The Impact of the Senate and House Tax Bills on the Small-Business Owner
Bluntly, the House tax bill does very little for small-business owners. The Senate bill, however, has a glimmer of hope for us, and hopefully, the objections and concerns of Wisconsin Sen. Ron Johnson (and the other senators working behind the scenes to help protect small-business owners' interests) will be heard.
Over the past three weeks, I have been extremely vocal about my personal concerns regarding the House bill and what should change in the legislation before it becomes law. In fact, I will go as far to say that the House version hurts small business and the average small-business owner.
In fact, I was shocked to see Treasury Secretary Mnuchin's comments that this legislation substantially helps small-business owners. Either his definition of "small business" is far from that of mine, yours and the Small Business Administration (SBA), or he can't do math. Since he is the Treasury Secretary, I'm going to assume we have a definition problem.
But enough rhetoric. Let's actually break down the bill, and I'll give you the pros and cons of both the House and Senate Bills in a simple, easy-to-understand format (at least, as easy as humanly possible with over 750 pages of combined legislation material to pour through and decipher).
Moreover, at the end of this article, I'm going to give you the method and resources to contact your elected representative, and preferably your senator, to express your concerns and plead for some relief for the small-business owner as reconciliation between the two bills takes place over the next few weeks.
Now, as we dive into the numbers, it is important to put this bill in perspective regarding the "facts" being thrown around. It may be interesting for you to note that the IRS and SBA have an extremely broad definition of "small business." Believe it or not, under both of these institutions, a small business could be anywhere from two employees to 500 employees, or sales from $7 million to $35 million.
However, according to the U.S. Census Bureau in 2014, there are two critical facts you and I need to recognize:
- According to the definition of "small business" by the SBA and IRS stated above, in 2014 over 97.9 percent of these small businesses had less than 20 employees or no employees at all, and ...
- Among employer C corporations in 2014, 85 percent had fewer than 20 employees, and 99 percent had fewer than 500 workers.
The point is that, when the GOP leadership stands up in front of the microphone or camera and says that this legislation is going to substantially help small business, or "Main Street," you shouldn't be fooled by the smokescreen. There is a very slim cross section of small-business owners this legislation will substantially benefit, and it's primarily big businesses, not the firms with less than 20 employees.
Moreover, legislation from both the House and Senate delivers a whopping 15 percent permanent and across the board tax cut to large corporations, not the 97.9 percent of small-business owners or 99 percent of C corporations that have no global impact and need a tax cut to be competitive.
The benefits to the pass-through businesses that the GOP leadership loves to boast about are so convoluted, complex and watered down, they're truly a joke. In fact, if I were IRS Commissioner John Koskinen, I would be thrilled to get this legislation on my desk. The IRS has been trying to find any method to further regulate pass-through compensation for years!
This legislation will give the IRS carte blanche latitude to now further scrutinize officer/owner compensation. In fact, it will have a negative impact on pass-through tax planning, potentially even lessening the whole benefit of a pass-through company. The negative impact this legislation could have on millions of S corporation owners is actually frightening.
Here is what the small-business, pass-through business owner really gets in terms of tax savings:
Provision: Maximum 25 percent tax rate for flow-through entities
House Bill: No savings whatsoever until a business owner makes at least $260,000 Married Filing Jointly (MFJ) or $180,000 (after salary). In order to save just $5,000 in taxes, a business owner needs to make $426,666 MFJ or $346,666 Single (after salary). Is this the impact you need in your business to expand and grow? Bottom line: Not helpful for large majority of small-business owners.
Senate Bill: N/A
Provision: 9 percent tax rate on first $75,000 MFJ or $37,500 Single
House Bill: Save $750 MFJ in 2018/2019 and $375 Single. Save $1,500 MFJ and $750 Single in 2020/2021. The most a taxpayer will save is $2,250 MFJ in 2022. Personal service businesses get to participate in this benefit. However, it phases out completely at $150,000/$75,000 of income, and is this "significant savings" that will affect your business to hire more employees? Bottom line: This deceptively isn’t good for small business when you weigh the meager benefit compared to the increased scrutiny from the IRS on salary levels and pass-thru income.
