Concern over Social Security Insolvency suggests S-corp at lower income levels?

[DAK]

Something I was pondering today. It looks like the Social Security Trust fund will reach insolvency a year earlier thanks to COVID.

One of the common "solutions" to the insolvency is to raise or eliminate the cap on wages subject to Social Security taxes. It seems like a solution is to payoneself as a S-corp to save on the Social Security taxes on business earnings above the reasonable compensation to the owner paid as wages.

I know we shouldn't generally plan based on "possible" tax law changes in the future.

So my question is related to permissibility of switching to a S-corp from a sole proprietor (or disregarded LLC) for the same 1099 income in future. Are there any restrictions about the ability to switch if you've been a contractor serving the same client company for a while?

Are there any steps to take to preserve option value such as forming a LLC from the start of a contract so you can always elect S-chapter status without changing EIN?

[Gamma Knives]

I don't think there are any particular steps you have to take to make switching to s-corp easier in the future.

Along with discussion eliminating cap on wages subject to social security tax there has been talk of taxing s-corp earning so it may be a moot point.

Many physicians create an S-corp for 1099 wages and pay themselves significantly less than their 1099 income. However, I would argue this is not correct based on IRS guidance:

"But to the extent gross receipts are generated by the shareholder's personal services, then payments to the shareholder-employee should be classified as wages that are subject to employment taxes.

In addition to gross receipts generated directly by the shareholder-employee, the shareholder-employee should also be subject to wage treatment for administrative work performed by him for the other income-producing employees or assets."

[spiritrider]

Gamma Knives is correct on what he quoted from the IRS guidance on reasonable compensation. However, the IRS and the courts over the last dozen years have established that the quotes are a baseline. Reasonable compensation is a facts and circumstances determination. The IRS and the courts have establish that what the individual would receive as a W-2 employee in similar circumstances is the single most important factor in determining reasonable compensation. The other top tier mitigations are whether there are employees, capital equipment and cost of goods sold.

A S-Corp may not be the panacea you think. The IRS tends to chase enforcement where the money is. It would be reasonable to expect the IRS to be far more aggressive if/when maximum taxable earnings are substantial increased.

In case you are not aware, the failure to pay reasonable compensation requires the payment of unpaid Social Security and Medicare taxes and a 100% penalty. When that amount goes from (2.9% - 3.8%) * 2 = 5.8% - 7.6% to (15.3% - 16.2%) * 2 = 30.6% - 32.4%. It seems pretty obvious that the IRS would be far more aggressive on reasonable compensation, when the whole purpose of such a change is to generate greater receipts to shore up the trust fund.

[CordMcNally]

I wouldn’t spend much time pondering on things that haven’t happened yet with regards to politics and taxes.