A federal court has ordered James Watts and eight corporations to begin paying employment taxes to the United States on a timely basis, the Justice Department announced today. According to the government complaint in the case, Watts, of Bettendorf, Iowa, is the president of Watts Trucking Service, Inc., an Iowa corporation, of which the other seven corporations are subsidiaries. The complaint alleges that the companies fail to pay over to the Internal Revenue Service (IRS) all of their employment and unemployment taxes, including the income and social security taxes withheld from their employees’ wages.

...The injunction also prohibits the defendants from closing a waste-handling business and reopening it under a new name without the written consent of the government.

According to the complaint, Watts has formed and controlled at least 23 different business entities over the past two decades, most of which have accrued delinquent tax liabilities. The complaint states that the defendant corporations, along with 15 inactive entities, owe the government over $30 million in federal employment and unemployment taxes.

The penalties for not remitting payroll taxes build up quickly, and "responsible persons" can be held personally liable for payroll taxes not paid by their businesses. As I understand the injunction, the judge is saying that it appears the defendant is likely already behind on his taxes, and he isn't to dig any deeper.

Links:

Order on moion for preliminary injunction
Amended IRS complaint
Answer to amended complaint

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We seem to have forgotten that the fundamental purpose of our tax system is to raise revenue to fund government. The current system is riddled with tax provisions that favor one activity over another or provide targeted tax benefits to a limited number of taxpayers. Whether permanent or temporary, these provisions create complexity, impose enormous compliance costs, breed perceptions of unfairness, create opportunities to manipulate rules to avoid tax, and lead to an inefficient use of our economic resources. The tax code has become less stable, increasingly unpredictable, and more and more difficult for taxpayers to understand.

While she is talking about the federal income tax, it all applies just as much here in Iowa. But it is hoping for way too much to expect wisdom under the domes.

Related: The Quick and Dirty Iowa Tax Reform.

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(hgstern on Feb 3, 2012 9:49 AM) "the fundamental purpose of our tax system is to raise revenue to fund government" Bwahahahaha!

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The bill, HF 2085, provides an exclusion on sales of stock to Employee Stock Ownership Plans if the corporation owns at least 30% of the company's stock after the transaction.

The key language of the bill:

(1) To the extent not already excluded, the net capital gain from the sale or exchange of employer securities of an Iowa corporation to a qualified Iowa employee stock ownership plan when, upon completion of the transaction, the qualified Iowa employee stock ownership plan owns at least thirty percent of all outstanding employer securities issued by the Iowa corporation.

(2) For purposes of this paragraph:

(a) "Employer securities" means the same as defined in 1 section 409(l) of the Internal Revenue Code.

(b) "Iowa corporation" means a corporation whose commercial 3 domicile, as defined in section 422.32, is in this state.

Even if you think extra state breaks for ESOPs are a great idea (they aren't), this bill is a mess. It meshes badly with Federal Code Section 1042, which provides an elective deferral for sales to ESOPs owning 30% of the corporation stock if the proceeds are re-invested in public securities. The gain is deferred until the public securities are sold.

The way this bill is written, it may make people selling stock to ESOPs choose between a federal deferral of taxable income and a permanent state exclusion. Remember, the Iowa break only applies on a sale of "employer securities." The securities purchased when proceeds are re-invested under Section 1042 are not "employer securities," so the Iowa break will not apply when they are eventually sold. If language excluding the deferred Section 1042 gain is added to the bill (Iowa gain is normally the same as federal), it would require taxpayers taking advantage of the federal break to remember to reduce the gain on the eventual sale of the rollover securities for their Iowa returns.

So why are state ESOP breaks not a good idea? The ESOP rules are incredibly complicated, and for many closely-held S corporations, almost hopelessly so. A state break adds an additional layer of complexity to an already byzantine part of the tax law. It also makes the Iowa tax law even more complicated. It will do about as much good for the Iowa economy as a bill signed yesterday "RELATING TO FINANCIAL ASSISTANCE FOR PURPOSES OF THE BATTLESHIP IOWA."

