Incorporating to Avoid Self-Employment Tax

Richard Winchester calls our attention to a method that some self-employed people are using to successfully and legally escape social security taxes:

Employment taxes account for an enormous share of federal tax receipts. And it is widely acknowledged that taxes on the self-employed are collected under a dysfunctional set of laws that is long overdue for repair. Yet, there is surprisingly little legal scholarship in the field. This article fills a portion of that gap. It examines some fundamental flaws that plague our nation’s employment tax laws, focusing on how President Bush’s dividend tax cut created an incentive for wealthy individuals to exploit those flaws at the government’s expense when they work for a corporation that they also own and control. Specifically, prior to the Bush tax cut the corporation would have (correctly) paid these employee-shareholders a salary for their labor. However, the corporation is now more likely to substitute a dividend for that compensation, preventing any employment tax from coming into play and shortchanging the social security trust fund at a time when its long term solvency is in jeopardy.

I wonder to what extent this sort of technique is practical for individual tax resisters.

The IRS hasn’t forgotten how to play mean. Excerpts from a Tax Court Memo:

A mentally disabled veteran… sought review of the IRS’s refusal to abate interest… for liabilities that were assessed during a period that he was intermittently hospitalized and homeless, and did not receive notices of deficiency. Acting pro se, the taxpayer had agreed to a stipulation of facts that would do little to prove his case, and that would prohibit him from presenting useful evidence. The taxpayer subsequently obtained pro bono counsel and moved to vacate the stipulations so that his interest abatement claim could be decided on its merits.

…The taxpayer was not represented by counsel when the stipulations were being drafted; the stipulations were prepared by the government’s counsel without negotiation or bargaining. Additionally, he had no legal training and suffered from a weakened mental and physical condition. The government’s argument that the taxpayer would not be prejudiced by the agreed-upon stipulations was rejected. Finally, the taxpayer did not understand the stipulation process; he believed that the government’s counsel was there to assist him, rather than to represent the IRS.

The Tax Foundation have released their estimate of “Tax Freedom Day” for :

Tax Freedom Day answers the basic question, “What price is the nation paying for government?” We divide the most authoritative figure for total tax collections by the most authoritative figure for the nation’s income. The answer this year is that taxes will amount to 32.7 percent of our income. We convert that percentage into days worked, and if we started on January 1, it would take . That’s when we could start keeping some of our earnings.

The funny thing about this is that if the Tax Foundation took its own advice and offset taxes paid by households with government spending on behalf of households to come up with a “net tax burden” instead of just looking at the tax side of the equation (see ’s Picket Line), then ’s “Tax Freedom Day” would have to be moved all the way back into !

This earlier Tax Foundation report on “net tax burden” continues to be misinterpreted by design in the media. Some characteristic distortions: