One of President Joe Biden’s promises during his campaign was that he would roll back the Trump-era tax cuts, and implement a series of new federal tax reforms that would include higher taxes on the wealthy, and raise the capital gains tax. As of today, none of these goals have yet to be accomplished, however, the White House has begun actively working towards some of them.
As part of the Democrat’s $3.5 trillion spending plan, the Biden Administration is seeking a new tax plan that would increase taxes on, according to the administration, the wealthiest Americans. The spending plan, which House Speaker Nancy Pelosi has tied the fate of the infrastructure bill to, would include new government investment and spending in the realms of child care, education, and climate change.
With such an unprecedented level of spending potentially on the way, many Americans, particularly small business owners, have been left wondering who will foot the bill. After all, such grand ambitions will have to be paid for somehow. President Biden has pointed to the tax increase as the way to do this – which rightly raises questions of who will be impacted by the most by these proposed tax hikes. In this article, we’ll discuss some of the details surrounding the proposed tax plan and then cover how it might impact small businesses across America. And while Congress has yet to pass the spending plan (many obstacles, including dissent within the Democratic Party about the spending level, remain in the way), it is still a good idea for small businesses to start thinking about what sorts of consequences the associated tax plan might have on their business if it manages to make its way through both chambers.
What Exactly is the Proposed Tax Plan?
The first order of business in understanding how the Biden tax plan will impact small businesses is to first understand what exactly is even in Biden’s proposal. The tax plan itself is long and complex, so it would be futile to try to reiterate the entirety of it here. Instead, we’ll hit on the major points and cover the tax changes that are most relevant to small business owners.
One of the critical components of the Biden tax plan is to raise the top federal corporate tax rate from 21%, where it currently is, to 26.5%. It is important to remember that the corporate income tax rate would then be above 26.5%, since most states, like California and New York, also tax corporations on their income.
Under this plan, the United States would have the third-highest average corporate tax rate in the Organization for Economic Co-operation and Development (OECD), behind only Colombia and Portugal and far ahead of countries like Germany, Japan, France, and Canada (all of which the United States currently has a lower average corporate tax rate than). Under the initial White House proposal for the infrastructure plan, which would have raised the corporate income tax to 28%, the United States would have had the highest average corporate tax rate in the OECD.
Now, an increase in the corporate income tax would not only impact large corporations across the United States. It would also impact many small businesses that are organized as corporations. However, if your small business is not a corporation that doesn’t mean you are in the clear yet. The Biden proposal also includes tax rate increases that would impact individuals, and thus anyone with a small business that operates as a pass-through entity.
Following up on Biden’s campaign promise to raise taxes on the wealthy, under the new proposed tax policy and spending bill, which is being called The American Families Plan, the top marginal income tax rate would be raised from 37% to 39.6%. Changes to the individual income tax code would impact any businesses that operate as pass-through entities where business income or losses are reported on the personal income tax returns of a business’s owners. This includes s-corps, sole proprietorships, and partnerships. Limited liability companies (LLCs) are also considered pass-through entities. How the tax changes would impact individual businesses would ultimately depend on what tax bracket they fall in.
The tax plan would also increase the long-term capital gains tax rate for high earners. Under the new tax proposal, long-term capital gains and dividends would be taxed as ordinary taxable income for taxpayers whose income exceeds $1 million in a single year.
The plan would also introduce a few business tax credits for certain job onshoring activities as well as for small businesses buying healthcare coverage for employees through the Affordable Care Act (ACA) – colloquially known as Obamacare. The White House has claimed that the latter tax incentive would lead to tax cuts for 3.9 million small business owners. At the same time, the plan would repeal a number of tax credits and tax deductions that are currently being offered to the fossil fuel industry.
Impact of the Biden Tax Plan on Small Businesses
Expected Impact of the Income Tax Increase
The impact that the Biden tax plan will have on small businesses remains a topic of debate. A study released by the U.S. Treasury Department, currently headed by Secretary of the Treasury Janet Yellen, a Biden-appointee, claims that 97% of small business owners won’t face an income tax increase under the Biden tax plan.
However, other groups have argued that this statistic is misleading and leaves out certain important factors. These individuals argue that assessing the economic effect of higher marginal tax rates requires that you look at how much income or investment is impacted as opposed to just how many taxpayers are impacted. A group at the Tax Foundation found that “using data from the 2011 Internal Revenue Service (IRS) Public Use File, we found that the 6 percent of filers with pass-through net income with adjusted gross incomes above $400,000 were responsible for 52% of all pass-through income reported to the IRS. That such a small group of filers generates more than half of all pass-through income implies that taxes that target his group could impact the economy significantly.” As the group points out, this could indirectly impact many more businesses for two reasons:
“Business income is volatile such that many businesses, even small businesses, can expect to earn over $400,000 in a future year even if they earn below that level currently [and…] tax increases on such a large share of pass-through business income can depress economic activity generally, which ultimately reduces demand for businesses of all sizes.”
In essence, the impact of the tax increase could go far beyond just those who it directly impacts by raising their taxes and impact millions of small businesses indirectly by depressing demand and other market factors. This, coupled with the pandemic that has already strained the financial stability of thousands of American small businesses, could mean that the taxes will have a greater negative impact on small businesses than is being portrayed by the Biden Administration.
