When a therapist should elect S corporation status

A therapist who practices as a sole proprietor, or through a single-member LLC that has never made an election, reports the practice’s profit on Schedule C and pays self-employment tax on it. Only a corporation, or an entity such as an LLC that is eligible to elect to be treated as one, can make the S election, so a sole proprietor forms an entity first. In North Carolina, G.S. 57D-2-02 lets an LLC render a licensed therapist’s services only to the extent a professional corporation could, so the practice is organized as a professional LLC, and Chapter 55B requires a certificate of registration from the therapist’s licensing board before it opens. For a practice that already has its LLC, the election leaves the license and the clinical work as they were. It changes how the profit is taxed, and it adds payroll and a second tax return to every year that follows.

Whether that trade is worth making is arithmetic specific to each practice. The saving is Social Security and Medicare tax on the profit above a salary you can defend. Against it run the cost of payroll, the corporate return, any state tax on the corporation, and, for an owner whose taxable income is below the section 199A threshold, a generally smaller qualified business income deduction. Inside the phase-in range that effect can reverse, because the salary the corporation pays you counts as W-2 wages for the deduction’s wage limit. This post takes each piece with 2026 figures, works a hypothetical example through to the end, and then covers the Form 2553 deadline and what changes in the books after the election.

What the election changes

Without the election, self-employment tax reaches all of the practice’s profit. The 2026 Form 1040-ES worksheet applies it to 92.35 percent of net profit, at 12.4 percent for Social Security on earnings up to $184,500 for 2026 and 2.9 percent for Medicare on all of it, and allows half of the tax as a deduction in figuring adjusted gross income.

With the election, the corporation pays you a salary through payroll. For 2026, Publication 15 sets Social Security tax at 6.2 percent each for the employer and the employee on wages up to $184,500, and Medicare tax at 1.45 percent each with no wage limit, so the salary carries the same combined 15.3 percent, and the two treatments part ways only on the rest of the profit. The Form 1120-S instructions say that S corporation income “isn’t self-employment income and isn’t subject to self-employment tax,” so the profit you take above the salary as distributions carries neither payroll tax nor self-employment tax.

The saving therefore depends on the salary. The IRS says an S corporation must pay reasonable compensation to a shareholder-employee for services before making non-wage distributions, and its guidance on S corporation compensation ties the answer to where the practice’s receipts come from. Receipts generated by your own sessions point to wages, while receipts generated by non-shareholder employees and by capital and equipment point to distributions. For a solo therapist who sees every client, that leaves less room above the salary than a first look suggests. How we build the salary for a clinician-owner is in our post on reasonable compensation for therapists.

What the election costs

The first cost is payroll, because Publication 15 says that when a business is incorporated, corporate officers who work in the business are employees of the corporation. The corporation withholds and deposits your income tax and the employee share of Social Security and Medicare, generally files Form 941 each quarter and Form 940 for the year, and issues you a W-2. Federal unemployment tax applies at 6.0 percent to the first $7,000 of each employee’s wages for 2026, and the credit for state unemployment tax can bring the rate down to 0.6 percent, which is $42 for one employee with the full credit. In practice the election means a payroll service, or a bookkeeper who runs payroll, for as long as it lasts.

The corporation also files its own return. Form 1120-S is due by the 15th day of the third month after the tax year ends, which is March 15 for a calendar-year practice. The penalty for a late return is figured per shareholder for each month it is late, for up to 12 months under the instructions, and Rev. Proc. 2025-32 sets the monthly amount at $260 for returns required to be filed in 2027. Preparing that return is a cost a Schedule C filer does not have.

