How Should a Physician Practice Owner Pay Themselves to Minimize Taxes?

Physician practice owners who operate as S-Corporations have a significant tax planning opportunity in how they structure their own compensation. The split between W-2 salary and profit distributions is one of the most commonly mismanaged decisions in physician-owned practices, and it costs many owners $10,000 to $30,000 or more in unnecessary payroll taxes every year.

What Is the Difference Between Salary and Distributions for a Physician S-Corp?

Salary is subject to payroll taxes: 15.3 percent up to the Social Security wage base, plus 2.9 percent above it. Distributions are not subject to payroll tax. By setting a reasonable salary and taking excess profits as distributions, a physician owner can reduce the amount of income subject to payroll taxes.

What Does Reasonable Compensation Mean for a Physician?

The IRS requires that S-Corp owner-employees pay themselves a reasonable salary for the services they perform. Reasonable compensation for a physician is determined by: what the physician actually does day to day, the specialty and clinical complexity, market compensation data for the region and specialty, and hours worked clinically versus administratively.

The risk of setting the salary too low: the IRS can reclassify distributions as salary and assess back payroll taxes, penalties, and interest. This is a real enforcement area, not a theoretical concern

What Does This Look Like in Practice?

We had a healthcare practice owner who, when they came to us, were doing over $1M in annual net profit and was still structured as an LLC, meaning the owner paid self-employment tax on the entire amount. Converting to an S corporation with a reasonable salary of $250,000 would save around $75K in annual tax savings.

This case is a little unusual as we’d typically look at conversion to an S corporation sooner, but it’s a great example of how a well-structured reasonable salary can drive additional income to the bottom line via tax savings.

If your owner’s compensation has never been reviewed strategically, that review should happen before year-end. Book a Free Strategy Session at https://redbikeadvisors.com/book-a-free-strategy-session