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The tax burden facing entrepreneurs is a heavy one. Indeed, some on Capitol Hill say entrepreneurs are the most overtaxed group in the United States. To help on this front, congressional leaders have set forth an agenda to bring about some long overdue relief. President Bill Clinton has also proposed some tax-related measures as part of his fiscal year 2000 budget package, including several tax credits that Congress typically renews each year.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 13 years.
Clash In Congress
While the congressional hopper is churning, analysts say compromise between Republicans and Democrats over specific tax proposals may be difficult to achieve because a good deal of political maneuvering is already taking place in preparation for the presidential elections. Nevertheless, momentum and support for a tax-cut bill are building, especially in light of last year's budget surpluses. "Money is burning a hole in the pockets of lawmakers,' says Thomas P. Ochsenschlager, a tax partner in the Washington, DC, office of accounting firm Grant Thornton LLP. "They're anxious to give their constituents some tax cuts."
Republicans are pushing for a $15 billion tax-cut package, which is likely to include some adjustment in the marriage tax penalty. As part of the package, the GOP has also agreed to wall off a portion of the budget surplus to help shore up Social Security. President Clinton, on the other hand, maintains that the bulk of the surplus should go to relieving the strain on the Social Security system.
While the debate over the size and specifics of a possible tax bill continue, advocates of tax relief for entrepreneurs believe they can muster enough support this year to pass their proposals. Here are some of the more important small-business tax measures on the horizon, as well as the outlook for their passage.
There are plenty of backers in Congress for legislation that would allow the self-employed to deduct 100 percent of the cost of their personal and family health insurance even sooner than had originally been planned. Sen. Christopher S. Bond, (R-MO), chair of the Senate Committee on Small Business, is the number-one sponsor of the Self-Employed Health Insurance Fairness Act (S.343), which would increase the deductibility to 100 percent beginning this year. The self-employed health-care deduction now stands at 60 percent and is scheduled to reach 100 percent by 2003.
The bill also has a new twist: It would allow a deduction for the business owner even if he or she could obtain health insurance through a spouse, regardless of whether the business owner takes advantage of the insurance or not. Under current law, the self-employed lose all their health-insurance deductions if they are eligible to participate in another health-insurance plan.
Bond cites Steve Hagan, a financial planner in Mexico, Missouri, who runs his own small business, as an example. Although Hagan has established a group medical plan in his employees' benefits package, he can't currently deduct the cost of covering himself or his family because his wife is eligible for health insurance through her employer.
Supporters say Congress is likely to pass the measure, if not this year, then next.
Estate Of Affairs
Rep. Christopher Cox (R-CA) has rallied nearly 200 members of the House to sponsor the Family Heritage Preservation Act (H.R. 86). The bill would eliminate individual estate taxes.
This measure is of particular interest to owners of family businesses, who argue that estate taxes make it extremely difficult for them to pass on their businesses to successive generations. Federal estate taxes can eat up as much as 55 percent of a company's assets, often meaning heirs have to sell the business to pay the taxes on it. According to Cox, the bill's prospects for passage look good in the wake of a Congressional Joint Economic Committee report indicating estate taxes have the potential to cause slowed economic growth, reduced social mobility and wasted productivity.
Tax analysts, however, believe the Cox plan goes too far in its attempt at total repeal. What may happen instead, says Ochsenschlager, is that Congress will pass a partial reduction in the existing tax that would provide at least some relief for family business owners.
Several other measures of importance to small business that stand a good chance of passing this year are the "extenders." The president's budget plan includes proposals to extend the work opportunity credit, a welfare-to-work credit, and a research and development credit, all scheduled to expire this year.
Accountant Ken Powell, a tax partner with accounting firm David Berdon & Co. LLP in New York City, says, "The extenders have traditionally been extended, leading taxpayers to frequently ask, `Why keep extending them; why not make them permanent?'" For its part, Congress prefers to consider them annually.
When lawmakers take up the extenders this year, they may consider a new tax credit proposal outlined in the president's budget package. The new proposal would encourage more entrepreneurs to offer pension plans to employees by lessening the costs of establishing these plans. Under the proposal, business owners with 100 or fewer employees would receive a credit equal to 50 percent of the first $2,000 spent for first-year administrative and educational costs associated with setting up a new qualified benefit or defined contribution plan. In the second and third years, the credit would equal 50 percent of the first $1,000 of such expenses.
Proposals such as this one are attractive to lawmakers and can gather substantial bipartisan support. In this case, however, lawmakers are likely to have a difficult time deciding how to raise the revenue to pay for the deductions, says Susan Jacksack, a small-business analyst with CCH Inc., a provider of legal, tax and business information in Riverwoods, Illinois.
On the tax-hike front, President Clinton has proposed doing away with what he calls "corporate welfare" by closing a few loopholes. One of particular interest for small to midsized businesses would make converting from a regular corporation to an S corporation taxable.
Under the proposal, says Ochsenschlager, "Any appreciated property at the time of conversion would be taxed as if the property had been sold and then contributed to another corporation." If Congress agrees to the proposal, 1999 would be the last year corporations could switch to an S corporation without paying a tax. The president has included an exception to the proposed change for companies with a value of $5 million or less at the date the company decides to become an S corporation. Currently, making the change from a regular corporation to an S corporation is tax-free for both the corporation and its shareholders. Although it's not clear whether the proposal will pass, Powell advises regular corporations seriously thinking about a conversion to take action this year while the process is still tax-free.
While a good number of tax proposals for small companies are under consideration, ironing out a compromise between the Democrats and Republicans remains a major challenge. Even so, says Ochsenschlager, "There's tremendous pent-up demand in both tax-writing committees to provide some tax benefits." With such a climate brewing, analysts remain hopeful that tax relief for entrepreneurs is on its way.
Tuition Tax Savers
Skirting estate taxes while helping pay your child's college expenses
There's a unique way to fund your child or grandchild's college education and receive a sizable estate-tax break to boot. Qualified State Tuition Programs, basically tuition savings plans with an estate planning component, are just now attracting attention. Thanks to a small but powerful section of the 1997 tax law, these plans allow you to make tax-free gifts and still keep control of the account--which means Junior can't blow the money on a shiny new sports car if he decides to skip college.
Even better, your contributions count as a completed gift. This means if you die before the money in the account is used, it isn't counted as part of your taxable estate.
Money in the savings account grows tax-deferred until the student begins to withdraw it to pay for tuition and other education costs. Earnings from the account are then taxed at the student's tax rate.
As has been the case for quite some time, taxpayers are able to give up to $10,000 per year tax free ($20,000 for a couple) to each beneficiary they designate. But annual gifts greater than these amounts count against the lifetime gift tax and estate tax exemption. With this new savings plan, the donor can put $40,000 into a college savings account for a child or grandchild immediately and have it count as the next four years' $10,000 gifts. In addition, the future appreciation on that amount is in the beneficiary's account rather than the donor's estate.
By the end of the year, 43 states will offer these plans through brokers and banks, and more are sure to follow. Currently participating states include Connecticut, Delaware, Indiana, Iowa, Montana, New Hampshire, New Jersey, New York, Rhode Island and Tennessee. Check with the treasurers in each state for specific details.
Some states' plans allow you to change the beneficiary or take the money back if you need to do so. If you die within five years of giving the money, a prorated amount would be placed back into your estate.
Surprisingly, this remains a little-known tax benefit that could save you a bundle in estate taxes, while helping to pay for your children's and grandchildren's education. It's well worth checking out.
David Berdon & Co. LLP, (212) 832-0400, http://www.dberdon.com