Exploiting the Medicare Tax Loophole

52 Pages Posted: 26 Sep 2017 Last revised: 17 Jun 2018

See all articles by Karen C. Burke

Karen C. Burke

University of Florida - Levin College of Law

Date Written: September 22, 2017

Abstract

Section 1411 imposes a 3.8 percent surtax on investment income of high earners that mirrors Medicare taxes on earned income. The enactment of the net investment income tax highlights gaps in the employment tax rules for passthrough entities — particularly limited partnerships, S corporations, and limited liability companies. This article considers how businesses can be structured to allow active high-income owner-employees of passthrough entities to avoid all three of the 3.8 percent Medicare taxes (SECA, FICA and section 1411). Part I considers the anachronistic limited partner exception to the SECA tax and the well-known S corporation loophole under the FICA tax, as well as the failure of section 1411 to reach active business income that avoids these employment taxes. Part II considers the recent Renkemeyer case, which has reignited the employment tax debate and threatens to upend structures used in investment and real estate funds to shelter management fees from all of the 3.8 percent taxes. Although repeal of section 1411 remains high on the Republican tax-cutting agenda, Part III suggests the need to reform (not repeal) section 1411 to backstop the employment tax rules for active passthrough businesses, regardless of organizational form. The proposed approach would curtail opportunities to avoid the 3.8 percent taxes, raise substantial revenue, and promote the goal of parity in the taxation of earned and unearned income.

Keywords: Medicare Tax, Employment Taxes, Tax Reform, Tax Avoidance, Income Shifting, Partnerships, S Corporations, LLCs, Real Estate, Investment Managers, Trump Businesses, Renkemeyer

JEL Classification: K32, H24, H25, H26

Suggested Citation

Burke, Karen C., Exploiting the Medicare Tax Loophole (September 22, 2017). Florida Tax Review, Vol. 21, 2018. Available at SSRN: https://ssrn.com/abstract=3041694 or http://dx.doi.org/10.2139/ssrn.3041694

Karen C. Burke (Contact Author)

University of Florida - Levin College of Law ( email )

P.O. Box 117625
Gainesville, FL 32611-7625
United States

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