North Carolina

The CD-401S instructions say there is no separate S election for North Carolina income tax purposes, and the corporation files Form CD-401S by the 15th day of the fourth month after its year ends. The election does bring the practice into the state franchise tax. Under G.S. 105-114(b)(2), a limited liability company that elects to be taxed as a corporation is a corporation for franchise tax purposes, and G.S. 105-122(d2), in the version that applies to tax years beginning on or after January 1, 2025, sets the tax for an S corporation at $200 for the first $1,000,000 of its tax base and $1.50 per $1,000 above that. The Department of Revenue gives $200 as the minimum. The CD-401S instructions measure the tax by the corporation’s net worth, taken from the book balance sheet at the end of the tax year, so a therapy practice whose tax base is under $1,000,000 owes the $200 minimum under the rate in effect for 2026.

Other states

Other states set their own rules for S corporations, and some tax the corporation itself. California’s Franchise Tax Board, for example, taxes every S corporation with California source income at 1.5 percent and says S corporations are subject to an annual $800 minimum franchise tax, which it waives for a newly formed or qualified S corporation filing an initial return for its first taxable year. The waiver is for that first year only, so an entity that was already formed before it elects S status does not appear to get it on the Franchise Tax Board’s wording. If you practice outside North Carolina, or see clients in more than one state, the state side belongs in the comparison before the federal arithmetic does, and it is part of our multi-state work.

How the election changes the qualified business income deduction

Before P.L. 119-21, section 199A(i) said the qualified business income deduction would not apply to tax years beginning after December 31, 2025. Section 70105 of the act replaced that subsection with a minimum deduction of $400 for 2026 for an owner with at least $1,000 of qualified business income from businesses in which the owner materially participates, so the deduction continues for 2026 and later years and belongs in the S corporation comparison.

Section 199A(c)(4) excludes from qualified business income any reasonable compensation the business pays you for your services, so an S corporation salary never counts toward the deduction, while a sole proprietor’s practice income generally does. A therapy practice is also in the field of health. Treasury Regulation section 1.199A-5 lists health among the specified service fields and defines it as the provision of medical services by individuals such as physicians, nurses, psychologists, and other similar healthcare professionals, so the practice is a specified service trade or business and the deduction depends on the owner’s taxable income. Rev. Proc. 2025-32 puts the 2026 threshold at $201,750 of taxable income ($201,775 if married filing separately), or $403,500 on a joint return. Below it the specified service limits do not apply. Between the threshold and $276,750 ($276,775 separately, $553,500 joint) the deduction phases down, and above that range income from a specified service business produces no deduction at all.

Under section 199A(a) the deduction also cannot exceed 20 percent of taxable income figured before the deduction (less any net capital gain), and below the threshold section 199A(b)(3)(A) turns off the separate limit based on W-2 wages. Below the threshold, then, a sole proprietor deducts 20 percent of the practice’s qualified business income or of taxable income, whichever is smaller, while an S corporation owner’s 20 percent applies only to the profit left after salary. Above the phase-in range neither one gets a deduction from the practice, and the election costs nothing on this front.

Inside the range the comparison has to be run both ways, because a sole proprietor with no employees has no W-2 wages, and the wage limit that phases in over the same range cuts the deduction a second time. The salary an S corporation pays you is W-2 wages under section 199A(b)(4), and Treasury Regulation section 1.199A-2 says that for this purpose employees include officers of an S corporation, so the salary can keep that limit from applying. Near the top of the range the S corporation owner can end up with the larger deduction.

A worked example

The figures below are hypothetical and chosen to show the mechanics. They are not a threshold, and a different salary, state, or household changes the answer.

Take a single therapist with no other income who takes the standard deduction, which Rev. Proc. 2025-32 sets at $16,100 for 2026, and who has no retirement plan or health insurance through the practice. The practice earns $120,000 of profit in a year before anything is paid to the owner, and the example uses 2026 rates throughout as a stand-in for the first year of an election. If it elects, assume a reasonable salary of $70,000, set from market evidence for this therapist’s work rather than as a share of profit, and assume the election adds $3,000 a year of deductible costs for payroll processing, the corporate return, state filings and franchise tax, and unemployment taxes. That $3,000 is an assumption for the arithmetic, not a quote of anyone’s fees. The example leaves out state income tax and rounds to the cent.

