The SECA tax law was enacted in 1954 that requires the owners of small businesses—such as S corporations, partnerships, and sole proprietorships—to pay a tax of 15.3 percent of their net income from self-employment to cover their own Social Security, Medicare, and Old Age Survivors and Disability Insurance (OASDI) costs.
To avoid paying the 15.3% tax, S Corporations have for years taken advantage of paying cash to shareholders as distributions instead of wages—not exactly what the IRS had in mind. Don’t forget that S Corps also avoid corporate level income taxation too because that income is only taxed at the personal income tax level.
The IRS, of course, would like to tax as much of shareholder distributions as possible, so the House Ways and Means Committee has targeted this issue in H.R. 4213, Section 413, which specifically addresses S Corp personal services income. The SECA tax part of the bill is estimated to raise $11.25 billion in revenue over 10 years and the Medicare tax would raise $30 billion annually.
So what does this mean?
The IRS is stepping up audit efforts to identify these cases. They will be implementing a taxpayer education campaign, and the bill in congress will be targeting small personal and professional service businesses (performing artists, athletes, accountants, lawyers, actuaries, architects, consultants, engineers, health professionals, veterinarians, lobbyists, brokers, and investment advisors).
All professional service S-Corps with 3 or fewer professionally skilled individuals would see all pass-through net income taxed as SECA income, similar to sole proprietors who file Schedule C on their 1040 personal tax return.
The bill also aims to close a loophole that has allowed for the shifting of income to other family members to avoid SECA tax. Under this bill, the shareholder's share of income subject to SECA is increased by the share of family member shareholders who do not perform professional services.
Issues Not Addressed In the Bill
Possible Negative Affects
How much of the $11.25 billion in savings will really result is debatable. As the financial advising industry looks into this issue and realizes that there are other business-type entities, unaffected by the bill, that may be better to use, there could be a shift away from S Corps.
H.R. 4213, "The American Jobs and Closing Tax Loopholes Act of 2010", Section 413 (House Ways and Means Committee), passed the house as amended on 5/28/2010, effective for tax years after 12/31/2010. Portions of the bill concerning SECA would amend the Social Security Act, Section 211
Passed by house and awaiting review by the senate and the president to be signed into law.
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To contact your Representative:
 US Legal Definitions - http://definitions.uslegal.com/s/self-employment-contributions-act/
Fredrick James Tax, Accounting & Consulting