The ink is barely dry on what’s being billed as the most sweeping change in the tax code since the Reagan Revolution two decades ago, and small businesses are already caught in the crossfire.
The question is, are they victim, benefactor, or merely cannon fodder in a political debate that is all but destined to spill over into the presidential election? Since House Ways and Means Committee Chairman Charles Rangel, D-N.Y., introduced the Tax Reduction and Reform Act of 2007 on Oct. 25, both sides in the debate have repeatedly invoked small businesses to argue for or against the measure.
Obviously, they both can’t be right … or can they? Based on a preliminary reading of the measure, small businesses will be hurt by some provisions and helped by others. It all depends on how firms are structured and whether they rely on certain tax breaks that face repeal.
So far, only one prominent small business group, the Small Business & Entrepreneurship (SBE) Council, has taken a position on the bill. It fired off a statement saying the measure would be a “punishing blow” for small companies. “With all due respect, the bill takes aim at the entrepreneurial sector, and will vastly hurt their job-creating, innovative, and competitive capacity in the global economy,” SBE Council President & Chief Executive Karen Kerrigan asserted.
The organization’s chief economist Raymond J. Keating even went so far as to say the proposal smacked of “class warfare.” Indeed, the notion of class warfare has been the rallying cry of hard-right conservatives who don’t like the income redistribution aspects of the legislation. For his part, Rangel has made no secret of the fact that he is attempting to address imbalances favoring the wealthy that were written into the tax code by the Reagan administration in 1986.
In the years since then, there is no denying the rich have gotten substantially richer. The rest of the nation has seen incomes stagnate or rise only modestly. During the current expansion (since 2001), however, the gulf has widened even more significantly, according to the Center on Budget and Policy Priorities, a nonpartisan economic think tank based in Washington, D.C.
Pre-tax income for the top 1 percent of the nation’s households (earning $350,000 a year or more) increased from 17.8 percent in 2004 to 19.4 percent in 2005, marking the highest concentration of wealth since 1929. And the very rich, who make up the top 0.1 percent of households, saw their incomes rise even more, according to the center. “With income concentration returning to its highest level since before the Great Depression, it is difficult to argue that these data depict an insignificant, short-term blip,” the center noted.
Rangel attempts to address the disparity by imposing a 4 percent income tax surcharge on households with $200,000 a year or more in income, or 4.6 percent for those earning over $500,000 ($250,000 for singles). Rangel also would raise the capital gains taxes to 19.6 percent from the current 15 percent rate. Opponents claim that the surcharge would hurt sole proprietors, S corporations, and partnerships because they must treat business income as personal income for tax purposes.
But would it really?
The Tax Foundation, a nonprofit organization devoted to studying the tax code, claims 75 percent of the taxpayers in the highest income tax bracket are small business owners or farmers. But according to the Small Business Administration’s Office of Advocacy, home-based sole proprietors only averaged $62,523 in gross income in 2002 and $22,569 in net income. Sole proprietors with offices or store fronts grossed $178,194 and netted $38,243 after taxes. They not only avoid the surcharge, they would benefit from Rangel’s plan to abolish the Alternative Minimum Tax, which will start hammering the middle class ($75,000 or more in income) this year.
Sole proprietors who have higher receipts could simply incorporate as C corporations. The Rangel measure lowers the tax rate on them to 30.5 percent from 35 percent. The move will save companies $364 billion over the next 10 years. On the other hand, the Rangel bill would raise about $241 billion in corporate taxes by repealing a series of arcane loopholes, such as a deduction for domestic production activities, rules that allow the allocation of interest to foreign subsidiaries, and deferrals for expenses and taxes of repatriated foreign income. Those offsets will affect about 4 percent of small businesses, according to the U.S. Treasury Department.
In another plus for small businesses, the bill would make permanent the Section 179 deduction for plant and equipment expenditures up to $125,000, phasing out at $500,000. Then again, small businesses might be hit by the bill’s repeal of the LIFO (Last In, First Out) inventory accounting method, which would raise about $107 billion over 10 years. Many businesses, however, now use, or will likely switch to, “just in time” inventory management to dodge that cost.
One of the biggest bites out of corporate America will come from the repeal of rules governing taxation of so-called “carried interest” by hedge fund managers. It will raise $25.66 billion over 10 years. Critics argue that it could affect the availability of venture capital for small firms. That may be so, but there is no direct evidence at the moment that venture capital will become less available.
In the end, the full impact, plus or minus, on small businesses has yet to be fully determined. But that hasn’t stopped a full-scale assault on the measure by the Bush administration and other Republicans. The good news is the tax bill is unlikely to pass until after the presidential election next year. That will give small business advocates plenty of time to fully analyze the measure.
But there is one thing the Rangel bill clearly doesn’t do — simplify the tax code. That has long been a top priority for small firms. Until it happens, tax season will still be a punishing ordeal for the nation’s entrepreneurs.