Barbara’s Blog

Will federal sequestration—the automatic budget cuts set to take effect on March 1—impact you? It depends on your business and on who you ask.

What is sequestration?

Sequestration is the name for federal budget cuts (primarily in defense spending) scheduled to begin on March 1 if Congress fails to find way to make required budget cuts to meet a pre-set level. The exact amount of these cuts is difficult to determine; it changes from source to source (I’ve seen mention of $85 billion in initial cuts). Overall, sequestration is supposed to make cuts of $1.5 trillion over 10 years. Also, sequestration means that the federal government is limited in the amount of additional borrowing. Details about the cuts from sequestration can be found in a Congressional Budget Office Report.

Sequestration was suggested by President Obama and agreed to by Congress in the Budget Control Act of 2011 as part of a compromise to raise the federal debt limit.

Which businesses will likely be impacted?

Entrepreneur Magazine said sequestration could result in a “dramatic decrease” in government contracts (how much is unclear). The Chairman of the House Small Business Committee agrees. Many small businesses receive contracts directly or as subcontractors of prime contractors.

A White House blog fact sheet sequestration could result in fewer SBA-guaranteed loans. These are commercial loans that receive government guarantees. The fact sheet pegs the cutback at $902 million.

The New York Times reported that a senior policy analyst with the National Federation of Independent Business thought it impossible to predict the impact of sequestration on small business and whether it would hurt the economy.

Final thoughts

Let’s be realistic about the specter of sequestration vis-à-vis small business. Not every small enterprise is in the market for a loan or is a government contractor. Little else has been discussed on the overall impact that sequestration would have on small business. The actual budget cut resulting from sequestration is only a drop in the federal budget bucket (probably about 2%). Many businesses I know would readily cut their budget by this amount if they didn’t have the funds to pay 100% of what they had previously expected. Why shouldn’t the federal government do the same?

What’s more, even if March 1 comes and goes without further Congressional budgetary action, nothing prevents some activity down the road. Let’s not panic. Let’s wait and see.

Legislation, the Marketplace Fairness Act of 2013 (H.R. 684; S. 336) was introduced in Congress last week. The bill would effectively impose state sales taxes on Internet purchases even though sellers are in different states from buyers.

More specifically, the law would allow a state to enforce its sales tax rules against Internet sellers in other states. The purpose of the legislation is to put bricks-and-mortar stores based in states with sales taxes on a more competitive basis with Internet-based sellers who, until now, have offered their customers a sales-tax free ride.

The challenge for Internet-based sellers is to deal with 9,600 sales tax jurisdictions (counting not only state but local sales tax rates). The bill addresses this problem by requiring states to simplify their sales tax rules on “remote sales.” Toward this end, states must set up a single agency for sellers to deal with for collections, filing returns, and audits. States must also make available to Internet-based sellers at no cost the software that can be used to make them sales-tax compliant. Sellers that use certified software providers (currently Avalara, ADP, Accurate Tax, Exacto, and FedTax) to figure collections would have no liability for any errors made by these companies.

Alternatively, states can work within the existing Streamlined Sales and Use Tax Agreement.

The bill would not necessarily change sales taxes, but would not bar any changes either.

Small business exception

Despite the simplification requirements in the bill, sales tax collection on remote sales, followed by remitted collections to multiple states, and filing sales tax returns in multiple states will be burdensome. The good news: The bill would exempt “small sellers” from collections and other related sales tax responsibilities. The exemption would apply to businesses with less than $1 million in gross annual receipts from domestic online sales.

Prospects for passage of the bill

The idea of requiring remote sellers to collect sales taxes is not new. The Main Street Fairness Act was a regular feature on the legislative calendar in recent years but failed to gain passage.

This bill is different and has a greater chance of success. It has extensive bi-partisan support and the support of a number of major business groups, including NFIB and the National Retail Federation. (It is opposed by the American Catalog Mailers Association and eBay, among others.) And, because a number of states are in a revenue crunch that could be somewhat alleviated by new sales tax collections, there is extensive support from state legislatures and governors.

Find out more about the bill and its progress in Congress here.

A century ago this month (February 25 to be precise), the 16th Amendment to the U.S. Constitution was ratified, allowing for a direct tax on income:

“The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

We call this the income tax. The following are some interesting factoids about our beloved tax (my sources are “Our Changing Tax Laws,” issued by CCH in 1988 on the 75th anniversary of the income tax, and the National Taxpayer Advocate’s Annual report released last month.

Then

• The federal tax law was 16 pages.
• Every citizen with net income of $3,000 or more was required to file a return.
• The return contained graduated income tax rates of 1% to 6%; the top rate applied to income over $500,000. The first 1% was a normal tax; the additional tax rates were a super tax.
• The tax return was three pages; another page was instructions.
• The return had to be signed before an officer authorized to administer oaths.
• The filing deadline for individuals and corporations was March 15th. (The due date changed after enactment of the Tax Code of 1954.)
• Tax was collected by the Bureau of Internal Revenue. (The Bureau became the Internal Revenue Service in 1953.)
• You can view the original income tax form, called Form 1040 even then, at the Tax Foundation.

