Tax Cut Debate Affects Small Businesses

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businessCurtis Hamilton says he wants to hire more programmers and buy computer hardware for his Escondido, Calif., human resources firm. But he’s worried that his taxes will go up next year, and with the economy still struggling, he’s holding off.

“It gives me pause because I don’t know whether to hang on to the cash or whether to make the investments,” said Hamilton, 67, who founded Tri-Ad 35 years ago and now has about 100 employees.

People like Hamilton are the prime reason, Republicans argue, that the Bush-era tax cuts for those making more than $250,000 should be extended beyond their Jan. 1 expiration.

The GOP contends that tax cuts for wealthier Americans would pay an important dividend: Many of these people are small-business owners, and they are more likely to hire or invest in their businesses if their taxes don’t go up next year.

But President Barack Obama and most Democrats contend that small-business owners would not be affected much because only about 3 percent of them earn more than $250,000 a year. Democratic leaders agree with Republicans that those earning less should get a permanent tax break.

Rick Poore helps make their case. The owner of a Lincoln, Neb., clothing firm that employs about 30 people, Poore supports letting the top-level tax rates go up. The reason is simple: He won’t be affected. Poore, 56, and his wife clear about $140,000 a year from the business.

“The only people I can think of who can honestly call themselves small businesses that this would affect would be stockbrokers and lawyers,” Poore said. “And I don’t have a lot of sympathy for either of them.”

As the White House and lawmakers struggle to come to a compromise, Hamilton and Poore highlight the difficulty in determining the effects of an increase in the top-level tax rate. The truth might lie somewhere in between.

“It matters if you raise these taxes,” said Mark Zandi, chief economist at Moody’s Analytics. “It does affect small-business people — and particularly successful small-business people who are going to be hiring — but it is a small number of businesses that will be impacted.”

For privacy and other reasons, there’s not much definitive tax data on small businesses. What’s available includes a wide variety of businesses that report income on individual rather than corporate returns. They range from mom-and-pop operations to large law firms and hedge funds structured as partnerships.

Because of changes to the tax code, the number of companies reporting income on individual tax returns has increased dramatically in the past three decades.

Profits at typical corporations are taxed twice: once at the corporate level and again when distributed to owners and other shareholders as dividends or capital gains.

But companies can also file as S corporations or partnerships. The business income flows to the owners or partners and is reported on their individual returns, so profits are taxed only once.

Hamilton’s company, an S corporation, will have about $12 million in revenue this year. He owns the firm with his son, Thad, and how much they pay in taxes affects how they run their business, Hamilton said.

“Whatever profit we make at the end of the year is taxed to us at personal income rates,” said Hamilton. “Tax rates always have an impact on our ability to grow the firm.”

Hamilton opposes any tax increase, a position shared by groups such as the National Federation of Independent Business and the U.S. Chamber of Commerce.

“When you’re running a business, $250,000 is not that much money,” particularly in Southern California, he said.

“Maybe it’s more money than the average working person, but any business person knows how much risk they take in trying to start a business and run it.”

Hamilton wouldn’t say exactly how much he earns, but it is more than $250,000. A tax increase would make it harder for him to accumulate the working capital to hire new people or invest in new equipment, he said.

Just as big companies have been hoarding cash and avoiding much hiring, small businesses are sitting on cash “because of the uncertainty of the economy,” Hamilton said.

“The uncertainty of the tax rates all play incremental pieces in the decisions of any of us,” he said.

Poore, whose DesignWear Inc. takes in about $2.25 million a year, disagrees. He supports the expiration of the top-level tax cuts, pointing out that the costs of employees and equipment, such as a new automatic garment press he is purchasing, reduce his taxable income.

“I went out and bought an $80,000 piece of equipment. I did it so I wouldn’t have to pay taxes,” Poore said, adding that he plans to hire a new employee to run it.

“That’s how small business works. We reinvest in our businesses. We try to minimize the amount of taxable income we have,” he said.

Some small-business groups, such as the Main Street Alliance, a national network of state-based small-business coalitions, also support letting the top-level tax cuts expire.

“It’s disingenuous for people to say this is going to have such a horrible affect on small business if they let these expire,” Poore said. “Either they’re honestly ignorant of how this really works, or they’re being intellectually dishonest.”

The nonpartisan Congressional Budget Office said in a report in February that extending the tax cuts would not do much to create jobs.

Although an extension would help a company’s bottom line, “increasing the after-tax income of businesses typically does not create much incentive for them to hire more workers,” the CBO said. Demand is the principal driver of those decisions, it said.

Democrats and Republicans base their arguments on data from Congress’ Joint Committee on Taxation.

This summer, the committee estimated that 3 percent of taxpayers who had net business income — about 750,000 filers — would be affected if the current top-level rates increase. And those filers account for half of the approximately $1 trillion in net business income reported on all individual returns.

Tax experts said there’s no way to know whose income that is because the data can’t be tied to specific companies.

“We don’t know if this is the owner of a small tool-and-die plant or a McDonald’s franchise or a partner in KPMG,” said Scott Hodge, president of the nonpartisan Tax Foundation.

“The Republicans have been a little fast and loose in trying to define all of these taxpayers as small-business owners,” he said. “The lack of data has created this political debate, which gives a lot of leeway on both sides to kind of stretch their arguments.”

The Tax Foundation’s own analysis found that if the top-level tax cuts expire, just 39 percent of the additional money raised by the government would come from business income.

Hodge also criticizes Democrats’ argument that an increase in the top tax rates would cause little harm to small businesses because only about 3 percent of them would face the increase.

“Statistically speaking, only about a half a percent of all Americans will be diagnosed with cancer in any given year, and we take that pretty seriously,” Hodge said. “So to try to minimize the economic impact by saying only 2 to 3 percent of taxpayers will be affected is, to some degree, economic malpractice.”

Source: McClatchy-Tribune Information Services.