Archive for February, 2012

Is the LLC Dead?

Thursday, February 23rd, 2012

Or will it, as well as other pass-through entities, become relics after enactment of a 28% corporate tax rate. That’s something that should be on the mind of most small business owners who operate their companies as sole proprietorships, partnerships, limited liability companies, or S corporations.

Proposed cut in the corporate tax rate
The President has proposed to cut the current 35% corporate tax rate down to 28%. This move is designed to make U.S. corporations more competitive worldwide and makes good sense from this perspective. Last October, Rep. Camp (R-MI), who is the chairman of the House Ways and Means Committee, proposed a 25% corporate rate. There is little argument from anyone of most any political persuasion to keep the current high rate in light of the U.S. having the second highest corporate tax rate (behind Japan).

When a change could be expected, and how the change would be paid for (e.g., from cutting corporate deductions as proposed by the President) remains to be seen. Many think that there won’t be any change before the presidential election in November.

Impact on small businesses
While it may be many months or more before there is any reduction in the corporate tax rate, it’s important for small businesses to assess what a change would mean to them. Most small business owners pay tax on their share of business profits on their personal returns, so their tax rates are personal, not corporate.

While the President has proposed a reduction in the corporate rate (the rate paid by C corporations), he has also suggested an increase in the top rate for “high income” taxpayers (those with income over $200,000 if single or $250,000 if married filing jointly). The top rate on these individuals could rise from the current 35% (the same top rate on corporations) to 39.6%. In addition, starting in 2013, high income taxpayers could pay an additional 3.8% Medicare tax on unearned income plus 0.9% on earned income. In effect, the tax rate on certain individuals could be more like 44% (depending on their overall level and type of income). This would be 16% higher than the highest rate on corporations after the rate cut.

How does this play out starting in 2013, assuming the corporate tax cut and personal tax hikes take effect? Let’s compare a one-owner C corporation with a one-owner LLC:

Say the corporation earns $2 million (after deductions other than the owner’s salary) and the owner takes a salary of $100,000. The corporation would pay tax on $1,900,000. Using the flat tax rate for purposes of this example (in reality the rates would be graduated), the corporation would owe $532,000 in federal income taxes; the owner would pay personal income tax (assume a 25% tax rate) of $25,000, for total taxes of $557,000.

Now assume that the LLC earns the same $2 million. There is no deduction for salary to the owner because he/she is not an employee (the owner merely takes a nondeductible draw). The $2 million passes through to the owner and is taxed at the owner’s rate. The owner would pay 39.6%, or $792,000, plus $0.9%, or $18,000 (this example again ignores the graduated rates and floor for the additional Medicare tax), for a total tax of $810,000. This is $253,000, or more than a quarter of million in extra taxes.

Again, the numbers aren’t exact; they are merely illustrative of the growing spread that will result between the tax on C corporations and the tax on owners of other types of entities.

Bottom line
Across-the-board tax cuts would be welcomed by business owners. However, cuts likely will be paired with reductions in various write-offs. There’s no free lunch, and business owners will continue to pay taxes on profits. Their tax bills could remain relatively constant after rate reductions if write-offs they’ve used in the past are eliminated. The November election will certainly have an impact on any tax changes to come.

President’s 2013 Budget Proposal — What’s in it for Small Business?

Thursday, February 16th, 2012

Not much!  At least that’s the consensus among a number of small business experts. Here’s a brief overview of what the President has proposed:

Overall budget

The proposed federal budget would be $3.8 trillion for fiscal year 2013 (starting October 1, 2012, and ending on September 30, 2013). After spending cuts and increased revenue, the budget is projected to result in a $901 billion deficit.

Increased revenue would result from:

  • $1.4 trillion in new revenue, primarily raised from new or higher taxes on so-called “wealthy” individuals
  • $364 billion in savings from lower healthcare spending over the next 10 years


Tax changes

The changes would largely result from letting the Bush-era tax cuts expire for “wealthy individuals” ($200,000 for singles and $250,000 for joint filers) and by codification of the so-called “Buffett rule,” which requires those earning over $1 million to pay at least 30% in federal taxes.

It would also cap personal/dependency exemptions and itemized deductions for high earners. Most significantly it would change the capital gain tax rate and treatment of qualified dividends for these same high-income taxpayers so that the capital gain rate would be 20% (instead of 10%) and qualified dividends would be taxed as ordinary income rather than at capital gain rates.

