SMBs Must Look Beyond Platitudes and Their Party on Tax Policies

Fourth in a Series: When Republican John McCain gave the keynote address at the National Federation of Independent Business (NFIB) Small Business Summit over the summer, he was obviously interested in highlighting how business owners would benefit under his tax policies.

"I'll pursue tax reform that supports the wage earners and job creators who make this economy run and help them to succeed in a global economy," he told the audience. "I've proposed a reduction in the corporate tax rate from the second highest in the world to one on par with our trading partners, to keep businesses and jobs in this country."

Indeed, cutting the corporate income tax rate from 35 percent to 25 percent is one of the centerpieces of McCain's tax policy. There's only one problem: The overwhelming majority of small businesses are organized as S Corporations, partnerships, limited liability corporations (LLCs), or sole proprietorships. None of these entities pays taxes at the corporate rate. Rather, income is taxed at the owners' individual tax rate.

The distinction is significant but rarely, if ever, mentioned by either candidate. It also highlights the difficulty in determining which tax proposals actually benefit small business owners. And the contradictions aren't limited to one candidate.

Democratic presidential nominee Barack Obama has touted his tax policy because it would only raise taxes for households earning $250,000 or more a year. Is that good for small businesses? "Currently, there are 21.6 million sole proprietorships filing under the individual income tax," McCain noted in his NFIB speech. "When Senator Obama talks about raising income tax rates on those making over $250,000, that includes these businesses, as well." Is he right?

The payroll services Web site Salary.com conducts an annual survey of small business compensation that is one of the most comprehensive available. It examines 12 key executive job functions and includes data from more than 1,800 organizations representing more than 50 industries, 15 regions, all 50 states, 96 metropolitan areas, and 10 size ranges. It uses the Small Business Administration's definition of a "small business" to determine its survey sampling: 500 employees or less.

According to the survey, the national average salary for a CEO, partner, or owner is $258,400 annually. It found, however, that compensation varies widely depending on location. For example, small business CEOs/Partners/Owners in the District of Columbia earn $395,000 annually, more than 2.5 times as much as their counterparts in Oklahoma.

So McCain's assertion would be correct, but only marginally so, and only in urbanized, higher-cost areas of the country, which traditionally are Democratic strongholds. But an even closer examination of data shows yet another picture.

Another payroll services firm, Payscale.com, conducted a similar survey, but limited its sample to those who defined themselves as "self-employed." It found that annual salaries ranged from an average of $48,600 on the low end to $132,000 on the high end. These business owners would clearly benefit more from Obama's proposed tax policies.

Next to income taxes, the debate has focused on dividends, capital gains taxes, and estate taxes. "Under Senator Obama's tax plan," said McCain in his speech, "Americans of every background would see their taxes rise: seniors, parents, small business owners, and just about everyone who has even a modest investment in the market."

Obama advisors Jason Furman and Austan Goolsbee wrote recently in The Wall Street Journal that the top capital gains rate for families making more than $250,000 would return to 20 percent, the rate Clinton and Republican congressional leaders agreed to in 1997. The rate was lowered to 15 percent as part of the Bush administration tax cuts in 2003. The 20 percent rate is almost one-third lower than the rate President Reagan set in 1986. Most capital gains were taxed at a 28 percent rate before that.

Obama would maintain the 15 percent rate for households under $250,000 in annual income, and raise it to 20 percent on households over that threshold. McCain would keep the current Bush administration rates on capital gains across the board.

Until the Bush 2003 tax cuts, dividends were taxed as ordinary income, as high as 39.6 percent for households in the highest tax bracket. But after that, the dividend tax rate was reduced to 15 percent. Since S Corporations and LLCs are prohibited from paying dividends, small business owners would have to have investment income or be incorporated as a "C" corporation to be affected.

Obama would hike the tax rate on dividends to 20 percent, but again, only for households making more than $250,000. The rate would be 39 percent lower than the rate President Bush proposed in his 2001 tax cut and would be lower than all but five of the last 92 years that dividends have been taxed, according to Furman and Goolsbee.

Without any action, the estate tax exemption would revert in 2010 to $1 million and the top estate tax rate would return to 55 percent. McCain has called for permanent reduction of the tax in 2010 by increasing the estate tax exemption to $10 million and reducing the tax rate from 45 percent to 15 percent. Obama would effectively repeal estate taxes for 99.7 percent of estates, and tax estates valued at over $7 million at a 45 percent rate. This would cut the number of estates covered by the tax by 84 percent relative to 2000, his advocates say.

The capital gains and estate taxes are most important to small business owners who might be considering a sale of their business, or succession planning in a family business. Again, the $250,000 threshold could separate small business owners into opposing camps on this issue.

The problem with both McCain and Obama's proposals is that each would increase the budget deficit substantially. Obama's proposals would add about $3.3 trillion to the national debt over the next 10 years and McCain's plan would add about $4 trillion over the same period. In effect, both candidates are funding their plans and leaving it up to future generations to foot the bill. Both candidates say they will offset the cuts through federal spending reductions, but that's where their policies fade to gray.

Given the wide variation in circumstances of most small business owners, it's up to each to weigh the details of the respective plans against their own situation and avoid being swayed by platitudes and political ideologies.