Podcast Ep. 139 Optimizing Pay: 7 Key Factors For Setting Optometry Practice Owners’ Compensation

Evon: [00:00:00] Hey everybody. Welcome back to the Optometry Money Podcast. With we help and ODs all over the country make better and better decisions around their money, their careers, and their practices. I am your host, Evon Mendrin, Certified Financial Planner, practitioner, and owner of Optometry Wealth Advisors, an independent financial planning firm just for optometrists nationwide.

And thank you so much for listening. Really appreciate your time and your attention today. And today’s episode. We are gonna dive into the question of how much should you pay yourself from your practice? And a very common question I get, especially from early stage practice owners, so recently cold started or recently purchased within the last five years or so.

A common question is. How much should we pay ourself? How much income should we take from the practice? When should that change? But that isn’t a question only for early stage practice owners. This is a question that we need to think through with [00:01:00] established practice owners and keeping an eye on how much income they’re drawing from the practice and how much they’re paying theirself in wages, and when to make those adjustments.

And so into this episode, I wanna talk about seven key factors or seven key considerations to balance as you think about how much to pay yourself from your practice, specifically in terms of a wage, and this is for practices that are taxed as an S corporation.

Most of what we’ll talk about today are going to pertain to those practices that are taxed as this as corporations, because you have that requirement to pay wage, and so you have to decide how much of your income should you take and how much of that income should be an actual wage.

But I think regardless of how your practice entity is taxed, I think you’ll learn something about these decisions today.

How Optometry Practice Owners Take Income Depending on The Practice Entity

Evon: and this conversation today is just, is going to be an extension or a continuation of my article with Independent, strong. and that article was How to Pay Yourself: Key Factors For [00:02:00] Setting Your Owner Compensation. So I’ll throw a link to that in the show notes. Recommend reading that and some of the other articles we’ve done there.

But I think the, the first place that I think that makes sense to start is just talking through how you as the owner, take income from your practice depending on the different type of entity you have or really depending on how your entity is taxed.

The first one is if you are, if you own a sole proprietorship, meaning there is no actual. legal entity separate from yourself. It’s just you doing business as something, or if you have an LLC and that LLC is taxed as the sole proprietorship, there’s only one owner. And, this is the default ways that LLCs are going to be taxed if there’s one owner.

Unless you’ve chosen to do something else. So if you have this type of practice entity, how do you pull income from the practice? Well, it really is just an owner’s draw. You’re just taking dollars from the practice bank account and transferring it to your personal household bank account, or you’re [00:03:00] writing a check to yourself.

It really is as simple as that. I mean, that’s, that’s essentially how that looks.

If you are a partnership or if you have a. An LLC that is taxed as a partnership. There’s two or more owners, and it’s taxed as a partnership. It can come in two forms, number one, it can look like a profit distribution, so that’s gonna look.

Very much like it would look in a sole proprietorship. You’re moving dollars from your practice bank account over to your personal one, or it could show up as guaranteed payments. if you pull up profit and loss, you might see guaranteed payments in there for each partner.

And this is a Form of a wage like this, is the partnership’s version something similar to what you’d see as a wage? Basically, it allows the partnership to send dollars to an owner, regardless of what the actual profit of the business is.

So if different partners are working in different schedules or, or, different amounts of [00:04:00] production, this might be a way to sort of, distribute income among different partners depending on the production. Now, if you see that on your profit and loss, if you see that your, your practice is creating guaranteed payments as, as part of that income, I would talk to your TA tax professional and ask about how that impacts.

The QBI deduction and whether, you can distribute income in different ways that are not so heavily leaning on guaranteed payments. Because only the actual profit of the partnership is eligible for that QBI deduction, the guaranteed payments are not.

So something you’ll just wanna look into and. and your partnership agreement or your operating agreement’s going to be the rules around that. So that’s something you’ll wanna keep an eye on and, and review as well. But that’s what a partnership looks like it’s either gonna be profit distributions, to the partners, or it’s gonna show up as guaranteed payments on the profit and loss.

either way it’s going to be moving dollars from the bank account or the practice to the bank account of the owner.

S corporation is different. if you’ve listened to my, to my [00:05:00] episode on how these different entities work, I’ll throw a link to that in the show notes.

But an S corporation is a tax election. It’s a, it’s a way that your business chooses to be taxed. the legal entity isn’t an S corporation. the legal entity’s either going to be in LLC. It’s gonna be a, A corporation in certain states, and some states I’ve seen a PA as well, but the legal entity’s one thing, and then your legal entity, the LLC, the corporation can elect to be taxed as an S corporation.