Senate Bill: N/A
Provision: 17.4 percent deduction against pass-thru income from pass-thru businesses. For personal services such as health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services and brokerage services.
House Bill: N/A
Senate Bill: Phases out entirely at $150,000 MFJ and $75,000 Single filers, and starts phasing out at half-way there. The most a small-business owner will possibly save is $1,044 MFJ/$522 Single, and if you make more than $50,000/$25,000 it’s reduced from there. Bottom line: A minor benefit at best, and if you are in a personal service business making this level of income, it won’t last long.
Provision: 17.4 percent deduction against pass-thru income from pass-thru businesses.
House Bill: N/A
Senate Bill: This is a 17.4 percent deduction from qualified business income/trade or business, not including salary. No phase out, but it is limited to 50 percent of the salary of the business owner, which you want to keep as low as possible anyway. Thus, it will make for some creative planning opportunities. Approximate savings of $11,484 MFJ, assuming a business owner with a $75,000 salary and $200,000 in net income, the deduction would be approximately $35,000 and in a 33 percent tax bracket (under Senate Bill). However, it does not apply to Personal Service Firms. Bottom line: I can’t imagine tax savings being more than $15,000 to $20,000 for a successful business owner and a salary of approximately $96,000.
Provision: Entertainment expense
House Bill: Completely repealed: Not good. Business flourishes with constructive meetings between business owners, vendors, customers and employees.
Provision: Business tax credits: Employer-provided child care, rehabilitation credit, work opportunity tax credit, new markets tax credit, building access for disabled individuals, employee tips and various energy credits.
House Bill: The House bill repeals a long list of business tax credits that help motivate wise investment and business development.
Rather than just complain and not give any constructive recommendations, here are the 10 changes I would propose to the House and Senate:
- Change the Senate version of the flow-through business deduction of 17.4 percent to 12.4 percent and allow all trade or businesses to use it, including personal service firms, with no phase out limitations.
- Don't use any provisions of the House bill in regards to flow-through entities.
- Do not eliminate the entertainment deduction for business owners (part of the House bill). Audits and tax court guidance have prevented its abuse for years and will continue to do so.
- Keep the current provision of selling your personal residence with the two out of five year rule.
- Keep the Coverdell IRA (the 529 is a Wall Street strategy and we should encourage saving for education, not discourage it)
- Continue to allow for Roth IRA re-characterizations (it's not being abused, the IRS just hates it and Social Security is tenuous at best -- we need Roths!).
- Multiple business tax credits are gutted with the House bill. Leave these alone. They make sense for business and encourage wise business expenditures and investments.
- Go ahead and double the standard deduction and "simplify" tax returns for millions of Americans that own modest homes, rent and have a W-2 -- great ... but don't touch the itemized deductions. Leave them alone for those who want to and can use them. Don't touch the State and Local Income Tax (SALT) deduction, mortgage interest, charitable and medical itemized deductions.
- Yes, I know that these 10 recommendations will cost (at least the eight above). So, what you do is to reduce only the corporate tax rate to 25 percent or 27.5 percent in order to pay for the cuts above. Big corporations don't need all the breaks in this bill.
- Moreover, to help pay for the above cuts for "Main Street" and small-business owners, no one in the top 2 percent of income in the U.S. needs any sort of tax break. Gut those provisions out of the legislation, period.
In summary, I cannot emphasize enough how important this is for you, the small-business owner, to take seriously and contact your elected official. Share your concerns. Demand more. The two senators from your state are probably the best method to hopefully finding some resolution. This is primarily because the Senate has a much slimmer margin for victory and have to carve out a bill during the reconciliation that will pass the Senate.
Go to https://www.usa.gov/elected-officials to find the phone number and email addess to your senator and send a message immediately. This is your government. Demand more for Main Street.