Casey and Jarrod welcome Colt Smith, Senior Tax Accountant at Four Quadrants, to discuss what you should consider when setting your salary as a practice-owning dentist. Find out if you're paying yourself appropriately.
Announcer:
Hello, everyone. Welcome to The Millionaire Dentist Podcast brought to you by Four Quadrants Advisory. On this podcast, we break down the world of dentistry finances, and business practices to help you become the millionaire dentist you deserve to be. Please be advised, we do speak with an honest tongue and may not be safe for work.
Casey Hiers:
Hello and welcome, this is Casey Hiers back at it again on The Millionaire Dentist Podcast. In studio, we have Jarrod Bridgeman.
Jarrod Bridgeman:
Hey, good afternoon.
Casey Hiers:
Thank you, cohost. And we also have Colt Smith. He helps on the tax and accounting side here at Four Quadrants Advisory. We pulled him in to get his expertise on a topic that rings true for a lot of practice owners. And to sum it up, I think Randy Moss put it best, straight cash, homie. What we're talking about today are three things to consider when setting your salary. And guys, I'll set it up like this. When I travel country, present CE, and have offline conversations with dentists, too many of them skip paychecks, take what's leftover at the end of the month, or have massively erratic distributions throughout the year. That is the wrong way to compensate yourself.
Casey Hiers:
So today we're going to talk about the right way to compensate yourself. And some of those factors involved in it. Colt, from a high level, what's your take on dentist, dentists' salary, how they pay themselves, how they don't pay themselves, what's important from a tax and accounting standpoint?
Colt Smith:
Yeah. First off, thanks for having me, guys. I know I'm by the computer most of the day, so it's always good to come in here and talk shop with you guys and get a little break from the screen. But yeah, as Casey said, straight cash, homie, that's what everyone loves. Right? You know, cash is king. You know, how to get that cash out of the practice is kind of what we're going to talk about today. Whether that's via W2 distribution, kind of what works best for you.
Colt Smith:
The biggest thing when it comes to getting money out, paying yourself, is make sure you have a financial team behind you. So they're talking with you about what is best. And so as we go in today talking about this topic-
Casey Hiers:
Colt, I think you hit on some gold right off the top. There's typically a sweet spot for every single practice and practice owner out there to set their salary and set their income structure. You need people to help you along the way to look at numbers and data, analyze it and tell you what that is. A lot of folks don't get that from their team. If you're listening out there and you need to challenge your external team, do that because there is the right, the right amount for you.
Jarrod Bridgeman:
Well, and money In general can be very emotionally tied to your well-being in terms of, you feel like, oh, I should be getting paid this much, but should you really be getting paid that much? Like that's why you need that outside team to come in without any emotion and with all the numbers behind you, right?
Colt Smith:
100%. You could be happy with the money you're making, but you might not realize that there's more you could be taking home or if there's different tax advantages to taking it home one way versus another. So having that team behind you to make sure that you're capitalizing on all those advantages of paying yourself is very key.
Casey Hiers:
You just sit on another very key point, Cole.
Colt Smith:
I'm trying my best here.
Casey Hiers:
Solid gold is coming from you. We've worked with people who were maybe making five, six, 700,000, but they felt in the pit of their stomachs, I could be capturing more. But they felt that that wasn't enough and ego can get in the way and say, I'm fine. I'm fine. But to those folks who feel that way and figure it out, it's hundreds of thousands of dollars more in many cases.
Colt Smith:
Yeah, 100%. We have all of our different metrics here that we use to kind of come up with business cash flow, personal cash flow, and we do all of our analysis and all those types of numbers. So we do a pretty good job of figuring out what the sweet spot is, but to get there, it takes time. It takes time to realize what you have coming in and out monthly, what you have coming in and out monthly business versus personal. So in order to capitalize on all of that, you really, really, really need to sit down with your financial team and figure out what that sweet spot is. Which we'll get into some details here shortly about W2 versus distributions and 401k deferrals and maxing out is key. [crosstalk 00:04:07] So, yeah, go ahead.
