Joe writes about a new extender bill that would impose self-employment tax on certain S corporation K-1 income. He writes in his post titled Reputation and Skill:
If enacted, as seems likely, this rule would create odd problems.I agree that there are a lot of potential issues involved if the tax law were to require that we determine a monetary value for "reputation and skill."
It would penalize the smallest personal service providers to the benefit of their larger competitors.. A sole proprietorship would pay taxes at a rate at least 2.9% higher than a competitor whose "principal asset" is the reputation of more than three employees.
The bill also will require businesses and the IRS to determine what the "principal asset" of a personal service corporation is. The bill obviously requires the valuation of intangible assets -- reputation and skill -- but in a way not elsewhere attempted in the tax law. How do you do this?
This reminded me of a discussion in my graduate course on estate and gift tax, taught by the brilliant and engaging Dr. Boyd Randall. He told us about how previous tax law required that the gross estate include the value of gifts "made in contemplation of death." Answer.com echoes what Dr. Randall said:
Because determining whether a gift was in contemplation of death turned out to be subjective, difficult to prove, and somewhat morbid, a 1976 amendment to the estate tax law automatically included any gift that a decedent made within three years of death (26 U.S.C.A. § 2035(a)).If this professional service S corporation law is enacted, I will be interested to see how we talk about it a few years down the road. I'm guessing we'll say something like: "Because determining the value of a shareholder's reputation and skill turned out to be subjective, difficult to prove, and somewhat arbitrary, a 2016 amended to the tax code eliminated the self-employment tax on professional service S corporations."
I guess I'll just have to wait and see.