And so the S corporation is a tax election and the way that you draw income from an S corporation is you take a wage, a required wage. And then you can distribute to yourself profit distributions, similar to the other forms, you can send dollars from the practice bank account over to your personal bank account.

And so number one, and so your wages, you’re gonna be on a payroll just like everyone else in your practice. And then you can [00:06:00] take owners’ draws distributions in addition to that.

The Major Tax Benefit of Choosing to Be Taxed As An S Corporation

Evon: And the S corporation is, Is especially interesting and, and most of our conversation today is gonna be in light of those practices that are taxed as S corporations.

How much should you pay yourself in wage? How high should that be? How low should that be? When should that be increased?

And how much should you take as owners distributions and when you think about the benefit of choosing to be taxed as an S corporation. The primary benefit from a tax perspective is saving employment taxes, because when you are taxed as a sole proprietor, all of your net income from self-employment is subject to self-employment taxes.

So both halves of social security, and both halves of Medicare. However, when you are taxed as an S Corporation, only the wage portion of your income is subject to employment, taxes, social Security, and [00:07:00] Medicare. But the profit of the business is not.

And so whatever the profit is, you save roughly 15.3% of those employment taxes on that profit. That’s part of the benefit, and so very often we are thinking about the wages of trying to bring that wage as low as possible. And in some conversations I’ve had over the years, we’ve seen wages unreasonably low.

I mean sometimes around like $30,000 specifically to save taxes, but as we’ll ha as we’ll go through this conversation that that can’t be the case.

How Much Should Optometry Practice Owners Pay Themselves in Owner’s Wage?

Evon: And what I want to talk through today is what are the different considerations you need to think through? To figure out how much your wage should be relative to those profit distributions.

there is that he heavy incentive to bring it down. But as we’ll see, there are also situations where you want to increase your wage. I. there are other planning opportunities that are going to, that are where we’re going to want to increase that wage a little bit more. And so let’s talk about seven key considerations you wanna [00:08:00] keep in mind for figuring out how much wage to pay yourself in the practice when your practice is taxed as an S corporation.

1. Cash Flow Sustainability – What Can Your Practice Support?

Evon: the first one to think through, number one is cashflow. Sustainability. your practice has to be bringing in enough gross revenue. Collected revenue in order to pay for inventory, cost of goods sold in order to pay for all the other operating expenses, occupancy costs, non-OD staff, OD staff compensation.

If you have associate doctors, go through the list of operating expenses, your, your practice has to be creating enough cash flow after those primary expenses to pay yourself a wage. So the first thing that has to be looked at is what is the cash flow of the business. This is more so important with a cold start because in a cold start, it may take two, three years before you really start to see enough cash flow to provide for yourself a, a healthy wage.

So you really wanna keep an eye on the cash flow, sustainability of taking a wage and, and not taking too [00:09:00] much, too quickly. But even in situations where owners have, have purchase practices,it may make sense to keep that wage than we might otherwise set it.

But those owners are often wondering, Hey, when does it make sense to increase it? Right? So the first thing we just need to keep an eye on is what does the cash flow of the practice look like? What can the cash flow support.

2. IRS Reasonable Wage Requirements for Owners of S Corporations

Evon: number two is the IRS reasonable wage requirements.

When you own a business that’s taxed as an S corporation, the IRS has a requirement, you have a requirement to pay yourself, the owner, a reasonable wage, quote, unquote reasonable before you start taking profit distributions, the first thing that has to be met is you have a reasonable wage that is compliant to yourself and, and what is reasonable, quote unquote reasonable.

Well, there is no specific black and white rule or formula to figure out what is reasonable. you’ll see a lot of stuff out there about, like, rules of thumb, make [00:10:00] sure that it’s 50% of your profit or something like that. Well, there’s nothing really supporting that.

But when you look at the IRS website, and I’ll, I’ll add this to the show notes, you’re gonna see that they provide a list of factors. some factors they consider to determine like a reasonable compensation are training and experience, your duties and responsibilities. So what are you actually doing in the practice?

Are you only seeing patients? Do you have management or administrative responsibilities? How often are you seeing patients? How much time are you actually spending in the clinic seeing patients each week? your time and effort devoted to the business, your dividend history, so your, your history of distributions, payments to non-shareholder employees, timing and matter of paying bonuses to keep people.

What comparable businesses pay for similar services, compensation agreements, the use of a formula to determine compensation. When you kind of boil it down, it really comes down to what would you pay someone else, to do the work that you are doing in the business as an employee?

