It's important to note that the loophole is legal and used quite often, said Edward Rigby, a business tax expert at the accounting firm ParenteBeard. It's just a matter of degree on how it's used.  (Read more: How to maximize your Social Security)  So, let's say someone has set up their own S corporation, in this case a consulting firm, and makes $1 million for the year advising their clients. An S corporation is one that elects to pass corporate income, losses, deductions and credits through to its investors and shareholders for federal tax purposes. Many owners of S corporations classify themselves as investors and shareholders.  To use the loophole, that person will treat only $100,000 of that $1 million as personal wages. The other $900,000 is treated as company profits—not salary—even though the person, as owner, will get the money. (The $900,000 is not tax-free. It is subject to distribution taxes.)  That allows the business owner to avoid paying payroll taxes into Social Security and Medicare by some $26,000. By using the loophole, the person is declaring that he or she is more of an investor than an active employee of their own company.  (Read more: Cheat on taxes? Never! (Really)  "The red flag for the IRS would be if they think someone's work salary is too low in regards to compensation for services offered," said ParenteBeard's Rigby. "Then there would be some back taxes owed."  Controversy around S corporations has in recent years ensnared two prominent politicians, both of whom have seen their names attached to the loophole—usually by their political opponents. (Neither man's office responded to multiple inquiries that were made by CNBC.)
President Obama has called for ending a tax loophole that costs Medicare and Social Security millions of dollars. Here's how it works.