Many physicians, dentists and other practice owners elect S-corporation status to manage self-employment taxes. The strategy works because S-Corp profits paid as distributions are not subject to Social Security and Medicare tax, while wages are. The catch: the IRS requires owners who work in the business to pay themselves reasonable compensation first.
What “reasonable compensation” means
Reasonable compensation is the amount the practice would pay to someone else for the same services. The IRS and courts look at factors such as:
- Training, specialty and experience
- Duties performed and hours worked
- What comparable practices pay for similar services in your area
- The practice’s gross receipts, profits and distribution history
- Compensation agreements and how the figure was determined
There is no single safe percentage. A salary that is too low is a common audit trigger and can lead to reclassification of distributions as wages, plus penalties and interest.
Common mistakes we see
- Taking little or no salary while distributing most of the profit
- Setting salary once and never revisiting it as the practice grows
- Having no written support for how the salary was chosen
- Ignoring how salary affects retirement plan contributions
Salary also drives retirement savings
Employer contributions to plans such as a 401(k) are generally based on W-2 wages. A salary that is too low can limit how much you can save on a pre-tax basis, so the “lowest possible salary” is not always the best answer.
Is an S-Corp right for your practice?
An S-Corp adds payroll, a separate return and stricter bookkeeping. For some practices the savings justify the cost; for others they do not. It depends on profit level, number of owners, state rules for professional entities and retirement goals.
Our healthcare practice tax planning service models these choices and documents a defensible compensation figure. Book a consultation to review your practice structure.
Circular 230 notice: This article is general educational information, not a formal tax opinion or advice for your specific situation. Tax outcomes depend on your individual facts. Formal advice is provided only under a signed engagement agreement.