We shouldn't be adding more small-beer tax breaks to an Iowa tax law already full of them. Like the Battleship Iowa, the Iowa income tax is obsolete. It's time to start over with a simple system with low rates -- something like the Quick and Dirty Iowa Tax Reform plan. Unlike this break, it could actually more than a token difference for the Iowa economy.

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(Jake on Feb 2, 2012 12:01 PM) Joe, thanks for the stirring shot of the USS Iowa. Like the 1939 Code, they just don't make 'em that way any more.

(Joe Kristan on Feb 2, 2012 1:08 PM) Jake - glad you enjoyed. Thank Wikipedia Commons for the picture. I know, battleships and steam engines have had their day, but they will always be amazing and cool. I hope to be able to tour the Iowa someday.

In 2011, the total number of expatriates was 1,781, a 16% increase from 2010. Last year had the highest number of expatriates since at least 2004 (when I started keeping these records), and perhaps the most in any year in U.S. history.

According to the I.R.S., an estimated five to seven million U.S. citizens reside abroad. Many of these individuals have never lived in the U.S. and never expect to live in the U.S. However, these U.S. citizens must annually file U.S. tax returns.

For example, I spoke with a Canadian the other day who was born to two U.S. citizen parents in Canada. This individual therefore is a U.S. citizen. However, he has never lived in the U.S. and never expects to live in the U.S. Despite that he has never lived in the U.S., he will have to file U.S. tax returns for his entire working life.

The IRS hits people like these -- many of whom had no idea they were supposed to be filing -- with severe financial penalties. Meanwhile, it provides relatively cushy deals with actual criminals through its OVDI program, because you have to shoot the jaywalkers to really slap the wrists of the serious offenders. No wonder the jaywalkers don't want to play anymore.

Update: The TaxProf has more.

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We have reviewed your correspondence regarding the penalties that were charged to your account and based on your explanation that "the adult brain turns to jello those first few months raising a baby" we have decided to remove all penalty charges. A total of $2,533.00 in penalty charges have been removed.

If authentic, the most likely cause of the original penalty would seem to be failure to attach a check to a balance-due 1040, or sending one that bounced. The notice is for a 2010 filing, and it's too early for the IRS to be sending matching notices for income items for that year. The penalty could also arise from a math error, though that seems less likely. But if the notice is authentic, it's reassuring that there are humans on the IRS processing campuses -- because we know the IRS computers are nowhere near advanced enough to have humor.

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But if you make a lot of money and you want to continue to control and use it, you will eventually have to pay taxes. There is no special "de-tax" plan or double-secret pay-no-taxes-ever trust scheme that your preparer is just too lazy or ignorant to tell you about.

Good stuff every day at IowaBiz.com.

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Source: CBO, via the TaxProf. Click chart to enlarge.

What will it take for this money to come rolling in?

In particular, between 2012 and 2014, revenues in CBO’s baseline shoot up by more than 30%, mostly because of the recent or scheduled expirations of tax provisions, such as those that lower income tax rates and limit the reach of the AMT, and the imposition of new taxes, fees, and penalties that are scheduled to go into effect. Revenues continue to rise relative to GDP after 2014 largely because increases in taxpayers’ real (inflation-adjusted) income are projected to push more of them into higher tax brackets and because more taxpayers become subject to the AMT.

So, all that will have to happen:

- The Bush-era tax rates that have continued through the Obama presidency will have to be allowed to expire.

- Congress will have to stop passing the AMT patches it has been enacting for at least ten years, bringing 20 million or more tax returns into the Alternative Minimum tax and increasing taxes by sometimes over $8,000 per household.

- Congress will have to stop passing the annual "extenders" it has been passing since the 1980s.

That's only three far-fetched things that will never happen. Let's spend it!

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You might not win a grape ape, but you're sure to learn something.