As a sole proprietor, self-employment tax is figured on 92.35 percent of $120,000, which is $110,820. At 15.3 percent the tax is $16,955.46, and deducting half of it, $8,477.73, leaves adjusted gross income of $111,522.27. After the standard deduction, taxable income before the qualified business income deduction is $95,422.27. That is less than the practice’s qualified business income, so the deduction is 20 percent of $95,422.27, or $19,084.45, and taxable income is $76,337.82.

As an S corporation, the $70,000 salary carries $5,355 of employer Social Security and Medicare tax and $5,355 withheld from the paychecks, $10,710 in all. The corporation deducts the salary, its share of those taxes, and the $3,000, which leaves $41,645 of profit passing through to you on Schedule K-1. Adjusted gross income is the $70,000 salary plus the $41,645, or $111,645, and taxable income before the deduction is $95,545. The deduction is 20 percent of the $41,645 of qualified business income, which is $8,329, so taxable income is $87,216.

Both taxable incomes fall in the 22 percent bracket, which for a single filer in 2026 covers taxable income over $50,400 up to $105,700, so we treat each added dollar of taxable income as 22 cents of tax. Taxable income is $10,878.18 higher with the election, which adds $2,393.20 of income tax. Social Security and Medicare tax falls by $6,245.46. Take away the $3,000 of costs and the $2,393.20, and the election saves $852.26 for the year.

A payroll tax saving of more than $6,000 shrinks to under $900 once the costs and the smaller deduction are counted. Holding the salary at $70,000 and the costs at $3,000, the same arithmetic comes out about even at a profit of roughly $113,400. The result is just as sensitive to the salary. If the defensible salary for the same $120,000 practice were $80,000, Social Security and Medicare tax would be $12,240, qualified business income would fall to $30,880, taxable income would rise to $88,604, and the election would cost $983.10 for the year instead of saving anything.

When the numbers tend to support an election

The example points to the conditions that matter. Profit should sit well above a salary you could defend from market evidence, and it should do so steadily, because the salary and the payroll are commitments for every year the election is in place. A group practice can be in a better position than a solo one, because under the IRS compensation guidance, receipts generated by non-shareholder employees, such as associates’ sessions, support distributions rather than wages. Showing that margin takes books that track sessions and collections by clinician. At higher incomes the deduction stops mattering once taxable income is above the phase-in range, and inside the range it can favor either side. The saving on each added dollar of profit also narrows above the Social Security wage base, because the 12.4 percent Social Security part stops at $184,500 of earnings for 2026 either way and only the Medicare part remains.

Some effects run the other way and belong in the same decision. A lower salary means less income subject to Social Security tax, and the Schedule SE instructions note that the Social Security Administration uses the information from Schedule SE to figure benefits under the Social Security program. Retirement contributions shrink with it, since the IRS says in its retirement plan FAQs for S corporations that distributions are not earned income for retirement plan purposes and that contributions are based on W-2 compensation, which we cover in our post on solo 401(k) and SEP-IRA plans. And the election is not easy to undo and redo. The Form 2553 instructions say it stays in effect until it is terminated or revoked, and that IRS consent is generally required to elect again for any tax year before the fifth tax year after the first tax year in which the termination or revocation took effect. For a practice in its first year, with profit that is still a forecast, we generally suggest a year of real numbers before deciding. A practice that forms a new entity already intending S status should file Form 2553 when the entity is formed, as our late election post explains.

Filing Form 2553 on time

The election is made on Form 2553. Under section 1362(b) and the Form 2553 instructions, it has to be filed no more than 2 months and 15 days after the beginning of the tax year it is to take effect, or at any time during the tax year before. For a calendar-year LLC that wants S status from January 1, 2027, that means filing at any time during 2026 or by Monday, March 15, 2027. Section 1362(b)(3) treats an election filed later in 2027 as made for the following year, 2028.

