Pork-barrel tax bill takes aim at professional S corporations

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NASCAR is more important to Congress than your small professional practice. 

That's the inescapable conclusion arising from the "extenders" bill (HR 4213) that passed the House of Representatives last week.  The bill will subject K-1 earnings of professional S corporations to self-employment tax for the first time.  Worse, it will do so in a way that will be a compliance and planning nightmare.

The self-employment tax -- the self-employed taxpayer's version of the Social Security and Medicare tax -- starts at 15.3 percent on earnings up to the FICA base (currently $106,800, less any W-2 earnings subject to FICA tax).  Any amounts over the FICA base are still subject to the 2.9 percent. Medicare portion of the tax.  While salaries paid out of an S corporation are subject to FICA taxation, S corporation earnings passing through on a K-1 have always been exempt from FICA and self-employment tax.

Here's where the underprivileged folks at NASCAR come in.  A special tax break for race car tracks is set to expire, along with dozens of other so-called "temporary" tax breaks that Congress routinely passes for only a year at a time to conceal their real multi-year cost.  To pay to extend these porky provisions (for example, the biodiesel subsidy) for one more year, the bill would permanently subject some - but not all - professional S corporations to self-employment tax on their K-1 earnings. 

It would apparently be too simple to just subject all professional S corporations to self-employment tax.  It would instead apply to two sets of S corporations:

• Those who are partners in professional partnerships, and
• Those professional S corporations where "the principal asset of such business is the reputation and skill of 3 or fewer employees."

This obviously discriminates against smaller professional shops in favor of their larger multi-owner competitors.  It also creates obvious compliance nightmares.  How is a multi-owner professional corporation supposed to determine whether it's "principal" asset is the "reputation and skill" of three or fewer people?  Can it buy its office building to make that the "principal asset?"  What factors are used in valuing "reputation and skill?"  The bill provides no answers, creating a compliance nightmare for taxpayers and an enforcement nightmare for the IRS.

H.R. 4213 isn't final yet, but the Senate may take it up as early as today.  Call Senator Grassley, Senator Harkin, and anybody else you know in Washington and let them know how you feel about this wretched provision.  Unless, of course, NASCAR really is more important than your professional practice.