in 3 years. He feared by converting from an employment contract to an independent contractor contract (PSA aka employment lite) would prevent him from becoming a partner in the private practice later.

His reasoning was that his professional micro-corporation was essentially his individual private practice. Therefore, he believed he had to align himself either with his own micro-corporation or with the group practice, but not both. However, he was mistaken in thinking that he couldn't do both. Allow me to explain.

You Have Small Business Super-Powers

You have the superpower to choose to be an individual, or a single-member micro-corporation and can use either taxable entity interchangeably for the job/work/practice structure that you desire.

Myth-busting Truth

Doctors can use their professional micro-corporation to own shares in another professional corporation such as a group practice corporation (ie: PC, PLLC, LLC, etc..)

Here is a visual of what that looks like:

Therefore, my ophthalmologist client can purchase shares within the group practice through his professional micro-corporation. This approach is considered the most intelligent way to receive and manage his income from the group’s corporation. By doing so, he can take advantage of the individual tax and retirement plan benefits that the micro-corporation offers, rather than receiving the funds solely as an individual.

You Don’t Know What You Don’t Know

This is a prime example of a common blind spot among physicians.:

Most doctors just don’t know what they don’t know about their individual business powers.

Utilizing your micro-business powers to acquire shares in a private practice group is a prime example of this blind spot. The option remains concealed from your sight until you are able to perceive it, much like in this image.

Our tribe has a blind spot when it comes to the idea that choosing employment means there is no need or value in having a professional micro-corporation. However, the truth is that employment lite through your own micro-corporation is actually a much better arrangement than traditional employment. Unfortunately, many doctors are unaware that this option exists. Here is a visual representation of this arrangement.

One of my goals with Dr. Inc. is to inform and inspire you about the possibilities that arise from your innate small business powers.

Comparing 3 Common Entities For Side Income

Now let’s take a closer look at the 3 primary characters from my social story in my post How To Retain More Income From Your Side Job.

We have Dr. W-2

• He appreciates the convenience of having employment and takes on side work through his employer because they have offered him the opportunity for additional income. This makes him feel valued and appreciated, as his employer recognizes his capability to handle the extra workload. Moreover, having the title of "medical director" adds prestige to his CV and LinkedIn profile.

• Having his taxes managed by his employer's finance department makes it easy for him to simply check his bank account every few weeks to monitor the extra compensation deposits.

• The additional pay in his checks is nice, although the extra hospital calls and administrative tasks can leave him feeling tired. Furthermore, it can occasionally disrupt some of his family's plans. However, he justifies taking on the extra work because it enables him to financially support his family's shared passion for boating on the weekends. Therefore, his extra work and income serve a meaningful purpose.

We have Dr. Sole Proprietor

• He appreciates the predictability of his W-2 position with his hospital employer. The hours and pay are satisfactory, and his family loves their current location.

• Recently, he was approached by a local nursing home and asked to serve as their assistant medical director. He would receive an annual salary for this additional role. Considering that he already cares for nursing home patients in his primary job, this side job appeared to be low-stress and not overly time-consuming. The nursing home intended to pay him as a 1099 contractor. After speaking to his accountant, he was informed that he could receive the money either as a sole proprietor or as a professional micro-corporation, specifically as an S-corp. He really didn't want the burden of starting and running a micro-business, nor the additional tax filing requirements. Therefore, being a sole proprietor made the most sense for him.

• What he really likes are the business deductions that he will be able to capture on his personal tax form, which he previously missed out on as a W-2 employee. His accountant provided him with a list of common deductions (listed below) that he needs to track, and also explained the importance of paying quarterly taxes on his side job income.

   

We have Dr. Professional Micro-Corporation

• During his residency, he read a book that promoted the idea of starting a professional micro-corporation early in his career. Inspired by this, he decided to establish one and utilized the corporation for various moonlighting opportunities. Managing the business on QuickBooks proved to be straightforward, and he found that handling his taxes wasn't too challenging, especially with the assistance of his wife, who is an accountant.

• His first job was as a traditional employee because the financial incentives to take this route were too high to pass up. Now, three years later, with his repayment period behind him and his first three-year contract up for renewal, he is reflecting on his micro-corporation and how he can leverage it in the future.

• Over the past three years, he utilized a professional micro-corporation to earn some additional income through side jobs such as telehealth and medical surveys. However, these endeavors were not significant, and the total income amounted to less than $20,000.

• A local wound center has approached him to work as a contractor for their company, just half a day per week. He sees this as a great opportunity for an extra $40,000 income. Since the wound center is a joint venture with his current employer, they are supportive of him fitting in the extra hours into his current clinic schedule. He believes that this will integrate smoothly into his professional micro-corporation. This idea has sparked his curiosity, leading him to consider scaling up the entire operation and transitioning his primary employment to a contractor role through his micro-corporation. He intends to discuss this with his employer, but for now, he wants to assess the feasibility of utilizing his micro-corporation for a project as substantial as $40,000.

Which Entity Is Best?

This brings us to the point where practical implementation becomes crucial, especially when it comes to effectively managing income from side jobs..

Since side work is increasingly common for all of you, with nearly half of you engaging in some type of side job, let's take a look at how an average income of nearly $40,000 from side work actually affects each of our social story doctors.

This case comparison serves as a powerful reminder that activating your small business powers is far more beneficial than passively receiving them as a W-2 worker.

So, let's compare all three options for your side income dollars and pay special attention to the last two rows regarding taxes paid and retained household dollars.

