Time to Hire Employees or Collectivize?

published June, 2010

Here’s a new one that’s not quite law yet, and to be honest, I wish it would just go away.

HR 4213 has passed both the House and the Senate and now a committee is trying to resolve the differences between the House and Senate versions before it goes before the President.

In amongst some good things, in Section 413, they’re taking away the exclusion for distributions from SE tax in “Professional Service Businesses” if the principal asset of the firm relies on 3 or fewer employees’ reputation and/or skill. Professional Service Business is defined for this purpose as “any trade or business if substantially all of the activities of such trade or business involve providing services in the fields of health, law, lobbying, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, investment advice or management, or brokerage services.” All this would start 1/1/11.

This basically says that for many S Corporations, the tax advantage of splitting your income into payroll and distribution will go away, unless you have 4 or more key employees. So you might as well be a sole proprietor and save the $800 going to the Franchise Tax Board. Plus you’re going to help fund the Social Security and Medicare shortfall of funds (recently exacerbated by the HIRE Act’s ‘forgiveness’ of the employer side of Social Security tax for hiring previously un- or under-employed people). Welcome to the ‘extra’ 15% tax bracket.

I believe I’ve been quoted as saying the pendulum has swung too far towards shareholders and that it would swing back. I’ve also been quoted as saying the S Corporation offer tax advantages—and now they’re trying to take these away from smaller firms. The rich get richer?

If you’re not in a defined “Professional Service Business” or if you have more than 3 key employees, this doesn’t affect you.

Makes me want to “associate in” three other people and add in some employees.

We’ll be discussing this in my various professional groups—I’ll let you know what I come up with!