How Employed Physicians Can Improve Their Finances

As physicians increasingly become employees of hospitals and other institutions, they lose many of the tax advantages and other benefits of running their own practice. To counteract these financial losses, these physicians may wish to consider some independent consulting or other work that is not specifically related to their source of W2 income.  The options include some separate moonlighting, medical directorship work, and medical consulting.

Perhaps the best benefit of a separate side business is the ability to fund a second retirement plan.  If the physician is the sole worker in the new business, he can set up a SEP IRA, a self-employed 401K, and even a defined benefit plan.  I have seen several instances in which all the net income from the second business is sheltered by one or more of these plans. 

Both the SEP IRA and the 401K allow about 20 percent of net income from the employer (the employer and employee are of course the same person, and the business can be structured as a sole proprietorship) to be deferred without income taxes. 

If there is no salary deferral at the W2 primary job, then salary deferral is also permitted in the 401K.  If the physician is at least 40 years old, adding a defined benefit plan may be very cost effective, and it may allow another $50,000 to $200,000 annually in potential contributions (more with age). 

If the physician employs her spouse, paying a relatively low salary may allow substantial contributions to both a 401K plan and a defined benefit plan for the spouse.  I have seen examples where the tax deferral well exceeds the spouse's salary with combined plan designs.

Other benefits of a side business include the ability to deduct many business expenses that are not allowed through the W2 employment.  These include automobile expenses, cell phone and Internet costs, and some meals and entertainment.  Note that lowering net income by taking these deductions may reduce the allowable retirement plan contributions, so some coordination with your financial planner and accountant makes sense here.

If the side business cash flow allows, the physician can also pay older children for tasks related to the business.  This income can be mostly sheltered by the standard deduction and/or funding of a traditional IRA.  Alternatively, a Roth IRA can be used for savings, as contributions can always be pulled back out (not earnings) tax and penalty free as needed.

As briefly noted above, the side business can be structured as a sole proprietorship (no forms) and reported on a Schedule C on the personal tax return, or can be isolated more with an LLC or even a corporation.  The best structure is something to discuss as well with your trusted advisers.