Obama's Small Business Tax? Revenue or Profit?
October 16, 2008 8:05 AM   Subscribe

Will Obama's tax plan tax revenue or profit of $250k on small businesses?

We heard a lot about the plumber last night. After reading the actual conversation I was surprised that Obama said that those businesses that have revenue of $250k or more would be taxed. Did he misspeak? Did he mean profit? Most small businesses that I know of have revenue of well over $250k but have net incomes (profit) of much lower. I can't imagine him taxing a business at 39% that has a revenue of $250k but only a profit of $50k.

Could someone clarify this for me? And please no partisan bickering here, I just want the facts.
posted by blueplasticfish to Law & Government (17 answers total) 2 users marked this as a favorite
 
profit
posted by itsamonkeytree at 8:13 AM on October 16, 2008


Profit. And what Joe should do (besides hanging up his wrench, getting an agent and a business manager to help him take advantage of his newfound fame, get himself on Letterman, and start licensing 'Joe the Plumber' franchises), is incorporate as a C-corp rather than S-corp, so his profits will not immediately flow through to his personal tax return and he can pay himself a salary (deductible to the corporation), of whatever amount is most advantageous, tax-wise.
posted by beagle at 8:19 AM on October 16, 2008 [1 favorite]


That's an egregious mis-statement on Obama's part. He should issue a press release or something.
posted by goethean at 8:20 AM on October 16, 2008


Heck, even the illustrious Joe The Plumber may have got it wrong:

"To evaluate how Wurzelbacher and his wife would fare under Obama, one would need to know his wife's income (if any) plus what the plumber meant when he told Obama that the company he is getting ready to buy "makes" $250,000 - $280,000 per year.

Was Wurzelbacher referring to gross revenue or net profits?

Obama's higher taxes on small businesses would be leveled against those whose net profits exceed $250,000 per year, according to Obama's campaign."

posted by brandman at 8:55 AM on October 16, 2008


Wait. I thought that S-Corporation revenues were passed on to the shareholders, and the shareholders have to report that income on their personal tax returns. Wouldn't that mean that the company's revenue is taxed as personal income? Isn't personal income taxed without considering expenses?

I don't know if this is true, I'm asking if it is or not.

--FCOD
posted by flyingcowofdoom at 8:55 AM on October 16, 2008 [1 favorite]


Beagle is right and wrong:

Right: Profit (not revenue) is all that will be taxed.

Wrong: It is, however, incorrect to recommend a C-corp for such a small business. S-corps can also deduct salaries (even of owners) - only profits flow-through to personal returns. In fact, forming a c-corp will cause a second layer of tax (the c-corp will be taxed at the corporate level in addition to the personal level when profits are paid via dividends) that can be avoided via the flow-through of an s-corp to just the personal levels.
posted by webhund at 8:55 AM on October 16, 2008


flyingcowofdoom: Yes, that is how it works, except the company deducts its expenses before passing the income to the shareholders.
posted by itsamonkeytree at 9:31 AM on October 16, 2008


If Joe the Plumber reinvests $150k of his profits in his business, he's left with $100k as his "salary".

Would the Obama tax plan still tax him for the full $250k, or is there a way that he can deduct those investments in his business?
posted by BobbyVan at 9:44 AM on October 16, 2008


IIRC Reinvested net earnings are one of the kinds of phantom income that are indeed taxed. Reinvested income is complicated.

If that seems unfair, ask why it should be cheaper to take money at the front (before distribution) and invest it rather than at the end (after distribution).
posted by a robot made out of meat at 10:25 AM on October 16, 2008


@a robot:

Let's say that Joe the Plumber nets about $60k for himself at the end of the year (less $190 of reinvested income). Suppose those investments that he made were necessary to keep his business competitive (i.e., he didn't just buy himself a truck to drive himself to & from work).

If he's taxed at the top rate for that $60k he has leftover, that seems a bit unfair to me. Just sayin'.
posted by BobbyVan at 10:29 AM on October 16, 2008


Isn't personal income taxed without considering expenses?