Now

• Today the Internal Revenue Code is comprised of nearly 4 million words.
• 59% of taxpayers use paid preparers.
• Individuals and businesses spend about 6.1 billion hours and $168 billion each year filing returns and complying with the tax law.
• By my last count, there were at least 18 different definitions of “small business” (some dependent on income, some on assets, and some on the number of employees) and taxpayers must distinguish between a qualifying child, a qualifying dependent, and a qualifying individual (all who are the same in most cases) for different tax credits.
• The Internal Revenue Service (IRS) processes more than 133 million returns.
• The IRS collects taxes of more than $1.2 trillion.

Tomorrow

What is the future of the income tax? There is much talk about sweeping reform to eliminate “loopholes” (which are merely tax breaks created for special purposes, such as encouraging home ownership or charitable contributions) and, perhaps, reduce tax rates to a flat (or nearly flat) rate.

Personally, I don’t believe that today’s political climate would allow for real reform, no matter how much I think it is needed. There may be a new tax code in the offing, but likely it won’t be dramatically different from the one we have now.  However, a hundred years from now, there may indeed be a different tax landscape. For instance, down the road, the income tax may be scrapped for a national sales tax or other revenue raiser.

Whatever the change, it is certain that we will still be paying taxes. Oliver Wendell Homes, Jr. said (in a 1927 decision) that “taxes are what we pay for civilized society.”

Some sources say that the U.S. has started to run out of entrepreneurs.

The number of startups among American-born individuals is not growing as in the past.

For example, one study found that entrepreneurship among veterans has been declining steadily over the past two decades.

However, entrepreneurial talent is still abundant in foreign-born individuals. Some foreigners come to the U.S. for college and want to remain to launch businesses; others wish to move here to start businesses.

Still, the number of foreign-born entrepreneurs is slipping. A Kauffman Foundation report found that

“the proportion of immigrant-founded companies nationwide has slipped from 25.3% to 24.3% since 2005. The drop is even more pronounced in Silicon Valley, where the percentage of immigrant-founded start-ups declined from 52.4% to 43.9%.”

One of the main problems appears to be the current U.S. visa system. It is not friendly to entrepreneurs. Sure, there’s an H-1B visa for employees. Companies must prove that they control the worker, with the right to fire him or her (something an entrepreneur working for his own company can’t do).

Then there’s the E-2 visa for investors. It requires substantial investments in order to qualify (again, something that many entrepreneurs may not be able to do). But unlike in countries such as Canada and New Zealand, there is no special U.S. visa for entrepreneurs.

Bill to permit visas for entrepreneurs

Startup Act 2.0 is a bill introduced last year that would allow visas to be issued to entrepreneurs. The requirement for the visa: Invest $100,000 and create at least two jobs within the first year of the visa. The visa would last for four years. As long as the entrepreneur employed, on average, five full-time (non-family) employees during this period, he or she would then be eligible to obtain a green card (permanent residency). The bill calls for the issuance of 75,000 entrepreneur visas and eliminate per-country quotas.

The bill had bipartisan support from the likes of Sens. Mark Warner (D-VA) and Marco Rubio (R-FL). It remains to be seen whether the measure will be renewed in the new Congress.

Tax breaks to encourage entrepreneurship

The Startup Act 2.0 would go beyond visa assistance for foreign-born entrepreneurs. It would give every entrepreneur (native born or foreign born) access to the following tax breaks:

• 100% capital gains tax exclusion for stock in a C corporation held more than five years (a tax break that applied in 2011; currently the exclusion is only 50%). The break would apply only to qualified small businesses, such as tech companies and manufacturers.
• A special research credit for startups with less than $5 million in annual receipts and less than five years old.
• A tax credit to encourage employment. It would be up to $250,000 or 20% of W-2 wages, whichever is less.

Final thought

As the new Congress begins to consider the issue of immigration, let’s hope that attention is paid to the need to create a special entry process for entrepreneurs.

Now that Congress decided not to extend the payroll tax holiday that applied in 2011 and 2012, but did add a new tax bracket of 39.6% for high-income taxpayers starting this year, withholding rules for 2013 are a new ballgame.

Here’s what to do if you do payroll in-house:

• The IRS has released new withholding tables for 2013. Use them as soon as possible, but no later than February 15, 2013.

• If you used 2012 tables for any pay periods in 2013, you may not have withheld enough FICA tax from employees. (For 2013, the Social Security portion of FICA is 6.2% on taxable compensation up to $113,700.) You must make the appropriate adjustment no later than March 31, 2013.

