Physician Tax Terminology Guide

The Backdoor Roth IRA is a legal strategy that allows high-income physicians who exceed Roth IRA income limits to contribute to a Roth IRA indirectly. For 2026, Roth IRA contributions phase out for single filers earning above $153,000 and married filing jointly above $228,000. Most independent contractor physicians exceed these thresholds.

Last updated: May 2026

The Backdoor Roth process involves two steps: First, contribute up to $7,000 ($8,000 if age 50 or older) to a traditional IRA with no income limit restrictions. Second, immediately convert that traditional IRA to a Roth IRA. Because the contribution was made with after-tax dollars and converted immediately, the conversion generates minimal or zero taxable income.

Last updated: May 2026

For physicians with existing traditional IRA balances, the pro-rata rule complicates the strategy. The IRS requires that all traditional IRA conversions include a proportional amount of pre-tax and after-tax dollars across all traditional IRA accounts. A physician with $100,000 in a pre-tax traditional IRA who contributes $7,000 after-tax and immediately converts faces taxation on approximately $6,550 of the conversion due to the pro-rata calculation.

Last updated: May 2026

The strategy works for married couples where both spouses have earned income. Each spouse can execute their own Backdoor Roth, contributing a combined $14,000 annually ($16,000 if both are 50 or older). This provides $14,000 to $16,000 of annual tax-free growth potential that would otherwise be unavailable due to income restrictions.

Last updated: May 2026

A Cash Balance Plan is a defined benefit pension plan that allows significantly higher annual contributions than a Solo 401(k). While a Solo 401(k) caps contributions at approximately $72,000 for 2026, a Cash Balance Plan can permit contributions exceeding $300,000 annually depending on age and compensation level. This makes it the single highest-leverage tax deferral tool available to high-income physicians.

Last updated: May 2026

Unlike a 401(k) where the participant controls investment decisions, a Cash Balance Plan promises a specific account balance growing at a predetermined rate, typically 5 percent annually. The participant receives whatever the account value reaches at retirement, but the plan sponsor (the physician's S-Corporation) bears the investment risk. If investments underperform, the sponsor must contribute additional funds to meet promised benefits. If investments outperform, the sponsor can reduce future contributions.

Last updated: May 2026

Cash Balance Plans require annual actuarial certification costing $3,000 to $8,000. The actuary calculates the required contribution based on the participant's age, compensation, years to retirement, and the plan's funding status. Older participants closer to retirement require larger contributions to reach the promised benefit level, making Cash Balance Plans particularly valuable for physicians ages 50 and above.

Last updated: May 2026

Cash Balance Plans require consistent annual funding. Unlike a 401(k) where contributions can vary year to year, Cash Balance Plans impose minimum funding requirements. Terminating a plan early can trigger penalties and excise taxes if the plan is underfunded. This commitment makes Cash Balance Plans appropriate for physicians with stable, high income who plan to continue earning at that level for at least 5 to 10 years.

Last updated: May 2026

The plans can be structured to cover only the physician-owner or to include employees. Including employees increases costs and complexity but may be necessary depending on the practice structure. Physicians in solo S-Corporations without employees have the simplest implementation path.

Last updated: May 2026

The Mega Backdoor Roth strategy allows high-income physicians to contribute an additional $50,000 to $69,000 annually into Roth accounts beyond standard contribution limits. This strategy requires a Solo 401(k) plan with specific provisions permitting after-tax employee contributions and either in-service distributions or in-plan Roth conversions.

Last updated: May 2026

The IRS sets an overall 415(c) contribution limit for retirement plans of $72,000 for 2026 ($80,500 if age 50 or older including catch-up contributions). Standard Solo 401(k) contributions consume part of this limit through employee deferrals ($24,500) and employer profit-sharing contributions (up to 25 percent of compensation). The remaining space within the $72,000 cap can be filled with after-tax employee contributions if the plan document permits.

Last updated: May 2026

After making after-tax contributions, the participant immediately converts those dollars to Roth. Because the contribution was already taxed and the conversion happens immediately, minimal or zero additional tax applies. The converted funds then grow tax-free permanently, creating substantially more tax-free wealth than the standard Backdoor Roth IRA strategy which caps at $7,000 annually.

