The IRS Targets Income Tricks
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The IRS Targets Income Tricks
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Re: The IRS Targets Income Tricks
#2See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings.
So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's comp system.
What am I missing? Is it only legal to dodge withholdings in a c-corp?
Re: The IRS Targets Income Tricks
#3See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings. So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's…
A S-corp owner must take what the IRS deems to be a "reasonable salary" based on the overall profit of the company, and must pay self employment taxes (FICA, Medicare, etc.) on that amount.
The IRS does not give out much guidance on the definition of "reasonable salary" but has provided guidance on what is /not/ reasonable.
In this case the IRS evaluated the company's return and decided that his salary was less that reasonable and as such they went after him and got him to pay more tax.
This rule does not apply to C Corporations.
Re: The IRS Targets Income Tricks
#4See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings. So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's…
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.
Steve jobs effectively pays a 45% federal tax rate on income (35% corp on apple's income and then 15% long term cap gains on any shares he sells) -- so the IRS really doesn't care.
Re: The IRS Targets Income Tricks
#5See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings. So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's…
Social Security/Medicare/Workers comp get no money on passthrough from a c-corp either - c-corps pay taxes on profit, whereas s-corps pass any profit through to be taxed on individual returns of shareholders.
What would bother the IRS is that capital gains distributions are taxed at a different, lower rate than standard income, so taking distributions instead of income could reduce the total amount owed to the IRS.
(I'm not an accountant - if someone could verify or refute this, that would be nice)
Re: The IRS Targets Income Tricks
#6Small businesses are somewhat notorious for aggressively interpreting the tax code in one's favor, largely because they have a variety of options for doing so not available to the W-2 employee. The game theory sort of incentivizes it, too: heads you save 100% of the taxes at issue, tails you have to pay the taxes at issue and (if you had any sort of a good faith case) only interest at a below-market rate on them... and the coin is known to flip tails only a few percentage points of the time, due to how infrequent audits are.
This is complicated by the fact that, if the tax code were a spec, it would have some requirements which were contradictory and very many interactions whose behavior was totally undefined.
For example, BCC has a fairly similar issue: if the profits are earned income received for the value of my services as an engineer/etc, then they're subject to a generous exclusion since I was physically in Japan when I earned them (foreign earned income exemption, form 2555). If they're unearned income -- that is, if the business is generating profits above the fair market value of the time I am investing -- then they are not subject to that exclusion and I owe the IRS a few thousand extra. On a separate axis, they may not be attributable to the business at all, but as a result of sale of real property, depending on whether the computer software counts as personal property or not, which apparently turns on the degree of support/customization I offer and the mood of the examining IRS clerk. If they aren't attributable to the business and are a sale of real property, then they are excludable, as long as the transaction is not sourced to the United States. Sales of real property are sourced where the transaction physically takes place... but the IRS literally has no opinion on where that is for sales of downloadable software. (I asked. They said "Write up your reasoning with your tax form. If we don't bill you, you're good.") If they are not real property, they may be a sale of computer licenses, which are arguably a source of royalties, which could be subject to a US/Japan tax treaty provision which overrides some of these rules but not others.
The above is not tax advice. Don't even ask about the Japanese side -- I have a few more weeks to figure that mind-meltingness yet.
Re: The IRS Targets Income Tricks
#7See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings. So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's…
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, rightfully so. By taking a $1 salary, you are saying to the shareholders (world) that you believe so firmly in the company, that, you'll earn your income the same way a shareholder would - through the growth in stock price, etc. He does have to pay taxes on personal use of the corporate jets, and other benefits. I can't really imagine his situation being so dire that any social security income he could get would have any material impact on his life. We also don't know what the nature of his contributions were years ago.
Paying too little and taking out too much profit is actually tied to a separate issue. If one runs an S-Corp and is in the typical feast and famine cycle, i.e lots of work, bill lots of money, work slows down, time for lots of sales because there is no work, here comes work again, then, the IRS could say that you took $x+y during the time when you were cash-flush, and $x when you were in your income slump, making $y a dividend and taxed as such. In many cases, dividend income is taxed at a higher rate than personal income until you hit a certain income (I believe $373k/year or so and in 2013, $171k or so). If you earn less than those amounts, dividends are taxed more heavily than normal income.
A C-corp is its own financial entity. It pays its own taxes, has a separate tax structure. If you wanted to pay yourself a $1 salary, you could. Then, any money you take out of the company could be taxed as a dividend, you would have to assume 100% control of your retirement, probably wouldn't be eligible for Medicare after you retire, but, there isn't anything illegal there.
Re: The IRS Targets Income Tricks
#8See, this points out something I've never understood. If you own an s-corp, you have to be careful about paying yourself too little and taking out too much profit, presumably due to the reduction in FICA withholdings. So how does someone like Steve Jobs get away with making a $1 annual salary without being charged with tax evasion? It seems like he's found a way to avoid paying into the social security and workmen's…
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.
Re: The IRS Targets Income Tricks
#9I 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 year, whatever you don't spend as a legitimate business expense -- even if it's exclusively for business purposes -- is taxed at the same rate as if you had spent the money on whiskey and hookers.
Case in point: there is a huge difference between a high-income wage earner who uses S-Corp status for maximum flexibility and the local beautician or mechanic who does the same thing. Lots of independents who are S-Corps have highly volatile income: if you get a client that writes you a check for 50K in January that might be the last income those guys see for that year. So those guys have to make a difficult business decision as to what to do with the money, and the most logical thing to do is to pay business expenses as needed and withdraw the rest as cash disbursements only as a last result. Writing yourself a W-2 paycheck when you're not sure of future income is basically taking away spending money from the business for no logical reason. As I understand it, the system is designed this way on purpose: tough times allow S-Corps to ride on profits and re-tool for the good times. Good times S-Corps work just like "regular" businesses.
So for small folks with highly-volatile income, being able to move funds around is the only thing sometimes that keeps them afloat. Unfortunately, there are a lot of guys making 400K a year or more who pay themselves a salary of $20K and take the rest as cash disbursements (thereby avoiding paying themselves as W-2 employees mostly altogether)
The reason the tax code is such a mess is that folks get mad at one bunch or another that they think are not acting fairly, so they punish them -- usually punishing many more than the original target. Or politicians want extra votes, so they make an exception for certain people -- usually providing exceptions to hidden interests and creating perverse incentives. 60 years of this and you have a complete disaster.
So yes, by all means make folks pay their share, just be aware that the guy you read about in the paper isn't necessarily the average guy. It's not an "income trick" if it helps the economy grow.
Re: The IRS Targets Income Tricks
#10I 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…
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.