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The Iowa Department of Revenue last week released a protest resolution involving one such confused taxpayer (my emphasis):

The Department reviewed your 2006, 2007, and 2008 individual income tax returns and denied the capital gains deduction. The issue in this protest is whether your capital gains from investments, i.e., stock sales, dividends, and distributions reported on forms 1099-B and 1099-DIV qualify for the Iowa capital gains deduction.

The Department’s review finds that the assessment was correct and your protest is hereby denied. Your position relies on the Department’s instructions for completing the tax return. We found that you are not the only one that made this mistake, so our instructions now clarify that these types of capital gains do not qualify for the deduction.

Here is how the 2010 IA 1040 listed the deduction (line 23):

Here it is on the new form:

The instructions now include a useful flow chart to help you figure out if you qualify for the exclusion. I would prefer "Deduction for gains on certain business and farm sales (see instructions)," but at least it's an improvement.

Far better would be a mandatory form for all returns claiming the deduction. The form would list the holding period of the asset and contain a checklist of items to determine whether you qualify. Iowa currently audits every return containing a capital gain deduction; it would save a lot of Iowa and taxpayer time and money if the information could be reported with the return as filed, rather than years later when Iowa sends its examination letter.

Related: Iowa Capital Gain Deduction: an illustration

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(Virginia on Feb 2, 2012 9:02 AM) Iowa does now have a checklist on their website that you are suppose to fill out and keep on file for when they question the capital gains deduction--why didn't they just go ahead and make it a form to file???

(Joe Kristan on Feb 2, 2012 10:22 AM) They say it would interfere with e-filing, adding to their expense. I can't imagine that it's more expensive to process a manual form than to have a correspondence exam, but I never did understand governmental budgeting.

Ms. Olson has done good work pointing out the absurdity complexity of the tax law and the foolish ways in which the rules are enacted. Her record is marred by her advocacy of increased preparer regulation, which the IRS is botching with gusto.

So far she has made two posts since the blog opened on January 11. That's one more than Clarissa Potter has managed since she started Academically Taxing, one of the early tax blogs, in 2004, but she's a long way short of the TaxProf's productivity.

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You can ponder the passing of the Year of the Rabbit at the blog world's finest roundup of tax posts.

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Every year or two Congress passes 70 or so "extenders" -- tax breaks provisions enacted with an expiration date, but which they have no intention of letting expire. By pretending the breaks are temporary, they avoid facing up to the true revenue cost.

Len Burman proposes a "three-strikes" rule for Extenders:

I propose a “three strikes and you’re out” rule. After a provision has been extended three times, it should either be made permanent (and its cost fully offset) or it should be erased from the books.

Two strikes is plenty. After the first extension, any further extensions should be scored as a permanent provision, as if it will be in effect forever. But that would require an honest Congress, which is hard to imagine.

Related: Happy 2012! Your taxes may have just gone up!

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Why is Iowa's business climate perennially awful? Because we have high rates and a complex tax system. The high rates and complexity finance a bunch of deductions and tax credits for favored constituencies. So what what will Iowa do about it?

More Tax Credits! The Des Moines Register reports:

Iowa business leaders, hoping to jump-start a proposed $100 million seed fund, are expected to ask lawmakers to sweeten the tax credits available to lure investors into backing startup companies.

What wouldn’t change: The existing $8 million annual cap on state tax credits available to attract seed-fund investment. It was set last year by lawmakers and is part of Iowa’s $120 million annual lid on all tax credits used to spark new jobs and investment.

What could change: Boosting the tax credit used to match investment — now at 20 percent — to possibly as high as 100 percent, the amount that South Carolina and Hawaii provide for early-stage investors.

Of the 31 tax credits listed on Iowa's tax credit summary, Form 148, 22 are some sort of economic development subsidy. Three of them are venture capital credits, directed already at start-ups. A study of Iowa's tax credits in the Culver administration failed to show that any of them did any good.

Iowa can't force feed growth through subsidies. Taking money from some businesses and their employees and giving it to those who know how to work the system doesn't grow Iowa. The Film tax credit debacle should have taught us that.

