3 ways the Republican tax reform bill could impact small businesses

The GOP tax bill has very different implications for corporations and small businesses that pass income through their owners.

The GOP tax bill has very different implications for corporations and small businesses that pass income through their owners.

Last week, Republican lawmakers rolled out their much-anticipated tax plan. There’s been no shortage of commentary on what the bill might mean, if passed, for everyone from busboys to billionaires.

Tax reform is the #1 policy concern for small business owners, so there’s plenty of interest in the GOP tax plan on Main Street. As we wrote last month, local business owners are banking on the Trump Administration and Congress to deliver. Here’s a look at some of the biggest ways the current tax plan would impact small businesses.

Corporate taxes would be drastically reduced

Corporations would be one of the clear winners if the Republican bill became law in its current state. The corporate tax rate would be trimmed from 35% to 20%, so if your business is set up as a corporation, you could see a 43% reduction in your company’s tax liability. Unfortunately, this benefit wouldn't help many SMBs, since only about 7% of small businesses are corporations.

But partnerships and sole proprietorships wouldn't get the same benefits

Most small businesses pass income through their owners as individual income. Currently, individual income is taxed at different rates on a graduated scale as income increases (note that things change a bit if you’re married filing jointly):

  • 10% rate applied to income of $0 - $9,325
  • 15% for $9,325 - $37,950
  • 25% for $37,950 - $91,900
  • 28% for $91,900 - $191,650
  • 33% for $191,650 - $416,700
  • 35% for $416,700 - $418,400
  • 39.6% for $418,400 and up

Under the proposed law, the scale would look like this for a single filer:

  • 12% rate applied to income of $12,000 - $45,000*
  • 25% for $45,000 - $200,000
  • 35% for $200,000 - $500,000
  • 39.6% for $500,000 and up

* Note: Standard deduction would be $12,000 for individuals and $24,000 for married joint filers, and all brackets change for married joint filers.

This matters because 93% of small businesses are partnerships, sole proprietorships, or S corporations, so personal income tax brackets have a double whammy on local business owners since they carry business earnings as personal income.

In some cases, SMB owners with pass-through income would do better under the proposed law, and in some cases much worse. In many instances, it might just be a wash.

Let’s say, for example, that your business passes $400,000 of company earnings through you as personal income. Under the current graduated tax bracket system, you’d be liable for about $115,000 in taxes on that income, or an effective rate of 29%. Under the GOP plan, you’d owe about $112,000, or about 28% effectively. So, only a modest change.

That said, some businesses could face what’s called the 70/30 rule, where 30% of their earnings would be subject to a 25% rate, with the balance subject to individual tax rates.

Regardless, the law would give considerable tax advantages to larger corporations while failing to ensure a level playing field for smaller businesses, given the simplicity of the corporate tax and web of complexities for pass-through business income. That might be why the National Federation of Independent Businesses issued a strong statement against the bill:

This bill leaves too many small businesses behind. We are concerned that the pass-through provision does not help most small businesses. Small business is the engine of the economy. We believe that tax reform should provide substantial relief to all small businesses, so they can reinvest their money, grow, and create jobs.

You wouldn’t be able to deduct your state taxes anymore

One tax benefit enjoyed by many SMBs is the so-called SALT provision, which allows state and local taxes to be deducted from federal taxes. Small business owners in states like California, Oregon, New York, and Hawaii would have an unpleasant surprise under the new bill. From The New York Times:

Another area of contention is the bill’s treatment of the state and local tax deduction, which is popular among many middle- and upper-middle-class taxpayers in high-cost states like New Jersey, New York and California. The House bill would limit the deduction to just property taxes, rather than state and local income taxes and general sales taxes, and cap the benefit at $10,000.

The only upside of having to pay high state taxes is being able to deduct it from your federal taxes. If that benefit is removed, SMB owners who are already running tight ships would see another back-door pay cut. Here are the top 10 states for state income tax rates, according to TurboTax:

  • California 13.3%
  • Oregon 9.9%
  • Minnesota 9.85%
  • Iowa 8.98%
  • New Jersey 8.97%
  • Vermont 8.95%
  • District of Columbia 8.95%
  • New York 8.82%
  • Hawaii 8.25%
  • Wisconsin 7.65%

Ultimately, all of this is theoretical unless the bill is passed into law, which isn’t a sure thing given the political environment. It’s good to know how this law might affect SMB owners if passes in its current state. But, as CNBC’s Jim Pavia advises, don’t take it to the bank:

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