POLITICO Pro: Small businesses navigate frustrating tax maze back
By Kelsey Snell
Politicians never lose support back home when they position themselves as the champion of small business.
As the tax reform debate heats up this fall, expect to hear more talk about how the current tax system leaves small businesses with a raw deal. These firms, the argument goes, don’t have the armies of accountants and lobbyists that major corporations enjoy in the battle to drive down their tax bill.
But for all the love Washington throws at small businesses, the people who actually run these companies aren’t optimistic that tax reform is in the offing.
“I am doubtful that they will ever reform it,” said William Marsh, president of American Bar Products, a manufacturing business near Philadelphia. “It would be a massive boon to American business. It is one of the worst things about running a business but I’m doubtful.”
Over the past several weeks, POLITICO spoke to more than a half-dozen small-business owners across the country ranging from tech startups to manufacturers and service companies. Some executives weren’t even paying attention to the Washington tax wrangling and those that were expressed pessimism about the prospects for reform.
Marsh said he stopped watching coverage of the tax reform talks in Congress. He even ignored stories about a recent Philadelphia area visit by House Ways and Means Committee Chairman Dave Camp and Senate Finance Committee Chairman Max Baucus. The chairmen toured small businesses in the area to promote their tax overhaul effort.
Still, they’re worried about President Barack Obama’s recent push to reform just the corporate part of the tax code in exchange for a new jobs package. That kind of proposal stands to leave small businesses on the sidelines.
Small-business groups are fighting that proposal with data aimed at framing their companies as the victim of an already uneven tax system. The National Federation of Independent Business released a study that shows small businesses pay an average effective tax rate of 31.6 percent while large corporations pay 17.8 percent.
“The idea of corporate-only reform is still of grave concern for us,” NFIB tax counsel Chris Whitcomb told POLITICO. “You’d have to take away credits that benefit businesses of all sizes. That’s a real concern for us.”
But credits, tax breaks and benefits are only one part of the problem for most small-business owners.
In explaining the real-world impact of the tax system, owners said the headaches often begin before a company even gets off the ground.
One of the first decisions they must make is how to organize their business. Their options range from limited liability corporations to partnerships and S corporations. A misstep at the beginning could mean missing out on valuable deductions over the lifetime of the business.
For instance, LLCs require less paperwork to start up but the owner must pay a self-employment tax every year while S-corp owners have more flexibility and aren’t subject to the self-employment levy.
Chicago-based consultant Jeremey Sartori said choosing to be an S corporation helped whittle his tax rate down to around 26 percent. Sartori started his company, Metric Foundry, about a year ago and after one tax cycle he estimates that a different decision could have left him with a tax rate as high as 48 percent.
“I’m an S-corp,” he said. “It was just based on how taxes worked and advice from my tax adviser.”
Navigating the maze of tax policy that path alone can be difficult for many small businesses.
Each of the executives said they immediately turn to an outside tax professional before making a move. Most said they were completely disconnected from nearly every detail of the company’s taxes, such as the actual tax rates they paid and the deductions they were using.
“We quickly learned that there’s a reason that accountants exist,” Alex Cavoulacos, the founder and chief operating officer of the New York-based career development site the Muse, told POLITICO. “When we chose a law firm to work with, we said it was so important to have the right lawyers and it may be expensive but it is the right answer. We didn’t really think that way about accounting.”
Cavoulacos said she’s been paying the price.
Her company had to file for an extension after it became clear that she and her accountant had different numbers.
“I just want to understand what I’m required to do,” she said.
Sartori said taxes play into every decision he makes.
“Even before I can court a client, I have to figure out if it is even worth my money to do that,” Sartori said. “When I get a contract, it comes down to what I think I’m going to get from them, subtract the worst case tax and go from there.”
Of course, the current tax code is full of perks for small businesses. Companies can deduct up to $500,000 in capital costs and small businesses have access to a bonus depreciation benefit that allows them to write off more of the depreciation costs earlier in the lifetime of an investment.
But tax breaks and refunds don’t help with the upfront cost of buying that expensive equipment or expanding into a new market.
“A lot of small businesses prefer to fund their investments through earnings,” Marsh said. “When you’re looking at investments, when tax rates are at a level where they are and they’re as uncertain as they are, you don’t want to take a risk because the return certainty isn’t so great.”
Every year, the patchwork tax code changes. Some tax breaks expire, others are changed. Each twist affects the bottom line for a company. Some of them, like new tax credits for small businesses that choose to offer health insurance to their employees, are helping to defray the bottom line.
That’s forced small-business owners to learn to adjust quickly, said Jim Houser, the co-owner of Hawthorne Auto Clinic in Portland, Ore.
“One thing about small business is we manage to figure out how to get around whatever is in front,” Houser said. “We’re creative. We figure out how to do things.”
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