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S corporations’ owners can blunt the impact of the 3.8% surtax on unearned income.

Shareholders who materially participate in the S corporation’s operations generally aren’t subject to the 3.8% surtax on their allocable share of the firm’s income or on distributions paid to them.

This exception to the surtax does not apply to passive S firms or to S corporations whose business is trading in financials.The surtax hits net investment income of couples with modified adjusted gross incomes
over $250,000 and of single taxpayers with modified AGIs in excess of $200,000.

President Biden wants to end this loophole for some S firm shareholders. His proposal would expand the 3.8% surtax to cover income derived by individuals from pass-through entities, such as S firms, in which they materially participate. This tax hike would apply only to individuals with incomes over $400,000.

Either way changes are coming and none of them are going to be good for business owners.

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