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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"

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?
    - anigbrowl 16y ago
      Well, one complaint often leveled at bureaucracies is that the regulations are opaque and their application is arbitrary. Statutory clarification can thus help to lower the cost of compliance.
  - bradleyland 16y ago
    This isn't a deduction. A deduction is when you offset taxable income with deductible expenses. I also resent the fact that anyone would refer to these returns as "shady". 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.
    - tptacek 16y ago
      You are missing the part where only the small number of people who have enough shares in the S-Corp to soak up 40% of their income get to take advantage of this loophole. The rank and file employees of an S-Corp, even if they're getting "first-employee" levels of equity, don't get to play this game. 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.
tptacek 16y ago
This legislation "targets" people who have deliberately structured their business to take advantage of a tax loophole that allows them to pay lower payroll taxes than owners of LLCs, partners in LLPs and partnerships, startups in C corporations, and sole proprietorships, all of whom are required to pay their fair share of FICA taxes. 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.
_delirium 16y ago
It might be a bad idea, but I have trouble considering this something targeting the "middle class". I'd generously define middle-class as, say, 20th to 80th percentile of incomes, which in the U.S. is a range of about $20k-$90k. I suppose you could use a wider range, and say that everyone except the bottom and top 10% is "middle class": then you get the even more absurdly expansive range of $10k-$125k for middle class (a group that obviously isn't anywhere near coherent as a "class", but oh well). 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?

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?
  - anigbrowl 16y ago
    Well, one complaint often leveled at bureaucracies is that the regulations are opaque and their application is arbitrary. Statutory clarification can thus help to lower the cost of compliance.
- bradleyland 16y ago
  This isn't a deduction. A deduction is when you offset taxable income with deductible expenses. I also resent the fact that anyone would refer to these returns as "shady". 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.
  - tptacek 16y ago
    You are missing the part where only the small number of people who have enough shares in the S-Corp to soak up 40% of their income get to take advantage of this loophole. The rank and file employees of an S-Corp, even if they're getting "first-employee" levels of equity, don't get to play this game. 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.

tptacek 16y ago

This legislation "targets" people who have deliberately structured their business to take advantage of a tax loophole that allows them to pay lower payroll taxes than owners of LLCs, partners in LLPs and partnerships, startups in C corporations, and sole proprietorships, all of whom are required to pay their fair share of FICA taxes. 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.

_delirium 16y ago

It might be a bad idea, but I have trouble considering this something targeting the "middle class". I'd generously define middle-class as, say, 20th to 80th percentile of incomes, which in the U.S. is a range of about $20k-$90k. I suppose you could use a wider range, and say that everyone except the bottom and top 10% is "middle class": then you get the even more absurdly expansive range of $10k-$125k for middle class (a group that obviously isn't anywhere near coherent as a "class", but oh well). 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?