And Why the Biden Loophole Might Soon Close
SMITH BRAIN TRUST – A few weeks ago, Maryland Smith’s Samuel Handwerger wrote a letter to former President Bill Clinton. But it wasn’t a letter concerning the former President’s views, his presidency, or his politics.
“Good ol’ President Clinton has never met me, I am not related to him in any way that I know of, and I am pretty sure that I will not receive an answer,” explains Handwerger, who teaches in the accounting and information assurance department at the University of Maryland’s Robert H. Smith School of Business.
“Nevertheless,” he continued, “as a practicing CPA and having seen a copy of his 2015 tax return as posted voluntarily during Hillary Clinton’s presidential campaign, I thought that I might take a shot at getting his business for tax preparation. After all, it’s probably not every day that someone can say to him, unequivocally, ‘Hey, if you hire me to do your taxes, I can legally save you $280,000 or more in federal income taxes.’”
The first thing he would do, he says, is suggest that Bill Clinton take a look at former Vice President Joe Biden’s 2017 tax return.
Both Clinton and Biden have significant income from book royalties and speaking engagements. Biden, has reported that activity through two corporations – specifically corporations that have elected “S corporate” status for tax purposes. The other, Clinton, has reported royalty and speaking engagement income as a “sole proprietor,” meaning he’s in business for himself not doing business under the guise of some corporation.
“Now, interesting is that the amount of income from these activities for both parties is about the same – about $10 million. Nice work if you can get it,” says Handwerger.
Biden, however, paid about $280,000 less in taxes on that income, thanks to those S corporations.
You see, as a sole proprietor, Clinton pays income tax on the net earnings from those books and speeches, and he pays self-employment tax (SE) on top of that, Handwerger explains.
“SE tax is the enharmonic equivalent of Social Security and Medicare tax. The latter applies in an employee-employer relationship and the SE for those sole proprietors, like Clinton,” he says. Social Security does have a cap to it and phases out after about $132,000, leaving only the Medicare tax, which goes for 2.9%.
Biden, on the other hand, by doing business as an S corporation, maintains an employee-employer relationship, and, therefore, gets paid a salary like any good employee of a corporate business. The salary chosen by these corporations was around $250,000, “oddly enough just at about the cap for the Social Security tax in each of the two corporations’ cases,” he says. The rest of the income Biden made, roughly $9.75 million, is subject only to income tax, but unlike Clinton’s, it is not subject to the 2.9% Medicare tax. “At all,” adds Handwerger. “Do the math, and it’s about a $280,000 difference.”
Wait a minute, you say, why did those S corporations pay Biden a salary of only $250,000? Didn’t he “earn” about $10 million?
“Yes,” says Handwerger, “but – and here’s the legal tax loophole – a corporation only has to pay a ‘reasonable salary’ to its employees, and Biden is an employee of these corporations.”
What’s a reasonable salary?
“Well, when it comes to S corporation, a reasonable salary is as low as you can go,” Handwerger says.
To determine the exact salary, S corporations generally look to the regular marketplace for the cost of the raw product to get someone to do “the work.” In Biden’s case, they chose a “reasonable” pay rate that is going to yield a very advantageous tax position. Since the remainder of the $10 million, or $9.75 million after subtracting the salary, is left as income inside the S corporation subjected to income tax, but not that Medicare tax.
In essence, Biden wasn’t contracted to make those speeches and write those books, his corporations were.
Critics charge that the S corporations should pay Biden, and others like him, the full contract amount, as a salary. They say the entities shouldn’t get away with paying only the “reasonable amount.”
“The tax argument is that the corporations were paid a premium for his name, which represents profit – profit to the corporation; profit above the raw cost of having someone write books and speak,” says Handwerger. “To be sure, that profit does get subjected to ordinary income tax, but since it is not income as a sole proprietor, there’s no Medicare tax.”
That’s the legal S corporation tax savings in a nutshell.
“No other entity can boast this tax maneuver,” Handwerger says. “And that fact has given the IRS a lot of heartburn since the S corporation statute was first created in 1958.”
The Internal Revenue Service has “rigorously fought” the reasonable salary concept, Handwerger says, to little avail. It has appealed to Congress numerous times to make a statutory change in the law, as well, without success. That could change, Handwerger says, now that Biden is running for president and his taxes are in full public view.
“So run, don’t walk, to your nearest State business entity office,” Handwerger says. “Set up a corporation, make it an S for tax purposes, and agree to work for the corporation for next to nothing and then count all the taxes you will save before this loophole gets closed forever.”
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