Casey Hiers:
So I guess my question would be is, what do we usually recommend to people? I mean, obviously, there's several different ways people can pay themselves if they have their own company. What do we tend to tell people that they should do? Is it, because I mean, from what I can hear already, it's not just a pay your bills, pay your taxes, pay your staff and take what's leftover.
Colt Smith:
That's the wrong way. That is absolutely the wrong way and the big, and I'm glad you brought that up because it really comes down to the owner's tax basis in their practice. If they don't have basis and they take distributions, they're going to get taxed on those. So they're getting taxed extra on that money coming home. So what we really like to do to make sure people are capitalizing on cash flow is get that consistent W2, first. Build that up as much as we can. You can capture your withholdings through your W2, your federal and your state withholdings, or if you're lucky, you're not in those states that have state income tax, good for you. We're all jealous here in Indiana. But I mean, realistically, we want to get that W2 of as much as we can.
Colt Smith:
So it's consistent each month, each pay period, find that sweet spot. And once we get to that match or that max to be able to accommodate the maximum accrued match through a 401k plan, if you have one, if you can afford one, which is obviously the key to having a practice, saving for retirement, and getting to your goals there, once you hit that threshold, that's when we can talk about distributions, because if you are getting to that threshold, you're more than likely making some pretty good money in the practice. You're pretty profitable. And if that's the case, that's when distributions can come into play and you can take out some more money tax-free.
Casey Hiers:
Everybody wants a magic wand and a blanket answer. I find that out a lot when I talk to rooms full of people. Just tell me X. Is there a universal percentage as an owner that can help guide them in terms of paying themselves? Is there a generic benchmark?
Colt Smith:
There really isn't and it also does involve that there's more than one partner, that could change things.
Casey Hiers:
There's too many factors, for there-
Colt Smith:
There's way too many factors to have a universal percentage to pay yourself.
Casey Hiers:
And a lot of listeners, that makes them sad, right? Everybody wants that quick, this percentage, and you're good. But those blanket, that blanket technique is why firms like ours exist, it needs to be custom.
Jarrod Bridgeman:
Well, because I feel like a lot, I'm sorry, I feel like a lot of people, that are often in the same industry, no matter what the industry is, try to compare themselves to their peers. And as you said, everybody's practice and everybody's situation is so completely different, it's not really fair to yourself to really do that either.
Colt Smith:
Well, and one thing to look at, too, is if your overhead's 90% and you're only paying yourself a hundred grand, you probably can't afford to pay yourself more. So even though we want to get you to that 290, it's just not feasible at that level. So that's why cutting down on overhead and stuff, too, I know I'm going down a rabbit hole with different topics that we could start another 20-minute podcast on, but it really does. There's so many factors that play into getting that W2 up, different ways to pay yourself without paying a huge tax bill.
Jarrod Bridgeman:
Now is it, if I was a, let's say I'm a doctor, and I've only been taking distributions so far, how, I'm not going to say easy or hard, but is there a rather big process to [crosstalk 00:07:12] yourself to the W2?
Colt Smith:
Yeah, the distribution part of it really comes down to tax basis. So if that doctor might be not very profitable on the practice and his overhead's really high, he's got a lot of debt from equipment, from a practice acquisition, whatever it might be, and he's taking only distributions, he's going to be getting taxed pretty heavily on that. So that's where analysis from a business and personal standpoint comes into play to figure out, alright, how can we transfer some of this distribution over to W2 to make sure we have withholdings on that income going home, or else you're going to get hit with a huge tax bill at year-end.
Jarrod Bridgeman:
Gotcha.
Casey Hires:
You mentioned tax basis. We have a previous podcast where we covered tax basis. So if any of our listeners are hearing that and wondering, you can go back to the archives and find the podcast on tax basis.
Jarrod Bridgeman:
All on fourquadrantsadvisory.com.
