It's been said that the DC based small business trade association the National Federation of Independent Businesses (NFIB) is "less an advocate for small businesses than an arm of the Republican Party."
And even if that's a bit of an exaggeration, it's true that the NFIB almost always supports Republican legislative positions.
So it's both interesting and informative that the NFIB has come out against the proposed Republican tax cuts and jobs act.
According to their press release, the reason is:
“This bill leaves too many small businesses behind. We are concerned that the pass-through provision does not help most small businesses."
The "pass-through" business income rate applies to income from entities like like S-corporations and limited-liability companies (LLCs) that do not pay their own taxes, but pass their income through to their owners, who then pay tax on that income on their individual income tax returns.
The proposed 25% pass-through rate is substantially lower than the 39.6% top marginal rate for individuals.
The NFIB estimates only about 15% of small businesses will be able to make use of the 25% pass-through tax rate reduction provision in the plan.
We think, if anything, this estimate is high.
According to the non-partisan Tax Policy Center, only about 13% of all small businesses are in marginal tax brackets above the 25% rate.
Under this bill, to get above the 25% marginal rate you need to make more than $200,000 if you are single or more than $260,000 if you are married. This is the level at which the 35% marginal tax rate kicks in for individuals.
Because the median U.S. small business generates about $400,000 in revenue. and about $68,000 in owner income, few small business owners get to these levels.
The bill also contains "guard rails" that try to limit people who sell their time/labor from benefiting.
Some tax analysts think the guard rails are quite strong and will keep most services firms (doctors, lawyers, etc.) from using the pass-through rate. Others think many of these firms will be able to get around the guard rails.
We tend to think many will get around them, but it will depend on the bill's final language. But they will stop some high earning small businesses from using the pass-through rate.
Adding in the impact of the guard rails, it seems to us only around 7%-8% of small business owners will benefit from the new pass-through rate.
So who would be the winners?
The quick answer is small business owners who make a lot of money and can get around the guard rails. Some examples are:
- Owners of very profitable hedge funds, PE firms and real estate development firms: The owners of these firms are often wealthy and make lots of money. This plan cuts their taxes by a substantial amount. interestingly, the guard rails don't apply to these types of firms.
- High earning professional services firm owners like doctors, lawyers and high end consultants who can get around the guard rails: While many of these firms will be blocked by the guard rails, it seems likely some will figure out how to get around them.
- High earning owners of traditional small businesses that are organized as pass through entities: Again, if the owner is in the 35% or 39.6% marginal tax bracket they should see a tax reduction on their business income.
The vast majority of freelancers and other independent workers also aren't going to benefit. Based on what we've seen so far, few if any traditional freelancers and independent contractors will be able to take advantage of the pass-through provision, even if they make a lot money.
This is because the guard rails are specifically designed to stop people who sell their labor from benefiting. Also, most freelancers aren't in the higher marginal tax brackets.
So we agree with the NFIB that the pass-through provisions of this bill does not benefit most small businesses.
We have several other problems with this bill that are not small business related.
But since this is a small business blog, we'll keep the focus of this post on the direct impact on small businesses and independent workers.
The NFIB is hoping to get Congress to change the plan in ways that will benefit main street small businesses. Their press release says:
We will work with Chairman Brady to make the necessary corrections so that the benefits of tax reform extend to all small businesses.
We're confident many will point out that most small businesses and few, if any, freelancers/gig workers will benefit from this bill.
We're also confident there will a lot noise about the big winners being rich owners of Wall Street financial firms and rich real estate developers.
One reason for this is in addition to Wall Street types benefiting from the pass-through provisions, the bill doesn't eliminate one of Wall Street's favorite tax loopholes, carried interest. This despite a campaign promise by Donald Trump to get rid of it.
And since everyone pitching this bill is claiming a major goal of this legislation is to help to main street small businesses, there will likely be changes that will benefit this group.
So stay tuned.
BTW, the best article describing the pass-trough provisions of this bill we've seen is Money Watch's What's all the fuss about "pass-through income"?
Also, the Journal of Accountancy has a good article covering most of the bill in detail.
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