Newt and the NEWT Act

By David Cay Johnston
February 3, 2012

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.

11 comments

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First, I do not think it is fair to say they declared their income was “dividends” They were taxed on the Sub S earnings and whether they took distributions or not, the amount subject to tax would not change. Using the term dividends confuses the matter and might imply that they were taxed at a lower rate ala qualified dividends. All of the income was taxed at ordinary income tax rates.

The CPA case invloved taken an unreasonably low salary. Most CPA’s do not make $24,000. The IRS only adjusted the salary to about $90k. If congress and the IRS wants to argue that Newt’s salary of $252,000 is unreasonably low, and that all of the profits should be considered salary, then they will open up all of those reasonable compensation cases at the C Corp level.

IRS tries to argue that C corps bonus out all of their profits to avoid corporate taxes. So they restrict the amount of reasonable comp allowed. Do you think they really want to make an issue of this. As long as you take a salary above the Fica limit ($110,600) you should be fine.

Posted by curleybrothers | Report as abusive

Seems to me that it is time for us to extract ourselves from thinking inside the income tax box, and start thinking about what we really ought to be taxing, and what ought not to be taxed at all, or, if we need the revenue, taxed but lightly.

What ought we to tax? Not labor, or production, but that which nature provides or the community creates. The classical economists classified it as “land” as opposed to “labor” and “capital.” It has suited the powers-that-be — and their well-aid advocates both in Washington and in our universities — to subsume land under capital and pretend that they’re identical.

We can’t know whether collecting for public purposes the annual economic value of all the things that are rightly categorized as “land” — economic rent — will be sufficient to meet the revenue needs of all levels of government today. It may well not. But it ought to be our FIRST tax base, supplemented, if necessary, by taxes on production if we absolutely must.

My own guess is that, were we to collect the lion’s share of economic rent, we might find that a lot of other supposedly intractable problems would be well on their way to be being solved, and the revenue required by government would drop significantly. Can’t prove it, but the hypothesis makes sense.

In any case, we ought to be thinking outside the income tax box we seem to have accepted as the limit of our tax debate.

Posted by LVTfan | Report as abusive

Aren’t dividends taxed at 15%, where ordinary income … in this case significant, gets taxed at the highest tax table rate?

Newt and wife at least paid their legally required taxes for US reported income. His major opponent, Gov. Cayman Caiman paid only on monies earned in the US, avoid payments on significant sums of income.

Posted by SanPa | Report as abusive

Don’t get me wrong, Mr. Johnston, you are one of my favorite editorial writers, but I think you’ll understand where I’m coming from when I say I’m getting so sick and tired of hearing about the endless ways the the very rich can take advantage of the system they designed and how they continue to exert their influence on how we are governed. It’s beginning to feel like we’re being ruled by an invisible, authoritarian regime that chooses our “elected” officials as a governing front.

Think about it. Is Mitt Romney a fair representative of the American people or a fair representative of Wall Street? My take is that the power elite, our modern feudal rulers, can work with either Party–all candidates need lots of campaign cash–but prefer the Republicans. That is why the Republicans have contributed more in determining our nation’s direction during the last 3 decades than Democrats. The GOP has wielded more power during this time than probably any other time in our nation’s history.

Posted by flashrooster | Report as abusive

But as I stated, the plutocrats can work with either Party. Money is the lifeblood of politics and with our current disparity of wealth it is nearly impossible for the bulk of the American people, those being referred to as the 99%, to thwart the wishes of the plutocrats. The Democrats game plan is to try to appease both their monied sponsors AND their constituents. Instead of passing legislation that pleases their constituents, Republicans just focus on pleasing whoever has the most money and deal with their voting constituency by convincing them that everything they are doing is in keeping with being a patriotic Christian American and that everything the Democrats are trying to do is anti-Christian, anti-American, and moving us toward socialism. Love us, hate the Democrats; that is their message, and they pump that message across America 24/7, and it’s proven to be very effective. How else could they possibly hope to get someone like Mitt Romney elected to the Presidency just after our economic collapse that almost landed us in a depression caused primarily by a small group of people of which Mitt Romney is one and few of the rest of us are a part of? A large majority of Americans are upset about having to spend a trillion dollars bailing out the financial industry barons of which Romney is one, and what do we do? We consider putting one of their small number in the White House just as our economy is beginning to mend. It’s all the work of money, lots of money.

I’m neither envious of the wealthy nor do I resent people of wealth. In fact, I greatly admire those who work hard, play by the rules, and succeed. But what really gets my blood boiling are those who use their money to usurp our government, my government, and effectively cut me out of my right as a tax paying, voting member of our Republic to have any influence in how I am governed. People should remember that the Boston Tea Party wasn’t a protest against being taxed. It was a protest against being taxed without any representation. Well, here we are again, and we know how that ended up the first time.

