
H.R. 4213 - Payroll Tax for S-Corp Dividends - euroclydon
http://www.taxgirl.com/new-tax-bill-raising-eyebrows/
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tptacek
_GOOD_. The dividend/payroll split trick that S-Corps play is a huge scam.

Normal people in normal jobs --- hell, ace (non-founder) devs at startups
taking W2 wages --- have most of their income subject to payroll taxes (most
notably FICA). These taxes are a significant chunk of all your withholdings.

However, if you and your partners own an S-Corp, you can choose to pay
yourself not only in direct wages but also as cash distributions (think
"profit sharing"). Unlike wages, distros are not subject to payroll taxes. You
can skip out on your FICA payments for all the income you elect to pay as a
distro.

In an LLC, _all_ of a company principal's income is paid as distros (you can't
formally be an LLC principal and take W2 wages). But that income is all
subject to self-employment tax. It's only in the weird little blip between LLC
and C-Corp that this tax avoidance trick exists.

There is no legitimate reason why an LLC principal should have to fully fund
Medicare and Social Security, and a C-Corp director should have to fully fund
Medicare and Social Security, but an S-Corp shareholder should be able to
carve out some (or even _most_ ) of their income to avoid those taxes.

To my eyes, this is a loophole in the purest sense of the word, and I'd be
happy to see them kill it.

~~~
alex1
The big reason people do an S-Corp is to avoid double taxation (and to be a
corporation rather than LLC while not having the complex structures of a
C-Corp). Better than being a sole proprietor. Keep in mind that S-Corps can
only have a certain number of shares and shareholders (100?) in one class of
stock, so a startup or large corporation can't be an S-Corp and take advantage
of the tax benefits. Also, here in California, all corporations (S and C and
even LLC) owe tax even if the company's net income is zero.

~~~
tptacek
Um, I'm not a CPA, and I definitely don't know how California taxes work, but
at the federal level, isn't that (taxation at the corporate level) pretty much
the _opposite_ of how an S-Corp works?

~~~
alex1
An S-Corp just avoids double taxation. Salaries paid out are subject to FICA.
As for the remaining business income, each shareholder would still owe taxes
based on how much of the business they own. This is different than a C-Corp
where the business income would be taxed at the corporate level in addition to
the owners paying income tax on their salaries. And if the owners of a C-Corp
decided to pay themselves huge dividends to avoid normal income taxation, that
would raise red flags.

In California, S-Corps pay a 1.5% franchise tax on net income (minimum $800).
You pay this even if your net income is zero or negative. You pay this no
matter what.

Disclosure: I'm also not a CPA.

~~~
tptacek
Yeah, Alex, I'm just saying: S-Corps don't pay federal corporate taxes, do
they? I thought _that_ was the point of an S-Corp. Your comment, before you
edited it, said flat-out that they did.

(We file as S, but thankfully I'm not the person here that has to know exactly
how this stuff works. See previous comments for evidence that you should not
take tax advice from me.)

~~~
alex1
Right, yeah, looks like S-Corps don't pay _federal_ corporate taxes. I knew it
was to avoid double taxation but I had forgotten which taxation S-Corps were
exempt from. My bad. Unfortunately, for California, you owe the 1.5% (minimum
$800) franchise tax on company income whether you're an LLC or S-Corp or
C-Corp. In NYC, you are subject to the full corporate income tax rate, even as
an S-Corp.

~~~
tptacek
That explains why I suddenly had to start paying NY taxes, even though I live
in Illinois (we started filing differently).

------
hga
" _The bill slowly poisons many s corporations."

[...]

"I’m not alone in my concern over the scope of this bill and what it means for
our economy. We keep pushing a little bit at the edges of some pretty sweeping
changes at an alarming speed – so fast, in fact, that many taxpayers haven’t
had time to digest them, much less, react to them._"

A general term for this is "regime uncertainty." People continually complain
about a corporate focus on the next quarter while not noticing that major tax
and other business law (e.g. SarBox) changes every couple of years makes it
well neigh impossible to do long range planning.

