June 18, 2010
September 5, 2012
High-income traders are hit with ObamaCare’s 3.8% Medicare tax on investment income
Important Postscript: See our new blog "The IRS needs to fix their proposed regulations for the Net Investment Tax", dated May 1, 2013. The IRS proposed regulations throw a significant monkey wrench into this tax treatment.
Important Postscript: See our new blog "Post fiscal cliff tax planning for traders", dated Jan. 5, 2013. Excerpt: In an earlier blog (“High-income traders are hit with ObamaCare’s 3.8% Medicare tax on investment income”), I argued that an S-corporation trading company doesn’t reduce the ObamaCare 3.8% Medicare tax on unearned income, because unearned income passes through on the K-1. While that statement is still true, our new idea is different, carving out fee income into an earned-income related S-corporation. The ObamaCare 3.8% Medicare tax applies to “net” unearned income and this administration fee reduces the net trading income in the trading business partnership or S-corporation tax return.
This primer for traders and investment managers offers planning tips surrounding the new Medicare taxes.
By Robert A. Green, CPA
The Patient Protection and Affordable Care Act (ObamaCare) makes a big political point of raising taxes on the rich — defined as individuals with adjusted gross income (AGI) exceeding $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately) — and on the investor class, too. On Jan. 1, the first revenue raisers — the Medicare tax hikes on earned and unearned income — kick in. (The more contentious health-insurance mandate or tax penalties don’t start until 2014.)
The current Medicare tax rate of 2.9 percent applies to all earned income. But if you’re in one of the previously stated income groups, a new 0.9 percent Medicare hospital insurance tax raises this rate to 3.8 percent.
The more significant ObamaCare tax issue is this: Starting in 2013, the 3.8-percent Medicare tax will be applied to unearned income, too, for individuals exceeding these income thresholds. (Technically, it’s modified AGI, which means U.S. residents abroad must add back any foreign earned income exclusion reported on Form 2555.)
Unearned income includes investment or portfolio income (interest, dividends, most capital gains, and annuity distributions), royalties (net of oil and gas depletion expenses), rents (net of depreciation), and passive activity income, as well as gains from the sale of property not used in an active business.
The 3.8-percent Medicare tax on unearned income doesn’t apply to wages and self-employment income, tax-free municipal bond interest income, IRA and qualified plan distributions (retirement plans), or income from the disposition of, or pass-through from, active (earned-income related) LLCs, partnerships, and S-corps, among other revenue sources. If you sell your company for a capital gain and you have been active in the company, that capital gain is exempt from this Medicare tax. But if you have been passive in the company, it is subject to the Medicare tax on unearned income. The Medicare tax also applies to taxable income in trusts (and estates) with undistributed net income in excess of the dollar amount at which the highest tax bracket for trusts begins (this amount is $11,650 in 2012). You can reduce that trust-level Medicare tax by making DNI distributions, but that moves the potential tax trigger to the beneficiary level.
If you are active in rental real estate, that income is free of the self-employment (SE) tax and the Medicare tax on unearned income. It’s not 100 percent clear yet if the exclusion on the sale of a primary residence is exempt from this Medicare tax. Certainly, the taxable portion of the capital gain on the sale of a primary residence is subject to the Medicare tax.
While the Medicare tax on earned income is 50 percent tax deductible, it is not deductible on unearned income. Employers pay half the 2012 Medicare tax and withhold the other half from employees’ paychecks. Investors have to pay the tax on unearned income through estimated taxes and with their tax balance due.
Planning tips: Selling profitable investment positions before year-end 2012 and accelerating other unearned income could be a wise tax move if you know you are going to be over the $200,000/$250,000 income threshold in 2013, triggering the Medicare tax. Plus, if Bush-era tax cuts expire, ordinary, qualifying dividend, and capital gains tax rates will rise in 2013, too.
