S CORPORATION MAY LOSE MAJOR BENEFITS

Prepare to say “Goodbye” to avoiding the payment of Self-Employment Taxes (SECA Taxes) by electing S Corporation status with the Internal Revenue Service for your Corporation.

Let’s refresh a bit - When a corporation is enabled by the State, for tax purposes, that entity is a C Corporation responsible for paying income taxes at the Corporate level. The Stockholders of the C Corporation can elect special treatment as an S Corporation that moves the tax responsibility from the Corporate level to the Stockholders’ level.

The benefits of this special S Corporation status include - Potentially lower tax rates on Corporate Net Profits that are taxed at the Stockholder level; Net Profits for tax purposes are exempt from the 15.3% SECA Taxes; Net Losses for tax purposes can reduce other personal taxes; and Accumulated Amounts of Net Profits that have been taxed previously can be to given to Stockholders tax-free.

The Senate healthcare bill proposes to eliminate the exemption that S Corporations enjoy from SECA Taxes on distributions of Net Profits for tax purposes to Stockholders. Stockholders will be required to pay an additional 15.3% in taxes on distributions from S Corporations, as do Partnerships and Limited Liability Companies (LLC). Strike One!

With this proposal our Legislators are removing a valuable Compensation and Tax planning mechanism for Principals of S Corporations. The mechanism is to pay Principals a reasonable salary from the Corporation on which FICA taxes are paid and recognize any additional compensation in the Corporation’s distribution of Net Profit for tax purposes, which is exempt from FICA and SECA Taxes. The Legislators plan to ensure that all compensation is subject to either FICA or SECA Taxes. Strike Two!!

These potential changes will remove the tax advantage that an S Corporation has historically had over a Partnership or an LLC - exemption from SECA tax. So, as entities go, the limited liability protection and flexibility of distributions of an LLC will have the upper-hand in terms of entity tax advantages.

IRS is publicizing that it will increase its scrutiny of compensation levels and compensation planning for Principals of S Corporations, which the Feds consider areas of tax avoidance because of the ability to minimize FICA and SECA taxes. Strike Three!!!

Heck, when Congress and IRS instituted the S Corporation tax breaks did they not expect that prudent accountants would utilize these provisions to minimize the taxes for our clients? We’re Out!!!!

Anyway, we’ll keep you posted as, hopefully, this legislation will be finalized before we begin your year-end tax planning in November 2010.

Thanks for visiting and don't forget to glance at the Tax and Wealth E-Zines while you're here.

© Donald Carroll Moragne