Things have been quite a bit worse lately and as long as Team Obama and the
Congress continue to move at ramming speed a _lot_ of economic activity is
going to be suppressed until many months, probably more than a year, pass so
that people can digest the changes and their implications.

~~~
tptacek
If you were playing the S-Corp distro game, my understanding is that you were
already living in a world of uncertainty, because (a) paying out distros that
are large relative to your wages is an audit flag, and (b) the IRS already has
the authority to retroactively decide what fair market value for your company
role is and then whack you for the money you tried to stash in distros.

People do it anyways because everyone is unlikely to get audited almost no
matter what they do. That doesn't mean that closing the loophole is going to
throw people's tax planning in to chaos. You opt for chaos when you decide to
cheat.

~~~
apowell
Playing the "S-Corp distro game" is _not_ cheating.

If an S-corp brings in, say, several hundred thousand dollars in net profit
and the principal pays themselves a fair wage for an employee in that role
(perhaps it's in the neighborhood of $80k - $150k), then that is completely
legitimate under current law.

Aggressive but correct tax planning is not cheating, and for a responsible
business owner who wants to maximize personal income (and ability to reinvest
in the business), it's the way the game should be played.

~~~
tptacek
I agree, but what's your point? If you're getting ~90k in wages, the rest of
your income isn't subject to FICA anyways.

(That may soon change, with talks of lifting the caps on payroll taxes, and
that's a change I'll be far more ambivalent about).

~~~
apowell
I admit, that point had not occurred to me. Nevertheless, the Medicare portion
isn't subject to a cap.

My main issue was this: "You opt for chaos when you decide to cheat."
Aggressive tax planning within the bounds of the law is not cheating, and I
think it's unfair to characterize it that way.

The wage/distro setup is an advantage unique to S-Corp owners, and I
understand why some want to see it eliminated. But to use it today is not
cheating.

~~~
tptacek
The courts appear to disagree with you. "Aggressively" characterizing a
portion of your income as a distribution when it is really just disguised
wages appears to be a losing proposition, except for the fact that you're
probably not going to get audited (as long as you pay yourself a relatively
significant amount as bona fide wages).

A tax planning strategy that relies on never getting audited, and that fails
spectacularly when you do get audited, I think can reasonably called
"cheating". I get that reasonable people can disagree on this, and I'm fine
with reasonably disagreeing with you.

~~~
apowell
By "aggressively within the bounds of the law", I was suggesting that the
IRS's position and court's position was already taken into consideration (not
just the low chance of being audited).

Regardless, surely it's possible to have situations where distributions are
legitimately greater than zero. If I'm an absentee owner who pays a manager to
operate my business, my distributions shouldn't be treated as wages.

I see it as a continuum -- on one end, you have cheaters who are paying
themselves $10k annually and taking the rest as distributions. On the other
end, you have absentee owners who should legitimately be able to claim
distributions. In the middle there are many shades of gray.

~~~
tptacek
Here we converge on agreement. Thanks for your patience.

------
credo
Today, an s-corp founder does benefit by being able to split his/her income
between W2 wages and distributions (on which payroll taxes don't need to be
paid). Besides increasing tax burden, this bill will also make the tax-filing
process a bit more cumbersome for s-corp founders.

If HR 4123 goes through, the tax-benefit will be removed for S-corp founders.
However, venture capitalists (with carried interest income), perhaps some LLC
founders (who don't take W2 salaries) will still be exempted from payroll
taxes.

Unfortunately, as part of payroll taxes, s-corp founders are required to pay
unemployment insurance taxes that they can never benefit from. For example,
I'm required to pay FUTA taxes when I get W2 wages, yet I cannot claim
unemployment allowances if my company doesn't make money in a given month.

If they're talking about closing loopholes, I think they should close the
reverse-loophole that lets the fed govt collect unemployment taxes without
providing any unemployment benefits. My state (WA) exempts corporate officers
from paying unemployment taxes, but that just means that I pay even higher
FUTA taxes to the the federal govt.

~~~
tptacek
You have in reality no such benefit. From my cursory research, taxpayers have
consistently lost every case in which they attempted to hide wages as distros.
Courts have held that "wages" is a term that describes all remuneration for
services rendered in any form. Even loans from the company to shareholders
can, under the tax code, be reclassified by the IRS as FICA-eligible wages.

The only benefit S-Corp shareholders have under the present system is that
they can force the IRS to audit to recover this money, which is a game that
entrepreneurs often win because very few people really get audited anyways.

