Like many small business owners, tax reform may be high up on your wish list. Just be careful what you wish for.
President Barack Obama today released his administration's latest $3.9 trillion budget proposal for the 2015 fiscal year, which starts Oct. 1. All the usual suspects are present: infrastructure projects, education reforms, carbon emissions restrictions. Yet he also outlines a tax reform proposal that would jettison certain tax breaks coveted by small businesses--and that's the measure that could actually pass.
Representative Dave Camp (R., Mich.), chairman of the Ways and Means Committee, last week announced his party's plan to reform the nation's tax code. Like the Obama budget proposal, the Camp initiative (called the Tax Reform Act of 2014) would similarly prevent small businesses from excluding their earnings from self-employment taxes.
"Both of the plans have a provision that says S corporations [partnerships and limited liability companies] would need to conform to the self-employment tax that sole proprietors now pay," says Kyle Pomerleau, an economist at the Tax Foundation, a nonpartisan tax-policy think tank in Washington, D.C. "That's going to increase [business owners'] tax liability."
The Obama proposal lacks specifics regarding the actual tax change, but if it's anything like the Camp proposal, here's how it would work:
Unlike sole proprietors, limited partners of a partnership (including limited liability companies) and shareholders of an S Corporations can shield much if not all of their income from self-employment taxes.
While a general partner's earnings are subject to self-employment taxes, their "distributive share" of partnership income isn't. Similarly, an S corporation shareholder, who is an employee, is subject to regular employment taxes on his or her wages. But this person isn't subject to self-employment taxes on S corporation distributions.
The effect would be that partners and S corporation shareholders who "materially participate in the trade or business of the partnership or S corporation" would be required to treat 70 percent of their combined income--that is, compensation and proportionate business earnings--as net earnings from self-employment. As a result, that income would then be subject to self-employment taxes (or employment taxes in the case of S Corporations).
While the Camp proposal doesn't include revenue expectations for this provision, the Obama plan claims the tax tweak would raise roughly $37.5 billion over 10 years. Indeed, notes Pomerleau, that money makes up the largest portion of the funds that the President hopes will underwrite an expansion in the Earned-Income Tax Credit, a refundable tax credit for low-income workers.
"Our budget is about choices. It’s about our values," Obama said in his remarks announcing the budget today. "As a country, we’ve got to make a decision if we’re going to protect tax breaks for the wealthiest Americans, or if we’re going to make smart investments necessary to create jobs and grow our economy, and expand opportunity for every American."