WCI #20: Comparing Independent Contractor Jobs with Employee Jobs

This is the White Coat Investor podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli. Welcome to podcast number 20 where we're going to talk about independent contractors versus employees.

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Well, welcome to the podcast. We're glad to have you back here. We actually only record these about once a month, so a podcast may have been recorded immediately after the prior one or it may have been a month since we actually made these and this time it's been about a month. So we're glad to be back and glad to do this. It's been a really exciting month for us. We've got lots of exciting stuff coming up not only today in the podcast, but in every other aspect of the White Coat investor empire. In fact, this morning our registration for the White Coat Investor conference, or as it is more formally titled, the Physician Wellness and Financial Literacy Conference in Park City, Utah just went live. So we're excited to see that. I went to bed and it was just being put on the Internet where people could sign up and by the time I woke up there were 80 people signed up. So it looks like not only are we going to break even, which we were honestly a little bit worried about, but also we'll likely to fill this. So if it isn't full by the time you hear this podcast, I'd get online and get signed up and registered as soon as you can. It's going to be really awesome. We've got some great guests coming, including Jonathan Clements and Bill Bernstein and Mike Piper. So be sure to get signed up. You don't want to miss this one. Our quote of the day today is from Charlie Ellis. He he says, don't get confused about stockbrokers and mutual fund salespeople. They're usually Very nice people, but their job is not to make money for you. Their job is to make money from you. All right. I appreciate you listening to the podcast and I appreciate what you do in your regular lives. Last night I was working a late shift in the ER and had a father run in. And those who've worked there have seen this before and you're not exactly sure what's going on with the kid because the parent's carrying them and running at full speed and you're just hoping they don't trip on their way to the treatment room. Turned out the child had a partial amputation of his finger. It was really no big deal. The bone wasn't even involved and after sedating him a little bit, ended up suturing all the soft tissue back on top of the finger and actually looked really good in the end. But it's amazing how big little things that we do every day, how big of a difference that makes in the lives of those that we serve. So thanks for what you do. People don't thank you enough for it and it really does make a big difference. I also want to thank you for sending your questions in. In fact, today is the first time that we're going to do the entire podcast based on nothing but questions sent in for the podcast. In fact, our main question was specifically asked, can you address this on the podcast? And so we're going to do that today. This question comes from Antonio says, I was wondering, can you give me. Can you give us a podcast? Talk about employees such as myself who are strictly 1099. Could you go through some of the differences that we have compared to our W2 counterparts? Could you expound on any different tax breaks we could have or should be taken advantage of? Also, I've never gotten a straight answer about this, but since I am a self employed sole proprietor, should I incorporate or not? Well, I think it's important first that we get the terminology straight. In reality, we learned the terminology the language of medicine. We spent four years learning it in medical school. We didn't really learn how to practice medicine in medical school, but we learned how to speak the language. And finance has its own language. And it's important because each term has a precise meaning that you understand what the meanings of the terms are. For example, if you are paid on a 1099 form, you are not an employee, you are an independent contractor. By definition, you are self employed. Employees are paid on a W2 form, just like partners are paid on a K1 form. So it's important to keep that Straight. And also to realize that, you know, there are differences between being a sole proprietor and having an LLC and being incorporated. And it's important to understand what those are. And we'll be going through that today as well. But first let's go through how the IRS determines whether someone is an independent contractor or an employee. And it turns out that this is really squishy. It's not really. There's no hard and fast definition given anywhere. In fact, the IRS specifically says that many physicians are considered independent contractors. And so that's nice to see that they acknowledge that docs and other high income professionals often are independent contractors. So it shouldn't seem particularly strange to them when you are. But the facts that they look at to determine whether you are an independent contractor or not really is determined by some common sense rules. For example, does the company control only the output of your work or do they control when you work and how you do the work? If they only control the output, you're much more likely to be classified as an independent contractor. If they control exactly when you show up and exactly how you do the work, then you're more likely an employee. They also look at financial aspects. For example, are the business aspects of the workers job controlled by the payer? For example, how you get paid, whether they reimburse your expenses, who pays for your supplies. For example, if