The optical in Dr. Kling’s practice. He says that determining owner compensation requires a careful look at the profitability and expenses of the practice.
Optimizing doctor-owner compensation in optometry practices
By Mick Kling, OD
Dec. 18, 2024
In the first installment of “The Year-End Practice Checkup,” we explored strategies for analyzing the profit-and-loss statement, including organizing data, assessing goals and reducing costs.
In the second installment, we focused on the impact of debt on the practice and strategies to determine what we can afford in the coming year.
In this final installment, we’ll explore how compensation, including W-2 wages and distributions, affects cash flow, so we can properly prepare for the year ahead.
As a business coach, I often help practice owners answer the all-too-common question: “Where’s all the money?”
In many cases, I find owners either underpay themselves, often due to insufficient cash flow, or overpay, leaving the business without the capital it needs. Both scenarios create distinct challenges for the owner and the practice.
Taking too little in compensation over time leads to frustration and resentment toward the business. At some point, the owner begins to question their efforts, including their decision to own a business, possibly thinking, “I should just go work for someone else.”
More frequently, I see owners treat their business bank account like a personal ATM, withdrawing funds whenever cash is available to meet personal needs. This can lead to poor cash flow, inaccurate financial statements, and even IRS audits. Determining the right amount to pay yourself, however, is not always simple.
The Two Hats You Wear
As an optometry practice owner, you wear two hats that provide two distinct sources of income: one as an active contributor in the practice earning wages for clinical, administrative and leadership duties, and the other as an investor yielding a return for the risks of ownership. Many owners mistakenly view these as a single income stream.
Separating these sources—compensation for the work you do in the practice from the earnings of the business—clarifies your return on investment and ensures your time, effort and risk as an owner are justified.
Doctor-Owner Compensation
When determining your pay, there are two key considerations.
The first is, “How much can I pay myself?” Just like any other expense in your business, your personal compensation needs to fit within the framework of your business’s economics. This depends greatly on the size of your practice and how well you control expenses. Overpaying yourself creates the same cash flow problems as overspending on frames, rent or staff.
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The second consideration is, “How much should I pay myself?”
How Much Can I Pay Myself?
It’s tempting to withdraw money from your practice bank account whenever you need it, especially when it’s available. However, without a clear understanding of how much your business can afford, you are almost guaranteed to find yourself in a cash flow crisis before long.
Determining how much your practice can afford to pay you depends largely on three key factors:
1) The size of your practice
2) How well your expenses are controlled
3) The amount of debt you have
The size of your practice largely determines how much you can afford to pay yourself as both an employee and an investor. A practice that produces $3 million annually would likely be able to afford to pay its owner more than one generating $800,000.
However, a well-run $800,000 practice could outperform a $1 million practice if expenses are managed properly, resulting in more resources available to pay the owner.
The amount of debt you have, as discussed in the last installment, significantly impacts what’s left over to pay the owner. This is probably the biggest threat I see to owner pay.
It’s easy to get caught up in investing in the latest technology, accumulating massive amounts of practice debt. Because this debt must be repaid from the business’s profit, burying your practice in debt will surely take a major bite out of your personal income.
To better understand what your business can afford to pay you, you must first get to know your cash flow. A good place to start is by looking at a one-year snapshot of your P&L statement. This will tell you what’s left over after all expenses are paid, but before the doctors are paid (both owners and associates) and before the debt is repaid. This is sometimes referred to as the “Net Operating Income” (NOI).
Once you’ve determined your NOI, you’ll need to subtract your debt payments (both principal and interest), tax reserves and any capital reserves (i.e., emergency funds) planned to cover cash shortfalls during slow months or for unforeseen disasters.
