Tax Issues

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The Privileged Few

September 17, 2010 in Economics, Tax Issues by DJ | 3 comments

(Freefoto.com photo.)

With the current debate over whether or not to extend the Bush tax cuts on Americans earning over $250,000, I thought it would be interesting to see how many taxpayers in my state would be affected.  The answer: not many.

For 2008, the Utah State Tax Commission reports that just over 1 million tax returns were filed.  Of these, more than half reported an adjusted gross income that was below $40,000.  The median income for Utah, the point at which half of all taxpayers are above and half below, is reported as $34,530– far below the national average.

(Interestingly, the Census Bureau reports the median money income at a substantially higher $59K, suggesting that either much of the income isn’t taxable, or else people report higher numbers to a census worker than to the state’s taxing agency.)

A whopping 89% of Utah taxpayers reported income below $100,000.  As for those over $250K, the Tax Commission reports only 13,983 taxpayers in this income range, or just 1.36% of the total.

NPR reported this week that the $250,000+ bracket affects only 2% of American households, and is worth $700 billion in revenue over 10 years.  That’s a reminder that there is a lot of wealth concentrated in a very few hands.

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IRS: Never Attribute to Malice…

August 2, 2010 in Small Business, Tax Issues by DJ | 1 comment


(BJMcRay photo.)

“Never attribute to malice what can be adequately explained by stupidity.” –Murphy

I have a client who incorporated her business two years ago.  She pays herself a salary and pays all the required payroll taxes to the government.  One of the many advantages of this is that she pays into unemployment and state disability, and is therefore covered by those programs.

Last year, the IRS contacted her, saying they did not receive a payroll tax return for the 3rd quarter of 2008.  This was odd, since she had sent in a return with a check, and IRS had cashed the check.  However, with my assistance, she duly sent in a copy of the “missing” payroll tax return.

Subsequently she received a letter stating that they had received her “additional” payroll tax return and had added the wages to the original tax return, effectively doubling both the wages and the balance due.  And since she had only paid for the original amount due, IRS assessed her interest and penalties, too.

We wrote a letter to IRS explaining what had happened, and included a copy of the original payroll tax return.  This time, they replied that they were unable to change the amount of tax due because we had not filed the form as “amended.”  Therefore the erroneous balance remained due and payable.

Meanwhile the Social Security Administration also wrote to the client because the amount shown on her W-2 does not match the (erroneous) amount reported to them by IRS.  That required yet another response letter.

In June, we wrote to the IRS a third time, requesting a review of the matter by a supervisor.

In July, the client received two letters from IRS.  The first said that IRS had not completed researching the matter, and that they would respond within 45 days.  The second advised that IRS intended to levy the client’s bank account to collect the erroneous balance due.

Also in July, the client received a letter from the IRS regarding the 2nd quarter 2008.  She didn’t start payroll until the third quarter 2008, so her 2nd quarter payroll tax return reflected no wages paid and no tax due.  But the IRS letter says she filed a return showing over $6,000 due.  They have (of course) added interest and penalties, bringing the erroneous total to almost $10,000, and provided a convenient coupon for her to include with her payment.

We’ve written five letters so far, each costing the client time and money, each of which should have been unnecessary, and each of which should have resolved the problem.  Yet IRS is still trying to collect money it erroneously believes is due.  If I were a cynical man, I would suggest that IRS is intentionally burdening small businesses.

I’m not quite that cynical.  Douglas Adams suggested that the two most common things in the universe are hydrogen and stupidity.  I think the IRS may be a bit short on hydrogen.

Rangel, Author of HR4213, Cited for Gifts from Big Business

July 23, 2010 in Small Business, Tax Issues, US Politics by DJ | No comments

In an ironic turn of events, Rep. Charles Rangel (D-NY) who sponsored HR 4213 was determined to have committed ethical misconduct by a House ethics subcommittee on the same day his bill finally passed.

