FICAMedicareObamatax increases

Obama Policy Agenda Proposals Part IV

Well, I am back to discuss the fourth and final part of a series on the Obama Policy Agenda Proposals that I began last week. If you missed the former posts, you can find them here:

Obama Policy Agenda Proposals Part I
Obama Policy Agenda Proposals Part II
Obama Policy Agenda Proposals Part III

As I mentioned in Part III of this series, this last item has the ability to destroy many small businesses across America as it will massively increase their tax burden. This proposal is not new and is not even Obama specific. The Democrats in the Legislature have been trying to push this through for several years now and have been unable to get it out of Committee. Of course, it is a whole new world now and they will be able to do pretty close to whatever they desire.

In short, what they want to do is to make all S-Corporation earnings subject to FICA and Medicare taxes. Currently, the S-Corporation shareholder (owner) who also works in the S-Corporation pays the FICA taxes on his/her wages, but is not subject to the FICA taxes on the other earnings of the S-Corp. The S-Corporation shareholders are required by law to receive a reasonable compensation to prevent the abuse of this rule. The reasoning behind the way it is set up is basically that the earnings above and beyond the reasonable compensation components are actually a result of the Company making money – similar to the way a C-Corporation pays a Dividend.

Let’s look at an example of this. Joe owns an ice cream parlor. Currently, Joe manages the ice cream parlor and pays himself a salary of $35,000. The salary of $35,000 that Joe is receiving is approximately what he would have to pay someone else if he were to hire a manager and leave the day to day operations of the business. In addition to the $35,000 in salary, Joe also makes a Net Income from the business of $65,000 – for a total income of $100,000. Under the current law, the $35,000 would be subject to FICA and Medicare taxes, and the $65,000 would not be subject to FICA and Medicare taxes. As stated above, the $65,000 is similar to a dividend that is paid to Joe on his investment in the business.

Under the new law, Joe would owe FICA (12.4%) and Medicare (2.9%) taxes on the entire $100,000 of earnings (note that this assumes that Obama also ditches the cap on FICA – which is something else they are proposing). If these tax changes would take place, this would result in a tax increase of $9,945 on Joe’s income.

As one can clearly see, this certainly affects taxpayers making less than the $250,000 income threshold that President Obama promised as the cutoff for tax increases. I guess someone has to pay for all of the “welfare credits” that are proposed.