Originally Published on forbes.com on February 29th, 2012
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Back in January I stood up for Newt Gingrich on the issue of him avoiding Medicare tax. I just noticed that I posted that on my birthday. Newt didn’t call to wish me happy birthday, but he has since done something to impress me.
One of my favorite books growing up was The Moon is a Harsh Mistress. I don’t know what else he is right about, but he is clearly right about the lunar colony. Anyway, to return the favor I’m going to stick up for him again and say that the Eighth Circuit decision in David E. Watson, P.C implicitly vindicates him on the Medicare issue. I have to acknowledge, though, that David2012, who had a spirited debate with me in the comments section, could argue that the decision condemns Newt. I’ll lay it out for you and you be the judge.
The Rap on Newt
When Newt released his 2010 tax return we learned that he had taken a salary of $252,500 from Gingrich Holdings, Inc. GHI was an S corporation which flowed $2,450,000 of income through to him. The thinking is that Newt should have taken a salary of around 2.7 million which would have cost him $29,000 or so in additional Medicare tax. Commentators mentioned that the IRS attacks S corp owners for not taking adequate salaries thereby shorting FICA and Medicare. My defense of Newt was that although the IRS has taken that position, it has been mostly with people who have taken no salary at all. A quarter mil, while less than 10% of the pre-salary profit is still more than twice the FICA base. I would have told him to take more, but I cannot prove that his advisers were being too aggressive.
The Watson case is the only one of this type I know of where there is some salary rather than none at all. David Watson was a partner in a CPA firm. In 1996, he formed David Watson PC and transferred his partnership interest to the corporation. I have known a few CPAs who have done this. It is the type of thing that only seems like a good idea. At least, anybody I know who did it came to regret it.
In 2002 and 2003 the corporation paid Mr. Watson salary of $24,000. The corporation distributed profits of $203,651 in 2002 and $175,470 in 2003. The IRS converted some of those distributions to salary. The Eighth Circuit approved. The interesting part is how much. It appears that David Watson PC is not a real business. The real business is taking place at the partnership level. If Mr. Watson had held the partnership interest directly all his compensation would have been subject to FICA/Medicare. So how much did the IRS say he should have as salary ? An IRS “engineer” came up with $91,044.
I am amazed that Mr. Watson decided to appeal but that is neither here nor there. They did not even bring him to the FICA max even though there was apparently no real independent business there. I think Newt is being more than generous to Medicare compared to what the IRS has let Mr. Watson get away with. Of course, the other side of the argument is that the IRS made Mr. Watson pay payroll tax on almost half his total compensation while Newt is at less than 10%. So it depends on whether you want to focus on the percentage or the absolute number. You can be the judge. I’m busy packing for the moon.
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