Here is a pattern that comes up often enough to be worth examining closely. A three-dentist practice generates approximately $2.4 million in annual collections. The owner, an active practicing dentist, takes a $95,000 W-2 salary and roughly $600,000 in distributions. This is an illustrative fact pattern, not an actual NexusWorks client – but the shape of it, a modest salary next to a large distribution on a profitable S-corporation, is exactly the pattern that draws scrutiny under the IRS’s S-corp reasonable compensation rules.
It would be easy to look at that $95,000 figure next to $600,000 in distributions and conclude it is obviously too low. It would be just as easy to assume the owner is fine because two other dentists also produce revenue. Neither conclusion follows from the numbers alone. Before any judgment is possible, the analysis has to answer a longer list of questions: How much clinical work does the owner actually perform, and how many hours a week? What procedures does the owner perform, and how does that compare to the associates? Does the owner manage the practice – hiring, scheduling, vendor relationships, compliance – and supervise the other dentists? What would it cost to hire a dentist and a practice manager to do what the owner does? What portion of the $2.4 million in collections traces to the owner’s own chair time versus the associates’ production, and how are those associates compensated? How much of the practice’s profit really comes from employees, equipment, and brand rather than the owner’s personal effort? What has the owner’s compensation looked like historically, and is there a written methodology behind the $95,000 figure, or was it essentially arbitrary?
Revenue and distributions alone do not establish whether compensation is reasonable. But a large disparity between a modest salary and large distributions is exactly the fact pattern that warrants a documented analysis – not because the hypothetical owner is doing anything wrong, but because “we never looked into it” is not a position anyone wants to defend later. S-corp reasonable compensation for a medical or dental practice is best answered with a documented, facts-based process, not a rule of thumb, and the rest of this guide works through how that process actually runs.
Reasonable compensation is the amount an S-corporation shareholder-employee should receive as wages for the services they actually provide to the business, based on the facts and circumstances rather than a universal percentage of revenue.
The underlying rule is straightforward: an S corporation must generally pay reasonable compensation to a shareholder-employee for services performed before making non-wage distributions. Wages are compensation for personal services; distributions are attributable to the shareholder’s ownership interest, capital, and the contribution of non-shareholder employees and equipment. When the IRS believes an S-corp has understated wages and overstated distributions, it has authority to reclassify some or all of those distributions as wages – bringing payroll tax, penalties, and interest with it.
It is also worth being precise about what a distribution is: not automatically tax-free. Treatment depends on the shareholder’s stock basis and other factors, and distributions in excess of basis can create taxable gain. This article’s focus is reasonable compensation, but “distribution” is not synonymous with “no tax consequence.”
The IRS has not published a formula. It has published factors, drawn from the case law it relies on, examining what the shareholder-employee actually did for the corporation by looking at the source of its gross receipts – the shareholder’s personal services, services of non-shareholder employees, or capital and equipment. Applied to a medical or dental practice, those factors translate into specific, answerable questions.
IRS Factor | What to Ask in a Medical or Dental Practice |
|---|---|
Training and experience | What credentials, specialty, board certification, and years of experience does the owner have? |
Duties and responsibilities | Is the owner primarily clinical, managerial, executive, or some mix of all three? |
Time and effort devoted to the business | How many hours or days per week does the owner actually work, clinically and administratively? |
Comparable compensation | What do similarly trained professionals earn for comparable duties in a comparable market? |
Compensation agreements | Is there a written employment or compensation arrangement, or was the figure set informally? |
Payments to non-shareholder employees | What are the associate dentists, physicians, or clinical staff being paid for similar work? |
Dividend/distribution history | How much has the owner received as distributions relative to wages, and how has that ratio changed over time? |
Timing and manner of bonuses | Are bonuses formula-based and consistently applied, or discretionary and irregular? |
Source of gross receipts | How much of practice revenue traces to the owner’s own services versus associates, staff, and capital? |
Almost every reasonable-compensation dispute comes down to this question, broken into three distinct categories that are easy to blur together in a closely held practice.