As is the case with self-employment tax calculations, the Medicare tax on unearned income is assessed on net investment income. That’s defined as net trading gains — proceeds minus cost basis on securities — less “properly allocable” expenses. For traders and investors, these allowable expenses include trading expenses. For business traders, all trading expenses are deducted on Schedule C or on a pass-through entity tax return. For investors lacking trader tax status, Section 212 investment expenses don’t include education, home office, and some other expenses.
Social security taxes are limited to a base amount; Medicare taxes are not
Historically, social security and Medicare taxes were limited to a social security base amount on earned income only. The 2012 social-security-base amount is $110,100. Congress raises the base every few years by around $3,000 or more. The base was $76,200 in 2000, $51,300 in 1990 and $25,900 in 1980. That’s a serious tax hike on the middle class. Benefits have risen too with the inflation index.
In 1994, Congress untethered Medicare taxes from the social security base, applying them to unlimited earned income. While Congress failed in passing universal health care reform during the first Clinton administration, it did pass this Medicare tax hike which was intended to pay for that health care reform. Go figure.
Medicare costs are spiraling upwards and Congress seems bent on raising Medicare taxes to pay for these runaway costs. There seems to be credence to the popular saying that “spending equal tax hikes.”
An important proposal in Obama’s 2008 presidential campaign was his social security tax plan. To use the regular social security tax base and have the base return again on earnings over $250,000 in an unlimited manner. This proposal seems to be a precursor to ObamaCare’s Medicare tax hike on incomes over $250,000.
Traders can’t avoid the tax with an S-corp
Even though the Senate’s recent attempt to repeal the S-Corp self-employment (SE) tax loophole on earned income failed, taxpayers won’t be able to avoid the Medicare tax by operating their trading activities in an S-Corp. Initial suggestions in the media and tax webinars have indicated otherwise: In the Wall Street Journal tax report “About That Investment Tax,” a CPA suggested the loophole might work to avoid Medicare taxes on investment income. However, our tax research clearly shows these advisers are wrong.
Our tax attorney Mark Feldman, JD, says recent articles covering the loophole are referring to S-corps that engage in active businesses, such as cleaning carpets, not businesses trading financial instruments. Feldman says that even though active income normally is not subject to the unearned income Medicare contribution tax but is subject to SE tax, in the case of these active S-Corp businesses, the active income is subject to neither.
According to Feldman’s research, Temp. Regs. Sec. 1.469-1T(e)(6) states, “An activity of trading personal property for the account of owners of interests in the activity is not a passive activity.” Some taxpayers may argue that their investment is an active trade or business based on this regulation and thereby Medicare tax doesn’t apply to them. Feldman says Congress expected tax advisers to try this loophole and specifically ruled it out in the new law. ObamaCare specifically lists businesses to which this tax applies, including “a trade or business of trading in financial instruments or commodities.”
Here’s how the S-corp SE tax loophole works: Underlying earned-income businesses conduct their activities within an S-corp. S-corps do not pass through SE taxable income from earned income activities as LLC partnership returns do. The IRS requires S-corps to pay “reasonable compensation” to officers/owners. This area of the law is under challenge and the IRS is becoming more aggressive. In the past, 25 percent of income could be attributable to officers’ compensation, but the factors are much more complex and beyond the scope of this article. Check with a tax adviser before you proceed.
The marriage penalty is back
If the Bush-era tax cuts expire as scheduled at the end of December 2012, for either everyone, or as President Obama proposes, for taxpayers making more than $200,000 (single) and $250,000 (married), the significant marriage tax penalty will return. Plus, it will be even greater with ObamaCare’s Medicare tax on unearned income.
Many taxpayers don’t remember the significant marriage tax penalties from before the Bush-era tax cuts 2001 in 2003. Read about the history of the marriage tax penalty.
Consider this scenario. One unmarried partner could report the couple’s unearned income on a tax return filing single, and the other partner could report a high wage job on a second tax return filing single. That would save significant income and Medicare taxes versus filing as a married couple.
