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ELIMINATION OF SELF
EMPLOYMENT TAXES (SE)
HISTORY AND BACKGROUND
Self-Employment Tax (SE) is in addition to
the self-employed individual's income tax. Currently the SE
tax consists of the combination two (2) taxes: 1. Social
Security of approx. 12.6% and 2. Medicare of
approx. 2.9%, totaling 15.3%.
For the year 2007, the SE tax applies to net
earnings of up to $106,800.00, thus $16,340.00.
This is already a significant burden on the self-employed,
however the worst may be yet to strike.
Congress, faced with a significant shortfall
of revenue, should the split social security retirement
plan be adopted for younger workers, is considering
raising the taxable SE income level to $200,000.00, thus a SE
tax of $30,600.00.
In contemplation of a SE tax of $30,600.00,
and the uncertainty of the future of Social Security itself,
it is most understandable that most self-employed are eager
to minimize or eliminate their entire SE
tax obligation.
This can be legally done, and be morally correct, under
the old supreme court ruling advising, "No one is obligated
to pay more than the tax codes require".
The elimination of SE tax can only be accomplished via
a business entity.
LET US EXAMINE THE PRINCIPAL BUSINESS ENTITIES AND THEIR
TAX RELATIONSHIPS TO THE PRINCIPALS.
BUSINESS ENTITIES
1. THE SELF EMPLOYED INDIVIDUAL; THE PROPRIETOR OR ENTREPRENEUR.
All taxable income from the schedule C, up to $96,000.00, goes
directly to the SE form of the taxpayer's 1040.
The individual has no opportunity to mitigate the SE
tax; is significantly limited in business deductions and has
no NEVADA "CORPORATE VEIL" insulating the individual from business
liability and subsequent litigation.
2. THE GENERAL PARTNERSHIP AND PARTNERS
Arguably the worst form OF OWNERSHIP.
PARTNERSHIPS HAVE NO SE TAX SHELTER AND NO "CORPORATE
VEIL" AND PARTNERS CAN BE PERSONALLY TOTALLY LIABLE FOR THE
MISTAKES OR MISCONDUCT OF OTHER PARTNERS.
3. THE NEVADA LIMITED LIABILITY COMPANY (LLC) AND MEMBERS
All LLC's are tax classified as a PARTNERSHIP.
They can not "employ" their members, nor pay them wages. All
taxable income is passed directly thru to the member's personal
1040 and is generally subject to SE
up to $14,750.00 (2007), plus regular income tax predicated
upon each member's individual tax bracket.
The salient salvation of the Nevada LLC is the very strong NEVADA
"CORPORATE VEIL", BUT NO SE PROTECTION, EXCEPT AS "S" STATUS BELOW
4. THE NEVADA "S" CORPORATION AND STOCKHOLDERS
All the Nevada corporations begin as a "C"
Corp, the "S" Status is granted by IRS
via form 2553, if the corporation so elects. Nevada LLC's are now eligible for "S" status.
The election form 2553 must be filed with IRS
no later than the 16th day of the third (3rd) month of the tax
year the election is to take effect.
Upon acceptance by IRS the "S"
status, the corporation will thereafter annually file an 1120S
FORM to IRS.
PRINCIPAL CRITERIA OF THE ELECTION
1. The corporation or LLC must be a Domestic Corporation or LLC ;
All Nevada corporations and LLC's are domestic.
2. No more than 100 stockholders or members.
3. Stockholders or members must be individuals (some exception).
4. No non-resident or alien stockholders or members.
5. Only one (1) class of stock or ownership.
6. Each stockholder or member must sign and consent to form 2553
to include each stockholder's: (1) Full Name, (2) Address, (3)
Social Security Number, (4) Date, (5) Number of Shares Owned
or units of ownership, (6) Date Acquired, and (7) Date of filing of stockholder's or members year
end 1040 tax return.
NOTE: THERE ARE SOME RESTRICTIONS ON THE TYPES OF
CORPORATIONS ELIGIBLE TO MAKE THE ELECTION. SEE IRS INSTRUCTIONS
FOR FORM 2553.
The stockholder(s) maybe an employee of an "S"
corporation.
The stockholder(s) with the dual role may receive both wages
and a share of the corporate income.
THE WAGES AND STOCKHOLDERS'S SHARE OF CORPORATE INCOME
ARE BOTH SUBJECT TO INCOME TAXES, HOWEVER ONLY THE WAGES ARE
SUBJECT TO PAYROLL TAXES, I.E. SOCIAL SECURITY AND MEDICARE
TAXES. MEMBERS OF AN LLC CAN NOT BE EMPLOYEES.
THE INCOME PORTION IS NOT SUBJECT TO EITHER PAYROLL OR SELF-EMPLOYMENT TAX.
THE
INCOME PORTION PASSES DIRECTLY, VIA K-1, TO SCHEDULE "E"
OF THE STOCKHOLDER(S)'S OR LLC MEMBER'S 1040 RETURN; THUS TO ELIMINATE SELF
EMPLOYMENT TAXES.
PLEASE
EXAMINE THE FIRST PARAGRAPH OF PAGE 20, IRS 1120S INSTRUCTION
(web site: www.irs.gov)
PROCEED WITH CARE
Since income that passes thru an "S"
corporation is not subject to payroll taxes, stockholder(s)
may be inclined NOT TO RECEIVE ANY WAGES.
IRS is privy to this strategy, and under
a close audit of a stockholder(s)'s 1040,
may reclassify the "pass thru income" as wages, thus to assess
the stockholder(s) with payroll taxes, plus penalties and
interest. Consequently "S" corporation stockholder(s)
must refrain from evading payroll taxes by a weighted distribution
favoring "PASS THRU INCOME" OVER WAGES.
THE SOLUTION
Study
the average wages in whatever job classification that reflects
the stockholder(s)'s corporate job; use this as a statistical
guide.
This statistical approach should satisfy IRS and.
for a successful corporation, legally shift the preponderance
of income from wages to a "PASS THRU" status.
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