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BUSINESS OF
MEDICINE
IS YOUR BONUS
‘reasonable’ compensation?
By Pamela C. Smith, PhD
You consider yourself a successful physician: You own your own the employees, provided such payments, when added to the stipu-
specialty practice, have numerous locations, employ well-qualified lated salaries, do not exceed a reasonable compensation for the serv-
staff and administrators, employ some of the best and brightest physi- ices rendered.”3
cians, and you own it all. Your closely held business generates more
than $15 million in total billings for the year. Your practice keeps Items that can help substantiate the reasonableness include evidence
you very busy – you see patients, perform surgeries, and you’re deeply of comparable salaries. In Midwest Eye Center, they did not provide
involved with the managerial tasks of the business. Since you are so any such evidence. They argued there were no “like enterprises” under
engaged, you carry many titles – CEO, president, COO, and medical “like circumstances” for which to draw comparisons. The physician’s
director – just to name a few. The many hats you must wear might increased workload and various roles (CEO, CFO, etc.) were the rea-
increase your stress level, but your efforts do not go unnoticed. You son for the bonus. This “reason” was not substantiated with any
are able to collect a basic salary of more than $700,000 per year, but methodology for calculating the bonus relative to those responsibilities.
your successful juggling of tasks and increased workload are also well This lack of substantiation led to the denial of part of the bonus de-
worth the $2 million end-of-year bonus. You were the one who duction – which led to an underreporting of income – which sparked
brought in more than 25 percent of the billings for the year, so that the application of accuracy-related underpayment tax penalties.
bonus is well-deserved.
WHO PREPARED THE RETURN
IRS MAY DENY BONUS The next logical question in this story might be: Who prepared
To the average physician, who is aware of the stress, demanding
this tax return? Why is that paid-preparer not responsible for some
schedule and expertise needed in today’s environment, this compen- of this? In the Midwest Eye Center case, the company failed to pro-
sation arrangement appears sufficient. To the Internal Revenue Serv- vide any evidence concerning the identity of the paid tax preparer,
ice (IRS), however, the bonus amount might not be completely what type of information the center provided to the preparer, or even
reasonable. The IRS and the tax law require compensation to be rea- whether or not the center relied on the preparer’s judgment.
sonable, considering all facts and circumstances. Otherwise, the com-
pensation deduction will be denied for tax purposes. The moral of this story: reasonableness of compensation should
not be ignored. Your opinion of your expertise, brilliance and cut-
The above scenario occurred in a recent tax court decision, Midwest ting-edge technologies may not be sufficient to justify your compen-
Eye Center, S.C. v. Commissioner1. The IRS denied $1 million of sation package arrangement. From the government’s perspective, it
the total $2 million bonus, arguing the taxpayer failed to establish the is unlikely your situation is so unique that a “comparable enterprise”
reasonableness of the bonus. The eye surgery center failed to prove with “like circumstances” does not exist. Medical practices and
the bonus was reasonable because it did not provide any evidence of physicians are encouraged to employ competent advisors that under-
comparable salaries, and failed to show exactly how the bonus was cal- stand and follow tax laws. With proper consultation and methodol-
culated. Furthermore, the center failed to substantiate why the bonus ogy, the next Midwest Eye Center case should not occur.
was paid in four equal installments at the end of the year.
REFERENCES
Taxpayers are allowed to deduct eligible expenses, as a matter of
legislative grace, as long as the expense is considered “ordinary and 1 Midwest Eye Center, S.C. v. Commissioner, TC Memo 2015-53.
necessary.” Salaries and bonuses also must be deemed to be (1) rea- 2 See Treas. Reg. §1.162-7(a)
sonable in amount and (2) paid or incurred for services actually ren- 3 See Treas. Reg. §1.162-9
dered2. What is defined as “reasonable” is all based on the facts and
circumstances of each particular situation. For bonuses, the tax reg- Pamela C. Smith, PhD, is a professor in the depart-
ulations stipulate they are deductible “when … made in good faith ment of accounting at the University of Texas at San An-
and as additional compensation for the services actually rendered by tonio.
visit us at www.bcms.org 21
