Some S Corporation Dividends May become Subject to SE Taxes

The American Jobs and Closing Tax Loopholes Act of 2010 is expected to be passed in the next week or so.  In this tax act, there is a provision that states all ordinary income earned by S corporation from professional services (such as accounting, consulting, medical and other related professions) will be subject to self-employment taxes.  Currently, an S corporation is required to pay appropriate salaries to owners that are active in the business, but any income earned above the salary is not subject to any self-employment tax.

Now, for those businesses that are affected, all ordinary income will either be subject to self employment tax or normal payroll taxes on salaries paid.  It may now make sense not to pay any salaries for these owners since the income would not be subject to any state or federal unemployment or worker’s compensation taxes.  This provision is effective for years beginning after 2010.

This provision will not apply to most farmers, however, in many situations, a farmer will set up a corporation that they will list as being in the consulting business.  You need to make sure to list the corporation as a farmer and therefore, the current tax situation on these earnings still should be in effect.

Also, this is probably the first step to making all ordinary income from S corporations subject to self employment taxes sometime in the future when Congress needs to raise more revenue.

Please note this Tax Act has not yet passed, however, it is expected to become law by the end of May.