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The IRS Targets Income Tricks

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Re: The IRS Targets Income Tricks

#21

Post by usaar333 »

diziet wrote: post #8
usaar333 wrote: post #4

Earlier quoted context omitted.

You really can't "cheat" with a C-corp. Your company's income is going to first be subject to corporate income taxes (30 to 35%). Then if you pay dividends, that is also taxed. In other words, trying to skirt payroll taxes with a C-corp is going to end up with you paying more taxes than doing no hack. Hence, why the IRS rule only applies to S-corps which pass on their income and are not subject to corporate taxes. St…

Well, apple ends up paying about 24% in corporate taxes, even though the corp tax rate is 35.

That's probably effective after all deductions, etc. 35% should be their marginal rate. So if the last $500k of income was converted into Steve's Salary their taxes should be dropping by 0.35*500k

Re: The IRS Targets Income Tricks

#22

Post by piguy314 »

tptacek wrote: post #18
ams6110 wrote: post #17

There is so much "waste motion" expended in trying to game the tax code in so many situations... what could creative people achieve in that time if they didn't spend it that way. We need a vastly simplified income tax code... I'm talking throw it all out and start from scratch. Or replace it with a national sales tax, rebating some amount to make it less regressive.

This implies that if you simplified the tax code, people would stop gaming it. The opposite is probably true; the simpler you made the tax code, the more accessible tax games would be to average taxpayers.

How would you game a 22 percent national sales tax? (Other than buying things on the black market).

Re: The IRS Targets Income Tricks

#23

Post by wuputah »

tptacek wrote: post #16
matwood wrote: post #10

Earlier quoted context omitted.

Well in this case it really is an income trick. I have friends who do S-corps for this reason and the main thing they stress over is paying themselves a fair market salary. The guy in the article was paying himself barely 1/2 what a new grad would make so it's clear that he was well below fair market. If he had just paid himself fair market he would still have come out ahead and not had to deal with the IRS.

I think there's a lot of smoke being blown about the "fair market salary" thing, as if the IRS was capriciously planning the US economy during audits. It seems to me --- and I'm prepared to be wrong here --- that the deal is simple: look at your quarterly estimated payments, add up all your income, and if it looks like you're getting a significant break on FICA because of the way you've structured your income, fix it…

I disagree unless the payment you are making to yourself as distributions is fair compensation for services provided to the company. A company's purpose is to make a profit, and if you are distributing profit to yourself, then there is no reason to pay FICA on that income. The "fair market salary" is important because if you are forced to pay yourself arbitrarily more (like you suggested), it would be in the best interest of the person to instead hire someone to do his job for him (at fair market salary) and simply collect the profits. (In fact, this could be the long term goal: hire someone to manage the business and retire on the profits!)

If you'd like to know why it's "fair" for people to be allowed to pay income tax and not FICA tax on profit, then you need to look at the C corporation code. Under this system, the corporation pays a corporate income tax, and then can pay profits to its shareholders as dividends, which are then also subject to a second tax. You'll note that there is no payroll tax in this system. The purpose of an S-corporation is to avoid this "double taxation" for very small companies and instead use the personal income tax code, which may be (but is not necessarily) cheaper for the shareholder. This is not a loophole: it is by design.

It is also worth noting that just because the taxes are paid through the personal income tax code, that doesn't mean that person received that profit as a cash distribution. That money may very well be put to a different purpose, e.g. investing in the business in some way which is not yet tax deductible (like a large capital purchase), in the bank as float, or invested in some way.

In the case mentioned in the article, I certainly agree the owner was not paying himself enough by W-2 for his services, particularly if he was the sole employee and otherwise received that income as a cash distribution. He is obviously an experienced CPA who would be paid much more on the open market, and as a CPA, he should have known better.

