S-Corp Tax Structure for Physicians: Is It Right for You?

If you've spent any time in physician finance forums or chatted with colleagues about tax planning, you've probably heard the advice: "You need to be an S-Corp." It's repeated so often that it's become almost a rite of passage.

But here's the truth: S-Corp election isn't automatically the right move for every physician, and choosing the wrong business structure can cost you thousands in unnecessary taxes, compliance headaches, and missed opportunities.

The decision isn't about following what everyone else is doing. It's about understanding the specific tax mechanics, analyzing your personal income structure, and determining whether the administrative burden justifies the tax savings.

What is an S-Corporation?

Let's clear up a common misconception: An S-Corp is not a legal entity type, it's a tax election.

When you form a business, you first choose a legal structure:

• Limited Liability Company (LLC) OR Professional Limited Liability Company (PLLLC)

• Corporation (C-Corp by default)

• Partnership

• Sole Proprietorship

Then, if you've formed an LLC or Corporation, you can elect to be taxed as an S-Corporation by filing Form 2553 with the IRS. This election changes how the IRS treats your business income for tax purposes, but it doesn't change your legal entity structure.

So when physicians say "I'm an S-Corp," what they usually mean is: "I formed an LLC (or Corporation) and elected S-Corporation tax treatment."

How S-Corp Taxation Works

1. W-2 Wages (Reasonable Compensation)

You must pay yourself a salary as an employee of your own business.

This salary is subject to:

• Federal income tax

• State income tax (if applicable)

• FICA taxes: 15.3% (12.4% Social Security + 2.9% Medicare)

The IRS requires this salary to be "reasonable" based on your role, experience, specialty, and geographic location. You can't pay yourself $20,000 and call it a day, the IRS will challenge that in an audit.

2. Distributions (Pass-Through Income)

After you've paid yourself a reasonable salary, any remaining profit is deemed to "flow through" or "pass through" to the shareholders (i.e., you) and is reported on your K-1. You then report this income on your personal tax return and pay taxes at the individual level. Because you're paying taxes on this "flow through" business income, you receive what's known as "basis" in the S-Corporation. You can then take distributions tax-free from the S-Corporation to the extent you have sufficient basis. Essentially, because you've already paid tax on the business income, you can then distribute the cash to yourself tax free.

You might be thinking "If I'm still paying tax on the business income, how is the S-Corporation helping me save on taxes?". The answer largely has to do with self-employment tax (i.e., Social Security and Medicare).

"Flow Through" Business income is subject to:

• Federal income tax

• State income tax (if applicable)

• BUT NO FICA taxes (up to 15.3% saved)

This is the key advantage. Splitting your income between wages and business income/distributions allows you to significantly reduce the amount subject to self-employment taxes (FICA).

On the contrary, if you were a Schedule C/Sole Proprietor, all of the income would be subject to self-employment tax . (Although you would only pay the Social Security portion up to the Social Security Cap)

When S-Corp Election Makes Sense for Physicians

1. You're a 1099 Independent Contractor

If you're a locum tenens physician, work as a 1099 contractor for hospitals or surgery centers, or own your own practice, you're paying self-employment taxes on all your net income. This is the classic scenario where S-Corp election shines (assuming there is also a business purposes for setting up this entity).

Who this applies to:

• Locum tenens anesthesiologists, radiologists, emergency medicine physicians

• Physicians with 1099 income from multiple facilities

• Private practice owners (solo or group)

• Medical directors with independent contractor agreements

2. Your Net Income is $80,000+

There's a rough break-even point where S-Corp tax savings justify the additional costs of running an S-Corp (payroll processing, bookkeeping, tax return preparation).

General guideline: If your net business income (after deducting business expenses) is below $60K-$80K, the administrative costs often exceed the tax savings. Above $100K, the math usually works in your favor. The higher your income, the more compelling the S-Corp election becomes.

However, if you also have a high paying W-2 job and are already at the social security cap (or close to it), then you could potentially end up paying more in taxes than you would if you remained a Schedule C. This is a common trap for the unwary and is due to the employer portion of social security taxes you would pay on your reasonable salary, even if you (as the employee) have already paid the maximum social security tax, perhaps through your other W-2 job.

