off the charts
POLICY INSIGHT
BEYOND THE NUMBERS
BEYOND THE NUMBERS
Policymakers across the political aisle agree that we should avoid the sharp increase in interest rates on student loans scheduled for July 1, but that consensus falls apart when it comes to how to pay for the proposal.
It shouldn’t. This should be an easy call.
One option, which the House approved last week, would eliminate a fund that promotes preventive health care. The other, much more sensible option (which the Senate will consider next week) would crack down on people who underreport their income to the IRS, thereby addressing a significant tax compliance problem that we have previously described.
The issue concerns S corporations, which — instead of paying corporate income tax — “pass through” their profits (and losses) to shareholders, who pay taxes on those profits at individual rates. Many S corporation shareholders receive both wages from the S corp and a share of the S corp’s profits, but they pay payroll tax only on their wages. This gives them a huge incentive to underreport the share of their income that consists of wages in order to reduce their payroll tax liability.
While such employee-shareholders are supposed to report “reasonable” compensation to themselves, many don’t — as several investigations have documented:
- The Government Accountability Office calculates that in 2003 and 2004, S corporations underreported about $23.6 billion in wage compensation to shareholders, “which could result in billions in annual employment [i.e., payroll] tax underpayments.”
- The Treasury Department’s Inspector General for Tax Administration has concluded that “The S corporation form of ownership has become a multibillion dollar employment tax shelter for single-owner businesses.”
- Separately, analyzing 84 suspect S corporation tax returns, the IG found that shareholders reported average wages of $5,300 and average profit distributions (which are exempt from payroll taxes) of $349,323.
Topics:
Stay up to date
Receive the latest news and reports from the Center