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As the article said, there's already a "reasonableness" test for setting a correct salary for the work that an S Corp. owner does. If owners are still not setti

As the article said, there's already a "reasonableness" test for setting a correct salary for the work that an S Corp. owner does. If owners are still not setting reasonable salaries for themselves (and pay the appropriate additional employment taxes), then we need more enforcement in that area—not a new law. 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>

cma 16y ago
The fact is, S-corps provide several advantages, and if you think the tax is too high, you are free to forgo forming an S-corp and form a partnership instead. I don't see the coercion; "double taxation" isn't usually a complaint about extra taxes that are voluntarily paid in exchange for extra benefits.
- grandalf 16y ago
  By that logic, why shouldn't a larger corporation have to pay 15% of its entire gross income as payroll tax? Why shouldn't someone who is a W2 employee earning $500K per year?
  - anigbrowl 16y ago
    Because you only pay payroll tax on payroll, not on expenses or capital purchases like equipment. A w-2 employee (and his or her employer) pays into social security up to $106,800 per annum. Same if you're self-employed; in that case one pays both the employee and employer contributions, but the latter are deductible for calculating taxable income payable to the IRS. 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?
    - bd_at_rivenhill 16y ago
      We are witnessing evolution in action here. Sole proprietorships and partnerships have become uncompetitive dinosaurs due to the explosion of litigation, and the system is in the process of reconfiguring itself to provide liability protection at a similar level of taxation. Given the risk of being involved in legal action, I don't understand why anyone would want to organize using an unprotected structure; fill out the paperwork and get yourself covered.
    - tptacek 16y ago
      I don't understand why you aren't already organized as an LLC. Apart from some minor paperwork and nominal fees, there's no downside to it over a sole proprietorship. 'bd-at_rivenhill is right about this.
      - anigbrowl 16y ago
        No special reason - just that freelancing and my financial situation has been simple enough that the 'ez' filing has generally been sufficient, and the potential for liability has been minimal.
        grandalf 16y ago
        I don't disagree with your logic, but I think you've simply chosen a non-optimal business arrangement. There is really no reason not to form an S-Corp or an LLC. In most cases, S-Corps are a better idea. Changing the tax code to prevent the taxing of distributions as capital gains simply amounts to raising taxes on small businesses. 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).
        tptacek 16y ago
bradleyland 16y ago
What really bugs me about this legislation is who it targets. Obama's entire campaign hinged upon a commitment to avoid imposing new taxes on the "middle class" and going after big money hoarders who evade taxes. Those who operate S-corps aren't the ones avoiding massive amounts of taxes. This is a backdoor way of increasing taxes on the upper-middle-class, and it really sucks.
- grandalf 16y ago
  True. Obama has changed few of Bush's policies and amplified the worst of them.
- hugh3 16y ago
  Aww, gee, well in that case I assume Obama will veto it, since in this video he makes a "firm pledge" that "no family making less than two hundred and fifty thousand dollars a year will see any form of tax increase": http://www.youtube.com/watch?v=Q8erePM8V5U http://www.youtube.com/watch?v=Q8erePM8V5U
  - tptacek 16y ago
    This isn't a tax increase. People taking this informal tax "deduction" are counting on the IRS never reviewing their tax returns. As it stands today, and as it stood when Obama took office, if the IRS gave any of these shady returns a second look, the filers would wind up in tax court.
    - hugh3 16y ago
      I don't pretend to understand the details here, but if it's just a question of better enforcing existing laws then why is there a bill?
      - tptacek 16y ago
        If you don't pretend to understand the details, why do you feel comfortable making political arguments that rely on them?
jcnnghm 16y ago
The "reasonableness" test is bullshit also. Last I checked, a salary is a predetermined amount of money that will be paid over a predetermined amount of time, for a predetermined amount of work. A reasonable salary for the owner of an S Corp should be whatever the company can guarantee they will be paid over the course of the next twelve months, or, in retrospect, their lowest monthly cash income over the last twelve months, times twelve, or a comparable employee salary, whichever is lower. 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.
- bradleyland 16y ago
  My sister is an accountant specializing in audits and forensic accounting. I've talked to her about this extensively. Any portion of the tax code that mentions "reasonableness" is indeed open to interpretation. The interpretation of this code is (much like criminal law), based on judicial rulings; case law. In the case of a "reasonable salary", the following stipulations apply: * 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.
  - tptacek 16y ago
    Unfortunately for S-Corp advocates on HN, the "natural" FICA exemption already stops right around the "reasonable" salary of a computer professional.
anigbrowl 16y ago
Y'know, I file Schedule C (ie, self-employed), and also pay the 15.3% rate of SS up to ~$106k (ie the employer's share in addition to the employees) - and like owners of S corps, that employer's contribution is deductible when calculating the taxable income, so that I'm not paying taxes twice on the same money. 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.
- bd_at_rivenhill 16y ago
  I think the real question here is why you don't reorganize your business to take advantage of the benefits of an S-corp.
  - tptacek 16y ago
    If he has no employee shareholders, exactly what is the benefit of structuring as an S-Corp?
    - deleted 16y ago
      [deleted]
  - anigbrowl 16y ago
    I don't; that's a side issue about me personally (the actual reason being that that film production, which is the field I'm in, is generally insured by the producer so I don't have significant liability). 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.