The best thing Iowa could do for start-ups -- and those who are already here and trying to keep the doors open -- is to give us a low-rate system that is easy to comply with. The Quick and Dirty Iowa Tax Reform would do more to help the state's business environment than any number of targeted tax breaks.

Related: I spent $450 million and all I got were these localized intangible benefits.

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Thursday, California accountant Lowell Baisden was sentenced to 37 months in federal prison for his involvement in the tax evasion scheme involving three North Platte doctors. As part of his plea agreement, several other federal counts were dropped. He will also receive three years of supervised release after his sentence is up.

A co-defendant in the case, Michael Koning, a former anesthesiologist in North Platte who has since moved to Montana, was sentenced to five years of probation with a $60,000 fine and was also ordered to pay $989,531 in restitution. Koning, who operated Anesthesia Consulting of Nebraska, also had several counts dropped as part of a plea agreement.

Mr. Baisden was Dr. Koning's brother-in-law, which is how a Bakersfield, California CPA ended up working with a group of medical practitioners in Western Nebraska. Things began to go badly when other local tax practitioners got wind of Mr. Baisden's planning methods, which involved setting up related corporations and, if his own Tax Court case is any indication, some creative accounting.

Mr. Baisden consented to withdrawal of counsel from his case on the grounds that he received bad advice from him. That may telegraph an appeal of his plea or sentence to the Eighth Circuit. It's an ironic argument, considering that reliance on his advice didn't save his clients from their problems.

Other coverage:

Accountant sentenced in North Platte tax dodge scheme
North Platte doctors sentenced for tax evasion (UPDATED)

Prior Tax Update coverage: Plea deal on the Platte

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Related: Don't waste your tax prep fee by cheaping out on postage

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(Steve Shores on Jan 30, 2012 1:39 PM) Joe, I am not sure if Russ's list is correct. I Googled "private delivery services" on the IRS website which lists DHL, FedEx and UPS - as Russ does. However, the IRS page has a link to the street addresses which can be used for delivery by a PDS. There are only five processing centers listed. Am I missing something? I think the IRS is consolidating its processing centers so there probably are only five acceptable addresses (as currently shown on the IRS website). Here is the link to the IRS processing centers list: http://www.irs.gov/file/article/0,,id=251098,00.html Steve

Sometimes you just have to concentrate on making honey.

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May that whistle mean your train has arrived!

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Click to enlarge

In so many words:

So taking half of the yearly income from every person making between one and ten million dollars would only decrease the nation's debt by 1%. Even taking every last penny from every individual making more than $10 million per year would only reduce the nation's deficit by 12 percent and the debt by 2 percent. There's simply not enough wealth in the community of the rich to erase this country's problems by waving some magic tax wand.

Even lowering the bar by taking 100% of the earnings of taxpayers over $1 million would only reduce the deficit by 35%, while of course bringing on an economic catastrophe that would make the Great Depression look like good times. By railing against "millionaires and billionaires" the President tries to distract us from the sad reality: failing to address the government's incontinent spending will eventually require a big tax increase on everybody. The rich guy isn't buying because he simply can't.

Other coverage of the President's tax proposals:

Shikha Dalmia, Obama's Daft Plan to Insource Jobs Back to America
Howard Gleckman, President Obama’s Tax Deform Agenda
TaxProf, President Obama Calls for 30% AMT on 'Millionaires and Billionaires'
Kay Bell, State of taxes in Obama's State of the Union address.
TaxGrrrl, Taxes and the State of the Union
Janet Novack, Obama Proposes Doubling Romney’s Taxes, With Minimum 30% Rate
Scott Hodge, Unanswered Issues on the "Buffett Rule"
Linda Beale, Obama's State of the Union vs Romney's Tax Returns

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(Roger on Jan 26, 2012 12:51 PM) It would be interesting to see the tax return of Buffet's secretary. According to public records in NE, she owns a rather nice home in Bellevue, NE and according to AZ public records she owns a winter home in AZ. According to Buffet, she pays at the 30% rate. Thus, she is making somewhere between $200,000 and $300,000 per year. That is, unless her tax advisors are incredibly stupid. Not the typical victim that she was portrayed as.

