NEW YORK (AP) — Taxes and uncertainty.
Those words sum up one of the biggest worries facing small business owners. With the scheduled expiration on Dec. 31 of tax cuts enacted during the Bush administration, many people who run small companies don't know how much they'll be paying in tax in 2013. And many say that's why they have put off plans to hire and expand.
The uncertainty is compounded by the fact that the outcome of the presidential and congressional elections is far from clear. President Barack Obama and challenger Gov. Mitt Romney have different ideas about tax policy and it's hard to say whether Congress will act to stop the cuts from taking place.
Here are some questions and answers about the tax cuts and how their expiration may affect small businesses:
Q. Which scheduled tax increases are small business owners concerned about for the tax year that ends Dec. 31, 2013?
A. The change that's expected to affect owners the most is an increase in personal tax rates. The top rate will rise to 39.6 percent from 35 percent. That would affect single taxpayers with income of $200,000 or more and households with income of $250,000 or more.
Also expiring is the 15 percent rate on dividends. They will be taxed as ordinary income, which means business owners who receive dividends from their companies will likely be paying much more tax on this income than they have since 2003.
Q. How do personal tax rate increases affect small business owners?
A. Most small businesses are what's known as "pass-through" or "flow-through" companies. That means the company itself doesn't pay taxes on what it makes. Owners report the income on their personal tax returns. These companies include sole proprietorships, partnerships and what are called S corporations (named for a provision of the federal tax code). The income is taxed according to the owner's tax rate. So single business owners with income of $200,000 or more and those whose households have income of $250,000 or more will see their taxes rise next year. There are no exact numbers on how many small businesses are pass-through companies, but the National Federation of Independent Business estimates that 75 percent of small businesses are in that category.
Q. How many small business owners would be subject to the highest rate?
A. No one has exact figures, but the number appears to be in the mid-single percentages. The staff of the congressional Joint Committee on Taxation estimates that next year, 940,000 taxpayers with profitable businesses will have tax rates of 36 percent of 39.6 percent. That represents 3.5 percent of the total number of taxpayers with profitable businesses.
Another estimate comes from a survey by the lobbying group Small Business Majority. Five percent of the small business owners who participated in the survey said their household income was $250,000 or more.
Q. What about large companies?
A. Large companies pay their own income taxes, and owners then pay tax on any dividends they receive. This form of taxation is used by what are called C corporations. Those companies include large companies, like General Motors Co. and Apple Inc., but they also include small businesses. The top tax rate on C corporations is scheduled to drop to 28 percent next year from 35 percent in 2012.
Q. So if a company can avoid the higher personal tax rate by organizing as a C corporation, why not do that?
A. It's important to remember that C corporations have "double taxation" — on the company's income and the dividends paid to the owners. And corporations are subject to more regulation than other types of companies. Owners need to comply with the laws of the states where a company is incorporated. Turning a company into any type of corporation means legal fees. And over the long run it might make sense not to change a company's structure.
"Tax rates can change year after year," says Charles Massimo, CEO of CJM Wealth Management, a financial advisory firm based in Melville, N.Y. He says owners need to choose a structure for their company based on their long-term needs.