the business is buying all your supplies, you're more likely to be an employer employee than you are an independent contractor, because an independent contractor is in business for themselves and tend to bring their own supplies to the business relationship. Also, they look at whether there are contracts or employee type benefits. For example, if they're providing you a bunch of insurance and paid vacation and a pension plan, well, that makes you look like an employee. Whereas if they provide none of that and you got to provide it yourself, you're much more likely to be classified as an independent contractor. Now let's talk a little bit about how to determine whether you want to be an independent contractor or whether you want to be an employee. This is a question I get pretty frequently. People are just trying to figure out they can't compare their job offers because some of them are independent contractor offers and some of them are employee offers. Well, first of all, I think the most important thing I can say in this respect is that you don't want to choose a job based solely on this. It just doesn't make that big of a difference. The after tax, after benefit difference between the two offers is unlikely to be very high and at the level of income at which an attending paid. A difference of a few thousand dollars really isn't going to affect your happiness one way or the other. So this shouldn't be a huge factor in your job search. The location you're going to live in and how much you like the people you're going to work with should be far more important than whether you're going to be an independent contractor or an employee. But it's important to realize that if you're going to be an independent contractor, you should get paid more than you should if you're an employee. And the reason why is you have some additional expenses as an independent contractor than you do as an employee. You've got to pay for both halves of the Social Security and Medicare taxes, these payroll taxes. When you're an independent contractor, you are both the employer and the employee, so you have to pay both halves of it. That means you need to be paid more so you can pay that stuff. Same thing with any benefits. If you're an employee, you might get a 401k match, you might get your dental insurance and health insurance premiums paid. You might get a CME stipend, you might get a moving allowance. All that stuff needs to be added in in order to compare apples to apples when you're looking at one job versus the other. Now, there are some additional benefits of being an independent contractor, and the main one of these is that it's easier to deduct business expenses. The ideal when you're an employee is to have your employer pay the business expenses because it's tricky to deduct it for yourself. But when you're self employed, when you're an independent contractor, you can just deduct all that on schedule C. It's very easy. Every legitimate business expense you have, the entire thing comes out of your business profit before you pay taxes on it. It's the best kind of deduction there is, especially if it's something you had to buy anyway, like, you know, a license or, you know, CME costs, that sort of a thing. So if you are an employee, the place you take that deduction is at the bottom of schedule A. So not only do you have to itemize, you can't take a standard deduction and get this deduction, but it's also subject to a 2% floor, 2% of your adjusted gross income. And so the problem with that is 2% of a physician's income is pretty high amount. And so if you have $500 worth of unreimbursed business expenses, and 2% of your income is $4,000. You're not going to be able to deduct any of that. And so it's much harder to deduct unreimbursed business expenses as an employee than it is to just deduct your business expenses as an independent contractor. Now, what can you deduct? Well, you can deduct any legitimate business expense. If you're an independent contractor. You've got to pay for everything. You've got to pay for, you know, maybe somebody to prepare your taxes. You might have to pay for some, for your scrubs or white coats, for your stethoscope, for all those kinds of things that you need. All your CME expenses are business expenses. And you know, just about anything else that is ordinary and necessary in your line of work can be deducted as a business expense. You know, it may be the cost of your pager or phone or, you know, part of your computer costs, all kinds of things. Whatever you can come up with that is a legitimate business expense, you can deduct right off your schedule C. Now how much does that all add up to for most docs? Well, maybe a couple thousand dollars. It's not some huge benefit, but it's enough that there are a few more deductions that you can take in that respect. Finally, let's talk a little bit about Antonio's question about incorporation. A lot of docs wonder about this, should I incorporate? Because they think incorporation carries these magical benefits, that it not only dramatically reduces their taxes, but eliminates all their liability. Well, the truth is, for a doc that's just working as a sole proprietor that doesn't have any employees, becoming a corporation doesn't really eliminate liability at all. I mean, the main liability a doc has is malpractice. And malpractice is always personal. You cannot get rid of malpractice by incorporating. And so what liability does a corporation protect you from? Well, business related liability. Like if someone feels like you're not, you know, fulfilling your contract and they sue you for breach of contract, well, you know, your corporation can help you in that respect. But if a patient sues you because they feel like, you