According to the Treasury’s Green Book, which is an explanation of the tax proposals in the budget, there are several tax incentives for small business included in the budget proposals:

  • Extend 100% bonus depreciation through 2012
  • Create a new tax credit for small businesses that add to payroll
  • Transform the deduction for energy-efficient commercial buildings into a tax credit
  • Double the domestic production activities deduction from 9% to 18% for certain manufacturers
  • Make permanent the 100% exclusion for gain on the sale of qualified small business stock
  • Double the write-off for startup costs
  • Expand and simplify the credit for small employers providing health coverage

What the budget means to you
It’s way too early to assess the provisions in the budget. The Senate has yet to pass any budget for the three years, and there’s little reason to think it would do so now, during this election year.

However, if the suggestions in the budget were to be approved, I don’t think small business comes out ahead. Just the opposite, it seems that small business will be the ATM machine for continued federal programs, including extensions for unemployment benefits and entitlement programs.

From a tax perspective, since most small business owners report their share of business income on their personal returns, it’s likely that any tax breaks from these proposals would be canceled out by the new tax burden on so-called “high-income” taxpayers.

Let’s keep a close watch on what Congress does with these budget proposals. It would mean that we’ll have to ante up more!

Future Hiring Expectations

Thursday, February 9th, 2012

Jobs numbers announced on February 3 were surprisingly good. More jobs were created than had been expected and the nominal unemployment rate dropped. Maybe we’ve turned a corner in the economy and can expect things to continue to improve. At least that seems to be the sentiment from the Wells Fargo/Gallup Small Business Index for the fourth quarter of 2011.

The Index shows:

  • Small business hiring intentions are the best since 2008
  • 22% expect to increase the total number of jobs in their companies over the next 12 months

But looking closer at the results of the Index, there are some disturbing finds:

  • Only 26% of small-business owners said they would hire full-time employees, compared with 72% who said they’d rather add temporary or contract workers (36%) or part-time workers (36%)
  • 21% of owners said it is very to find the qualified employees they need for their businesses; 32% said it was somewhat difficult to find qualified employees

Why these disturbing results? It doesn’t look like small businesses are doing any significant job creation. Small business traditionally has been responsible for 60% to 80% of all job growth, but in recent years it has been lagging in this regard and likely will continue to do so.

Maybe owners are still feeling shaky after the recession and don’t want to commit to full-time workers at this time. Maybe tax uncertainty, the potential costs of health care, and regulatory burdens continue to plague small business owners.

For a robust economy, we need to create about 2.5 million jobs each year (4 million were lost during the recession). But maybe we need to reexamine the jobs that are needed so people can be trained to do them. Manufacturing jobs likely will continue to decline over time (despite a recent uptick).

I’m not an economist; I’m a small business owner who speaks to other owners. The consensus is that the environment for hiring is still not good. But let’s remain hopeful!

40,000 New State Laws!

Thursday, February 2nd, 2012

An estimated 40,000 new laws have already taken or will take effect in 2012. Many rules apply exclusively to consumers, but many other new rules affect businesses. Businesses will have to familiarize themselves with the new laws and comply so that they avoid penalties and other problems. Some rules may exempt small businesses; often the definition of what constitutes a small business varies, so it’s not easy to determine whether your company is exempt.

Learning about new laws

It’s a challenge for small businesses to keep up with changes in government rules—be they statutory (new laws) or regulatory (issued by government agencies such as the IRS and EPA). I monitor numerous government sites daily and I’m certain many changes slip by me.

While you’re busy running a business, how can you also stay up on new rules you need to know about? Here are two ways:

  1. Be a reader. Find the sites, blogs, and other resources that can help you stay abreast of new rules from the government. Industry associations and trade groups can help. My Idea of the Day® and Big Ideas for Small Business® present many of the changes you need to know about. Following these resources won’t cost you any money, but there is a time commitment you’ll need to handle.
  2. Work with a proactive attorney. Many law firms send their newsletters to alert clients to relevant changes. Working with an attorney may cost you billable hours, but save you penalties and hassles with the government.

Cost of compliance
In 2010, the SBA’s Office of Advocacy released a report showing the cost of compliance on small businesses. At that time, the cost of compliance was $1.75 trillion annually. The largest burden falls on small firms (those with fewer than 20 employees), which represent 89% of all small businesses in the U.S. On average small firms pay 36% more than large firms (those with 500 or more employees), but the cost for EPA compliance is four times as much for small firms as large one.

In round numbers, regulatory compliance costs small businesses more than $10,000 for each worker each year. How can this continue? The cost is still rising (remember the cost does not even reflect the increased burdens of Obamacare which are yet to take effect).

Any hope for change in 2012?
Last year the President issued an executive order to improve regulation and regulatory review. The intention is good; the results so far have been questionable.

Small businesses have yet to see any significant results from government on this issue. What’s needed is not just an executive order; we need more common sense from government officials. A small business should not be shut down (because of onerous fines) for a minor, unintentional, infraction. Regulations certainly have their place to protect the public, but overregulation doesn’t help anyone but the bureaucrats who are authorized to enforce them.