Re: The IRS Targets Income Tricks

#24

Post by tbrownaw »

tptacek wrote: post #14
DanielBMarkham wrote: post #9

I hope I don't get slammed for this, but the tax code is a large pile of stinking dung, and good luck trying to do the right thing. S-Corps work under the general premise that it's just like you, if you were a corporation. So if you don't spend all the income in your business in the year, you owe income tax on what remains. If you have plenty of profits, you write yourself a regular W-2 paycheck. At the end of the ye…

Respectfully --- I like you and your comments, even though our politics couldn't be more different --- you should get slammed for this analysis. You're muddying the waters and you know it. The prevailing market wages for beauticians and mechanics are so low that that benefit of evading FICA is marginal. S-Corp owners are rarely audited period , but here you ask us to consider that enforcement of the tax code might fo…

> What makes this a particularly easy rule of thumb to follow is that it's exactly what you would do anyways if you didn't know about the S-Corp loophole.

So if everyone is supposed to pretend it doesn't exist, why does it exist?

Re: The IRS Targets Income Tricks

#25

Post by BRadmin »

jabits wrote: post #13
anonymous246 wrote: post #11

This is one of those few instances where I actually support the IRS and also support the law that's being contemplated. S corps (and AFAIK LLCs) are supposed to have "pass through" taxation. I think it's fair that all income (whether salary or profit distributions) from S Corp is treated as regular W-2 income. If you don't care about the simplicity that "pass through" offers, register a C-corp.

So then as a small Sub-S owner (wife and me), I would have to pay FICA and Medicare on the money spent on health care insurance, disability insurance, etc., which you as a W-2 employee do not pay payroll taxes on. In the end, the payroll tax savings are not that great for a small Sub-S. And as you get older, toward retirement, if you pay yourself too low, you take a big hit on SSA benefit payments (which are based on…

Hey can you provide some reference for the SSA benefit payments being "based on your latest 40 qrtrs."

I could only find this worksheet online: http://ssa.gov/pubs/10070.html

And under "Estimating your Social Security retirement benefit" your payments appears to be based on your highest index earnings over 35 years.

Re: The IRS Targets Income Tricks

#26

Post by cd34 »

tptacek wrote: post #19
cd34 wrote: post #7

Earlier quoted context omitted.

There is some confusion there. His $1 salary is exactly that. A token amount paid by Apple for his work. It cannot be $0, otherwise he wouldn't be considered an employee and wouldn't be entitled to bonuses, stock options, insurance, etc. The fact that he is taking a $1 and tying all of his income to options, bonuses, perks means that he firmly believes his impact to the company will be rewarded - and it has, rightful…

I upvoted you; you clearly know more about taxes than me. However, let me chime in again here and say that the feast-or-famine thing seems overblown. The IRS isn't dinging you for miscategorizing income; it's dinging you for underpaying taxes. You can make your income as irregular as you'd like, as long as you end up paying what you owe.

If your income fluctuates based on profit and the IRS deems that a dividend, then, you are charged at the dividend rate rather than the personal tax rate. That dividend tax rate is higher than your income rate until you hit $373k annual salary in 2011/2012, and yes, you would get hit for underpaying taxes.

http://www.irs.gov/businesses/small/article/0,,id=101038,00....

Publication 535, mentioned further down under reasonable compensation talks further about how income is qualified.

Basically, if you pay yourself $8k/month, and in July have a really great month and pay yourself $40k, the IRS could determine that the $32k you gave yourself is a distribution of profit, and therefore a dividend. Even paying your taxes as if that was taken as a wage could end up being scrutinized by the IRS. If the IRS determines that your wage fluctuates as much as your profit does, and you're audited, you could have an issue.

Lets say you run a consulting company, pay yourself $5k/month, write an IPhone app, sell $200k, hand yourself $200k right there, it is possible that the IRS could take that view. The difference in taxes on $200k of income versus a dividend is 2% or $4000. If that is greater than 10% of the amount you owe at the end of the year, you could be subject to underpayment penalties of another few hundred. In the fictional $32k, the underpayment of tax would be $3200.

