June 18, 2010

In an effort to keep you informed of new developments in the ever-changing landscape of tax law, I wanted to send you some quick bullet points of recent legislation that will have a far-reaching impact on our tax planning focus and on how you conduct your business.  These two new pieces of legislation impact almost all of my clients in some manner.

EMPLOYMENT TAX TREATMENT OF PROFESSIONAL SERVICE BUSINESSES

The Senate has tried three times to pass a bill containing this provision, but has failed three times to obtain enough votes to pass it.

The long and short of this is that IRS wants to impose self-employment tax on the PROFITS allocated to S-Corporation shareholders.  I know…I had to read the law several times to be sure I was interpreting it correctly.  And sadly enough, I am. 

The new law basically states that each shareholder who provides substantial services to a disqualified S-Corporation shall take into account his/her pro-rata share of all items of income or loss in determining net earnings from self-employment.  Translated – my take on this is that you would have to subject the S-Corporation earnings, whether you distribute them as dividends to yourself or not, to 15.3% self-employment tax in most cases.

A disqualified S-Corporation is one that is engaged in a professional service business (the fields of health, law, lobbying, engineering, architecture, accounting, actuarial service, performing arts, consulting, athletics, investment advice or management, or brokerage services) if the principal asset of the business is the reputation and skill of 3 or fewer shareholders.

This applies to many of my S-Corporation clients.  The new law takes effect for years after December 31, 2010, so that means NEXT YEAR, if the Senate passes it (and everything I have read seems to indicate that the Senate will pass it, at least in some form).  In essence, this new tax law removes one of the basic premises behind our advising S-Corporation status to our clients – no self-employment tax on distributions or net income, only on the salary that you pay yourself.  While I did read today that the Senate is now haggling over this bill and could make some changes, the proposed changes only further complicate the bill and make it very difficult to sidestep this ENORMOUS increase in income taxes.  This could be a huge problem for some of you, and I will keep you posted on the developments as I am informed by AICPA. I am strongly opposed to the bill, and AICPA is lobbying loudly for small business owners everywhere by trying to have this provision stripped from the bill. I am hopeful, as you are, that they will be successful.

REPORTING REQUIREMENTS FOR FORM 1099-MISC

Beginning in 2012, companies will have to issue 1099-MISC to all companies from which they buy more than $600 in goods and services.  Up until now, the form was only required for companies that used contract labor, but the new tax law explicitly extends the requirements and the definitions to encompass just about everyone.  With the effective date of this new law, it’s money paid to corporations or individuals for services, rent, royalties, or other such covered payments.  Unlike many laws affecting business reporting, there is no provision limiting the size of the corporation, so a corporation with 3 people is as liable as one with 303.  It’s all about IRS cracking down on unreported income.

The law would require issuing a 1099 to your telephone company, office supply store, or your IT provider if you pay them more than $600 in the calendar year. Whoa! The paperwork burden this now places on businesses by including “goods” in the definition is astounding.  And not excluding incorporated businesses from the requirement to receive a 1099 places a huge burden on small businesses who have hundreds of vendors.

I have read recent interpretations and forecasts that indicate debit and credit card purchases would be exempt from the reporting requirements.  I don’t know if that’s true, but it’s been discussed.

You have a couple of years before this becomes an issue, but you need to remember to get those W-9’s filled out….and fast!  This law is part of the Healthcare Bill, so it’s here to stay unless Congress changes the scope of the bill.  We will keep you posted.