3. You Have Stable, Predictable Income

S-Corps require regular payroll processing, typically monthly or biweekly. If your income fluctuates wildly month-to-month (which can happen with locums work or seasonal practices), managing payroll can be administratively annoying.

However, most established 1099 physicians have relatively predictable annual income, even if monthly cash flow varies. As long as you can forecast your annual earnings within a reasonable range, S-Corp works fine.

4. You're Willing to Handle Additional Compliance

S-Corps come with more paperwork than sole proprietorships.

These include:

• Quarterly payroll tax filings (Form 941)

• Annual W-2s and W-3s

• State unemployment insurance (SUTA) and workers' compensation requirements

• Separate business tax return (Form 1120-S)

• Corporate minutes and resolutions (even if it's just you)

If you're organized and work with your tax team, it won't be overwhelming. But if you're the type who forgets to pay quarterly estimates or loses receipts, S-Corp adds complexity you might not be ready for.

When S-Corp Election Does NOT Make Sense

1. You're a W-2 Employee with Minimal Side Income

If 95% of your income comes from W-2 hospital employment and you only have $15,000 in side consulting income, forming an S-Corp for that side income is likely overkill.

Why: Your main W-2 income is already subject to FICA taxes. The side income might save you $2,000-$2,500 in self-employment taxes, but the administrative costs of running an S-Corp could eat most of that. In addition, if you are already at the Social Security cap, then the S Corporation will not save you on the employee portion of the social security tax. However, you will end up paying the employer portion of that tax on your reasonable salary.

Better option: Keep side income on Schedule C (sole proprietorship) and focus on maximizing retirement contributions and business deductions instead.

2. Your Net Income is Below $60,000-$80,000

If you're just starting out in locums work or have a part-time consulting practice, the absolute dollar savings may not justify the complexity. Wait until your income grows, then revisit the S-Corp election.

3. You Plan to Sell Your Practice or Business Soon

S-Corps have some nuances around asset sales that can create unexpected tax complications. If you're planning to sell your practice within 1-2 years, the structure of the sale (asset sale vs. stock sale) matters significantly.

C-Corps or LLCs/PLLCs taxed as partnerships may have more favorable treatment for certain types of business sales. Consult your tax team before making any structural changes if a sale is on the horizon.

4. You Have Passive Investment Income

S-Corps can lose their S-Corp status if they have excessive passive income (more than 25% of gross receipts) for three consecutive years.

Passive income includes things like:

• Rental income from real estate (unless it's part of your active business)

• Dividend and interest income

• Royalties

If you're a physician-investor with substantial rental properties or other passive investments, you need to carefully structure which activities belong in your S-Corp and which should be held separately. Mixing active medical income with passive rental income in the same S-Corp can create problems.

Solution: Keep your medical practice in the S-Corp, and hold rental properties in a separate LLC taxed as a partnership or disregarded entity.

5. You Live in a State with Additional S-Corp Taxes

Some states impose additional taxes or fees on S-Corporations that can reduce or eliminate the federal tax savings. Always consult your tax team with your state's rules before making a decision.

States to watch:

• California: S-Corps pay a minimum franchise tax of $800/year, plus an additional 1.5% tax on net income over $250,000

• New York City: Unincorporated business tax (UBT) can sometimes be more favorable than S-Corp structure

• Tennessee: Excise tax on net earnings

• Texas: Franchise tax (though there's a large exemption threshold)

If you're in one of these states, factor the state-level costs into your break-even analysis.

States With No Income Tax

Texas, Florida, Nevada, Washington, Tennessee (and a few others): No state income tax, which makes the S-Corp savings even more attractive since you're avoiding the full 15.3% federal self-employment tax without state complications.

Always consult with your tax team about your state's rules before making a decision.

