Fiscal Cliff and Higher Taxes For Small Businesses

The drama known as the “fiscal cliff” has come and gone, but left behind residuals that are sure to grab the attention of small business owners. The compromise between the White House and Congressional Republicans settled a contentious game of chicken which determined future tax rates for Americans. Individuals earning $400,000 and families earning $450,000 will now pay a 39.6 percent rate on any income above those thresholds, as opposed to the 35 percent it was previously. And depending on how you operate your small business, these new tax rates will also take a bite out of your overall profits.

S-Corporations vs. C-Corporations

The fiscal cliff compromise is not friendly for regular Americans in many ways, but was a major victory for large corporations. Unfortunately for small businesses owners, the perks will not extend to them. The largest corporations in the world, such as Wal-Mart and Exxon Mobile, are taxed as C-corporations. These entities are considered a “person” and are taxed separately from their respective owners. But most small businesses and LLC’s were established as S-corporations. These entities do not pay federal income taxes. Instead the owners of these companies divide the profits and claim them on their individual tax returns. In other words, gross profits minus all expenditures accumulated on their American Express small business credit card, divided by the number of partners, is the taxable amount for each partner.

Health Care Taxes

Small businesses with 50 or more full-time employees now face further taxes as a result of the Patient Protection and Affordable Care Act; also known as “Obamacare.” Not only will individuals and families above that $400/$450 threshold pay an addition 0.9 percent in Medicare payroll taxes, but are now one year away from mandatory healthcare coverage for their employees. This will likely cause many small business owners to layoff employees, or drop them to part-time to avoid the provisions. Some will be able to take advantage of another law which takes effects this year to secure additional funding for the new tax obligations. The Jumpstart Our Business Startups Act (JOBS Act) creates a “crowdfunding” forum, which entrepreneurs can use social media and other platforms to solicit funding from individuals who like their business ideas or just simply wish to contribute. The ACT does not go into effect, however, until the Securities and Exchange Commission establishes universal regulations for the program.

3.8 Percent Medicare Surtax

In addition to the payroll tax increase for Medicare, 2013 also brings with it a 3.8 percent investment tax which also goes to funding Medicare. This, again, will only apply to those earning above the $400/$450 threshold. The tax will apply to all unearned income, including interest, dividends, and capital gains. And though IRA’s are exempt from this new tax, contributions are still considered taxable income. Thus, monies deposited into said accounts will count towards your personal income and could in fact push some small business owners over the threshold.

Kelly Romero

Kelly is a student affairs advisor and freelance writer from Florida.

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