cma 16y ago

The fact is, S-corps provide several advantages, and if you think the tax is too high, you are free to forgo forming an S-corp and form a partnership instead. I don't see the coercion; "double taxation" isn't usually a complaint about extra taxes that are voluntarily paid in exchange for extra benefits.

grandalf 16y ago
By that logic, why shouldn't a larger corporation have to pay 15% of its entire gross income as payroll tax? Why shouldn't someone who is a W2 employee earning $500K per year?
- anigbrowl 16y ago
  Because you only pay payroll tax on payroll, not on expenses or capital purchases like equipment. A w-2 employee (and his or her employer) pays into social security up to $106,800 per annum. Same if you're self-employed; in that case one pays both the employee and employer contributions, but the latter are deductible for calculating taxable income payable to the IRS. 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?
  - bd_at_rivenhill 16y ago
    We are witnessing evolution in action here. Sole proprietorships and partnerships have become uncompetitive dinosaurs due to the explosion of litigation, and the system is in the process of reconfiguring itself to provide liability protection at a similar level of taxation. Given the risk of being involved in legal action, I don't understand why anyone would want to organize using an unprotected structure; fill out the paperwork and get yourself covered.
  - tptacek 16y ago
    I don't understand why you aren't already organized as an LLC. Apart from some minor paperwork and nominal fees, there's no downside to it over a sole proprietorship. 'bd-at_rivenhill is right about this.
    - anigbrowl 16y ago
      No special reason - just that freelancing and my financial situation has been simple enough that the 'ez' filing has generally been sufficient, and the potential for liability has been minimal.
      - grandalf 16y ago
        I don't disagree with your logic, but I think you've simply chosen a non-optimal business arrangement. There is really no reason not to form an S-Corp or an LLC. In most cases, S-Corps are a better idea. Changing the tax code to prevent the taxing of distributions as capital gains simply amounts to raising taxes on small businesses. 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).
        tptacek 16y ago

bradleyland 16y ago

What really bugs me about this legislation is who it targets. Obama's entire campaign hinged upon a commitment to avoid imposing new taxes on the "middle class" and going after big money hoarders who evade taxes. Those who operate S-corps aren't the ones avoiding massive amounts of taxes. This is a backdoor way of increasing taxes on the upper-middle-class, and it really sucks.

grandalf 16y ago
True. Obama has changed few of Bush's policies and amplified the worst of them.
hugh3 16y ago
Aww, gee, well in that case I assume Obama will veto it, since in this video he makes a "firm pledge" that "no family making less than two hundred and fifty thousand dollars a year will see any form of tax increase": http://www.youtube.com/watch?v=Q8erePM8V5U http://www.youtube.com/watch?v=Q8erePM8V5U
- tptacek 16y ago
  This isn't a tax increase. People taking this informal tax "deduction" are counting on the IRS never reviewing their tax returns. As it stands today, and as it stood when Obama took office, if the IRS gave any of these shady returns a second look, the filers would wind up in tax court.
  - hugh3 16y ago
    I don't pretend to understand the details here, but if it's just a question of better enforcing existing laws then why is there a bill?
    - tptacek 16y ago
      If you don't pretend to understand the details, why do you feel comfortable making political arguments that rely on them?

jcnnghm 16y ago

The "reasonableness" test is bullshit also. Last I checked, a salary is a predetermined amount of money that will be paid over a predetermined amount of time, for a predetermined amount of work. A reasonable salary for the owner of an S Corp should be whatever the company can guarantee they will be paid over the course of the next twelve months, or, in retrospect, their lowest monthly cash income over the last twelve months, times twelve, or a comparable employee salary, whichever is lower. 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.

bradleyland 16y ago
My sister is an accountant specializing in audits and forensic accounting. I've talked to her about this extensively. Any portion of the tax code that mentions "reasonableness" is indeed open to interpretation. The interpretation of this code is (much like criminal law), based on judicial rulings; case law. In the case of a "reasonable salary", the following stipulations apply: * 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.
- tptacek 16y ago
  Unfortunately for S-Corp advocates on HN, the "natural" FICA exemption already stops right around the "reasonable" salary of a computer professional.

anigbrowl 16y ago

Y'know, I file Schedule C (ie, self-employed), and also pay the 15.3% rate of SS up to ~$106k (ie the employer's share in addition to the employees) - and like owners of S corps, that employer's contribution is deductible when calculating the taxable income, so that I'm not paying taxes twice on the same money. 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.

bd_at_rivenhill 16y ago
I think the real question here is why you don't reorganize your business to take advantage of the benefits of an S-corp.
- tptacek 16y ago
  If he has no employee shareholders, exactly what is the benefit of structuring as an S-Corp?
  - deleted 16y ago
    [deleted]
- anigbrowl 16y ago
  I don't; that's a side issue about me personally (the actual reason being that that film production, which is the field I'm in, is generally insured by the producer so I don't have significant liability). 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.