How The Fiscal Cliff Deal Affects Small Business With Higher Taxes

COMMENTARY | Small businesses have come under fire as of late. As previously reported by The Inquisitr, small business in America seems to be dying, with less Americans willing to take the risk to be an entrepreneur. The recent Fiscal Cliff deal only adds to the uncertainty that small business owners now face.

As previously reported by The Inquisitr, the Fiscal Cliff deal raises taxes not only on the rich but on the average worker. According to Forbes, the Alternative Minimum Tax, or AMT, is scheduled to affect 100 million people, and your paycheck will have an extra two percent deducted automatically to pay for Social Security. The super-rich will especially feel the sting of capital gains taxes, which affects wall street investors, going up by five percent with an additional 3.8 percent going to funding Obamacare. But how will all these changes affect small business?

The President and the Democrats have long argued that raising the top marginal income tax rates would only affect three percent of small-business owners. As previously reported by The Inquisitr, this number ignores the fact that they are including the self-employed or contractors, who likely are not hiring others or could be considered a mom-and-pop small business as people normally define the term. But how you choose to define “small business” largely affects the substance of the debate.

According to The Wall Street Journal, 98 percent of jobs were through small businesses and 48 percent were projected to see their taxes rise:

“The 3% figure, which is computed from IRS data, is based on simply counting the number of returns with any pass-through business income. So, if somebody makes a little money selling products on eBay and reports that income on Schedule C of their tax return, they are counted as a small business. The fact that there are millions of people in the lower tax brackets with small amounts of business income may be interesting for some purposes, but it is irrelevant for the assessment of the economic impact of the tax hikes. The numbers are clear. According to IRS data, fully 48% of the net income of sole proprietorships, partnerships, and S corporations reported on tax returns went to households with incomes above $200,000 in 2007.”

According to Small Business Trends, if you include all the self-employed the “numbers from the U.S. Treasury show that a tax increase on businesses earning more than $1 million per year would affect less than seven percent of small companies but would hit 81 percent of small business income.” This shows just how important definitions are to this discussion since The Washington Post also makes mention of small businesses making more than $1 million, and they claim that number stands at 14 percent.

These numbers are likely including people who get at least 25 percent of their adjusted gross income from small business income, but separating out self-employed contractors from those who are “truly” a small business is difficult. Fortunately, independent contractors, which also includes news writers, will be spared a tax hike for the moment. But besides arguing over definitions let’s see how the Fiscal Cliff deal affects most small businesses.

According to The Washington Post, about 750,000 taxpayers account for 50 percent of the estimated $1 trillion in small business income reported in 2011 and these are the largest categories:

“[R]etail trade (such as mom-and-pop shops) accounted for about 11 percent of so-called S corporations, holding 12 percent of total assets, and five percent of partnerships, with less than one percent of total assets. Another 14 percent of S corporations were in construction but the largest category, at 15 percent, were ‘professional, scientific and technical services.’… it would seem the big money is being made by a relatively small group of companies, law firms and the like.”

Many of these businesses have income levels that are concentrated in the $200,000 to $500,000 category. Based upon the Fiscal Cliff deal, if your small business makes less than $400,000 and files single, or less than $450,000 on a joint return, your top ordinary rate is still 35 percent just like in past years. Above that it climbs to 39.6 percent, amounting to a 4.6 percent tax increase for small business owners.

For the sake of the ease of calculating, let’s start with $400,000 and calculate how much the new taxes will cost. The tax increase of 4.6 percent amounts to $18,400 which is worth about one employee making a little under $9 hourly before benefits. A small business making $1 million would be forced to lay off a middle class employee making $46,000. So either small business owners are going to be forced to lay off one person, raise prices on their services and goods, or they’re going to have to figure out how to cut other costs to make up the difference. These numbers do not even include the extra cost that Obamacare adds to small businesses.

There is one silver lining to this gloomy fiscal cloud. According to Forbes some small businesses may be able to benefit from a new tax credit:

“The other benefit that jumps out at me from this tax deal is IC-DISC. I’ve written on this in the past – this is a tremendous tax benefit for exporters (including computer software – software done here but sold overseas; architects, engineers – building designed here but built overseas). This tax benefit is for small and medium manufacturers who export — but also for businesses who manufacture a part, for example, an engine that goes on a plane that is exported. In a nutshell, the benefit is derived from getting dividend tax treatment for what would otherwise be ordinary income. Think big tax savings.”

What do you think about the Fiscal Cliff deal after seeing these numbers?