David Knoble, CPA, PLLC

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Is the End of the S-Corporation Near?

For years now a great vehi­cle for start­ing a small busi­ness was the S-Corporation.  Losses can be passed through to the owner dur­ing the startup years.  Then, when prof­its begin, as long as the owner takes a ‘Rea­son­able Salary,’ the remain­ing prof­its are not sub­ject to self-employment.  Well, this may be the last year this holds true.  Here’s why.We all remem­ber grade school where a few class­mates acted up and the whole class lost recess.  Appar­ently those same class­mates never learned their les­son.  The Trea­sury found sev­eral years ago that tax avoid­ance at small S-Corporations was extremely high.  Here are some sta­tis­tics that Kiplinger reported.  First, for one-owner S-Corporations with prof­its of $100,000 or more over 35,000 own­ers claimed no wages and paid no self-employment tax.  If you assume that each owner should have taken a salary of $60,000 and paid 7.51% FICA tax, then the total tax for each owner would be $4,506.  For 35,000 tax­pay­ers that would total $158,000,000 in avoided tax!

Sec­ond, there were over 40,000 S-Corporations with prof­its in the $50,000 to $100,000 range that also took zero wages and paid no self-employment tax.  Assum­ing each owner here should have taken $30,000 as a salary and paid 7.51% self-employment tax, then the total tax for each owner would be $2,253 or $79,000,000 in avoided tax.

As a result, Con­gress is defin­ing a small ‘Per­sonal Ser­vice ‘S-Firm’ or S-Corporation as a busi­ness with three or fewer work­ers rep­u­ta­tion or skill make up the pri­mary asset of the com­pany.  Thus, accoun­tants, lawyers, engi­neers, archi­tects, con­sul­tants, etc. will all fit this def­i­n­i­tion.  Fur­ther, Con­gress will be remov­ing the self-employment lim­i­ta­tions on these types of S-Corporations and the prof­its will be tax­able in full.

Thus, because a group of indi­vid­u­als decided to try and scam the IRS for between $2,250 and $4,500 — all small per­sonal ser­vice S-Corporations will lose the ben­e­fit of lower tax­a­tion than part­ner­ships.  I am con­fi­dent, how­ever, that the $237,000,000 that has been avoided will be made ten-fold under this new guid­ance.  Expect this to become law for tax years begin­ning in 2011.

© 2010, david.knoble
by David Kno­ble, CPA, PLLC
Serv­ing Non-Profits, Busi­nesses & Indi­vid­u­als
Rock Hill, SC

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