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Why Optometry and Ophthalmology Practices Should Consider Being S Corporations

by Matt Geller, OD and Gary Topple, CPA
Mar 18, 2020
13 min read

Seasoned practice owner? Looking to open your own private practice? Either way, you've got to understand basic corporate structure in order to get the most out of your earning potential—and avoid any unnecessary tax.

optometry and ophthalmology practices S Corp

Whether you’re a seasoned practice owner or a new optometrist or ophthalmologist thinking of opening a private practice it’s important to understand the basics of corporate structure so that you can maximize your earning potential and avoid paying unnecessary tax.

You likely will or have spent a tremendous amount of time planning, implementing, and troubleshooting every aspect of your practice. What a shame it would be to fork over money to the IRS that you didn’t need to or to limit your growth by choosing the wrong type of corporation! Corporate tax rules may benefit optometry or ophthalmology business owners, but it’s up to the business owner, along with their CPA and attorney to do the research and pick the appropriate entity. Pick the wrong corporation type and it’s no one’s fault but yours.

I am fortunate to meet with dozens of optometrist and ophthalmologist practice owners every year at our office, at trade shows, and on phone calls and I’ve identified common trends when it comes to corporation type.

If you don’t want to read on, I’ll give you the short version right here: in my experience the majority of optometry and ophthalmology private practices with 1-2 owners elect an S Corporation status because this structure makes the most sense for the type of business that eyecare professionals run. There is also a fairly significant tax savings in an S Corporation when compared to C Corporations, specifically as the company grows. Curious why? Keep reading.

What’s the difference between a C Corporation and an S Corporation?

First off, it’s critical to understand that the C corporation is the default corporation under IRS rules. The S corporation is a corporation that has elected a special tax status with the IRS. Both business structures get their names from the parts of the Internal Revenue Code under which they are taxed.

The Tax Cuts and Jobs Act brought into effect in December 2017 by President Trump reduced the top corporate income tax rate from 35% to 21%, which was the largest tax overhaul in over 30 years. S Corporations do not pay a federal tax, but the profits are taxed at the individual shareholder level which could be as high as 37%. C Corporations on the other hand do pay a federal tax.

There are seemingly numerous differences between a C Corporation and an S Corporation. This chart outlines the core differences between C Corporations and S Corporations when it comes to tax, class of shares, shareholder volume, and shareholder origin.

C Corporation S Corporation
Taxation Corporate tax on profits plus personal income tax on profits distributed as dividends No US corporation income tax. Only personal income tax on profits (pass-through taxation)
Class of Shares You can have multiple classes of shares You can only have one class of shares
Shareholder Volume Unlimited shareholders 100 or fewer shareholders
Shareholder Origin US and foreign shareholders allowed US shareholders only, limited to individuals, their estates, and specific types of trusts

What’s the difference between an LLC taxed as a partnership and an S Corporation?

Not all states and localities recognize S corporations and, consequently, do not extend the pass-through taxation advantages to them since they treat them as C corporations. The District of Columbia, New Hampshire, Tennessee, New York City and Texas do not afford special treatment to S corporations. Similarly, Louisiana taxes S corporations as C corporations, but allows an exclusion regarding the portion of income with respect to which Louisiana shareholders pay income tax. This article addresses US taxes and not necessarily state or locality taxes.

There are a variety of differences that distinguish LLCs taxed as partnerships and S Corporations from one another.

This chart outlines the core differences between LLCs taxed as a partnership and S Corporations when it comes to tax, class of shares, shareholder origin, who can own each, subsidiary flexibility, what to do with profit and loss, and how and when tax is paid.