The details of the allegations have not yet been made public.  However, in March, an ethics subcommittee ruled that Rangel had violated the ethics rules by accepting gifts from corporations– in that case, free trips to the Caribbean.  That decision forced Rangel off the Ways and Means Committee.

Rangel is described as an “ideologically committed liberal” and “pragmatic deal-maker”– in other words, he often says one thing and does another.  He has a history of speaking out against benefits to big business, only to later vote in favor o0f them.

To be fair, Sec. 413, which increases taxes on certain small businesses, wasn’t in the original bill as introduced by Rangel.  It was added later by Sen. Max Baucus (D-MT), and was vociferously opposed by Olympia Snowe (R-ME) and Mike Einzi (R-WY).  Snowe called the provision,

“a job-killing tax hike that will force entrepreneurs across the nation to retrench and reconsider any plans for hiring employees or expanding their business.”

She ultimately voted for the bill anyway.

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Senate Passes HR 4213: Without a Kiss

July 20, 2010 in Small Business, Tax Issues, US Politics by DJ | 8 comments

The Senate passed HR 4213 today with no changes to Section 413, raising taxes on thousands of small businesses in order to pay for tax credits for major corporations.  The bill now goes back to the House for approval, which is virtually certain.

Starting in 2011, small service businesses in certain industries will have to pay 15.3% FICA tax on their dividends.  Congress says this is to prevent abuse by doctors and lawyers.  (AICPA noted that this abuse could have been curbed if IRS had not resisted issuing guidelines.)  But this tax increase will affect far more than doctors and lawyers.  It will potentially double the taxes paid by a computer programmer earning $30,000 a year, a struggling actor earning $10,000 a year, a bookkeeper earning $20,000 a year, a personal trainer earning $8,000 a year.  It will apply to traveling nurses and nutritionists, paralegals and process servers.

In addition to the immediate tax increase, Congress has now opened the door for future tax increases.  Until this year, only wages and self-employment income were subject to FICA tax.  But the Democratic Congress, led by President Obama (who, I’m ashamed to say, I voted for), has now passed two (2) bills that apply FICA to unearned income– the health care reform bill, which assesses Mefdicare tax on investment income for high earners, and this bill, which applies FICA tax to S Corp dividends for “professional” service businesses.

Does anyone really believe it will stop there?  The door is now open.  It’s just a matter of time until all types of income are subject to the additional 15.3% FICA tax.

July 22, 2010: The house followed suit, passing the bill with no further changes.  Bend over, small business owners: Washington sends its greetings!

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Dear Rep. Matheson: Amend HR 4213

July 20, 2010 in Small Business, Tax Issues, US Politics by DJ | No comments

Dear Rep. Matheson,

I am disturbed that HR 4213 continues to make its way through Congress containing huge tax increases for small businesses like mine.

As written, the bill’s Section 413 would increase taxes for many small service businesses.  For example, I am a bookkeeper and tax preparer practicing through a Subchapter S corporation with a net income of about $20,000 per year.  At present, I take a reasonable salary, and any additional profits flow through to me as distributions or dividends that are not subject to self-employment tax.  Currently, my wife and I do not make enough money to pay income tax, but after FICA taxes the business provides us with disposable income of $18,500.  HR 4213 contains nothing that excludes low-income or unlicensed professions within the “excluded” industries.  If it passes, our increased tax liability will leave us only $17,000 in disposable income.  Could you live on that?

We are not alone.  In-home nurses, paralegals, process servers, freelance computer programmers, data conversion specialists, personal trainers, struggling actors and scriptwriters, and potentially many other occupations will incur a massive tax increase as a result of this bill.

AICPA opposes Section 4213.  They argue, rightly, that a business owner is entitled to a return on capital invested.  They also point out that social security recipients who still work part-time through an S Corporation will lose benefits under the new bill.

I understand the need to raise revenue, but to hit small businesses with a major tax increase in the midst of a recession is just plain wrong– especially when the money will be used t give tax breaks to large corporations.  Is this where the Democrats stand: for big business and against small business?  Although I am not a member of either party, I voted for both you and Mr. Obama in the last election.  Was I mistaken?

