Should Your Practice Be an S-Corp?

The S corporation is a tax election, not a type of entity. Your practice is already a PC, a PLLC, or a professional association under your state's licensing rules, and it stays exactly that after you file Form 2553. The election changes one thing: how the profit is taxed on its way to you.

So the decision has nothing to do with liability, or professionalism, or looking like a real business. It comes down to one comparison: whether the payroll tax you stop paying exceeds the payroll you start running. For a practice owner with real net profit, it usually does. For an employed physician with some 1099 income on the side, it usually does not, and the reason is arithmetic I will show you below.

How the salary and distribution split works

As a sole proprietor or a single-member LLC, every dollar of net profit lands on Schedule SE. Self-employment tax is 15.3% applied to 92.35% of net earnings: 12.4% for Social Security up to the annual wage base, then 2.9% for Medicare with no ceiling at all. The 0.9% Additional Medicare Tax stacks on top above $200,000 single or $250,000 married filing jointly, and those thresholds are not indexed for inflation.

Make the election and you become an employee of your own practice. You run a W-2 salary, which bears FICA the way any salary does. What remains after salary and expenses comes to you as a distribution and carries no employment tax. The savings equal the payroll tax rate applied to whatever you move out of the salary column and into the distribution column. Which is why every serious version of this conversation is really a conversation about the salary.

Why the savings shrink fast at physician income levels

Here is what the savings calculators leave out. The 12.4% Social Security piece stops at the wage base, a figure that is adjusted every year. Once your W-2 salary clears it, Social Security is finished for the year whether the next dollar arrives as salary or as a distribution. Everything above the wage base is escaping 2.9% Medicare, plus 0.9% once you are over the surtax threshold.

At physician and dentist income levels, then, the distribution is usually saving 3.8%, not 15.3%. That is roughly a quarter of what the marketing math implies, because the marketing math quietly applies the full rate to the entire distribution. On a large distribution 3.8% is still worth having. Just know which number you are deciding on.

Reasonable compensation when you are the revenue

An S-corp owner has to pay themselves reasonable compensation for services actually performed. There is no safe harbor, no percentage, and no IRS-blessed formula. The IRS weighs factors like training and experience, duties and time devoted, what comparable non-shareholder employees are paid, dividend and bonus history, and industry comparison. Underneath the list sits a simpler test: trace the practice's gross receipts to their source and split them three ways, between your own services, the services of employees who are not shareholders, and capital and equipment.

That test is unkind to physicians and dentists specifically. In a solo practice with no associate providers and no meaningful equipment, close to every dollar of collections traces back to your own hands, which leaves very little to characterize as a return on the business. A group with associates, hygienists, and an imaging suite has a genuine argument that some share of profit is a return on capital and other people's labor. A solo internist does not have that argument, and the IRS knows it.

Two cases are worth knowing by name. In Watson, an accountant paid himself a token salary out of a firm distributing far more; the district court reset his wages upward, the Eighth Circuit affirmed, and the employment tax followed. In JD & Associates, a federal district court rejected the mechanical percentage approach outright. So if someone tells you to take 40% as salary and the rest as distributions, they are quoting a marketing convention, not a rule any court has adopted. I go through the benchmarking in what reasonable salary actually means.

The retirement plan interaction, which usually decides it

For high earners this is the line that settles the question, and it cuts against the FICA savings. Inside an S-corp, the employer contribution to a 401(k) or profit sharing plan is calculated off your W-2 wages and capped at 25% of them. As a sole proprietor, it is calculated off net earnings from self-employment, which works out to roughly 20% after the deduction for half of SE tax. Drive the salary down to save Medicare tax and you can drive the retirement contribution down with it.

Cash balance and defined benefit plans sharpen this considerably, because those plans size the contribution off W-2 compensation. For a physician funding a large annual cash balance contribution, a salary set low for payroll tax reasons can cost more in lost deduction than the payroll tax it saved. I run that comparison before I run anything else. It reverses the answer often enough that doing it last is careless.

One thing to keep out of the argument entirely: the Section 199A deduction. A medical or dental practice is a specified service trade or business, so the deduction phases out completely above a taxable income threshold that is adjusted annually. Most practice owners asking this question are well past it, and the S election does nothing to bring it back.

State rules and professional entity limits

Licensing rules come first. Most states require licensed professionals to operate through a professional entity whose owners are licensed in the same profession, which limits who can hold stock before tax enters the conversation at all. The S election sits on top of whatever entity your board permits, never in place of it.

Then look at what your state does with the election. Some impose an entity-level franchise, net worth, or excise tax that a sole proprietorship never pays, clawing back part of the federal savings. If you are licensed and seeing patients across state lines, the entity needs foreign registration and the payroll follows you. On the other side, most income-tax states now offer a pass-through entity tax election that moves state tax above the line, and you have to be a pass-through to use it. Those elections carry hard annual deadlines, and a missed one is a loss you can calculate to the dollar.

When this is premature

If you are an employed physician with a hospital W-2 and some moonlighting on a 1099-NEC, the S-corp is almost certainly not your move yet. Your W-2 wages have likely already consumed the Social Security wage base for the year, which means the moonlighting income is exposed only to 2.9% Medicare plus the 0.9% surtax to begin with. The election would be chasing 3.8% of a modest number while adding quarterly payroll filings, a second tax return, and a salary you now have to defend.

Run the same arithmetic for a practice before you commit to anything. Estimate the distribution, multiply it by 15.3% if the salary will land under the wage base or by 3.8% if it will land above, then subtract the annual cost of payroll processing, the 1120-S, state registrations, and the higher preparation fee. If what is left is not enough to care about, the answer is no. That calculation, not a rule of thumb, is what decides it.

If you want this run for your practice

Send me last year's return, your current net profit, and what you are contributing to retirement. I will give you the number both ways, and I will tell you plainly when the answer is no, which happens more often than the conference circuit suggests. The initial consultation costs nothing.

The fee for the work is a flat amount quoted in writing before anything starts, scored on the complexity of the return rather than estimated by feel, which you can read about on the pricing page. More on how I work with physicians and dentists, or send me the numbers.