Tons of chatter has been circulating about the Tax Extenders Bill which is expected to pass the Senate sooner than later. Blogs, tweets and alerts have been coming left and right about one of the revenue producers in the bill. It concerns small business, specifically, S Corporations.
Many small businesses operate under the sub-chapter S election of their corporation. Like a partnership, they do not deal with double taxation(tax on the same flow of earnings to the employer and employee), and like a C Corp, self employment tax is limited to wages earned. This allows the small businesses to avoid payroll tax on dividends. Because payroll taxes are applied to the employee and employer, that is an 15.3% hit to the small business owner on dividends / distributions. UPDATE – some have debated that dividends or distributions is a loose and improper term as this would imply retained earnings from prior years would be subject to this tax. Because of this some have interpreted the proposed law as simply taxing the entire Net Earnings with the payroll tax on an effective date.
Current S Corp Example
- Doctor’s S Corporation earns $150,000 and the doctor classifies $75,000 of that income as compensation subject to self employment taxes (W-2 wages). The other $75,000 is taxed at the federal and state level, but payroll tax will not apply. That is a 15.3% tax that does not apply to $75,000 dollars.
The current law specifies a type of S Corporation. If the S Corporation is defined as a primarily professional service company with 3 or fewer key employees (shareholders?) than dividends would be subject to self-employement tax. I have had a couple interesting conversations with others on what this would be defined as..
A common problem blogged about is how the IRS will define “professional services”. RIP S Corporations? by Diane Kennedy highlights this question.
Here is the best technical explanation of the issue I have found included on the Wednesday Wire. S Corp Association
I noted some other blogs that discuss this issue as well in House Passes Tax Extenders.. But. blog yesterday.
Many have suggested contacting your Senator about this bill if you oppose it. I think its certainly something to watch. The legislation seems vague and there are sure to be varying opinions on how it will be enforced if passed into law. I find it interesting that the bill goes after small businesses for tax revenue when so much talk has been made about giving small business owners tax breaks.
-Joe
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If this blog does not answer your question, click the question icon at the top of the page to email me. Blogs are intended to be general in nature, if your internet search led you here, I have your answers. Email Me! -Joe Arsenault
[...] one of the hot topics surrounding the Extenders bill passed by the house (HR 4213) in my post S Corp Chatter. On June 7 Senate Majority Leader Harry Reid said he plans to bring the bill to the floor during [...]
Im so glad there are people like you posting this information for the public.