Last updated: May 2026

Not all Solo 401(k) providers offer the necessary plan provisions. Fidelity, Schwab, and specialized providers like My Solo 401k Financial and Rocket Dollar support Mega Backdoor Roth strategies, but the feature must be explicitly requested during plan setup. Providers like Vanguard do not currently support after-tax contributions in their Solo 401(k) plans.

Last updated: May 2026

The strategy becomes more valuable as income increases because higher compensation allows larger employer contributions, leaving more room under the $72,000 cap for after-tax dollars. A physician earning $500,000 who can structure reasonable compensation around $200,000 can make $50,000 in employer contributions plus $24,500 in employee deferrals, leaving limited after-tax space. The optimal structure requires careful salary planning to maximize after-tax contribution capacity.

Last updated: May 2026

MGMA publishes annual physician compensation surveys that provide specialty-specific salary benchmarks used to support reasonable compensation decisions for physician S-Corporation owners. The IRS requires S-Corporation owner-employees to pay themselves reasonable compensation subject to payroll taxes before taking distributions. MGMA data provides industry-standard evidence of what constitutes reasonable pay for physicians in specific specialties.

Last updated: May 2026

The MGMA Physician Compensation and Production Survey reports median and percentile compensation data across over 140 specialties based on surveys of thousands of medical practices. The data distinguishes between employed physicians, owners, and independent contractors. For S-Corporation reasonable compensation purposes, employed physician data typically provides the most relevant benchmark because it reflects W-2 salary without ownership profit distributions.

Last updated: May 2026

MGMA data is subscription-based and not freely available. Annual subscriptions cost several thousand dollars, making direct access impractical for individual physicians. CPAs and advisors serving multiple physician clients often maintain MGMA subscriptions and reference the data when establishing client compensation levels. Physicians working with advisors lacking MGMA access should request documentation of how their reasonable compensation was determined.

Last updated: May 2026

MGMA compensation data includes both salary and productivity-based incentives that employed physicians receive, making it comprehensive. However, the data reflects full-time employed physicians who benefit from employer-provided malpractice insurance, health insurance, retirement contributions, and paid time off. Independent contractor physicians operating S-Corporations must fund these benefits themselves, potentially justifying compensation toward the lower end of MGMA ranges.

Last updated: May 2026

The IRS has not published specific safe harbors for physician reasonable compensation, but Tax Court cases and IRS audit outcomes suggest that compensation within the 25th to 75th percentile of MGMA data for the physician's specialty generally withstands scrutiny when properly documented. Compensation below the 25th percentile or above the 90th percentile invites questions and requires additional justification.

Last updated: May 2026

The One Big Beautiful Bill Act, enacted in early 2026, made substantial changes to federal tax policy affecting high-income taxpayers including independent contractor physicians. The most significant provisions for physicians include expanded SALT deduction caps, extended QBI deduction rules, and modified individual income tax brackets.

Last updated: May 2026

Prior to OBBBA, the state and local tax (SALT) deduction was capped at $10,000 for all taxpayers. OBBBA increased this cap to $40,400 for taxpayers with income below $505,000, providing substantial benefit to high-income earners in states with state income taxes like California, New York, New Jersey, Oregon, and Minnesota. For physicians earning above $505,000, the cap phases back down to $10,000, making Pass-Through Entity Tax (PTET) elections critical for deducting state taxes at the federal level.

Last updated: May 2026

The legislation extended QBI (Qualified Business Income) deduction rules through 2028 with modified thresholds. The 2026 threshold for married filing jointly taxpayers increased to $383,900, above which the QBI deduction begins phasing out for physicians classified as Specified Service Trade or Businesses (SSTBs). The phase-out completes at $533,900. These thresholds require precise income management for physicians earning in the phase-out zone.

Last updated: May 2026

OBBBA also adjusted individual income tax brackets, slightly lowering rates for most brackets while maintaining the top 37 percent rate for income above $400,000. The standard deduction increased to $32,200 for married filing jointly and $16,150 for single filers. These changes create marginally lower tax liability for most physicians, though the benefit is modest compared to SALT and QBI impacts.

