Friday, August 29, 2014

Gingrich and Medicare Tax - Pig Maybe - Hog Not - Geithner Definitely Not

Originally Published on on January 23rd,2012
At Joseph B. Cohan and Associates, the top 20th century public accounting firm in Worcester Mass, we had many expressions.  Quite a few of them would not pass the contributor guidlines.  One that does is “Pigs get fed.  Hogs get slaughtered.”  Another way of expressing the same principle was “Don’t be a khazar”.  (After a few year at JBC, even a Holy Cross graduate would pick up a goodly number of Yiddish expressions.)  Herb Cohan would always provide a translation.  At any rate, the idea was to be aggressive, but not too aggressive.  Newt Gingrich’s 2010 return has been released.  There is commentary to the effect that Mr. Gingrich might be paying less medicare tax than is proper.  Since among the commenters is my esteemed editor Janet Novack, we must take this issue very serously, which I do.  I have a few other comments on Mr. Gingrich’s return to attend to first.
The Most Impressive Thing About Newt’s Return – To Me Anyway
This might cause you to make an inference about my marital status, which might be correct but there is something on Newt’s return that is very impressive.  He has total income of $3,162,424, which is not shabby, but by no means overwhelming.  Jennifer Aniston makes a lot more than that.  What is impressive, given the  not shabby 3 mil plus income is the alimony deduction. Less than $20,000. Who is his divorce attorney ? That is someone who should not be wanting for business in the future.
Capital Gains Rate – Who Cares ?
None of Newt’s income is taxed at the special rate for capital gains because he has net capital losses of $32,541.  He  used $3,000 of that against 2010 ordinary income. That does not necessarily mean he is not a good investor.  Investors sometimes “harvest” losses and let the winners run.  So his net worth may have gone up due to unrealized gains.  That is WarrenBuffet’s unkept secret.  There is another hint, though, that he might not be such a greater investor.  His charitable contributions of $81,133 are all cash. If you have appreciated securities it is better to give those, up to a point.
The Medicare Issue
Newt took a salary of $252,500 from Gingrich Holdings Inc..  Mrs. Gingrich took a salary of $191,827 from Gingrich Productions, Inc.  Gingrich Holdings, Inc. is  clearly an S Corporation.  The shareholders of an S Corporation are taxed on its income regardless of whether the income is distributed and losses will flow through to the shareholders.  The roughly $2,450,000 that flowed through to the return would be net of the $252,500 in salary.  Assuming Newt owns 100% of GHI the company made about 2.7 million before his salary.  Any salary paid is subject to social security tax on the first $106,800 and medicare tax on the entire salary with no limit.  If he had taken another million in salary it would have cost him $29,000.  This salary thing is something the the IRS is a little schizophrenic about.  When they are dealing with a C corporation that is subject to corporate tax, they get mad if your salary is too high.  When they are looking at an S corporation, they get mad if your salary is too low since you are avoiding at least medicare tax.  Janet Novack quoted tax attorney Robert Mckenzie:
There are a multitude of cases where the IRS has successfully challenged the improper tax strategy of this candidate and his accountants. Service businesses are only allowed to distribute a fair return on investment from an S corp. as profits exempt from Medicare taxes. The remainder of profits must be paid as salary subject to a 2.9% Medicare tax levy.
There are two problems I have with the analysis.  The first is that we cannot tell from the 1040 how much of the S corporation’s profits were distributed.  If they were retained the IRS has nothing to recharacterize. It might, however, be reasonable to infer that much of the profit had to be distributed since it is such a large percentage of Newt’s income.  The second problem is the “multitude of cases”.  The IRS mentions three on its website:
Joly vs. Commissioner 211 F.3d 1269 (6th Cir., 2000)
Veterinary Surgical Consultants, P.C. vs. Commissioner 117 T.C. 141 (2001)
Joseph M. Grey Public Accountant, P.C. vs. Commissioner 119 T.C. 121 (2002)
In those three cases, no salaries at all were paid.  We are talking hogs here. There is one case where a $24,000 salary was held to be too low, but I have not found a case where someone who took a salary over the social security maximum has had S corporation distributions recharacterized.  That does not mean that it has not happened in audits, but there are no guidelines there.  It is true that the salary of $252,500 is low relative to the profits, but it is still substantial.  If he were my client, I probably would have told Newt to consider taking a larger salary, but it is really a judgment call, not a Geithner situation:

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