Are you an owner of a medical practice taxed as a flow-through entity . . . such as an S-corporation? Most of the physicians we speak to who are “partners” in their practice are in this situation. As such, they are paid both as an employee of the practice — as a W-2 — and as an S-corporation owner of the practice — through a K-1 distribution.
What’s the Difference, and Why Does It Matter?
The key difference between income earned as a W-2 and that earned through a K-1 is that you pay FICA (Medicare and Social Security) tax on the income earned as a W-2 but not on K-1 distributions. While the large Social Security portion of FICA phases out after income of $90,000, the 2.9% Medicare tax has no phase-out.
While this is only a 2.9% tax, we have seen physicians overpaying $10,000 or more each year, every year of their career. Over their careers, this can amount to nearly half a million dollars of lost capital — for no good reason!
Do You See Yourself in These Scenarios?
Below are real-life examples.
1. Dr. Smith is part of a three-doctor dermatology practice. He earns about $400,000 annually as a dermatologist. He calls the two other doctors “partners” but technically they are co-owners of the practice, an S-corporation. Each month, Dr. Smith gets paid $20,000. Then at the end of each 6-month period, he gets another $80,000 or so based on the practice’s performance. His accountant deems both the monthly and semi-annual payments to be salary payments. Thus, he pays Medicare tax on all $400,000 for a tax of $11,600. This, of course is in addition to state and federal income taxes, property taxes, etc. If he works for 25 years earning the same income, he will have lost over $550,000 in Medicare taxes, assuming a 5% growth rate.
2. Down the road, Dr. Jones is in the exact same economic situation. However, his CPA treats the monthly payments as W-2 wages and the semi-annual payments as K-1 distributions. Thus, he pays Medicare on $240,000 for a cost of $6,960. If Dr. Jones works for 25 years earning the same income, he will have lost about $330,000 in FICA taxes, assuming a 5% growth rate — an improvement of over $220,000 over Dr. Smith.
Obviously, any of you reading here would not want to be Dr. Smith. Yet, we are continually astounded when see so many physicians in the same position — having all, or most, of their income treated as W-2. Wouldn’t all of us prefer to be in Dr. Jones’ situation? If we are allowed to be, then yes. So, the question really comes down to, “What are the tax rules that govern this situation?”
Following a Simple Rule of Thumb
In discussions with a number of CPAs, the consensus is that one should follow a simple rule of thumb. That rule is basically that you can earn a W-2 salary comparable to what you would make as an associate physician with the same training. The rest of your compensation can be characterized as distributions.
One CPA, practicing for more than 20 years, commented, “This is what I do for my clients, and when the issue has been discussed in audits over the years, the IRS finds it very difficult to argue that our client should be paid more on their W-2 than a staff member doing the same job.”
Looking again at the examples above, Dr. Smith could easily attract a young but experienced dermatologist to his practice paying $250,000 salary. This would allow him to avoid Medicare tax on $150,000 — saving more than $4,000 annually.
Not coincidentally, Dr. Jones is in the right situation.
Working the Same Hours, Earning More
As hard as physicians work, throwing away hundreds of thousands of dollars over a career — for no good reason — is a shame, yet it happens every day.
Take heed of how you are getting paid or how you will pay new physician employees, and hopefully this financial mistake will not be an issue.
The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action.
The authors offer a free audio CD (just cost of shipping) titled “How to Work Less & Make More.” If you are interested, call (800) 554-7233 or email info@wealthprotectionalliance.com.
Are you an owner of a medical practice taxed as a flow-through entity . . . such as an S-corporation? Most of the physicians we speak to who are “partners” in their practice are in this situation. As such, they are paid both as an employee of the practice — as a W-2 — and as an S-corporation owner of the practice — through a K-1 distribution.
What’s the Difference, and Why Does It Matter?
The key difference between income earned as a W-2 and that earned through a K-1 is that you pay FICA (Medicare and Social Security) tax on the income earned as a W-2 but not on K-1 distributions. While the large Social Security portion of FICA phases out after income of $90,000, the 2.9% Medicare tax has no phase-out.
While this is only a 2.9% tax, we have seen physicians overpaying $10,000 or more each year, every year of their career. Over their careers, this can amount to nearly half a million dollars of lost capital — for no good reason!
Do You See Yourself in These Scenarios?
Below are real-life examples.
1. Dr. Smith is part of a three-doctor dermatology practice. He earns about $400,000 annually as a dermatologist. He calls the two other doctors “partners” but technically they are co-owners of the practice, an S-corporation. Each month, Dr. Smith gets paid $20,000. Then at the end of each 6-month period, he gets another $80,000 or so based on the practice’s performance. His accountant deems both the monthly and semi-annual payments to be salary payments. Thus, he pays Medicare tax on all $400,000 for a tax of $11,600. This, of course is in addition to state and federal income taxes, property taxes, etc. If he works for 25 years earning the same income, he will have lost over $550,000 in Medicare taxes, assuming a 5% growth rate.
2. Down the road, Dr. Jones is in the exact same economic situation. However, his CPA treats the monthly payments as W-2 wages and the semi-annual payments as K-1 distributions. Thus, he pays Medicare on $240,000 for a cost of $6,960. If Dr. Jones works for 25 years earning the same income, he will have lost about $330,000 in FICA taxes, assuming a 5% growth rate — an improvement of over $220,000 over Dr. Smith.