And I’ve seen [00:11:00] some consultants and tax professionals really actually like formulate it down. Like, how much of your time are you spending seeing patients as a clinician? How much of your time are you doing administrative duties? And you know, what would the, what would the wage be for each of those broken down?

So. Really, that’s the way you’d wanna look at it, is what is a reasonable wage for the, the work that you are doing based on your experience, in the practice. And, and ultimately you would wanna just talk to your tax professional to make sure it’s compliant. There is no perfect amount. It’s, it’s all a, a, a range, right?

So you have to figure out what that reasonable range is for your area of the United States, and I would lean entirely on your tax professional that make sure that that’s compliant.

So number two is that reasonable rage requirements by the IRS. And for those of you who are paying yourself 30,000, $40,000, that’s unless you’re working less than part-time, that’s not reasonable.

So you wanna make sure you’re not gonna be falling into trouble with the [00:12:00] IRS. number three, employment, taxes and compensation. And this is the primary tax benefit of choosing to be, taxed as an S corporation, is that only your wages are subject to employment taxes.

The profit is not, and hence this incentive to keep your wages on the lower end of that reasonable range. and in 2025, wages up to 176,100 are subject to, , social security tax of 12.4%. So that’s both halves of it. The employer and the employee, you are both. Any wages above that are not subject to, so, social security taxes.

but all of your wages face Medicare taxes, and that’s a total of 2.9%. Again, half paid by you as the employee, half as the business owner.

So you do have to keep in mind the potential tax savings by maintaining a, reasonable, but potentially relatively low wage. As a part of your tax [00:13:00] planning. I would also look at things like fringe benefits.

For example, health insurance paid through the practice. HSA contributions,dental insurance paid through the practice. Those fringe benefits paid through your practice or through your payroll as the owner have to be added back to your pay stub as a wage for income taxes.

So you’re gonna see that added back as income on your pay stubs. However, those fringe benefits aren’t subject to these employment taxes. So. That’s sort of a sneaky way to increase your wage to something that is reasonable without increasing the amount of social security and Medicare taxes you’re gonna be paying.

So tax planning around employment taxes is definitely something you need to keep in mind and work closely with your um, Advisors on.

But the other side of that that’s really important is your social security benefit in the future. because if you are lowering your wages below that social security wage base, that [00:14:00] $176,000, if you’re lowering your wage below that, that means you are missing out on credited wages towards your social security, benefit in the future.

And, and so we kind of have to balance that out.

We have to consider that. However, when we, we also have to think about the way that Social Security calculates your benefit at full retirement age, which right now is age 67 for, most of the people listening.

When you think about what, how social security calculates your benefit. Again, at your full retirement age, what they’re gonna do is they’re gonna look at your past earnings at the highest subset of your, your past earnings history, specifically your wages or income that were subject to Social security taxes, and they’re going to adjust past years of wages or earnings. for inflation up to age 60. So they’re gonna sort of equalize them for inflation, and then they’re gonna look at your average monthly wages based on all these years of earnings history.

And then when they calculate your benefit, they’re going to [00:15:00] replace a certain percentage of that average wage, but in tiers. So, for example, they’re gonna replace 90%. In, in 2025’s dollars, they’re gonna replace 90% of the first $1,226 of monthly wage. for the next chunk of your monthly wage up to about $7,300.

They’re only gonna replace 32% of those dollars. And then for the last bits of your monthly wage, over and above roughly $7,300 a month they’re only gonna replace 15%.

So there’s a sort of tiered percentage of your monthly wage that’s gonna be replaced as part of your benefit. As we know, social security is meant to, is built to help lower earning, retirees more.

And so we see this in the formula in 2025 dollars, Once your annual wage gets to about $103,400, between [00:16:00] that and 170,000 or so, your benefit’s only gonna replace about 15% of your income.

So hopefully that’s not clear as mud, but the reason I point that out is because, you know, once you get to that point, you’re really getting back a small percentage of your income and social security benefit.

So if you have a healthy savings rate, which is really important, and a consistent habit of saving, then you may benefit from keeping your wage below that social security wage limit about 176,000 or so, and just investing the extra wages yourself. Your return on those dollars may be higher. Of course that’s not guaranteed, but it may very well be higher than just the 15% you’re gonna get back on that social security benefit for those extra wages in that 15% tier.

Now, that only works if you have a healthy savings rate and a consistent habit throughout your career of investing those wages. However, too often and I, [00:17:00] I’ve seen this many times too often. There just isn’t enough saved for retirement over the career of the owner. And the owner may have been better off increasing wages and just getting a higher social security benefit.