know, you caused them to lose their leg, you're not going to get any protection at all from incorporating for that. So for most docs that don't have any employees, incorporating probably just increases your expenses and doesn't really decrease your overall liability. Now, as far as taxes go, there is a way to reduce your taxes. So using a corporation, however, there's an easier way to do it when you form a limited liability company, which is easy to do and very inexpensive. For example, in my state of Utah, it costs $70 initially and then $15 a year to have an LLC. But that gives you basically all the same liability as a corporation, liability protection as a corporation. And you're allowed to decide how you want to pay taxes. You can pay taxes either a partnership or as a corporation. And so you don't have to incorporate even to avoid taxes like you can with an S corporation. So whether you are an llc, filing taxes as an S corporation or an official S corporation, there is a way to lower your tax bill a little bit. And the way you lower it is by declaring some of your income a distribution and some of your income a salary. You only pay payroll taxes on the salary. You don't have to pay any payroll taxes, the Social Security and Medicare taxes on your distribution money. Now, the downside of just declaring everything a distribution is that you can't use that money to determine how much you're going to put in retirement accounts either. So you have to strike a balance so that you have enough of a salary that you can max out your retirement accounts, but also enough of a distribution that it's worth the hassle to save a few Medicare taxes. Because for most docs, you're still going to max out your Social Security tax payments. It's just Medicare taxes that you're really saving by calling some of your income a distribution. Also, when you determine how much you're going to pay yourself as a salary, bear in mind it has to be reasonable. A doctor can't go, my salary is $50,000 and I'm going to take $400,000 in distribution. It just doesn't fly. You've got to have some legitimate means of determining what your salary is, and you can do that using, you know, the going rate in your specialty, using salary surveys, etc. The general rule that a lot of accountants use is never declare more than 50% of your income as a distribution. And I think that's a reasonable general rule. But there's really no specific guidelines. The IRS says they're going to consider the following factors to determine what reasonable compensation is, and that includes your training and experience, your duties and responsibilities, your time and effort devoted to the business, the dividend history of the corporation, payments to non shareholder employees, the timing and manner of paying bonuses to key people, what comparable businesses pay for similar services, compensation agreements, and mostly that you're using some sort of a formula to determine your compensation and not just making it up. All right, let's switch gears a little bit here and address some other questions that I've received, whether on the forum or by email or his comments after blog posts. Here's one would Schwab index funds such as the S&P 500 fund and the Total Stock Market Index be as good as the Vanguard funds? Yeah, they essentially are. You know, I'm a little partial to Vanguard. There's no doubt I like Vanguard and there's no doubt that these other companies like Schwab and fidelity and iShares, they wouldn't be offering such low expenses index funds if it wasn't for Vanguard. But in this day and age, they're all about equivalent. Whether you're investing in a Fidelity Total Stock Market Fund or Schwab Total Stock Market Fund or you know, an iShares version, etc. They're all about the same. The expense ratio is anywhere from three basis points to five basis points. And it's just, they're all just about the same. So it's perfectly fine if your 401k or your accounts are already at Schwab or Fidelity or iShares or you know, a brokerage where you're buying iShares, ETFs, that's all fine to use. They're just as good as the Vanguard funds in that respect. Now Vanguard does have a lot more lower, low cost actively managed funds. They also have more index funds at Vanguard. But as far as the main index funds, you can get those at any of these major brokerages just fine. Next question is a little bit longer. This is a doc writing in about his wife's retirement accounts. He says she's held two short term attending level positions while I've completed my training. She contributed 1403 account and 1401 account through her various employers and the total in both of them is about $9,000. These are invested in reasonably cost reasonable cost mutual funds and I think I can probably even lower the cost a little more by switching to index funds there for her new position. However, her employer works through principal. With our new increased income we want to max out our tax deferred retirement accounts, but principal's expense ratios for their target funds are all really high. According to our 403 information packet, all of those are 1.6% and even their other funds tend to be pretty expensive as well. For example, a 500 index fund has an expense ratio of 1.03%. An international index fund has an expense ratio of1.2.2%. And a bond market index fund has an expense ratio of 1.13%. I was interested if you thought this was a reasonable plan given the super high expense ratios at principal. I was going to leave the money in her Alaris and Fidelity accounts. Unless there's something that I'm missing. It would probably make my life a little easier to consolidate her retirement accounts. But I thought it would be better to keep that money in lower