How Will President Trump Impact Small Business Tax Liabilities

Change is unavoidable whenever there is a transfer of power, but it has already become clear that this transfer may come with more (and faster) upheaval than those in the past. Considering the rapidness of the changes enacted since President Trump’s inauguration, it is crucial to stay informed about what implications these laws might have for your business. Many business owners are wondering how the policies President Trump plans to enact will impact small business tax liabilities. The proposed policy changes would affect 2017 taxes for businesses of all sizes, but small business owners must be particularly vigilant about informing themselves regarding the tax code.

The current tax system

In order to understand what President Trump is aiming to change, you must be familiar with current corporate tax law. In the United States, a tax is levied on corporate profits after employee salaries, expenses, etc. have been paid. Most major companies in the United States are considered C-corporations and are taxed at a rate of 35 percent. However, these major companies make up a fraction of the businesses affected by corporate tax laws. As of 2012, 88.9 percent of the businesses filing taxes in the United States were part of the second group, known as “pass-through” businesses. Partnerships, sole proprietorships and S-corporations are all considered pass-through entities because instead of paying the standard corporate tax, their profits “pass through” as income to the owners and are thus taxed at individual income tax rates, which vary from 10 percent to 39.6 percent. This tax structure is built on the assumption that pass-through businesses are what we normally imagine when we say “small business” — entrepreneurs, store owners, independent tradesmen and other businesses that provide everyday income to one or a few people, not the impressive profits that large corporations might be expected to earn.

President Trump’s tax plan

The tax plan put forward by President Trump during his campaign would alter the rates paid by both businesses and individuals. President Trump has stated his intention to cut corporate tax from 35 percent to 15 percent. In addition, he also has proposed capping the pass-through business tax rate at 15 percent instead of the profits of pass-through businesses being taxed at the income tax rate of the individual, which may reach as high as 39.6 percent in the current system. This change is purported to benefit small businesses the most, but this may not hold true for all businesses, especially in conjunction with proposed income tax changes.

Instead of the current seven income tax brackets, President Trump proposes reducing that number to three: 12 percent, 25 percent and 35 percent. In 2013, 68 percent of the income claimed by pass-through businesses went to individuals claiming $200,000 in income or more. With two income tax brackets above the 15 percent proposed as a cap, individuals whose income would place them in those upper brackets are incentivized to try to be classified as a pass-through business instead. Additionally, in 2012 the 0.4 percent of S-corporations earning over $50 million accounted for 40 percent of all S-corporation income. In the same year, the 0.3 percent partnerships that took in over $50 million accounted for 70 percent of all partnership income. For these S-corporations and partnerships, the new tax rate cap of 15 percent on pass through businesses would dramatically reduce their tax liability.

Though this change could benefit lucrative pass-through businesses, the entrepreneurs and partnerships that are what many people picture as “small businesses” may not be affected at all. In 2009, 34 percent of pass-through businesses were either taxed in the lowest income tax bracket (10 percent) or did not make enough money to be taxed. For these businesses, they do not earn sufficient profits to have any benefit from the tax rate changes, as they will not reach the 15 percent cap.

What can you do?

As a small business owner, especially a sole proprietorship or partnership, you may not have the dedicated resources to analyze the tax code and how it applies to your business. Consulting with a tax attorney will help you make sure that you understand the new United States tax laws as they are set into place. It can be tempting to push the thought of taxes out of your mind until they come due, but especially when laws are changing, it’s crucial to have an expert keep you informed. You will want to know as soon as possible if changes in tax rates could benefit you or your business.