When an S Corporation Isn’t the Right Prescription for Physicians

You can’t claim victory in the S-Corp dojo until you’ve faced every hidden opponent.

If you’ve spent more than ten minutes in a Facebook group for self-employed physicians, you’ve probably seen this refrain:

“Form an S Corporation — it’ll save you a fortune in taxes!”

Like most good tax advice, it’s sometimes true, but dangerously incomplete. S corps can absolutely reduce self-employment taxes, but they also introduce extra costs, complexity, and unintended side effects. Before you rush to file Form 2553, here are twelve legitimate reasons you might prefer to keep your practice as a sole proprietorship (Schedule C).

1. The extra costs outweigh the tax savings

If your net profit is under $50,000, the math rarely works out. S-corps require payroll, bookkeeping, and additional tax filings (Form 1120-S, state payroll reports, etc.). By the time you pay an accountant to handle these, and after you cover the costs of software for bookkeeping and payroll, the savings in self-employment tax are attenuated (if not completely overcome) by compliance costs.

2. Your business carries significant debt

When you convert a sole proprietorship with debt into an S corporation, that debt doesn’t automatically follow you for basis purposes—even if you personally guaranteed it. If you later dissolve the S corp, you could face an unexpected capital gain. For debt-heavy practices or those with financed equipment, this can turn a paper transaction into a real-world tax bill.

3. Your operating agreement isn’t S-corp-friendly

This applies to multi-owner practices that started as LLCs. S corps can’t have multiple classes of stock, and distributions must be paid strictly according to ownership percentage. Many default LLC operating agreements assume partnership rules (special allocations, preferred returns, flexible distributions). Those provisions can invalidate your S election.

Translation: make sure your lawyer reads the fine print before the IRS does.

4. You actually want to pay more Social Security tax

This one sounds counterintuitive, but hear me out. If you’ve paid into Social Security for fewer than 10 years, your eventual benefit is based on bend points that heavily reward lower earners. In other words, every extra dollar you contribute early in your career gives you a strong return in retirement. By lowering your wages through an S corp, you might save on payroll tax now but lose those long-term benefits later.
Learn more about Social Security bend points

5. You’re ineligible due to residency status

S corporations are limited to U.S. citizens and permanent residents. If you’re on a visa or temporary work permit, the election simply isn’t available.

6. You already have W-2 income

If you also earn wages from employment with a health system, your Social Security tax cap may already be reached through that employment. Creating an S corp can cause duplicate FICA withholding or confusion between employers. Sometimes the cleanest route is to stay a sole prop and let your payroll withholding at the W-2 job cover your contribution.

7. You practice in multiple states

Running payroll in one state is simple.

Running payroll in three is… character-building.

Each state has its own registration, filing deadlines, and tax quirks. If you’re licensed (and earning) in several states, an S corp can multiply compliance headaches faster than your scheduler can book shifts.

8. You live in a state that “hates” S corps

Some states welcome S corporations; others greet them with new filing fees and surtaxes. If you practice in California, Illinois, New York City, Washington D.C., or Tennessee (among others), the state-level levies can wipe out the federal savings. In California, for instance, the franchise tax is 1.5% of net income—with a minimum of $800—plus state payroll taxes on top.

9. You want to maximize retirement contributions

Retirement plan limits are based on wages, not business profits. Because one of the main benefits of an S corp is paying yourself a lower salary, you may inadvertently cap your 401(k) or profit-sharing contributions.

You can’t have it both ways—less payroll tax means less eligible compensation.

10. You’d lose part of your QBI deduction

Under current law, Qualified Business Income (QBI) from a sole proprietorship is 100% eligible for the 20% deduction (subject to phase-outs). But wages you pay yourself through an S corp don’t count toward QBI. If most of your income becomes W-2 wages, your deduction may shrink.

11. You want to hire your kids

One of the best perks of being a sole prop: you can pay your children under 18 without owing Social Security or Medicare taxes. S corporations lose that exemption. Once you incorporate, those same wages become subject to payroll tax. Hiring your kids might still be a good move, but the rules are more favorable for sole proprietors.

Sometimes the family-friendly tax planning gets lost in the corporate paperwork.

12. You want to simplify certain deductions

If you’re a sole proprietor, the IRS lets you take simplified deductions for certain expenses:

• You can claim a per diem rate for meals and incidental expenses while traveling, instead of tracking every expense.

• You can use the simplified home office deduction of $5 per square foot (up to 300 square feet).

S corporation owners lose both options. You must deduct actual expenses, and while that can sometimes (but not always) yield a larger deduction, it adds another layer of documentation.

The Takeaway

Electing S corporation status can be a smart move for profitable, stable medical practices—but it isn’t a magic wand. For lower-income, multi-state, or sole proprietors who are also employed, the administrative friction and strategic trade-offs can outweigh the benefits. Sometimes, the simplest tax structure really is the healthiest one.

Author’s Note

At TaxSmart MD, prior to electing an S Corp for clients, we estimate the potential savings and extra costs a sole proprietor can expect by changing their business tax structure.

Most commonly, clients can expect to save a lot of money in self-employment taxes, which is mitigated by some of the factors mentioned in this blog post. However, there is no one-size-fits-all, and the answer truly depends on the numbers and the client’s specific situation.

If you book a complimentary introduction call, I’m happy to go through these with you and then email you a summary of the potential tax impact of converting from a sole proprietor to an S Corporation.
Book here