Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

Businesses can take advantage of law to avoid hidden taxes

- by Alan Duvall 

Published in Dayton Daily News   November 12, 2006 

“You can fool some of the people all the time, and all of the people some of the time, but you cannot fool all of the people all the time.”  Abraham Lincoln. 

Congress loves to slip hidden tax onto voters.  Take the Federal Insurance Contributions Act as an example. 

Deducted from the initial $97,500 of a laborer’s annual wages is a 6.2 percent FICA tax.  This amount is “matched” by the employer, creating a 12.4 percent extra tax on wages. 

A Medicare tax of 1.45 percent is also deducted from wages.  This tax has no limit and it's subject to an employer match for a total 2.9 percent tax.  These two taxes combined take out more than 15 percent in earned income.     

Now Congress would have the lower-middle class believe the rich are subject to vastly higher tax rates, but such is really not the case when FICA/Medicare are considered.   

A married couple earning $70,000 is in a 25% Federal income tax bracket plus 15% FICA/Medicare tax – a 40% marginal tax rate.  Since FICA taxes cease past $97,500 income, a couple earning $300,000 a year is only subject to a 33% income bracket plus 3% Medicare tax – a 36% marginal tax rate.  The middle class couple is actually paying more in taxes than the wealthy family for each extra dollar earned. 

The business income of self-employed individuals is subject to an equivalent FICA/Medicare tax as are partnerships.  So how can business people avoid this hidden tax? 

Try a Subchapter S corporation.  All Sub S corporate income is taxed directly to owners, but – drum roll please – such income is not subject to FICA or Medicare taxes.

For example, assume a Sub S corporation earns $300,000 before owners’ wages.  All $300,000 paid to the owners as wages is subject to full income taxes and $20,700 in FICA/Medicare taxes. 

But if the corporation only pays owners $50,000 wages and remaining income as dividends – income tax is the same but owners only pay $7,700 FICA/ Medicare taxes.  This is a tax savings of $13,000 a year.  Theoretically, an employee will receive Social Security retirement benefits from payment of FICA, but such benefits may be taxed upon receipt or even reduced depending upon the recipient’s income in any given year.

Therefore, the long-term advantage to FICA avoidance is in the eye of the beholder.  However, there is no perceptible personal benefit to the payor of taxes, so these 3 percent taxes can be eliminated without pain.  

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.