The Treasury Department wants to narrow the definition of small business in America. And small-business owners might wind up paying more taxes as a result.
There isn’t currently a standard definition for a small business, according to the Treasury Department. But a new report indicates that the fight to rewrite the tax code in Congress will start with defining what a small business is, precisely.
What’s believed to be behind the move is the all-too-common Washington, D.C. answer: politics. Small-business owners are commonly used as a political football when it comes to discussions of tax reform. So the Treasury Department has released a new, narrow methodology to define small business, which shrinks the number of small businesses and their assets dramatically.1
The narrower Treasury Department methodology defines a small-business owner as someone whose active profit or loss from the business represents, at a minimum, 25 percent of her adjusted gross income.1 The Internal Revenue Service draws the line between small and other business at $10 million in income or deductions.
So, what does this mean?
First, many S corporations and other “flow-through” entities are currently defined as small businesses when they’re really anything but small. And Uncle Sam wants a bigger cut.
“Before this, you had the largest law firms in America, with revenues over $1 billion, and they were being treated as small businesses,” said Edward Kleinbard, USC law professor and former chief of staff of the Joint Committee on Taxation,2 in a Bloomberg article.3 “That’s just preposterous on its face.”
The Obama administration and Democrats in Congress have long advocated for closing tax loopholes for businesses as a means of raising revenues. Opponents say revising the tax code will hurt small businesses. So, if the Treasury Department can narrow the definition of what a small business actually is, the impact on tax reform will be minimized.
Bloomberg paraphrased Payson Peabody, former tax counsel to former Sen. Jim Bunning, R-Ky., as having said that “Democrats could use the proposed definition to argue for tax increases.”3
“In the short term, this report is aimed at Republicans in Congress who say that raising top rates would impact small business,” Peabody told Bloomberg.
According to a study for the S Corporation Association of America,4 more than 90 percent of corporations are structured as flow-through entities, and from 2004 to 2008, the business owners paid 44 percent of all federal business taxes when they filed their individual tax returns.
The Wall Street Journal5 reported that the narrower Treasury Department small-business count revises the number of small businesses in 2007 from 20 million to 12.9 million and from $376 billion in net income to $335 billion in net income.
“Although ‘small-business owners’ are often the subject of tax-policy debate, a consensus does not exist regarding the specific attributes that distinguish small businesses from other firms,” the Treasury Department report said. “Previously, the Office of Tax Analysis had counted a small-business owner as any individual who receives flow-through income from a sole proprietorship, partnership, S corporation, farming operation, or miscellaneous rental activity. This overly broad definition was used because, for the majority of flow-through business income (partnerships and S corporations), it was not possible to trace income from the business entity to the respective owner(s). Due to newly accessible tax data, this technical constraint has been overcome.”
For more information, visit:
1. “Methodology to Identify Small Businesses and Their Owners”
2. Joint Committee on Taxation
3. “Higher Business Taxes May Follow Treasury’s Definition of Small”
4. “The Flow-Through Business Sector and Tax Reform”
5. “Using New Definition, U.S. Treasury Report Finds Fewer Small Businesses”