For those who missed it, Monday’s Congress Daily does an excellent job of outlining the challenge confronting S Corporations and other flow-through businesses as Congress prepares to take up reconciliation, tax reform, an extension of expiring tax provisions, and other tax legislation this Congress. Continued interest by the press regarding the Joint Committee’s recommendation is a clear signal this issue is not going away & JCT and the Treasury Department’s Inspector General for Tax Administration have proposed changing the rules to ensure that payroll taxes are levied on all a firm’s income, regardless of how it is counted. Concern in the small business community that Treasury might back a rule change of that nature was heightened when the IRS announced late last month that it was auditing 5,000 S-corporations with an eye toward recommending potential policy changes.
SOME STARTING TO QUESTION THE IRS’s AUDIT OF S CORPORATIONS
Last Friday’s BNA Tax Report suggests the IRS’s announcement that it intends to randomly audit 5,000 S Corporations over the next couple of years has left some tax practitioners questioning why the IRS is only targeting S Corporations.
“While several practitioners could list areas of possible S corporation noncompliance, many also said they were not aware of any egregious, widespread violations currently occurring. Other practitioners noted several compliance problems may be more prevalent in S corporations than with other types of corporate structures.”
August 8th, 2005
Business Groups Prep For Battle Against S-Corp. Change
Small businesses are fighting a proposal to collect more payroll taxes from millions of S-corporations and partnerships, a plan they fear might be used by tax writers to help underwrite expensive Social Security or tax overhaul efforts. The proposal was floated earlier this year by the Joint Committee on Taxation, which estimates it would raise $57 billion over the next 10 years. That represents one of the largest revenue sources from a single legislative change, as congressional tax writers seek options to shore up the long-term solvency of Social Security and to change the tax code. Congress is awaiting recommendations from President Bush’s tax panel at the end of next month.
“The tax panel’s charge is to report recommendations that are revenue-neutral … They’re going to have to come up with offsets someplace,” said Brian Reardon, a former White House economic adviser who is coordinating business efforts against the tax change.
At issue are amounts that small businesses organized as partnerships, limited liability corporations or S corporations claim as compensation for tax purposes. Current law requires Social Security and Medicare taxes to be levied on all “reasonable compensation” of employees of these pass-through entities. But according to a January JCT options paper, owner-employees have an incentive to under-report their wages to avoid paying excessive payroll taxes. They might take a large chunk of income as a distribution, which would not be subject to those taxes. JCT and the Treasury Department’s Inspector General for Tax Administration have proposed changing the rules to ensure that payroll taxes are levied on all a firm’s income, regardless of how it is counted.
Concern in the small business community that Treasury might back a rule change of that nature was heightened when the IRS announced late last month that it was auditing 5,000 S-corporations with an eye toward recommending potential policy changes.B A broad coalition of business groups that includes the National Federation of Independent Business, the National Restaurant Association, National Association of Manufacturers and a number of state chambers of commerce has been formed to lobby against the payroll tax change. The coalition is being coordinated by Reardon of Venn Strategies, which represents the S Corporation Association. Opponents of the JCT proposal claim that the IRS already has the ability to determine whether a taxpayer’s claims of “reasonable compensation” are accurate, and to collect whatever taxes it thinks have gone unpaid.
“Our goal is to educate members and educate staff to make sure they understand these are bad policies; they’re bad economics. They would represent a direct, unfair tax on a lot of employers,” said Reardon. But the coalition also faces a unique challenge when communicating the problem to Republican lawmakers in particular: The problem highlighted by JCT was earlier identified by Vice President Cheney in a debate last summer with then-Sen. John Edwards of North Carolina, the Democratic vice-presidential nominee. Cheney raised questions about whether Edwards was avoiding payroll taxes by structuring his law practice as an S-corporation and underreporting his “reasonable compensation.”
— by Martin Vaughan