There’s a New Tax in Town…

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For years, the one crucial question I had to ask my business tax clients was, “Can you be considered to be a real estate professional?”  (If you don’t recall my discussions on this matter, you can refer to my blog posts here and here.)  Because without that certification, it’s possible that all expenses involved in rental real estate operations may not be deductible on one’s Schedule E (1040).

But, now, we have a new series of hoops for business owners to consider.  As a result of Obamacare (PPACA or the Affordable Care Act), there is now a 3.8% surcharge imposed upon wealthier taxpayers.  For married couples, whose taxable income* is $ 250K or higher (or single taxpayers earning with at least $200K of taxable* income), this will be a new tax imposed on dividends, capital gains, and other investment income.

And, many business owners have “S” type corporations- corporations which pass through their income to their stockholders, where the business profits are considered dividends (reported on K-1 forms) accrued to and taxed upon the stockholders themselves.  Many LLC (limited liability corporations) have also elected to be taxed as “S” entities.

Given these facts, if one is not actively involved in the operations of their company, then the 3.8% surtax is imposed- because the dividends are accruing from passive activities.  So, now the new question to be asked is, “Can you be considered to be actively involved in your S entity?:

Obviously, if you are the only person involved in the firm, then you must be actively involved.  (By the way, if you are the only person involved in this firm, then these transfers are not really dividends and will be subject to self-employment [Medicare and Social Security, for a total of 15.3% in] taxes.)

Most of our clients have at least one (typically two or more) employees involved in the operations of the firm.  And, even the owners are paid a salary from the firm (that salary is also subject to employment taxes)- at a reasonable and customary rate for such businesses.  But, there are typically other profits that accrue to the stockholders.  And, these dividends could be subject to the 3.8% surcharge.

Medicare Surcharge On Investments

But not if the individual(s) in question devote at least 500 hours to the operations of the entity. Of course, if the individual also has a full time job… then, there could be a problem.  After all, that full time job requires at least 2000 hours a year. That means at least 10 hours a week (on average) will have to be devoted to the S corporation, to negate the imposition of the PPACA based surcharge.  Oh, and those 500 hours have to be on a “regular, continuous, and substantial basis”.

Start keeping those records!

 

 

* Too many folks mistake “adjusted gross income” and “taxable” income to gross income.  Don’t forget that those who itemize (and these could be limited by one’s income, as well) reduce their taxable income.  Likewise, the personal exemptions reduce one’s income.  The tax rate is a function of one’s taxable income.
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