Please amend HR 4213 to remove the tax increase on small businesses.  If revenue must be raised, please don’t do it on the backs of small business at a time when we can least afford it.

Thank you for your consideration.

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Senator Hatch on HR 4213

July 19, 2010 in Small Business, Tax Issues, US Politics by DJ | No comments

Senator Orrin Hatch responded to my letter about HR 4213, which would raise taxes on small businesses.  His letter was on point, addressed the issues I raised, and was typed in a typewriter and signed in felt-tip pen.  The typist’s information indicates that he wrote it (or dictated it) himself, rather than delegating it to an aide.  This wasn’t a canned letter, and I appreciate him taking the time.

His letter amplified the points I made:

H.R. 4213 would change the treatment of S Corporation earnings by applying SECA taxes to all S corporation earnings for shareholders in in disqualified S corporations.  A disqualified S corporation under the pending legislation includes any S corporation in the professional services industry.  The professional services industry is defined to include “the fields of health, law, lobbying, engineering, architecture, accounting, actuyarial science, performing arts, consulting, athletics, investment advice or management, or brokerage services.”

He also gives an update of the bill’s status:

The latest House-passed version is currently being debated on the Senate floor.

The he gives his position:

I agree with you that this bill is not worthy of support.  I believe the tax increases included in this bill are unnecessary and inappropriate.

Then he mentions that the bill includes “billions of dollars” in new spending, and adds,

In short, the bill would raise taxes but would not cut spending– continuing more of the “tax and spend” mentality that we have been seeing far too often.

That’s code for “I oppose this because it’s a Democratic proposal.”  So much for representing his constituents and judging legislation on its merits.

Meanwhile, Rep. Jim Matheson (D-UT) has not yet responded to my letter.  Matheson’s website calls small business “critical to our economic strength, to building America’s future and to helping the U.S. compete in today’s global marketplace.”  Yet he voted for HR 4213.

Do any of our representatives actually believe that raising taxes on small businesses in the midst of a recession is good for the nation?  Are they continuing on their knee-jerk positions, one party opposing whatever the other may propose?  Or are they intentionally shifting wealth and power from individuals to corporations?  There are so many recent instances of pro-corporate policy that it’s difficult for me to believe otherwise.

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Please Oppose HR 4213

July 16, 2010 in Tax Issues by DJ | 3 comments

From an email I sent out today:

Dear Clients and Associates,

I have never before asked my professional contacts to take political action.  I am not a member of either political party.  However, there is a bill pending in Congress that would have devastating effects on small businesses like yours and mine.

Congress is about to raise our taxes.  A little-noticed provision in a popular bill may double the amount of tax we have to pay, starting with the 2011 tax year.  I’m writing to ask you to email, write, or call your Senators and ask them to drop this tax increase, which would hurt small businesses at a time we cannot afford it.

I’m writing to you because you have a business that would be affected by the bill, or have at some point expressed an interest in setting up a business that would be affected.

The bill, HR 4213, extends unemployment benefits as well as several popular tax breaks.  However, its Section 413 raises taxes on Subchapter S corporations in certain industries.  The taxes raised by this provision will be used to provide tax credits for large corporations.

Currently, owners of Subchapter S corporations are required to pay themselves a reasonable salary, and any extra profits can be taken as distributions, also called dividends.  This is consistent with the premise that there is a risk to starting a business, and that risk ought to be compensated with a dividend.  The advantage is that salary is subject to income tax plus 15.3% FICA tax, while distributions are subject only to income tax.

HR 4213 would impose 15.3% FICA tax on distributions from S corporations in certain industries, potentially doubling the amount of tax due.

HR 4213 has passed the House of Representatives, and is being considered in the Senate.  This is the final step in the reconciliation process.  Despite GOP opposition, it is likely to pass.

