Dentist’s Compensation: More Than Just a Paycheck
By Jon Almeida, CPA, CFE, ABV, Partner, Tax & Business Services
Dental practitioners who own their own practices sometimes wonder how much they should pay themselves. However, they don’t generally consider the importance of separating their earnings for time spent caring for patients and managing the business from the profits of the practice. Some common thoughts are “I own the business and all the profits are mine, so why does it matter what I pay myself?” or “I’d like to take as high a salary as possible because that means I’m earning more, right?”
In a practice with multiple owners, practitioners are forced to tackle the compensation issue head-on due to owners’ competing interests. These practitioners need to settle on a compensation model that accounts for the revenues each individual practitioner brings to the practice, the management duties performed, and the various benefits owners receive from the practice. This is not so in a Sole owner practice, so these considerations are sometimes ignored.
Beyond the obvious equitable considerations of a multi-member practice, all practitioner-owners should be aware of the taxation and valuation considerations related to setting their compensation.
How is compensation determined?
Dentist compensation can vary significantly by specialty, years of experience, number of patients seen per day, number of days worked, and by region. A common formula used for a setting compensation of general practitioner is 30-35% of collections attributed to the dentist, and may be net of lab fees. A specialty practitioner may earn 40% of collections. Also, procedural differences can impact a salary entitlement. For example, a 2022 salary survey conducted by DentalPost indicated that on average, general dentists in private practice who do implants earn $105,000 more annually than dentists in private practice who do not. Another variable affecting compensation is the amount of time the owner spends actually managing the practice, as opposed to working in the practice. An allowance for these services should be added to the practitioner’s salary when applicable.
Tax Considerations
Internal Revenue Code Section 162 states “there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered”. As such, the practitioner needs to focus on whether or not their compensation is “reasonable.”
Depending on the structure of the entity, the practitioner may need to consider whether their compensation is too low or too high with respect to income tax exposure.
In the case of a C-corporation structure, where profits are taxed to the corporation, an owner also pays a dividends tax to receive those profits from the corporation. The Federal C-corp tax rate is currently 21%. For a long-term holding, dividends tax rates range from 15-20%. In this case, an owner may desire to increase their compensation, thereby reducing profits that are subject to double taxation as dividends when paid to the shareholder. However, the owner’s compensation still needs to be within a reasonable range for the services rendered.
In the case of an S-corporation structure, where operating profits are taxed to the individual shareholder at ordinary rates ranging from 10% to 37% and distributions are not taxed, the owners may wish to decrease their compensation to increase profits as much as possible. This is done to avoid paying compensation that is subject to Social Security and Medicare taxes, in addition to income taxes. Also, these increased profits could be subject to a 20% qualified business income deduction benefit, subject to certain income limits. However, under audit the IRS may seek to reclassify profit distribution payments as wages subject to payroll taxes if the S-corporation shareholder is not deemed to be taking reasonable compensation for services provided.
Valuation Considerations
Dental practitioner-owners also run up against the compensation question when it comes time to value their practice. They may need a valuation for a prospective sale, divorce, buy-ins or buy-outs of partners or shareholders, estate planning, or gifting considerations. Businesses are commonly valued based on the income the business can generate. An income approach determines value based on the business’s ability to generate an income stream for the investor/owner into the future, and the application of a risk factor to the income stream in arriving at a value. Therefore, the more compensation that is required to provide patient care and manage the practice, the lower the income stream to the owner and the lower the value of the practice. Conversely, the lower the compensation required, the higher the practice value.
It is also important to note that it is not just the dentist’s salary that affects the value calculation in an income approach. If there are certain discretionary items that the dentist is receiving, such as automobile or meals and entertainment expenses that are not deemed necessary to support the income stream, these items must be added back to income in calculating value.
In the case of estate or gift valuations, the Internal Revenue Service may question whether compensation is considered reasonable for the services provided. The Service looks to ensure that compensation is not excessive, such that it reduces the income of the practice and in turn reduces the practice value. A Job Aid for IRS Valuation Professionals issued by the IRS in 2014 provides clues as to what the IRS looks at in assessing reasonable compensation. These factors include the qualifications of the individual, the amount of time devoted to the activities, whether multiple roles are performed, and whether compensation is equivalent to other employees in similar-sized companies with similar roles.
Conclusion
Dental practitioners should carefully consider the salary they pay themselves for their services. These considerations should go beyond merely what cash flow allows and should include industry practices, experience, duties, hours worked, and comparative analysis. As CPAs and advisors at Marcum, we can assist dental service providers in assessing whether their compensation is reasonable by analyzing activities, practice data, benchmarking, and research tools to properly address both tax and valuation concerns.
