Small businesses are sensitive to tax laws in ways big businesses are not. Most small businesses are pass-through entities that pay taxes at individual rates.

The proposed infrastructure improvement plan, which includes raising the corporate tax rate to 28% from 21%, has prompted a negative response from groups such as the Business Roundtable who say a corporate tax increase will hinder U.S. companies’ business and decrease their competitiveness globally.

What taxes are likely to change with the new Congress? How will these taxes affect the various levels of wealth?

Small Business Tax Changes To Keep an Eye On

Capital Gains

The Biden administration has proposed changes in the capital gains tax that could affect Americans as early as 2022. Although these changes wouldn’t effect everyone, those making a high six figure salary on a consistent business, those that own or plan on selling a business, and wealthy investors should pay close attention.

Currently, long-term capital gains on assets held over one year are taxed at a maximum Federal rate of 20% plus a 3.8% Medicare surtax. President Joe Biden’s reported proposals would raise the top rate almost double to 43.4% in order to help pay for education and childcare proposals. The way this would work is that for those with income of over $1 million, long-term capital gains would be taxed at ordinary income tax rates. And under Biden’s plan, the highest tax bracket would be 39.6% (up from 37.0%), and the Medicare surtax of 3.8% would still apply.

Although President Joe Biden has said taxes would not be raised on those earning less than $400,00 per year, there are a lot of gray areas yet to be defined. More broadly, because capital gains taxes could jump significantly for those with an income of over $1 million, planning now could save a lot of money. There are essentially three ways to avoid the potential capital tax increase:

• Keep income below $1 million.
• Recognize gains in 2021 before the tax rate increases.
• Continue “normal” tax planning: defer gains, harvest tax losses.

What does an Increase in Capital Gains Mean for Investors and Small Businesses?

Additionally, capital gains are the reward for risky tech investments that take years to pay off, so if the capital gains tax rate rises, investors are more likely to move their funds to safer investments such as tax-free municipal bonds. The proposed doubling of the top capital gains tax rate from 20% to 40% would could potentially undermine investment in small businesses with cutting-edge technology.

Corporate Tax Rate

Large corporations have largely come out against President Biden’s $2 trillion American Jobs Plan, but for small businesses, whether to support the bill or not is a more complicated question.

The proposed infrastructure improvement plan, which includes raising the corporate tax rate to 28% from 21%, has prompted a negative response from groups such as the Business Roundtable who say a corporate tax increase will hinder U.S. companies’ business and decrease their competitiveness globally.

How Will an Increase in Corporate Tax Rate Impact Small Businesses?

As mentioned above, President Biden has proposed raising the corporate tax rate to 28% from 21%, which would affect roughly 1 million small businesses organized as corporations. But he is also considering raising the personal income tax rates on individuals and households earning more than $400,000, which will hit some small businesses organized as “pass-through” entities. This proposal is expected to be included in the president’s next piece of recovery legislation to be detailed later this month. About 90% of small businesses are organized as pass-throughs, according to the National Federation of Independent Business, and 75% are organized as unincorporated pass-through entities.

The outright tax proposal would raise rates on these small business owners’ income to 39.6% from 37%. As noted by NFIB, pass-through businesses are “highly sensitive to individual rates,” with one study finding that a 5% increase in the individual tax rate reduced the number of business owners making capital investments by 10%.

High corporate taxes divert capital away from the U.S. corporate sector and toward noncorporate uses and other countries. It could therefore limit investments that would raise the productivity of American workers and would increase real wages. This could result in business owners having less income to invest into future business operations, less income to pay employees and even the termination of jobs.

Policymakers should recognize that corporate tax hikes will not only impact large firms, but many smaller and younger firms as well. Considering that many of these smaller firms are significant contributors to net job growth, raising corporate taxes at this time would not be conducive for a speedy economic recovery.

Estate Tax

In 2021, the threshold for federal estate taxes is $11.7 million, which is slightly up from the $11.58 million in 2020. For married couples, this threshold is doubled, meaning they can protect up to $23.4 million in 2021. Congress could extend the exemption or even boost it, however, President Joe Biden has called for the federal estate tax to revert back to its 2009 level of $3.5 million per person.

His recently published tax plan calls for changes to income, gift generation skipping transfer and estate taxes. The change could help pay for fighting the pandemic and the infrastructure build out he’s promised along his campaign.

With the current $11.7 million threshold, very few Americans ever have to deal with the estate tax. The awareness and need to review any existing plan and or establish a plan is changing quickly with the Biden proposals lurking.  Changes of the current laws, which are very favorable for passing wealth from one generation to the next, are causing people to now focus on estate planning, and rightfully so.

Additionally, a major concern to planning is the change to the step-up in basis at an individual’s death. If this changes, the beneficiaries of assets would now owe capital gains tax from the growth of the prior generation’s assets. This would have a dramatic effect on most Americans who have accumulated wealth in real estate, equities, and any other capital gain type of assets. This would certainly make a dent in our government’s debt and deficit, but at a cost that is devastating.

Small business tax tips

If you’ve purchased a business this year or are new to small business tax structures, there are a few things to keep in mind. While it is possible to do your taxes on your own, consider working with an experienced tax professional to help navigate the various regulations. A tax professional can ensure that your business is taking advantage of all the deductions available and, more importantly, that you’re paying everything you owe. Let’s take a look at a few tax tips: 

• You don’t actually want a tax refund. It is possible to get a tax refund as a small business, but in most cases, it isn’t to your benefit. Typically, a refund means you overestimated the amount of taxes you paid, which could have been reinvested back into your business. 
• Don’t make assumptions. Never make business decisions assuming that particular tax breaks will pass or that certain policies will be enacted.
• Be aware of law changes.  As a small business owner, you should be aware of new laws and regulations that can impact your business. Even with the help of a skilled tax professional, you want to know what challenges you are navigating. This ensures your tax professional is doing the best possible job and keeps you informed as a business owner.
• Think about taxes all year long. Tax planning is not an annual event, rather, tax planning should be a year-round activity. Waiting until the last minute makes tax preparation more complicated and limits your money-saving options.

The Bottom Line

The implantation of new tax laws may effect small businesses around the United States. Every small business owners situation is unique, and it is important to stay up to date and devise a game plan if tax changes happen quickly.

Exemplar Tax Planning Experts

Exemplar’s team of CPAs, attorneys, financial consultants and estate planning experts can help small business owners devise tax strategies that fit best to their personal and business needs. Contact us for more information.