Patient care, procedures, diagnoses, treatment planning, surgery, and chair time are the most direct form of compensable service. Production directly attributable to the owner’s own clinical work – distinct from the practice’s total collections – is a central data point, along with any clinical supervision over associates or hygienists.
Hiring, vendor negotiation, scheduling oversight, regulatory compliance, financial management, and strategic planning are real services with real market value, even though none show up in a chair-time report. An owner who spends fifteen hours a week on administration is performing services a non-owner practice manager would otherwise be paid to do.
Owning stock in the S-corporation is not itself a service. The return an owner receives simply for having capital at risk – the equipment, facility, brand, and referral relationships the practice has built – is compensation for ownership, not labor, and belongs in distributions rather than wages. Separating “compensation for services” from “return on ownership” is the central distinction the whole analysis turns on.
In a solo owner-operator practice, the owner performs nearly all revenue-producing clinical services personally, which makes the source-of-receipts analysis relatively direct: most collections trace back to the owner’s own chair time.
A practice with associates looks different. Revenue comes from some combination of the owner’s own services, the associates’ services, hygiene or other clinical staff production, and the practice’s capital and systems. This does not mean reasonable compensation should be calculated as a fixed percentage of total production – there is no such formula – but it does mean the analysis has to separately document the value of the owner’s own clinical output, the value of the owner’s management role over associates and staff, and how much of the remaining profit reflects their contribution rather than the owner’s.
A reasonable-compensation analysis should not be a one-page internet salary search performed once and forgotten. A defensible file has several components, gathered and updated on a recurring basis.
No single benchmark should automatically set the owner’s salary. The appropriate figure depends on percentile selection, geographic market, specialty, experience, full-time versus part-time status, the clinical-versus-management balance, actual production, practice size, and ownership-level responsibilities.
A useful sequence: role, then hours, then specialty, then geography, then comparable market data, then internal payroll evidence, arriving at a compensation rationale that ties it together. This is not a suggestion to default to the 50th percentile of a survey – the right point in the range depends on the practice’s specific facts.
The trade-off that makes this issue matter economically, not just legally, is straightforward: W-2 wages are subject to payroll taxes (Social Security and Medicare, generally called FICA, split between employer and employee), while properly classified S-corp distributions generally are not. That differential is precisely why the IRS scrutinizes S-corp compensation, and why it has authority to reclassify distributions as wages when the wages paid do not reflect the value of the services performed – this is a structural feature of the S-corp form, not a tax-free loophole to maximize.
Consider two illustrative scenarios on the same $2.4 million practice, with the same total owner compensation package of $695,000 split differently between wages and distributions:
Scenario | W-2 Salary | Distributions | What Still Needs Analysis |
|---|---|---|---|
Scenario A | $100,000 | $500,000 | Whether $100,000 reflects the value of the owner’s actual clinical and management services, given the source-of-receipts factors above |
Scenario B | $250,000 | $350,000 | Whether $250,000 is itself defensible, or overstated or understated relative to the owner’s actual role and comparable data |
Neither number can be judged correct or incorrect in isolation. Both scenarios require the same underlying analysis: what did the owner do, and what would it cost to pay someone else to do it.
The Section 199A qualified business income deduction allows owners of eligible pass-through businesses, including S-corporations, to potentially deduct up to 20 percent of qualified business income. The One Big Beautiful Bill Act (OBBBA) made §199A permanent for tax years beginning after 2025, removing the scheduled expiration, and widened the income phase-in ranges that apply to specified service trades or businesses.
A few mechanical points matter here. W-2 wages paid to the owner are not themselves QBI – QBI is measured at the entity level from net income, and wages paid out reduce that net income, so increasing shareholder wages can reduce QBI. At the same time, W-2 wages paid by the business factor into a separate wage-and-property limitation that can apply above the applicable income threshold, so “higher salary always reduces the QBI deduction” is not reliable either – the wage limitation can work in the opposite direction depending on the taxpayer’s full facts.
For tax year 2026, the IRS has published a §199A threshold of $201,750 for single and other non-joint returns and $403,500 for married filing jointly, with phase-in ranges completing at $276,750 and $553,500 respectively. These figures are adjusted annually for inflation; the 2027 amounts had not yet been released as of this writing and should be verified against the current IRS revenue procedure.
