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Most small business owners in the United States structure themselves as a business entity in the simplest way possible – sole proprietor or simple partnership if they have a low liability risk, LLC or subchapter-S Corporation for greater liability protection.

These four main business structures all feature something few are talking about today – the flow-through of all income to the owners personal income and his 1040.

How the proposed budget and other potential changes may affect his budget can and will directly affect those (s)he employs because the bottomline is the owners income.

Let’s set up a hypothetical couple, married, two kids.  The husband is the primary earner since the kids are small and his wife helps with the business, but isn’t an employee.  His business nets him an income of $300,000 a year.  After federal taxes, social security and medicare (which he must pay both sides of, employer and employee) and living in a no state tax state, taking nothing but the standard and personal deductions, takes home $209,181 each year.  Note, he paid out, in various taxes $90,819 of his earnings from his business.

A very respectable take home at the end of a year of hard work – taking home about $17,430 a month.

How will the family situation change, if the proposed changes take effect?

All things remaining the same, except his federal taxes going up, his take home will be reduced to $196,741; stated another way, doing the same exact thing he’s always done, he’ll now have to pay $9,440 more to the government, taking $787 less home each month.

Would your budget be affected if you had to take a $787 hit on your take home money?

Could it get worse for our business owner?

Sure could, especially if the powers that be decide to remove the cap on social security taxes – abolish the limit that currently exists that taxes the first $106,800 of income so that all income is now taxed.

Doing that, on top of the above hike in federal taxes now will take another $23,957 out of his household budget because right now he pays $13,243 for his social security contribution and will, if the cap is removed, then have to pay $37,200 instead.

Now this couple isn’t simply taking a $787 monthly hit on their income for their household, they’re now taking $2783 LESS home each month, with their annual take home reduced to $172,784….or a 28% reduction in his take home, taking his taxes and social security from $90,819 for a year to $127,216!

Now yes, there’ll be naysayers who can’t quite fathom why this is potentially a problem in our economy, they’ll say this couple should pay the higher amount, they can afford it. 

How many out there can truly say, with a straight face, they can easily take a 28% reduction in their take home pay?

If the hypothetical business owner doesn’t figure out how to adjust income to pay less taxes, he and his wife are going to sharply cut spending (they no longer have the same disposable income) and likely will begin to look at whom to layoff in their business since the wife can step in and do that work instead of their paying someone else to do it.

Either way the economy loses – be it through spending less on services and convenience, or by someone getting laid off to make up the $36,397 in additional tax burden the couple will have to face and deal with.

Take $36,397 out of this couple’s disposible income equation and you’re likely to be hitting the service sector – they’ll reduce meals out, salon services, cleaning services, etc. because they have $3,033 LESS to spend on services each month – and it will domino through the economy as each service provider makes less, they’ll need to cut back on their own use of services, and so on and so on.

Just food for thought, especially when you consider that in an interview, Obama told Fox News:

“In terms of raising the cap on the payroll tax, right now everybody who’s making $102,000 or less pays 100 percent of payroll tax on 100 percent of their income. There are about 3 percent to 4 percent of Americans who are above $102,000 in income every year. So if you want to talk about who’s middle class, me giving cuts to folks making $60,000 or $70,000, and potentially asking more from friends of mine like Warren Buffett. That’s a debate I’m happy to have…because it’s the people making $75,000, $50,000, $60,000 who are hurting.”

Last night Keith Olbermann railed Mitch McConnell, naming him ‘Worst Person in the World’  for suggesting that

“When our good friends on the other side of the aisle say raising taxes on the wealthy, they really mean small businesses,” in an interview on CNN’s Late Edition.

Here is what Olbermann ranted on about:

“…more importantly, if you own a small business and it pushes your own income over 250-grand and you haven’t incorporated and you haven’t been able to enjoy lower taxes that result and you’re still treating it as your personal income, you better ask to see your accountants diploma because in the vast majority of cases either you or he is crazy.”

Olbermann simply failed to do his homework, and instead relied upon supposed fact checking that wasn’t complete.  Instead, he referred to the statement as “Joe the Plumber crap” and said that checking the facts revealed only 2% of small businesses would be affected. 

