A Memo to the New Congress [Part 1 Of 2]
By Cliff Ennico
As the new 114th Congress slouches its way towards Washington this week, America’s small businesses and their owners may well be wondering: is this a good thing or a bad thing?
While nobody knows for sure, I personally believe there is a chance for some real reform in the new Congress, for two reasons:
Republicans now control both houses of Congress: not only is the G.O.P. generally more sensitized to the needs of America’s business community, but having been branded over the past several years as “the party that just says ‘no” to everything,” it will be under tremendous pressure to take the initiative and push through lots of politically popular bills. If it doesn’t, the G.O.P. is likely to be steamrolled by Hurricane Hillary in 2016, and most Congressional Republicans know it.
President Obama, for his part, will be focused on building his legacy so that when he leaves office in 2016 he will have something to populate his planned Presidential library in Honolulu. By working closely with Congress and signing legislation that proves to be economically beneficial and politically popular, he can cement his place in history without hurting his party’s chances in 2016.
One of the surest ways for both the G.O.P. Congress and the President to achieve their respective goals is to pass laws making it easier for America’s small businesses and early-stage companies to survive, prosper and grow. There’s a growing consensus that America’s economic future depends on its entrepreneurs, small businesses and self-employed professionals. It’s time for Government not only to get out of the way of new companies, technologies, work styles and business models, but to get behind them and start pushing.
Starting with taxes.
There is already talk in Washington about a major tax reform bill in 2015, one that would, among other things, reduce corporate income tax rates and make permanent lots of tax benefits that currently have to be renewed from year to year.
But such “fine tuning” is not nearly enough. What is needed is an entirely new tax code designed to promote entrepreneurship and small business development as a fundamental policy objective. Here is my “wish list” for such a code.
Eliminate Taxes for “Qualifying Small Businesses.” First, Congress should create a new class of “Qualifying Small Business,” defined as any for-profit business, regardless of how it is legally organized or how long it has been in business, that:
- Has less than $2 million in annual revenue;
- Has less than $750,000 in annual pretax earnings (gross margin); and
- Has fewer than 50 full-time equivalent employees (using the same calculation method as for Obamacare).
Then, Congress should exempt “Qualifying Small Businesses” from all federal income, employment and Medicare taxes. That’s right. Make them exempt from taxes, at least at the federal level (states would be free to tax QSBs, but many will choose not to do so in the hopes of generating in-state business development and attracting businesses from other states). Each year QSBs would file “information returns” with the IRS showing they continue to qualify for tax-exempt QSB status (similar to the “postcard” annual reports filed by small nonprofit organizations).
Yes, there will be a negative impact on federal revenues at first, but it won’t be as serious as many think. Most QSBs make little money, especially during their first few years, and those that are profitable jump through hoops trying to “zero out” their earnings each year to minimize their tax burden. With tax-free status, that would no longer be necessary, and QSBs would be free to hire more people, invest in plant and equipment, and make more aggressive/creative business decisions without the need to factor in tax consequences. Rather than creating roadblocks to entrepreneurial startups and companies, the Government would become their incubator.
Eliminate the “Employee vs. Independent Contractor” Distinction. It is virtually impossible for most small businesses to distinguish between employees and independent contractors using the IRS’ vague and confusing “20 Factor” test. As a result, they face a no-win choice between:
- Paying outrageously high payroll taxes for their employees;
- Paying outrageously high fees to employment lawyers for legal advice; or
- Treating all of their workers as independent contractors (or paying them “under the table”) and praying they don’t get audited.
QSBs should be allowed to “elect” to treat their workers either as employees or independent contractors, in much the same way small businesses can currently “elect” to be taxed as a corporation, partnership, or LLC. New businesses could make the election when applying for a federal tax ID number (EIN) on IRS Form SS-4, while existing businesses could make the election using a form similar to current IRS Form 8832.
QSBs electing to treat their workers as “independent contractors” would continue to file Form 1099 for each worker in January of each year, with a penalty for failing to do so, and workers so treated would be required to pay self-employment income on their earnings.
Would it be too much to ask also for a reduced self-employment tax rate for QSB contractors? Hey, I can dream, can’t I?
More next week . . .
Cliff Ennico (www.succeedinginyourbusiness.com), a leading expert on small business law and taxes, is the author of “Small Business Survival Guide,” “The eBay Seller’s Tax and Legal Answer Book” and 15 other books.