THE SUBCHAPTER'S CORPORATION SOCIAL SECURITY TAX AVOIDANCE SCAM By David G. Hanger March 22, 2014
To which I can only respond, I do hope you have the integrity to pay your clients’ penalty and interest charges when you screw up, because you will then be bankrupt several times over, and I won’t have to worry about your silly ass anymore. This does not fit in the category of ignorant, but rather complete moronic, idiotic stupidity. And arrogance, with possibly a dose of dishonesty tossed in. No one likes taxes, but this is not an undiscovered magic bullet. It is more a bonehead reading one thing only, when in fact he needs to read, combine, and comprehend several dozen sections of the IRC Code. A Subchapter S corporation is actually one of the lesser used forms of business organization, particularly in Alaska. Partnerships are not obligated to report much to the state; corporations are, so unless you have to be a corporation for some reason alternate forms of business organization are frequently used. Generally, a Subchapter S corporation is used in the early years of a business’s operation to report out losses proportionately and directly to investors, so they can write those losses off on their individual tax returns. It is generally not advantageous for a corporation to report out gains the same way, and thus most profitable corporations operate as ‘C’ corporations, basically your general run-of-the-mill corporate form. Some say that a Subchapter S corporation is treated for tax purposes somewhat like a partnership, and this is true to the extent that the earnings or losses of the entity are proportionately and directly passed through to the investors’ individual tax returns; but here precisely there is also a critical difference, for the partnership income is ordinary earned income subject to self-employment tax, but direct payouts from a Subchapter S corporation to the individual investors are by definition corporate dividends which are not subject to self-employment (social security) tax. Wow, what an undiscovered loophole!! Instead of allocating salaries we just pay out dividends, and never again worry about social security. And look at all us dummies out here, all us licensed practitioners, who should have long since formed hundreds of Subchapter S corporations locally, and no one in K-town would ever again have to pay into social security. We are so stupid indeed that we are not all running to our lawyers to protect us from your wrath. Anyway, someone out there thinks we are all that stupid. And so we have a whole lot of small businesses here locally in the past several years that have been organized as Subchapter S corporations and are paying out their salaries as dividends, thereby avoiding paying out social security taxes. Every one of you will be audited by the IRS, and every one of you will lose. This scam is so stupidly transparent the IRS does not even need to send an audit team down. They will just send you a bill and invite you to take them to court. You will lose there, too; badly!! You will pay $3 to $5 for every one dollar you try to dodge over a three- to four-year period. Let me explain it briefly to you, because it really is that simple. The law respective Subchapter S corporations also requires that everyone working for the corporation, particularly working investors, must be paid a salary or wage comparable to the salaries or wages specified for that occupation in the Fed’s standard industrial code. So all of those dividends for you working investors, which is most of you out there right now, will be converted by the IRS to salary dollar for dollar, and on that you will be assessed social security taxes and penalties which you will be compelled to pay. If it’s too good to be true, it ain’t true. And in this case the only dummy is the person perpetrating this on the public. And all of his victims are a bunch of knuckleheads, too, who deserve what they are going to get. An example or two might help. Let’s say three of you get together and decide to open a tourist shop to sell these new special homemade widgets that no one else has. So you form a Subchapter S corporation you call “Kamikaze Tax Dodgers, Inc.,” and agree that all three of you will devote all your time to making this new business a success, thus while a few draws will be allowed along the way, at the end of the season we will divvy it all up, distribute it as dividends, and brilliantly avoid paying social security tax, while all those dumb ‘proles down there keep doing that old-fashioned thing. Yuk! Yuk! So at the end of season #1, each of the three takes home $30,000 paid out as a dividend. No salaries. This is such a transparent violation all the IRS needs to do is stack ‘em up and start sending out the bills. But instead they wait. They really like to hurt “willfully negligent” fools. If their timing is really good, they can get you for four years; they will definitely get you for three. If they decide to assert criminality, they can open it up for a decade or more. The base social security tax on $30,000 is right at $4500, so being the first year in a three year string, double it. You owe the IRS around $9000; times three that is $27,000 for the gang. And that is only year one. Multiply that times around three and that defines the actual extent of your problem, $80,000 and counting, plus court costs. Try to pull this crap with more than two or three people, and the prospect of criminal charges magnifies considerably. That is evidence of fundamental and systematic fraud with malice aforethought; very bad country. What happens if there are four investors, one of whom invests only money, while the others work as part of their investment? They are equal investors, each one owning one-fourth (25%) of the business. Before any salaries or dividends are paid out there is $120,000 to divvy up amongst the four. While it is possible for these investors (or any group of investors) to have a sidebar agreement that this $120,000 will be split four ways with $30,000 X 3 = $90,000 reported out as salaries, the remaining $30,000 kicked out as dividends to the money only investor, the actual accounting format is that salaries are a deduction against gross income to determine net income (or net profit in this example), thus the profit of the business is $30,000 divided times the four proportionate shares owned by the investors, $7500 apiece X 4 = $30,000. The dividend allocation is different because the salaries are subtracted from income to arrive at the net profit. Either way there is $30,000 in dividends paid out in this example, but for the three working investors if the $30,000 paid to each of them was substantially lower than the average salaries for their job, that $7500 in dividends apiece could still be redefined by the IRS as salary subject to social security. A non-working investor can receive a dividend as the routine and only method of payment. No working investor has that tolerance, and in these small closely held operations trying to split in any way between salaries and dividends is an invitation to serious trouble in territory that requires a very experienced guide (those licensed practitioners you think are so stupid). Your choice. Your money. They feed on you, they won’t be feeding on someone else; and for the rest of us that has obvious advantages. There is at least one jerk out there who like lemmings is leading a bunch of you over yonder cliff. I have done my job, so if you go now, it is all on you. David G. Hanger, EA, MBA
Received March 21, 2014 - Published March 22, 2014 Viewpoints - Opinion Letters:
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