Possible Tax Increase: What Small Business Owners Should Know
- April 28, 2022
- 5 min read
- 172 reads
The pandemic has created numerous financial hurdles for startups and small businesses. Now, many experts believe that small businesses may incur higher tax expenses and tax obligations due to new proposals from the U.S. president.
Small businesses that are floundering currently or on the point of closing their operations will be highly sensitive to the proposed Biden tax increase.
According to President Biden, the tax increase is aimed at supporting startups. In March 2021, more than 400,000 businesses had already closed due to COVID-19.
The health crisis left millions of small business enterprises hanging by a thread. According to the U.S. Treasury Secretary, the Biden administration will not introduce policies that could hurt small businesses.
However, many startups stand to suffer a hit if the U.S. president follows his tax reform proposals. While the policies are aimed at large companies and wealthy households, and individuals, small businesses could take a hit.
If you‘re a startup or own a small business, it is critical to know about a potential tax hike and whether it will impact your income and cash flow. With this awareness, you can shape your business objectives accordingly.
Tax Hikes – What You Need to Know
Biden’s government has come up with a proposal to increase tax rates to 28 percent from 21 percent. The proposed tax policies may impact one million startups and small businesses working as corporations.
However, the U.S. President is also considering increasing personal income tax rates on households and individuals earning $400,000.
As mentioned above, it can hit small businesses structured as “pass-through” entities. The proposal might be a part of the president’s recovery legislation. It is expected to be detailed at the end of this month.
It is worth mentioning that about 90 percent of startups and businesses are structured as pass-throughs, and 75 percent are unincorporated pass-through entities as per the National Federation of Independent Business (NFIB).
Entrepreneurs who own unincorporated pass-through entities can report the profits or income on personal taxes. Therefore, they are not subject to any corporate tax rates.
Note that the outright tax proposal will increase the rate on the income of startups and small business owners to 39.6 percent from 37 percent.
NFIB, in its recent report, noted that pass-through businesses are particularly sensitive to these individual rates.
The report showed that a five percent raise in the individual tax rates had lowered the number of business owners or entrepreneurs’ capital by 10 percent.
There are chances that certain pass-through entities could get hurt if the new policy revokes a 20 percent deduction for pass-through income.
Referred to as the qualified business income or QBI deduction, it enables an eligible taxpayer to withhold approximately 20 percent of the QBI from the taxable income.
Keep in mind that the deduction decreases their net tax rate from 37 percent to 29.6 percent for the individuals included in the top tax bracket.
This deduction could be significant for businesses and taxpayers.
If these businesses lose this deduction, the next net tax rate will increase to 39.6 percent from 29.6 percent as Biden’s tax raise proposes.
Potential Tax Hike Pressures Businesses to Make Significant Decisions
With the possible tax hike on the horizon, many business owners are considering selling or transitioning the companies. However, it is important to remember that not all entities can reroute their business direction the way the government can.
Even the slightest suggestion of amendment to tax codes or regulations is enough to jolt the business operations and compel them to make decisions that can affect the organization.
So, if you’re mulling over some major decisions like transitioning or selling, here are a few important things to consider with the proposed Biden tax plan:
1. Selling Your Business
Let’s suppose you’re planning to sell a company in the next three years; you might come across questions like “should you sell now at a reduced capital gain rate or after some time when your business might be worth more?
With the new Biden tax increase, will potentially higher taxes undercut the gains?
If you sell your business for $10 million today and pay 20 percent capital gain tax, you will be left with $8 million. However, if you decide to wait for at least three years when your business is worth more than $12 million, you can expect more profits from the sale.
That means if your business is growing, waiting to sell is a big risk as circumstances may change quickly.
However, it typically depends on the changes to taxes in the next three years.
If the tax rate increases to 40 percent, the business owner will be left with no more than $7.2 million. Under the current tax rates, you might have to sell your business for $13.5 million.
2. Transitioning Your Business
If you’re planning to transition the company to the next generation, you should have a succession plan. It is particularly important as the tax environment is changing. A proper strategy ensures that your wealth is safe in the future.
Biden’s new tax plan may impact small businesses in many ways.
The increasing taxes on entrepreneurs and small businesses may lead them to fight against the 3.5 trillion stimulus package the U.S. President is considering.