The S-Corp payroll tax issue is back in play! This issue was debated two years ago in the Senate and it went nowhere then but, according to the news sources today, the Obama Administration and Senate Democrats are planning to bring up the issue again in order to raise taxes on S corporation shareholders by $6 billion to offset the cost of extending low interest rates for student loans.
Though decisions have not been finalized, it seems at this time that the proposal would affect S corporation with earnings of at least $250,000 annually and it would be targeted to raise roughly $5 billion to $6 billion over the coming decade.
The Democratic plan would tighten the definition of S corporation income on which payroll taxes must be paid. The
bill will require S Corporations with three or fewer shareholders who declare income of at least $250,000 a year to pay employment taxes.
An S Corporation is a corporation whose shareholders have made a special election to be taxed as partnerships instead of being taxed as a corporation. That election means that the tax-attributes of the corporation are passed through the corporation with little or no tax and reported on the shareholders’ individual income tax returns instead. The rub, if you , will, is that presently the income that passes through the S corporation to its shareholders is not considered earned income and so it is not subject to Social Security or Medicare taxes.
This specific area has been a point of contention between S corporation shareholders and the Internal Revenue Service for decades. The problem, as the IRS sees it, is that shareholders sometimes pay themselves unrealistically low wages in order to avoid the Social Security and Medicare taxes. Instead the businesses report a high net income which is passed through to the individual return with no corporation level tax and is not subject to the Social Security or Medicare taxes at either the corporation on the individual tax return levels.
Today there is a body of legal decisions supporting the IRS position that when the shareholder’s salary is unrealistically low the distributions that are made to the shareholder may be partially or fully recategorized as wages and Social Security and Medicare taxes paid at the corporation level as a result or the recategorization.
So the question today is do we need new legislation to make shareholders pay their fair share of Social Security and
What do you think?
Jeremiah K. Murphy, CPA is an accounting firm providing tax services, audits and business consulting.