Legislature’s tax plan would impact few small business owners

On Monday, the Legislature passed a new fourth-tier income tax bracket on taxable incomes above $200,000 for a married couple filing jointly as part of a larger budget plan.

Analysis finds that few small business owners would pay more under this proposal, despite concerns that have been raised.

There is no universal definition of “small business.” In tax policy discussions, the term “small business” is often used to refer to businesses that are organized so that their income is taxed at the owner or shareholder level through the individual income tax (regardless of its size). These businesses may have one of several ownership structures, including sole proprietorships, farms, partnerships and S-Corps. The net profit of these businesses is reported to the owners and/or shareholders, who report this “flow-through” income on their federal and state income tax returns.

According to the Department of Revenue, only 6.4 percent of Minnesota households with flow-through income (or losses) have household incomes high enough to be in the new tax bracket. While only a small number of households with flow-through income fall into the fourth income tax bracket, 46 percent of households in that bracket have at least $1 of flow-through income.

The universe of households with some flow-through income goes well beyond those people who run a small family business, such as a restaurant, hardware store or barbershop. They also include doctors, lawyers and other professionals who have structured their businesses as S-corps or partnerships, as well as those who are passive investors in small businesses. The flow-through income on any individual return could be only be a small part of that household’s total income. Only 25 percent of the households impacted by the 4th tier proposal receive at least one-fifth of their total income from flow-through income.

As illustrated in our 2009 issue paper, small businesses pay taxes on their net income. Take as an example John Q. Public, who owns a sole proprietorship lawn service business. He earns gross income of $200,000. On his individual income tax return, he can deduct many business expenses, including car expenses, fees, health insurance, equipment depreciation, office expenses, business meals, rent and pension contributions. If he has employees, he can also deduct their wages and benefits. After these deductions, he reports a net profit of $50,000 as income, and pays individual income tax on that $50,000 – just as a salaried worker would.

The evidence does not suggest that small businesses would be disproportionately impacted by the legislature’s income tax proposal. Even though the budget-balancing bill was vetoed by the Governor, this proposal should be part of ongoing negotiations.

-Scott Russell and Nan Madden

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One Response to Legislature’s tax plan would impact few small business owners

  1. Ralph Yehle says:

    2010 Legislative Session report – interesting conclution,”unfortunately, policymakers did not seize opportunities.” It was a Minnesota-nice report and I’d hoped for more. A better understanding of the polical process, the choices legislative leaders had, and why they ended up going along with the Governor. I’ve heard there was no stomach for a fight because there were insuficient votes for an over-ride and a feeling the public would fault the wrong people.

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