The Hidden Federal 'Tax' All Small Businesses Must Pay

With the federal tax deadline only days away, millions of small business owners are facing that familiar pencil-snapping frustration over the tax code’s complexity. As Montana Sen. Max Baucus once said, “Tax complexity itself is a kind of tax.” Small business owners know all too well the truth in that pithy maxim.

The National Small Business Association (NSBA) has conducted an in-depth survey of its members on how the federal tax code affects small business owners. The result? More than half of those responding spend 40 hours or more filling out tax forms, and 38 percent said they spend more than 80 hours! Even more depressing, more than 50 percent spend more than $5,000 annually on tax preparation, and 30 percent spend more than $10,000.

When will it end? Likely never.

Reforming the tax code has been a top priority of small business owners for decades. But Congress has never mustered the courage to get it done. Instead, the tax code, now exceeding 10,000 pages, has only grown more complex, more loophole-ridden, and more daunting to understand. As one wag said, it makes “War and Peace look breezy.”

But if there was ever a time to finally tackle tax code reform, it’s now.

The U.S. economy is tenuously emerging from the most devastating recession since the Great Depression. Although it's finally expanding, years of growth at current rates will be required to replace all of the jobs lost during the downturn. It’s generally accepted that small businesses are the biggest generators of new jobs. But many business owners say can't hire because they are handcuffed by taxes.

The fact that 87 percent of those surveyed are forced to pay an external accountant to do their taxes “sends a strong message to the IRS and Congress that the tax code is far too complex,” the study notes.

Among the most significant challenges to the growth and survival of small businesses, economic uncertainty and lack of sales top the list. But in terms of policy issues small businesses must battle, federal taxes ranked behind only regulatory burdens and the cost of health insurance.

As the economy improves, concerns over uncertainty and lack of sales should fade. But the policy issues -- taxes, regulation and health care -- won't go away unless someone does something about them. If you're looking for a place to start, 37 percent of survey respondents said the cost of complying with the tax code was their biggest burden, followed by the tax code's lack of consistency (17 percent). Time lost filling out forms (15 percent) was next and concerns about getting audited because of mistakes (14 percent) came after that. Burdensome paperwork (12 percent) and the code's inequity (5 percent)were also cited.

The complexity of the tax code also weighs on businesses when it comes to deductions -- many small businesses don't even take advantage of all the deductions they're entitled to. Outside of the home mortgage deduction, Section 179 expensing is the most frequent tax break taken by small businesses. Yet less than half of all business owners (just 47 percent) said they utilize it. The numbers are even smaller for other deductions. Only one quarter of those surveyed say they used bonus depreciation; 18 percent took a home-office deduction; 12 percent took advantage of research and development credits and only 11 percent took advantage of energy tax credits.

“Small businesses would most benefit by extensions to expanded section 179 expensing as well as permanency to the one-year provision included in the Small Business Jobs and Credit Act of 2010 which allows self-employed individuals —- for 2010 only —- to deduct the full cost of their health insurance from their self-employment taxes,” the study notes. The health care deduction, long at the top of the agenda for small businesses, amounts to a 15.3 percent tax break on health insurance.

Even though the Obama administration made health care reform one of his top priorities, the survey shows that most small business owners don’t understand the law’s tax benefits. More owners (34 percent) were unaware of, or unsure about, the self-employed health insurance tax break than those (32 percent) who said they planned to take the deduction. When asked if they planned to take advantage of the small-business health care tax credit included in the new law, a whopping 62 percent said they were unsure.

In addition to lack of knowledge about tax benefits, fear and uncertainty make other tax deductions too scary to take. Of those businesses otherwise eligible to take a deduction for home-offices, almost half (47 percent) choose not to do so -- of those, 58 percent are afraid it might trigger an audit. Even more respondents (51 percent) said the rules are too rigid, or the paperwork is too complex or burdensome to claim a home-office deduction.

The problem is that while we all may agree on the need for tax reform and simplification, lawmakers' views diverge radically on how best to accomplish that goal. Small business owners, on the other hand, are surprising unified on the question. Many would even trade their own tax deductions in order to simplify the code.

Some 64 percent said they would favor reducing deductions if it meant lower corporate and individual tax rates. Almost half (40 percent) would agree to cut their own deductions if it meant lower taxes and nearly one quarter (23 percent) support letting the Bush tax cuts expire for the highest earning 2 percent of households. But they also want to see government spending cut.

Nine out of ten respondents want to reform and reduce entitlement spending such as Medicare, Medicaid, and Social Security. Nearly as many (85 percent) want across-the-board cuts in federal agencies and a majority (64 percent) want to give the president the power to make line-item vetoes of budget items.

Right now, Congress is locked in a heated debate over a small slice of the federal budget -- and a government shutdown might result. The pain that will cause could reverberate through the economy and threaten the fragile recovery. It’s time for both parties in Congress to stop the political grandstanding and listen to Main Street.

Tax reform promises to do far more to reduce the deficit and strengthen the economy than cutting a program like Head Start. But taking on all the special interests will take courage, and that’s something that always seems to be in short supply in Washington.