You may be ready to tune out anything having to do with politics after the year we’ve had, but small business owners should be paying close attention to corporate tax reform, which is on the docket for Congress this fall.
Though President Trump and other Republican leaders have long promised tax reform, including lowering corporate tax rates to levels as low as 15 or 20 percent, passing such reform is going to be difficult.
The Trump plan for lowering corporate tax rate may not happen, many business leaders —particularly small business owners—would love to see some kind of change to the current tax rate.
Let’s examine the current political climate surrounding tax reform, and how possible reform would affect small businesses.
What are corporate taxes?
One of the main ways the U.S. federal government raises money is by taxing corporations, with rates starting at 15 percent and going up to 35 percent. (Corporate taxes are also levied by state and local governments, but at much lower rates.)
Though most corporate income is eligible for the top rate, many companies don’t actually pay it, thanks to credits and loopholes, such as keeping their foreign profits offshore.
How does corporate tax affect small businesses?
The answer to this question depends on how the small business is structured.
According to the National Federation of Independent Business, most small businesses—which are considered “pass-through entities,” not corporations—pay tax at the personal tax rate of the business owner.
Typically, average effective tax rates range from 13.3 percent for sole proprietorships to 26.9 percent for S corporations.
Still, many small business owners have called for changes to the tax code, citing taxes as the most critical issue facing their business today.
Where does corporate tax reform stand now?
As of this writing, the future of the corporate tax code is very much up in the air, and we may not see a clearer picture until 2018.
A few weeks ago, President Trump unveiled his tax reform plan, and though this should be considered just a rough guideline (the plan will likely go through many changes as members of Congress and other politicians and administration officials tweak it to make it more palatable to those skeptical), here are some highlights for business owners:
- A 20 percent corporate tax rate: Trump wanted a tax rate at 15 percent, but that wouldn’t have raised enough money to make sense for the federal budget. This would be a 15 percent cut in the corporate tax rate, which is significant.
- A 25 percent pass-through rate: This is big for those who own their own business—they will pay taxes at the pass-through rate, rather than getting their business profits taxed at their personal rate.
- Elimination of some deductions and incentives: This is considered “streamlining” the tax code, a big talking point for the administration.
- A one-time repatriation rate: This likely won’t affect small business owners, but will be huge for companies like Apple that stash assets overseas.
With everything that needs to be hammered out, it’s unclear whether Congress will pass tax reform (which includes many changes to individual tax rates as well) this calendar year.
What about a flat tax?
Whenever tax reform is discussed, some politicians float the idea of a flat tax, to which many respond, “What is a flat tax?”
Simply put, a flat tax is a constant marginal rate, where the same tax rate is applied to every taxpayer or corporation.
Republican Ted Cruz recently said that the flat tax would lead to growth and higher wages, because there is “power in bold simplicity.”
However, flat tax is not a part of the Trump plan.
Will there be corporate tax reform?
Analysts are optimistic that something along the proposed lines will get done, though probably by next year.
One of the major issues will be whether Republicans, Democrats, and the White House can work together. Some representatives will refuse to support a bill that adds to the deficit, while others are personally quarrelling with the president.
Either way, the future of taxes for small business owners is currently in their hands.
With corporate tax reform on the horizon, it’s not a bad time to explore your financing options.
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