6. You Do Not Meet The Requirement to Be an S-Corporation

To be an S-Corporation, the business must be a domestic entity, with no more than 100 eligible shareholders (US Citizens / US Resident Aliens, or certain types of trusts, estates, or non-profit organizations). In addition, S-Corporations may only have one class of stock, which must confer identical economic and distribution rights. Always make sure to discuss S- Corporation eligibility with your tax advisor, particularly if you have foreign partners/shareholders, or if your entity has an operating agreement with language that may inadvertently create 2 classes of stock.

What is "Reasonable Compensation"? (The IRS's Favorite Audit Issue)

The IRS uses a multi-factor test based on case law and Revenue Ruling 57-29.

They look at:

1. Training and experience: You're a physician with 10+ years of training. That commands higher compensation.

2. Duties and responsibilities: Are you seeing patients? Managing a practice? Performing surgeries? More responsibility = higher salary.

3. Time and effort devoted: Full-time work justifies a full-time salary. Part-time locums might justify a lower salary.

4. Comparable salaries: What do other physicians in your specialty and region earn? This is your benchmark.

5. Economic conditions: What's the going rate for your services in the current market?

What Happens If You Lowball Your Salary

Let's say you're an anesthesiologist earning $400,000, and you pay yourself a $50,000 salary to maximize FICA savings. That's a red flag.

In an audit, the IRS can:

1. Reclassify distributions as wages: They'll re-characterize $100,000 or more of your distributions as W-2 wages retroactively

2. Assess back taxes: You'll owe the unpaid FICA taxes (15.3%) plus interest

3. Impose penalties: 20% accuracy-related penalty under IRC § 6662 for substantial understatement

4. Audit multiple years: If they find it in one year, they'll often look at the previous 2-3 years

Real case example: In Watson v. United States (668 F.3d 1008 (8th Cir. 2012)), a CPA paid himself $24,000 in salary while taking $175,000 in distributions. The court ruled his reasonable compensation should have been at least $93,000. He owed back taxes, penalties, and interest.

Beyond Tax Savings: What Else an S-Corp Unlocks

1. Solo 401(k) with Mega Backdoor Roth

As an S-Corp owner, you can establish a Solo 401(k) and make both employee and employer contributions, potentially deferring up to $72,000 (2026 limit, adjusted annually) or more if you're over 50.

You can also design the plan to allow after-tax contributions up to $72,000, then convert them to Roth (the "Mega Backdoor Roth" planning), building tax-free retirement wealth.

2. Health Reimbursement Arrangements (HRAs)

If you don't have access to a group health plan, you can set up a QSEHRA (Qualified Small Employer HRA) to reimburse yourself for medical expenses and health insurance premiums, pre-tax.

3. Augusta Rule

As discussed in our Augusta Rule article, S-Corps can rent your home for up to 14 days annually, creating a tax deduction for the business and tax-free income for you personally.

4. Accountable Plan for Business Expenses

An S-Corp can establish an accountable plan to reimburse you for business expenses (mileage, travel, continuing education) without treating it as taxable income, provided you document everything properly and the plan is IRS compliant.

5. State Pass-Through Entity Elective Taxes

As a "work-around" to the $40K (or $10K for higher earners) limitation on the state and local tax ("SALT") deduction on you personal tax return, many states allow eligible pass-through entities (such as S-Corporations) to make an election to pay state income at the S-Corporation level. By paying the tax at the S-Corporation level (as opposed to paying personal state tax at the individual level), the business is allowed a deduction for this state tax, reducing the Federal ordinary income flowing through to the shareholder(s). In effect, this allow the shareholder(s) to receive a federal benefit for state taxes they were going to pay anyway. Essentially, this is a way to bypass the "SALT" cap.

How to Elect S-Corporation Status

Step 1: Form Your Legal Entity

You need a legal entity first. Most physicians choose a PLLC or LLC for its simplicity. However, it is critical to consult state law to determine what type of entities physicians may practice out of. For example, some states require a PLLC or PC (Professional Corporation) as opposed to a basic Limited Liability Company (LLC).

