Why a Sole Proprietor Dentist Should Consider an S Corporation Election

Introduction

Many dentists file taxes as sole proprietors. In the past two weeks alone, we’ve talked to three dentists who are filing taxes as sole proprietors. Unfortunately, they are missing out on the tax savings that come with an S corporation structure. This blog post outlines how you might benefit from switching to an S corporation if you’re a dentist that currently operates as a sole proprietor.

Am I a Sole Proprietor?

If you file a Schedule C – Business or Profession on your Form 1040 personal income tax return, then you are considered a sole proprietor. You might be filing under your personal name, a DBA (doing business under an assumed name), or as a single-member LLC.

Tax Savings on Self-Employment Taxes

As a sole proprietor, all of your net income is subject to self-employment taxes. This includes Social Security and Medicare taxes. However, if you switch to an S corporation structure, you could easily reduce both of these taxes. Here’s how:

• Reduced Self-Employment Tax Liability: With an S corporation, you can pay yourself a reasonable salary. This salary is subject to payroll taxes, but the remaining profits can be taken as distributions. Distributions are not subject to self-employment taxes, so this strategy can save you several thousands of dollars each year. 
• Salary vs. Dividends: S corporation shareholders can decide how much of their earnings will be treated as a salary (subject to payroll taxes) and how much will be treated as dividends (not subject to self-employment taxes). Dividends are also commonly called “distributions.” This flexibility allows you to optimize your tax situation. 
• Reasonable Salary: The IRS requires S corporation owners to pay themselves a reasonable salary. If your salary is too low, the IRS may scrutinize it. Setting a fair salary is important to avoid penalties. Dental practices are in a good position to divide net income between the dentist’s salary and owner distributions. Dental practices generate profit from several sources — capital investment in equipment, the efforts of the team, and the dentist’s personal work. This means you can justify a significant portion of your income as distributions, since the equipment and team are essential to generating profits. 
• State Tax Considerations: Some states offer additional tax benefits or protections to S corporations that sole proprietors don’t receive. However, it’s important to talk to a tax professional to understand how state laws might impact your situation. 
• Financial Benefits: Switching to an S corporation can also help protect your assets and allows you to gain more control over your income. This can lead to substantial financial gains for your dental practice and for your future retirement. 

So, if you’re currently filing your taxes as a sole proprietor, it might be time to reconsider your options.

Administrative Requirements

S corporations require more administrative work than sole proprietorships. This includes maintaining corporate records, holding shareholder meetings, and filing separate tax returns. These responsibilities should be considered alongside the above benefits. Generally, the tax savings will outweigh the administrative costs when the S corporation’s net profit after expenses exceeds $50,000 per year. Most sole proprietor dentists have income that far exceeds this amount, so it’s a smart and tax-effective solution.

While you can elect S corporation status yourself, we highly recommend working with a tax professional to get everything set up correctly. A tax professional will check your eligibility status and make sure that you fulfill the requirements. They can help with filing the Articles of Incorporation with your state, assist with obtaining an EIN, and help you set a reasonable salary to avoid IRS scrutiny.

Conclusion

For a dentist currently operating as a sole proprietor, choosing to become an S corporation can offer significant tax advantages. It can also provide increased asset protection and greater flexibility in managing your income. However, it’s essential to consult with an experienced tax professional or dental CPA. They can help you evaluate whether this change aligns with your financial goals, set an appropriate wage, and help you navigate the complexities of the transition.

To find out more about electing S corporation status and the numerous tax advantages available, book a free consultation with our expert team of Dental CPAs here at DrillDown Solution.

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