Newt Gingrich’s recently released tax returns show some questionable items, according to one tax expert.
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The former Speaker of the House and Republican Presidential candidate released his tax returns last week, adding pressure to rival Mitt Romney to release his returns. Romney has now agreed to make public on Tuesday his 2010 return and an estimate of his 2011 return (see Gingrich Releases Tax Returns and Romney Does Reversal on Releasing Tax Returns).
Bob McKenzie, a tax partner at the Chicago law firm Arnstein & Lehr, has examined Gingrich’s tax returns and found that, like another former Presidential candidate, former Democratic Senator John Edwards, Gingrich could run afoul of IRS rules on paying Medicare taxes. McKenzie pointed out that Gingrich had service income through his S Corporation, Gingrich Holdings (later renamed Gingrich Productions), and paid himself a modest salary in relation to his gross service income.
“He paid himself a salary of $420,000 but distributed profits from the S Corp of $2.4 million to himself,” said McKenzie. “That means he avoided Medicare taxes of 2.9 percent on $2.4 million of income. John Edwards’ tax return came under the same misconduct with [his] law practice when he first sought a Presidential nomination.”
The Gingrich campaign did not respond to a request for comment.
McKenzie noted that there are a multitude of cases where the IRS has successfully challenged a tax strategy such as Gingrich’s. “Service businesses are only allowed to distribute a fair return on investment from an S Corp as profits exempt from Medicare taxes,” he said. “The remainder of profits must be paid as salary subject to a 2.9 percent Medicare tax levy. Individuals like Gingrich and Edwards are good examples of why Medicare is facing insolvency in several years.”
He noted that the same strategy had landed Edwards in trouble. “He was taking millions out of his S Corp, which was all law practice income, and claiming it was not subject to Medicare taxes,” said McKenzie. “The IRS thinks you should only take out a reasonable return on your investment, and the rest has to be treated as salary subject to the 1.45 percent Medicare [withholding tax] for the employee, and the 1.45 percent Medicare tax imposed and paid for by the company.”
The Gingrich return shows $475,000 in earnings, and $2.54 million in the S Corp that were being distributed as profits, but not as salary, he noted. “I don’t know for sure, but it does seem to be the same problem that Mr. Edwards had,” said McKenzie.
The Gingrich return is unclear in places, however, and there may eventually be a plausible explanation from the campaign.
“If you look on Schedule E on Mr. Gingrich’s return, you see this large amount that was being paid as distributions,” he said. “Is that for his consulting businesses or not? Other than the 400-something thousand dollars in salary, I don’t see any significant other income, so it certainly appears that he’s using the S Corp to reduce some of his income that would have been subject to the Medicare [taxes]. It would be appropriate for them to comment what he’s been doing.”
McKenzie is also looking forward to seeing Romney’s tax return and has already taken a close look at Romney’s financial disclosure statement for USA Today.
“Based on the financial election form, I estimated his income to be from $9.8 million to $38 million,” he said. “We couldn’t get it any closer than that because of the income ranges. More than half of his income, apparently, was in a tax-favored investment, i.e., dividends and capital gains, all of which are taxed at 15 percent, not the higher rate that all of us pay who work for a living.”
McKenzie had pulled up Gingrich’s financial disclosure statement back when it was filed last June. “Gingrich Holdings was on it, but it did not show his profits or salary, from what I could see,” said McKenzie. “I was trying to analyze it with respect to my conclusion that some portion of it was subject to Medicare, but I could not pinpoint what he actually did. It certainly appears to be a problem because he has his own little company and pays himself a fairly nice salary, but then on top of it there’s a lot of alleged profits that are not subject to Medicare. I’ve defended audits a lot of times from the IRS and if I can’t show my client has a significant investment and employees, and he’s in some type of service business, the IRS will re-characterize a substantial portion of those profits to be subject to Medicare. There’s a whole group of Tax Court cases finding that way.”
He cited one case involving a St. Louis accountant last year who had paid himself a salary of approximately $25,000 to $30,000, but made substantially more that he distributed as S Corporation profits. McKenzie personally defended another accountant last year who clamed a salary of $50,000 a year from her small accounting practice, but she also took out $150,000 as profits not subject to Medicare taxes. The IRS flagged that tax return for auditing.
“What the IRS has done to create audit opportunities is they look at the S Corporation return,” said McKenzie. “On the 1120S it has your gross income up top, adjusted by cost of goods sold, and then it goes down and asks for salaries to officers. And when the IRS sees a modest salary to officers and then a large profit that has not been subject to Medicare tax at the bottom of the return, they pull it to audit. These people were sort of standing up and waving a red flag at the IRS. That was what I saw when I looked at Mr. Gingrich’s return. It certainly looked like the type of thing the IRS would like to look at: aggressive.”