The Edwards loophole

townhall.com ^ | 3/01/04 | Robert Novak

[GailA]

btt

[GailA]

My daddy worked in a steel mill as a boilermaker..does that mean I qualfiy to be President??????????

[moneyrunner]

To understand Novak’s point, look at your own pay stub. Deductions from your gross pay include federal & state taxes as well as Medicare tax on every dollar you earn. Forget about social security taxes because they stop after about $80,000.

So, if you collect $10,000,000 in ordinary income you pay federal, state AND Medicare taxes on the entire amount. However, if you pass the income through a Subchapter S corporation and pay yourself $100,000 in ordinary income and $9,900,000 in dividends you avoid paying Medicare taxes on the dividends because dividends are not subject to Medicare taxes.

The issue here is: is that legal? It sure isn’t ethical.

[ClintonBeGone]

Faircloth, a self-made and largely inarticulate businessman

You're right, he was a pretty entertaining old chap, but Novak's right - he came off as dumb as a box of rocks.

[GraceCoolidge]

I thought the point of the article was to attack Edwards' hypocrisy, though you are right that it could be clearer. But when you say "[i]t is not a loophole, it is not illegal," I don't follow what you are saying. Do you think that to call something a "loophole" implies that it is illegal? I have the opposite reaction: a loophole is legal by definition. I don't think you can argue that this isn't a loophole, and certainly it is legal. I think the article is clear on both those points. I believe the issue is candidates who complain ceaselessly about "the rich" who "don't pay their fair share," etc., etc. all the while making darn sure that they use every, admittedly legal, means to shelter their own income. To me, the point is that if someone (say, a Republican) is going to be attacked for using a legal method to minimize their taxes, then a Democratic candidate is subject to the same scrutiny, particularly if the Democrat is complaining that we don't pay enough taxes.

[Shane]

I believe that you are missing MY point. Novak is on a false trail. Dividends are not a deductible corporate expense. Consequently they constitute taxable income to the stockholder, at a higher rate than they would pay for the Medicare tax. Yes, they avoid the Medicare tax but in the end pay more in income taxes. And yes, it is legal. Ethical - no more or less than all other tax avoidance approaches.

[moneyrunner]

I’m afraid that it’s you who do not understand the tax treatment of Subchapter S corporations. They are known as “pass through entities” and the good Senator is running a payroll tax scam.

The Sub S Corporation issues a K-1 to Edwards, classifying the smaller amount ($600,000) as salary, and the larger amount ($5,000,000) as Trade and Business Income. The salary shows up on his W-2 and the Trade and Business Income shows up on his Schedule E. A neat dodge of the Medicare tax. In Edwards’ tax bracket, both salary and Schedule E income are taxed at the same rate.

Novak has only one thing wrong; Sub S corporations do not pay dividends. The distributions are classified as I explained above.

Less exalted people have gotten prosecuted for this particular tax dodge.

[moneyrunner]

See my reply #27. What Edwards is doing is neither legal nor ethical let alone hypocritical.

[Shane]

Look I'm going to try this one last time. I completely understand the tax treatment of Sub Chapter S corporations and I believe that I indicated that they " pass through" to stockholders. I'm not sure what your point is in detailing the tax forms (K-1 & W-2) that the various incomes are reported on. They still pass through to the stockholder to be taxed as ordinary income. You in fact prove my point when you confirm that " both salary and Sch. E income are taxed at the same rate." What I am trying to convey is, yes, he avoids the lower rate Medicare tax (2.754%) but pays a much higher marginal income tax rate on his income. I find it to be an uncomfortable position in defending Edwards, but disagree with you that it is a tax scam.

[moneyrunner]

"What I am trying to convey is, yes, he avoids the lower rate Medicare tax (2.754%) but pays a much higher marginal income tax rate on his income."

What is it about my previous statement that you don't understand? Let me repeat, his marginal tax rate on both ordinary income and Schedule E income are identical. If they were not, why in the world do you think he is doing this? The pure pleasure of paying more tax?

[GraceCoolidge]

Let me repeat, his marginal tax rate on both ordinary income and Schedule E income are identical. If they were not, why in the world do you think he is doing this?

I don't know about the tax treatment... it has been too long since I studied tax law. I can, however, suggest another reason "why in the world" Edwards would set up his practice as a corporation. It's a liability issue; for example, if he is sued for malpractice, then it can (I think) protect some of his personal assets. There is, of course, something called "piercing the corporate veil" to get at personal assets, but it can be an uphill battle as I understand it. Oftentimes a corporation is set up for liability issues as much as tax ones.

[moneyrunner]

Yes, one of the reasons for setting up a corporation, even a Sub. S corporation is to limit one’s liability. However, I don’t believe for a moment that a hot-shot personal injury lawyer has the kind of liability issues that a manufacturer would have. Lawyers don’t get sued that much, especially successful trial lawyers who have a reputation for winning their cases.

Then there is the matter of the income streams from the corporation: classifying roughly 10% of the income to salary (subject to Medicare tax) and 90% to Trade & Business Income (not subject to the Medicare tax) is prima fascia evidence of a tax scam because there is such a huge disparity. For each $1 million dollars reclassified this way, Edwards saved $29,000.

By the way, I checked my facts with a CPA before posting on this issue. It’s not some amateur spouting off.

[onyx]

My daddy worked in a steel mill as a boilermaker..does that mean I qualfiy to be President??????????

Gail, I'd vote for you, but never for Edwards. :)

[Notasoccermom]

It is known fact that he failed to pay property taxes on time for more than once. Isn't this keeping money from one of his two public school systems?

[Howlin]

I did NOT see this article!

[Mo1]

I had missed it also ... Edwards is such a HYPOCRITE!

[mabelkitty]

Health care corruption bump.

[Mo1]

How can he explain setting up a dummy corporation to avoid paying an estimated $290,000 in Medicare taxes in the two years before he ran for the Senate? It would be an embarrassing question for a self-described populist inveighing against privileges for the rich and powerful.

Wonder if he every got this straighten out??

[nopardons]

I doubt it and it's a good thing to tara him with,right out of the shoot. :-)

[VOA]

bump