From the summary slide, it is is clear that it is best to avoid receiving your side income as a W-2 worker. While you may earn an additional $30,000 for your household while making $40,000, it is important to consider that working harder within the corporation's flywheel may lead to increased tax drag. As a result, you may end up with less money in your bank account than you initially expect.

This is due to the progressive nature of the current tax brackets, where higher earnings result in higher tax payments. Please refer to the reminder below for a clearer understanding of how the federal tax system operates in a tiered manner. As a high-income earner, the more you earn, the more taxes you will be required to pay.

The Professional Micro-Corporation is the Best

As depicted in the table comparing taxable entities, using a professional micro-corporation is the clear winner for generating a side income. By opting for this approach, you can enjoy several benefits. Firstly, you won't have to pay taxes on your earnings. Additionally, you'll be able to save $25K in your 401(k) and have $13,500 in household funds at your disposal. Moreover, you can also claim $2000 in deductible business expenses to cover the operational costs of your micro-corporation, such as corporate reports, books, and tax filings.It is likely that you will be able to operate your business for less than $2000. Whatever you don't spend on business expenses will further contribute to your net retained household income and increase it beyond $38,500. It's worth noting that many deductible business expenses can actually save you money that you previously paid out of pocket. Examples of this include household vehicle mileage and cell phone expenses. It's also noteworthy that corporations have more options for deductible business expenses compared to sole proprietors, including the tax-free home rental program. Here is a list of some S-corp business deductions:

Sole Proprietor A Respectable 2nd Place

It is worth noting that a similar logic applies to the sole proprietor model when it comes to deductible business expenses and how they affect available household income. The key lies in the business's access to a solo 401(k) retirement plan and its tax-friendly expenditures. As you can see, the sole proprietor fares better compared to the W-2 earner, but still falls short of the professional micro-corporation. In this case, the sole proprietor will pay $2000 more in taxes than the professional micro-corporation.

MVP for Professional Micro-Corporation

Considering that a basic professional micro-corporation can be set up for $2000-$5000, a common question arises: "What is the minimum value proposition (MVP) required for a doctor to start his or her professional micro-corporation?"

The MVP business term essentially answers the question:

“At what level of income does the return on investment for the cost of a micro-corporation result in you saving money?”

As demonstrated in our case study, the professional micro-corporation emerges as the winner with an income of $40,000. This is due to the fact that, even after considering the cost of starting a professional micro-corporation (which is a deductible business expense), you still come out ahead compared to being a sole proprietor..

How Low Can You Go?

Although everyone's tax situation is unique, the tipping point for considering a professional micro-corporation versus filing as a sole proprietor or having W-2 income is typically between $10, 000 and $20, 000 in side income.

General Recommendations

• The sole proprietor, earning under $20, 000 in side income, outperforms both the W-2 and the professional micro-corporation.

• For a side income of $20,000-$30,000, both sole proprietorship and professional micro-corporation options are viable. Your individual tax situation should guide your choice. I recommend consulting with a tax professional for personalized advice in this matter.

• With the SimpliMD physician business structure, for individuals who are generating over $30,000 in side income—The micro-corporation proves to be more advantageous than a sole proprietorship, with the margin of benefit increasing as the side income increases.

I would like to add that it is possible to form a professional micro-corporation online for a much lower cost than $2,000-$5,000 through services like Legal Zoom. However, I highly recommend working with an attorney who is familiar with the needs of doctors, as this will become a foundational asset in your professional life. I recommend you take the time and money to build it the right way—personalized to maximally benefit your household. No two professional micro-corporations are exactly the same!

Many doctors choose to start their corporation with a basic model and then add features and fringe benefit plans later on. I recommend you work with someone like SimpliMD’s network who specialize in assisting doctors with this process.

Scalability

The tax savings and retained income associated with scaling up a professional micro-corporation can have a significant impact on reducing your annual taxes, especially if you allocate it fully to your professional work. This often involves working as an independent contractor, a practice that is becoming increasingly common among doctors. Personally, I follow this approach through my primary job with an employment lite contract, and my side jobs also flow through my professional corporation.

The scalability element becomes more apparent when you combine a W-2 job with 1099 side income flowing through your professional micro-corporation. This structure offers various benefits, such as tax savings, retained income, customized fringe benefit programs, business deductions, and professional autonomy. The more professional income you channel into your micro-corporation, the more you can save.

If you are a W-2 earner and were frustrated by the large tax bill you received when filing your taxes this year, it may be worth considering a professional micro-corporation as a way to reduce your tax burden.

Summary

If you earn over $20,000 in side income, it becomes evident that starting a professional micro-corporation will enable you to retain more of your earnings and pay significantly fewer taxes.

Once you start the micro-corporation, you will have the opportunity to learn how to effectively utilize it for generating side income. This can then be scaled up to eventually include your primary job or additional side jobs. This is called job stacking and it’s increasingly common—check out my free e-book on Job Stacking that explains it all.

FREE Business Coaching Session

I am so passionate about the value of doctors activating their small business powers that I want to meet with you one on one to talk about it. Please all me to provide you with a business consultation reviewing whether a micro-corporation can help you.

Why give away your extra income to the government when you don't have to?

I am reminded of what Federal Judge Learned Hand said about taxes:

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.”

In other words, Judge Hand emphasizes that it is acceptable to organize your professional affairs in a way that enables you to pay the lowest amount possible to the US Treasury.

The most effective approach to organizing your business affairs is to leverage your professional micro-business powers, which come with additional tax strategies that can greatly benefit you.

So, take the next step of reducing your tax burden by signing up for a business consultation where I’ll listen to your situation and provide you with some recommendations on how to best manage your side income. You can sign up for that here.

tod