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October 15, 2007

S Corporations: A [Fill-in-the-Blank] Tax Dodge

Business formation websites, business books and magazine articles, and self-help hotel seminars still flog the S corporation as a clever way to avoid paying self-employment taxes on earned business income-namely, by reducing your S corporation salary and paying out S corporation profits to yourself as unearned income, which is not subject to self-employment (Social Security) taxes. Just form a corporation, then fill in the blanks on a simple-to-use one-page IRS tax-election form and voila, you're home free (tax-free).

I don't agree. First of all, the IRS sometimes [fill in the blank: "challenges on audit, "successfully sues," "seizes corporate profits paid out to"] business owners who work for their S corporation for free (that is, without paying themselves any or much of a corporate salary).

Second, this S corporation tax strategy seems penny-wise and pound-foolish ["dollar-dumb," converted to US currency].

Even if a Social Security payout cannot, by itself, adequately fund retirement, the fully-funded, top Social Security benefit of [fill in your projected maximum benefit as shown on your most recent Social Security Administration earnings and credits report mailing, such as "$1,500" or more per month, ] can put a serious dent in what you owe for [insert basic household necessities, such as "groceries, utilities, high-speed Internet, digital cable TV, cat food, etc."].

A typical riposte is "It doesn't make sense to pay into Social Security since the fund will go broke by the year [insert worst-case scenario date, such as 2040], after payouts to retiring boomers and excessive borrowing from the fund by the feds have drained the fund dry."

Again, I don't agree. Even if the fund needs replenishing to make up for a flood of baby-boom claimants and years of deficit-driven borrowing by other federal agencies, the majority of federal legislators have consistently expressed and shown their resolve to protect it, come hell or high-water or [insert other future fund-balance challenges, such as occasional pushes for privatization, investment-industry lobbying for opt-out alternatives, and the like].

In short, I think Congress will keep the fund functioning and afloat, and I believe it makes sense to plan ahead for the best possible Social Security payout after you reach the mandatory Social Security retirement age (even if you decide to continue working).

Copyright 2007 by Anthony Mancuso

This article is provided as information and opinion. Please check with a legal or tax advisor for legal or tax advice.