Reasonable Compensation for S-Corp Medical Practice Owners: How to Set Your Salary

By Brian Giesecke, CPA/EA | Giesecke Advisory

If you're a medical practice owner operating as an S-corp, you have to pay yourself a "reasonable salary."

But what does "reasonable" actually mean? And what happens if you get it wrong?

This is one of the most misunderstood parts of S-corp taxation for practice owners. Reasonable compensation is the IRS requirement that S-corp owner-employees pay themselves a salary that reflects the fair market value of the services they provide to the business. Let's clear it up.

Why Does Reasonable Compensation Matter for Practice Owners?

With an S-corp, your profit comes out two ways: salary and distributions.

Salary is subject to FICA payroll taxes — the combined rate is 15.3% (12.4% Social Security + 2.9% Medicare).

Distributions are not.

So there's an incentive to pay yourself a low salary and take the rest as distributions.

The IRS knows this. Which is why they require your salary to be "reasonable."

Get it wrong, and you're either paying too much tax or inviting an audit. Neither is great.

What Does the IRS Consider "Reasonable" Compensation?

The IRS looks at what someone in a comparable position would be paid.

Factors that matter:

• Your role — provider vs. manager vs. both
• Your specialty
• Your geography
• Hours worked
• Practice size and revenue

There's no magic formula. But there are data sources — MGMA compensation surveys, Bureau of Labor Statistics (BLS) data, AMGA benchmarks, and regional industry reports — that help justify your number. The IRS references these same sources, so you should too.

What Are the Most Common S-Corp Salary Mistakes?

Paying yourself way too little. $40,000 salary when you're taking $300,000 out of the business. That's a red flag. No physician works full-time for $40,000.

Paying yourself too much. $250,000 salary when $150,000 would be reasonable. You're paying unnecessary payroll taxes.

Not documenting your reasoning. Even if your salary is reasonable, you need to explain why. Keep notes. Reference data sources.

How to Determine Your Reasonable Compensation

Step 1: Research comparable salaries. What would you pay someone to do what you do?

Step 2: Consider your profit. Your salary needs to be sustainable relative to what the practice makes.

Step 3: Apply a reasonable percentage. For physician-owners who are also primary providers, 50-70% of total distributions as salary is common.

Step 4: Document it. Write a memo explaining your reasoning.

The real test: Could you defend this number if asked?

What If You've Been Setting It Wrong?

Don't panic. Fix it going forward.

Increase (or decrease) your salary to a reasonable level this year. Document your reasoning.

For large discrepancies, consider consulting with a tax professional about your options.

Key Takeaways

• The FICA payroll tax rate is 15.3% (12.4% Social Security + 2.9% Medicare) — this is what you save on distributions vs. salary
• There is no IRS formula for reasonable compensation — it's based on comparable market data for your role, specialty, geography, and hours
• For physician-owners who are primary providers, 50-70% of total compensation as W-2 salary is a common defensible range
• Documentation is required — keep a written memo referencing MGMA, BLS, or other benchmarks to justify your salary
• Setting compensation too low is an audit trigger; setting it too high wastes money on unnecessary payroll taxes

FAQ

Can the IRS reclassify my distributions as salary? Yes. If the IRS determines your salary is unreasonably low, they can reclassify distributions as wages subject to FICA taxes — plus penalties and interest. This is reported and enforced through payroll tax audits.

How often should I review my reasonable compensation? At least annually. If your role, hours, revenue, or practice size changes significantly, your salary should adjust to reflect that. A compensation memo updated each year is your best defense.

The Bottom Line

Reasonable compensation isn't about finding the lowest number you can get away with. It's about finding the right number — one that's defensible and tax-efficient.

Get it right, and you save money legitimately. Get it wrong, and you're creating risk.