(Anonymous on Jan 27, 2012 8:43 AM) The dollar amounts are "in thousands." It stands for comparison that a working class citizen can work tirelessly for 30 years at a job earning $50k, and still not approach Romney's tax refund for a single year ($1.6 million in 2010). That's just his REFUND. What we have is runaway wealth, as much as the argument is made that it would solve all our problems to tax it -- the real issue is that a small number of people are running away with this country's power through investment and lobbying, controlling businesses and political system.. because money works for them and not against them. Out democratic society is not run by the people, it is run by the powerful people. And that's sad.

Was GE's conduct in this case any more morally upright or commendable than most of the persons who have been herded into OVDP 2009 and OVDI 2011 with far more draconian penalties? Yet, GE drew a relatively light 20% penalty.

Because you have to shoot the jaywalkers to wrist-tap the bad guys.

Related: Darth Shulman to foreign account holders: I am altering the deal. Pray I don't alter it any further.

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Prosecutors said during filming of “Underground” in 2009, Goldstein created false invoices and used them to support claims for tax credits.

Goldstein will face an estimated year-long extension of his 46-month federal sentence, according to the Iowa Attorney General’s Office. He pleaded guilty to all three counts as charged without a plea deal. As a result, Polk County District Judge Karen Romano agreed with recommendations from both parties and sentenced Goldstein to three suspended sentences, including two years of probation, and a $2,500 fine. Goldstein also was ordered to pay the cost of transport to Iowa and back to California.

OK, so maybe Mr. Goldstein's film, "Underground, " hasn't yet triggered a tourist boom, but we will always have the intangibles.

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Des Moines police reported Tuesday the use of red light cameras in Des Moines from July through December last year reduced accidents at five major intersections by an average of some 33 percent, compared to the same six-month period at the same locations over the previous four years.

The cameras at these intersections resulted in 4,473 $65 tickets, costing drivers $290,745 -- all to prevent 9 accidents -- and that assumes that the entire reduction in accidents is attributable to the revenue cameras. Considering that this winter so far has been mild and almost snow-free, while the prior three winters were anything but, that's a shaky assumption. It would be worthwhile to know what the city-wide accident statistics were for the same period. In real life, the cost per accident "prevented" may be much higher.

Police and city officials are defensive about this tax on normally harmless behavior, like not quite stopping before making a right turn at an empty intersection or not quite beating the yellow light before it turns red. That's why they feel the need to justify it, even with this batch of cherry-picked statistics.

A more complete disclosure would include the nature of the accidents "prevented." We know of one high-speed wreck the cameras didn't prevent. It would also be worthwhile to compare these intersections to a control group of other intersections where revenue cameras weren't installed, but other means, like extended yellows and all-red phases, were tried. But as these alternatives pick no pockets, the police and the city aren't interested.

UPDATES:

"Extensive, two-year study finds red-light cameras don’t decrease accidents" (via Instapundit)

"Traffic camera ban clears House subcommittee"

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(B Jamison on Jan 25, 2012 1:45 PM) Good timing on your article - The following is from a link @ Instapundit: "Red-light cameras have not reduced accidents at most Kansas City intersections they monitor, according to a police analysis. In fact, the analysis of more than 2,500 wrecks in the two years after the cameras appeared shows that injury wrecks, rear-end wrecks and overall wrecks all increased. Only right-angle crashes — the ones most likely due to red-light running — decreased."

(Joe Kristan on Jan 25, 2012 1:54 PM) B: Thanks! Link added.

Here in Iowa, identity theft apparently can have other uses. From an Iowa Department of Criminal Investigation press release:

Today, Friday, January 20, 2012, Zachary Edwards, age 29, from Des Moines, Iowa, was arrested and criminally charged with Identity Theft, an Aggravated Misdemeanor (Iowa Code 715A.8(2))...

