Geithner's Small Business Tax Hike

This week, Congress is considering reforms to the tax code. One proposal though could slam small businesses with the same rules and rates that govern large corporations.

A House Ways and Means subcommittee is considering tax reform on small business. Treasury Department Secretary Tim Geithner has suggested that there should be an examination of “pass-through” entities which allow small businesses to pay taxes at the same rate as individuals.  Any proposals to eliminate the ability of small business to pay taxes at individual rates should scare small business to death.

Generally, I hate the slippery slope discussion, but losing the “pass-through” opportunity for small business has all of the possibility of a very significant long term financial hit (tax increase) on every successful small business.

Virtually any company, small or large, if it has less than 100 shareholders or elects LLC status has the opportunity to have its income taxed not at the corporate level, but based upon individual ownership percentages, calculated and paid at individual levels.

This can be a huge tax break for small business because of the different tax rate schemes for corporations and individuals as well as the fact that these “pass-through” entities are not taxed when previously taxed funds are paid to the owners from their businesses. (There is no tax on these payments by “pass-through entities” as they are not considered dividends.)

The short form on tax rates is that today, individuals who file joint federal income tax returns do not reach the 33% tax rate until there is taxable income of $209,250. Corporate tax rates reach the 34% tax rate at $100,000. The rate swings are no different than at lower taxable income amounts.

So, do the math. Corporations pay higher tax rates and any moving away from the ability to “pass-through” the income to individual owner’s personal tax returns will have to result in higher tax rates and the economic consequences that follow higher tax rates: less job creation and less investment capital.

Add to that the fact that corporate income is taxed both at the corporate level and then again at the individual level after dividends are paid, the totality of possible tax increases for small business is gigantic.

One of the other beauties of “pass-through” entities is that if they lose money, the investor can offset his or her business losses against other income. As a result, investment risk is encouraged and we have resulting small business creation along with job creation.

If new business is going to require the use of already taxed funds and losses being treated as capital losses (identical to investing in the stock market), finding investment dollars for small business is going to be very difficult, if not impossible.

Small business should be terrified of any corporate tax reform that could eliminate “pass-through” taxation and fold small business into the corporate rates and rules of publically traded companies. Not everyone should be taxed under the rules and tax rates that govern Exxon.

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