fee funds. Well, that certainly isn't a great 401k. I mean, if you're paying more than 1% in expense ratios for an index fund, those guys running that fund are basically just one. Or if they can sucker people into buying it, and obviously they have, they suckered her employer into buying this fund in their 401k. And it's really a problem because her employer is actually at pretty high risk to be sued. The employer has a fiduciary responsibility to the employees to have a good 401k. And offering a 500 index fund with an ER that's 20 times the going rate isn't exactly being a fiduciary. So that's a real risk for the employer. If you're an employer offering crappy mutual funds in your 401k, you ought to change that as soon as you can. But what should you do with your money in this situation? Well, there's one option that you're not really thinking of. You're thinking that you got to choose between leaving it in the old 401ks and now having to manage basically three different accounts, or roll it all over into the new crummy 401k. Well, there's one other option. This isn't all that much money. It's only $9,000. You can just convert the whole thing and put it in your Roth ira. That's far easier to do that and while still allowing you to do backdoor Roth IRAs. In the olden days, what everybody always did when they left a company is they would just roll their 401k or the 403 to a traditional IRA where they could get more investment options at lower costs. But these days, now that we're having to do backdoor Roth IRAs, at least high earners are. You can't have that traditional IRA hanging out there or it screws up your pro rata calculation on your backdoor Roth ira. So you got to convert the whole thing or you got to stick it in a 401k somewhere. And I think in this respect, what I would do is I'd pay the three or four thousand dollars in taxes and just put that all into a Roth ira. Especially since this is a couple that wants to be saving even more money next year than they did last year. Paying for those, those taxes on that conversion is really the equivalent of saving more money. Alright, here's another one. This question comes in from the forum. I've read varying opinions on this topic. At age 35, is having 100% of my assets invested in low expense ratio index funds. He gives a couple of examples, both of which are 500 index funds advisable or not? Well, this is a hard question to answer. Again, it comes back to like I mentioned earlier, it's important to keep your terminology straight. All these words have definite meanings. They have precise meanings that you got to understand what they mean. So I couldn't really tell if this questioner was asking whether it's okay to have all your money in index funds and none of it in actively managed funds, or if he's asking, is investing in just two mutual funds okay? Or is he asking if holding 100% stocks at age 35 is okay? Or is he asking if these two 500 index funds are the best two funds you could be holding? You know, the truth is, for each of those questions I've got a different answer. So let's just address them one by one. The first one is, is it okay to have 100% of your money in index funds and none in actively managed funds? And yes, I think that's just fine. I've been doing that for years. There's actually been a lot of press lately. I've noticed this last month or two about all the money that's flowing into index funds. It seems that the word is finally getting out to investors that investing in actively managed funds is a pretty huge gamble. And so more and more of new money being invested is going into index funds. It's still a relatively small percentage of the total amount invested and certainly a small percentage of the total amount traded each day. And so there's lots of people speculating about what happens if lots and lots and lots of people are invested in index funds. Is it going to screw everything up and cause a new bubble and all that? And we're a long way from that happening. It just doesn't take that many trades a day to keep the market efficient enough that buying index funds instead of actively managed funds is the right move. The next question was whether it's okay to just be invested in two mutual funds. And I think that's Okay. I think it's okay to be invested in just one mutual fund as long as it's a very diversified fund. But the two funds of this poster was asking about are both 500 index funds. One at Vanguard and one at Fidelity. Well, if you're going to have two funds, they probably ought to be different funds. I don't see any reason to, you know, have two funds that invest in the exact same stocks. That just seems silly to me. The third question was whether it's okay to be 100% stocks at age 35. Well, maybe it is. I don't really know if it's okay for that particular investor until I've been able to watch their behavior in a bear market. Personally, I think everyone, especially when you're just starting investing, you ought to err a little bit on the side of being overly conservative and have at least a little in bonds until you know how you behave in a bear market. And since we haven't had a real bear market since 2008, you know, there's a lot of investors who have never invested in a bear market. They have no idea what their behavior is going to be like and how hard it is to watch your money that you saved instead of spending on something you really wanted, like a new car, a new kitchen or a vacation or whatever. And to watch that money disappear down the rat hole, not knowing if it's coming back. You know, I think until you've had that happen, you really don't know what your risk tolerance is. So if you're just guessing, like a lot of new investors are, err on the side of being conservative. And