Draws versus Salaries

In an S-Corp, the shareholders are required to take salaries, not draws.  If an S corp shareholder takes out salary of $20,000, she will still pick up that $20,000 as W-2 income.  Taxes would have to be withheld, and shareholders would receive a W-2 at the end of the year.

In an LLC, members take “draws” rather than salaries, and taxes are not withheld on those draws.  A draw means an owner is just taking money out of the bank against the balance sheet account called partner draw (liability).  Instead, if an owner takes out $20,000 in an LLC, it doesn’t affect her ownership income, and she’ll receive a K-1 at the end of the year showing that $20,000 in income.

Unlike salaries in an S corp, LLC ownership draws do not reduce the company’s income.  A draw is not an expense, so although cash is decreased by the amount taken out as a draw, the payout of the draw does not constitute an expense that would lower net income of the company.  A salary is an expense account on the income statement that reduces your net income and your cash account.

Profits and Losses of the Company

In either case, shareholders or members will receive a K-1 from the company at the end of the year.  If the business has net income for the year (including deduction for salaries paid but excluding deduction for any draws) then that income will pass through to the owners on a K-1.

Therefore, while a company’s owners could reduce taxable income through salary payments in an S corp, they’re going to recognize the same total 1040 income through the combination of salaries and profit distributions via K-1.  Self-employment taxes (discussed below) will effectively cost them the same, and the only possible variable will be varying effects of marginal tax rates and capital gains treatment of profits versus salary.  (More on that last point under a separate posting coming soon.)

Self employment (SE) taxes

In an S-Corp, a shareholder is still (effectively) going to pay the full SE tax.  A shareholder cannot avoid SE taxes by taking salary rather than a draw, because while the company would indeed pay half of the SE tax, since the shareholder is essentially the company, the shareholder is effectively paying all of it.  And that would then be the same as if an LLC owner received all of here income on via owner draws.

Question: Can a 501c3 private foundation or public charity put its tax-exempt status at risk by hosting a social media platform?  Specifically, could the advocacy and electioneering activities of individuals and groups using that social media platform be treated as the direct action – or facilitation of direct action – by that foundation of activities inconsistent with its tax exempt 501(c)(3) status?

Tax exempt organizations under Section 501(c)(3) of the Internal Revenue Code are expressly prohibited in engaging in any of these activities (as described by the IRS in its “Exemption Requirements”): “it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.”

Would the electioneering or advocacy conduct of third party users of an exempt organization’s social media platform be deemed the conduct of that exempt organization?

As of this date, there is no specific IRS guidance on the question, nor directly applicable tax court or other caselaw of which I am aware.  In 2000, the IRS announced an intention to explore the implications for nonprofits of new media activities, and issued a formal Request for Comments.  The IRS posed a series of questions for public comment, including this one:

“To what extent are statements made by subscribers to a forum, such as a listserv or newsgroup, attributable to an exempt organization that maintains the forum?  Does attribution vary depending on the level of participation of the exempt organization in maintaining the forum (e.g., if the organization moderates discussion, acts as editor, etc.)?”

The Request for Comments did not, however, result in new rules or guidance at that time or in the ensuing years.  The IRS has issued guidelines relevant to online political activities of exempt organizations, including rules issued last summer addressing the practice of directing users to and linking to political action sites, see http://www.irs.gov/pub/irs-tege/internetfielddirective072808.pdf.  These Rules govern direct activities of nonprofit organizations, however, and do not obviously address the open questions of what activities will be “attributed” to an organization, as raised in the 2000 Request for Comments.

An analogous situation governs copyright infringement under the Digital Millennium Copyright Act (DMCA), and defamation, obscenity and other activities under the Communications Decency Act (CDA) Section 230.

Section 512 of the DMCA provides a safe harbor from copyright infringement for “Internet Service Providers” (ISPs), and Section 230 of the CDA provides a broad immunity from liability for a “provider or user of interactive computer service” (ICS).  In both cases, a host of a website is protected from liability for the actions of third party users.  The host cannot knowingly or willfully facilitate the unlawful conduct of the third party user, but the cases where a host’s immunity has been pierced consistently involved aggressively proactive interactivity with users, and even moderate editorial and supervisory oversight has been permitted.

Since the IRS issued its Request for Comment there has been little commentary on the subject, although in 2001 the Alliance for Justice argued for extending the DMCA copyright analogy to nonprofits social media activities.

Without further guidance from the IRS or applicable caselaw or even helpful commentary, the Alliance for Justice “best practices” still make a good deal of sense.  In particular, the site’s Terms of Use are important for establishing the ground rules for use of social media, including prohibitions on activities that would not be permitted by the hosting organization if performed directly, as well as the rights (but not necessarily the obligations) of the host to monitor and remove content.

In other words:

(1) Generally, hosting – in and of itself – should not be deemed equivalent to direct action by the hosting website.

(2) Terms of Use should clearly state limitations and restrictions on activities in using the site that would not be permitted by the hosting organization if performed directly, such as electioneering and advocacy.

(3) A hosting organization’s role should be limited only to periodic monitoring and not active editing, auditing or supervision, and definitely not screening submissions – unless intending to directly edit submissions prior to posting, which for various reasons may not desirable or practical.

(4) A hosting organization need be responsive to alerting to complaints about violations of Terms of Use and enforcement of policies, including enforcing “take down” policies similar to the same kinds of rules under the Digital Millennial Copyright Act.