In theory, what’s left over would be available to compensate the practice owner. If, after performing this exercise on your own practice, you don’t like what you see, you have three choices:
1) Increase your practice revenue
2) Decrease your expenses
3) Reduce your debt
Here’s an example of how a practice might determine how much it can afford to pay its owner:
Your tax reserves should never be neglected since this is not your money and belongs to Uncle Sam. You should also avoid prioritizing or padding your own compensation before considering your capital reserve targets. This is your safety net for slow months (there will be slow months), an office flood, personal illness or a planned vacation. It’s going to happen, so you need to be prepared. Only after you have met all of these obligations should you consider what’s left to pay yourself.
How Much Should I Pay Myself?
Once you determine how much your business can pay you, the next question is how much you should be paid and how.
Many small businesses, and most optometry practices, elect S-corporation tax status, which passes the profit and loss of the company through to the owner to avoid double taxation (which typically occurs with C-corporations) and minimize self-employment taxes.
Self-employment tax is part of FICA, the Federal Insurance Contributions Act, which funds Social Security (old-age, survivors, disability insurance) and Medicare (hospital insurance). Both employers and employees contribute to Social Security and Medicare taxes at a total rate of 15.3 percent, with 12.4 percent allocated to Social Security (applies to earnings up to $176,100 in 2025, an increase from $168,600 in 2024) and 2.9 percent to Medicare.
For non-owner employees, these taxes are split equally between the employer and employee, meaning the company is responsible for 6.2 percent of Social Security and 1.45 percent for Medicare.
However, if you own your company and are both the employer and employee, you are subject to self-employment tax and responsible for the entire tax (15.3 percent). That means for every $100,000 of W-2 income you earn, your self-employment tax would be $15,300.
Since distributions from an S-corp are not subject to Social Security and Medicare taxes, taking that same $100,000 as a distribution instead of a W-2 wage would avoid the tax liability altogether, saving $15,300 in taxes.
Because of this obvious advantage, it’s tempting for S-corporation owners to take compensation in the form of company distributions rather than a W-2 salary. But not so fast! This is a major red flag with the IRS. An owner who fails to take an appropriate W-2 wage to avoid self-employment taxes may be asking for an audit.
Determining “Reasonable Compensation”
According to the IRS, S-corporation owners must pay themselves a “reasonable compensation” if they are providing “meaningful service” to the business. If a doctor is actively seeing patients and managing the business, the IRS expects that the doctor’s compensation (W-2) would be appropriate for the services provided.
IRS rules state that employee-owners must pay themselves a comparable wage to that of someone with similar training and experience performing the same job.
For example, if Dr. Jones is seeing patients three days per week, spending one day performing administrative duties, and taking a half day off for personal time, reasonable compensation could be calculated based on what it would cost to have an associate doctor in the practice three days per week, an office administrator one day per week and a CEO for half a day per week.
Once you have satisfied the IRS’s requirements for reasonable compensation by paying yourself a fair market W-2 wage, it would be reasonable to take any additional profit as a distribution, which would avoid self-employment taxes. It is important to consult your CPA or tax advisor since other considerations may affect this decision.
Conclusion
Achieving the right balance in doctor-owner compensation is crucial for both personal financial health and the success of your practice. By understanding the dynamics of your dual roles—employee and investor—you can ensure that your compensation reflects the value you bring to the practice while maintaining the financial stability of your business.
Start by determining what your practice can afford to pay you by analyzing your Net Operating Income from your P&L statement, accounting for taxes, debt and cash reserves. Then, evaluate what you should pay yourself based on your contribution of service to the practice, adhering to IRS guidelines for reasonable compensation.
Remember, overcompensating or under-compensating yourself creates unique challenges, so it’s essential to strike a careful balance.
Finally, consult with your financial advisor or CPA to customize these strategies to your specific circumstances.
By thoughtfully managing your compensation, you can meet your financial needs while safeguarding the health of your practice for the new year.
M
ick Kling, OD, is the president of Impact Leadership and the founder and CEO of Invision Optometry in San Diego, Calif. Dr. Kling is also the Practice Management and Transition Advisor for Vision Source. To contact him: dr.kling@invisioncare.com
