“Reasonable compensation” is where the IRS wins S-corp audits against healthcare practice owners. It’s also where most CPAs hand-wave their way to a number that doesn’t survive scrutiny.
This is the documentation standard we build for every Practice Partner client — the exact methodology the IRS expects when they audit your wage-vs-distribution split. Real BLS data, hours-worked logs, comparable-position analysis, and the signed annual memo that goes into your tax workpapers.
The IRS targets healthcare practice S-corps disproportionately because: (1) the gap between physician/clinician comp data and actual wages claimed is large and easy to spot, (2) BLS publishes detailed occupational wage data for every healthcare role, and (3) practice income flows are predictable enough to reverse-engineer.
Watson v. Commissioner (2012) — an accounting firm S-corp — set the precedent. Sean McAlary Ltd. (2013) — a single-shareholder PT — locked it in for healthcare specifically. Both lost. Both had documentation that looked reasonable on its face but didn’t survive cross-examination.
They paid themselves a wage their CPA “felt comfortable with” — without any actual documentation tying the number to market data or hours worked. The IRS’s reverse-engineering wins by default.
Get a defensible reasonable-comp study built for your practiceThe Bureau of Labor Statistics publishes May-of-each-year occupational wage data by state and metro area. For California healthcare, the 2024 data (the most recent at time of writing):
| Role | CA Median | 75th %ile | 90th %ile |
|---|---|---|---|
| Nurse Practitioner | $169,330 | $192,150 | $215,470 |
| Physical Therapist | $107,490 | $129,830 | $158,460 |
| Occupational Therapist | $105,180 | $126,540 | $152,300 |
| Speech-Language Pathologist | $96,810 | $118,720 | $142,180 |
| BCBA (ABA) | $87,420 | $108,300 | $132,790 |
| Clinical Psychologist | $118,440 | $148,210 | $182,560 |
For practice owners, the starting wage is typically the 50th–75th percentile, adjusted for geography and ownership premium. Bay Area, LA, San Diego: add 15–30%. Central Valley, Inland Empire: subtract 10–20%.
The IRS will reverse-engineer your hourly wage from total hours worked. If you bill 30 clinical hours/week and claim $50K W-2 wage on $250K of income, that implies $32/hour — well below any reasonable clinical comp. Audit-loser.
The defensible log separates:
Most clinician-owners work 50–60 hours/week. The split is typically 60–70% clinical, 25–35% admin/management, 5–15% business development. Each hour bucket gets a different comparable-position rate.
Ask: “If I hired someone to do what I do, what would I pay them?” For clinical hours, use BLS data above. For management hours, use clinic manager or practice administrator data ($75K–$110K in CA, typically 50th–75th percentile for owner-managers). For business development, sales / business development manager rates apply ($85K–$125K in CA).
Blend the rates by hours allocation. For most owners this lands in the $135K–$185K range as a defensible W-2 wage at typical practice income levels.
One page. Signed and dated. Filed in your tax workpapers. Cites the BLS data, your hours allocation, the comparable positions, and the geographic adjustment. Concludes with the wage decision and why.
Keep it for 7 years minimum. If audited, this is your first defense and usually ends the conversation before recharacterization is even discussed.
NP-owned family practice in Sacramento. 2026 numbers:
This split saves approximately $11,000/year in SE tax vs sole proprietor and survives IRS scrutiny because every dollar is tied to published wage data and documented hours.
Annually. BLS publishes new May-data each spring. We update during Q3 tax planning so the new wage takes effect Q4 or January.
Your W-2 wage should track. If income drops 20%, your hours may have dropped too — update the log and recalculate. The IRS expects your wage to reflect actual work performed, not a fixed historical number.
Yes — over-paying yourself is rarely audited. The risk is under-paying. If you’re worried, paying at the 90th percentile is safer than the median.