Small Business and Marginal Tax Rates

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Small Business and Marginal Tax Rates

As a former tax accountant, it annoyed me last week to hear all the noise about higher taxes for small businesses. First of all, what is a small business? According to the Small Business Association, it’s “one that is independently owned and operated and which is not dominant in its field of operation”. I read somewhere else it meant less than 500 employees. That’s pretty vague. And how many of those are making the kind of money Obama wants to raise taxes on?

Who’s Making a Quarter Million a Year? Not Me

I can tell you from the 1040 trenches perspective that I saw very few businesses netting over $250,000. (And those who did understood the role of competent tax planning advice in decreasing their tax burden.) In checking the facts of last week’s debates, CNN Money reported that a National Federation of Independent Business found only 14% of respondents said they had $200,000 or more in annual income. (They also make a very good point about lumping Schedule E filers in with small businesses for the sake of this argument.) However, just because you make more, doesn’t mean you’re going to pay more overall. Why? Marginal tax rates.

What is a Marginal Tax Rate?

Even if you buy a business this year and that business ends up with over $250,000 in profit (not revenue mind you), and even if tax rates go up – you’re still not looking at a huge increase.  The way our tax code works is that only the income that falls in the higher bracket is taxed at the higher rate. Let me say that another way because people sometimes have trouble with this.

Even if you’re lucky and industrious to make over $250,000 under Obama’s prospective tax hikes, all the money you make from $1 to $250,000 would be taxed at the same rate as for people who make say $249,000. It’s only the money you make beyond the threshold of the tax bracket that is taxed at the higher rate. So say you make $260,000. Under the hypothetical Obama plan, you’d pay more tax on $10,000 of that.

It always drives me nuts to hear people say ‘I can’t do that – it would bump me into a higher tax bracket’ as if once you cross a line all your income is subject to higher rates. That’s not the way it works.

Let’s keep it all in perspective. We’re in a war and the world economy is going insane. Taxes are going up, no matter who you vote for.

9 Comments
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  • October 22, 2008 at 6:47 am

    Thanks for the explanation on the higher tax bracket bit. I’d been confused by that one as well, although in a personal sense not a small business sense.

  • October 22, 2008 at 8:03 am

    Thank you. I’ve been saying this until I’m out of breath. I can only assume all of the noise was coming from people that aren’t business owners and/or people that just parrot what they hear from the campaigns instead of doing a little research.

  • Drea
    October 22, 2008 at 8:59 am

    Lela, great post. There are certainly scarier taxes than marginal tax rates, and I agree…we’re getting taxed anyway, no matter how you slice it.

  • DRob
    October 22, 2008 at 9:03 am

    You’re falling right into how they want you to think. It comes down to jobs. Remember that 3 letter word? 70% of all jobs in our economy are created by small businesses. You say that the National Federation of Independent Business found only 14% of small businesses have an annual income of $200,000 or more. By the way, doesn’t this also show why you saw very few businesses netting over $250,000 as an accountant? So 86% of small businesses are not affected by Obama’s tax increase. Great! But what percentage of jobs do you think that 86% creates? The majority are being created by that 14%. The National Federation of Independent Business also says that almost 20% of the small businesses that employ from 10 to 19 people will see Obama’s tax increase, and 50% of small businesses with over 20 employees get hit. It’s convenient that you just use $260,000. Let’s change it to millions. A tax increase, marginal or not, is an expense for a business owner. How do you think that business owner will handle this new expense? Cut jobs maybe?

  • Ben
    October 22, 2008 at 11:40 am

    Thanks for the clarification – I was under the impression that the tax was on businesses that gross 250K.

    In the end though, it really bothers me that this is not a even a piece of legislation that has been put through Congress and it already needs to be parsed so carefully to determine who is helped and hurt by it. It seems like this plan isn’t designed to simplify the tax code, make it inherently more fair or do anything different in Washington.

    It is one of the same slimy political moves that we have seen from every politician that help them to be able to hit the right talking points to get elected. In other words, Obama is just moving the turd to the other pocket.

  • October 22, 2008 at 2:40 pm

    DRob, that’s a good point about the larger businesses creating more jobs. I was looking at it from an individual taxpayers point of view. No matter how you look at it, we’ve got a lot of things to pay for in this country at right now. We’re at war and we just agreed to buy up a bunch of real estate and banks. I’m not sure how we balance the equation.

  • DRob
    October 22, 2008 at 4:01 pm

    Lela, you’re right, this country is in a big mess right now. Our politicians are to blame, both Republicans and Democrats, but we’re the ones the vote them into office. And we just keep on giving them that power, whether they’re looking out for our best interests or not. I saw this quote today that seems very appropriate:

    Supreme Court Justice John Marshall – “the power to tax is the power to destroy.”

  • John Nettles
    November 20, 2008 at 12:21 pm

    You intellegent people can explain the tax system all you want to these morons that want to blame Obama,they will not get it,it is hard to explain common sense to someone that do not have common sense.

  • November 21, 2008 at 11:40 am

    It’s been pretty stunning to see the number of people who were getting confused by this issue. A lot of them don’t even understand the difference between “profit” and “revenue”. You would think that anyone who is even close to making it to the precious income threshold of $250k would be intelligent enough to at least grasp these relatively simple concepts, especially a person running their own business. Unless they were maybe a pro athlete or supermodel or something. In which case their accountant should be aware of that information and hopefully talk their client out of voicing his or her idiocy in public.

    There are certainly some portions of the tax code that are so indecipherable as to make it nearly impossible for the average (non-plumbing) Joe to figure out. This is not one of them.

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