No. The deduction for ordinary and necessary expenses of a trade or business is available to individual taxpayers.

It is, however, incorrect to recommend a C-corp for such a small business. S-corps can also deduct salaries (even of owners) - only profits flow-through to personal returns.

I agree in all respects. I would also worry that Joe the Plumber's C-corp would qualify as a personal holding company (since it's closely held and earns primarily income from personal service contracts under which Joe himself performs the services). A personal holding company may be subject to additional taxes in addition to the second level of taxation imposed on C-corps.

Since a single-member LLC can receive partnership (i.e., flow-through) tax treatment and is more flexible than an S-corp, that might be the best choice.

IIRC Reinvested net earnings are one of the kinds of phantom income that are indeed taxed. Reinvested income is complicated.

Indeed. It would depend on what people meant by "reinvested." Current operating expenses of the business would probably be currently deductible, but capital expenditures would probably give rise to a depreciation deduction over a period of years. Other, non-depreciable expenditures might be recovered only when the property is disposed of.
posted by Mr. President Dr. Steve Elvis America at 11:16 AM on October 16, 2008


If those investments "to stay competitive" were replacements, repairs, etc. then there's a matched amount of loss or depreciation which also gets passed through to the shareholder. If they were upgrades needed because CompanyB upgraded then consider two things: 1) Joe now owns a new add-on to his company, which he purchased with his income from the older crappier company. It's the same net effect if he had created CompanyC with that income which owned the purchased assets and leased them to PlumberJoeCo. 2) CompanyB' (which was net neutral) to expand either paid the same tax or its shareholders chipped in money from another source, which was at some point income which they paid taxes on. It woul be patently unfair to CompanyB's shareholders.

If reinvestment were not taxed, the Joe could continue to pay himself $60k (as long as that's what his services were worth) while PlumberJoeCo grew to be a giant company which he solely controlled and not pay any taxes on the money which fueled that growth, unless of course PlumberJoeCo directly paid tax. That's a C-Corp, which doesn't pass through reinvestments or losses to the holders for tax but pays a corporate income tax instead.
posted by a robot made out of meat at 11:23 AM on October 16, 2008


Suppose those investments that he made were necessary to keep his business competitive (i.e., he didn't just buy himself a truck to drive himself to & from work).

I'm not an s-corp tax expert and what I'm about to say is just a high-level corporate finance perspective...

The kind of reinvestments you're talking about are capital expenditures. Let's say Joe buys some machinery for a metal shop*, those machines become fixed assets of the business and he will use them for business purposes for a number of years. In other words, the capital expenditure is an expense associated with future revenue streams over a number of years. In order to best match revenues with their associated expenses, Joe will have to depreciate his new machinery over a number of years (say 5 years). That depreciation will show up as an expense on the company's P&L (in my example, the expense would be 1/5 the price of the machinery each year). Depreciation expense is tax deductible. So over 5 years, Joe will have effectively reduced his taxable income by the same amount as the up-front cost of the fixed assets.

*that's something a plumber would need, right? I dunno.
posted by mullacc at 11:30 AM on October 16, 2008


uh, on (lack of) preview what everyone else said. Bah.
posted by mullacc at 11:32 AM on October 16, 2008


I hope this is clarified officially soon.
posted by canine epigram at 2:11 PM on October 16, 2008


Also note that the additional tax is only on income above $250,000. So if he made exactly $250,000 then his taxes would not increase at all. For each $100 in excess of $250,000 he would pay an additional $3 in taxes beyond the current rate. For example, if he made $300,000 then his taxes would be about $1500 higher than currently.
posted by JackFlash at 2:18 PM on October 16, 2008


Those interested in the facts on this issue can find them here:

http://www.barackobama.com/pdf/taxes/Factsheet_Tax_Plan_FINAL.pdf

The source of course is www.barackobama.com, where all of Obama's policy proposals are laid out in detail.
posted by zhivota at 10:03 AM on October 17, 2008


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