Bottom line: Employees don’t have to do anything as a result of the new law. However, they may want to file new W-4s with you to adjust their withholding allowances.

If you do payroll in-house, expect to put in more time and money in 2013 to comply with your withholding obligations. Because Congress did not fix the fiscal cliff by the third week in December, it is too late for the IRS to change its withholding tables for January.

The American Payroll Association posted on its Facebook page on December 21: “we believe that employers should continue to use the 2012 withholding tables if they have to process their first payrolls of 2013 before any official guidance is released, as it is the only workable option.”

Down the road
Eventually, the tax situation will be resolved, allowing the IRS to revise withholding tables accordingly.

• If Congress retains 2012 tax rules. If Congress extends the 2 percentage point reduction in the employee share of Social Security taxes (part of FICA) as well as the tax rates for all individuals, then current tables, with some adjustments reflecting cost-of-living increases, will apply. Employees will see little or no changes in their paychecks.
• If Congress does not extend the Social Security tax break and/or retain current income tax rates. The IRS will issue new tables to reflect tax law changes. The tables will incorporate tax rates as of January 1. If, for example, the Social Security tax break is not extended for 2013, someone earning $50,000 would owe $1,000 more in this tax than he or she paid in 2012. This amounts to lower take-home pay of about $42 per paycheck (assuming paychecks are issued twice a month). If income tax rates are raised on high earners, their income tax withholding will reflect their added tax liability.

What is already new for 2013

• Regardless of movement on the fiscal cliff, some payroll tax changes are certain to apply starting in January. Higher Social Security tax wage base. Earnings up to $113,700 will be subject to the Social Security portion of FICA in 2013 (up from $110,100 in 2012).

• Additional Medicare tax on high earners. Employers must begin withholding for the 0.9% additional Medicare tax once an employee’s taxable pay exceeds $200,000. This withholding obligation applies even if the employee will not owe the tax (e.g., because he/she is married with a threshold for the tax of the couple’s earnings over $250,000).

You can find more information about withholding and the additional Medicare tax, which likely won’t apply to any employees until later in the year, here.

What to tell employees
Employees listening to the news about the fiscal cliff may be confused about what the news means for them. Here are some items to share with your staff:

• You are complying with tax law requirements on payroll withholding.
• If Congress fails to extend the Social Security tax cut for them, their paychecks will be smaller; you cannot do anything about this.
• Inform high earners about the new additional Medicare tax. High earners cannot request that you increase FICA withholding, but they can ask for additional income taxes to be withheld; these taxes can then be applied toward their FICA obligation when they file their Form 1040 for 2013.
• Regardless of any payroll changes, employees who have experienced or expect to experience life changes in 2013 (e.g., the birth of a child, the purchase of a home, or a spouse returning to or retiring from the workforce) may want to complete Form W-4, Employee’s Withholding Allowance Certificate, to make changes in their income tax withholding. More withholding allowances equals less withholding and more take-home pay; fewer allowances means less take-home pay.

Final thought
Confused? Who wouldn’t be at this point? It’s tough enough for employers to figure withholding on wages. With Congressional inaction making it impossible for the IRS to craft new tables for the start of 2013, it means that the rest of the year will be slightly off. When withholding tables are eventually released, they will have to take into account what was not done at the start of the year. Instead of doing payroll in-house, this year may be the time to use an outside payroll service. Whatever you decide, good luck.

The election is behind us and Congress will hopefully focus on fixing the tax mess we’re in. According to the Heritage Foundation, the U.S. is facing taxmageddon, which is a one-year $494 billion tax increase slated to strike the economy on January 1, 2012. What will the tax fix mean for small businesses?

Our tax survey
In mid-October, we conducted an entirely unscientific survey of subscribers to our Big Ideas for Small Business newsletter. We wanted to know whether taxes really matters to you, and in which way. We learned the following.

More than four-fifths (80.6%) of responders said taxes influence their business decisions; only 13.1% said taxes had no impact on their business decisions while the balance was not sure.

For those who said that taxes influenced their decisions, here is how:

• Hiring and firing/outsourcing: 56.1%
• Purchasing/leasing equipment: 66.1%
• Buying/leasing vehicles: 44.6%
• Fringe benefits (including retirement plans, health insurance coverage, etc.): 64.6%
• Legal business structure: 54.6%

When asked “what is the most important tax issue on your mind right now,” the answers were evenly divided among uncertainty, high rates, and complexity. One person noted that complexity with compliance has a huge impact on his decisions to hire and grow. Another person said that he is not hiring now due to unknown pending tax changes. Others said that spending, particularly at year-end, is dependent on tax laws.

