Newt and the NEWT Act
Newt Gingrich’s 2010 income tax return inspired a quick response from U.S. congressman Pete Stark.
Twelve days after Gingrich, a Republican presidential hopeful, made his return public, Stark proposed the Narrowing Exceptions for Withholding Taxes (NEWT) Act.
This proposal has an uncertain future in Congress, but it would be a good addition to our tax laws, closing a significant loophole that Gingrich took advantage of.
In their 2010 return, Newt and Callista Gingrich declared that most of the money they earned from their multimedia company, Gingrich Productions, was dividends, rather than compensation for their services.
Because the Medicare tax applies only to labor income, this move allowed them to avoid paying $71,152 in Medicare tax — the amount of the dividend times the 2.9 percent tax rate.
Michelle Selesky, Gingrich’s spokeswoman, did not respond to multiple requests over several days for an interview or comment.
This technique is used by many accountants, lawyers, lobbyists and performers who, like Gingrich, set up S corporations, a type of business organization that passes any tax obligations on to its owners.
The same loophole was used by John Edwards, the 2004 Democratic vice presidential nominee, to avoid about $600,000 of Medicare tax on his earnings as a trial lawyer over a period of four years, information he made public showed back then.
THEIR OWN LABOR
Some investors in S corporations have capital at stake but do little or no work. It is reasonable to classify their profits as dividends. But in the case of Gingrich, and Edwards, their income resulted from their own work and it should be taxed as such.
Stark, a California Democrat, told me he introduced the NEWT Act after learning that Newt and Callista Gingrich reported 80 percent of their nearly $3.2 million in income in 2010 as dividends, mostly from Gingrich Productions, which is set up as an S corporation.
Under Stark’s bill, the income from an S corporation with three or fewer principals would be taxed as compensation, thus incurring Medicare taxes.
Passing Stark’s bill and closing this loophole is a matter of fundamental fairness. The principle that government should tax makers of microchips and potato chips alike should also apply to earnings from work, whether it comes from work on the factory floor, or, as in Gingrich’s case, making videos.
Just as you cannot claim a depletion allowance for your aging body, you should not be able to declare that money you earned by working is a dividend.
The official scorekeepers on tax matters, Congress’s Joint Committee on Taxation, estimated in 2009 that closing the loophole would raise $11.2 billion over 10 years.
IRS ATTACKS LOOPHOLE
The IRS has been attacking this loophole in audits, challenging many tax filings that have used the same strategy that Gingrich used. One of those challenges is now before the 8th U.S. Circuit Court of Appeals in St. Louis in a case watched closely by tax professionals.
It involves David Watson, a certified public accountant in West Des Moines since 1982, who paid himself a salary of $24,000 in 2002. He then reported nine times that much in dividends, which reduced his Social Security and Medicare taxes. He followed a similar pattern in 2003. The IRS said the dividends were really labor income and demanded Medicare taxes.
Watson sued. Robert W. Pratt, the chief federal judge in Iowa’s southern judicial district, wrote in a 23-page decision in 2010 that such a small salary was “unreasonable.” A salary of $91,044 would be reasonable for someone with Watson’s skill and experience, he wrote.
The judge then ruled that Watson owed payroll taxes on $67,044 of the money he had labeled dividends, saying this finding “is amply supported by the evidence.” Watson’s case has been argued on appeal and he now awaits a ruling.
Watson told me that he does not think the IRS has the authority to decide what is salary and what is a dividend. Other court cases show that it does. But Congress should remove any ambiguity by passing Stark’s bill now.
Stark’s proposed NEWT Act contrasts with Gingrich’s own tax plan, which he released in December. Under Gingrich’s plan, dividends would not only be free of Medicare tax, they would also be entirely tax-free.
Had Gingrich’s tax proposal been the law when he filed his 2010 return, my calculations show that his income taxes would have fallen more than 90 percent. His is one of the most outrageously self-serving tax proposals I have seen in years of studying our tax system.