Tax-bill’s small-business problem: Most wouldn’t benefit
WASHINGTON — The House Republican plan to cut taxes for small businesses has a big problem: It wouldn’t help most of them.
The typical small business, whether it’s a sole proprietorship, partnership or limited liability company, doesn’t pay taxes itself, but its owners do as individuals.
And already about 86 percent of these so-called passthrough businesses pay no more than 25 percent under the individual code, the new top rate proposed for smallbusiness income in the tax bill announced last week. So they wouldn’t get the legislation’s much-hyped small-business tax cut.
On top of that, the bill would make it very difficult for lawyers, engineers, doctors, consultants and other personal services providers, who make up a good share of small businesses, to qualify for the 25 percent rate.
“The whole thing doesn’t work for most small businesses,” said Jack Mozloom, spokesman for the National Federation of Independent Business, which said it does not support the bill at this point.
"We think there ought to be a substantial benefit for everybody,” he said.
Rep. Brad Sherman, D-Sherman Oaks, an accountant and attorney who practiced tax law before he was elected, said the pass-through tax changes would be of no benefit to the vast majority of small businesses.
“It’s the worst idea I’ve seen in a long time,” he said. “It’s able to combine incredible unfairness with a level of complexity beyond any provision of the tax code dealing with domestic income.”
The centerpiece of the Republican bill is business tax cuts to spur economic growth and job creation.
The tax rate for corporations would be cut to 20 percent, from 35 percent, and they would no longer be taxed on most foreign earnings.
But specifically cutting taxes for pass-through businesses, which would also include S corporations — a structure often used by midsize businesses that might sell shares of stock — is more difficult. Their net income is subject to the individual tax code, which has a top rate of 39.6 percent.
So House Republicans proposed a new way to encourage investment by small businesses through a formula that seeks to tax revenue applied to capital expenditures at 25 percent. However, ordinary wage income paid by small businesses would not get the preferential rate and would continue to be subject to the individual tax code.
“We drive almost half a trillion dollars of tax relief for our Main Street job creators,” said Rep. Kevin Brady, R-Texas, chairman of the taxwriting House Ways and Means Committee.
But most of the benefit from that new 25 percent rate — which the congressional Joint Committee on Taxation estimated would reduce taxes collected from small businesses by $448 billion over the next decade — would flow to a small percentage of business owners.
Only about 13 percent of businesses paid more than the 25 percent tax rate this year but they accounted for 77 percent of all pass-through income, according to the nonpartisan Tax Policy Center. Depending on their income, they now pay top marginal rates ranging from 26 percent to 39.6 percent
“It’s only people above the 25 percent bracket who can even possibly benefit from the preferential rate,” said Joseph Rosenberg, a senior research associate at the center.
The current 25 percent rate kicks in for income above $91,900 for individuals and $153,100 for couples. The House Republican tax bill would raise those thresholds to $200,000 for individuals and $260,000 for couples.
But the typical NFIB member wouldn’t benefit from such changes, Mozloom said, since the average small business has five employees and $75,000 in taxable income.
“If the point of tax reform, as the drafters claim, is to lift the U.S. economy and boost Main Street America, it ought to boost Main Street America,” he said. “The way they’ve structured it now, it’s not truly a business pass-through rate.”
Pass-through businesses with net income above the 25 percent tax bracket level would have two options for claiming the preferential rate under the bill.