it's far better to have a little bit lower return due to having 20 or 40% of your portfolio in bonds than to sell out at the bottom of a bear. If you get to your first bear market and you realize, yeah, I can handle a lot more risk than I thought, you can buy more stock then, and you'll end up buying low. And so that's a great time to increase the riskiness of your asset allocation. Finally, he's asking about these particular mutual funds. And I really don't see much of a reason to own a 500 index fund if you can own a total stock market fund instead. Not only do you not have to worry about people front running the index, but you also get a lot more stocks like 3500 instead of 500, and you get a little bit more of a tilt towards smaller stocks, which in the long run should provide you a slightly higher return. And so I think a total stock market fund is better than a 500 index fund when you're given the option and everything else is equivalent. If I was going to add a second fund to this investors 500 index funds, it would probably be a bond fund or an international index fund rather than another 500 index fund. Alright, here's another question. In your opinion in a taxable account, is there's a large difference or benefit between investing in an ETF versus a traditional mutual index fund? For example, should I invest in the Schwab fund or the Schwab ETF for total stock market? Well, at Vanguard it really doesn't matter because they're two share classes of the same mutual fund. At other companies like Schwab, it might matter a little bit. And ETF might be slightly more tax efficient. ETFs have a method of flushing highly appreciated shares out of the mutual fund. And so it's nice to have an ETF for that mechanism. At Vanguard it doesn't matter. At Schwab it does. It's a very slight difference. The Schwab traditional total stock market mutual fund is very tax efficient and you're not gaining a lot. But if you got a, you know, if you have to say which one is slightly better, well, It'd be the ETF at Schwab. Here's another question. Your children have Roth IRAs. How do you get around the earned income requirement? And the only reason I include this in the podcast is because I get this all the time. This is amazing to people. Apparently. Yes, my children have Roth IRAs and I don't get around the earned income requirement. I pay my children because they earn income. They work as models for the website. You see all those pictures all over the website? That is those pictures of my children, are them modeling for the website. How much can you pay a child model? Well, if you look online, the going rates about $100 an hour. And so if you have your children model for 10 hours a year, you can pay them $1,000 legitimately from your business. And so that's what I do. My oldest is now starting to write posts for White Coat Investor and she gets paid for that as well. And they work for other people as well, for example, babysitting or shoveling driveways or whatever. And so all that money is also earned income that can go into the Roth ira. Now your kid might not be very excited about having the money they worked hard for go into a retirement account. And if that's the case, you can do what I call the daddy Match, you can give them money that you earned for them to spend and take their money that they earned and put it in the Roth ira. Trust me, it spends the same and they'll be perfectly happy with that. And in the meantime, you've helped them get a jump start on their retirement savings. Okay, final question. When you suggest saving 20% of your gross income per year, does that include 401k contributions or is the 20% suggestion above and beyond 401k? That includes 401k contributions. It also includes the match on your 401k. Your match is really just part of your salary. If you don't get your complete match, you're just leaving part of your salary on the table. And so you should include that as well, not only in the numerator, but also in the denominator when you're calculating out your savings rate. I had somebody ask the other day and point out that 20% isn't perfect. You know, some people might need to save a little bit more and some people might be okay saving less. And obviously that's true. It's just a rule of thumb. But if you can get into the neighborhood of around 20% of your gross income going toward retirement, you're most likely going to have enough to have a dignified retirement and be able to, you know, not worry about running out of money throughout your retirement years. If you calculate out your savings rate, what you save divided by what you earn and you find that number is 2%, well, that's not enough. You need to figure out a way to get that up. And maybe that is making some dramatic changes in your spending. Maybe it's saving your raises, maybe it's trying to increase that number by 1% a year. Whatever it takes, you got to get it up higher than 2% if you want to have a nice retirement.

The White Coat Investor is proud to introduce our no Hype Real Estate Investing course, which will provide the framework for developing further knowledge and experience as you progress in your real estate investing career. We call it an introductory course because there's always more to learn. But this is no short, superficial course. There are over 200 lectures and videos adding up to more than 27 hours of content by over 15 different instructors.

We think it just might be the.

Best real estate course on the planet. Continue your wealth building journey today with the no Hype Real Estate Investing course@whitecoatinvestor.com courses. You can do this and the white Coat investor can help.

Head up, shoulders back. You've got this finance stuff, see you next time it.