November 8, 2010

Taxing the rich or destroying jobs?

Of the 6 million employer firms in America, about 2.8 million have less than 10 employees. They are most often S-Corps, which means that the owner has to claim company profit as income on their personal tax filings.

If an S-Corp has a very good year and generates a profit of $500,000, the owner will pay a Federal Tax rate of 35% and a State rate of 5.75%. The Feds get $175,000 and the State $28,750 of that $500,000 profit. What remains is usually kept in reserve by the owner to expand the business and for those inevitable slow periods when income does not cover expenses. After-tax profit is not usually income the owner spends on their life style.

A typical small equipment manufacturer that produces a $500,000 profit could have monthly operating expenses around $100,000, not including money required to purchase materials to build products to fill orders.

Many small businesses use their homes as collateral for business Credit Lines to augment cash reserves. In a growing economy, both reserves and credit are usually applied to purchasing parts to build products and to grow the business.

In tough times the owner must reduce expenses before all reserves are gone to avoid using the entire credit line and risk personal bankruptcy. The only way to lower expenses significantly is to reduce staffing. In this example, the $203,750 of Profit paid in taxes would have kept 3 people employed for a year or kept everyone employed on an austerity budget for 2 years. Instead, more middle class Americans lose their jobs. Now multiply that times 2.8 million small businesses!

What tens of millions of Americans really don’t need is high taxes on S-Corps. What they do need is a reduced tax rate on S-Corp. “retained earnings”, which is the profit put into company reserves that allow the owner to keep people employed. Now that’s change I could believe in!

Rex A. Hoover