Last updated: May 2026

The legislation's sunset provisions require Congress to act again by 2028 to extend these benefits or they will revert to pre-2026 rules. This creates planning uncertainty for long-term strategies, particularly for physicians considering Cash Balance Plans or other multi-year commitment strategies based on current tax law assumptions.

Last updated: May 2026

Pass-Through Entity Tax (PTET) elections allow S-Corporation owners to pay state income taxes at the entity level rather than the individual level. This workaround to the $10,000 federal SALT deduction cap permits state taxes paid by the S-Corporation to be deducted as a business expense, effectively removing the SALT cap limitation for those taxes.

Last updated: May 2026

Over 30 states now offer PTET elections including California, New York, New Jersey, Illinois, Massachusetts, Oregon, Minnesota, Connecticut, and Rhode Island. Each state structures its PTET program differently with varying election deadlines, payment schedules, and credit mechanisms. Some states require annual elections by March 15, others permit mid-year elections, and some allow retroactive elections with the prior year tax return.

Last updated: May 2026

When an S-Corporation makes a PTET election and pays state tax at the entity level, individual shareholders receive a refundable or nonrefundable state tax credit equal to their share of the PTET payment. The S-Corporation deducts the PTET payment as a business expense on its federal return, reducing the income that flows through to shareholders. This effectively converts a nondeductible personal state tax payment into a deductible business expense.

Last updated: May 2026

PTET becomes particularly valuable for physicians earning above $505,000 who lose access to the expanded $40,400 SALT cap under OBBBA. For these physicians, PTET remains the primary mechanism for deducting state taxes at the federal level. Physicians earning below $505,000 must compare the $40,400 SALT cap benefit against PTET advantages to determine optimal strategy, which varies by state and income level.

Last updated: May 2026

Some PTET programs impose limitations. Massachusetts and Maine provide only 90 percent refundable credits, creating a small leakage where 10 percent of the PTET payment generates no state-level offset. New York limits PTET payments to $10 million per taxpayer. Several states impose different PTET rates than standard individual income tax rates. Physicians must evaluate their specific state's PTET rules to quantify actual benefit.

Last updated: May 2026

Qualified Business Income (QBI) is the deduction created by Section 199A of the tax code that allows eligible taxpayers to deduct up to 20 percent of qualified business income from pass-through entities including S-Corporations, partnerships, and sole proprietorships. For physicians, this deduction can reduce federal income tax liability by $8,000 to $30,000 or more annually depending on income and structure.

Last updated: May 2026

For S-Corporation physician-owners, QBI consists of the ordinary business income reported on Schedule K-1, excluding W-2 wages paid to the owner. If a physician's S-Corporation generates $400,000 in net income, pays the physician $180,000 in W-2 salary, and distributes $220,000, the QBI amount equals $220,000. The potential deduction is 20 percent of $220,000, or $44,000, subject to limitations.

Last updated: May 2026

Physicians face unique QBI limitations because medical practices are classified as Specified Service Trade or Businesses (SSTBs). For 2026, the QBI deduction begins phasing out at $383,900 of taxable income for married filing jointly taxpayers and fully disappears at $533,900. For single filers, the phase-out begins at $191,950 and completes at $266,950. Taxable income, not gross income, determines phase-out status. This allows physicians to use retirement contributions, self-employed health insurance deductions, and the standard or itemized deductions to reduce taxable income below the threshold.

Last updated: May 2026

The QBI deduction is also limited to the lesser of 20 percent of QBI or 20 percent of taxable income. A physician with $200,000 in QBI but only $150,000 in taxable income due to large mortgage interest and charitable deductions receives a QBI deduction of $30,000 (20 percent of $150,000), not $40,000 (20 percent of $200,000). This limitation typically binds only for physicians with substantial itemized deductions relative to their business income.

Last updated: May 2026

For physicians in the SSTB phase-out range, the deduction decreases proportionally. A married filing jointly taxpayer with $450,000 of taxable income is $66,100 into the $150,000 phase-out range, which is 44 percent through the phase-out zone. Their QBI deduction reduces by 44 percent from its full amount. Strategic year-end retirement contributions, equipment purchases, or other deductions can pull taxable income back below the threshold, preserving the full deduction.

