A nonpartisan analysis of President Barack Obama’s 2013 budget proposal suggests that at least some small business owners and shareholders could face significant tax increases on capital gains, dividends and income next year.
The president wants to do away with the Bush-era cuts for taxpayers in higher income brackets, affecting couples who report more than $250,000 in earnings or single filers who earn more than $200,000.
Opponents of the proposed tax hike say it will hurt entrepreneurs and investors who report business income on their personal returns and pay the individual rate. Most of these so-called “flow-through” companies, also known as S-corporations, are structured as partnerships, sole proprietorships or closely held corporations.
But supporters of the president’s plan say the new, higher rates would apply only to a comparative handful of much larger companies organized as S-corporations, leaving the vast majority of smaller “flow-through” businesses unaffected.
According to a report prepared last month for the Joint Committee on Taxation, 940,000 households reporting business income in 2013 would pay the higher marginal tax rates of 36 percent or 39.6 percent under the Obama plan, compared to the current rates of 33 percent and 35 percent.
In an election year, the debate about changes in the tax code has generated a lot of political heat but sheds little light on the practical implications for those who own or invest in small businesses.
Some analysts in the private sector, however, are wary. Small business advocates have long complained that the president’s tax plan ignores the key issue of individual rate reform.
A recent study by the National Federation of Independent Businesses found that 75 percent of small businesses are structured as “flow-through” entities.
In a statement on its website, the NFIB argues that “after-tax income is an especially important source of capital for small businesses. High tax rates mean less money that small business owners have to reinvest back into their business.”
Part of the problem in reaching a consensus on the issue is that “small business,” like beauty, is apparently in the eye of the beholder. Each party defines “small business” in terms that best suit its own political agenda.
Republicans opposing the president’s rate hike tend to broadly categorize all “flow-through” organizations as small businesses. JCT statistics, however, show that about 3 percent of “flow-through” businesses have income in excess of $50 million, hardly a mom-and-pop operation.
The problem with the Democrats’ position is that the $250,000/$200,000 income threshold might be set so low that companies who would otherwise qualify as a small business by any other measure would nevertheless have to pay the higher rates.
Let’s say a small-scale injection molding plant employing less than 50 people secures a new contract that pushes profits just over the $250,000 threshold. Under the new tax structure, the company would have to earn an additional 3 cents for every dollar just to break even. Budget hawks warn such penalties could remove any incentives for growth and job creation.
In an attempt to make sense out of this maelstrom of conflicting numbers and opinions, the JCT scheduled a hearing for June 28. There were few expectations of a breakthrough, but both sides had at least acknowledged the need for meaningful and substantial tax reform.
Of course, the issue might be entirely moot if President Obama fails to win re-election in November.
With all the confusion and uncertainty swirling around the possible rate hike, the best advice for anyone involved in a small business is to sit down right away with a trusted CPA or financial advisor for a nice, long talk. Otherwise, 2013 could turn out to be a very unlucky year.