Former Vice President Joe Biden’s tax returns show he took advantage of a planning strategy that the Obama administration tried to shut down.
The planning technique involves the use of an S corporation to allow only a small portion of an individual's earnings to be subject to self-employment tax. On the portion that isn’t on the hook for self-employment taxes, in some cases it can also escape the 3.8 percent net investment income tax for high-income earners enacted into law during the Obama administration.
“It’s truly astounding to me that Biden would take such an aggressive position while contemplating a run for president,” Steven Rosenthal of the Urban-Brookings Tax Policy Center said. “I don’t get it.”
Similar planning strategies were criticized when it was revealed that other politicians had used them: Former presidential candidates Newt Gingrich and John Edwards were both chided for the workaround.
Practitioners were quick to point out that before becoming president, Barack Obama earned income as an author but listed it on Schedule C, subjecting it to self-employment tax. Sen. Elizabeth Warren, D-Mass., similarly earned income as an author and listed the amounts on Schedule C.
Biden, who is now a Democratic presidential candidate for 2020, released federal and state tax information July 9 showing that he and his wife, Jill, earned millions from speaking and writing engagements since leaving office.
The bulk of Biden’s income in 2018 and 2017 came from an S corp called CelticCapri Corp., established for Biden’s speaking and writing engagements after the release of his 2017 book, Promise Me, Dad, according to his most recent financial disclosure report. Giacoppa Corp. was established for Jill Biden’s speaking engagements.
But one thing that jumped out was how the S corp was used to minimize taxes. Practitioners pointed out that in 2018, Biden earned nearly $3 million from CelticCapri but reported only $300,000 in reasonable compensation, meaning that portion would be subject to self-employment taxes.
Perhaps even more startling is that in 2017, Biden earned $9.5 million through his S corp, but it paid him a salary of only $145,833, Rosenthal added.
Material Participation
The rest of the income wasn’t subject to self-employment taxes, and because an attachment to the return claims Biden “materially participated” in the activities that generated the income, the 3.8 percent NII tax didn’t apply.
The NII tax applies to interest, dividends, and rental and royalty income, but it doesn’t apply to operating income from a business in which the taxpayer materially participates.
President Obama sought to end that workaround.
In its proposed fiscal 2017 budget, the Obama administration would have expanded the 3.8 percent NII tax to passthrough income so it wouldn’t escape the tax based on a technicality. The provision, included in a section entitled “loophole closers,” would have raised $271.7 billion over 10 years, according to the Treasury Department’s analysis of the proposal.
Under the S corp law, an owner who provides substantial services to the business must pay him or herself reasonable compensation, but it’s never been clear what that means, Tony Nitti of RubinBrown LLP told Tax Notes.
Nitti said there are varying opinions on how much S corp income should be treated as reasonable compensation.
“History has shown that once a shareholder has paid themselves compensation equal to the Social Security wage base, the likelihood that the IRS will attack compensation as being unreasonably low is very unlikely,” Nitti said. “A logical result, given that the Service only stands to collect an additional 3.8 cents on every additional dollar reclassified from distribution to compensation.”