Most doctors who elect S corp status get one thing wrong: their salary. They pick something round — $100,000, maybe $150,000 — because a colleague mentioned it at a conference. Then they distribute the other $200,000 and hope nobody asks.
Someone asks eventually (end of the year). Here's how to set the number correctly the first time.
Once you elect S corp status, draws-only stops being an option
If you're a sole proprietor or a single-member LLC taxed as one, you don't have a salary. You take draws, and you pay self-employment tax on every dollar of profit. Simple.
An S corp changes the rules. The IRS requires any shareholder who performs services for the corporation to be compensated as an employee — W-2, payroll taxes withheld, quarterly 941 filings. You can still take distributions on top of that salary. You just can't take *only* distributions. I wish I had a nickel for every doctor I have met who said, "I don't take a salary. I just pay myself when I need it." Pay in this case means just a withdrawal from the business bank account.
When doctors ask whether a business owner should be on payroll, the answer is always "YES" if you're an S corp shareholder seeing patients. Not optional. The real question is how much goes through payroll and how much comes out as distributions — the owner draw vs salary S corp split that determines your actual tax bill.
What "reasonable" means for a physician
The IRS doesn't publish a formula. It publishes factors: your training, your duties, the time you devote to the practice, what comparable practices pay for comparable work, and what the business could pay a non-owner to do your job.
That last one is the practical test. If you'd have to pay a hired physician $160,000 to cover your patients in the coming year, your salary shouldn't be $40,000. Physician reasonable compensation should track real market data — MGMA, AOA and AMGA specialty surveys, regional salary benchmarks, employment offers from local hospital systems. Keep the data in your file. A benchmarked number with documentation behind it survives an audit. A round number pulled from memory does not.
One adjustment matters: if you also manage the practice — hiring, contracts, billing oversight — that administrative time is compensable too, and it pushes the number up, not down. Conversely, if you're part-time or the practice employs other providers generating revenue you don't personally produce, a portion of profit is genuinely a return on the business rather than payment for your labor. That portion belongs in distributions. Think of it this way — I get a salary because I am a working doctor. I get distributions (a return on my investment) because I am an owner. Value each role accordingly.
The math, run honestly
Say your practice nets $420,000 after expenses. You set a defensible salary of $240,000 and distribute the remaining $180,000.
Above the Social Security wage base, self-employment tax is 2.9% Medicare plus the 0.9% Additional Medicare Tax on earnings over $250,000 for joint filers. That's 3.8% on the distributed $180,000 — roughly $6,800 in savings compared to taking the full $420,000 as self-employment income. Real money, but not the five-figure windfall people expect at this income level.
The bigger savings show up for physicians netting $200,000 to $300,000, where a meaningful chunk of distributions falls below the wage base and escapes the full 12.4% Social Security portion. There, the swing can clear $12,000 a year.
One more item to consider. Your W-2 wage determines your retirement contribution ceiling — a salary set too low caps your 401(k) employer contribution and can cost you more than the payroll tax you saved.
Not sure where your practice lands? Find out which service fits your practice with our Financial Health Quiz — it takes about four minutes.
If the IRS says your number is too low
They reclassify distributions as wages. In *Watson v. United States*, an accountant paid himself $24,000 and the court upheld reclassification to $91,044 per year. Physicians have less room to argue than accountants, because specialty salary data is abundant and specific.
The tax bill includes back payroll taxes on the reclassified amount, failure-to-deposit penalties, interest from the original due date, and often a 20% accuracy-related penalty. Three open years compound fast.
The defense is boring and effective: a written compensation study, salary survey data matched to your specialty and region, and payroll actually run on schedule with deposits made on time. Medical practice payroll setup done properly costs less than one week of an examination.
Set it once, review it yearly
Your S corp salary for doctors shouldn't be static. Revenue changes, your clinical hours change, and market compensation moves. Review it every January before the first payroll of the year — not in April when it's already history.
Ratio handles payroll and tax services for medical practices nationwide. We reconcile books daily, so your financials are never more than 24 hours old, and we run tax strategy year-round instead of once in the spring. We charge a flat monthly fee. No hourly billing and no contracts. QuickBooks Online ProAdvisor certified, 200+ clients. Give us a try. Your wallet will thank you.
Request a proposal for owner payroll setup and we'll price it in writing.