Healthcare is expressly included within the Specified Service Trade or Business (SSTB) definition under §199A – services in the field of health performed by physicians, dentists, and similar professionals providing care directly to patients generally fall within this category. The OBBBA left the SSTB rules themselves in place while expanding the phase-in ranges around them.
SSTB status does not automatically mean no QBI deduction. What matters is taxable income relative to the threshold and phase-in range above. Below the threshold, an SSTB can generally still receive full QBI treatment if otherwise eligible. Within the phase-in range, only an applicable percentage of QBI, W-2 wages, and qualified property is taken into account, phasing down as income rises. Above the phase-in range, the SSTB limitation can eliminate the QBI deduction attributable to that business entirely.
It follows that it is incorrect to say all dental or medical practices lose the QBI deduction – many owners with lower household taxable income remain fully or partially eligible. It is equally incorrect to say raising salary always increases QBI, or always decreases total tax; the interaction depends on where taxable income sits relative to the threshold and phase-in range.
Because wages, QBI, and retirement-plan capacity are all connected, a practice owner often needs to evaluate several variables at once rather than optimizing any one of them in isolation.
A lower salary can mean lower payroll-tax exposure and higher pass-through income, but greater reasonable-compensation risk and a QBI picture that depends on the owner’s overall taxable income. A higher salary can mean higher payroll-tax exposure and, depending on the facts, lower QBI from the entity – but also more W-2 compensation to support retirement-plan contribution capacity, and potentially lower taxable income after the resulting retirement-plan deduction. None of these outcomes is universal; each depends on the owner’s specific numbers.
A cash balance plan is a type of defined benefit plan that expresses each participant’s benefit as a hypothetical account balance, even though it is legally a defined benefit arrangement rather than a defined contribution one. The IRS recognizes cash balance plans within its defined-benefit-plan framework, and contributions to a properly designed plan are generally deductible to the employer, subject to applicable rules and limitations.
Medical and dental practice owners sometimes consider one when the practice has high, stable income, the owner is older with a shorter runway to retirement, cash flow supports a larger and less flexible annual contribution, and the owner wants to accelerate retirement savings beyond what a 401(k) or profit-sharing plan alone allows. A practice with multiple highly compensated owners, or one nearing sale, may find the calculus different.
What a cash balance plan does not offer is a fixed, predictable contribution the owner can simply choose. Contribution levels are determined through plan design and actuarial calculation by an enrolled actuary, based on the participant’s age, compensation, and plan formula, and the plan generally requires more consistent annual funding than a discretionary profit-sharing plan. It is not appropriate for every practice, and it should not be implemented without actuarial and legal design work specific to the practice.
This is the strategic question underneath much of the interest in this topic, and it deserves a careful answer rather than a promise.
The mechanics work roughly like this: the practice generates substantial profit; the owner’s compensation is reviewed and, where the analysis supports it, increased to a defensible level; the practice establishes an appropriately designed retirement plan, potentially including a cash balance component; employer contributions are made per the plan’s terms and the actuary’s calculation; and the resulting deduction can reduce taxable income – which can, in turn, affect where the owner sits relative to the §199A SSTB threshold and phase-in range.
What this does not mean is that increasing salary plus a cash balance contribution will automatically pull taxable income below the §199A phase-out. Depending on filing status, total taxable income, plan design, contribution amount, and other deductions, coordinated compensation and retirement planning can affect whether the taxpayer ends up below, within, or above the SSTB threshold – but it is a planning interaction to model with complete numbers, not a guaranteed result.
Returning to the hypothetical three-dentist practice: $2.4 million in collections, a $95,000 owner salary, $600,000 in distributions. Suppose the practice undertakes a documented reasonable-compensation review and has an actuary evaluate a cash balance arrangement. The table below shows the direction each variable might move – not a specific dollar result, which depends on facts this hypothetical does not specify.