Obviously, any of you reading here would not want to be Dr. Smith. Yet, we are continually astounded when see so many physicians in the same position — having all, or most, of their income treated as W-2. Wouldn’t all of us prefer to be in Dr. Jones’ situation? If we are allowed to be, then yes. So, the question really comes down to, “What are the tax rules that govern this situation?”
Following a Simple Rule of Thumb
In discussions with a number of CPAs, the consensus is that one should follow a simple rule of thumb. That rule is basically that you can earn a W-2 salary comparable to what you would make as an associate physician with the same training. The rest of your compensation can be characterized as distributions.
One CPA, practicing for more than 20 years, commented, “This is what I do for my clients, and when the issue has been discussed in audits over the years, the IRS finds it very difficult to argue that our client should be paid more on their W-2 than a staff member doing the same job.”
Looking again at the examples above, Dr. Smith could easily attract a young but experienced dermatologist to his practice paying $250,000 salary. This would allow him to avoid Medicare tax on $150,000 — saving more than $4,000 annually.
Not coincidentally, Dr. Jones is in the right situation.
Working the Same Hours, Earning More
As hard as physicians work, throwing away hundreds of thousands of dollars over a career — for no good reason — is a shame, yet it happens every day.
Take heed of how you are getting paid or how you will pay new physician employees, and hopefully this financial mistake will not be an issue.
The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action.
The authors offer a free audio CD (just cost of shipping) titled “How to Work Less & Make More.” If you are interested, call (800) 554-7233 or email info@wealthprotectionalliance.com.
Are you an owner of a medical practice taxed as a flow-through entity . . . such as an S-corporation? Most of the physicians we speak to who are “partners” in their practice are in this situation. As such, they are paid both as an employee of the practice — as a W-2 — and as an S-corporation owner of the practice — through a K-1 distribution.
What’s the Difference, and Why Does It Matter?
The key difference between income earned as a W-2 and that earned through a K-1 is that you pay FICA (Medicare and Social Security) tax on the income earned as a W-2 but not on K-1 distributions. While the large Social Security portion of FICA phases out after income of $90,000, the 2.9% Medicare tax has no phase-out.
While this is only a 2.9% tax, we have seen physicians overpaying $10,000 or more each year, every year of their career. Over their careers, this can amount to nearly half a million dollars of lost capital — for no good reason!
Do You See Yourself in These Scenarios?
Below are real-life examples.
1. Dr. Smith is part of a three-doctor dermatology practice. He earns about $400,000 annually as a dermatologist. He calls the two other doctors “partners” but technically they are co-owners of the practice, an S-corporation. Each month, Dr. Smith gets paid $20,000. Then at the end of each 6-month period, he gets another $80,000 or so based on the practice’s performance. His accountant deems both the monthly and semi-annual payments to be salary payments. Thus, he pays Medicare tax on all $400,000 for a tax of $11,600. This, of course is in addition to state and federal income taxes, property taxes, etc. If he works for 25 years earning the same income, he will have lost over $550,000 in Medicare taxes, assuming a 5% growth rate.
2. Down the road, Dr. Jones is in the exact same economic situation. However, his CPA treats the monthly payments as W-2 wages and the semi-annual payments as K-1 distributions. Thus, he pays Medicare on $240,000 for a cost of $6,960. If Dr. Jones works for 25 years earning the same income, he will have lost about $330,000 in FICA taxes, assuming a 5% growth rate — an improvement of over $220,000 over Dr. Smith.
Obviously, any of you reading here would not want to be Dr. Smith. Yet, we are continually astounded when see so many physicians in the same position — having all, or most, of their income treated as W-2. Wouldn’t all of us prefer to be in Dr. Jones’ situation? If we are allowed to be, then yes. So, the question really comes down to, “What are the tax rules that govern this situation?”
Following a Simple Rule of Thumb
In discussions with a number of CPAs, the consensus is that one should follow a simple rule of thumb. That rule is basically that you can earn a W-2 salary comparable to what you would make as an associate physician with the same training. The rest of your compensation can be characterized as distributions.
One CPA, practicing for more than 20 years, commented, “This is what I do for my clients, and when the issue has been discussed in audits over the years, the IRS finds it very difficult to argue that our client should be paid more on their W-2 than a staff member doing the same job.”
Looking again at the examples above, Dr. Smith could easily attract a young but experienced dermatologist to his practice paying $250,000 salary. This would allow him to avoid Medicare tax on $150,000 — saving more than $4,000 annually.
Not coincidentally, Dr. Jones is in the right situation.
Working the Same Hours, Earning More
As hard as physicians work, throwing away hundreds of thousands of dollars over a career — for no good reason — is a shame, yet it happens every day.
Take heed of how you are getting paid or how you will pay new physician employees, and hopefully this financial mistake will not be an issue.
The information contained in this article is general in nature and should not be construed as comprehensive financial, tax, or legal advice. As with any financial or legal matter, consult your qualified securities, tax, or legal representative before taking action.
The authors offer a free audio CD (just cost of shipping) titled “How to Work Less & Make More.” If you are interested, call (800) 554-7233 or email info@wealthprotectionalliance.com.
