The Bulletin, 6/16/2010
By David Holley
Small-business owners offering professional services — including attorneys, accountants or engineers, among others — could pay anywhere from 3 percent to 15 percent more in taxes on certain portions of their business income if Congress passes an amended version of House Resolution 4213, known as the American Jobs and Closing Tax Loopholes Act.
A section of the act, included in an amendment approved by the House of Representatives in late May and now being examined by the U.S. Senate, would charge Medicare and Social Security taxes on most income garnered by a business that operates as an S-corporation, according to a Bend accountant. Previously those corporations only paid Medicare and Social Security taxes on income that pays for wages.
Maggie Erickson, a certified public accountant at McGregor-Caverhill in Bend, said the taxes would be detrimental to businesses hoping to grow and develop. She said S-corporations’ earnings that aren’t targeted toward wages are typically used for business improvements, such as hiring additional employees or making capital investments.
“They’re going to get hammered,” Erickson said. McGregor-Caverhill would be impacted, she said.
The amendment would only affect small S-corporation businesses with three or fewer employees, whose “reputation and skill” make up the principal assets of such businesses. That could include professions ranging from consulting to brokerage services, but doesn’t include firms with more than three people working in those professions.
The additional taxes are estimated to raise about $11.25 billion over 10 years, according to a summary of a Senate substitute amendment of the act filed with the Senate Committee on Finance June 8. This section of the act, 413, was maintained in its entirety between the House and Senate versions.
The summary of the Senate’s substitute amendment contends that those business owners should be paying Medicare and Social Security taxes on all income. It says that some people have been using an S-corporation designation as a loophole.
“Some service professionals have been avoiding Medicare and Social Security taxes by routing their self-employment income through an S-corporation,” the summary says. “These taxpayers then pay themselves a nominal salary and take the position that the remaining earnings are exempt from employment taxes.”
U.S. Sen. Ron Wyden’s office said that while it is not the time to be raising taxes on small businesses, loopholes that allow tax evasion are unfair to citizens who pay all their taxes. They force everyone to pay more, said Jennifer I. Hoelzer, communications director for Wyden, D-Ore.
“Closing this loophole will prevent some of that evasion and, in this case, help pay for the package of tax-extenders for critical expiring programs like unemployment insurance and health care for seniors,” Hoelzer wrote in an e-mail.
How it would work
The tax change would become effective for tax years starting after Dec. 31, 2010. It is buried in what is now a more than 300-page house resolution, which Erickson said would also do good, such as providing tax deductions for teachers and property owners. Most of the press HR 4213 has received is for proposing to extend unemployment insurance.
“We love the fact that those are in there,” Erickson said.
The federal filing status of a business determines the method by which it pays taxes. While C-corporations pay corporate taxes, and the executives and shareholders of them pay income taxes, S-corporations don’t typically pay corporate taxes because all of the profits are passed through to the businesses’ owners or shareholders.
That income is then charged both state and federal income taxes. As the law works now, Erickson said, business owners pay themselves a wage out of the profits, which is subject to the Medicare and Social Security taxes. Medicare and Social Security taxes don’t have to be paid on the remaining income, she said.
For self-employed S-corporation owners, there’s a heavier tax burden when they’re paying the Medicare and Social Security taxes for their own wages and profits, Erickson said. The Social Security tax is 12.4 percent and the Medicare tax is 2.9 percent.
In businesses with employees, employers pay half of the Social Security and Medicare taxes, while the employees pay the other half. Self-employed individuals, such as S-corp owners, pay all of both taxes on their own wages, however. No Social Security tax must be paid on wages above $106,800.
Say an S-corporation, owned by a physical therapist for example, had $100,000 in post-income tax earnings, and planned to pay himself $55,000 in wages and keep $45,000 in profits for investments in his business. Today, the $55,000 in wages is subject to the Medicare and Social Security taxes — $8,415 in taxes — while the $45,000 isn’t.
If the amendment to the American Jobs and Closing Tax Loopholes Act is approved, the physical therapist would have to pay the 12.4 percent Social Security tax and the 2.9 percent Medicare tax on that $45,000 — an additional $6,885.
“It’s just killing small business,” said Erickson, adding that the additional tax takes away the incentive to grow.
Gary Holbrook, who owns HD Architecture in Bend, said the amendment would hurt his business. He said he hopes local groups will advocate against the amendment.
“I don’t think it’s going to get too far,” Holbrook said about the section calling for the tax. “Going after really small businesses doesn’t make too much sense.”
While the amendment as is would make S-corporations pay more in taxes, Erin Shields, press secretary for the U.S. Senate Committee on Finance, wrote in an e-mail that the Finance Committee “is working to ensure the provision is precisely targeted and does not hamper the growth of small businesses.”
Andrew Whelan, press secretary for U.S. Rep. Greg Walden, R-Ore., said Walden voted in May against adding the section of the act that charges the Medicare and Social Security taxes.
“New taxes on small businesses are crippling right now, especially when small businesses are the job creators for 80 percent of new jobs,” Whelan said.