Tax Reduction and Reform Act of 2007 will increase payroll tax on S-Corp owners

In the last week of October, U.S. House Ways & Means Committee Chair Charles Rangel introduced H.R. 3970, the Tax Reduction and Reform Act of 2007.  While Rangel says he doesn’t see the bill getting much action until next year, S-Corp owners should be aware, and in my opinion very upset, at a specific provision in the bill that will increase taxes on many S-Corp owners.

The provision is designed to make sure S-Corp shareholders who are not actively engaged in the business, and not paying their "fair share" of taxes, are made to do so.  However, the unintended consequence of the provision is that owners who are paying their fair share will have to pay more.  

Here’s the skinny:  Payroll taxes have historically applied to labor income only, not capital income.  Part 2, Sec. 1211 of the legislation will change that for S-Corp owners of service businesses by applying the payroll tax to income related to that service business.  So, the engaged business owner who actively participates in the business and pays payroll taxes properly will end up paying more if this legislation passes.  The payroll tax works out to 15.3%, which is not an insignificant amount to have to pay.  

The provision is expected to generate $9.5 billion in the first 10 years after passage.  While a portion of that is tax money the government is rightfully owed from S-Corp shareholders who don’t pay their fair share now, much of it will come from owners of family-owned businesses. 

Part of the problem is that it is currently time-intensive and costly for the IRS to make sure S-Corp shareholders who don’t work at the business pay the appropriate amount of tax, but this is not the solution to correct that. 

TRRA of 2007 Not All Bad

The bill, as a whole, does some good things like reducing the top corporate tax rate from 35% to 30.5% and repealing the individual Alternative Minimum Tax.  But it also does some things to harm small business owners.  Last time I checked, they’re the ones who create most of the new jobs in this country.  I think they deserve a lot better from our government.

What can you do if you’re upset about this?  Write your representative and let them know how you feel.  Call their offices.  Also, call Representative Rangel’s office and let him know there has to be a better way to bring in $9.5 billion over the next 10 years. 

Warren Buffett wants to pay more taxes - maybe Rangel should ask him for more!