Former presidential candidate John Edwards saved $600,000 with his S Corporation. Edwards made $26.9 million as a trial lawyer in 1995, and he minimized paying Medicare and Social Security taxes by operating his legal practice as an S corporation. Edwards paid himself a salary of $360,000 each year for four years and had the S corporation pay him the rest in dividends.
Salary is subject to Medicare and Social Security taxation, but dividends escape these FICA taxes. So, Edwards saved 2.9% of $25,460,000 or $738,000 in Medicare taxation and just under $600,000 in total taxes.
John Tuzynsky, chief of employment tax operations for the IRS Small/Business/Self-Employed division says the division’s chief priority in auditing returns is non-filers. That makes sense; you don’t collect a lot of self-employment tax from people who don’t report their income.
He also said the IRS is going after what we call the “John Edwards shelter.”
While Mr. Edwards came under fire for this, his position probably isn’t abusive under current practice. The only cases on this issue deal with professionals who take little or no salary from their S corporation to avoid both the 12.4% FICA tax and the 2.9% Medicare tax.
The IRS, however, is paying more attention to this issue: The compensation of corporate officers is also receiving increased scrutiny. Tuzynski said that his office was ramping up audits of S corporations to ensure that officers were being paid appropriate salaries. For example, Tuzynski said, it would be unreasonable for a doctor involved with an S corporation who reports hundreds of thousands of dollars in distributions to report a minimum wage-level salary.
Next week, we will delve a little deeper into employment taxes. But the case of John Edwards is an interesting start because of his status as such a large public figure. The IRS will be critical of his returns and even though Edwards saved around $600,000 in taxes, the IRS did not challenge his return. Tax strategies like Edwards’ should always be run by a tax attorney or accountant first because each case is unique and there is no guarantee that your case will bring about the same result.