If we poke around on the net, we find an article where “facts” were presented to support Olbermann’s opinion, in the CNN article Fact Check: Plumber Joe’s Taxes.  The CNN article isn’t factually incorrect, but it suffers the sin of omission, which is why Olbermann’s rant last night irked me as a small business owner!

In the CNN article, it says that “…[the] broad definition of what counts as a small business, including everyone who files a Schedule C, E and F. ”

“In 2005, there were 21.5 million Schedule C returns filed, according to the IRS.”

Since most Americans have no idea what a Schedule C is, they wouldn’t know that the CNN article fails to include Schedule K filings.  A Schedule C is for Sole Proprietors ONLY, that is, a business owned legally by one and only one person that remains unincorporated.  If you ask me, 21.5-million folks filing a Schedule C is a lot of sole proprietors out there.

But what about Schedule K? 

Schedule K is used to file Partners share of income, deductions, credits, etc. in partnerships, joint ventures, LLC’s and S Corporations – basically anyone doing business not as a full c-Corporation. 

In 2001 there were 23-million Schedule K filed with the IRS.  Taken together with those filing Schedule C, this is now no less than 44.5-million small business owners – a far cry from the CNN articles use of SBA data suggesting that based on the Census there were “6 million small businesses in 2005.” 

The IRS is a far more accurate agency for small business data than the Census Bureau; and the Census data also says that  “a firm is defined as the aggregation of all establishments owned by a parent company” – meaning if a person has a parent company and one or more subsidiary companies at the same time, they’re included as only one company in the data.

So was McConnell making a boldly wild statement when he suggested that “[w]hen our good friends on the other side of the aisle say raising taxes on the wealthy, they really mean small businesses”?

Nope – he’s dead-on…and Olbermann is the one who should have done his homework so he wouldn’t look the fool who knows nothing about small businesses, their owners, and how they have to structure their businesses legally in the United States.

Obviously Olbermann has no clue that doctors, lawyers and others classified as “professional service providers” have little choice but to organize as an LLC or S-Corporation – if they incorporate as a C-Corporation, they’re subject to the highest corporate tax rates because they’re defined as a personal service corporation, not simply a traditional corporation!

Olbermann is oblivious to the fact that it makes little sense for many business owners to go the route of incorporating as a C-Corporation due to the increased reporting required (translation: more time consuming paperwork) by the IRS and the very real double taxation they may face going for a C-Corporation. 

Here’s an idea – perhaps it is Olbermann that needs to sit with an accountant to get some facts before he speaks?

Let me spell it out for Olbermann about corporate taxes!

If a corporation makes between $100,000 and $335,000 – their tax rate is 39% (higher than if the owners kept their business as an sole proprietorship, simple partnership, LLC or S-Corporation).  Next time you hear the likes of Olbermann claiming small business owners are stupid, crazy or poorly structured in business -just remember, if they listen to him, they’ll be paying even more without a tax increase!

If professionals (doctors, lawyers, etc.) incorporate, structuring as a c-Corporation, their tax rate is 35% (higher than if the owners kept their business as a sole proprietorship, simple partnership, LLC or S-Corporation)

The tax rate actually goes DOWN if a business makes more than $335,000 a year – and has profits of less than $15-million….the tax rates for this range is 34-35% (still higher than if the owners kept their businesses as sole proprietorship, simple partnership, LLC or S-Corporation).

Even those corporations earning $15-million to $18.3-million pay less taxes (38%) than those making just $100,000 to $335,000!  Make more than $18.3-million and your taxes drop even more – to 34% (which is still more than if you allow the income to flow through to personal income since you’ll then have double taxation – the tax on the corporate profit and then taxed again when you pay yourself a paycheck from the corporation).

Oh and let’s not forget the Accumulated Earnings Tax – more money to pay on top of the above rates if a corporation has accumulated taxable income in excess of $250,001 ($150,000 for personal service corporations).   Yup – do that and you’ll pay an additional 15% ….. to put it simply, if you have profits of $250,000, Uncle Sam gets 39% first in corporate tax, then another 15% for AET – combined, that’s a tax rate of 54% if a corporation has a profit of just $250,000.

Yo, Keith – when is 54% of your profits less than 33%***? 
***the tax rate a small business owner will pay if they have their income flow through to their personal income taxes via proprietorship, simple partnership, LLC or S-Corporation

Me thinks Olbermann needs to go back to school and learn math, don’t you?