Most dental practices that operate as an LLC or a professional corporation will, at some point, be advised to elect S corporation status. The advice is often correct. It is also often given without anyone having run the numbers for that particular practice.
How the election works
The owner of a practice taxed as a sole proprietorship or a single-member LLC pays self-employment tax, which covers Social Security and Medicare, on substantially all of the practice's profit, with the Social Security portion capped at an annual wage base. A practice taxed as an S corporation pays the owner-dentist a salary through payroll, and the payroll taxes apply to that salary. Profit above the salary can be paid to the owner as a distribution, which is not subject to Social Security or Medicare tax.
The savings come entirely from that difference. If the salary is close to the practice's total profit, there is little to save, and the election adds a separate business return, payroll filings, and administrative cost.
The salary must be defensible
The IRS requires an S corporation to pay its owner reasonable compensation for the services the owner performs before taking distributions. For a dentist, that standard is demanding. The owner is generally the practice's primary producer, and a reasonable salary is measured against what the practice would have to pay another dentist to perform the same clinical work and management duties.
Associate compensation in your market, hours spent in clinical work, and the practice's production per dentist are all relevant. A salary set well below those benchmarks to increase distributions is the position most likely to be adjusted on examination. We discuss how the number is set, and why it is revisited, in a separate post on reasonable S corporation salaries.
Other factors that change the answer
Retirement plans. Employer contributions to a 401(k) profit-sharing plan or a cash balance plan are calculated on W-2 wages. A lower salary reduces the payroll tax but can also reduce the contribution the practice is permitted to make for the owner. For dentists who want to defer substantial income into retirement plans, the two decisions are usually evaluated together.
The qualified business income deduction. Dentistry is a health field, which makes it a specified service trade or business under Section 199A. Above certain income thresholds, which are adjusted each year, the deduction is reduced and then eliminated. Below those thresholds, the S corporation salary reduces the qualified business income on which the deduction is calculated. The interaction is different for every practice.
State taxes. Some states tax S corporations at the entity level or treat them differently from the federal rules. In Georgia, an S corporation can elect to pay tax at the entity level under the pass-through entity tax, which can preserve a federal deduction for state taxes that would otherwise be limited.
Entity rules for dentists. Many states restrict which entity types a licensed dentist may use to practice. The state dental board and the state's professional corporation statute determine whether the practice is a professional corporation, a professional LLC, or another form, and that question comes before any tax election.
When to look at it
The election is usually worth examining once a practice's profit is comfortably above what a reasonable dentist's salary would be. It is also worth reviewing whenever a practice adds a location, brings on an associate, or adopts a new retirement plan, because each of those changes the calculation.
This is general information rather than advice for a specific practice. The right answer depends on the practice's profit, the owner's other income, and the state where the practice operates. If you would like to see the calculation for your own practice, our dental practice page describes how we work with dentists.
This post is general information, not specific tax, accounting, or legal advice. Your situation may differ, so talk to us before acting on anything here.