Understanding S Corporations for Physicians: The Good, the Bad, and the Myths, Part 2/2
What Every Physician Should Know Before Electing S Corp Status
In Part 1, I explained that an S corporation is a tax election, not an entity election, allowing pass-through taxation instead of the double taxation plagues by C corporations. I also covered the process of forming a state-level entity (PC or PLLC) in order to make a S corporation election. Lastly, I shared that while S corporations provide some liability protection, they do not shield personal assets from malpractice claims, making malpractice insurance essential.
Here’s Part 2.
What Are the Compliance Requirements for an S Corporation?
There are several important requirements that you must follow to maintain S corporation status and avoid unintended and costly tax consequences.
#1: Maintaining S Corporation Eligibility
The tax rules for maintaining S corporation status can be complex, and failure to comply may result in the termination of the S election.
For instance, if you own 100% of an S corporation and marry a non-resident spouse while living in a community property state, your S corporation status could be automatically terminated unless your spouse makes a §6013(g) election to be treated as a U.S. resident for tax purposes. If the election is not made, your business would default to a C corporation, which is subject to double taxation—first at the corporate level and again when profits are distributed to shareholders.
#2: Payroll & Reasonable Compensation
As an S corporation owner, you must pay yourself a reasonable salary if you actively provide services to the business. Although you own 100% of the S corporation, the S Corp is a separate legal entity, and you are considered an employee of the corporation. The salary must reflect fair market value for your role and services.
Key Considerations for Reasonable Compensation:
The salary should not be an arbitrary amount or solely based on the Social Security wage base to maximize payroll tax-free dividends.
Compensation must be properly analyzed and justified to withstand IRS audit.
While the IRS audit rate for reasonable compensation is relatively low, compliance is essential to avoid penalties
To ensure payroll compliance, you will need payroll services (e.g., Gusto, ADP) to withhold and remit payroll taxes like any other employer.
For a sole S corporation, annual payroll processing fees typically cost around $1,000 per year.
#3: Annual Tax Filings
S corporations are required to file a separate tax return each year using Form 1120-S.
Filing Deadline: The deadline for filing Form 1120-S is March 15, which is one month before the personal tax return deadline (April 15). A six-month extension is available if needed.
Late Filing Penalties: Failing to file on time can result in significant IRS penalties. In 2025, the penalty for a late S corporation return is $255 per shareholder per month, up to 12 months.
Tax Preparation Costs: Hiring a reputable CPA to prepare an S corporation tax return typically costs $1,000–$3,000 per year. S corporation tax law is complex, and only tax professionals with proper training and regular experience in preparing S corporation tax returns can competently handle the filing.
#4: Corporation Formalities
Maintaining corporate formalities is critical to preserving liability protection and ensuring your S corporation remains compliant.
Key Corporate Formalities:
Hold annual board meetings and maintain official meeting minutes.
Appoint a board of directors (e.g., your spouse or adult children) and hold formal board meetings.
Keep personal and business finances separate—always use a separate corporate credit card for business expenses and maintain proper documentation (e.g., receipts) to ensure compliance.
Pro Tip:
You can take advantage of the Augusta Rule for tax benefits when holding board meetings. For example, if you host a board meeting at a resort, the related expenses could be deductible as a business expense—provided you follow IRS guidelines.
Common Myths About S Corporations
There are several myths about S corporations. Here are a few common misconceptions I’d like to debunk:
#1: “An S corporation allows more business deductions than a sole proprietorship.”
False!
Most business deductions are available to both S corporations and sole proprietorships. The primary exception is the Pass-Through Entity Tax (PTET), which applies only to S corporations and not to sole proprietorships.
#2: “I can avoid payroll taxes by taking all my S corporation profit as dividends.”
False!
The IRS requires that reasonable compensation be paid before an S corporation distributes any remaining profits to the owner as dividends.
Reasonable compensation is the fair market value of the services you provide on behalf of your S corporation. If you actively work for the corporation, you must take a salary that reflects the nature and extent of your role.
#3: “An S corporation always provides significant tax savings.”
Not necessarily.
While S corporations offer payroll tax-free dividends, they also come with added costs, such as:
State-level franchise tax (e.g., California imposes a 1.5% tax on net income or a $800 minimum tax).
Administrative and compliance costs (e.g., payroll processing fees, tax preparation costs)
Due to these additional expenses, an S corporation may not provide tax savings at all. You must analyze your specific situation to determine whether an S corporation is financially beneficial.
For an in-depth comparison, check out my S corporation vs. sole proprietorship analyses for:
Attending physicians with W-2 & 1099 income
#4: “An S corporation is always the best choice for physicians.”
Not true.
In some cases, a C corporation may actually be a better option, particularly for physicians with high medical expenses that are not covered by insurance.
Why?
A C corporation can provide tax-free medical benefits through a Health Reimbursement Arrangement (HRA)—a tax advantage not available to fully owned S corporations.
How an HRA Works in a C Corporation:
Step 1: The C corporation hires your spouse as an employee.
Step 2: The C corporation offers the spouse an HRA.
Step 3: The HRA reimburses your family’s uncovered medical bills.
Step 4: The C corporation deducts those expenses as a business expense.
This strategy converts personal medical costs into deductible business expenses, making a C corporation the better choice in certain situations—especially for physicians with high medical expenses.
Final Thoughts: Is an S Corporation Right for You?
An S corporation can potentially provide payroll tax savings and access to Pass-Through Entity Tax (PTET) deductions, but it also comes with additional administrative burdens, compliance costs, and state-level franchise taxes.
Before making an S election, physicians should carefully evaluate:
Liability Protection Needs – Do you need protection from business liabilities other than malpractice?
Expected Tax Savings vs. Additional Costs – Will the tax savings outweigh the added costs of maintaining an S corporation?
Comfort Level with Compliance Requirements – Are you prepared to manage payroll, tax filings, and corporate governance rules?
S corporations are not a one-size-fits-all solution. The best choice depends on your individual financial situation and long-term business goals.
Pro Tip: Tax laws change, and your financial situation evolves—work with a tax professional who scan determine the best strategy for your practice.
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