You have to know yourself a little bit and, you know, can you be disciplined about taking those extra dollars and investing it rather than just spending it and, and let it go to waste. So there’s two sides to that coin. Yes, you wanna save taxes on social security taxes and Medicare taxes, but you also want to optimize your wages for that social security benefit as well.

4. Optimizing for the 20% QBI Deduction

Evon: Number four, the QBI deduction. And this is what I, I talked about earlier with guaranteed payments and partnerships. with an S corporation, the QBI deduction, that 20% deduction that is currently happening through 2025, and we expect that through legislation to be extended into 2026.

Although we don’t know for sure, only the profit of your business is eligible for that deduction. [00:18:00] The wage portion of that is not, so the higher your wages, the lower your profit, that means the lower that deduction’s gonna be. The lower your wages, the higher your profit, the higher that deduction’s potentially going to be.

Of course, it all depends on the math of, of the situation there, but so that deduction is something you wanna keep in mind as well of figuring out, okay, what is the optimal wage to have based on the, the planning opportunity with that QBI deduction.

5. Personal Financial Stability and Covering Your Ideal Lifestyle

Evon: Number five, personal financial stability.

Above all else. Your practice should be providing for your ideal lifestyle. I would consider that the primary and main reason you own the business, that you go to work every day is so that business can provide for your ideal lifestyle, which includes saving and investing for the future and for different goals like college savings and different things like that.

But it should support your ideal lifestyle spending. What do you wanna spend dollars on? What are home updates you wanna [00:19:00] plan for? Who are the people or. Institution, organizations you wanna give money to on a regular basis?

So you wanna make sure that your practice is supporting it and there’s no simpler way to create a consistent, predictable income from the business than setting your wage at or around that ideal lifestyle. And this requires, of course, you understanding the numbers, understanding, what you actually want your ideal lifestyle to look like in dollars? What, what do you wanna spend? Ideally, who do you wanna gift to? Ideally, what are some of the other goals you wanna set aside dollars for each and every month? What are the debts that you’re paying, on a month to month basis?

And so, having clarity around what that ideal lifestyle is gonna be should then inform your wage as well, so that you can set a wage that can give you predictable, consistent income to meet that lifestyle.

6. Optimizing Contributions to Your Practice Retirement Plan

Evon: number six, retirement plan maximization. This is one of the, one of the important factors that are going to nudge you to [00:20:00] increase your wage.

Because your W2 wage is directly going to determine your retirement plan contribution limits. So for example, if you’re making salary deferrals as an employee, whether it’s to, 401k or simple IRA, you have to have enough wage in order to do that and to cover payroll and to cover your lifestyle expenses.

So your, your salary has to be high enough to, to meet your, your retirement plan savings goal. but importantly, 401k Profit sharing contributions are directly impacted by the wages paid in your practice and by the wages you pay yourself. 401k profit sharing contributions are limited as a whole to 25% of W2 wages in your practice.

And your age and the wage that you pay yourself can directly impact that amount of the contribution from when you’re doing profit sharing that skews towards your accounts Versus all other employees, [00:21:00] depending on the, the calculation, the method of, of your profit sharing. if you’re doing new comparability for example, that’s gonna be very important.

And so sometimes for just to increase that profit sharing contribution to where it needs to be, sometimes increasing that wage helps quite a bit and allows more of that contribution to skew towards your account versus all other employees. this is something we saw with, tax projections over the last year.

as we got towards the end of the year. We saw that there’s opportunities where clients are phasing out of certain deductions like the QBI deduction or the child tax credit and large, healthy profit sharing contributions allowed them to phase back in and increasing their wage at the end of the year, before the end of the year, allowed them to really benefit even when you account for the additional social security taxes.

So that’s something you wanna keep in mind as well. And cash balance plan. If you have a, an established practice, if you’re older and you have really healthy cash flow in the practice, maybe you have a cash balance plan or considering it, [00:22:00] that’s gonna be directly impacted by your age and your compensation history.

So for owners focusing on retirement, accumulation of getting the most out of these retirement plans. You know, there’s a temptation to lower your wage as much as possible for those tax savings, but it’s gonna directly impact this. This is something you have to balance with those tax savings.

7. Practice Valuation and Accurate Reflection of Practice Profit

Evon: number seven, practice valuation and accurate accounting of profit. And, I say this because your wage should reflect the true replacement cost of your clinical and management work because someone needs to do the work. Whether it’s you seeing patients or whether you hire someone else, whether you bring in an associate doctor your wage, the cost of you doing that work is a true expense to your business. when you have artificially low compensation for yourself.

