You don't need us to tell you that taxes are complicated. But they're certain to become even more challenging, and costly, for small business owners if Congress and President Obama fail to negotiate a deal to prevent the U.S. from heading over the so-called fiscal cliff on December 31.
Should that happen, taxes will rise for 90 percent of all Americans, according to the non-partisan Tax Policy Center. On average, households would pay an additional $3,500. Middle-income earners would see their rates jump to 18 percent from around 14 percent in 2012. The highest earners would see their rates jump seven percentage points to 38 percent.
A fiscal cliff calculator can help you determine how you'll be hit. Some, like the one offered by PaycheckCity.com, provide a simple estimate using an interactive bar chart that calculates your new tax burden according to your gross income. For a more sophisticated view, check out tools offered by The Tax Policy Center or Tax Foundation. Both allow you to fill in a wider range of information, including capital gains and dividends, itemized and mortgage deductions, and they give pretty similar results. They also let you calculate what your tax bill will look like under various Democratic or Republican plans, as well as factor in such things as new payroll taxes. The Tax Foundation's calculator also lets you add in potential new costs from the Affordable Care Act.
We took three examples—with adjusted gross incomes of $200,000, $500,000, and $1 million—to see how things stacked up. As a basis in each case, we assumed a married business owner with two dependents whose spouse contributes $50,000 to gross income. The business owner also has $10,000 in annual dividends and $20,000 in long-term capital gains.
According to the Tax Policy Center's tool, a filer with an income of $200,000 would see her federal income tax rate jump to 22 percent, or $78,399, in 2013, from 17 percent, or $63,764, in 2012. The marginal rate would rise 2.5 percentage points to 35 percent. Then there's the Alternative Minimum Tax, which will hit about 26 million more people for the 2012 tax year if Congress cannot come up with a temporary fix. As a result, our fictional entrepreneur would wind up paying an additional $3,446, compared to $758 in the previous year.
The problem is that the AMT, originally constructed to make sure the wealthiest did not deduct and loophole their way out of paying taxes, was never indexed for inflation. So Congress has applied temporary patches to fix the problem. When taken in combination with higher taxes resulting from the expiration of the Bush tax cuts, the impact could be pretty devastating for small business owners. "We could have people on the lower range whose federal taxes will go up a considerable amount who are now paying a share of the AMT," says Bernadette Schopfer, director of taxation for Maier Markey & Juspic in White Plains, New York. Schopfer's clientele is primarily small business owners.
If our fictional entrepreneur had a gross income of $500,000, she would wind up paying net income tax of 30.2 percent, or $202,373, up from a rate of 25.76 percent and a tax bill of $172,525 n 2012. The marginal tax rate would increase nearly 12 percentage points to 39.6 percent. The additional burden from the AMT, however, would drop to zero from nearly $2,884. That's because the entrepreneur would be paying a higher tax rate already.
Finally, our entrepreneur earning $1 million would find himself paying 34.45 percent in taxes—more than $400,000— compare to the 29.69 percent rate for 2012. His marginal tax rate would also jump to 39.6 percent, an increase of nearly 5 percentage points.
Like our previous example, there would be no AMT. The federal government would swallow more than $400,000 of gross income, however.
It's important to remember that the bulk of the higher taxes will come from letting George W. Bush era tax cuts, worth about $200 billion annually, expire. One component of these tax cuts allowed small business owners to take an immediate deduction for fixed asset expenditures, rather than amortizing them, Schopfer says. And those incentives would also face the ax.
Small business owners must pay attention to the fiscal cliff, as the current administration may take the gamble and let us go over it, experts say. Yes, that would result in higher taxes, but it would also put the president in an advantageous position. "It will be easier for President Obama to cut taxes than to raise them," Schopfer says.