In 1998, former Democratic presidential candidate John Edwards reported $360 thousand in wages and $5 million in a distribution of profit from his S Corporation law practice.  In 2010, GOP presidential candidate Newt Gingrich reported $444,327 in wages and $2.4 million in a distribution of profit from his S Corporations.  By deferring most of their S Corporation earnings into a distribution of profit, Edwards and Gingrich, combined, saved over $200 thousand in tax by not paying Medicare Insurance tax.

The Internal Revenue Code imposes a self-employment tax on personal service income that does not arise from the employer-employee relationship.  Internal Revenue Code Sections 1402.  The self-employment tax has two separate taxes - a social security tax and a Medicare insurance tax.  While the social security tax only applies to the first $106,800 of wages, tips, and net earnings, the Medicare insurance tax has no limitation.  To decrease their tax liability a wealthy individual actively engaged in providing services to their S Corporation just classifies a large portion of his S Corporation earnings as a distribution of profit, not wages. 

 

The IRS is aware of this loophole and reclassifies an S Corporation distribution of profit as a wage, and subject to the Medicare insurance tax, if the wage is not "reasonable compensation," i.e. earned through the shareholder's personal services.  More wealthy individuals are expected to consider this loophole when a part of Obama's new health reform law takes effect in 2013.  Couples with compensation greater than $250 thousand ($200 for singles) will then pay the 2.9% Medicare insurance tax on all compensation, plus an additional .9% Medicare surtax on compensation above these amounts.

If you need Elite Asset Protection or Secrets to Income Tax Planning, please call Givner & Kaye at (310) 207-8008.