Companies can choose to be taxed as a sole proprietor, a partnership, or a corporation depending on the number of owners (one, more than one, or unlimited, respectively). If you choose a corporation, you can decide to be either an S corp, where the person receiving the money pays the taxes, or a C corp, which has its own tax rates. Further, as doctors, we can choose to limit who can join our companies by making it a “professional” corporation (hence the “PC” after Five Roses Urology, PC).
Unless you have a background in accounting, one of the problems with this strategy is that not only are there startup costs, as I had to pay my accountant to draft and file the appropriate paperwork with the state and federal government, but there are yearly accounting costs associated with running the business. My startup costs were under $1,000, and I estimate that my annual costs should be about $1,600 a year, which is not huge, but real.
So why bother? Two reasons. First, from a defensive point of view, having your primary company pay your S corp isolates you in some ways from any potential tax shenanigans by your partners.
For example, maybe one of your partners has decided to write off his Maserati as a business expense. If you are all part of one corporation or partnership, some of that liability may fall to the company, whereas if every partner is an S corp, only the partner who deducted his Maserati is responsible for that decision. And being a little more responsible for my own fate with the IRS is worth some amount of money to me. Maybe not $1,600 a year, but maybe.
Of note, the other significant liabilities that go along with being a doctor (malpractice) and owning a company (accidents and business issues) unfortunately aren’t helped with the S corp. And sure, deducting a Maserati may seem like an egregious example that won’t happen, but there are plenty of gray areas in tax law that two reasonable accountants can disagree on and only the IRS gets the final say during an audit.
The second reason to be an S corp, and this time from an offensive point of view, is to minimize your taxes. As an S corp, you can pay yourself with either “wages” or “distributions.” You pay normal income taxes on both but you only pay payroll taxes (Medicare and Social Security) on your “wages.” This means that you save the 2.9% Medicare tax and the special 0.9% Obamacare tax on any distributions, and that 3.8% can be real money (assuming your “wages” are over $117K so that you max out your Social Security contribution).
Before we crunch the numbers, we need to talk a bit about how you set your “wages” or salary.