Tax Planning Strategy for High Income Earners with S-Corporations

 

Whenever I’m talking about tax strategies for high income earners with my clients they always ask, “What do you mean by high income?”  If I’m talking to a person face to face and I bring up tax strategies for high income earners, I mean the person I‘m talking to.  I wouldn’t bring it up otherwise.  Since you happen to be reading this on the internet, for this post I generally mean people with incomes over $200,000.

 

Here’s what’s up:  The new Medicare tax on investment income (or Obamacare tax, Net Investment Income tax, Healthcare tax, or whatever you want to call it) also taxes your  S Corporation profits.  Let that sink in for a minute.  S Corporation profits will be counted in the same category as interest and dividends and capital gains for the 3.8% Medicare investment tax.

 

Let me give you an example of how this could affect you:  Let’s say you’re single and you have wages of $150,000 and S-Corp profits of $200,000 for a total of $350,000 in Adjusted Gross Income.

 

To figure the medicare investment tax you’d take $350,000 – 200,000 (the base) = $150,000.  You have $200,000 in investment income, you’re only going to pay the 3.8% on whatever is over the base so your Medicare investment tax is 3.8% time $150,000 which equals $5,700.

 

At $150,000 on wages, you’ve already maxed out the Social Security withholding that you were subject to so additional Social Security tax doesn’t affect this example.

 

Now let’s compare your investment Medicare tax with your wage Medicare tax.   Withholding on your wages is 1.45%, plus the employer contribution on your wages is an additional 1.45%–so as the owner/employee of your S-Corp you’re paying 2.9% Medicare taxes on your wages.  Once you cross the $200,000 wage point, there’s an additional 0.9% Medicare wage tax bringing the Medicare wage tax to 3.8%.  That’s the same rate as you would pay with the Medicare Investment tax.

 

It used to be that one of the benefits of being an S-Corporation was that you didn’t pay the extra 2.9% (now 3.8%) Medicare tax.   You’re losing the savings benefit you used to have.

 

Now this doesn’t affect everybody.  If your S-Corp income is lower, this might not matter to you.  That’s why you have to do some comparisons.

 

So, a really important question for you is going to be–is your S Corporation still the right business structure for you?  For some people, the answer will be yes.  For others, it might be time to convert to a regular C Corporation, a Sole Proprietorship, or Partnership.

 

The Obamacare tax will be reported on Form 8690 and added to your 1040 personal income tax return.

 

How can you tell?  This year, more than any other year, you want to get your taxes done on time.  Run the numbers all the ways that you’re thinking about.  Be sure to figure things based on the changes you’d make if you had a different business structure.  Then you can make an informed decision based on the numbers.

 

Remember, your corporation taxes are due by March 15^th.  If you want to revoke your S-Corp election for 2014, you have to do that by March 15^th of 2014 otherwise it will be too late.  Of course, you can revoke your S-Corp election and still file an extension for your 2013 taxes.  But the smart thing is to run your numbers before you revoke the election–because you still might be better off keeping your S-Corp.   For many companies, changing your corporate status will give you no benefit–for many others it will.  That’s why it’s so important to make the decision with your eyes wide open and with all the facts in your hand.