To form an LLC or PLLC (if required):

• File Articles of Organization with your state (usually Secretary of State office)

• Pay the state filing fee ($50-$500 depending on state)

• Draft an Operating Agreement (even if you're a single-member LLC or single-member PLLC)

• Obtain an EIN (Employer Identification Number) from the IRS

Timeline: Most states process LLC/PLLC formations within 1-2 weeks. Some offer expedited processing for an additional fee.

Step 2: File Form 2553 (S-Corp Election)

Once your LLC/PLLC exists, you file Form 2553 (Election by a Small Business Corporation) with the IRS to elect S-Corp tax treatment.

Critical timing rules:

• For new LLCs/PLLCs: File Form 2553 within 2 months and 15 days of forming your LLC/PLLC, or by March 15 of the tax year you want the election to take effect

• For existing LLCs/PLLCs: File by March 15 of the year you want S-Corp treatment to begin

Example: You form your PLLC on January 10, 2026. To have S-Corp treatment for all of 2026, you must file Form 2553 by March 15, 2026.

Late election relief: If you miss the deadline, the IRS offers relief under Revenue Procedure 2013-30, but it requires additional paperwork and a reasonable cause explanation. Don't rely on this, file on time.

Step 3: Set Up Payroll

You're now required to run payroll for yourself as a W-2 employee.

You'll need:

• Payroll software (Gusto, QuickBooks Payroll, ADP) or a payroll service provider

• State unemployment insurance account (SUTA)

• Workers' compensation insurance (if required in your state)

Payroll frequency: Most physicians run payroll monthly to simplify bookkeeping, though biweekly is also common.

Don't DIY payroll: Unless you're a CPA or have significant accounting experience, outsource this. Payroll tax mistakes are expensive and time-consuming to fix. A good payroll service costs $50-$150/month.

Step 4: File Quarterly Payroll Taxes

Your business must file Form 941 (Employer's Quarterly Federal Tax Return) every quarter.

It must include:

• Wages paid

• Federal income tax withheld

• FICA taxes (both employer and employee portions)

Deadlines: April 30, July 31, October 31, January 31

You'll also need to deposit payroll taxes regularly (either monthly or semi-weekly depending on your payroll size, though most physicians are monthly depositors).

Penalties for late filing: The IRS does not mess around with payroll tax penalties. Late Form 941s can result in penalties of 2-15% of unpaid taxes. Stay on top of this.

Step 5: File Annual Tax Returns

Calendar year S-Corps file Form 1120-S (U.S. Income Tax Return for an S-Corporation) annually by March 15 (or September 15 with an extension).

This is a separate return from your personal Form 1040, though the income flows through to your personal return via Schedule K-1.

Key forms:

• Form 1120-S: The S-Corp tax return

• Schedule K-1: Your personal share of income (you'll receive this from your S-Corp and report that activity on your Form 1040)

• Form W-2: Your salary (reported on your personal Form 1040)

• State S-Corp returns: Most states require a separate S-Corp return

Cost: Expect to pay $1,000-$3,000+ for S-Corp tax return preparation, depending on complexity.

The Bottom Line: Is an S-Corp Right for You?

You should probably wait on an S-Corp if:

• Net 1099 income < $100K annually

• Income is sporadic or likely to decrease

• You're overwhelmed by current administrative tasks

• You're a resident or fellow with income-driven loan repayment

You should strongly consider an S-Corp if:

• Net 1099 income ≥ $150K annually

• Income is stable and predictable

• You're willing to manage (or outsource) payroll and compliance

• You want to unlock advanced retirement and tax planning strategies

You should absolutely talk to your tax team if:

• You're earning $200K+ in 1099 income and haven't restructured yet

• You're unsure whether your current structure is optimized

• You're planning to scale your practice or add new revenue streams

The S-Corp is a powerful tool, but it's not one-size-fits-all. The right structure depends on your income level, practice structure, long-term goals, and risk tolerance.

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Disclaimer: This material is intended for educational and informational purposes only and does not constitute tax, legal, accounting, or financial advice. The content is general in nature and may not apply to your specific circumstances. Tax laws and financial regulations are subject to change and interpretation, and the application of these laws can vary based on individual situations. Before making any decisions, you should consult with a qualified tax advisor, legal counsel, or financial professional.

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