Today, I am going to talk about taxes- but for the small business owner. Like it or not, taxes are going to go up- not for everyone, but small business is a ripe target. Part of the reason is that small business- just like big business- has found ways (or paid advisors to find ways) to pay the minimum amount of axes required.
And, the GAO (Government Accounting Office) has been clamoring for the IRS to clamp down on S corporation (these are corporations that pass their profits to the stockholders and do not pay corporate income tax; the stockholders pay taxes on the profits that flow to them as part of their individual tax returns.) In particular, most have limited employment taxes (that’s called Social Security and Medicare taxes). Right now, there are about 4.5 million corporations operating in America. And, even though many use tax preparers, some 70% (according to the GAO) do not prepare/pay the proper amount of taxes. Most of that problem comes about from determining basis, a technical (but critical) item. I am not going to deal with that item, because that is not the area that our elected Congressman and the IRS have placed their focus.
Some S corporations fail to pay adequate wages to shareholders for their labor for the corporation, which means they underpay employment taxes. The goal is to convert ALL or almost ALL dividend income these corporations flow through to their stockholders. Why does the government want to do this? More employment taxes. More why? Because too many S corps don’t provide a reasonable compensation for its officers. (If you want more information on reasonable compensation, you can find a good article here. (Of course, it’s good, I wrote it.)
Reports from the Joint Committee on Taxation and from the Treasury Inspector General for Tax Administration indicate that this is a significant issue. The GAO determined (using IRS figures) that the underpayment of wages for 2003 and 2004 was roughly $24 billion. Assuming this is all subject to employment taxes (it is generally not, but could be), this would increase the Social Security coffers by some $ 3 billion a year.
So, now Congress is planning to pass HR 4213. This bill includes provisions that any professional services corporation that relies on the reputation and skill of three or fewer individuals will find their entire profit subject to Social Security taxes. Part of the issue I find with the bill is the language says because these entities pay themselves “minimal” compensation. I have stressed- and continue to stress- the requirement to pay adequate compensation to my clients. That means a company must analyze its situation throughout the year. However, if this law passes, it is not clear that reasonable compensation will remain the law of the land.
Who is covered, assuming this bill passes the Congress and then is approved by the Senate? At a minimum: Attorneys, architects, engineers, accountants, doctors. Any corporation with the ending PC is ABSOLUTELY covered. Probably inclusion: Consultants and stockbrokers. Potential inclusion: Real Estate Professionals, Insurance Agents.
Forewarned is forearmed.
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