I just took an important tax update CPE class with RIA and the instructor suggested that divorce would be good tax planning. Isn’t that a little extreme, and have we come to that? Certainly, some taxpayers may think twice about getting married sooner, rather than later.
Although business traders work hard, they generate unearned income
Many of our clients are full-time business retail traders, combining hard work, skill and capital within the investment arena. Most put in more sweat equity than capital, and they use leverage and volume to make up for insufficient trading capital. They are certainly not coupon-clippers in the rich investor class.
Many aspiring business traders changed careers involuntarily through downsizing, while others pursue their dreams in trading. Some want a business from their home location to fit their lifestyle or family needs. Few online traders make over the $200,000/$250,000 from trading and many traders appreciate ObamaCare.
Even though many traders work full time, their trading gains are still considered unearned income — business-related “portfolio income.” Under the “trading rule” in Section 469, trading gains and losses are exempt from passive income or loss treatment. That’s good news. Trading losses are deductible in Section 212 (investment up to $3,000 per year against ordinary income) or Section 162 (trade or business) if other tax-treatment elections for ordinary loss treatment are in place, like Section 475 MTM for securities or Section 988 for forex. Congress didn’t want taxpayers with suspended passive losses to invest in hedge funds to easily generate passive income.
Ordinary trading losses (Section 475 and 988) are much more powerful than capital loss limitations of $3,000. The ordinary loss reduces both MAGI and net investment income (NII), and both of them can affect the Medicare tax on unearned income calculation. You pay the tax on the lower of the NII or the excess over MAGI, so always try to lower your MAGI, too. Roth IRA distributions don't generate MAGI, but RMD from traditional retirement plans do.
A few types of business traders have earned income subject to SE taxes:
-Futures traders who are full members of futures or options exchanges generate earned income — otherwise called SE income — on their trades executed through their exchange membership (Section 1402i in the SE rules).
-Investment management advisory fees — including management fees and incentive fees — are considered SE and earned income. Carried interest or profit allocation which is a share of portfolio income is not SE income, and that's one reason it's considered a tax loophole when it replaces incentive fees.
-Proprietary traders who trade the firm’s capital rather than their own as retail traders are sometimes paid as independent contractors and issued a Form 1099-Misc. for non-employee compensation, which is considered SE and earned income.
These traders with SE income have the tax benefit opportunity of AGI deductions for retirement plans and health insurance premiums, both of which require earned income. These income tax savings can outweigh SE tax costs.
Business traders who do not generate SE income start with the earned income glass empty, generally a nice thing. If these traders want AGI deductions for retirement plans and health-insurance premiums to put net tax savings in their pockets, they need to form an entity to financially engineer earned income. They use an administration fee in an LLC/partnership and a salary in an S-Corp. These business traders can also save more in income taxes than they pay in SE taxes.
Planning tips: Business traders affected by the Medicare tax in 2013 have more incentive to form an entity to convert trading gains to earned income with a fee or salary to increase retirement plan tax deductions. If they are going to pay Medicare tax on unearned income, they may as well have AGI deductions to offset that tax cost. Consider a defined benefit plan with a maximum contribution allowed up to $200,000 for 2012. That’s far higher than a defined contribution plan deduction of $50,000.
Trading within a retirement plan is already a good idea for saving income taxes — retirement plan earnings and distributions are exempt from the Medicare tax on unearned income — and now it can help save the additional Medicare tax on unearned income, too. When trading in a Roth IRA or Roth qualified plan, the income and Medicare tax savings are permanent. Conversely, in traditional retirement plans, income taxes are only deferred until retirement, when Required Minimum Distributions must start (no later than age 70½).
