Given the implications of the Pediatric Surgical decision, I feel that 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. It appears that a 1990 Tax Court memorandum decision, Richlands Medical Association v. Commissioner, may provide the best guidance in establishing a compensation plan that will pass IRS scrutiny. While I do not want to reiterate the entire decision in this letter, the case provides insight into the tax court’s rationale for allowing some compensation based on various “other medical responsibilities” performed by the physicians.

Based on the Richland case, I would offer the following suggestions to medical practices for augmenting a compensation plan for its shareholder-physicians:

• Determine and document the billings and collections of each physician employed in the practice.

• Determine and document the offices held by each shareholder-physician and the responsibilities associated with each office.

• Determine and document any responsibilities, in addition to offices held and the provision of medical services to patients, assumed by the shareholder-physicians on behalf of the practice; administrative duties, managerial duties (personnel as well as practice), marketing activities, pro bono activities, etc.

• Determine and document the amount of time devoted to such activities.

• Determine and document the time and compensation other physicians in similar settings are receiving for similar services.

• Determine and document any other sources of income of the practice, and whether services performed by shareholder-physicians are in any way related to such sources of income.

• Determine whether shareholder-physicians have been underpaid for any of the above services in prior years. If it is determined and future compensation is allocated as “make up” compensation, document the purpose and amount clearly and thoroughly.

• Pay a meaningful dividend to the shareholders of the practice.

There are alternatives to having to address the compensation issues raised by Pediatric Surgical. However, these alternatives, the conversion to “S’ corporation or LLC status, are fraught with numerous additional issues and complications.

I believe that the best way to defend the amount of compensation you are paying your shareholder-physicians for their services is to be able to document the source to which an item of income of the practice is attributable, and having a justifiable rationale for the allocation of that income to the shareholder-physicians in return for their services. In both Pediatric Surgical and Richlands, the court denied further deductions due to a lack of documentation of their assertions.