Of course, not everyone plans their activities on tax results. Some said taxes are only an influence, not a deciding factor. One person indicated that dreams, goals, and self-realization are his driving factors, not taxes. Another person indicated that she focuses on generating income, not worrying about taxes.

If only Congress could know what my readers think!

With the election only days away, take this posting as an important reminder to cast your vote (if you didn’t vote early). Before you vote, consider the positions of candidates with respect to small business issues if these issues matter to you (and they should). Are the candidates going to be helpful in supporting legislation favorable to small business and owners?

Use resources to help you decide:

• National Federation of Independent Business’ How Congress Voted shows how members of Congress voted on issues related to small business. Lawmakers who voted with small business 70% or more of the time have been designed by NFIB with a Guardian of Small Business Award.
• Small Business & Entrepreneurship Council’s Congressional Scorecard for the 112th Congress shows how those in Congress voted on 20 key issues.

Should business owners suggest how employees should vote?

This is an interesting question that’s been raised recently. An Entrepreneur blog post discussed the issue.

While there’s nothing illegal about sharing your political views with your staff, I think making any suggestions about how they should vote is problematic. Just read the comments to the Entrepreneur blog to get a taste of how this action by an owner can be viewed.

There have been some instances recently where business owners have told employees that a particular election result would cause them to have to layoff workers. Is sharing this information with staff an unfair business practice?

My opinion on this: I’d be glad to share my views with anyone who asks and wants to debate the issues, but I wouldn’t go as far as dictating what employees should do with their vote.

Giving employees time off to vote

Whether you have to do so depends on where you’re located. Some states require employers to allow employees to take up to three hours off, with pay in some places or without in others; some states have no mandatory time-off rules. Check FindLaw for the rules in your state (the information here appears to be up to date even though it’s under a 2008 presidential election banner). You can always be more generous in giving time off than the law requires.

Final thought

Vote!

Some members of Congress have impressive voting records on small business issues and have been recognized by the National Federation of Independent Business (NFIB), the nation’s leading small business association, for this distinction.

The NFIB recently named 294 members of Congress as Guardians of Small Business for their outstanding voting record on behalf of small businesses nationwide. These members stood with small business on key issues at least 70% of the time in order to make the cut for the award.

The list is comprised of 47 senators and 247 members of the House, based on their record in the 112th Congress. Members have been listed without regard to party affiliation, although it is fair to say that there are more Republicans on the list than Democrats. The reason: The issues identified by the NFIB by surveying its members as those issues important to small business, such as repealing the healthcare law and putting a lid on government interference (such as the actions concerning Boeing in South Carolina by the NLRB); support for the issues was very heavily party-oriented.

Did your representatives make the cut? Read the complete report on the voting record of members of the 112th Congress to help you decide on how to cast your vote for in November.

We all applaud our Olympians who have done us proud. Their countless hours of hard work and personal sacrifice have paid off in their athletic achievement. Winners have been rewarded with fame (their names are in the record books) as well as medals and cash prizes from the U.S. Olympic Committee (e.g., $25,000 for a gold medalist). Under federal tax law, prizes and awards are fully taxable. Now there is a bill entitled the Olympian Tax Elimination Act in Congress (proposed by a Republican Senator and supported by the Democrat President) that would exempt the winnings from income tax. Is this the right thing to do?

Tax law by pet project
One of the reasons why the tax law is so complex is that it’s a patchwork of special rules to serve certain causes, special interests, and objectives. Let’s become energy independent (the objective), so let’s give tax credits for energy-related activities. Let’s help the housing market (the objective), so let’s create a first-time homebuyer credit. Let’s support NASCAR racing (the special interest) with a faster depreciation recovery period for motorsport racing track facilities. It seems that special interests with sufficient lobbying funds can effectively buy tax breaks in many cases.

Special tax breaks for small businesses
So my special interest is small business. What’s in it for me? All of the so-called incentives for small businesses, such as the health insurance tax credit for small employers, could be viewed as gimmicks. They appear to support small business. They appear to provide special help for the small business sector. And they do cut taxes for those who qualify. But the reality is that the small business tax breaks provide inadequate tax savings to incentivize action.

The health insurance credit, for example, does not underwrite the cost of providing health coverage for employees. I have not met one small business owner who took any health insurance action based on the credit. What’s more, in many cases, the paperwork and audit exposure for using various tax breaks is more costly than the tax savings. So special tax breaks for small businesses are rather illusory.

Tax-free treatment for small business winnings?
Would anyone suggest that profits earned by small businesses should be tax free? Don’t small business owners put in countless hours of hard work and personal sacrifice on behalf of their companies? There are no record books or medals for small business owners who succeed. And there is no tax-free treatment for small business winnings.

Bottom line
The tax law should be (or try to become) more neutral in its treatment of earnings of individuals. The tax law should not be picking winners. I admire the Olympic athletes, but I can’t support enactment of a new tax break for them.