What would tax reform mean for small businesses?

Last week, the U.S. Senate narrowly passed a Republican budget proposal that was an important step toward President Donald Trump fulfilling his campaign promise of comprehensive tax reform. While nothing is certain in the current political environment, Trump and GOP lawmakers are aiming to deliver tax reform by the end of the year.

It’s officially crunch time for Trump and other politicians who won big political points on the merits of delivering tax relief to American small business owners. Let’s take a look at why this issue matters so much, and what’s at stake for Main Street entrepreneurs.

Show me the money!

First, let’s unpack what small business owners stand to gain or lose with tax reform. Let’s start by looking at the complexion of U.S. small businesses and then see how taxes affect business and personal income.

According to the U.S. Small Business Administration, there are 28.8 million small and medium-sized businesses (SMBs) in the country. They use a liberal definition of “small,” which companies that have ~500 employees. That said, 17% of all American businesses have less than 20 employees. So, there are about 5 million truly “small” businesses in our fair country.

Image courtesy U.S. Small Business Administration.

Among small businesses, only about 7% are set up as corporations. This matters because business income is taxed very differently depending on the type of business entity you’ve created. In a C corporation, business income is taxed separately from personal income.

For the other 93% who set up their companies as partnerships, business income is “passed through” owners as personal income. This is true for sole proprietors, partnerships (including LLCs), and S corporations. So, the company’s income is taxed at ordinary personal income rates. On average, according to the SBA, small business partnerships pay taxes of 23.6% and S corporations pay 26.9%.

Here’s the point: no matter how your business is set up, you’re likely paying much more than 15% in taxes, which is the rate Trump proposed for all businesses during his campaign. That kind of tax cut would put loads of cash back in your pocket.

Death and taxes

It’s no wonder, then, that small businesses overwhelmingly supported candidate Trump during the 2016 election. According to our spring survey of nearly 3,000 small business owners, tax reform is the top policy area SMBs want changed, and it’s not even close. Take a look:

It makes sense that local merchants were initially quite optimistic about the Trump presidency, but that optimism is waning as the weeks and months pass without a new tax bill. Here’s some telling analysis from CNBC’s Eric Rosenbaum:

The percentage of business owners who expect changes in tax policy to have a positive effect on their business in the next 12 months declined from 42 percent to 31 percent quarter-over-quarter, according to the CNBC/SurveyMonkey survey, conducted in August with more than 2,200 small-business owners using SurveyMonkey‘s online platform and based on its survey methodology. Small-business owners who said tax policy would have “no effect” went up from 33 percent to 40 percent. Another 27 percent expect a “negative effect.”

Clearly, small business owners are expecting results. These concerns take on new meaning when you consider the daily struggle many face on Main Street. As we recently outlined in another post, small business owners typically run low-margin enterprises and struggle to save enough money.

That makes their companies more vulnerable to threats. Also, with low profits, owners are unable to set aside proper funds for retirement, which as Womply founder Toby Scammell recently wrote, is putting the family business at risk of extinction.

‘It’s the economy, stupid!’

On a micro level, tax reform is a big deal for individual small business owners looking for a break, and for politicians hoping to get re-elected. On a macro level, it takes on a whole new meaning.

Confidence is a major driver of economic prosperity, and conversely, pessimism can trigger economic contraction. Because Trump’s election, and his promises to lower taxes, resonated so profoundly with small business owners, the outcome of the current tax battle could have a sweeping effect on confidence on Main Street.

Because small businesses hold such enormous economic sway, their general sentiment is a powerful indicator of where the overall economy may be heading. Right now, no issue is likely to have a bigger impact on the collective psyche of Main Street merchants than taxes. As Toby (our founder) wrote in Forbes:

According to our data, Trump’s election is the No. 3 reason for confidence among optimistic owners and the No. 1 reason for concern among pessimists. This matters because optimists are 3.5 times more likely to hire and give raises to employees, while pessimists are 6.5 times more likely to reduce staff and employee pay. In short, Trump’s ability to build and maintain small business confidence could have enormous economic consequences, with room for wide swings in either direction.

Whew! That’s a lot to process, but there’s a lot on the table. The next few months aren’t just critical for Trump and GOP lawmakers. They’re also critical for American small businesses and the broader economy.

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