Is there any legislation before Congress concerning S corporations?
In large part due to the increased avoidance of employment taxes, Congress is looking to pass legislation that will do away with any reasonable allocation between wages and S corporation earnings. House Bill 4213 proposes to tax all earnings from select S corporations as self-employment income subject to self-employment tax. This would eliminate any planning with reasonable allocation arrangements.
The current proposal would apply to any S corporation that has, as a significant asset, the business reputation of three or fewer persons. For example, the earnings of a law firm owned by two attorneys who are also the only persons performing legal services on behalf of the firm would be completely subject to self-employment taxes whether paid as wages or distributed as S corporation earnings.
Standards such as significant assets and business reputation of three or fewer persons will inevitably require further guidance from Congress or the Treasury. If the legislation becomes law, it also will inevitably lead taxpayers to merge or add other employees to avoid the application of these new rules.
Are there advantages to the proposed legislation?
Early in the development of S corporations as a choice of business entity, shareholders attempted to include the earnings from the S corporations as self-employment income for purposes of funding their own qualified retirement plans.
The IRS ruled quickly on these attempts and concluded that because S corporation earnings were not subject to self-employment tax, they could not be considered as self-employment income for purposes of funding qualified retirement plans.
It remains to be seen how the new legislation will impact qualified retirement planning.
WALTER M. McGRAIL, JD, CPA, is a senior manager at Cendrowski Selecky PC. Reach him at (248) 540-5760 or [email protected].