According to the Criminal Complaint, on June 24, 2011, Edwards fraudulently used, or attempted to use, the identity of Iowa Secretary of State Matt Schultz and/or Secretary Schultz’s brother, Thomas Schultz, with the intent to obtain a benefit, in an alleged scheme to falsely implicate Secretary Schultz in perceived illegal or unethical behavior while in office.

Until Friday Mr. Edwards worked for a consulting firm linked to Iowa Senator Tom Harkin. The firm has this testimonial from the Senator on their web site:

The folks at LinkStrategies have been helping me win campaigns since 1996. Whether it is managing campaigns or handling research, their specialty is doing quality work while finding smart, creative solutions to problems. In a tough fight, there is no question that I want LinkStrategies in my corner.

This isn't the first time someone linked to Senator Harkin has had troubles with the law:

Ramona Cunningham and Senator Harkin at the dedication of the Harkin Learning Center at CIETC headquarters.

But Ms. Cunningham's scandal was more old school, fragrant of sex and money.

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- Mitt had a much better 2010 than 2009. His "protective" estimated tax based on 2009 tax was about $1.37 million. He had to pay in another $3.25 million with his extension. Much of that was cushion to cover 2011 estimated tax payments; he had a $1.6 million overpayment on the completed return, all of which went to 2011 estimates.

- 2010 was better because of $16.7 million in capital gains, offset by a $4.8 million capital loss carryover.

- That said, with $3.3 million in interest income and $4.9 million in dividend income, Mitt can hardly have a really bad year.

- The return was signed by somebody at PricewaterhouseCoopers on October 15, at the end of the extension period. Can you imagine the scene if Mitt had pointed out a mistake on the return on the extended due date? I can only imagine the logistical nightmare of making sure the return was signed and filed by the taxpayers on time.

- The return was, of course, prepared on what Robert D. Flach would call "flawed and expensive" tax return software. To do this return by hand, like Robert does his returns, would require a small army of flawed and expensive staff accountants with good penmanship. If nothing else, it shows that the current complexity of the tax law is possible only because of computers.

- Mitt has a $2 million passive loss carryforward, of which over $1 million is attibutable to 2010 losses.

- His return is fraught with potential expensive foot-faults. For example, he has a Form 8865 to report a foreign partnership and a Form 5471 for a controlled foreign corporation. Failure to file either one of these on time would have generated a $10,000 IRS penalty notice.

- The total tax on the 1040 is just over $3 million. If you counted the 35% tax paid by corporations on income generating the $3.3 million in qualified (15%-rate) dividends he reported, it would be about $1.79 million higher.

I'm sure the Obama, Gingrich and Santorum opposition research teams will be forthcoming with much more detailed analysis soon.

Link: Romney campaign page tax return links and campaign overview.

UPDATES:

TaxGrrrl, "Romney's Tax Returns are Remarkably... Unremarkable"
The TaxProf has a roundup.
Kay Bell, "Romney Release 2010 tax returns"
Philip Klein, "Romney needs no apology on tax returns"
Christopher Bergin, "Romney’s Returns: Wrong Point"
Anthony Nitti, "Reactons to the Romney Tax Returns"

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(Peter Reilly on Jan 24, 2012 10:32 AM) Did you notice Newt seems to have used a small local firm ? Their website is pretty sketchy. The signing preparer has 8 linked-in contacts. Low profile. Don't knock the Tax Pro about doing returns by hand and scorning software. Just stand in awe and wonder of him

(Jake on Jan 24, 2012 12:21 PM) Having prepared many returns for other folks, using fancy software, I prepare my own return by hand to this day. And, for nailbiting excitement, I do it in ink. Pencils are for the timid.

(Joe Kristan on Jan 24, 2012 12:34 PM) I am in awe of Robert - with my penmanship, a tax career without computers is unthinkable. I don't share his contempt for software, though -- it is "flawed," but everything is this side of Heaven. It does wonders for carryforward computations, error checking and productivity, and I'm sure that returns are far more accurate than they would be without it.

