Impact of Biden Tax Proposals on Small Businesses

Through his first 100 days, as he did during his campaign, President Biden has clearly stated his desire to raise taxes. His spending proposal for a large-scale infrastructure initiative is deemed to include the largest tax increases in decades, and his primary targets are corporations and the wealthy. Under the Tax Cuts and Jobs Act (TJAC) of 2017, both have benefited from the lowest tax rates since the inception of the federal taxes in 1913. Under the Biden proposal, they will experience significant tax increases. That is if what he has proposed actually gets enacted.

With the slimmest majority in the House in decades and an even split in the Senate, Biden is not expected to get everything he wants. But it is still a worthwhile exercise to game his tax plan out to see how it could potentially affect taxpayers. Small businesses, in particular, could end up taking it big on the chin even though they aren’t a primary target of Biden’s proposal. Here’s what small business owners should know about the proposed tax increases and how they could impact them.

First, the Good News

Two of the aspects of small business taxes that Biden didn’t target are payroll tax contributions or the pass-through deduction. That’s good news for now, but it could change under future proposals. Small business payroll tax contributions have been targeted in the past with proposals to double them at higher income levels.

The Qualified Business Income (QBI), or pass-through deduction, is already scheduled to end on January 1, 2026, unless extended by Congress. However, it shouldn’t surprise anyone if Congress decides to chip around the edges by tightening eligibility requirements or reducing the phaseout thresholds. Biden has proposed in the past that a tax increase on wealthy individuals could include an elimination of the pass-through deduction for individuals earning over $400,000. So, stay tuned.

Higher Corporate Tax Rates

The current proposal will increase the corporate tax rate from 21% to 28%, a significant hike. Although the primary target is large corporations, the 25% of small businesses that are incorporated could be taxed at the same increased rate. Because it is a flat tax, there has been no discussion of graduated income levels. All incorporated businesses, regardless of income, would pay the same flat tax.

The Pro Act and Freelancer Classifications

The Pro Act, a union-promoted law that represents the most significant change to labor laws in decades, passed the House in March 2020. Its impact on small businesses that hire independent contractors and freelancers would be massive. While Pro Act policies target large corporations, small businesses will be disproportionately impacted. Under the proposed law, many independent contractors and freelancers will be reclassified as employees, which could substantially increase small business labor costs. Although the Pro Act passed the House, there doesn’t seem to be much appetite for it in the Senate.

Capital Gains Tax Increase

The current proposal would eliminate the current rate on long-term capital gains for individuals with taxable income above $1 million. That would effectively raise the capital gains rate to 39.6%, the top tax rate for high earners. This could have significant implications for small business owners who want to sell their businesses. If this increase does go through, small business owners will have to consider the timing of the sale of their businesses.

Tax Increases for the Wealthy

Under the TCJA, the top tax rate on the highest earners was lowered to 37%. Under Biden’s proposal, the rate would increase to 39.6% where it was previously. The tax increase targets individuals earning more than $400,000 a year. While small business owners making more than $400,000 probably can afford the slight tax increase, they could feel a bigger pinch with the possible elimination of the pass-through deduction for those with taxable income of more than $400,000.

Being Forewarned is Being Forearmed

Biden’s tax proposals are far from being carved in stone. His slim majorities in the House and Senate almost ensure they won’t be finalized in their present form. However, while the current status of new tax proposals raises more questions than answers, business owners should still be planning their 2021 tax strategies under the assumption they could be subject to a very different tax code in 2022.