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S-Corp SECA Tax Hike Catches Most Small Businesses Off-Guard

If you are a owner of a small business engaged in delivering professional services who has an adjusted gross income of under $200,000 and thought you were going to skate by the massive income tax hikes coming in 2011 and 2013, think again, also about the benefits of PAN card.  Many business owners with salaries under $107,000 are about to see a significant increase in their taxes.

The Kiplinger Tax letter, May 28th, reported that the House just passed a SECA tax hike that will effect many S firm owners.  The tax will make all dividends from service firms subject to SECA tax, starting next year.

This revenue-raising bombshell was passed by the House as they adjourned prior to the Memorial Day recess. 

Hardest hit will be very small personal service S firms where the principal product is the reputation and skill of three or fewer workers. Owners of S firms that are partners in a service partnership will owe SECA tax on their entire profits, not just their salaries.

Currently, the tax is 15.3% of the first $106,800 in salaries and 2.9% above that. Now, the dividends of small S firms in these fields will be treated as if they are salary and subject to SECA tax. The companies effected are those engaged in accounting, law, health, actuarial science, engineering, architecture, lobbying, consulting, brokerage services, investment management, sports and the performing arts.

The change will end a popular SECA tax saver for personal service S firms: Taking a modest salary and receiving the rest of the profit as a dividend, which are not subject to SECA taxes. Those dividends are hit with income tax.

A few years ago, Treasury inspectors found massive tax avoidance in this area. More than 35,000 one-owner S companies with profits of $100,000 or more paid no payroll taxes on the profits because the owners didn’t take a salary. It was the same for owners of about 40,000 S firms with profits in the $50,000-$100,000 range.  So Congress decided to take action to end any possibility of gaming the system. 

Of course, they are also substantially increasing taxes on the millions of small business owners that earn ligitimite dividends.

This ends one advantage of choosing S status for small service businesses. No exception will be allowed for amounts left in the firm for working capital, at least for small professional service S firms. Dividends passed through to owners of larger S service firms or of S corporations that aren’t in professional service fields, such as manufacturers, will continue to be exempt from self-employment tax.

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14 Responses to S-Corp SECA Tax Hike Catches Most Small Businesses Off-Guard

  1. Bobbie in Atlanta June 16, 2010 at 9:39 am #

    I suspect that if they had just enforced the “reasonable salary” rule they would have come up with significant revenues without having to do this. But all those people who listen to their bar room advisors become S corps and don’t take a salary. It’s all their fault:-)

  2. Shawn June 22, 2010 at 5:51 am #

    I agree with Bobbie. A few bad apples ruined it for the rest of us.

  3. Robert July 22, 2010 at 1:10 pm #

    Will this income be considered “earned income” and affect people drawing social security benefits at age 62-66 ? I have several clients who are retired but still own stock in service S corps that will be affected by this if it is considered earned income because of the earnings limits.

  4. Rick Kahler July 22, 2010 at 2:35 pm #

    Robert, good point. My hunch is that this will be considered “earned income.” How could the code consider it anything else if it’s subject to FICA?

  5. V Nail July 23, 2010 at 8:04 am #

    The article states the ones that are not in professional service fields, such as manufacturers, will continue to be exempt from self-employment tax. Can anyone give examples of what they consider Manufacturers. I am a construction company, would that be considered manufacturing.
    Thanks for the input

  6. Rick Kahler July 23, 2010 at 6:24 pm #

    V Nail, I think you are safe. I don’t believe a construction business is a personal service.

  7. Robert July 25, 2010 at 9:25 am #

    I guess there will be a lot of small firms merging to avoid the 3 skilled worker rules.
    I am curious why insurance and real estate companies are not mentioned as personal service companies.

  8. Rick Kahler July 25, 2010 at 11:04 am #

    Robert,Good point and a good planning strategy. Real estate has long been exempt from independent contractor status, so it doesn’t surprise me. Excluding insurance does surprise me when brokers are not excluded. However, the insurance and real estate lobbies are huge and powerful, so that may be part of the reason.

  9. Michael Eick CPA August 2, 2010 at 11:49 am #

    Your information states that the House passed the bill re:SECA tax. Has the Senate passed the same bill? Or a variation? Thank you.

    • Rick Kahler August 2, 2010 at 12:46 pm #

      My understanding is that it has not passed the Senate yet, but I could be wrong. I am still tyring to find a good source. Its amazing how little is published about this.

  10. Warren CPA August 6, 2010 at 11:54 am #

    I believe this bill was the “American jobs & Closing Tax Loopholes Act of 2010” which passed the House. As such it is an “engrossed in the House” bill. Passage in the Senate should be much tougher, BUT it contains a whole laundry list of things favorable to business that were in the Tax Extender Bill passed way back in December 2009. Anything can happen…..

  11. Mark November 28, 2010 at 7:57 pm #

    It appears that this provision was stripped from the final legislation, which was renamed H.R.4213 – Unemployment Compensation Extension Act of 2010, and signed by the President on July 22, 2010. See text of final bill here. Do you concur?

  12. Rick Kahler November 28, 2010 at 8:15 pm #

    Yes, I do.

  13. Steve C. February 9, 2011 at 4:12 pm #

    Does anyone know whether Kiplinger or any of the other tax research services out there ever bother to issue “Emily Litella–‘Never mind'” alerts when a previous item put folks on edge? If not, wouldn’t that be the professional and responsible thing to do?