Medical Practice Saves $72K/Year Converting from S-Corp to C-Corp

The Problem

This client operated a solo orthopedic practice through an S-Corporation generating $1.8M in revenue. After paying six employees and all operating expenses, the practice produced $620,000 in net income. As an S-Corp, all net income flowed through to the owner's personal return and was taxed at the top federal rate of 37% plus California's 13.3% top marginal rate. The combined effective rate on the last dollars of income was approximately 43.3% (after accounting for the QBI deduction phase-out, which applied because the medical practice was classified as a Specified Service Trade or Business under IRC §199A(d)(2)).

The owner-physician was the only partner, age 54, and planned to practice for another 10-12 years. The prior CPA had never discussed C-Corp conversion because of the traditional concern about double taxation. However, with the Tax Cuts and Jobs Act reducing the C-Corp rate to 21% and the client's personal marginal rate exceeding 43%, the math had fundamentally changed. A C-Corp could retain earnings at 21%, fund fringe benefits not available in an S-Corp, and implement a defined benefit plan with contributions far exceeding what was possible in the S-Corp structure.

AE Tax Strategy

1. C-Corp Conversion and Retained Earnings Strategy Under IRC §11

We converted the practice from S-Corp to C-Corp by revoking the S election under IRC §1362(d)(1). The C-Corp pays tax at a flat 21% under IRC §11, compared to the 43.3% personal rate the owner was paying on S-Corp flow-through income. We structured the owner's W-2 compensation at $350,000 (defensible as reasonable compensation for a solo orthopedic surgeon based on MGMA salary data) and retained $270,000 in the corporation at the 21% rate ($56,700 in corporate tax) rather than distributing it at the 43.3% personal rate ($116,900 in personal tax). The retained earnings strategy saved $60,200 in the first year alone.

2. MERP and Fringe Benefits Under IRC §105(b) and §132

As a C-Corp, the practice could offer tax-free fringe benefits to the owner-employee that are not available in S-Corps (where more-than-2% shareholders are not eligible for tax-free fringe benefits). We implemented a MERP covering the owner and family for out-of-pocket medical expenses ($18,000/year), group term life insurance ($4,200/year in premiums), and a qualified transportation benefit ($3,480/year). These $25,680 in benefits were deductible to the corporation and tax-free to the owner, producing $6,400 in annual tax savings at the owner's marginal rate.

3. Defined Benefit Plan Under IRC §401(a) and §415

We implemented a defined benefit pension plan designed to maximize contributions for the 54-year-old owner. The actuarially determined contribution was $185,000 per year based on a target benefit at age 65. Combined with a 401(k) deferral of $23,500, total retirement contributions were $208,500. At the 21% corporate rate, the net tax cost of funding was significantly lower than in the S-Corp structure, where contributions reduced income taxed at 43.3%. The retirement plan restructuring produced $5,400 in net incremental savings after accounting for the changed deduction dynamics between entity types.

Before & After Comparison

Tax Category	Before	After	Savings
Federal + State Tax on Pass-Through	$116,900	$56,700	$60,200
Fringe Benefit Tax Savings	$0	$6,400	$6,400
Retirement Plan Optimization	$0	$5,400	$5,400
Total	$116,900	$44,900	$72,000

Key Takeaways

• C-Corp conversion makes economic sense when the owner's personal marginal rate (federal + state) significantly exceeds the 21% corporate rate and the business can retain substantial earnings.
• California's 13.3% top marginal state rate, combined with the federal 37% rate, creates a 43%+ effective rate that makes C-Corp retained earnings strategies particularly powerful.
• MERPs and other fringe benefits that are tax-free to more-than-2% S-Corp shareholders become available when converting to C-Corp, adding incremental savings.
• The accumulated earnings tax under IRC §531 must be monitored — C-Corps cannot retain earnings beyond reasonable business needs without facing a 20% penalty tax.