Dental S-Corp Fair and Reasonable Compensation Question

For those who are an S Corp, what ratio of overall compensation to the dentist should be classified as salaried as opposed to dividends? I do the payroll but I'm thinking I've got my husband (dentist) salary too low. As I look at the end of the year numbers, I'm afraid I'm setting us up for an audit by pulling out too much money as dividend income that we aren't paying SS or Medicare taxes on. In terms of overall compensation, is there a ratio that is "safe" enough to not be a red flag to the IRS - like 80% salary, 20% dividends?

It has little to do with ratio of W-2 to dividends and everything to do with "fair" or "reasonable" compensation for services rendered.

Don’t let the fear of an audit make you overpay. Here’s an real case\client:

I have a client who owns a 50% interest in four fast food stores. He and his partner took W-2 wages of maybe $4k each for the past 10 years or so. Their dividends each year were easily $300k+ each. This was one of my S-Corp clients that got audit because if low wages. You’d think they got screwed right?

Nope, it's facts and circumstances.

My client is a dentist and works 5 days/week in his practice, his partner in the fast food stores lives about 1,000 miles away in another state and has his own construction company. They have a full time manager to oversee ALL the stores and each store has its own manager. My clients W-2 wage is paid for his services at quarterly or semi annual meetings to discuss store operations and performance.

IRS audited and left it alone. So it's not about a ratio of wages to dividends, it's about "fair" or "reasonable" compensation for services rendered.

So is Fair and Reasonable considered what an average associate might be hired for to perform the same job duties?

Generally, yes. Look at what your husband produces and consider what you might have to pay someone to replace that production. You’d have to consider the same question if he became disabled, god forbid. How much would you have to pay to get someone in there to produce what he does? Is it a flat salary? Is it a percentage of production, percentage of collections? Obviously you want to hire someone for the least amount of money the market will bear. You’d also need top consider any management duties he might perform, UNLESS they could be shifted to someone else, which is usually the case.

I thought the average salary for a dentist was somewhere around $150,000 a year, is that a good bench mark?

That's certainly one number to consider, however, if that's an average it may NOT be relevant to your specific situation, that's where a percentage of production or collection may actually be closer to reality. So again, it simply gets back to what you would offer someone off the street to produce what your husband produces.

This post originally appeared on Dentaltown.

Send your questions to Tim Lott, CPA, CVA at tlott@dentalcpas.com

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