Case Study Profile

Business Type:

"Hospital-based Physician" as an "Independent Contractor"

Business Entity:  

Professional Corporation (P.C., Subchapter "C" Corporation)

Owner's Income: 

$351,000 earned income reportable on W-2 net of plan contribution deduction

Owner's Age:

45

Marital Status:  

Married; spouse age 43

Employees:   

None

Plan Objective:  

Maximize tax deductible contribution to provide maximum retirement benefit

Comments:

Prior to 2002, the physician's spouse was not compensated due to the 15.3% cost associated with Social Security and Medicare taxes (FICA), and a previously repealed pension law that limited plan contributions if a spouse was included in the plan. 

The physician typically receives a bonus at year-end ("zeroing out the P.C.") to yield no corporate profit or tax.  However, starting in 2002 the physician's spouse receives $40,000 ($49,000 in 2009) earned income reportable on W-2  as the practice office manager and bookkeeper.

The spouse income and the additional pension expense mitigate the need for a taxable bonus and dramatically increases the retirement benefit for the physician's family.  Learn more about adding a spouse to your plan

Outside tax counsel affirmed the physician's status as an independent contractor of the hospital.

$36,750 more with the Mini(k) in 2009!

Learn more about increased savings provided by Roth 401(k).

Plan Design Analysis

Prior to the effective date of the EGTRRA pension law in 2002, the employer Profit Sharing Plan contribution deduction limit was 15% of eligible compensation, the individual plan contribution allocation limit was the lesser of 25% of compensation or $35,000 and the compensation limit considered in determining the employer maximum deduction and the individual contribution allocation was $170,000.  Further, spouses working for  family owned businesses were oftentimes not compensated due to the 15.3% cost associated with the Social Security and Medicare taxes (FICA), and a previously repealed pension law that limited plan contributions if a spouse was included in the plan, however...

Starting in 2002, the revised pension law provides the following:

  • An employer has the discretion to contribute and deduct from 0-25% of eligible employee compensation to a Profit Sharing Plan.

  • The individual compensation limit increases to $200,000 ($245,000 in 2009).

  • The individual contribution allocation limit increases to the lesser of 100% of compensation or $40,000 ($49,000 in 2009).

  • The 100% of compensation or $10,500 (16,500 in 2009) individual 401(k) contribution limit is not considered in determining the employer 25% deduction limit.

  • The $5,000 ($5,500 in 2009) 401(k) "Catch-up" contribution limit is not considered in determining the employer 25% deduction limit.

Also Consider the following factors before adding your spouse to your plan:

  • Justification and extent of compensation for services rendered

  • Business income available for payment of services rendered

  • The extent of the plan contribution based on payment for services rendered

  • The cost attributable to FICA taxes (Social Security and Medicare) by both the business and the spouse (and the relatively small cost for FUTA or SUTA taxes) - see analysis below

Learn more about the factors to consider before adding your spouse

FICA Tax Analysis

Owner's W-2 income:

$253,000

  

Spouse W-2 Compensation:

49,000

  

FICA paid by employee (7.65%):

3,749

  

FICA paid by employer (4.97% in 35% bracket):

2,437

  

Total FICA tax: 

6,185

  

Medicare Tax Savings by adding spouse:

1,172

  

Net additional FICA Tax Cost:                    

5,013

*

Plan contribution (100% of compensation):

49,000

  

Tax Savings (35% tax rate):

$17,500

  

*The business owner would pay Medicare tax on the $49,000 if he received it as earned income reportable on Form W-2.

What's the catch?  Just one, in reality the Mini(k)Plan is a Profit Sharing Plan with a 401(k) feature.  This means that the Mini(k) is a qualified retirement plan subject to numerous government compliance requirements.  If you don't comply with these requirements, you can lose the benefits gained by choosing this plan type over a SEP or a SIMPLE.  Here's a chart that illustrates just some of the compliance requirements and features for these different plan types.

Compliance Requirements and Plan Features

 SEP SIMPLE Mini(k)Plan

Formal Plan Document

 No

No

Yes

Trust Reconciliation

 No

No, for SIMPLE IRA

Yes, for SIMPLE 401(k)

Yes

Annual Filing

 No

No, for SIMPLE IRA

Yes, for SIMPLE 401(k)

Yes*

Rollovers from other Plans and IRAs 

 Yes

Another SIMPLE only

Yes

Loans Permitted

 No

No

Yes

Advantage to add Spouse

 No

Yes

Yes

Updates Required by Law

 No

No

Yes

Establish New Plan By

Due date of

return or any extension

October 1 unless

new employer

December 31

Must fund Employee Contribution by

Not

 Applicable

Corporation: Earliest date employer can transmit contributions.

Sole Prop/Partner: by due date or extension.

Corporation: Earliest date employer can transmit contributions.

Sole Prop/Partner: by due date or extension.

Must fund Employer Contribution by

Due date of

return or any extension

Corporation: by due date of return or extension.

Sole Prop/Partner: by due date or extension.

Corporation: by due date of return or extension.

Sole Prop/Partner: by due date or extension

*Recommended but not required until assets exceed $250,000

This chart illustrates basic requirements only.  All plans shown may be selected for audit by the government; all require timely and accurate completion of forms and other related documents when established and ongoing.  Chart is intended as a resource only; consult a professional before implementing any plan.

View comprehensive chart for these plan types: "Compliance Requirements and Limits"

View comprehensive chart for these plan types: "Available Benefits and Features"

Closing Comments

A SEP or SIMPLE plan is traditionally the appropriate plan type for an independent contractor (self-employed individual).  These plan types do not require formal plan documents or governmental reporting and disclosure and the additional cost for professional services typically associated with these requirements. The Mini(k) is a qualified retirement plan (Profit Sharing Plan with a 401(k) feature) requiring a formal plan document and governmental reporting and disclosure.  However, as a qualified retirement plan, the Mini(k) also permits a contribution for your spouse of 100% of compensation up to $49,000 in 2009.  This means the business owner and his spouse can contribute a total of $98,000 to the Mini(k) in 2009!

Bottom Line:  The associated cost to establish and maintain the Mini(k) is justified based on the additional taxes you save and the dramatic increase in benefits at retirement.

Back to previous page

We intend the information provided as a general resource, not as formal investment or retirement planning advice or counsel. If you consider any actions discussed in this analysis, we suggest that you consult a qualified planning professional. ERISA Expertise LLC does not warrant and is not responsible for any errors and omissions from this information. Any tax advice included in this written or electronic communication is not intended or written to be used, and it cannot be used, by the taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.