Congress wants to make Sub S shareholders pay more payroll taxes
forbes.com
forbes.com
Of course, this is really just a money grab on behalf on the politicians which affects a limited number of the (most productive) tax-paying population.
The net effect of this is that S Corps that use their retained earnings from year-to-year to build their business (employ more people and spend money in the private sector) now would be saddled with not only the income taxes on that money (which they already pay), but also a 15.3% (up to the Social Security limit) and 2.9% surtax above that.
Next, you know that Congress would love to remove that annual Social Security limit and make all income above the Social Security limit taxable at an additional 15.3%—for everyone.
<sarcasm>Why not? The "rich" aren't paying their "fair share." So, we need to soak them some more.</sarcasm>
Here's what I don't understand about the people who are complaining. If you're self-employed, like me, you have unlimited liability for debts, torts and so on incurred as a result of work. Similarly, if I form a partnership with my buddy, either or both of us who are general partners also have unlimited liability. As an individual or a partner, I can also hire people, make business purchases and deduct those expenses for tax purposes. But if my employee or my business vehicle or whatever is the cause of liability, as a sole trader or general partner all that liability comes back to me (tax on partnerships is a little different again).
Now, if instead I or myself and my friend set up an S corporation, I/we enjoy the benefits of limited liability up to (or more realistically, 'down to') the value of the shares held which are usually nominally priced at $1 or suchlike. So if I have an irresponsible employee who is negligent or runs up debts in the company's name, my personal/family assets are protected from business-related liability claims. This protection is nothing to sneeze at, and indeed, I'm looking at reorganizing for that exact reason.
So why is it, exactly, that those who enjoy the considerable benefits of limited liability for their business operations should also be able to exempt part of their annual business gain from social security obligations, whereas a self-employed person, with unlimited financial liability, can not?
One could argue that there is no feasible legitimate reason for an s-corp smaller than 3 employees, but one could equally argue that there is no reason to cap the payroll taxable income or that there is no reason to collect payroll taxes from young people who will surely never benefit from Social Security 50+ years from now (the program will likely be pure welfare by then which removes the justification for the regressive payroll tax to fund it).
That's what you meant, right? =)
Most "small businesses" are not S Corporations. An even smaller number are S Corporations that have been jiggered to allow owners to avoid FICA. And only fraction of the people employed by small businesses could ever take advantage of the loophole, since it's effectively usable only by owners.
My accountant tells me that the reasonable salary requirement is typically interpreted as anywhere between a 60/40 and 80/20 ratio of salary to distribution income. "Abuse" in this case is when someone takes the vast majority of their income as a distribution in order to avoid paying SS and FICA tax.
The reason S-corps get a break here is because of the unique niche they occupy. A well capitalized business is a good business. The intended operation of an S-corp, and what is currently incentivized through the tax structures in place, is this: an S-corp owner takes a "reasonable salary" (as defined above), but enjoys pass-through tax status on the remainder of the income. They pay federal withholding on this amount, but benefit from a lack of SS or FICA taxes. The primary source of capitalization in a small business is the primary shareholder. That is, in tough times, the owner will have to contribute money back in to the business in order to sustain it. This is because the corporation itself cannot hold any assets.
Without this benefit, there's really no point in filing an S-corp election. You might as well just file as a C-corp. The tax differences are negligible.
You're also dancing around the fact that the IRS can already determine by fiat what "reasonable" salary is. I'm not an accountant. We're an LLC filing as an S-Corp. We have professional accountants. We have not been advised of any "60/40" rule. What I have been advised of is that tax courts interpret any compensation an employee of an S-Corp gets for services rendered as a wage, and wages are subject to FICA.
My hunch --- and that's all it is --- is that this 60/40 business is less about what the tax courts interpret the tax code as, and more about what will prevent your returns from getting caught in the IRS dragnet. That doesn't mean that taking 40% of your wages as distributions and skipping FICA on them is actually aboveboard.
The big differences between S and C corps is that C corps pay federal corporate tax and C corps have preferred stock.
I also have to add, at severe risk of getting smacked down by 'grellas, that I think your argument about "the reasons why S-Corporations get this break" is unsupported by evidence. In fact, when I read the "Opinion" sections of court cases involving decisions about distros versus wages (every one of which I found finds for Revenue and not the company owner), I see things like:
Dr. Sadanaga performed substantial services on behalf of petitioner. The characterization of the payment to Dr. Sadanaga as a distribution of petitioner's net income is but a subterfuge for reality; the payment constituted remuneration for services performed by Dr. Sadanaga on behalf of petitioner. An employer cannot avoid Federal employment taxes by characterizing compensation paid to its sole director and shareholder as distributions of the corporation's net income, rather than wages. Regardless of how an employer chooses to characterize payments made to its employees, the true analysis is whether the payments represent remuneration for services rendered. Spicer Accounting, Inc. v. United States, 918 F.2d 90 (9th Cir. 1990); Joseph Radtke, S.C. v. United States, 895 F.2d 1196 (?th Cir. 1990).