Impact of the Corporate Income Tax Increase
The National Federation of Independent Businesses has argued that over a million small businesses across the United States would face a tax increase on account of the increase in the corporate income tax. When individuals think of corporations, they often think of massive conglomerates and companies like Apple, Google, Amazon, The Walt Disney Company, and Facebook. However, in reality, many small businesses are organized as corporations for one reason or another (nearly 70% of all C-corps are small businesses).
Certain small business owners might recall that prior to the Tax Cuts and Jobs Act (TCJA) of 2017, which was passed under the Trump Administration, the corporate income tax was actually premised on a graduated rate scale with various tax brackets. Corporations making more than $50,000 were taxed at 25% or more (as high as 35% for businesses earning over $10 million), while corporations making $50,000 or less were taxed at 15%. This meant that when the TCJA was implemented, changing the new corporate tax rate to a flat tax of 21%, many small businesses were hurt.
Under the Biden Administration’s plan, this flat tax rate would now be raised to 28% with no accommodations for those businesses that were at one point being taxed at just 15% on account of their tax bracket. This result would be that in a period of just four years the tax rate on businesses that were making less than $50,000 a year has been raised by 87% – an astronomical amount when you think about the tight margins small businesses often operate on. Such a change in the tax code would further impact thousands of small businesses and Americans that don’t make a large sum of money off their small business every year. Indeed, small businesses organized as c-corps in California and New York would now be faced with a tax rate of well over 30% when factoring in state corporate income taxes. And many Main Street policy experts remain quite concerned that the proposed tax changes – despite targeting large companies like Amazon and Apple – will actually have a bigger and more damaging impact on small businesses still trying to recover from the coronavirus shutdowns.
Impact of the Capital Gains Tax Increase
The capital gains tax increase will undoubtedly have one of the biggest impacts on entrepreneurs who are planning to eventually exit from their business with a profit. Selling a business that you have owned for more than a year is considered a capital gain and is thus taxed at the capital gains tax rate. Under the Biden Administration’s tax plan, the tax rate on capital gains of over $1 million in a single year would essentially double. This will undoubtedly change the calculus for entrepreneurs across the nation as well as individuals, like venture capital firms, that plan to invest in them.
Currently, the highest capital gains tax rate is 23.8%. Under the new proposal, the top capital gains tax bracket would be 39.6%.
Impact on Payroll Taxes
One thing that will certainly benefit small businesses (or at least not negatively impact them) is that Biden’s tax proposal didn’t include any increases in the payroll tax contributions for Social Security. One of the things that the Biden Administration and other Democrats had been considering was doubling the payroll tax contributions for Social Security at higher income levels. This, of course, would’ve increased the tax burden for most small businesses. It remains to be seen whether or not the Biden Administration or Democrats in Congress will pursue this increase in the future. For now, Congress and the administration certainly have their plate full with the current spending bill and tax reform measures.
What are the Odds that the Spending Bill and Tax Reforms Pass?
At this time, it is still to be seen whether or not Biden’s proposed tax hike will make it through Congress. Though the preliminary budget blueprint passed the Senate, Democratic Senators Joe Manchin and Kyrsten Sinema remain opposed to such a massive spending package. Since the Senate remains split evenly with 50 Democrats and 50 Republicans, the Democrats will need both of their votes to pass the spending plan. President Biden has been meeting with both Manchin and Sinema in order to try to persuade them to his side, however, reports indicate they remain quite skeptical.
This doesn’t even account for the opposition the bill may face in the House Representatives, where the Democratic majority is narrow and more moderate Democrats have already begun voicing concerns. The house only narrowly approved the initial $3.5 trillion budget blueprint. It remains to be seen what will happen if it comes up for a final vote.
Understanding the PRO Act and Employee Benefits Changes
One of the changes that small businesses are most concerned about is the PRO Act proposal. Under this proposal, more freelancers would have to be classified by businesses as employees – which would increase the financial burden placed on businesses by employing them.
Kevin Kuhlman, the Vice President of federal government relations at the National Federation of Independent Business, explained to CNBC that, “It seems that these policies are targeted at large corporations, but the problem is the burden falls on smaller businesses.”
In fact, a recent survey conducted by Alignable found that 45% of small businesses said that the changes made under the PRO Act would destroy their business. Currently, the Biden Administration plans to include elements of the PRO Act in the massive spending bill and tax reform proposal. Not only would this plan hurt small businesses that employ independent contractors and freelancers, but it would also hurt independent contractors and freelancers themselves by decreasing overall demand for them.
The United States is regarded as one of the most pro-business nations in the world. However, one of the biggest challenges small businesses have faced over the last decade or so is the constant back and forth on tax policy between Republicans and Democrats. The potential for dramatic changes to the tax code makes it increasingly difficult for small businesses to plan for the future in an effective and appropriate manner. The Biden Administration’s new plan is no exception.
While the bill has not yet passed – and many obstacles remain for it – small businesses should still invest some time into familiarizing themselves with the changes it would make.
In particular, it would be a good idea for small businesses to begin thinking about how the changes might impact their business specifically. At the same time, small businesses should try not to get too wrapped up in the potential changes until they appear more set in stone. That means while it may be a good idea to think about how the tax changes may impact your small business, any changes you might make to your business to prepare for them should only be made once the bill has actually made its way through congress.
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