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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). B

by credo 16y ago

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 16y ago
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 16y ago
  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 16y ago
    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.

by credo 16y ago

tptacek 16y ago

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 16y ago
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 16y ago
  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.