LLC S Corporation
Taxation Pass-through taxation. Profits of active owners are subject to regular income tax and self-employment tax at the owner level Pass-through taxation. Wages to owners are subject to self-employment taxes because active owners are treated as employees and must be paid a reasonable salary. All profits and wages are subject to regular income tax and only the wages are subject to self-employment tax
How & When Tax Is Paid Tax is paid by the owners on the net profit of the company. The owners make quarterly estimated tax payments to the IRS Tax is paid by the owners on the net profit of the company. The owners make quarterly estimated tax payments to the IRS and taxes are withheld from wages of the active shareholders
Shareholders Unlimited members 100 or fewer shareholders
Shareholder Origin US and foreign shareholders allowed US shareholders only, limited to individuals, their estates, and specific types of trusts
Who Can Own Shares LLCs may be owned by corporations, LLCs, partnerships, S Corporations, estates or many types of trusts S corporations cannot be owned by corporations, LLCs, partnerships, or many types of trusts
Subsidiary Flexibility LLCs are allowed to have subsidiaries without restriction S Corporations are allowed to have subsidiaries with limited restrictions
Profit & Loss Allocation Can allocate profits and losses to members disproportionate to ownership Profits and losses are allocated to shareholders based on their percentage of ownership
Salary For Active Owners No salary for active owners Active owners must take a reasonable salary

In the past, some S Corporation owners avoided paying Social Security and Medicare taxes by not having wages paid to the active shareholders of the S Corporation. However, in two different court decisions, one in 2006 and the other in 2010, this avoidance of self-employment tax was addressed and these cases are used by the IRS to determine reasonable compensation.

An active LLC owner does not receive wages, and therefore the LLC does not contribute to state unemployment or statutory disability benefit funds. Because of this, an active LLC owner cannot receive state unemployment or statutory disability benefits.

Why are S Corporations more tax advantageous for optometry and ophthalmology practices?

S Corporations are pass-through entities so the corporation itself is not subject to federal income tax. Instead, the shareholders are taxed upon their allocated share of the income. These S Corporation shareholders report this passed through income on their personal tax returns.

In an S Corporation, after salaries are paid to the active shareholders (business owners), the remaining profit or loss passes through to the business owners, and with it the tax liability or tax savings. With C Corporations, after salaries are paid to the active shareholders (business owners), the company pays a corporate tax on the remaining profits and then, if the remaining profit is paid to the shareholders as a dividend, the shareholders will pay income tax on the dividend at a “capital gains” tax rate. This is known as double taxation and there is an example below. In summary, S Corporations are not subject to federal income tax that C Corporations are.

In an S Corporation, if shareholders are actively working in the business, they are also employees and they must take what the IRS calls a reasonable salary. The IRS does not provide a definition of a reasonable salary. The salary is subject to Social Security and Medicare tax as well as regular income tax. An LLC is similar except that no salary is required to be taken and all profits and losses flow through to the owners. All of the profits that are allocated to the active owners are subject to self-employment tax as well as regular income tax.

One disadvantage of an S Corporation is that the shareholders will still need to pay taxes on the corporation’s income based on their proportion of ownership, even if the business didn’t pay dividends to shareholders. This can be a drawback to an S Corporation since the shareholders may be subject to a tax on income that is retained by the company, even though they did not physically receive the income because the company decided to retain these earnings. In a C Corporation this isn’t the case because the corporation can accumulate earnings and profits, without paying them out to business owners, and pay tax at a flat 21%. However, if a C Corporation accumulates more than $250,000 beyond the reasonable needs of the business, it may be subject to a 20% accumulated earnings tax.

Although just mentioned above, let’s clarify this again. S Corporations are not required to pay dividends to shareholders. The business files a tax return (Form 1120S) that shows its net profit or loss for the year. This amount is then passed to individual shareholders and reported on their personal returns. Even if the shareholders don’t actually receive the amount of profit in the form of dividends, the profit will still be taxable to the shareholder. When businesses pass through a loss, the shareholder receives a deduction for the loss limited by their basis in the corporation. To explain the concept of basis in its most simple terms—it’s the amount of the shareholder’s original investment, plus profits, less losses, plus loans from shareholders. You should consult your tax advisor for a more detailed explanation of S corporation basis.

Each shareholder then receives a Schedule K-1 from the S Corp, which shows the amount of profit or loss that each individual receives. Shareholders must then report K-1 income on their personal tax returns, and the profit or loss will then be added to or subtracted from their other income.

How can optometrists and ophthalmologists take advantage of the 20% qualified business income?

Owners of S corporations and other pass-through entities (like LLCs, sole proprietorships, and partnerships) are able to deduct 20% of qualified business income from their personal tax returns. The problem is that if you make too much money you do not qualify for this deduction. In 2020, the limits are taxable income of $163,300 for single filers or $326,600 for joint filers. Above those income thresholds, businesses in specific service trades or professions, such as consulting, medicine, or law are precluded from taking this deduction.

