For dental practice owners, it’s important to understand the nuances associated with forming an S Corporation, as it can mean the difference between getting to keep more of the money that they earn, and paying more in taxes than they need to.
However, it isn’t quite true to say that by forming an S Corporation, dental practices can automatically lower their taxes. As professional accounting services for dentists will tell you, the reality is a little more complex.
Read on to learn how to maximize your savings and grow wealth as the owner of a dental practice S Corporation:
S Corporation basics
As flow-through entities, the profits and losses of S Corporations are passed through to the owner, who reports them on their personal tax return. The owners of S Corps, unlike sole proprietors, are classed as employees of their corporation, allowing part of their income to be taken as W2 wages, as well as distributions.
When managed effectively, this distinction can create a significant tax advantage for dental practice owners.
The important difference between W2 wages and distributions.
W2 wages are subject to Medicare (FICA) and Social Security taxes, which currently totals 15.3% on wages up to $184,500, after which the only applicable portion is Medicare. Distributions, on the other hand, aren’t subject to Medicare, which means that dental practice owners can reduce payroll taxes legitimately, by balancing distributions and wages effectively.
Use of this strategy helps to lower taxes while the practice remains IRS compliant.
What is reasonable compensation?
S Corp owners are required by the IRS to pay themselves an amount deemed reasonable for their work. If they pay themselves too little in W2 wages, an audit might be triggered and distributions may be reclassified as wages, leading to penalties and back taxes.
too little in W2 wages can trigger audits and reclassification of distributions as wages, leading to back taxes and possible penalties.
Here are the reasonable compensation guidelines for dentists:
- Minimum W2 – for a modest practice, at least a six figure sum
- Moderate to high-profit practices – W2 should scale with income to stay reasonable
- Maximum W2 – usually capped at $360,000 for retirement funding purposes
When allocated properly, compliance is assured, savings can be made on taxes, and retirement contributions maximized.
Strategies for retirement plans
Owners of S Corps can fund Profit Sharing, 401(k) Safe Harbor or Defined Benefit plans, but contributions are tied to W2 wages. As W2 wages increase, the higher the permissible level for contributions, and the greater the tax deductions.
The importance of cashflow integration
Every decision made about W2 wages or equipment purchases, can have an impact on cashflow, hence S Corp strategies and tax planning should never be viewed in isolation.
For instance:
- Investing in new equipment for deductions without properly planning cashflow, can cause problems for the following year
- When funds are allocated to retirement plans, dental practices must carefully consider their overheads, debts, and personal living expenses.
- When proper planning is carried out, any excess cash can be made available for the growth of the practice, or for personal pursuits
To get the most out of an S Corp as a dental practice, you should work closely with an experienced firm who provide bookkeeping for dentists in Miami, as well as accounting and tax guidance. They will regularly review your allocations for W2s and distributions, help you to align your retirement contributions with W2 to maximize deductions, and guide you on making equipment purchases so that your needs in terms of cashflow and tax planning, can be met. When carried out effectively and legitimately, S Corp strategies can help dentists save many thousands of dollars every year, accelerate their retirement savings, and give them the financial freedom they’ve worked so hard to achieve.
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