Review Physician-Owner Employment Agreements in Light of Recent Tax Case

The particular case is Pediatric Surgical Associates PC v. Commissioner TC Memo 2001-81 (April 2, 2001).  The case contains decisions that have implications with regard to compensation arrangements of medical practices operating as “C” corporations.

Pediatric Surgical involved a “C” corporation medical practice that had been paying to its shareholder-surgeons compensation derived from collections attributable to their personal services, as well as from collections attributable to the services of nonshareholder-surgeons of the practice.   The IRS successfully argued that the compensation that was attributable to the nonshareholder-surgeons was not paid “purely for the services” of the shareholder-surgeons and therefore was not deductible by the practice.

Under Section 162(a)(1) of the Internal Revenue Code, a corporation may deduct payments of compensation to its employees “for personal services actually rendered.”  The regulations further provide that “any amount paid in the form of compensation, but not for the purchase price of services, is not deductible.”  This case is also significant because it might also apply to medical practices that generate profits from internal services lines that do not require the constant, hands on attention of physician owners - in house ancillary services, non-physician providers such as nurse practitioners, diagnostic testing, etc.

Given the implications of the Pediatric Surgical decision, medical practices who are organized as “C” corporations need to take precautions to ensure that their shareholder compensation plans do not result in the payment of nondeductible dividends. These precautions will be discussed in the next issue of the RTCPA Alert.