A newly formed practice has no year before, so its window is the 2 months and 15 days after its first tax year begins. The instructions tell a new entity to enter the earliest of the date it first had owners, the date it first had assets, and the date it began doing business, and they say an election made before the first tax year begins is not valid. An LLC that files a timely Form 2553 is treated as a corporation from the election’s effective date and does not need to file a separate Form 8832.

The form needs an officer’s signature and a consent from every shareholder. The instructions accept a certified mail receipt as proof of filing, and when the acceptance letter arrives, the IRS page on the CP261 notice says to keep it in your permanent records.

If the deadline has already passed

A missed deadline is not always final. The Form 2553 instructions describe relief under Rev. Proc. 2013-30, generally requested within 3 years and 75 days of the intended effective date, for an entity that intended to be an S corporation from that date, had reasonable cause for filing late, acted diligently once it found the mistake, and has shareholders who reported their income consistently with S status. Because intent from the effective date is a condition, relief repairs a missed filing. It does not let a practice decide in October that it would have preferred S status since January. The requirements are covered in our post on late S election relief.

Practices with more than one owner

A small group owned by two or three clinicians through an LLC that files a partnership return can elect too, but every owner consents on the form and the entity has to qualify. An S corporation can have only one class of stock. Treasury Regulation section 1.1361-1(l)(2) tests that against the governing provisions, which for an LLC means the operating agreement. An agreement drafted for partnership taxation can allocate profit by who brought in the revenue or give one owner a preferred return. Provisions like that need to be rewritten before the election, because every ownership interest has to carry identical rights to distribution and liquidation proceeds, and differences in what each owner earns for clinical and management work belong in salary.

What changes in the books after the election

The day-to-day change shows up in the books. Your pay moves from owner draws to a salary run through payroll on a regular schedule, with the withholding and payroll tax expense recorded each pay period, and the withholding can do the work your quarterly estimated payments used to do. Anything you take beyond the salary is a shareholder distribution, recorded in equity rather than as an expense. Under section 1368(b), for a corporation with no accumulated earnings and profits, a distribution is tax-free only up to your stock basis, and any excess is treated as gain.

Business costs you pay personally, such as the home office you use for telehealth, mileage, or a license renewal, are reimbursed by the corporation under an accountable plan. Under Treasury Regulation section 1.62-2(c)(4), amounts paid under an accountable plan are not reported as wages on the W-2 and are exempt from employment taxes. Health insurance changes too. The IRS compensation guidance says premiums paid for a more-than-2-percent shareholder are reportable as wages on the W-2, and when they are paid under a plan for all or a class of employees they go in box 1 but not in boxes 3 and 5. The owner can then take the deduction for the premiums on the personal return if the other requirements are met, under IRS Notice 2008-1. The details are in our post on health insurance for S corporation owners.

The balance sheet matters more than it did on Schedule C. The corporation’s tax year starts on the effective date of the election, so the books need a clean cutoff on that date, and in North Carolina the franchise tax is measured from net worth on the book balance sheet at year end. Our affiliated bookkeeping company, bookkeepz, LLC, explains how the owner’s salary, distributions, health insurance, and reimbursements are recorded in its post on S corporation owner pay in a therapy practice’s books, and how a group practice tracks sessions and margin by clinician in its guide to group practice bookkeeping.

Where we help

We run this comparison with therapists as part of tax planning, ideally in the fall, with most of a year of real numbers in hand and time to file Form 2553 for January 1. The salary, the state costs, and the qualified business income deduction are worked out together, which is where our S corporation work starts, and our page for therapy practices covers what else is different about a therapist’s return. If you are deciding whether to elect for 2027, book a consultation and we will run your numbers with you.

This post describes federal tax rules and selected North Carolina and California rules for 2026 as general information. The worked example is hypothetical, and the post is not advice for any particular practice.

• S corporation
• Elections
• Private practice