Profits as Distribution – Not Wages

Posted on December 20, 2008 by Dr. David Edward Marcinko MBA

56371606Payroll Tax Strategies for Doctors

By Edwin P. Morrow; III, JD, LLM

[Staff Writers]

Any business, like a medical practice with employees, has to concern itself with payroll taxes.  This includes any C or S Corporation with a sole owner/employee. 

Payroll Taxes

Payroll taxes include: 1) income tax withholding for any employee for federal, state and local taxes; 2) the employer portion of federal social security and Medicare taxes (also called OASDI – old age, survivors and disability insurance); 3) the employee portion of federal social security and Medicare taxes; 4) state and federal unemployment tax [See IRS Publication 15, Employer’s Tax Guide]. These include a social security tax of 12.4% on earned income up to $106,800 (2009 number increases annually) and Medicare taxes of 2.9%. And, although there are not nearly as many tax “loopholes” with payroll taxes as with income taxes, impacting issues like this should be noted.

Distribution of Profits

And so, profits as distributions are a valid strategy for passive physician-investors not working in a business entity. If no work was done to earn the distribution and the profits earned based only on the owner’s capital contribution, then the distribution should not be subject to social security and Medicare taxes as wages. 

An Aggressive Strategy

However, this may be a more aggressive strategy for owners working in a business; or practice.  Yet, some tax practitioners are comfortable characterizing a certain amount of payment to owner/workers as a distribution of profits to owners rather than as wages, which could save up to 15.3% employment tax. 

Avoiding Wage Re-Characterization

This may be done through a partnership or S Corporation (this technique would lead to potential double tax in a C Corporation), though many practitioners feel treatment of S Corporation distributions is more likely to safely avoid re-characterization as wages due to older IRS proposed regulations that are more negative on this point to tax partnerships.  Proposed Regulation § 1.1402(a)-2(h)(2).  This regulation has not been passed and is not law, but is the closest thing to guidance on IRS thinking in this area.  The IRS will not likely subject a distribution of a tax partnership to self-employment taxes unless one of the following apply:

 

  • the partner or member has personal liability for debts of the partnership (common in a general partnership or LLP, but not in an LLC, and not for a limited partner in a LP);
  • the partner or member has authority to contract on behalf of the partnership (common in member managed LLP or LLC, but not for a limited partner in a LP or a non-managing member in a manager managed LLC); or
  • the partner or member participates in the business more than 500 hours a year.

As can bee seen, at least one of these criteria will often apply to many partners or owners of LLP or LLC interests, but will not apply to a limited partner or an LLC owner whose interest closely resembles that of a limited partner.  That said; some practitioners go beyond these regulations because they are not binding interpretations.  

A Warning

Remember the adage, however, that “pigs get fat and hogs get slaughtered”. If you try to declare everything you make as a dividend style distribution and not wages, the IRS will use the “reasonable salary” guideline to re-characterize the distribution as truly wages. The company or practice must pay its owner/employee a reasonable salary for work done based on the nature of the job.  Basically, what would it cost to hire someone to do what you do? 

Assessment

The IRS may be more successful in treating a distribution as wages where a company is primarily a service business, like a medical practice, and capital investment is not a factor in production of income, or where there are no other employees that one can claim as helping to produce the excess income.

Conclusion

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Understanding Payroll Taxes

Posted on December 18, 2008 by Dr. David Edward Marcinko MBA

Accounting Issues for Doctors56371606

By Edwin P. Morrow; III, JD, LLM

Staff Writers

Any business, like a medical practice with employees, has to concern itself with payroll taxes.  This includes any C or S Corporation with a sole owner / employee. 

Payroll Taxes

Payroll taxes include: 1) income tax withholding for any employee for federal, state and local taxes; 2) the employer portion of federal social security and Medicare taxes (also called OASDI – old age, survivors and disability insurance); 3) the employee portion of federal social security and Medicare taxes; 4) state and federal unemployment tax [See IRS Publication 15, Employer’s Tax Guide].

Non-Employees

A non-employee business or medical practice owner (which may be a partner in a tax partnership) must pay the equivalent of these taxes, called Self-Employment Taxes, in lieu of the above taxes  IRC § 1401. These include a social security tax of 12.4% on earned income up to $106,800 (2009 number increases annually) and Medicare taxes of 2.9%. Instead of income tax withholding, the owner doctor pays Estimated Taxes on a quarterly basis. A non-employee owner is unlikely to be required to pay unemployment taxes.

Impacting Issues 

Both the employer and the employee must pay a social security tax of 6.2% of wages up to $106,800, and a Medicare tax of 1.45% of all wages. This totals 15.3% of the first $106,800, and 2.9% of all wages above that. You will notice that when combined, the employee and employer tax rates equal the self-employment tax rates. 

Assessment

Although tax planners often only discuss income tax planning, payroll taxes may sometimes be greater than the corporate income tax (starting at 15%) or individual income tax (which may be as low as 0, 10 or 15%), and should be considered just as important in planning to avoid excessive taxation.  Unlike income taxes, there is no standard deduction, exemption or delayed starting point for these taxes. The tax starts on the first dollar.  Although there are not nearly as many tax “loopholes” with payroll taxes as with income taxes, impacting issues should be noted.

Conclusion

And so, your thoughts and comments on this Medical Executive-Post are appreciated.

Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com  or Bio: www.stpub.com/pubs/authors/MARCINKO.htm

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