The Senate has proposed an amendment to H.R. 4213 (The American Jobs and Closing Tax Loopholes Act of 2010) that would increase taxes on payments made to small S-Corporation owners in the form of additional FICA taxes, even though these payments are not currently subject to payroll taxes.
As an example, a small professional services firm (lawyers, architects or doctors) of two professionals and one para-professional would normally pay the professionals a salary commensurate with what they would be paid in the open market for their years of experience, etc. Earnings above payroll and other administrative expenses may be paid out to the owners and those earnings are taxed as ordinary income but are not subject to payroll taxes.
Proponents of the bill submit that they are trying to close a “loophole” whereby some S-Corporation owners pay themselves nominal salaries and large distributions in order to avoid the payroll taxes, and further, that they believe they are putting S-Corporations on par with C-Corporations and partnerships.
Detractors offer the following arguments:
- Owners of S-Corporations are already required to pay owners “reasonable compensation” in return for the services that they provide to the corporation before non-wage distributions may be made. Owners who do not comply are subject to audit by the IRS.
- This amendment fails to take into account the return firm owners should be entitled to for their risk, and investments of time and capital to grow the business
- Passage of the amendment will create further friction between small business owners and the IRS
Currently, this bill is being debated in the Senate but is not expected to move to the floor for final passage prior to the Independence Day break. Additionally, Republican Senators Snow and Enzi are leading efforts to have the amendment removed from the Bill entirely