Democratic supporters of the tax increase claim they are simply closing a loophole being abused by rich doctors and lawyers.  But the bill affects several industries, including health, law, accounting, performing arts, consulting, and athletics.  The bill defines those industries in such a way that the tax increase will apply to bookkeepers as well as accountants, nurses as well as doctors, paralegals and process servers as well as attorneys.  If the IRS interprets the legislation broadly, it could also affect computer programmers, new age practitioners, personal trainers, and many other small service businesses.  These are not wealthy tax cheats, they are small businesses trying to make a living in an environment that increasingly favors large corporations.

AICPA wrote an open letter to the drafters of the bill, opposing Section 413.  The letter said in part:

“The AICPA believes that the change in the law proposed by the House represents a major change in policy that should have been the subject of public hearings.  This proposal not only threatens to result in a significant increase in taxes and complexity for S corporations and their shareholders, and for certain limited partners, but it continues the definitional blurring between capital and labor begun in the general partnership arena by further expanding laws that were clearly established to tax only labor.”

The full letter can be found here.

Please email, write, or call your Senator and ask him or her to remove Section 413 from HR 4213.  Here’s a link to the letter I wrote. And here’s a site that will locate your Senators.

My Senator seemed unaware of the effect this provision would have on small businesses.  If we all contact our Senators, perhaps we can change a policy that would make our lives more difficult.

Thank you for your time.  Please feel free to forward this message to anyone you think may be interested.

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Dear Senator Hatch: Fix HR.4213

June 17, 2010 in Letters and Rants, Small Business, Tax Issues, US Politics by DJ | 1 comment

If you’re a small business owner, please write your Senator about the proposed tax increase for S Corporations.  Here’s what I wrote to mine:

Dear Senator Hatch,

I am writing in regard to HR4213, and specifically with respect to changing the tax law for Subchapter S corporations.  The bill proposes to apply FICA tax to dividends (distributions) from S Corporations for service businesses in certain industries.

The proponents of the bill claim that this will curb abuses by highly paid doctors and lawyers.  However, as AICPA noted in their letter of June 9, these abuses could have been curbed by firm guidance by IRS, which IRS has resisted issuing.  In my opinion, the fault here lies with IRS, which enjoys a certain level of flexibility in its audit process as long as it does not issue specific guidelines.  Yet until specific guidance has been detailed, it is disingenuous to suggest that taxpayers are abusing them.

My concern is that these changes contained in HR4213 will affect far more than just doctors and lawyers.  The wording of the bill suggests that it will increase taxes on small businesses across the nation.  Bookkeepers, independent tax preparers, struggling actors, independent computer programmers and repair people, fitness trainers, and potentially yoga teachers, part time nutritionists, and writers, as well as many other small businesses would see a significant tax increase as a result of this change.  Those of us already struggling in this challenging economy will be hard hit by such an increase.

In addition, this change opens the door for future tax increases.  The Health Care Bill assessed SECA tax for the first time on unearned income.  Now HR 4213 proposes to assess FICA tax on dividends for certain S Corporations.  It would appear that the eventual goal of the Obama administration is to expand FICA tax to *all* income.

My immediate concern is with HR4213.  Consider a bookkeeper supporting a family on $20,000 a year.  Using current tax law, they have set up an S Corporation, pay themselves a reasonable salary, and take the rest in distribution.  This bill could potentially increase their tax from $1,500 per year to $3,000 per year, reducing their disposable income from $18,500 to $17,000.  How are is a family supposed to live on that?

Rather than opening the door to widespread tax increases, please support removing this provision from the bill.  Instead, Congress should direct IRS to issue firm guidance on what is and is not an appropriate level of salary for an S Corporation owner/employee.

Thank you for your consideration.

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AICPA on S Corp Changes

June 16, 2010 in Small Business, Tax Issues, US Politics by DJ | No comments

mo' money taxes by Molly Des Jardin.
(Molly Des Jardin photo.)

