Tax Increase for S Corps in 2011
A change has been added to a bill that reinstates a set of expired tax breaks to help offset some of the measure’s tax relief. The change will eliminate the ability for small service firms to circumvent Self Employment Contributions Act (SECA) taxes on their profits. The tax is currently 15.3% of the first $106,800 in profits and 2.9% for all profits exceeding $106,800.
The tax increase is aimed at S firms where the principal value of the entity is the skills and/or reputation of the three or less workers. Generally this applies to firms that specialize in accounting, architecture, brokerage services, consulting, engineering, health, investing, law, lobbying, performing arts, and sports.
The intention of the law is to end abuse of S firm owners taking profits in the form of dividends. These dividends are taxed as income on the owners 1040, however, are not subject to SECA.
A recent court decision (Watson, D.D., Iowa) upheld the IRS' power to recharacterize dividends as wages subject to payroll tax. In this situation, the owner of a S firm performing CPA services took an annual salary of $24,000 and also received dividends of $220,000. The IRS deemed his salary unreasonably low and required that $175,000 of the dividends be reclassified as wages subject to payroll taxes. Contact: Jim Ritter (jim.ritter@qtspayroll.com)
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