Planning Variable | Before Review | Illustrative Revised Structure | Potential Effect |
|---|---|---|---|
Owner W-2 | $95,000 | A higher, benchmarked, defensible amount | Higher payroll-tax cost |
Distributions | $600,000 | Lower relative to salary | Different employment-tax treatment |
Retirement contribution | Existing 401(k)/profit-sharing only | Potentially higher if plan design and cash flow support it | May reduce taxable income |
QBI | Higher before any wage increase | Potentially different QBI and SSTB position | Requires full modeling of the owner’s facts |
Audit/IRS defensibility | Documentation-dependent | Stronger if supported by a written benchmarking file | Depends on the underlying facts and documentation |
Every figure above is illustrative only – it shows the direction of the interaction, not a calculated outcome for any actual practice.
A practical examination file should include:
☐ Employment agreement and written job description
☐ Payroll records, W-2s, and Form 941 filings
☐ Compensation benchmarking documentation, with sources cited
☐ Time records or a reasonable estimate methodology
☐ Production reports by provider, and practice financial statements
☐ Compensation data for other clinicians on payroll
☐ Owner distribution and bonus history
☐ Shareholder or board records, if applicable
☐ Written compensation methodology and documentation of how it was set and approved
☐ CPA or advisor analysis supporting the figure
☐ Records of any changes in the owner’s duties or compensation over time
The documentation should tell a coherent story: what did the owner do, what was that work worth, what evidence supports the figure chosen, and how was it approved.
This is a diagnostic checklist for organizing the analysis, not an IRS-approved scoring system and not a determination that any resulting score is “IRS compliant.”
☐ Owner role – clinical, management, and/or executive
☐ Time commitment – clinical, administrative, and management hours documented
☐ Practice economics – gross collections, owner and associate production, staff productivity, operating profit
☐ Compensation evidence – market, geographic, and specialty benchmarks, plus internal employee comparison
☐ Distribution pattern – W-2 salary, distributions, bonus history, and multi-year pattern
☐ Tax planning – QBI and SSTB position, taxable income, retirement and cash balance plan review, estimated taxes
☐ Documentation – written compensation agreement, benchmarking file, shareholder approval, annual review scheduled
NexusWorks put together a Healthcare Practice Tax & Owner-Compensation Scorecard to help medical and dental practice owners review current W-2 salary and distributions, clinical workload, management duties, compensation benchmarks, practice production, QBI and SSTB considerations, retirement-plan opportunities, and documentation quality in one place.
This scorecard is an educational planning tool and does not determine whether compensation is reasonable under federal tax law.
Get the Healthcare Practice Tax & Owner-Compensation Scorecard
Reasonable compensation is not an isolated payroll decision – it connects to federal income tax, payroll taxes, the QBI deduction, retirement planning, and practice cash flow. NexusWorks works with medical and dental practice owners to build a documented, defensible compensation analysis, coordinated with tax planning and strategy, tax filing and compliance, fractional CFO support, financial advisory and optimization, and accurate bookkeeping that supports the production data a benchmarking file depends on – part of NexusWorks’ broader healthcare industry advisory practice.
We do not guarantee audit protection, IRS acceptance of any compensation figure, tax savings, QBI eligibility, or a specific recommended salary without an actual engagement. What we offer is a structured, documented process for reaching a defensible number.
No universal IRS dollar figure or percentage exists. It is the wage a dentist-owner should receive for the clinical, management, and administrative services actually performed, benchmarked against comparable compensation for similar roles, specialty, hours, and geography.
The IRS looks at training and experience, duties and responsibilities, time devoted to the business, comparable compensation, distribution history, payments to other employees, bonus practices, and the source of the corporation's gross receipts.
Yes, but only after the shareholder-employee has been paid reasonable compensation for services performed. The IRS can reclassify distributions as wages, with payroll tax and penalties attached, when wages do not reflect the value of the services provided.
No fixed minimum exists in the Internal Revenue Code. The figure depends entirely on the shareholder-employee's actual services, evaluated using the IRS's reasonable-compensation factors and comparable market data.
Yes. The portion of practice collections directly attributable to the owner's own clinical work is one of the strongest pieces of evidence, particularly in a multi-provider practice where revenue comes from several sources.
