IRS Nails CPA For Copying Steve Jobs, Google Execs 509
theodp writes "It seems $1 salaries are only for super-wealthy tech execs. The WSJ reports that CPA David Watson incurred the wrath of the IRS by only paying himself $24,000 a year and declaring the rest of his take profit. It's a common tax-cutting maneuver that most computer consultants working through an S Corporation have probably considered. Unlike profit distributions, all salary is subject to a 2.9% Medicare tax and the first $106,800 is subject to a 12.4% Social Security tax (FICA). By reducing his salary, Watson didn't save any income taxes on the $379k in profit distributions he received in 2002 and 2003, but he did save nearly $20,000 in payroll taxes for the two years, the IRS argued, pegging Watson's true pay at $91,044 for each year. Judge Robert W. Pratt agreed that Watson's salary was too low, ruling that the CPA owed the extra tax plus interest and penalties. So why, you ask, don't members of the much-ballyhooed $1 Executive club like Steve Jobs, Larry Ellison, Sergey Brin, Larry Page, and Eric Schmidt get in hot water for their low-ball salaries? After all, how inequitable would it be if billionaires working full-time didn't have to kick in more than 15 cents into the Medicare and Social Security kitty? Sorry kids, the rich are different, and the New Global Elite have much better tax advisors than you!"
Karma (Score:2, Interesting)
Re:The Joys of employeehood.... (Score:5, Interesting)
As I read it, he had an S-Corp, not an LLC, but paid himself a salary just as you suggest. The problem is that the IRS claims he paid himself too little (which he could have also done with an LLC). The reason he did this was to reduce his payroll tax contributions. This can also reduce your eventual social security benefits, but as a CPA he probably figured he could do better investing the money. As an independent consultant this is the same situation I am in. I take a fixed, modest salary and take any additional income as just profits from the corporation. In year where I book a lot of hours, my income from profit can be more than my salary... which it looks like according to this article could put me in the cross-hairs of the IRS. I guess its time to give myself a raise. :-/
Re:Wow! Delusional much? (Score:5, Interesting)
I must admire Bush's (or his Republican advisors) political skill in one way. Any politician can pass massive tax cuts to win popularity, that's obvious. But he went one step further. He passed the tax cuts with an expiary date set for the next term, knowing that there was a more than fifty-fifty chance that it would be a democrat who would be in office and thus have to either take the blame when taxes went up, or be forced to extend cuts that were obviously unsustainable.
Re:Not so Easy (Score:5, Interesting)
So rather than "free money under a different name", stock options as a form of executive compensation more closely resemble a one-sided bet... If he wins, he wins. If he loses, he doesn't really lose anything.
Exactly. Options mean that he can buy n shares for $m per share. If the current share price is greater than $m, then the options are worth $n*m. He doesn't pay tax on the shares unless he sells them. He can exchange them for other shares, including diversified funds that are very low risk. There are also other tricks possible, like taking out a loan (doesn't count as income) with some shares as collateral, not repaying the loan, and having the shares seized by the lender - effectively, he's sold the shares, but the whole thing is actually written off as a loss and so can be used to offset even more tax...
Welcome to an over complicated tax system. (Score:4, Interesting)
A simple consumption tax system would rid us of these problems, but Congress would lose their power to grant favors and impose penalties on entities of their choosing.
An income based tax system with this many different requirements and exceptions is designed to be abused. A consumption system is not because what good is their wealth if they don't spend it. If you want to soak the rich you simply implement a consumption tax and void all taxes paid up to a specified amount. As in, you determine the amount of spending required to keep people happy and whole and refund it, all beyond that goes into the coffers. This includes taxing services as consumption as well so that getting around the system becomes less likely.
Looks like he just pushed things a little farther (Score:5, Interesting)
There's a difference between owning/doing business as an S Corp like he does (and I do, as do a lot of independent professionals) and being the CEO of a conventional C Corp. As CEO of a C Corp, you're not the owner, you work for the company. Steve Jobs and other people who get $1 in compensation get paid primarily in stock grants. If the stock rises, they cash it in and get money out when they want to. If the company doesn't do well, worst case is they get nothing - for practical purposes most boards will re-price or reissue options so they get some pay out of it. Lower level execs are usually paid with a combination of more cash pay and fewer options, but current thinking seems to be that a CEO is most directly tied to stock value.
Also, in many cases with "rock star" CEOs like the ones in tech, they have som much stock from taking the company public in the first place that they don't need much cash compensation, and it doesn't look as cool if they take it.
In the S Corp world, I think most of us do it for the liability protection. At least at mine, I pay myself a pretty good salary. I take out occasional payments that I pay taxes on - it's usually easier to do it as a bonus in my payroll and have taxes dealt with, especially because I pay bonuses to my employees. The flip side is that owning an S Corp does let you expense things that ordinarily might not be deductible as a regular company employee, like cars and at least part of your housing (as a previous poster mentioned). I keep things very above board - pretty much the only things that the company expenses in my life are my car and its related costs, my cell phone, and any tech I buy that isn't specifically for the house. I could push more stuff on the company if I wanted to be really aggressive, but it's not worth the potential hassle to me.
The one place where I get hit in return as an S Corp owner is in health insurance - I don't get as much of a tax benefit for my own insurance as I do for that of my employees.
What this CPA did was pay himself a token paycheck and then push a lot more off as profits. Had he paid himself a higher base - say, $50-$60k he likely wouldn't have had a problem with it and still would have had a nice profit distribution.
Re:Why Jobs and Ellison don't get in trouble (Score:5, Interesting)
Yes, indeed. One company I worked for was facing hard times. I reviewed the earnings report and it noted that the CEO took a pay cut due to the hard times the company was facing, however if you read down further he got a bonus that was 3x greater than the cut in pay he took, meaning he actually made more that year than the one previous...
Re:The Joys of employeehood.... (Score:3, Interesting)
Four years later, the IRS came back and imputed a salary of $24k for me so that they could collect the Social Security contribution. They couldn't collect Income Tax because I had no income.
That is when I learned that as a S-Corp owner, you cannot forgo a salary, even if you have no money to pay it. Any actual cash on hand goes to pay the taxes first and then the company can owe you.
Seventeen years later, after selling my network and customer base in 1998, the shell of that ISP is still around and I pay myself $16k a year to manage it. Not the $50k some might think necessary, but $16k is a good salary for managing a company that currently has no revenues. My accountants haven't said anything about this being too low and the IRS hasn't bothered me in awhile. Hopefully, they look at other factors such as effort expended and corporate revenue received, and don't just have a number from a table.
Re:The Joys of employeehood.... (Score:5, Interesting)
That's what got this guy in trouble, he was taking profits three to four times higher than his salary every year.
Indeed. Had he learned from the big boys, what he should have done would have been to implement part of his job as an excel macro, then sold that part to an Irish subsidiary which would then charge his company license fees for the use of the macro. Then, to avoid even the Irish bitty corp tax, he should drain the Irish company of profits (again by using intellectual 'property') through another irish company with a Cayman HQ, funnelling the revenue stream through the Netherlands to use further tax loops there. The full double irish with dutch sandwich.
Then he could do what Google, Microsoft, Oracle, Pfizer, etc, do and cry to the IRS that he's not making any money at all so obviously his salary at $1 isn't unreasonable.
Of course, he'd probably get nailed anyway and sent to GITMO for taking on the airs of his betters; doesn't seem like he's got the net worth to be above the law.
Re:Welcome to an over complicated tax system. (Score:4, Interesting)
On the whole, however the taxes are fair. Individually they seem like a scam, but it works out pretty well.
The people who own 40% of the wealth in this country (the top 1% earners) pay roughly 40% of the taxes. That's with all their tricks and loopholes to get out of them, they still pay 40%. The people who own 3% of the wealth (the bottom 50% earners) pay about 3% of the taxes.
On the whole, it's fair. Individually it doesn't seem so, because a lot of those top 1% will be paying almost 50% of their income in taxes, while a huge portion of the bottom 50% pay 0% in taxes, but overall it works well.
Consumption based taxes would even things out individually, but would flip the scale on its head by class. Someone making $100 million a year isn't likely to spend more than $20-30 million, a frugal multi-millionaire may only spend $10 million. A 20% consumption tax would mean he is only paying 2% of his income in taxes.
Contrast that with someone living pay check to pay check, making $15,000 a year. They have to spend all of their money every year, so a 20% consumption tax would mean he pays 20% of his income.
You end up with the people who need every dime they can get their hands on to survive paying the highest percentage of their income in taxes. That can only be considered fair by the cruelest definitions of fair.