Taxes and other legislative actions have an undeniable effect on human behavior. Regardless of what you may believe about taxation and regulation—whether or not it’s beneficial—most people cringe when it comes to paying taxes (or being forced to comply with bureaucratic regulatory mechanisms). Being the ingenious species that we are, we tend to approach any type of restrictions by doing one, or perhaps all, of the following:
- Comply with the system
- Leverage the system to find loopholes for our benefit
- Outright refuse to comply with the system.
Big corporations (the looming C corps) tend to have an army of corporate attorneys at their beck and call. A new regulation from Congress? No problem, have one of the attorneys—who may also be a lobbyist—contact a key Congress member on the committee that wrote the regulation. An increase in taxation? Time to call the tax attorney, they’ll advise on the best path to avoid more taxes.
Meanwhile, small corporations (S corps), LLCs (if they’re not filing as a C corp), sole proprietors and freelancers don’t have the same access to high-level resources for keeping their taxation and regulatory costs low. This is also true for small C Corps. Before we move forward with the discussion on Trump’s proposed tax reform as it relates to small business, it bears emphasizing that this isn’t an excoriation on the C Corp behemoths. The power of the large C Corps is mentioned to underscore the distinct disadvantages that smaller enterprises encounter when having to grapple with the same issues successfully.
Small Business Burdens
Admittedly, due to political reasons, it’s difficult to find news presented in a neutral tone about the Trump Administration. Despite this fact, since Trump has assumed office, a distinct boost in small business optimism has occurred. On the surface, this may seem at odds with the fact that Trump himself is an icon of big business. Yet, if you read his tax reform plan, he specifically mentions small businesses as the “true engine of our economy.” According to the Small Business Association, Trump is correct:
- Small businesses account for 99.7% of the total number of businesses in the U.S.
- 48% of U.S. employees work for small businesses
- Small businesses have produced 65% of new jobs since 1995
Currently, the U.S. has the highest corporate tax rate worldwide: 39%. For the smaller enterprise, this represents a large financial levy on their earnings. Pass-through taxation for sole proprietors (including freelancers), partnerships and S corps doesn’t solve the issue of high taxation. Keeping in mind that deductions often lower where the entrepreneur falls within the marginal tax rate, the single taxable income threshold is 25% for those earning between $37,951 and $91,900. With the average salary of a small business owner hovering between $25,000 and $152,000, the single taxable income rate can range from anywhere between 15% to 28%. (For related reading, see: 5 Tax Breaks Overlooked by Small Business Owners.)
While still much lower than the 39% corporate tax rate, this does not relieve small business owners from the cost of additional regulations, such as the Affordable Care Act (ACA). Indeed, the National Small Business Association released the results of a survey stating that “the average small business owner is spending at least $12,000 every year dealing with regulations.” The Affordable Care Act and the federal tax code were the top two financial burdens.
The details of Trump’s tax plan are still being hammered out through the sinuous Congressional pathways. But, the initial proposition of an across-the-board 15% corporate tax rate is a promising relief to small businesses.
Furthermore, the narrowing personal income tax to three “buckets” may also provide a boost to the small business bottom line. If we take the average salary of a small business owner, $25,000 to $152,000, and apply it to Trump’s plan, the highest they will pay is 25%. On the lower end of the scale, a small business owner can owe 0% to 10%.
Currently, there is still a war raging about repealing and replacing the Affordable Care Act. Granted, the ACA isn’t the only regulatory burden that small businesses face. And adding regulations costs both the taxpayers and businesses of all sizes and scope a hefty amount of money. In 2016, 401 regulations were added, which increased the taxpayer-funded implementation of those regulations by $164 billion. (For related reading, see: Government Regulations: Do They Help Businesses?)
There are many moving parts involved in both the implementation of a new tax plan and rolling back regulations which dampen the ability of a small business to grow. Certainly, since both affect more than just small business owners, the politicians must use a scalpel rather than a sledgehammer when removing—or adding—taxes and regulations. Meanwhile, many small businesses quietly wait to determine whether or not they’ll spend their earnings on hiring new employees (thus helping to boost the economy) or sending the money to support increased bureaucracy.
(For more from this author, see: Finding the Right Financial Advisor for You.)