The new presidential administration has proposed a large new tax bill to offset other priorities such as improving infrastructure, funding the American Rescue Plan, combating employment inequality and tackling climate change. These are expected to be financed with increased taxes targeted at high income brackets and corporations. According to the Tax Policy Center, the tax hikes would generate $2.4 trillion dollars between 2021 and 2030.
We have been getting questions lately on how the new tax bill will affect small businesses. The main points the new tax bill proposes should not affect most small businesses and Biden has made it clear that he will only tax “the rich.” But what does that actually mean for small businesses owners?
Corporate Tax Rate
The proposed corporate tax rate would see an increase from 21% to 28%. This is still less than under other presidents such as Clinton, Bush, and Obama where the corporate tax rate was 35%. This is good news for the small businesses that have been hit the hardest in 2020 since they will most likely be exempt. The last thing the administration wants to do is put these businesses through more hardship. Big giants such as Amazon and WalMart who have significantly profited from the pandemic will see this tax increase, while the mom and pop ski shop most likely will not.
You may be wondering how you know if your business is in line with the tax increase since there is not a clear definition of what constitutes a “small business”. While this is not yet determined, it will most likely be that the administration sets a threshold of greater than 2.5 million dollars in annual profit or over $400,000 in individual income. Only about 10% of businesses would fall into this category while the rest of the 90% of businesses will see no change to their corporate tax rate. It’s targeting Wall Street not Main Street.
If you are a pass through business owner (s-corp, LLC, partnerships, and sole proprietors) which is the category most of our clients fall under, the tax bill would phase out the qualified business income deductions if you make over that 2.5 million dollar profit or over $400,000 in individual income. Let’s break this down into two scenarios.
Joe owns a small business named “Joe’s Ski Shop.” His annual profit is $400,000. He pays $100,000 to his employees and he pays $100,000 (subject to typical payroll taxes) to himself as a salaried employee. This leaves $200,000 as business profit left over to be taxed at ~20%. Therefore; his tax bill in April would be roughly $40,000 ($200,000 x .20). Since his personal income is under $400,000, nothing would change for Joe.
Mary owns a large advertising firm. Her annual profit is $2,000,000. She pays $1,000,000 to her employees and she pays herself $500,000 leaving an additional $500,000 exposed. Under Trump’s tax plan, that $500,000 of exposed income would be taxed as qualified business income (pass through income) at around ~29%. With Biden’s new tax plan, since her income is so high, she would not be able to have the pass through deduction and would be taxed in the highest proposed income bracket which is 39.6%. Therefore; her tax bill in April would be $198,000 ($500,000 x .396) under Biden’s policy, a $50,000 increase.
In order to avoid large corporations from manipulating the system and paying no corporate taxes, Biden has proposed a 15% minimum corporate tax. It may come as a breath of fresh air to stop hearing stories about large corporations paying no federal income tax and in some cases even receiving a refund.
In order to increase production in the United States, there is a proposed 10% “Made in America” tax cut for companies who produce products in the US and hire US employees instead of farming out work overseas.
In order to successfully navigate any changes, here are a few tips for small business owners:
1- Wait until the tax plan gets signed. Right now, the Biden administration has been focused on COVID relief and like all of America has not paid much attention to taxes yet… We cannot predict the future and until we get a concrete plan, there’s no sense in stressing. It’s just a proposal right now and will have a long road ahead to become policy.
2- Stay informed and collaborate on the best way to handle any changes that could be coming your way. Does it make sense to put more into retirement? Should you switch to growth mode and hire more people instead of putting profit in savings?
3- Schedule a meeting with a consultant. Our team of experts can help you navigate the dynamic and rapidly changing tax policy to get you set on the best strategies moving forward. No small business is the same and having a professional on your side could save you thousands.
Unless you fall into the top 1%, the new President has said that he will not raise taxes on small business. If you’re a startup or small business not making a huge profit, there is no reason to lose sleep over the proposed tax plan. You would be better off brainstorming about how to position your business to capture the economic lift created from all the new infrastructure projects that will happen in your area. Construction workers spend those paychecks on Main Street.
However; nothing is set in stone and our team is diligently monitoring the situation to see if anything changes. If you are wondering how the new proposed tax plan will affect your small business, reach out to our team of experts and schedule a free consultation.