Most people don’t understand how Biden’s double taxation proposals hurt small businesses
What many people don’t realize about small businesses is that there are millions of them — 30 million actually — according to the Small Business Administration of which 6 million have employees. The media likes to show “Main Street” shop owners and restaurateurs as what’s typical. But it’s not.
What many people also don’t understand is that a great number of these businesses are owned by more than one person and are not on Main Street. They are family businesses or partnerships or joint ventures and they’re located in corporate centers and industrial parks near airports. For these businesses, the impact of President Biden’s tax increase proposals is potentially significant … and hurtful.
Take, for example, a client of mine. They have 150 employees and three partners, all members of the same family. Each partner takes about $350,000 out of the business a year as salary. They live in nice, middle-class houses and drive Fords. Their kids go to public schools and they vacation down the Jersey shore.
These are smart people and their business does well, generating about $2M each year in profits. Good for them. So in addition to the $350,000 that each takes, another $700,000 is also considered income on their “pass-through” partnership tax returns — which is also the most popular form of tax filing among small businesses.
Unfortunately, the partners don’t see that $700,000. Why?
Because most of it is left in the business. The owners, like most good business owners, re-invests those profits into inventory, property and operations (translation: people). However, under Mr. Biden’s current and upcoming proposals to increase personal income tax rates for those earning more than $400,000, these business owners would have to pay a much higher rate — almost 40%. And they would have to pay it with cash that they don’t have because it’s been invested elsewhere.
Boo-hoo, right? Well actually, it’s boo-hoo for their employees. Because coming up with that cash means taking money from operations — money that would be used for hiring and benefits — so that their tax liabilities can be satisfied. So less jobs, less benefits. Is that mean, greedy or unfair? No, it’s just what business people do because, unlike their employees who receive a paycheck, these people take substantial risks in order to get a reward and have headaches that employees will never have, like collecting money and dealing with supply chain issues.
That’s the first big impact of Mr. Biden’s tax increases on small businesses: a tax on income that’s never received because it’s been reinvested. Unfortunately, there’s now a second proposed tax on top of the first.
The president has proposed increasing the capital gains rate to the top ordinary rate of almost 40%. Adding the Obamacare tax and state taxes, businesses owners in some localities could be facing as much as a 50% capital gains tax when they sell a capital asset.
And what is the most valuable capital asset for any business owner? It’s their business!
When someone sells their company, a capital gain is recorded for the difference between the allocated fair value and historical cost of an asset held over a year. That gain would be subject to a hefty capital gains tax if the business owner is “earning” more than $1 million per year.
But are my clients really “earning” this amount? No, they’re reinvesting the profits of their business back into the business. Unfortunately, their tax returns show it all as income, so now they must pay the price.
Which means that when the three owners at my client look to retire in the near future and reap the rewards of decades of hard work building a substantial business that’s employed hundreds and contributed value to their community, they’re potentially looking at giving away half of what they’ve built — their retirement — to the government.
Most people don’t understand that for small businesses there are “earnings” and there are “earnings.” A business owner takes some profits as compensation. But most of my clients must leave the remainder of their profits in their businesses in order to continue funding their operations. However, they’re double-taxed on both the income and then the future gain. And now they’re facing much higher tax rates which means parting with even more.
Should big corporations and CEOs earning zillions pay their fair share? I’m open to that. But it’s not fair to ask all of these small business owners to be treated the same.
* Gene Marks is a CPA and owner of The Marks Group, a technology and financial management consulting firm that specializes in small- and medium-sized companies.
Originally published at https://www.washingtontimes.com on April 29, 3600.