Last month, I posted about proposed changes to the treatment of S Corporations that would be devastating to small businesses like mine.  I was shocked at the lack of response– even from other small business owners.  Today I spoke to one, who said she doesn’t even have time to pay her bills, how can she find time to write her legislators?  Perhaps Congress feels safe in raising small business taxes because we’re too busy to complain, and not rich enough to hire full-time lobbyists.

However, some folks have noticed the proposed tax increases.  A colleague forwarded me the AICPA’s open letter on the subject: They oppose these changes.  While that might be expected, considering CPAs are one of the occupations that will suffer, they offer some excellent reasons for their opposition.

First, quoting from the letter,

The AICPA, first and foremost, believes that the Internal Revenue Service currently has the appropriate enforcement tools it needs to re-characterize the distributions of S corporations as salary subject to employment taxes under FICA.  We also believe that the IRS can and should expand such enforcement tools by providing taxpayers with stronger guidance on determining a reasonable fair market value of compensation.  Doing so would reduce litigation, increase compliance and allow employment taxes to continue to be levied only on the performance of personal services as intended.

The AICPA believes that the change in the law proposed by the House represents a major change in policy that should have been the subject of public hearings.  This proposal not only threatens to result in a significant increase in taxes and complexity for S corporations and their shareholders, and for certain limited partners, but it continues the definitional blurring between capital and labor begun in the general partnership arena by further expanding laws that were clearly established to tax only labor.

They note that the bill, as proposed, will have the following detrimental effects:

  • It will reduce social security benefits for certain retirees bu including S Corporation income as “earned income.”
  • It will impose FICA taxes on returns on owner investments, discouraging such investments.
  • It will impose FICA tax on profits generated from the hiring of employees, discouraging hiring by small businesses.

The AICPA also (rightly) notes that any abuse in question could be prevented if the IRS would issue guidance on what is and is not an appropriate level of compensation versus return of capital for an S Corp owner/employee.  IRS has failed to issue such guidance, and has instead approached perceived abuse on a case-by-case basis.  If there is no rule, how can a taxpayer follow the rule?

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Congress Takes Aim at Small Business

May 21, 2010 in Small Business, Tax Issues, US Politics by DJ | 1 comment

Its not THAT bad! =P by Ava Whalen.
(Ava Whalen photo .)

Congress is hard at work extending a set of popular tax breaks , including tuition credits, sales tax credits, real estate tax credits, credits for construction of housing developments, and lots of credits to encourage large corporations to hire new employees.

But in a little-noticed section, Sec. 413, Congress proposes additional taxes on Subchapter S corporations.  Specifically, they propose that under certain conditions, 100% of S Corp income will be subject to self employment tax.

Currently, an S Corp owner pays FICA tax on his/her salary, which is supposed to be equivalent to what the owner would have to pay someone else to do that job.  (The rules are pretty vague.)  Any additional income is subject to income tax, but not FICA (social security) tax.  That’s because someone who starts a business is entitled to a return on his/her investment– the equivalent of a corporate dividend.

The proposed law would change that.  For service businesses with three or fewer employees doing the primary work, all S Corp income would be subject to FICA tax.  The rationale is that lawyers and doctors are abusing S Corps to avoid self-employment taxes, paying themselves a minimal salary and taking the vast majority as dividend.

But what about the rest of us?  Some 62% of American corporations are S Corps.  According to the IRS , in 2003 (the most recent year available), they averaged gross receipts of less than $1,300.  For services industries, the averages are even lower.  So the vast majority of S Corps are not rolling in untaxed income.

Let’s take some real-life examples: a bookkeeper who made $20,000 AGI last year.  A barber who supports his wife and four kids on $40,000.  A real estate agent who can’t afford health insurance for his 5-year-old daughter on $42,000.  These are people who have taken the risk to become self-employed, who have used the S Corporation rules to ease the burden of being self-employed– that 15.3% surprise at the end of the year, no matter how little you earned.

Now Congress wants to cut their income even more, while offering big corporations more tax credits?  There’s something seriously wrong with that.  It appears that our government doesn’t like people to work for themselves.

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