The 2012 year witnessed a host of activity and changes with respect to the federal tax laws, including the U.S. Supreme Court’s decision upholding the Patient Protection and Affordable Care Act1 and the re-election of President Obama. The combination of these events ensured the introduction of two new Medicare surtaxes in 2013, namely the 3.8% net investment income tax (“NII”) under Internal Revenue (“IRC”) § 1411 and the 0.9% additional Medicare tax (“AMCT”) under IRC §§ 3101(b) and 1402. Both of the new surtaxes went into effect on January 1, 2013 and serve to increase taxes on the earned and investment income of higher-income taxpayers.
Perhaps unexpectedly, the introduction of the AMCT and NII surtaxes favors the use of S corporations2
over other types of pass-through entities in certain cases. The use of an S corporation, unlike a limited liability company3 (“LLC”) or partnership, can prevent the imposition of self-employment taxes (provided that “reasonable compensation” is paid to shareholder-employees) and the imposition of the AMCT surtax on S corporation allocations. These benefits are largely unavailable to the owners of partnerships and LLCs. Consequently, 2013 and beyond may see a renewed proliferation of S corporations in the context of service oriented businesses.
This article briefly explains the operation of the new AMCT and NII surtaxes and then considers the choice of entity ramifications of the new taxes for 2013 and beyond.