Avoid Fiscal Cliff Panic

As you can imagine, I have heard a lot of panic from clients since the election results came in last month.  Some panic is warranted, as most acknowledge that the 2% payroll tax reduction will not be extended, capital gains will likely be increased to 20% or 25% at most, and that tax rates will likely be increased for married couples with AGI over $250k.  However, when it comes to capital gains, panic can actually be very detrimental and cost you much more in taxes than you would think.

Naturally, you would assume accelerating a large capital gains to take advantage of the 15% rate would result in large tax savings, but unfortunately the alternative minimum tax erodes the tax savings if you are a high-income taxpayer.  In fact, most of the time it results in an overall tax rate between 20% and 25%.  Why this happens is very complex and even CPAs get frustrated in fully understanding the alternative minimum tax, but here is the best explanation I could find.  Basically, if a large amount of your income is long-term capital gain income and you are a high-income taxpayer, the AMT tax can kick in and erase the benefit of the 15% rate.  We witnessed this quite a bit back in 2010 when financial advisers worried about the expiration of the 15% rate and advised their clients to sell off their low basis stock.  It sounded like a great idea at the time, but when preparing the tax returns in 2011, many were surprised at how AMT tax erased much of the benefit.  Well, the same thing can happen for tax year 2012 if you give in to panic.

Before you make any big moves on capital gains before year-end, talk to your CPA and and have them run a projection to see what the true impact would be.  It may just be that there is no need to panic.

Reasonable Wage For S-Corporation Shareholders

For those of you with S-Corporations, now is the time of year to look at your wage for the year-to-date as well as start the planning for 2009.  A “reasonable wage” needs to be paid to more than 2% shareholders in S-Corporation, and there is still time to make changes without incurring payroll tax penalties.

This is a crucial issue as an S-Corporation return without wages to the shareholder is pretty much a red flag to the IRS – especially if you took distributions during the year.  The law requires a “reasonable” wage be paid, but what is “reasonable”?

I have been through several IRS audits where this was brought into questions and the IRS answer is to look to the online salary guides and they are always going to look to the high side of the scale.  If you are in a state unemployment audit, they will magically select a wage equal or greater than the unemployment tax limit (in OR – $30,200 for 2008).  I believe most S-Corporation shareholders should be somewhat aggressive and argue for the lower side of the salary guide scale, but it does still need to be a reasonable figure that you can make a case for.   Basically, it should be the wage you would have to pay to hire someone to do your job.  In some industries, this is fairly easy to calculate using salary guides; however, many industries are very unique and salary guide data is not going to be as readily available.

At this point in the year, you can pay yourself just about any amount needed provided you pay your payroll tax monthly.  However, if you wait until December or only want to pay payroll tax quarterly, then the maximum you can pay yourself without incurring payroll tax penalties is $16,339.00 (assuming you do not have any Federal or State withholdings and you are the only employee).  Why such a specific number?  Well, the IRS payroll tax rules state that when your payroll tax liability is less than $2,500 for the quarter that you do not have to deposit monthly and can pay the tax due with the report, and $16,339 in wages gives you $2,499.88 in liability.  That means you can pay yourself this payroll amount (or reclassify distributions) as late as 12/31/07 and you will not have to pay the payroll tax liability until 1/31/08.

If you have taken funds out of your S-Corporation during the year (distributions) and have not paid any wages, please pay yourself some wages before year-end and save yourself potential problems with the IRS or your state unemployment agency.

For more information, refer to IRS Publication 15 and contact your CPA or accountant.  For payroll processing, feel free to contact our firm, Adrienne Derryberry at Paychex, or Dan Burke or Jaymie Steck at ADP.