I own an S-Corp. I use to think that all you had to do was pay yourself a salary that was reasonable for a dentist and then take the rest in dividends.
That is the general “rule”.
So if my office profited 250,000, then I would pay myself 110,000 in salary (a fair salary for a dentist in my area) and then take out the remaining 140,000 in dividends. I think this somehow saves me taxes.
My accountant recently told me that it is more a percentage of the total amount of profit for your office and not a reasonable salary for a dentist. So if my office profited 400,000, i can’t just pay myself 110,000 salary and take out 290,000 in dividends. I would have to increase my salary, since my office profited much more.
Is my accountant right? Please tell me what you think.
Well, I don’t believe you’ll find anywhere in the tax code that defines “reasonable” as a percentage of the practice “profit”, so this may be what they use as their guide to avoid potential problems.
By the same token, you won’t find a definition in the code for reasonable as “fair salary for your area” and that doesn’t make you wrong.
It’s a judgment call. While $110,000 may be a “fair” salary in your area, if a doctor is producing $1 million would you expect a “reasonable” salary for them to be $110,000? Probably not.
Consider this: what do you think is a “reasonable” salary is for an OS specialist making $1.5 million BEFORE their W-2 comp and S-Corp dividend and producing nearly $3 million?
In my opinion taking $110,000 as W-2 comp and $1.390 million as S-Corp dividend is begging for trouble if audited. There’s simply no way I could support that $110,000 for this doctor was “reasonable” in this situation.
Point being, each situation is different with its own set of facts and circumstances. So, until the IRS comes out with a definition for “reasonable” you use your best judgment and keep your fingers crossed.