Casey Hiers:
There you go. And shout out to our sponsor W. Booker. Happy to have you join the sponsorships. So Colt I've seen it where income is structured the correct way, taking into account a variety of variables that you've mentioned. And it literally makes tens of thousands of dollars of difference from a tax perspective. These are smart people. These are successful people. They have CPAs that they like and financial planners that they like. And the way they're set up from our perspective, we make some tweaks and a $30,000 difference in their tax situation. People keep telling me, I don't want to pay taxes. How do I pay less taxes? Are there gray areas? Let's take some risks. And I always say, no, no, no. That's not where it's at. How's your income structured? I mean, this topic is tens of thousands of dollars per year to some people just because they're professionals have not structured it right.
Colt Smith:
Yeah. I think if you want to look at an ideal situation with a practice, let's say the practice is extremely profitable. The doctor has plenty of basis in the practice. You have a 401k plan in the practice. So to capitalize-
Casey Hiers:
Is basis, in other word for equity?
Colt Smith:
You can look at it that way. To dumb it down, basis is essentially, let's say historically, you've just brought more money in than you've spent. We can put it that way. And that includes equipment purchases, stuff like that.
Casey Hiers:
Very positive cashflow.
Colt Smith:
Yeah, positive cashflow. If you're profitable each year and you're not depleting your accounts with distributions, you probably have good basis in the practice. So if the ideal situation is good basis, profit in the practice, and we can get you up to $290,000 W2, 290 is the magic number for 2021 to max out your accrued match through a 401k plan. So you get that extra $17,400 of accrued match expense. That's also a write-off. So you get that tax advantage. You can defer, you can max defer 19,500 for 2021. So that decreases your gross wages that you have to report on your W2 or on your 1040. And if you're 50 or older, now we're talking 26,000 401k deferral that you can decrease your gross wage by.
Colt Smith:
So if you can get to that sweet spot-
Casey Hiers:
That's a minute of magic right there for our listeners. Write that down and make sure. I would hope that your external team knows these things and has these benchmarks. But if you want to have a little pop quiz to make sure what Cole just said was valuable information.
Colt Smith:
And that allows them to get those extra accrued match expenses in the practice, which decreases your practice income. So there's just a lot of different tax advantages to getting to that sweet spot. Now, once you get there, if you have good basis, that's when distributions can come in and you can take money out tax-free. That's just cherry on top after that. But making sure that the retirement contributions, the deferrals are maxed out is very important. I mean, you want to utilize as much as you possibly can within any plan that you're involved in, and getting you to that 290 spot in 2021 makes that happen.
Casey Hiers:
How about like, what's good look like? So you mentioned 290 is like 10 or 12,000 monthly distribution. Is that like a, like, what's a common distribution that is kind of-
Colt Smith:
Oh, man. I mean, it seriously varies. It varies from 2,500 to 15 grand, depending on the size of the practice.
Casey Hiers:
Is monthly or quarterly better for distributions? Is there-
Colt Smith:
Monthly. Monthly 100%. Yeah. The more you can get it down to a consistent weekly, monthly sort of situation, it's always better for cash flow because you know what's going to come out when it's going to come out. Even if you're doing quarterly, it's still, it's like every three months or so it's like, you're taking a huge distribution. It kind of hurts your cash flow. Now from a tax side, that's why we have withholdings each paycheck to accommodate that. And then we have the quarterly tax estimates to make up for anything that might not be covered through that W2.
Jarrod Bridgeman:
Well, I mean, you may never know When something could happen. I'm just looking at last year with COVID and stuff. If you've been taken out too many large distributions, instead of as you said, kind of like leveling it out, You may hit a few months where business is rough.
Colt Smith:
Well, non-clients, if they don't have their financial house in order, I mean, they get a tax surprise for $30,000 and a machine goes down. Oh boy, talk about not being prepared. Talk about bad cash flow. Talk about a frustrating three or six months right there. I mean, those are the challenges you get when it's not forensically monitored and looked at like what we're talking about today.