So, two things. First, the loophole doesn't really simplify your life. For
many years after filing one of these bogus returns, you can still be levied
for the hidden wages, plus penalties (including a huge extra negligence
penalty). Second, there's nothing fair or sensible about the exemption S-Corp
shareholders are taking; people with exactly the same skin in the economy have
to pay FICA, so why shouldn't S-Corp owners?

~~~
credo
You're making the assumption that _all_ S-corp distributions amount to "hiding
wages". Most accountants will tell you that IRS regulations disagree with you
on that point.

I see that you didn't respond to the reverse-loophole point on FUTA taxes. Why
should a company pay unemployment insurance taxes for founder-employees when
these employees can never claim unemployment allowances ?

~~~
tptacek
The general line of argument would be that FUTA payments fund a broad social
safety net, and that no "insurance" payment we make to the government has
implied 1:1 benefits for the payers.

But we don't have to bother with that argument because I agree with you on
that point.

The general logic of the tax code and the IRS' enforcement of it seems to be
that as an employee of a company --- which you are unless there's some
patently obvious reason why you would be performing services for the company
otherwise --- then your role has a fair market value. If you make at least
that amount of money in any way, you owe payroll taxes on it. Over that
amount, you don't.

The reality of the software business is, if you're a principal, founder,
officer, director, or lead at a company that can afford to distribute tens of
thousands of dollars to its employees, your fair market value is probably
greater than the FICA cap, and the notion of what "is" or "isn't" a
distribution is academic.

Are there scenarios where people are legitimately taking profit sharing
distros that are not, under the spirit of the tax code, wages? I'm sure there
are. Do those scenarios really account for a significant fraction of the cases
where people take a "wage/distro split"? _I really doubt it_. My casual sense
of it is, people that take a "wage/distro split" feel entitled to pay lower
taxes simply because they've finagled themselves into an S-Corp.

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sfbrando
First of all let me point out that employees who are not business owners do
NOT have to pay in the full 15.3% (SS & Medicare) to the government. Only 1/2
of that gets taken out of their paychecks. The other 1/2 is paid by the
employer (social security wage base is $106,800 and unlimited for medicare).
Also, in most states employees do not have to pay into unemployment. The
employer pays into that for them. They also usually get vacation/sick pay and
health insurance benefits. A one owner S Corporation has to pay in the full
15.3% on their wages plus $434 into FUTA that he/she cannot use. In addition
they have to pay for their own health insurance and obviously no vacation/sick
pay. Please do not compare employees to business owners. Employees have NO
idea. This HR 4213 bill is another attack on the small businesses probably
because the politicians cannot control us since most of us are free thinkers
and usually not tied to one party. The S Corporation has been around for 50
plus years and has been a blessing to us small one-owner firms. I pay myself a
reasonable wage (what I would expect if I work for someone else in my line of
work) and then I usually leave a good chunk of money in the company savings
account and take a small amount in shareholder distribution. With this new
bill even amounts I don't take out will be subject to SECA. I usually save
about $3,000 per year in SECA because of the S Corporation. This might not
seem like alot to most people but an extra $3000 to my family seems harsh. Why
am I being penalized when bigger firms won't be? Why are they picking on the
little guy who works hard?????

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toddh
Also <http://biztaxtalk.com/node/1576>

~~~
tptacek
The main advantage of forming an S-Corp should be that it allows you to have a
formalized corporate structure with shareholders (including employees with
bona fide ISOs or restricted stock) without incurring the rather large
overhead of maintaining a C-Corp. An S-Corp should simply be the corporate
version of an LLC.

It doesn't seem to me that the intent of the S-Corp structure was to allow a
small number of people at the top of the company to exempt half their income
from taxes that virtually everyone else in the country has to pay.

~~~
sfbrando
I don't think you know what you are talking about. I am a CPA and there isn't
any larger overhead expenses for one owner C-Corps vs. S-Corps. The main
difference is that owners/employees of C-Corps usually just take money out by
way of wages only. If they also take dividends they have to pay income tax on
the dividends on their personal return, but get no deduction on their
corporate income tax return. Thus "double taxation" is the result. S-Corps
make it simpler to take distributions and make more sense and are more fair
and equitable. Most S-Corps take money out in wages and shareholder
distributions. The wages need to be reasonable and the shareholder
distributions are a distribution of profit of which you pay income tax on, but
there is no double taxation since the income flows through to your personal
tax return anyway. I don't know what you mean about small number of people at
the top of the company get to exempt half their income from taxes that
virtually everyone else in the country has to pay. Our income is not exempt in
any way. You might want to know your facts before spouting off stuff you don't
know.