How does an optometry or ophthalmology practice set up an S Corporation?

Corporations are generally set up by registering with the state where the corporation is located. Once a corporation is formed, the corporation elects to be an S-Corporation with the IRS and possibly the state in which the company is incorporated. The “S” in S Corporation refers to Subchapter S of the Internal Revenue Code. S Corporations provide the same protection against business liabilities for shareholders as C Corporations. You should consult an attorney regarding the protection that is provided.

What is required to establish an S Corp?

  • USA-based corporation
  • No foreign owners
  • Maximum of 100 approved shareholders
  • Can only issue one class of stock

Do S Corporations offer legal protection for optometry and ophthalmology practices?

Owners of C Corporations and S Corporations have the same protection for shareholders against the corporation’s lawsuits, referred to as a “Corporate Shield.” Generally, shareholders can’t be held liable for other than professional liability, and they also aren’t responsible for any debts incurred unless there are guarantees by the shareholders. You should consult an attorney to discuss legal protections provided by a corporation.

S Corporation vs. C Corporation tax example for optometry and ophthalmology private practices:

For this example, we plugged in revenue, salary, and expenses into professional tax software in order to understand the tax rates for C corporations and S corporations in California. For S Corporations California charges a franchise tax based on gross revenue. We listed some effective tax rates but please understand these are “effective” and cannot be applied to every situation. Your accountant can determine your exact tax rate.

Methodology For This Example: In this example we compare 3 business types, a start up doing $1,000,000 in revenue, an expanding business doing $1,500,000 revenue, and a mature business doing $3,000,000 in revenue. In all 3 examples, the practice owner takes 15% of revenue as their salary and also runs a net profit margin of 20%. Additionally, the net profit is paid to the C corporation shareholder as a dividend.

The Start Up The Expanding Business The Mature Business
Revenue $1,000,000 $1,500,000 $3,000,000
Salary to owner $150,000 $225,000 $450,000
Expenses $650,000 $970,000 $1,950,000
Profit $200,000 $305,000 $600,000
Profit Margin 20% 20% 20%
C Corporation plus Individual Effective Tax Rate % 43.80% 45.32% 50.09%
C Corporation plus Individual Taxes $ $153,313 $240,178 $525,899
S Corporation plus Individual Effective Tax Rate % 43.40% 44.92% 47.82%
S Corporation plus Individual Taxes $ $151,892 $238,094 $502,074
S Corporation Savings % 0.41% 0.39% 2.27%
S Corporation Savings $ $1,421 $2,084 $23,825

We can see that for the Start Up and the Expanding Business there is no real tax difference for choosing one type of corporation over the other. For a mature business the advantages begin to show as the S-Corporation has a 2.27% tax savings over the C-Corporation.

This was actually surprising for us to see! When we originally wrote the article we were under the impression the S Corporation savings would be far higher. The reduction in the C corporation tax rate beginning in calendar year 2018 from a maximum of 35% to a flat tax of 21% brings the effective tax rates of owning an S corporation or a C corporation closer than they were prior to calendar year 2018. Keep in mind that if your revenue, expenses, and personal salary change, your results will change. Also, this example is a California example where state taxes are high, so the example will be different in one of the seven states like Florida, Texas or Nevada where there is no individual state income tax.

DISCLAIMER: CovalentCareers does not provide tax, investment, legal or financial services and advice. The information is being presented without consideration of the business objectives, risk tolerance or financial circumstances of any specific business and might not be suitable for all businesses.

About Matt Geller, OD

Dr. Matt Geller is an entrepreneur with a track record of developing successful online platforms to solve problems in the healthcare space. Matt is the co-founder and CEO of CovalentCareers and NewGradOptometry.

About Gary Topple, CPA

Gary Topple CPA, the owner of Gary Topple CPA, P.C., provides accounting and tax services to a variety of businesses, not-for-profit organizations and professionals including optometrists. Gary Topple, CPA obtained his Bachelor of Business Administration degree from Bernard M. Baruch College of the City University of New York. The accounting office is located in Jericho, New York with clients in Arizona, California, Connecticut, Massachusetts, Michigan, New Jersey, New York, Washington, D.C. and Barcelona, Spain.