The question doesn't appear to be "does your company deserve a break". Rather, it's pretty straightforwardly: "is this money you're earning as compensation for your work, or is this money you're earning as compensation for the downside risk of an investment you hold".
I'm sorry that you feel like I'm calling you shady. I don't even know you. I don't think you are shady. But this business of allowing S-Corp owners to exempt themselves from half their FICA obligation just because of a quirk in how they file taxes is, as I see it, shady.
Hate on Medicare and Social Security as much as you want, but as long as we have those programs, it is simply bullshit that company owners (not their employees, mind you, just the owners) can organize as an S-Corp, ratchet down their pro forma salaries, and collect the difference as "distributions".
As the parent poster slyly notes, this behavior is already unlawful. You'll find plenty of analyses on Google of people's attempts to skirt payroll taxes with distributions and then getting smacked down in IRS audits with 20% negligence penalties attached. The problem is that in order to catch those people, the IRS has to aggressively audit S Corps and take people to tax court, which is (a) a waste of everyone's time and money and (b) a nuisance for S-Corps who are playing by the rules.
All that's happening here is that a bright line is being created where a dim and flickering line was previously. That's a step forward. The notion that there was some social benefit to this quirk of the tax code is silly. If you try to defend it, you don't get to complain about the tax code being too complex anymore.
The purpose of an S-Corp is to allow the flexibility of an LLC while allowing companies to create real equity incentive plans for employees. It isn't a grant to small consulting companies to exempt them from FICA.
But it seems the S-Corp owners in question aren't even mainly in that ultra-expanded middle class. Is someone who's at, say, the 93rd percentile really in the "middle" of anything, or even at the upper end of the middle?
The fact of the matter is, as the owner of a company, you are at risk of not getting paid, or getting paid less than you would if you were employed somewhere else in the same position. 15% is a substantial amount of money to blow on a social program that will likely never benefit the individual paying into the system. Unless the government plans to begin compensating S corp owners that are making below a "reasonable" salary, to bring them up to a "reasonable" salary, something I also don't support, they should drop the onerous tax and allow small businesses to grow.
* The IRS will not force your corporation in to an unprofitable scenario as a result of the salary requirement; i.e., if your corporation is yielding a net loss, they will not force you to take salary, but then again, your tax issue is already solved if you have a NOL
* The reasonable salary clause is targeted and applied specifically to S-corp operators who take a disproportionately large amount of their income in the form of a distribution, rather than salary
There is potential for abuse with the existing tax code, but the reasonable salary requirement was created specifically to address that. Enforcement of this clause isn't intended to be applied in the context of market salaries (which is how we usually think of them), but in the context of the ratio of salary to distributions.
Why, exactly, should someone who owns or part-owns an S Corporation - the essence of which is that it is a pass-through entity and thus has greatly simplified filing requirements compared to, say, a C corporation - be able to designate part of the money they receive as income, to be taxed at one rate, and part as profit, to be taxed at a different one? Does setting up an S corporation magically make you more enterprising or worthy than individuals who file schedule C?
I mean, I'd love to be able to say that in a good year I just 'earned' the same amount as I did the previous year, but that the same activity also yielded a 'profit' which should be taxed differently...even though this 'profit' found its way into my bank account, rather than being reinvested in tax-deductible stuff like new plant or equipment or suchlike.
The question I'm asking, though, is why S corporation owners should not pay the same payroll taxes as anyone else. It's not like they don't get to deduct normal business expenses or necessarily create more economic value.
This phrasing, quoted from the bill, seems open to lots of interpretation. My business sells advertising on websites I've created. Is the principal asset of my business my personal "reputation and skill" or is the principal asset the websites themselves (which required my skill to build, but are distinct from the skills themselves)?
I'd argue that my business (and others like it, which I'm sure there are many here) doesn't fall under that description since (1) the principal asset is the website, not me personally, and (2) even if my skill is the business's principal asset, my personal reputation certainly is not, and the bill stipulates "reputation and skill", not "reputation or skill".
http://www.govtrack.us/congress/amendment.xpd?session=111...