(Anon on Jan 24, 2012 3:47 PM) Well, we don't really know if his estimate was truly "protective", do we? To me, the possibility of an underpayment seems a little high. A fair amount of his income seems like it should be roughly SALY... Plenty of people don't file a 2210 and let the IRS sort it out.

(Joe Kristan on Jan 24, 2012 4:43 PM) Anon, good point, but I suspect Mitt wouldn't do that.

(Bill Killory on Jan 25, 2012 10:44 AM) Contrary to Mitt's assertion that he paid the minimum tax required he put his health insurance on schedule A instead of adjusting his gross income on page 1. He was also eligible for a SEP IRA deduction if he chose to add to his enormous IRA account. Notice the tax prep fee Newt paid last year. Not bad.

As Congress desperately searches for revenue to pay for a reduced corporate tax rate, it should consider limitations of interest deductions when there is excessive debt. Even if the Romney campaign convinces you that leveraged buyouts are totally benign, there is still no reason for the United States to maintain a tax system that favors them over venture capital.

His second sentence may well be true, but it doesn't mean the solution in his first sentence is the way there. Instead of punishing borrowers by limiting their deductions, you can instead reward equity financing by making dividends deductible.

I still think a dividends-paid deduction is a promising but under-discussed solution to the problem of high corporate rates and double taxation. Such a system would tax revenue at the corporate level when it is earned, but it wouldn't prefer debt over equity. The problem of deductible dividend payments to tax-exempt or foreign entities could be handled with a withheld excise tax on the payments to ensure the income is at least taxed once. It would eliminate the need for a preferential rate for dividends, perhaps quieting the smug and ignorant.

Related: Why not a dividends-paid deduction?

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There is one case where a $24,000 salary was held to be too low, but I have not found a case where someone who took a salary over the social security maximum has had S corporation distributions recharacterized. That does not mean that it has not happened in audits, but there are no guidelines there. It is true that the salary of $252,500 is low relative to the profits, but it is still substantial. If he were my client, I probably would have told Newt to consider taking a larger salary, but it is really a judgment call, not a Geithner situation.

Prior coverage: What do Newt and John Edwards have in common?

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Now that it seems that Newt Gingrich might somehow be the Republican nominee for president, his tax return has come under scrutiny. The biggest income item on the return is from an S corporation, Gingrich Holdings. His Schedule E shows top-line K-1 income of $2,478,539, offset by a $25,130 Section 179 deduction. Meanwhile, he took "only" $252,500 in salary from the corporation. His wife took another $191, 827 in W-2 wages from Gingrich Productions, Inc., which is apparently a C corporation.

That leads to this comment reported by Janet Novack:

"It appears that he is not paying his fair share of Medicare tax," Robert E. McKenzie, a partner in the Chicago law firm of Arnstein & Lehr LLP concluded, in an email to Forbes, after reviewing Gingrich’s 2010 tax return. McKenzie, a past chairman of the Employment Tax Committee of the American Bar Association Tax Section and a member of the IRS’ Advisory Council, added: "There are a multitude of cases where the IRS has successfully challenged the improper tax strategy of this candidate and his accountants. Service businesses are only allowed to distribute a fair return on investment from an S corp. as profits exempt from Medicare taxes. The remainder of profits must be paid as salary subject to a 2.9% Medicare tax levy."

A multitude?

While there are plenty of cases where taxpayers have been called to account for taking no salary or nominal salary out of their S corporations, avoiding FICA and Medicare tax, there is no "multitude" of published cases where employee-owners who took salary of at least the FICA base ($106,800 in 2010) have had to take additional salary. In fact, there are none.

The closest case I can see to the Gingrich fact pattern is Watson, a district court case right here in metro Des Moines -- and the facts aren't very close. Watson involves an accountant whose practice generated around $200,000 in income, but for which he took only $24,000 in annual salary. Even in that case, the judge only boosted his annual salary to about $91,000. An appeal of the case by the taxpayer is currently before the Eighth Circuit.