With the advent of online trading accounts for retirement plans and brokers making commissions competitive, more traders are self-directing their retirement funds into active trading. Some traders simply trade within their retirement plans, avoiding “early withdrawals,” which trigger ordinary tax rates and 10-percent excise taxes before age 59½ in IRAs and age 55 in qualified plans. We recommend business traders set up a qualified plan and then use a qualified plan loan to fund their business trading accounts. Factoring the Medicare tax on unearned income into the mix, some traders may prefer trading more inside of their retirement plans rather than taking distributions or plan loans.
We understand well that many of our trader clients count on trading gains to pay their bills and support their families. Trading is their job and living. Switching to trading retirement plan funds is simply not feasible for them. Others just haven’t accumulated much retirement capital. Plus, it’s risky to put retirement plan assets at risk and those funds are meant to provide income in retirement and to be a safety net.
We think Roth conversions are better than ever because they will help save this Medicare tax on unearned income. Remember, if the conversion is a mistake with subsequent losses, you can always recharacterize the conversion after year-end. We also recommend making non-deductible IRA contributions each year.
Whether you trade taxable accounts individually, in a pass-through entity like a general partnership, LLC or S-Corp, or through estates and trust accounts, keep in mind the unearned income passes through to your individual return and it’s subject to this new Medicare tax if you exceed the income thresholds.
C-Corps are bad for trading activities, but maybe they can help
The 2013 tax rates on individuals are scheduled to move higher when the Bush-era tax cuts expire. At the same time, Congress is talking about reducing the corporate tax rates. In 2012, the top rates are both 35 percent, but in 2013, individual rates could approach 44 percent (39.6 percent plus phase outs and the 3.8-percent Medicare tax) and corporate rates could drop below 30 percent. Tax advisers then suggest using corporations to report income. But, don’t forget to factor in double-taxing including on the state level: The entity pays taxes on income, and the individual pays taxes on dividend payments from the entity.
Generally, trading in a C-corp is a bad idea. Trading losses are trapped in corporations and it’s better for individuals to use pass-through entities, utilizing the losses on their individual tax returns. Especially when they’re fully deductible as ordinary losses, like with Section 475 MTM on securities and Section 988 on forex. C-corps also can’t get lower Section 1256 60/40 tax rates on futures and other Section 1256 contracts.
Planning tip: One strategy is to house your earned income activities in a C-corp and grow accumulated earnings before double taxation on the individual level. Conduct your trading activities in pass-through entities and try to keep your AGI under the higher tax rate thresholds. Caution: The preferential qualifying dividends tax rate (15 percent) expires with the Bush-era tax cuts, and all dividends return to the ordinary income tax rate.
While tax planning is uncertain based on expiration of Bush-era tax cuts and promised tax reform, the ObamaCare Medicare tax changes are on the books and traders should adjust their tax planning accordingly. Even if a new Congress reverses some of ObamaCare, will they reverse these new Medicare taxes? Not if you look to 1994 as a precedent.
A version of this article appears in Active Trader’s November issue, on newsstands in October.
Is the tax extenders bill passable?
The tax extenders bill is struggling and the Senate voted 56-40 Thursday night to close debate on the bill. Some pundits argue this type of vote is a final “no.” But Sen. Harry Reid (D-Nev.) is trying to pass a revision of this bill by the July 4th recess.
Sen. Max Baucus (D-Mont.), chairman of the presiding Senate Committee on Finance, says, “The bottom line is, we're going to keep trying (on this bill).”
The latest round of voting included several important amendment modifications. (See the text of the last modified bill and a summary on the Senate Committee on Finance Web site.) The latest amendment took back some of the split between ordinary and carried interest — not good news for investment managers. The Senate removed the two-year phase-in period (with a 50/50 split), and the original 75/25 ordinary/carried-interest split in 2011 is back on the table after being lessened to 65/35 last week. (Perhaps this is to help lessen the harsh impact of a wider repeal of the S-Corp SE tax loophole.) The Senators listened to venture capitalists and shortened their holding period to five years (rather than seven) for the 50/50 ordinary/carried split.
