Caution: Government at Work

Back in the 60s, Eldridge Cleaver said “you're either part of the solution or you're part of the problem.” Today, while government tries to be part of the solution, it seems to be the problem.

Taxes
According to NFIB’s Small Business Economic Trends June 2010, the second most important problem facing businesses (after sales) is taxes. In addition to increases in many state taxes, here’s what small business owners face in the coming years on the federal level:

  1. Elimination of special treatment for dividends. Currently they’re taxed at no more than 15%; starting in 2011, it’s likely that they’ll be taxed like other ordinary income, at rates up to 39.6%. This means closely-held corporations lose the opportunity to make tax-favored distributions to owners.
  2. Hike in the top tax rates and end to numerous tax breaks. The expiration of the Bush tax cuts as scheduled at the end of 2010 will mean top tax rates on individuals (which includes many small business owners) of 36% and 39.6%. The expiration of the cuts will see the return of the marriage penalty and the elimination of a host of tax breaks; all this results in higher taxes.
  3. Additional Medicare tax on wages and self-employment income. Starting in 2013, there’s an added 0.9% tax for those receiving wages and/or self-employment income over $200,000 ($250,000 for joint filers; $125,000 for married persons filing separately). For joint filers, this additional tax is imposed on the combined wages/self-employment income of the spouses.
  4. Medicare surtax for investment income. Starting in 2013, there’s an added 3.8% Medicare tax on net investment income over $200,000 ($250,000 for joint filers; $125,000 for married persons filing separately).

When these tax hikes are added to state income taxes, some individuals may find themselves with effective tax rates (for income and Social Security/Medicare taxes) well over 60% of their income.

Owners selling their businesses at a profit will face higher capital gains rates after 2010. The top rate, currently 15%, is scheduled to increase to 20%. The Congress is debating a small business jobs bill  which would allow a 0% tax on certain small business gains. However, this tax break would only apply to sales of stock in certain C corporations held more than five years, so it would have limited benefit for the sea of small business sellers.

Health care burden
While the health care reform package exempts small businesses (those with fewer than 50 employees) from being required to pay for employee health care starting in 2014, the package contains numerous other taxes and rules that will burden small business, including:

  • Including employee health coverage on W-2 forms after 2010, whether the coverage is paid by the employee, employer, or a combination of both.
  • New 1099 reporting payments of $600 or more for goods and services of any provider (not just independent contractors), starting in 2012.

Regulations
Research by the SBA’s Office of Advocacy shows that firms with fewer than 20 employees annually spend 45% more per employee than larger firms do to comply with federal regulations. While this office works with state and federal agencies to help reduce this burden, the burden persists. The Annual Report of the Chief Counsel January 2010 said that in the three decades since the passage of the Regulatory Flexibility Act of 1980 (RFA) (and amendments made by the Small Business Regulatory Enforcement Fairness Act of 1996), which requires agencies to analyze the impact of their proposed regulations on small businesses, small business continues to be burdened by regulations.

What to do?
There’s no quick fix. Entrepreneurs likely will continue doing what they do, and paying the price, because it’s in their nature to work, create, and earn. They will face higher taxes but will meet the challenge. They’ll deal with health care mandates. They’ll handle regulations applicable to them.

Lobbying at state and local levels for change can be an effective strategy (read the August issue of Big Ideas for Small Business® on how to do this).

Electing new government representatives at all levels of government will result in some change, but even a dramatic shift in the makeup of Congress will likely not produce dramatic change. Government is what it is: a big bureaucracy encumbered by high debt (with some exceptions, like North Dakota), with both the size of government and the amount of debt growing all the time. Government tries to be all things to all people, and it costs small businesses for this goal.

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