Ever wonder why some executives seem content to earn only $1/year in salary? True, some request such modest compensation for symbolic reasons, but for others the reason may be to lower their taxes. As noted in a March, 2008 Portfolio.com article:
Taking no or little salary is often done for symbolic reasons: an executive trying to bolster employee morale at a company in need of an immediate turnaround. But there is a practical motive as well. Salary is taxed at rates as high as 35 percent, while capital gains from stock sales are taxed up to 15 percent. Cutting down the salary portion of an executive’s compensation could help reduce the overall tax bill.
Let’s also not forget the impact of Social Security obligations that amount to an additional 7.65% savings for both the employee AND the employer (15.3% total) on the first $106,800 (in 2011) of wages. That means an otherwise million-dollar earner who only takes $1 in salary (and the remaining $999,999 in profit-sharing) could save significant money, as much as $200,000 which represents the difference between the 35% top income tax rate and the 15% capital gains tax rate.
But, you may be asking, can this tax-saving approach be employed by a “mere mortal” earning far less? Apparently the answer is “No.” David Watson, a Des Moines CPA and his partners tried to consider the bulk of their earnings from their so-called Sub-S Corporation as profit distributions, hence exempting the bulk of his earnings from Social Security and the significantly higher income tax rates (he claimed a $24,000/year salary and a $203,651 in 2002 and a $175,470 in 2003 profit distribution). The judge in his case with the IRS decided that Mr. Watson’s real earnings were $91,044 each of the two years and found Mr. Watson liable for the difference in taxes and any applicable interest and penalties.
Think about that for a minute – the government changed his salary, and is holding him liable for the unpaid taxes on the new income level. Mr. Watson plans to appeal, but the burden in s on him to convince the court of his innocence in the matter, as is common in tax cases…
In a case before the Tax Court, between the IRS and a taxpayer, the Court presumes that the IRS’s determination is correct. This presumption shifts the burden of proof to the taxpayer to prove that the determination is in error. But the taxpayer can shift the burden of proof by introducing credible evidence with respect to the issue Sec. 7491(a)(1).
In other words, despite his documentation for tax years 2002 and 2003 that is salary was $24,000 for each year, the judge decided to increase his income and hold Mr. Watson liable for the difference…
I wonder if this judge will turn his eye to the members of the $1 Executive Club, like Steve Jobs?
Portfolio.com: The $1 Executive Club
Wall Street Journal: IRS Targets Income Tax Tricks
Social Security Administration: Contribution and Benefit Base
Social Security Administration: Social Security & Medicare Tax Rates
About.com: Burden of Proof
Slashdot.org: IRS Nails CPA For Copying Steve Jobs, Google Execs
Future of capitalism: Steve Jobs Compensation
Note: The above image is from scoopertino.com