The Senate also narrowed the S-corp SE tax repeal in its last modification; S-corps that have a material amount and number of non-owner professionals would be exempt from SE tax. I argue it’s unfair to charge an SE tax on the “return on human capital” element in S-corps, when owners have a material number of non-owner workers. This last modification says “only if 80 percent or more of the professional service income of the S-corporation is attributable to the services of three or fewer owners of the corporation.”
The good news is this bill is failing. Drama and brinksmanship continue in the Senate over trying to pass it. This fight seems to be the new battle line for the upcoming midterm elections, with campaigns well under way. Growing heat from the Tea Party over excessive spending and deficits is making it very difficult for Democrats to enact more Keynesian spending, including extending unemployment benefits and helping states, teachers, police and firefighters. Republicans also generally cry foul when Congress tries to raise taxes on job creators, especially during a jobless recovery and potential double-dip recession.
After harried attempts to make changes, which some liken to putting lipstick on a pig, Chairman Baucus seems to be throwing in the towel. But Leader Reid won’t have it; he vows further revision and voting before the July recess. Will this bill be out after three strikes?
Senator Olympia Snowe (R-Me.) — an important moderate who is courted by Democrats for key votes — was particularly interested in reducing the S-corp SE tax impact on small-business job creators. The Senator voted for closure along with all other Republicans and a few key Democrats.
It may be more prudent going into the midterm elections for the Senate to follow the successful lead of the “doc fix” arranged on Thursday. That vote succeeded because Senators on a bi-partisan basis narrowed the length and amount of this spending allotment and found savings and revenues, besides tax increases, to pay for this targeted bill. Maybe we have a new winning formula here.
Click here for more media coverage: WSJ, The Hill, Reuters, New York Times, and Courthouse News.
The Hill article on Saturday, June 19 explains the politics of this bill. The author doesn't agree with Leader Reid who blames Republicans again for failure to pass the bill, and not caring about the unemployed.
Key Democrats like Nelson (D-Neb.) and Lieberman (I-Conn.) also voted no both times on this bill, insisting it be fully paid for without adding to the deficit. They may like some Republicans' suggestions (Thune amendment elements) to use available stimulus funds rather than new deficit spending, but they don’t want to go as far as the Republicans in entirely dropping tax increases from the bill too.
Perhaps round three of this bill will include stimulus funds, reduce spending and still keep in the tax increases. That may win back the “say-no-to-deficit-spending” Democrats, but is it enough to also win over the "gettable" Republicans Snowe and Collins? Both groups are needed to gain 60 votes for passage.
Many economists, the Chairman of the Federal Reserve and the Secretary of Treasury are advocating more Keynesian spending and not withdrawing stimulus too early. What's anyone’s logic for not using available stimulus funds now, and in this bill? Perhaps some elements of this bill don't qualify for stimulus spending. Last year, Republicans and blue-dog Democrats were upset that TARP and other stimulus bills were not being used as intended. If those stimulus funds are adequate for pared-down stimulus needs in this bill, why also raise taxes now on small-business job creators? Stimulus only makes sense if it spurs growth and tax increases generally hurt growth.
June 16, 2010
Tax extenders bill fails in Senate
Good news for traders — the Senate failed to gain enough votes to pass the “tax extenders” bill (H.R. 4123) in conference with the House, as some moderate Democrats joined all Republicans in voting against it today. The Senate fell short of the 60 votes needed for passage. See these stories in the WSJ, The Hill, CNBC and WebCPA for the latest.
But don’t get your hopes up just yet. I predict the Senate and House conference will pare down spending in this bill and raise more tax revenue in other ways, perhaps on oil companies (the latest villains). And, unfortunately, I don’t expect many Senators to hear the plight of hedge-fund managers when it comes to the repeal of carried-interest tax breaks. The Senate already threw investment managers a last-minute bone when it watered down the final split between ordinary vs. carried interest income (from 75/25 to 65/35), and reduced this split even more on venture capitalists holding underlying investments for seven years or more (55/45).
Pleas from small business owners and professionals using S-corps to reduce self-employment (SE) taxes probably won’t curry favor either, as Congress views this break as a “loophole” – in fact, it uses that label in the bill’s title.
Accounting groups have opposed this change; click here to see their efforts. I think the accountants raise good points, but they're facing a serious effort by Democrats, with the support of the labor movement, to swing the pendulum of taxation back from being labor-intensive to applying more to capital. Progressive taxation concepts, which are fundamental to our tax code, are supposed to mean that the wealthy pay higher tax rates. The labor sector feels too many rich people are getting away with paying lower taxes by pinning lots of income on capital rather than labor. Think hedge fund carried interest too.
This same concept applies in the carried-interest repeal debate. Democrats argued that investment managers are really receiving incentive fees (subject to ordinary rates and SE taxes) disguised as “profit allocation” capital gains.
The AICPA and other accounting groups pointed out to Congress that S-corps made up of professionals such as investment managers have owner and non-owner workers and generally a low amount of non-human capital (equipment and deposits). Like other businesses, they should be allowed a return on the capital that's not deemed to be service fees subject to SE taxes. The accountants argued that those non-owner professionals pay SE taxes on their compensation, and the owner's mark-up profits on their workforce should constitute a return on human capital rather than service fee revenue attributable to their own labor efforts. They're happy to pay SE taxes on their service fees. The accountants ask for a compromise split similar to the one given for carried interest. They also point out that current law is fair on these points, with S-corp owners taking 30 percent of profits as SE income subject to SE taxes. Perhaps they will be heard and Congress will offer some type of split.
Back to the tax extender bill in general. Republicans are proposing their own version that eliminates most of the debated tax increases (see the Thune amendment in the WebCPA article), but moderate Democrats aren’t expected to join forces with them. A Democratic-controlled Congress feels it must extend certain tax breaks, extend unemployment benefits and apply the Medicare doctor fix. This bill is very important to them. Politics is calling for a haircut on spending in the bill, so they may reduce some spending and find more taxes to increase too.
Financial regulation reform and tax change bills affecting traders, investment managers and professionals are picking up steam with lots of debate and changes in Congress this week. We'll be covering these issues in our weekly conference call tomorrow, June 17 at 4:15 - 5:30 pm ET. For more information, click here.
I added this comment earlier today on the media articles above. (This is an edited version.) Please add your comments as well to help sway Senators.
· Skip this job-killing bill entirely. Even if spending is reduced, the bill still contains nasty tax increases placed on job creators such as small business professionals operating in S-corp structures. That nasty Medicare tax will heap 3 percent more taxes on those small businesses now and 4 percent in 2013 with the health care tax increase. This bill also takes revenge on hedge-fund managers, venture capitalists and real-estate managers with a repeal of carried-interest tax breaks. These managers have skin (capital) in the game and many are being sued for losses in their funds during the recession (coughing up their own capital to cover it). Capital deserves capital gains. All these types of funds are under distress now with lower returns, losses and problems due to Meltdown 2.0 contagion in Europe and a potential double-dip recession in Europe and the U.S. Now is not the time to take tax retribution/redistribution. Why redistribute taxes from job creators (professionals and investment managers) to people who won't pick themselves off the dole-out unemployment lines already. Extending unemployment insurance forever is not fair to taxpayers who work hard every day to pay taxes and keep smaller and smaller net amounts.
One reason Congress will redo this bill is to beef up their attack (in the form of tax increases) on oil companies to pay for more of this runaway spending. They will block drilling in the Gulf too and get more people fired, bringing another great U.S. and global industry to its knees. Good luck collecting taxes with declining growth. This bill will be known as a "kiss campaign contributions goodbye" bill, as professionals, small businesses and investment managers will no longer support the enactors. Any tax bill will face a rocky road before the midterms and voters will carve these mistakes in stone in their minds. You don't have to be a tea party supporter to kick the incumbents out. Just kill this bill entirely!