Last updated: May 2026

Reasonable compensation is the W-2 salary an S-Corporation owner-employee must pay themselves before taking distributions. The IRS requires S-Corporation owner-employees who provide services to the corporation to receive reasonable compensation subject to payroll taxes (Social Security and Medicare). Distributions taken without adequate salary violate IRS rules and trigger penalties, back taxes, and interest.

Last updated: May 2026

The IRS has not published a specific formula or safe harbor for determining reasonable compensation. Instead, Tax Court cases and IRS guidance indicate that reasonable compensation should reflect what an independent third party would pay for similar services in similar circumstances. Factors include the nature and extent of services provided, qualifications and experience of the employee, time devoted to the business, compensation paid to comparable employees in similar businesses, and the overall financial performance of the business.

Last updated: May 2026

For physician S-Corporation owners, MGMA (Medical Group Management Association) data provides the most widely accepted benchmark. MGMA publishes annual specialty-specific physician compensation surveys. CPAs and tax advisors commonly reference MGMA median or percentile compensation for the physician's specialty to support reasonable compensation determinations. Compensation within the 25th to 75th percentile of MGMA data for the relevant specialty typically withstands IRS scrutiny when properly documented.

Last updated: May 2026

Reasonable compensation interacts with QBI optimization. Higher salary reduces payroll taxes paid by the corporation and owner combined, but also reduces QBI (which equals S-Corporation income minus salary). Lower salary maximizes QBI but increases audit risk if compensation falls too far below industry standards. Physicians earning near QBI phase-out thresholds face additional complexity balancing salary levels against threshold management.

Last updated: May 2026

Documentation matters. CPAs should document the methodology used to determine reasonable compensation, reference to MGMA or other industry data, and consideration of relevant factors. Annual review is advisable as income levels, service scope, or market conditions change. The IRS typically reviews reasonable compensation during S-Corporation audits, making contemporaneous documentation critical.

Last updated: May 2026

An S-Corporation is not a business entity type but rather a tax classification elected by filing IRS Form 2553. A corporation or LLC files this election to be taxed under Subchapter S of the Internal Revenue Code, which provides pass-through taxation while allowing owner-employees to split income between W-2 wages (subject to payroll taxes) and distributions (not subject to payroll taxes).

Last updated: May 2026

For independent contractor physicians, S-Corporation status creates payroll tax arbitrage. Sole proprietors and single-member LLCs pay self-employment tax (15.3 percent for Social Security and Medicare) on all net business income. S-Corporation owner-employees pay payroll taxes only on their W-2 salary. Distributions escape payroll taxes entirely. For a physician earning $300,000, this difference can generate $10,000 to $20,000 in annual tax savings depending on salary level.

Last updated: May 2026

To elect S-Corporation status, the entity must first exist as a corporation or LLC. Most physicians form an LLC and elect S-Corporation tax treatment, combining the legal simplicity of an LLC with S-Corporation tax benefits. Some states, notably New York and California, require physicians to form Professional LLCs (PLLCs) or Professional Corporations (PCs) to comply with state professional licensing laws. These entities can still elect S-Corporation tax treatment at the federal level.

Last updated: May 2026

S-Corporations face operational requirements. The entity must run payroll for the owner-employee, file Form 941 quarterly employment tax returns, provide the owner a W-2, file a separate business tax return (Form 1120-S), and maintain corporate formalities such as annual resolutions and separate bank accounts. These requirements add approximately $2,500 to $5,000 in annual accounting and payroll costs for most physician S-Corporations.

Last updated: May 2026

Form 2553 must be filed within two months and 15 days of the entity formation date to make the S-Corporation election effective retroactive to formation. Late elections are possible but require additional IRS approval. Many physicians form their entity in December and immediately file Form 2553 to ensure S-Corporation status applies for the full following calendar year.

Last updated: May 2026

S-Corporation status provides additional benefits beyond payroll tax savings. It enables Solo 401(k) plans with higher contribution limits than SEP IRAs. It creates a structure for Cash Balance Plan implementation. It allows certain fringe benefits such as health insurance reimbursement and accountable plan expense reimbursement. The combined value of these benefits often exceeds the direct payroll tax savings for high-income physicians.

