How ridiculous!If you are self-employed, either as a sole proprietor or a partner, all of your net income from self-employment is subject to the “self-employment” tax, which is the equivalent of the FICA (Social Security and Medicare) tax paid by employees. There is a maximum subject to the Social Security portion, but 100% is subject to the Medicare portion.
A self-employed taxpayer can incorporate his/her business and limit the FICA tax to the wages he/she pays himself/herself. Any additional profit that the shareholder gives to himself/herself is considered to be a dividend, and is subject to “double-taxation”.
Self-employed taxpayers can avoid some of the Social Security and Medicare tax on their net earnings and avoid the double-taxation of a regular “C” corporation by electing to be a “sub-chapter S” corporation. The FICA tax is still limited to wages paid, and the balance of the corporation’s income is passed through to be taxed as ordinary income only on the shareholder’s Form 1040. The “sub-S” corporation itself does not pay any federal, and generally state, income tax on the net profit of the business.
For years the sub-S corporation has been used to avoid paying FICA/self-employment tax. If the shareholder pays himself/herself too small a salary he/she faces the possibility of an audit in which the IRS would “reclassify” some or all of the pass-through “dividends” as wages subject to payroll taxes – but the risk was, for the most part, worth it.
In order to pay for the various provisions of the American Jobs and Closing Tax Loopholes Act of 2010 Congress chose to close this “loophole” provided by sub-chapter S corporation treatment. However, the cafones want to close the loophole for only certain sub-S shareholders.
If a loophole is considered “inappropriate” it is so for all who can take advantage of it. If Congress wants to do away with the exemption from FICA/self-employment tax for sub-S shareholders it should do so for all sub-S shareholders.
{As an unrelated aside, I also think that if a tax deduction is “appropriate” it is appropriate for all taxpayers, and should not be “phased-out” based on some arbitrary level of income.}
Limiting this loophole closing to only a certain “class” of shareholders makes no sense.
You should read the posts of Joe Kristan and Monica Lawver, which I included in this past Saturday’s BUZZ, for more detail.
This action clearly sends a message, as pointed out by TAX GIRL Kelly Phillips Erb, that “Congress Hates Small Businesses”.
To repeat – how ridiculous!
TTFN
