QUESTION: I enjoyed reading Bill Bischoff's article about the self-employment tax. I was hoping there might be some info about SE tax for small corporations, specifically S corporations. I heard that Congress was planning on applying SE tax to S corporation profits. Is this true?
— Roy Ovenell, Seattle, Wash.

ANSWER: Applying the self-employment tax to the profits of S corporations has been bandied about for years, but Congress hasn't taken any action — at least not yet.

As the rules currently stand, the owner of an S corporation takes a piece of the company's profits as salary, and then the rest of those profits pass through and are reported on his or her own personal income tax returns. What's the problem? The IRS can only collect self-employment taxes — that is, Social Security and Medicare taxes — on the owner's salary. For instance, if the corporation makes $200,000, and the owner sets his or her salary at $30,000, then the IRS can only collect a 15.3% SE tax on that $30,000 salary.

As a result, the temptation for many owners of S corporations is to under-report salary to avoid paying SE taxes, says Barbara Weltman, contributing editor of "J.K. Lasser's Small Business Taxes 2008." And that's a no-no. The IRS rule is that owners of S corporations must pay themselves a "reasonable" salary, which can be determined by researching salaries in similar industries in the same geographic region, she says.

It's uncertain whether a change in tax laws regarding S corporations will happen any time soon, but the issue has been the subject of Congressional testimony and numerous studies. One Treasury Department report, released in May 2005, argued that S corporations have become a "multibillion-dollar employment tax shelter for single-owner businesses."

Most recently, Rep. Charles Rangel (D., N.Y.) introduced a proposal, H.R. 3970, in October that would require owners to pay self-employment taxes on all S corporation income. The proposal, which wasn't acted upon in the 2007 session, could reappear this year but would likely encounter robust debate before it passes, according to Steve Hurok, tax director at BDO Seidman in Woodbridge, N.J., who has followed the issue.

"It's a difficult problem," he says, "and there's not a black-and-white answer." For instance, instead of applying SE tax to all S corporation income, the government could set minimum salary requirements for S corporation owners across a broad range of industries. Until any change happens, it's best for an S corporation owner to make sure his or her salary is reasonable — and keep careful records in the event of an IRS audit.

QUESTION: I'm self-employed and sometimes pay to park my car while working. Can I list parking fees as deductible business expenses? I’ve read the instructions for Schedule C Part II and V but don't see parking fees listed there as business expenses.
— Elie Tabet, Durham, N.C.

ANSWER: Yes, you can deduct parking fees as a business expense, so long as you're visiting clients or attending meetings at a location that's not your regular workplace. Keep in mind that commuting costs (even when they include parking your car in the expensive lot next to your office) are considered personal and not deductible. But for offsite visits, tally your receipts and add the figure in the line "car and truck expenses" on the Schedule C.

QUESTION: I was an independent contractor for part of 2007. I mailed my first three estimated tax checks in but am unsure what to do for the final payment. I know about the safe-harbor exception; however, in 2006 I did an adjustment due to a large business expense write-off which ended up netting me a return. So I am confused as to how much to send in. What line on my 2006 1040 and/or 1040X adjusted form must I use to avoid any underpayment penalties for 2007?
— Michael Mason, Kansas City, Mo.

ANSWER: Self-employed individuals have the pleasure of filing estimated taxes four times a year — April 15, June 15, Sept. 15 and Jan. 15 — based on income projections for the year. You don't have to guess the quarterly amount precisely, but the IRS will penalize you if you underpay.

To avoid that penalty, you're allowed to base your estimated tax payments on last year's tax bill. In this case, under that safe-harbor exception, it's perfectly fine for you to base the final payment on last year's tax bill, despite that big write-off in 2006. If you wind up underpaying, you'll have to make up the difference when you file your complete 2007 tax return (due April 15). But so long as you base this fourth payment on last year's figures — that's the total tax number on Line 63 of the 2006 1040 — you'll avoid the IRS penalty for underpayment. For more information, see IRS Publication 505, Tax Withholding and Estimated Tax.

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