Last updated: May 2026

A Solo 401(k), also called an Individual 401(k) or Self-Employed 401(k), is a retirement plan designed for self-employed individuals with no employees other than a spouse. For physician S-Corporation owners, the Solo 401(k) permits maximum annual contributions of approximately $72,000 for 2026, significantly exceeding SEP IRA contribution capacity for most income levels.

Last updated: May 2026

Solo 401(k) contributions consist of two components: employee deferrals and employer contributions. Employee deferrals for 2026 are capped at $24,500 ($32,500 if age 50 or older with catch-up), with an additional $8,000 catch-up available for ages 60 through 63. Employer contributions can reach 25 percent of W-2 compensation for S-Corporation owners. Combined, these sources can reach the overall $72,000 limit ($80,500 with catch-up contributions).

Last updated: May 2026

Unlike SEP IRAs which accept only employer contributions, Solo 401(k) plans allow employee deferrals from day one of self-employment even if the business generates little or no profit. A physician in their first year of locum work earning $80,000 can contribute the full $24,500 employee deferral regardless of profitability, whereas a SEP IRA would be limited to 20 percent of net self-employment income after expenses.

Last updated: May 2026

Solo 401(k) plans offer Roth contribution options unavailable in SEP IRAs. Employee deferrals can be designated as Roth contributions, creating tax-free growth. Some plans permit Roth employer contributions as well, though this is less common. The Roth feature provides tax diversification, creating both pre-tax (traditional) and after-tax (Roth) retirement savings.

Last updated: May 2026

Plans offering after-tax contribution provisions enable Mega Backdoor Roth strategies. After maxing out employee deferrals and employer contributions, participants can contribute additional after-tax dollars up to the $72,000 cap and immediately convert them to Roth. This requires specific plan language permitting after-tax contributions and in-service distributions or in-plan Roth conversions. Not all Solo 401(k) providers offer these features.

Last updated: May 2026

Solo 401(k) plans permit loans up to $50,000 or 50 percent of the account balance, whichever is less. This provides access to retirement funds for emergencies or opportunities without tax penalties, though loans must be repaid with interest. SEP IRAs do not permit loans. Solo 401(k) plans also allow the participant to self-direct investments into alternative assets like real estate or private equity, depending on the custodian.

Last updated: May 2026

A Specified Service Trade or Business (SSTB) is a classification under Section 199A that subjects certain professional services to QBI deduction phase-out rules based on income thresholds. Medical practices are explicitly classified as SSTBs, meaning physicians face QBI deduction limitations that other business owners do not.

Last updated: May 2026

The IRS defines SSTBs to include businesses involving the performance of services in health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing and investment management, trading, or any business where the principal asset is the reputation or skill of one or more employees or owners. This definition intentionally excludes businesses selling products or providing services not based primarily on individual expertise or reputation.

Last updated: May 2026

For SSTB owners, the QBI deduction begins phasing out once taxable income exceeds $383,900 (married filing jointly) or $191,950 (single) for 2026. The phase-out completes at $533,900 (married filing jointly) or $266,950 (single). Within the phase-out range, the deduction reduces proportionally. Above the upper threshold, SSTB owners receive no QBI deduction regardless of business structure or income level.

Last updated: May 2026

Some physicians can structure practices to potentially avoid SSTB classification. A physician who owns a medical practice but does not personally provide patient care services may argue the business is not an SSTB because the principal asset is the employed physicians' work, not the owner's personal reputation or skill. This argument requires careful structuring and documentation. The IRS scrutinizes such claims closely, particularly when the owner previously provided clinical services through the same entity.

Last updated: May 2026

Ancillary services provided by physician-owned entities may qualify as non-SSTB income. A dermatologist who also operates a medical spa offering cosmetic treatments performed by employed aestheticians might allocate a portion of income to non-SSTB activity. Similarly, a physician-owned imaging center where the physician reads studies but does not operate equipment might partially qualify for non-SSTB treatment. These strategies require detailed accounting separating SSTB and non-SSTB revenue and expenses, with legal and tax advisor review to ensure compliance.

Last updated: May 2026