6 Tax Reform Changes Needed to Help Small Businesses Grow
Every politician claims they want to help small businesses. Here are six ways they actually can.
We always hear how small businesses are the backbone of the US economy and rightfully so -- they account for more than half of all jobs and sales in the US. However, even though this entrepreneurial cohort is 28 million strong, their fragmentation -- from different industries to different sizes to different geographies -- often leave them behind when it comes to legislation.
As the president and Congress look to tackle much-needed tax reform, I'm concerned there aren’t enough small business voices at the table ensuring that the reform thoughtfully includes the needs of the various types of small businesses in our economy. This is critical as Congress evaluates President Trump’s outline of reform priorities and tries to make tax reform a reality.
Here are some of the items that they should make sure are included in any final regulation to benefit small business.
1. Ensure small businesses benefit from tax rate reductions.
It is widely believed that a lower corporate tax rate will be a cornerstone of any tax reform plan, and that makes sense, given that we have the second-highest corporate tax rate in the entire world. However, without careful planning, that won’t benefit most small businesses, as the majority of entrepreneurs use pass-through entities like single-member LLCs and are taxed at an individual tax rate, not a corporate one.
While President Trump’s campaign proposal did recognize this, it is of key importance to find an easy way to handle it in any legislation. The rate small businesses owners pay on their income should not be any higher than the rate that bigger companies pay.
This should also go for freelancers, who are becoming a bigger part of the workforce and, in effect, are their own solo businesses.
Also, if small business owners are accommodated with a lower rate, that accomodation shouldn’t be negated by the Alternative Minimum Tax formula (which should go for its own reasons).
2. Offer thoughtful pension options.
One of the only benefits of the current archaic tax code for a small business is that there are various pension plans that can allow business owners to put away six figures a year on a tax-deferred basis. The options and incentives for small business owners to continue to save for their retirement should not be sacrificed during reform, but should be significantly simplified, so it’s easier to implement and easier to understand.
It should also not create disincentives for hiring. Based on the way certain plans are required to be structured by the current tax code, you can’t add employees (or add hours to certain existing employees) without offering them plan access, which can be a deterrent to hiring.
3. Revise the 1099 definition.
If you are confused by the difference between a 1099 worker/independent contractor and an employee, you are not alone. Per the IRS, “Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee. You do not generally have to withhold or pay any taxes on payments to independent contractors.”
This may seem like a small distinction, but to small business owners who are already consumed with burdensome administrative tasks, not to mention a cost structure that may not be yet scalable, it is a significant one.
While small businesses make extensive use of independent contractors and freelancers as a way to fill in gaps in their business, the IRS says that if you perform work that would be done in the normal course of business by an employee (including, among other things, not setting your own hours or methodology for completing the work), you are considered an employee, not an independent contractor, for tax purposes.
This stands even if you own your own firm or have additional clients.
This outdated definition creates a barrier to hiring for small business owners because, for example, a freelancer may be considered an employee by IRS standards, creating additional paperwork and compliance for a small business owner.
If a small business only needs a person for projects, shortened hours or even for part of the year, having an expanded 1099 definition would allow an independent contractor to be employed by multiple businesses without creating redundancy in administrative work.
As reporting is taken care of (currently via W-9 and 1099-MISC forms) and if both parties are in agreement that an independent contractor arrangement makes sense, why would the government stop that? Income and other taxes are still getting paid. While businesses pay and collect Social Security and Medicare taxes (aka FICA taxes) for each employee, an independent contractor is subject to self-employment taxes, which cover both Social Security and Medicare contributions in an amount roughly equivalent to the FICA tax.
This simple definitional change is critical for allowing small business to grow and more jobs to be created.
4. Allow for the expensing of capital investments.
The current tax code considers a business's major capital outlays (property, equipment and more) as capital investments instead of expenses. This means that you can only expense (for tax purposes) a portion of the investment over its useful life.
As a simplified example: If the expected useful life of a piece of technology is 5 years, you can only expense 20 percent of what you paid per year for five years.
In recent years, there have been some temporary rules that allow small business owners of a certain size to be able to fully expense these “investments” immediately, up to a certain cap. This should be fully allowed at any time for all businesses (especially small businesses) with no caps as a way to encourage the investment needed for growth.
5. Stop penalizing family businesses if someone dies.
The estate tax (or “death tax”) is supposed to be one of those “stick it to the 1-percenters” types of legislation. The tax, which penalizes estates valued over a certain mark, not only raises very little revenue each year, but often affects small, family-owned entities who have the majority of their wealth tied up in their business.
No family should be forced to sell a small business because a family member has passed away. That’s a completely inane and damaging tax rule.
6. Abandon extra taxes.
Tax reform doesn’t work if other taxes end up getting piled on. One that could be a big issue for small businesses is the talked-about border tax. As a good number of small businesses rely on international markets for raw material imports and also as potential customers for their own products, creating taxes that further limit free trade will be felt strongly by entrepreneurs.
While there are certainly other considerations related to small business owners and taxes, making these six changes would be a huge step toward helping our small businesses continue to prosper and hire.
Carol Roth is the creator of the Future File™ legacy planning system, a “recovering” investment banker, business advisor, entrepreneur and best-selling author. She is also a reality TV show judge, media contributor and host of Microsoft’s Office Small Business Academy. A small business expert, Roth has worked with companies of all sizes on everything from strategy to content creation and marketing to raising capital. She’s been a public company director and invests in mid-stage companies, as well.