Aug 31, 2011

Narrower Treasury Definition of Small Business Could Mean More Taxes

[caption id="attachment_393" align="alignright" width="425" caption="Narrower Treasury Definition of Small Business"]

[/caption] 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”