Posted by flashrooster | Report as abusive

Something has to change and I can’t think of a realistic scenario of how that change would come from inside our government. Anyone threatening change is either constrained or removed. I do think Obama had, and still has, good intentions. But there was no way possible for him to implement the change we so desire. In fact, had he fought tooth and nail to bring about the kind of change we need, not only would he have failed, but his adversaries, the GOP and ruling plutocrats, would have successfully defined him as a radical outsider threatening our traditional American way of life and he would have lost his bid for reelection in a landslide. Romney and the Republicans are trying this tact anyway, something they have been working on since the last Presidential election. The only problem is that Obama has given them very little to work with. He’s been a mainstream moderate.

Make no mistake, our government has been hijacked. It’s not BEING hijacked; it’s been accomplished. As I said, the fact that Romney is running neck and neck with Obama in the polls speaks volumes, and it’s not a coincidence that this has come about as Wall Street, whose markets have come roaring back like few could possibly have imagined 4 years ago, pumps Romney’s campaign coffers full of cash over what they donate to Obama, who had much of their support in the past. Why? It’s simple. Romney is one of them. He has vowed to cut their taxes and repeal the Dodd-Frank financial reform law. By contrast, Obama wants to raise their taxes and keep Dodd-Frank. Never mind what is best for the country. Wall Street is looking out for their own personal interests. That’s capitalism, right? The rest of us are not afforded the same influence as the folks on Wall Street. In fact, we HAVE no influence.

Posted by flashrooster | Report as abusive

The current Greek financial FUBAR is a apropos example of a failed taxation paradigm. The two overriding caveats of a government taxation structure are; 1. It must be perceived by a overriding majority of those being taxed as equitable; i.e.like income streams are treated as a class and the tax liabilities are assessed based on the volume amount of money; 2. It must be easily collectable or reported/paid voluntarily. That being said our national tax structure was deliberately designed to be progressive; those with higher income streams are judged to use more of societal structural components and therefore pay higher fees for use.

Our current tax paradigm was very effective until Congress [collectively] began carving out tax giveaways to corporate America and began giving government subsidy to private enterprise, election campaign donors and special interest groups. These Congressional tax giveaways grew geometrically in the last 25 years and unfortunately were also accompanied by sequential contingent tax liability reductions again by Congress fiat which has caused the US to become a debtor nation. According to a recent C.B.O. report,”the Bush tax cuts reduced revenue by at least $2.9 trillion below what it otherwise would have been between 2001 and 2011. These tax giveaways to the super wealthy and corporate America will continue to decrease tax revenues and reduce the SS Trust Fund; Al Gore was right, put the Social Security revenue in a lock box and keep politician’s hands off it.

A company, corporation or government can’t reduce enough expenses and still meet its’ current obligations or grow to meet new demands or maintain infrastructure; IT CANNOT; 20 years of hospital management experience taught me that a income stream must increase over time!

Posted by JBltn | Report as abusive

@ SanPa, your premise about Romney is not correct.

As explained earlier by me in my columns and in broadcast appearances, he has carried interest payments from the Caymans and the like because foreign investors and also American tax exempt investors (public pension funds, charitable endowments) use offshore corporations to invest in partnerships like those Bain established. Otherwise the foreigners would be subject to filing an American tax return and the tax exempts would pay income tax on investment gains from borrowing.

Romney reports this income from the offshore investment corporation and pays tax on it. See my earlier columns for the tax benefits he does get.

Gingrich paid income tax, as the column makes clear, but not the Medicare tax.

@Btitn, you would find my 2003 book Perfectly Legal on point.

Posted by DavidCayJ | Report as abusive

Why isn’t there a piece somewhere on Reuters with a headline “Gingrich tax proposal would lower his own taxes by over 90%”? It seem to be pretty relevant, especially in the context of a record breaking negative campaign where the tax rates of the candidates are suddenly a hot topic. If nothing else, Romney should be using this to bludgeon Newt in some of his ads…

Posted by spall78 | Report as abusive

Good piece David, though many commenters seem to run off-point. Can you provide the citation to the Watson case. It strikes me as ridiculous that the judge ruled what a reasonable salary was at all in the case if this was a wholly owned S corporation where service income was the only income: all the income should be classified as ordinary income subject to FICA and FUTA.

There is a similar scam used by hedge funds (and lawyers) where the hedge fund managers claim that as limited partners, they are not subject to FICA and FUTA. This was wiped out by the IRS also:

http://www.ustaxcourt.gov/InOpHistoric/r enkemeyer.TC.WPD.pdf

Ironically, the defendant in this case, Renkemeyer, seems to have been a tax lawyer and was earning serious amounts of money during the years in question: I wonder what he was doing??!

These schemes do not work, but the IRS’s problem is finding them and auditing them. The IRS wins all these cases but the amounts involved may not justify a full-blown litigation. Whether legislation will solve this is another question: as written it would be easy to avoid by dropping other investment assets into the S corp. or limited partnership, I suggest.

Posted by Dobe | Report as abusive

After reading some of the comments I do believe that some of you realize that the republicans rhetoric is nothing but brainwashing on a very large scale and I am sure they will keep it up until the election. Is there another candidate out there somewhere that has the American ideals and can placate the republicans to the extent that they will actually want the best for our country. We will see.

Posted by David123456789 | Report as abusive