This could in inflate practice profitability, if you are looking at your p and l each month or each year, [00:23:00] each quarter in whatever cadence, you’re looking at that and you’re looking at how profitable your business is. If your wage is too low, that profitability is too high. It doesn’t reflect the accurate profitability of the practice, it’s gonna skew your own benchmarking, and it can skew your decision making.

So just for benchmarking and KPI perspectives. I like to make sure there’s a market based wage for the work that you’re doing. And if you’re doing valuations, then any valuation that’s happening for your practice needs to account for market based compensation happening for the work you’re doing.

So adjustments would have to be happening as a part of that valuation process. So just for clean accounting and accurate KPIs and decision making on your part, I, I like to see there to be a market-based wage, in the practice and. So that’s number seven.

Wrap Up – There’s More to Balance When Setting Owner’s Compensation Than Taxes

Evon: Again, when we think about these, these factors.

Number one, cashflow sustainability. Number two, the IRS, reasonable wage requirements, number three. Employment taxes for tax planning [00:24:00] purposes. Number four, planning around that QBI deduction. Number five, your own personal financial stability. Number six, retirement plan maximization is something that’s gonna nudge you to increase that wage.

number seven, practice valuation. Just accurate accounting, of the profit of your practice. Those are seven key considerations I think about as you talk with your financial professionals, your financial Advisors, your tax Advisors. Those are different things you’re gonna wanna balance and don’t allow one to override all of the others entirely.

You wanna think about all these things sort of holistically depending on your goals, right? What are you, what are you planning for? What are the opportunities that you’re seeing as you are wanting to increase your savings rate as you’re wanting to? as you’re going through tax projections and wanting to make good tax planning decisions, what are the opportunities available to you?

And you’re looking at your own cash flow. What are the opportunities available to you? One thing that just popped in my mind as well and related to the wage, related to employment taxes and compensation and that there are also state [00:25:00] and local benefits. For example, State disability insurance or paid family leave that are dependent on the wage you’re paying yourself as well. So, you know, look at your state and local benefits that you are maybe missing out on or not taking fully advantage of if your wage is unreasonably low. So keep that in mind as well, but hopefully this is helpful.

Again, if you are, if your practice is taxed differently, for example, a partnership, some of these things you’ll want to think about like guaranteed payments in relation to the QBI deduction and. What your operating or partnership agreement allows you to do, says you have to do there. but things like the profit and loss, for example, if you are, if you’re not taxed as an S corp, the profit and loss is kinda look different like your owner distributions if you’re, if you’re taxed as a sole proprietorship, well that’s gonna, that’s not gonna show up on your P&L as wages, right? You have to account for that separately when when looking at your business and, and, looking at the real true profitability of business.

So, it’s gonna look, some of these things are gonna look differently depending on the way your business is taxed, , but a lot of these are [00:26:00] primarily gonna be around the S corporation.

What does it look like if your practice is in S corporation? And so as you set your wage, hopefully this is helpful. As you think about what are the different considerations to doing that, what should you be thinking about and balancing as you are wondering if you should be increasing that or if your wage is too low relative to, to the profit.

And and then the other consideration is. How much and when should you take distributions from the practice? and that’s even another discussion of when you should be able to take distributions from the practice and do other things with that cash, because you don’t wanna leave too much cash in the practice.

You wanna leave just enough cash to provide a healthy cash buffer, a reasonable cash buffer for the practice, to know that your debt payments can be made. You wanna know you’re setting aside enough dollars for Quarterly tax payments if you’re making quarterly tax payments. and then finally, once you’ve kind of taken care of those things, then you have a clear idea of how much cash is available for distribution.

So that’s another [00:27:00] discussion that relies heavily on what the cash flow of the business looks like. But as you’re thinking about your own compensation, as you’re thinking about your own life circumstances, like. Practice revenue growth or increased profitability or additions of a partner to the practice or major personal finance changes like you wanna buy a home or planning for a college for kids.

if you are implementing a new retirement plan in the practice, if you’re expanding the business, if there’s changes in laws, like tax laws are all in flux right now. all of those things are good opportunities for you to review this and see if changes need to be made.

So talk with your financial advisor, talk with your tax professional, and if you don’t have one, if you are looking for someone to, to look at these numbers with you to make good decisions around all these different, sometimes competing goals and, and priorities. Reach out. We’d love to have that conversation with you.

We’d love to hear the financial questions on your mind and talk about how we help optometrists solve those and navigate those decisions all over the country. Check out the show notes. I’ll throw on link in there if you’d like to schedule a short [00:28:00] introductory call..

And appreciate your time. We’ll catch you on the next episode. In the meantime, take care.