Employment tax refers generally to the 15.3% withheld for Social Security and Medicare. Both the employer and employee are responsible for half of this amount. However, employment taxes are imposed on salaries and wages, not investment. These characteristics can significantly reduce employment taxes.
The Concept of Return on Investment
Among the reasons people invest in corporations is the “return on investment.” People who invest in Apple stock, for example, do so because of the prospect of realizing gains from stock appreciation and cash payouts from the issuance of dividends. The hope is that the cost of investment is outweighed by the subsequent gains in profit. This concept is referred to as return on investment.
While S-Corporations are not typically utilized for the purpose of realizing gains from stock appreciation or cash payouts from the issuance of dividends, owning S-Corp. stock nevertheless creates an investment component. The shareholder-employee can receive a salary for services rendered to the corporation. This amount is, of course, subject to employment taxes.
However, profits in excess of costs incurred during the taxable year may be distributed to shareholders as a return on investment. This amount completely escapes the 15.3% employment tax because it is received not as salary or wages, but as a return in “investment.” To come full circle, amounts received as investment are not subject employment taxes.
The IRS is certainly aware of these methods. To prevent corporations from distributing 100% of profits as a distribution, the IRS requires that shareholder-employees receive a “reasonable” salary. As such, employment taxes cannot be evaded by simply designating all profits as distributions, and hence, a return on investment exempt from employment taxes.
Contact Randhawa Hundal LLP Tax Attorneys to Learn More!
We have experienced Tax Lawyers ready to assist individuals and businesses in Sacramento, Roseville, Folsom, and the greater Sacramento area. Our Tax Attorneys can assist you with organizing your S-Corp. and reducing employment tax liability. We will also provide assistance with approximating a “reasonable salary.” Determining a reasonable salary is not an exact science, and receiving assistance from a tax attorney is highly recommended to avoid recharacterization and penalties.
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