Are Your Optometry Practice's S-Corp Distributions Taxed?

?? "I own an S-corporation. Am I taxed when I distribute money to myself?"

This is a really common question, and I see it quite a bit in different optometry social media groups.

If you send money to yourself from your optometry practice, does it get taxed again?

Do you save taxes by keeping it in your business bank account?

It’s common for practice owners to have business entities taxed as S-corps. Even independent contractor ODs - right or wrong - are often advised for tax reasons to form an LLC and be taxed as an S-corp.

But S-corps can be confusing. I've seen this confusion lead to decisions that aren’t always favorable, like keeping too much cash sitting in the practice.

So let's bring some clarity to this question with S-corp tax basics!

How do you create an S-corporation?

The S-corporation isn’t actually a legal entity you can form or create with your state. It’s a way your business chooses to be taxed. ?

You create an LLC or a corporation as your legal entity, then you decide whether to be taxed as an S-corporation (using Form 2553) if it makes sense to do so.

On a High Level - How do S-Corporations get taxed?

S-corps are "pass-through" businesses.

Meaning, the S-Corp doesn't pay its own tax, even though it files its own tax return. All the taxable profit of the business will “pass through” and land on your personal tax return.

When you own a business taxed as an S-corp, you get income from the business in 2 ways:

1. A required "reasonable" salary, and
2. The profit of the business

Paying yourself a “reasonable” salary for the work you do in the practice is a requirement. The first dollars you pay yourself out of the practice have to meet this requirement.

After that, assuming your practice can support it, you can also distribute profit to yourself out of the practice. Essentially, simply transfer funds out of the business bank account to your personal account and account for it correctly in your bookkeeping.

Your salary is taxed just like working as an employee elsewhere. You'll get a Form W2 from your practice, and you’ll find this in the Line 1 "Wages" spot on your federal tax return.

The profit is also taxed in the year it's earned - regardless of whether you keep those dollars in your business bank account or distribute them.

Your practice will file a 1120S informational tax return. You'll receive a Form K-1, and you'll find the business profit on the Schedule E spot on your return (Line 8 under “other income from Schedule 1”). A benefit of S-corps is that your profit is not subject to self-employment taxes, just income taxes!

Ok, but what about those distributions?

What does this mean for distributions? When you distribute profit to yourself, is that taxed again?

Distributions generally don't trigger additional income tax. That profit has already been taxed (or will be this year) whether it stays in your business bank account or not.

It's just a return of (already taxed) profit to you, the shareholder.**

So, whether or not to distribute money out of your practice should be determined by:

1. Have you set aside enough for taxes?
2. Are required debt payments made?
3. What are the cash / reinvestment needs of your practice?
4. Cash needs of your household - how do you plan to build net worth outside of the practice?
5. Are there cost basis issues if you distribute?**

I think a lot of confusion comes from the fact that C-corporations (think any publicly traded stock) issue dividends that are taxable income. If you own any stocks, stock mutual funds, or ETFs in a non-retirement investment account, you’ll see those dividends on your tax return.

But simply sending money out of your S-corporation bank account to your household generally does not trigger additional income tax. This should not be a reason to more cash in your practice than is reasonable and necessary.

Hopefully this helps bring some clarity around how your business works.

Want to learn more? Feel free to reach out and learn how Optometry Wealth Advisors serves optometrists nationwide. Or, check out this recent podcast episode I did on how different business entities work.

As always, work closely with your own professionals. Don't take this as tax advice. Once a business entity is involved in your life, you’ve likely moved beyond the help of just social media groups - as smart as the groups are. Good tax, legal, bookkeeping, and financial advice is well worth the investment.

Take care!

**P.S….Distributions do impact something called the “cost basis” of your S-corp. That’s sort of an ongoing ledger of all the value in your business that’s already been taxed, and won’t be taxed again. In certain situations - when your distributions are more than your cost basis, it can trigger some weird tax stuff like capital gains tax.

That’s a bit more than this newsletter can handle, so, keep in touch with your tax and financial pros when planning distributions.