June 8, 2010
Senate Democrats offer substitute amendment
Carried interest tax percentages are lowered in new amendment; S-corp provision remains unchanged.
In an effort to secure a 60-vote passage during final proceedings, the Senate filed an amendment today to water down the carried-interest repeal changes already passed by the House. Follow the process here
and read the Summary of this amendment.
The final phased-in 75/25 split for ordinary income vs. capital gains carried interest is changed to 65/35. Venture capitalists cried bloody murder and won further relief with an even lower 55/45 final split on assets held for seven or more years.
May 28, 2010
The "tax extenders" bill passed the House
Update later today: Per PWC, "The House today voted 215 to 204 to pass a modified version of H.R. 4213, the "American Jobs and Closing Tax Loopholes Act," featuring tax extenders and revenue offsets.
Senate action on the legislation will be delayed until the week of June 7, following a Memorial Day recess. Senate Majority Leader Harry Reid (D-NV) stated today the Senate is likely to make some changes to the House-approved legislation and consider a number of amendments. If the Senate approves any amendments, the House would need to consider the legislation again."
Bill summary text on these specific points per RIA:
Individual Tax Revenue Offsets:
... Generally for tax years ending on or after Jan. 1, 2011, the bill would prevent investment fund managers from paying taxes at capital gains rates on all investment management services income received as carried interest in an investment fund. To the extent that carried interest reflects a return on invested capital, the bill would continue to tax carried interest at capital gain tax rates. However, to the extent that carried interest does not reflect a return on invested capital, the bill would require investment fund managers to treat 75% of the remaining carried interest (50% for tax years beginning before Jan. 1, 2013) as ordinary income. ( Code Sec. 83172(j) , Code Sec. 710172(j) , Code Sec. 856 , Code Sec. 1402 , Code Sec. 6662 , Code Sec. 6662A , Code Sec. 6664 , and Code Sec. 7704 )
... For tax years beginning after Dec. 31, 2010, the bill would prevent individuals engaged in professional service businesses from avoiding employment taxes by routing their earnings through a limited liability corporation or a limited partnership. The crackdown would apply where (1) an S corporation is engaged in a professional service business that is principally based on the reputation and skill of 3 or fewer individuals or (2) an S corporation is a partner in a partnership engaged in a professional service business if substantially all of the activities of the S corporation are performed in connection with the partnership. The bill also would clarify that individuals engaged in professional service businesses are unable to avoid employment taxes by routing their earnings through a limited liability corporation or a limited partnership. ( Code Sec. 1402(m) )
Before the vote:
The "tax extenders" bill being debated in the House and Senate (H.R. 4123) containing the proposed tax increases for repeal of carried interest and the S-corp SE tax breaks is facing difficulty in passage.
I'm glad to see Blue Dog Democrats joining Republicans to push back against extending unemployment benefits again, because that part of the bill isn't paid for with the above tax increases. Congressional leaders may break it into two separate bills so they can ensure passage of the paid-for bill, and continue to debate the unpaid for one. If that’s the case, it still indicates these tax repeals may pass.
There are also heated objections from the venture capital and real estate industries, who don’t want to be lumped with hedge fund managers. They argue their case is different on carried interest because they're more long-term players in less lucrative industries than hedge funds, and this tax will hurt their vital industries. Congressional leaders are considering subjecting only 60 percent of their carried interest income to the ordinary rate, while leaving it at 75 percent for hedge fund managers.
Perhaps Blue Dog Democrats have an eye out to austerity measures being passed around Europe to tackle run away social and entitlement benefits, and they're considering the upcoming midterm elections and the political danger of more deficit spending on entitlements.
There are good articles on these debates in the WSJ and The Hill today.