The Gaming Den

Say you have a small business, you file 1099s for the various part-time floor help (6 hours twice a week), you're getting payments put down to start having a new/better building constructed down the road for the business, and you have a take-home profit of ~100k. What would make you have to fire some of the floor help were the Bush tax cuts to expire?

I was under the impression that the tax-cuts, were Obama to have his way, would only tax you more if the take-home profit were greater than $250k for the year; and if all of them expired, the only reason to fire someone would be just to maintain your profit/lifestyle of $100k/year rather than maintain or improve the business because money given to employees or building construction isn't taxed (business expense and all).

As I understand it, you can pay that $100K to yourself as salary and then your company has $0 dollars in taxes because it has $0 in profit. The Bush tax cuts mean nothing to you as a small business.

This is why 2/3rds of US corporations pay no Federal taxes.

You only pay taxes if you want to keep money in the bank. So if you paid yourself a salary of $90K and kept $10K for a rainy day (or if your cappuccino machine at your business breaks), you'd pay taxes on that $10K.

What about personal income taxes from that salary or money reinvested from your personal bank to fix that office coffee machine?

virgil wrote:What about personal income taxes from that salary or money reinvested from your personal bank to fix that office coffee machine?

You have to be super careful about mixing personal and company funds if you incorporate, but as I understand it the expense to fix your coffee machine would come from a "loan" from yourself to the company. I'd talk to a tax guy first before you did something like that because I think you need to have actual paperwork for the money transfer to claim it as an expense (thus reducing profit and tax burden).

Any money that makes it to your accounts is taxable as personal income.

The reason that people leave money in their business is because it gets taxed at a lesser rate than personal income. This means that it's easier to bank money for future investments and improvements.

If you don't incorporate, then the personal/business divide is a lot more blurry, but all profit is taxed as income and you can't pay yourself a salary as a way of reducing tax burden.

The moral of the story is to find a good CPA with small business experience and have a long talk with him so that he can tailor a business plan for your specific business.

virgil wrote:What about personal income taxes from that salary or money reinvested from your personal bank to fix that office coffee machine?

Generally speaking, it makes more sense to write off the repair as a business expense before you pay yourself, and take home slightly less.

Okay, I'm going to work through the easy-case assumptions which I am most familiar with

Assumptions

• You are a sole proprietorship (although it is likely more tax advantageous to be an S-Corp or LLC if you can)
• You are therefore filing a schedule C for your 1040 (long form) individual income taxes
• You have no other income than that $100k in net profit from the business
• You are single, have no dependents, and are claiming the standard deduction (as someone who is neither blind nor elderly)
• You have no adjustments to income other than the SE adjustment (which is inherent to having a profitable business).
• You do not qualify for any federal tax credits.
• You are a US citizen and not anyone else's dependent.

Under Tax Year 2011 law You have to file a
1040 Long form
a Schedule C
a Schedule SE

As per the example, there is $100,000 in business profit, so I assume that someone else has already correctly worked through the Schedule C to determine that, and for my part I can just enter $100,000 on line 12 of the 1040. Although in reality I would never trust another preparer's work on a Schedule C -- it's a common source of both confusion and probable fraud. I have previously caught errors on this area of returns done by people with far more education, credentials and experience than myself on such things.

There's no other income, so that $100,000 carries down to line 22, total income.

There will be one adjustment to income. Since a sole proprietor is self-employed, they have to account for both sides of their payroll taxes, which is painful, but schedule SE allows them to exclude a portion of those taxes from their income for tax purposes. Assuming my quick math is correct, this works out to a $7064 adjustment entered on line 27 of the 1040.

This leaves an Adjusted Gross Income of $92,936 to be entered on lines 37 and 38.

You then subtract a $5800 standard deduction on line 40 and a $3700 personal exemption on line 42. This leaves you with a federal taxable income of $83,436, which as per the 2011 tax table is a federal tax liability of $16,981 entered on line 44. That's high enough that you will face penalties if you did not make quarterly estimated tax payments in advance.

However, you are also self-employed, so you are liable for both sides of payroll tax and must file schedlue SE. Assuming my quick-math is correct, that comes out to another $12,283 in taxes to be entered on line 56.

So total federal tax burden comes out to $29,264 under the most current tax law

Moving on to make some additional assumptions:

• The Bush cuts expire and tax rates reset to year 2000 levels.
• SE taxes, and the SE adjustment stay the same as they were for 2011
• The Standard Deduction and personal exemption amounts stay the same as they were for 2011
• No piece of tax law changes to make our example eligible for additional credits or adjustments.

These assumption let us simply look up the exact same amount of AGI in the [http://www.unclefed.com/IRS-Forms/taxta ... 1040tt.pdf]tax tables for 2000[/url](which the IRS website seems to have an outdated PDF for)

yields an income tax burden of $20,543. We add the same $12,283 in SE taxes for a total federal tax burden of $32,826.

Thus, under these assumptions, the Bush tax cuts reduce taxes for our hypothetical small business owning taxpayer by $3,562.

Although those assumptions are likely generous. A taxpayer with that amount of income is highly likely to be eligible for various other ways to reduce their tax burden (for example having a mortgage, putting money in an IRA, paying student loans, having kids and/or being married) While such things would reduce the total federal tax burden under both current and pre-Bush rates, they would also reduce the difference between the two figures.

virgil wrote: rather than maintain or improve the business because money given to employees or building construction isn't taxed (business expense and all).

Okay, this deserves a separate discussion. In my above post, I assumed that the total NET profit on the schedule C was $100,000. If you are filing schedule C, then contract labor (1099s and the like) are subtracted from the business gross on line 11 of schedule C and "repairs" are subtracted on line 21 of the schedule C.

