Bell Curve The Law Talking Guy Raised by Republicans U.S. West
Well, he's kind of had it in for me ever since I accidentally ran over his dog. Actually, replace "accidentally" with "repeatedly," and replace "dog" with "son."

Wednesday, November 17, 2010

Income Taxes and Small Businesses

Hi Everyone,

The Republican argument against allowing the Bush tax cuts to expire for tax payers making more than 250k/year is that raising taxes on this income bracket would kill off small businesses or at least slow their growth/recovery. They say this as if it is self evident but it raises a number of questions for me that I'd like to hear the opinions of some tax experts about (like maybe LTG or Seventh Sister).

First, are all small business profits treated as income for the owner for tax purposes?

Second, is there a way for a small business owner to reinvest their profits in their business before it can be taxed as income?

Finally, depending on the answers to the first two questions, shouldn't it be fairly straightforward to prevent what is intended to be a tax increase on the richest portion of the population from directly affecting small businesses in general?

Or is this just a typical Republican canard based on dishonest presentations of the facts?


eiscremeluvr said...

Most small business profits are taxed as income to the owners.

Small business owners can reinvest their profits only in the same tax year, and only for deductible expenses (not all things necessary to run a business are deductible--and some can only be deducted over years.) There may be exceptions here, but this is the rule. Any cash left in most small businesses at the end of the year is taxed as income.

The fact is that many many small business owners also make up the richest portion of society--they're not Wall St. rich, but many are in the top 5-10%, by income and assets. (Though both are very often deeply linked to, and always at risk from, their business.) I like to think that small business people bear direct risk and put in work that is proportional to their income, vs. the $100 million CEO, etc...but I'll leave that discussion to the rest of you.

Raised By Republicans said...

OK, so it sounds like the Republicans have a point about the problem. But it seems to me this could be solved by setting up specially define accounts for small businesses that separate the businesses reinvested revenue from revenue extracted by the owner for their own salary.

I'm sure an accountant or a lawyer could figure out a reasonable compromise that would mitigate the Republicans' objections without having to give a tax break to the majority of wealthy tax payers.

The Law Talking Guy said...

The effect of allowing the 2001 tax changes to expire as planned are quite modest unless your business has post-deduction income substantially above the $250K mark. Unlike ordinary individual taxpayers, small businesses get lots of deductions and they use them in ways that you and I cannot. Corporate cars and cell phones come to mind, business lunches, business trips, etc. As a total percentage of gross income, a small business usually can arrange to pay signficiantly less tax than an individual with W-2 form.

In addition, the IRS estimates that tax compliance is consistently the worst in small businesses because they often (1) overstate or cheat on deductions and (2) just plain don't report cash income. he IRS has estimated that 75% of its lost taxes (the "tax gap") comes from small businesses. The estimated noncompliance rate for small businesses is 3 times that for mid- to large-size businesses.

I have great sympathy for small businesses that follow all the rules and (therefore) are at a competitive disadvantage to their noncompliant competitors. But in general I do not believe that reverting to the tax rates in place during the 1990s dot-com boom will cause serious economic dislocation for small businesses. Far more harm to the economy will be caused by refusal to extend unemployment benefits to individuals who immediately spend that money on local needs. The GOP is blocking that for more than 2 million people right now.