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| S Corporation Dividend vs. Wage Trick: Saving FICA Taxes |
ettleMyTax is the easiest way to resolve IRS tax problems online. Online tax resolution for IRS tax debt.
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Last week we talked about how John Edwards had sheltered almost $600,000 from taxation by electing to be treated as an S Corp for federal income tax purposes. But how was this accomplished?
It is accomplished by splitting up income earned between wages and dividends: wages are subject to FICA taxes, dividends are not. FICA taxes included Social Security taxes and Medicare taxes. FICA taxes are imposed on most wages earned as an employee, as well as an employer.
As an employee, FICA taxes are withheld automatically from your paycheck by your employer. Employers, say running their business as a partnership or Limited Liability Company, are subject to FICA taxes on all earnings of the business that are attributed to them (their share of the profits). These taxes attributable to an employer are called self-employment taxes.
So how is an S Corporation different from a partnership or a Limited Liability Company? Because an S Corporation may differentiate between wages and dividends (whereas the other types of entities cannot), and only wages are subject to FICA taxes: this is just what John Edwards did. So what is the limit? Why not just claim no wages and take all of the profits from the business as dividends? The short answer: Because the IRS is aware of this tactic and has prohibited it. Using this tactic, an employer has to take “reasonable compensation” as a wage. If this employer does not take reasonable compensation, the IRS may claim that some of the dividends were actually wages, and claim that the employer owes more taxes (which may include penalties for not paying payroll taxes).
With all of that being said, all of these cases are fact and circumstance specific. The taxpayer must be ready to show that they received “reasonable compensation” for the services that they performed.
Next week, we will discuss what factors the IRS looks to in determining whether wages are reasonable and when the IRS will re-characterize dividends as wages, thus subjecting the taxpayer to paying more taxes.
As with any information provided by SettleMyTax.com, these articles are only for a general information purposes only and do not constitute legal advice. If you wish to set up an S Corporation and/or split your profits between wages and dividends, make sure to speak with a professional. These cases are extremely fact specific and your situation should be discussed with someone who can tailor your situation accordingly.
Website: http://www.settlemytax.com/
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Posted on Jun 26, 2011 21:32pm by settlemytax
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