Yesterday, the Senate failed to achieve the 60 votes necessary for Senate bill S. 2343, the “Stop the Student Loan Interest Rate Hike Act of 2012,” to advance. The bill would have paid for the lost revenue caused by keeping the interest rate on subsidized Stafford loans steady at 3.4% for another year by closing a long-standing S corporation “loophole” (their words, not mine).
The loophole in reference is the ability of S corporation shareholder/employees under current law to forego compensation in favor of distributions to reduce their payroll tax obligation. The Senate bill would have taken a hybrid approach to closing the loophole by subjecting the income allocated to shareholders of “professional service” S corporations — law, lobbying, accounting etc… — to self-employment tax only if:
1. the shareholder provides substantial services to the S corporation;
2. 75% or more of the gross income of the business is attributable to 3 or fewer shareholders; and
3. the shareholder has AGI > $250,000 if MFJ and $200,000 if single.
With the Senate bill dead — and with no other bill currently in the pipeline to close the loophole — S corporation shareholder-employees can continue to play the compensation/distribution game, but be warned…the IRS is watching.