Congress Responds to Newt Gingrich’s “Reasonable Compensation” S Corporation Play
Last week we drew your attention to Newt Gingrich’s use of a well-documented nuance in the S corporation law to forego a portion of salary in favor of distributions from his two corporations/employers and avoid $70,000 in payroll taxes.
Over the years, several solutions have been suggested to curb what is seen as abuses of this S corporation payroll advantage, including:
- Imposing self-employment tax on the flow-through income of all shareholders owning 50% or more of an S corporation’s stock;
- Imposing self-employment tax on the flow-through income of all shareholders, which would equalize the payroll tax treatment of S corporations and many partnerships.
- Impose self-employment tax on the flow-through income of all “professional service corporations,” i.e., those S corporations engaged in law, accounting, consulting, etc…
Most recently, in response to the news that Gingrich took only $450,000 of salary from his S corporations while allowing net-profits of $2.4 million to flow through payroll-tax free, U.S. congressman Pete Stark proposed the not-so-subtly-named Narrowing Exceptions for Withholding Tax, or NEWT, Act.
Under Stark’s bill, the flow-through income of an S corporation with three or fewer shareholders would be taxed as compensation, thus requiring both the corporation and the shareholders to pay the necessary payroll taxes, effectively closing this lucrative loophole for closely-held S corporations.
From my perspective, Congress has had 50 years to close this loophole, and if they didn’t feel compelled to do so when former vice president candidate John Edwards took advantage of the same rules in a far more egregious manner, then there’s no reason to believe they will now.