So what is the "fair share" of Medicare taxes? Warren Buffett famously takes only $100,000 salary from Berkshire Hathaway, when comparable executives draw salaries in the millions. Should he be forced to take additional salary just to pay a "fair share" of Medicare tax?

"Reasonable compensation" is a notoriously difficult area of the tax law. Traditionally the IRS has tried to go the other way, trying to reduce W-2 compensation -- reclassifying it as dividends to make the payments non-deductible to C corporations. The incentive to do so was reduced when the salary cap was removed from the 2.9% medicare tax, but I know of no case where the IRS has tried to force a C corporation to pay more compensation to collect more Medicare tax.

You can accurately say that the tax law doesn't support an employee-owner taking no salary, or a token salary, out of an S corporation. You cannot say that the FICA base is a safe harbor "minimum wage" for an S corporation shareholder, but the IRS has won no court decisions involving such taxpayers. There is a huge gray area between token salaries for S corporation employee-owners and Ken Lay-sized salaries that hasn't been litigated.

While I may like Gingrich and Edwards only a little more than a bitter ex-spouse might, the existing case law simply does not support a claim that they failed to pay their "fair share" of Medicare taxes.

The TaxProf has more.

Related: Court sets 'reasonable' comp for Iowa CPA S corporation shareholder

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(David2012 on Jan 23, 2012 12:53 PM) Warren Buffett doesn't own all of Berkshire Hathaway, and it is a C corporation. Berkshire Hathaway is a real business enterprise, with its own capital at risk and its own activities. It does not depend exclusively on the services of its sole shareholder. I don't think that situation is comparable to the former Speaker's. Gingrich Holdings IS the former Speaker. Its activities are his, and its income is his. Maybe there is some income at the margin that is not related to his personal services. Tom Daschle is reported to have been given $2 million by Alston & Bird in 2008 as a "consultant", and that sounds about right. $250,000 is laughable as "reasonable compensation" to the former Speaker.

(Joe Kristan on Jan 23, 2012 1:07 PM) David, it is laughable. I wouldn't give him a dime. The case law doesn't support broad assertions that he isn't paying his "fair share." You can argue all you want that it should be more, but there is no case where the IRS has prevailed when more than a token salary is involved.

(David2012 on Jan 23, 2012 1:26 PM) The case law stands for the proposition that compensation paid to shareholder/employees of S corporations must be reasonable, and comparable to that paid to employees of corporations in which those employees are not shareholders. That is all it stands for. It is a factual question. It is true that the cases decided to date have involved egregious fact patterns, with no or very minimal compensation. That is not what they are based on, however. They are based on the compensation being unreasonably low. To my mind, this is an equally egregious case, bordering on outright evasion, and if it were anybody else, it would be treated that way. The Speaker is the corporation. Its income is his income. Those are the facts, and this is after all a factual question. It is not like it is a real business, with real capital, and real other employees making real other money for its shareholders. Seriously, who is kidding whom here?

(Joe Kristan on Jan 23, 2012 1:35 PM) "To my mind" is your key observation. While you can argue that the reasoning of the S corporation cases support you, there are no cases that directly face the hard issue of whether and when a $250K salary can be inadequate for these purposes. Whether a $60K IRS agent -- or a judge -- would conclude a $250,000 salary is inadequate remains in doubt.

(David2012 on Jan 23, 2012 4:05 PM) Are you suggesting that the issue is not whether Gingrich's salary was arm's length -- that that is irrelevant? And that the real issue, the "hard" issue is what fixed number of dollars is never "inadequate for these purposes"? Because that is not true. The question is whether, in all the facts and circumstances of the case, the Gingrich salary was reasonably arm's length. I think it was Upton Sinclair who said that it is hard to get a man to understand something when his salary depends on him not understanding it. It was repugnant when Edwards did it, and it is here, too.

(Jake on Jan 24, 2012 12:25 PM) Joe gets it right. The allegations that Gingrich is abusing the S corporation form are inflammatory and do not ring true. It's hard to imagine the IRS would litigate the supposed insufficiency of a $250K salary to an S corporation owner.