Casey Hiers:
Jarrod, what's that third point that you wanted to mention down there? I wanted to get some clarification from you on what lifestyle creep means.
Colt Smith:
Beware of the lifestyle creep. In my mind, that meant as you begin to make more money, people tend to spend more money. And so it's your fancy lifestyle creeping up on you.
Casey Hiers:
Oh, I've actually noticed a lot of practice-owning dentists, they've worked so stinking hard that once they're owning and busy, they want that lifestyle. Regardless if their financial situation cash flow, et cetera, warrants it. That's really, really dangerous. And so to your point, once they start living well, most like it. A lot of dentists don't mind living below their means, but a lot of them live above their means too early. And it's hard to go back.
Colt Smith:
Well, once you get used to that way of living, it is hard to downsize or downgrade or anything like that.
Casey Hiers:
Well, it's just like anything. When I was a kid, I thought a watch was a watch, right. And then I learned that there's nicer watches and more expensive watches. And then I started to notice them. Then I started to want them, right? It's just like anything, ignorance can be bliss, but once you get a taste of a certain lifestyle, it's hard to go back. And I guess a little bit more of what you meant, was that right? As you get older and progress, and maybe you go to a friend's house and you're introduced to a delicious bottle of wine that you've never heard of and...
Jarrod Bridgeman:
Yeah. And-
Colt Smith:
Boone's Farm.
Jarrod Bridgeman:
Boone's Farm, right, yeah. Mad Dog 20/20.
Casey Hiers:
That's what you can be used to, and then you get a nice bottle of Caymus or something. Well, shoot all of a sudden that's your new normal, and all those things are expensive.
Jarrod Bridgeman:
And now you end up possibly overpaying yourself to get to that point of keeping that lifestyle up. Like you are constantly giving yourself a mini raise or overly large distributions.
Colt Smith:
And that's part of this thing, too, is getting yourself to these income levels and taking money out of the practice, certain different ways. Obviously, the key is to make sure that your lifestyle does stay the same or improve, right? We want the quality of life to improve. We want your retirement picture to improve. And so these types of avenues and making sure you're talking to your financial team about what's best for me, all plays into that.
Casey Hiers:
And ask why. Why is my income structure the way it is? Why is it at the level that it is, right? Hopefully, they have good answers. But unfortunately, if they're working in vacuums, sort of in a singular myopic view of things, they may just be setting income or salary based on their benchmarks for their customers who are in all sorts of different industry.
Jarrod Bridgeman:
Don't screw up your future because of your lifestyle you want to have in the present.
Casey Hiers:
That's most philosophical.
Colt Smith:
Wow, yeah.
Jarrod Bridgeman:
Thank you.
Colt Smith:
That's like some Socrates-type stuff.
Casey Hiers:
Colt, anything else you'd like to share with the listeners with regarding salary. Obviously, we touched on what's not good. What's ideal. There is a sweet spot for everybody. Hopefully, you have yours. If you don't, find out why or what that could be. But yeah, the tax implications, I never hear people say, I want to confirm that my income's structured correctly so my tax situation benefits. Instead, they just say, I want to pay less taxes. Can I buy something? Can I do something? Yes. Every little thing counts and setting the correct salary is paramount.
Colt Smith:
Yeah. It's it sounds pretty bland, but it's very important. Talk to your financial team. If you don't have one, get one. That's very, very important.
Casey Hiers:
Thank you for your wisdom. Thank you for your time. Jarrod, as always.
Jarrod Bridgeman:
Thank you.
Colt Smith:
Thanks, guys.
Announcer:
That's all the time we have today. Thank you to our guests for their insight and for sharing some really great information. And thank you to you, the listener, for tuning in. The Millionaire Dentist Podcast is brought to you by Four Quadrants Advisory. To see if they might be a good fit for you and your practice, go on over to fourquadrantsadvisory.com and see why year after year they retain over 95% of their clients. Thank you again for joining us and we'll see you next time.
