S-Corp is for Savings

S-Corp is for Savings

“S-Corp” is for Savings

How to find tax-saving opportunities under ObamaCare

By Wesley Middleton

As in many situations, new taxes create new opportunities.  Wait, what?  Opportunities?

Absolutely!  With the enactment of the Patient Protection and Affordable Care Act (PPACA), a new 3.8% Medicare tax (popularly referred to as the “ObamaCare Tax”) is imposed on the net investment income of tax payers at a certain Adjusted Gross Income level.  In addition, the Medicare tax on self-employment income has increased from 2.9% to 3.8% on income in excess of $250,000 for a joint return.

Not sounding like an opportunity yet?  Well, you only have to look to the political leadership to see where it exists.  Former House Speaker Newt Gingrich and former North Carolina Sen. John Edwards have both made the news recently for their use of S-corps (or S corporations) to avoid the Medicare tax and now the ObamaCare Tax.

An S-corp. election exempts the profits and
distributions of the S-corp. from self- employment tax.

For example, we recently advised a company with $1.3 million in earnings (after the owner’s salary) to leverage this strategy.  Under their previous structure, these earnings would be taxed at the normal income tax rate.   Now, throw a 3.8% tax on top of that and you’ve got $49,400 in additional taxes simply due to the entity structure.

By converting to an LLC and electing to be taxed as an S-corp., their earnings are no longer subject to the self-employment tax, and because the owner is active in the business, the earnings are not subject to the ObamaCare tax either, saving the client almost $50,000 in taxes!

This is a perfectly legal entity strategy we use every day and one that many small business owners are simply unaware of!  If you’re operating in an entity structure other than an S-corp. or you’re starting a new business, this is an excellent opportunity to minimize your overall tax burden.   Existing entities may be able to simply elect to be taxed as an S-corp., or you may be able to convert your entity to an LLC and then make the “S” election.

You should exercise caution in order to avoid triggering a taxable event upon making the election or conversion.  In addition, you must still meet the Material Participation Test found in the Section 469 regulations.  Make sure to consult your legal and tax advisors before taking any steps or making any decisions.  But, by all means, consider the strategy as a potential way to improve your tax position and grow your bottom line.

“Wesley Middleton is the Managing Partner at MiddletonRaines+Zapata, LLP, a leading Houston-based CPA firm offering a full suite of accounting, tax, audit, and consulting services to the small and middle markets.” wmiddleton@middletonraines.com

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