However, building construction and repairs cannot generally be subtracted out on a single years' return. Such things are depreciable assets and have to be depriciated rather than straight-line expensed. The assumption is that the building will provide decades of use and therefore the cost is spread out over decades. So if, you spend $100,000 on a new building for your business in 2012, you do not get to subtract out that full $100,000 on your 2012 Schedule C, but you instead only get to subtract a small percentage for each month remaining in this year, and then a similar percentage for each month of the next 39 years (under MACRS) where the business remains in service. If you want the hair-pulling details with rules for section 179 and special depreciation allowances you can read Pub 946 or you can do what I do and change to the more illustrative example of llama taxation

So the adjusted gross income is the part that's taxed, which is after any money used for stuff like contract labour, repairs, & utilities? I'm basically trying to understand the situation where an increased tax rate (Bush's cuts expiring, specifically) would force you to 'tighten the belt'.

virgil wrote:So the adjusted gross income is the part that's taxed, which is after any money used for stuff like contract labour, repairs, & utilities? I'm basically trying to understand the situation where an increased tax rate (Bush's cuts expiring, specifically) would force you to 'tighten the belt'.

Here's the question: at $100K, the Bush tax cut is at most $3K for you if you can't get any deductions (and you will get some). Is $3K enough for you to cut staff even if you take home $70K in after taxes personal income?

Probably not. Your staffing decisions are based on maximizing profits and cutting staff will also cut into those profits. You only cut staff when there is not enough demand to employ those staff (so you might cut hours because no one is showing up at those times of day, but if people would be showing up and you are closed it's just lost profit).

I'd be more worried about Romney's plan to increase taxes for your income bracket by removing deductions. An Obama win has you keeping the Bush Tax Cut and not losing deductions.

virgil wrote:So the adjusted gross income is the part that's taxed, which is after any money used for stuff like contract labour, repairs, & utilities?

That's accurate but not entirely precise.

For individual income taxes it works like this

1. Add up all income (Wages, Tips, Interest, Profit, Gambling Winnings, Rent, Royalties, Capital Gains, Jury Pay, etc) to get total income. Note that Profit is a sub category here and you have to fill out a Schedule C to determine it. It is on that Schedule C which you enter your business's gross income and you subtract out the allowable business expenses
2. Then apply all adjustments to income to derive AGI
3. Then subtract your deduction (either Standard or Itemized) from AGI.
4. Then subtract a fixed dollar amount for each exemption you can claim
5. At the end of that, you have your Taxable Income

So to be pedantic about this, it is the Taxable Income entered on line 43 which is taxed, not the Adjusted Gross Income (lines 37 and line 38). Taxable Income will always be AGI minus ( Deductions and Exemptions ).

But your general point that the money spent on business expenses is not taxed for this sort of case is true (Aside from some minor exceptions where "allowable business expenses" differ from "actual business expenses" )

I'm basically trying to understand the situation where an increased tax rate (Bush's cuts expiring, specifically) would force you to 'tighten the belt'.

In the above example, the tax cuts expiring cost our hypothetical small-business owner $3562 per year. That is far less than the cost of a full-time employee, but it's enough to hire a kid for a summer job or to pay a contractor to do a moderately large plumbing or landscaping job. If that money is going to the Government, it's not available to pay for labor. *

Yeah, sure if that $3,562 is paid out for labor, it reduces the net profit and therefore AGI and therefore taxable income by $3,562. But that only reduces the tax burden by a percentage of that $3,562 x the relevant marginal percentage rate. (31% using 2000 rates, less using Post-Bush rates) meaning that the total cost is higher to the proprietor is higher.

And well, if our hypothetical businessman has a net profit significantly larger than $100k, then the tax difference is likewise significantly larger. Due to our progressive marginal tax rates, the difference for a businessman making $200k in net profit will be more than twice the difference for our $100k example. Although from a policy perspective I would counterargue that at $200k profit it's questionable whether you are still a "small" business and doubtful that you are still in the middle class.



*( Well, at least if you follow the Post-Reagan Republican Orthodoxy that any money going to the government is wasteful. My own personal experience with Government jobs as well as textbook Macroeconomic theory says otherwise. ) [/color]

K wrote: Probably not. Your staffing decisions are based on maximizing profits and cutting staff will also cut into those profits. You only cut staff when there is not enough demand to employ those staff (so you might cut hours because no one is showing up at those times of day, but if people would be showing up and you are closed it's just lost profit).

This is mostly true, but your staffing also depends on how many hours you the proprietor are willing to put in. Virgil's example has a couple of floor positions putting in 12 hours / week. You could cut one of those and do the job yourself. (Not that you're probably thrilled about going from like 60 hours / week to 72, but you could if you were desperate.)

ModelCitizen wrote:

K wrote: Probably not. Your staffing decisions are based on maximizing profits and cutting staff will also cut into those profits. You only cut staff when there is not enough demand to employ those staff (so you might cut hours because no one is showing up at those times of day, but if people would be showing up and you are closed it's just lost profit).

This is mostly true, but your staffing also depends on how many hours you the proprietor are willing to put in. Virgil's example has a couple of floor positions putting in 12 hours / week. You could cut one of those and do the job yourself. (Not that you're probably thrilled about going from like 60 hours / week to 72, but you could if you were desperate.)

In the example I'm thinking of, as the floor positions work simultaneously with the proprietor (who also puts in work during the rest of the week). So letting go of any of them would just make the remainder have a more work-filled 12 hours each week.

My business is set up as an LLC, so the basic taxes for us should be easy, but I am starting to wonder about things like SSI. I will deal with it when the time comes. No employees, just the two owners.

Good info in this thread, I will have to keep it in mind!