The Dental Lawyer | Innovative Tax Strategies for Dental Practices Part 1: Taking a Reasonable Salary

It has been preached by many canons in the industry that a dental practice is a vehicle to bring a dentist from dental school to retirement.  A dental practice, however, can also be made into an incredibly efficient and alluring vehicle of another type.  A tax vehicle.  Here are some strategies every practice should entertain.  Keep in mind that while these are general tips, an accountant or tax attorney is almost always going to be able to provide your particular practice with the most tax efficient strategies for your particular practice.

      Taking a “reasonable salary” – For those practices which are taxed as a corporation taking a reasonable salary and retrieving additional funds as a dividend can allow the owner to save on FICA taxes (Social Security, Medicare), and other items which are “automatically” deducted from someone’s paycheck.  Here’s how it works. 

When an owner pays himself a salary he is required to pay certain federal and state taxes and fees (noted above).  For many of these taxes and fees, the employer actually gets hit twice as it is the employer’s responsibility to match the employee contribution.  For example, if the doctor has an employee who has $20 withheld from her paycheck for FICA taxes it is the employer’s responsibility to match that $20 with an employer contribution in the same amount.  This means that when the owner is being paid as an employee, the owner is actually seeing twice the amount of these taxes and fees being withheld as the owner is responsible for both the employee and employer portion. 

The way to avoid these taxes and fees would simply be to not take a salary at all and simply take one’s entire income as a dividend from the corporation.  The amount taken as a dividend would still be subject to income taxation, generally, at ordinary income tax rates (as is all money you would receive as a salary).  The benefit would be avoiding all of the withholding taxes which are “automatically” deducted from a normal paycheck.  This apparent loophole is known to the IRS, and as a result owners of corporations like dental practices are required to take a reasonable salary.

Whether or not the practice owner is taking reasonable salary is somewhat subjective, but the IRS and tax court will look at:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to non-shareholder employees
• Timing and manner of paying bonuses to key people
• What comparable businesses pay for similar services
• Compensation agreements
• The use of a formula to determine compensation

(source IRS FS-2008-25, August 2008 Wage Compensation for S Corporation Officers)

The IRS is fairly strict and increasingly aggressive in making sure that individuals don’t dodge taxes by taking dividends instead of salary, so it’s important to play by the rules.  It is however still possible to arrive at a significant tax savings by taking some of the would-be profit of the corporation as a dividend.   Taking the above factors into consideration, the practice owner should set himself a reasonable salary for his location.  The rest should be taken as a dividend.  The amount taken as a dividend will rightfully avoid some taxation which would result if that amount was taken as a salary.