I was disappointed to read “How the Bidens Dodged the Payroll Tax” last week in the WSJ, not because Biden is a good guy, but because the author of the screed, Chris Jacobs, gets it all wrong. Those of you who read my columns regularly know that I’m no fan of Biden, but in this case, Biden is in the right. There is nothing legally wrong with how he structured and paid his taxes – to the contrary, it elucidates an ongoing tax inequity that was completely missed in the article.
In order to understand what Biden did and didn’t do, you need to understand a little bit about s-Corps, LLCs, partnerships, and Social Security taxes. Foremost is that Social Security taxes are imposed on individuals’ earned income – salaries for employees and earned business income for independent earners. It is a tax on earned income — and only earned income. It’s money contributed from your work that goes into your retirement social security pension, not your business profits, interest and dividends income, capital gains or anything else. Social security is calculated from your working history, because you are taxed only on your earned income. That’s why it’s dubbed the payroll tax.
So now let’s look at some different scenarios. Say you work for a business operated as a C corp or S corp, and you also are a stockholder in that business. The money you get as a stockholder — such as dividends–is not working income so you do not pay the Social Security tax. But the money you earn on your labor for your work in this company – salary – up to $137,700 (for 2020)- is subject to the social security tax.( Amounts earned over the $137,700 is still subject to the much smaller Medicare Tax).
But it gets more complicated when you consider partnerships (or LLC’s which are taxed as partnerships). If you work for and are also an owner of a partnership, your share of the partnership income – both for your labor and share of profits are included in one number reported to you on a K-1 form. And the full amount is subjected to the social security tax. For instance, say you are a 50% owner of an architecture partnership and the firm makes $2 million, you would get a K-1 form showing $1 million. Though that would be for both labor and profit, you would have to pay Social Security tax on the full amount.
But if you are structured as an s-Corp, you pay yourself a salary. If the architecture firm were an s-Corp and it earned $2 million and each shareholder received a $400K salary and netted $600K in profit, they only pay the Social Security tax on the earned income, the $400K. And this is exactly what Biden did. He paid tax on his earned income.
So with an S-corp, you have cleared defined salary and (hopefully) profits. It is conceivable that, in Biden’s case, his salary was too low. That is a bit unclear. But what is absolutely clear is that the business is not all labor and therefore he should not be paying Social Security on the full amount. The problem, therefore, isn’t that Biden did something wrong or that he used an S-Corp “loophole” to “get away with” only paying tax on some portion of the business. The problem is that just because someone is a business owner should not mean that he has to pay social security tax on his business profits. Remember Social Security is a tax only on earned income and thus Biden rightly paid the Social Security tax only on his salary. The real problem is that partnerships, unlike their C-corp and S-corp counterparts, have to unjustly pay the full Social Security tax on both their labor and profits. This is the real problem with the tax code that has needed reform for many years. Biden and Trump would do well to address this inequality in the future.