S Corp Tax Bill Passes House

Update

The Act was approved by the House yesterday (May 28th). Now it goes to the Senate, where it won’t be heard until June 7th at the earliest.

We’re still waiting on Congress to debate and vote on the American Jobs and Closing Tax Loopholes Act of 2010. This is the bill that’s getting some play in the news, as it provides a package of “extenders,” which is what Congress calls tax cuts that should expire, but they aren’t quite ready to let them go yet. Examples are R&D credits for business, a credit for teachers who buy school supplies with personal funds, etc.

Tax cuts make the people receiving them happy, of course, but those who are tasked with paying are less than enthusiastic. That includes S Corporation owners this time around, who are facing the prospect of having distributions hit with payroll taxes.

But the legislation isn’t across the board in its application. As written, it only applies to S corporations engaged in a professional service business, which it defines as “any trade or business if substantially all of the activities of such trade or business involve providing services in the fields of health, law, lobbying, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, investment advice or management, or brokerage services.” And then it narrows things down even further, to just apply to corporations who make their income on the reputation and skill of 3 or fewer shareholders.

The intent is clear – the change would catch what Congress sees as highly-compensated business owners who take a minimal salary and the rest of their income as profit distributions.

But the way the bill is currently structured, large S Corporations would likely be exempt, while small companies would not. That’s led to claims that it would stifle investment – after all, would you invest in a small company if your profits were going to be hit with an extra tax? Or, would you invest somewhere else, where your profits would not be hit with extra tax?

And, because the provision would only apply to some, but not all, S Corporations, there’s a potential for a discrimination claim. Not to mention the vagueness of the “professional services” description. There’s plenty of room to catch all kinds of other business owners in the web.

In any event, Congress is finding the legislation harder to pass than they first thought. It’s been delayed for 2-3 weeks now, with rumors that it’s headed to a vote this weekend, before the Memorial Day break. If that doesn’t happen, the bill could be shelved or rewritten later in the year.

We’ll keep our eyes on this one. A tax on S Corporation distributions could turn tax-planning on its head for small business owners.