I'm not an accountant, but, if you run into any of these situations, you need to know when to talk with an accountant. Even thinking that you paid the proper tax is something best left to someone that does that for a living. And if you're going to find an accountant, do it in October.. give them your numbers for the current year and what you're projecting for the rest of the year and give them time. You still have room to maneuver a bit more than talking to him on March 14th when the forms are due March 15th. Tax planning is almost as important as tax filing.

Note: yes, I was audited due to the above situation - prior to having an accountant. Ironically, it was a contract with the Navy that did it - I thought, finally, I made this money, I am going to pay myself for all of the hard work I put into this and reward myself for the last two years of subsistance living. After all was said and done, the penalties and accountant fees were grossly disproportionate to the $2100 in underpaid taxes.

Re: The IRS Targets Income Tricks

#27

Post by wuputah »

anonymous246 wrote: post #11

This is one of those few instances where I actually support the IRS and also support the law that's being contemplated. S corps (and AFAIK LLCs) are supposed to have "pass through" taxation. I think it's fair that all income (whether salary or profit distributions) from S Corp is treated as regular W-2 income. If you don't care about the simplicity that "pass through" offers, register a C-corp.

Per the IRS:

> The federal government does not recognize an LLC as a classification for federal tax purposes. An LLC business entity must file as a corporation, partnership or sole proprietorship tax return.

As for your suggestion that all pass-through income is W-2 income - that would never work. It implies that all business "profits" were paid to its shareholders (that's what payroll / W-2 income is). A cash distribution to its owner is not the only thing a company chooses to do with its profits!

Re: The IRS Targets Income Tricks

#28

Post by jabits »

tptacek wrote: post #15
jabits wrote: post #13

Earlier quoted context omitted.

So then as a small Sub-S owner (wife and me), I would have to pay FICA and Medicare on the money spent on health care insurance, disability insurance, etc., which you as a W-2 employee do not pay payroll taxes on. In the end, the payroll tax savings are not that great for a small Sub-S. And as you get older, toward retirement, if you pay yourself too low, you take a big hit on SSA benefit payments (which are based on…

The tax code already goes way, way out of its way to make it easy to pay for health insurance; get a high-deductable plan and build an HSA. It's what you should be doing anyways, even if you don't care about taxes. The fact of the matter is, as a member of the workforce, you owe FICA on your compensation. This isn't a subject of dispute. The IRS says you do, the courts say you do, your accountants will say you do. Th…

"...you owe FICA on your compensation". Exactly. I want to be taxed (and get the same breaks) as my corporate client employees. Business writes off all possibly related equipment, as do I. I try to write off everything a C-corp would for employees, but it is much more difficult for us (and very time-consuming even trying to be IRS-compliant).

Again, payroll tax savings (on the income/distribution differential) does not usually add up to that much money.

Re: The IRS Targets Income Tricks

#29

Post by tptacek »

tbrownaw wrote: post #24
tptacek wrote: post #14

Earlier quoted context omitted.

Respectfully --- I like you and your comments, even though our politics couldn't be more different --- you should get slammed for this analysis. You're muddying the waters and you know it. The prevailing market wages for beauticians and mechanics are so low that that benefit of evading FICA is marginal. S-Corp owners are rarely audited period , but here you ask us to consider that enforcement of the tax code might fo…

> What makes this a particularly easy rule of thumb to follow is that it's exactly what you would do anyways if you didn't know about the S-Corp loophole. So if everyone is supposed to pretend it doesn't exist, why does it exist?

The tax structure S-Corp owners are taking advantage of is the one that governs investment income. These people are deliberately reclassifying their compensation as return on the investment of having started a business.

Re: The IRS Targets Income Tricks

#30

Post by johnwatson11218 »

Can anyone comment on how personal income tax is handled in other countries? I don't mind paying tax but I hate the fact that I can take my paper work to several different tax preparation services and get different tax bills. In some cases I have heard of people owning the IRS thousands, going somewhere else and claiming a refund.

Is the US the only country in the world where 2 to 3 percent of our GDP goes into tax preparation?

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