Proposed boost in federal income taxes could hurt some small businesses

A new national study has found that a proposed boost in federal income taxes could hurt the small companies that employ the most people.

The report, from Gallup and the National Federation of Independent Business, found that although higher tax rates on personal income wouldn't affect more than 10 percent of all small businesses, the higher levies would ensnare the most-successful small businesses, and the operations with the biggest labor forces.

About half of small-business owners with 20 to 249 employees earned more than $200,000 in 2007, the groups' survey reported. Around 40 percent made more than $250,000.

Just 3 percent of all U.S. companies employ 20 or more people, the Census Bureau says. But that 3 percent has a major impact on job formation: Small companies created 70 percent of the country's net new jobs in the last decade, said Bill Rys, tax counsel for the National Federation of Independent Business.

"If the Nevada economy is struggling, it's really going to be up to small businesses to take those risks and create those jobs," Rys said. "If they don't have the resources to do that, it's going to be difficult for them to lead any recovery."

The Obama administration has argued that the vast majority of small-business owners wouldn't face tax increases, because most entrepreneurs simply don't earn the $200,000 to $250,000 a year that would qualify them for the higher levies. Nor are their companies big enough, the thinking goes, to affect broad swaths of workers.

But Dianna Russo, a local certified public accountant and managing principal of accounting firm Houldsworth, Russo & Co., said her experiences show otherwise.

"Most people think of small business as someone working out of their home making $100,000 a year and taking expenses," Russo said. "But I'm a small business, and I employ 17 people."

What's more, Russo said, about 95 percent of her business clients declare business income on their personal returns, and roughly half of those filers earn enough to see their tax rates rise under the proposed budget, she estimated.

Avoiding personal income tax by shifting business earnings from an individual return to a corporate return isn't an option for many smaller companies, because such a move could result in double taxation. A company owner would pay corporate income tax first. If he then paid his personal income directly from those corporate profits, he'd have to take the cash either as a dividend or a wage, which means a second income tax. The twin levies could mean a tax burden of 50 percent to 70 percent, Russo said. The result: Most business owners don't see any realistic alternative to including business income on their individual returns. And that means they'd have no choice but to pay the higher personal income tax.

Under the proposal, the two highest personal income tax brackets would jump. The top rate, which kicks in at $373,000 a year for a couple filing jointly, would increase from 35 percent to 39.6 percent, the rate in place when Bill Clinton was president.

The second-highest rate, which applies to marginal income between $209,000 and $373,000, would rise from 33 percent to 36 percent.

Meeting that higher tax burden would require businesses to pare expenses in other areas, perhaps reducing charitable contributions, slashing employee benefits or even laying off workers, Russo said.

"People will find ways to make up those tax dollars, and it's usually not in good ways," she said. "I think it's going to have a negative impact."

Rys agreed.

After-tax income represents the No. 1 source of capital for small businesses, so boosting income levies on entrepreneurs takes away their best financing prospect for new equipment, expansion and even paying salaries.

"Something has to give," Rys said.

For Richard Amar, what will give, at least temporarily, are new hires and equipment purchases.

Amar, president and owner of the 39-employee Ritz Cleaners in Las Vegas, said any bump in taxes would force him to wait a few months to bring on new workers or buy new machinery.

But Amar added that he would find a way to expand regardless.

"Anytime there's a tax increase, it affects someone," Amar said. "But you have to grow. You have to spend money to make money. I will not hesitate to buy more equipment. I just have to adjust how and when I buy it. Whether you like it or not, your business has to grow."

But Larry Monkarsh, owner of LM Construction in Las Vegas, said any noticeable bump in tax rates on small businesses would encourage many entrepreneurs to reconsider expanding.

"People will be analyzing things and making conscious decisions as to whether they want to make more money," said Monkarsh, a business owner since 1996 who now employs about 40 workers. "And good entrepreneurs also find new ways to keep their money. I don't mind paying taxes, but I don't like paying taxes when I feel like I'm being singled out. He (Obama) would be singling out me and my peers."

Monkarsh said business owners could decide upgrading an operation wouldn't be worth the cost in added taxes. If buying new machinery translates into 9 percent or 10 percent in additional levies, some managers might skip the improvements, he said.

"Based on what Mr. Obama is planning, the small-business guy could be a thing of the past," he said. "The middle class might be a thing of the past. Look at a guy like me who's middle class. I either want to go up or down. But there wouldn't really be a whole lot for me to go up to. We need to be very careful about changing the climate and makeup of this country by singling out the small-business owner and cutting them out of business."

The higher tax rates look increasingly likely. Both the House and Senate budget outlines debated last week assume Obama's tax increase will pass.

The tax boost will come from allowing tax cuts enacted under former President George W. Bush to expire in 2011.

On tap would be new limits on itemized deductions, including those for home mortgage interest and charitable donations. Obama's proposal also calls for eliminating capital gains taxes on certain small-business stock held for at least five years. He would, however, increase the top capital gains rate paid on other securities from 15 percent to 20 percent.

Supporters and opponents of the plan cite dueling analyses of just how many taxpayers would pony up more under the proposal.

Treasury Secretary Timothy Geithner says 97 percent of small-business owners would see their taxes drop or stay the same under Obama's plan. The plan counts on Congress extending Bush's middle-income tax rates beyond 2010, as well as a new tax credit that withholds $400 to $800 less per year from workers' paychecks.

Geithner's numbers jibe with a widely cited analysis by the Tax Policy Center, a collaboration of two liberal-leaning think tanks, the Brookings Institution and the Urban Institute. According to the analysis, only 1.9 percent of taxpayers who report business income on their individual returns would fall into the top two income-tax brackets.

Republicans cite a different analysis, by the Treasury Department in 2007. That study showed that 8 percent of taxpayers with small-business income fell into the top two tax brackets in 2006 -- about 2.1 million taxpayers. Roughly 1.1 million of those taxpayers received more than half their income from a small business.

Benjamin Harris, a senior research associate at Brookings, said the studies used different definitions for business income and different methods to estimate the percentage of taxpayers in each bracket.

The Associated Press contributed to this report. Contact reporter Jennifer Robison at jrobison@reviewjournal.com or 702-380-4512.