The truth about taxing those wealthy small business owners

In case you haven’t been paying attention, in his address to Congress last week, President Obama promised to raise the marginal income tax rate on the top 2% of taxpayers to help pay for his new agenda and to give the other 98% of taxpayers a tax cut. Now, most folks probably think that this elite group of Americans can handle a tax increase. After all, we’re talking about people like Bill Gates and Alex Rodriguez, right? But in his speech, the president goes on to further define the people on his hit list. Specifically, if you have annual taxable income of more than $250,000, you’re wealthy enough to pay more.

Lately there seems to be some confusion about whether this attempt at redistribution of wealth will impact small business owners. So let me provide some clarity with a small business story that plays out across America every year.

This particular small business will put $100,000 on the bottom line of its Profit and Loss statement. Most big businesses blow more than that every year in wasted soap in the men’s rooms. But for a small business to accomplish these numbers, someone had to work extremely hard and very smart, and at some point along the way, risked everything.

The owner of this small business pays herself $75,000 in annual salary. Not too bad by national average income standards, but still less than she made when she worked for a big company and, when the work, worry and risk-taking is considered, not enough. Oh, by the way, this business that our intrepid entrepreneur started from scratch now provides livelihood, benefits and prosperity for the families of its ten employees. Meanwhile, the spouse of this employer has a job elsewhere that pays him $95,000 annually.

It’s important to note that this small business, like millions of others, is structured legally as a Subchapter S Corporation. That means that any profits produced are distributed to the owner as taxable income to be included with her personal tax reporting. Since this couple files a joint tax return, they have annual gross income of $270,000. Allowing for reasonable personal deductions, their taxable income is over $250,000. It should also be noted that a goodly portion of the hundred grand of business income does not exist as cash - it’s tied up in inventory, accounts receivable, etc. - but still taxable.

According to President Obama, this couple, like Warren Buffet and Oprah, is among America’s wealthy and should pay more taxes. But here’s a critical piece of information that I doubt our President understands: Ask small business owners – as I have – what they would do if they paid lower taxes and every one will tell you that they would re-invest that precious capital in their business. That means buying more capital goods and employing more people. In 2009, it might mean surviving.

So, with all due respect, Mr. President, if you want to get our economy going again, not only would you not raise taxes on even one member of the sector that creates over half of the U.S. economy, signs the front of over 70 million paychecks each Friday, and creates most of our new jobs, but you will find out what they need to help them grow their businesses and do that – all of it. Even if it means you have to cut back a little on your ill-conceived Robin Hood act and even if it means you have to let GM, Chrysler and AIG get a little less bail-out money.

And trust me, sir, this strategy will be time and money well spent for our country - and the world. And here’s a political bonus you probably haven’t considered: it will do more to help you get re-elected in 2012 than anything else you could do.

Recently, on my small business radio program, The Small Business Advocate Show, I talked about the difference between the Obama world view and the world view that I believe is good for small business. Take a few minutes to listen to my thoughts on taxes and other issues. And be sure to leave your thoughts.

5 Responses to “The truth about taxing those wealthy small business owners”

  1. 5
    Rogers Smith Says:

    Well put Jim. Why should we punish those whose blood, sweat and tears has allowed them to get a little ahead. The top 2% already pay a lion’s share of US taxes. If we punish success, success will leave us.

    If the country needs higher tax revenue, lower taxes. What!?

    That’s right, lower them. As Arthur Laffer pointed out, within reason, lower taxes actually raises government revenue. This fact has been proven over and over again. Virtually every tax cut over the last 100 years grew the government coffers by stimulating economic activity. More money in our pockets…we create more jobs.

    Why cannot the public (and politicos) understand this?

  2. 4
    John Dini Says:

    Right on, Jim! And not only do we get to pay more taxes, but we are seeing our interest rates on working capital lines jacked up to pay for those “bad” debtors, paying more fees on our bank accounts to “make up” for increased FDIC premiums, and watching our hard earned SIMPLE IRA and Roth dollars evaporate in the meltdown of a financial bubble we did not participate in.

    I’m just waiting for you to tell us when enough is enough. The widespread belief is that we will “just work a little harder to make it up.” I’m getting tired of working just a little harder.

  3. 3
    Robert Levin Says:

    There is more Jim. If you live in NYC, or even the NYC area, the cost of living and state and local taxes are astronomical. In fact with this tax increase, the effective tax rate for a family earning around $250,000 is close to 50%. That leaves $125,000 or so to pay for rent or a mortgage (I am guessing that the average home price in the area is around $600,000-$800,000), classes and/or private school for the kids, and other routine expenses that are priced much higher in this area.

    When you factor in flow-through entities like LLCs and S corps, at best this will put business owners in the position where they can’t reinvest in their businesses. At worst, some businesses will go under.

    So what does all this pay for? It pays for the stupid risks taken by many on Wall Street, who have cashed out in the millions. Oh yeah, it pays for a lot of other bailouts of people who, at the end of the day, don’t put their necks on the line like business owners do. Probably the same people who will come to us for jobs soon. I don’t blame them. But I do blame the governments who want to raise on the “rich”.

    PS - while we are at it here, people keep asking me what do small businesses get out of the Stimulus Act? Ask anyone who understands it (e.g., accountants)… small businesses get just about nothing of value.

  4. 2
    Bob Kustka Says:

    Jim,
    I wholeheartedly agree with your point that the best stimulus for the economy is to put money in the hands of the small business owners who will spend on new equipment and create new jobs as their businesses grow. They are the backbone of America and represent our best chance to stimulate the economy. The bailouts for many of the large players amounts to feeding the bloated corpocracy, especially as their CEO’s continue to spend excessively and are rewarded despite poor performance (see my post on CEO pay http://thefusionfactor.typepad.com/).

    We do need to find a way to raise more revenue to fund the stimulus. Taxation is a necessary evil at this point and we will need to place a greater burden on those who have the ability to contribute, but we also need to put mechanisms in the tax code that allows the small business owner to plow his profits back into the business without penalty and reduce his overall burden.

  5. 1
    William Halal Says:

    Dear Jim:

    Yes, I know how you feel, and nobody would dispute the claim that small business is the backbone of the economy. But I think the issue is a little different - we need a slightly different system to overcome the flaws that produced this American bubble and it’s horrible collapse.

    We should be quick to note that none of us has the answers, but I do think we can improve the economic system as a whole, and Obama is trying to find ways to do that. Better education, more efficient health care, sophisticated regulations, alternative energy, and other forms of infrastructure seem a good place to begin.

    But it takes resources to improve a system, and I feel it is reasonable to ask the top 2% of our society to shoulder a larger burden since they have profited so much during the past few decades while others saw little gain.

    Why not think of this as an investment in our economic system? I hope this is useful is making the adjustments facing the U.S. more acceptable.

    Bill

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