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Fixing the Fiscal Cliff: What Can Small Business Expect?

Fixing the Fiscal Cliff: What Can Small Business Expect?

By: Melanie Berkowitz, Esq., Monster Contributing Writer

Even before the last helium balloons had deflated at President Obama’s victory celebration, Republicans and Democrats alike were turning their attention to how to avert economic crisis from the so-called “fiscal cliff” on December 31st, 2012. 

If Congress does not act before then, the expiration of a number of Bush-era and other tax credits, coupled with the implementation of mandatory spending cuts on a host of social and economic programs, will result in $7 trillion taken out of the economy over the next ten years. 

This may be good for the deficit, but economists warn that such a stark drop in spending could send the country tumbling back into recession.

This should be old news for employers who have been trying to plan for hiring and growth in 2013 amid daunting uncertainty as to what the economic climate will look like. 

Depending on how the process of negotiation and compromise plays out, here are some of the tax changes that small business owners might be facing on January 1st:

Payroll Taxes
Small businesses look to take a double hit if the current payroll tax “holiday” rate of 4.2% is allowed to expire, raising social security taxes collected via payroll to 6.2%. That is because payroll taxes are split between employer and employee. 

Where the small business owner is both, he or she will effectively be taxed twice through the so-called self-employment tax. If payroll taxes are allowed to rise, the self-employment tax will rise too.

Personal Tax Rates
According to a National Foundation of Independent Businesses survey, 75% of small businesses are organized as “pass-through” entities, which means that business income is taxed at their owner’s personal rate. 

When Bush-era personal tax cuts expire at the end of 2012, the tax rate for individuals making more than $200,000 a year ($250,000 for couples) will rise from 35% to 39.6%. This means that many small businesses could see their tax rate rise and their bottom line shrink.

Given the renewed discussion about raising taxes on the country’s wealthiest citizens, it is quite possible that any small business that earns more than $200,000 will need to prepare to be taxed at a higher rate next year.

Other Loopholes and Deductions
If the fiscal cliff compromise does not end up raising the highest tax rates, a negotiated tax reform could result in the richest Americans paying more in taxes anyway. Both parties have expressed a willingness to take a hard look at how to eliminate tax loopholes and other deductions that benefit the wealthy, a result that many Republicans prefer over a rate hike. 

While no one can predict for certain what deductions might be cut, small business owners should meet with their accountants to determine how possible loophole and deduction eliminations could affect their tax returns.

Spending Cuts
Last year’s bi-partisan Budget Control Act institutes more than $1 trillion in mandatory spending cuts over the next decade. If these cuts go into effect, we will see $55 billion in defense appropriations and another $55 billion in non-defense spending eliminated from the budget. 

Government contracts, particularly those available to small businesses, could disappear, experts warn. Whether some of these mandatory cuts for government contracts are actually eliminated during negotiations remains to be seen.

Read More about Small Business Trends:

A Look Ahead to 2012 Tax Changes for Small Business
2013 Small Business Trends: Known Unknowns Ahead
Employment Law: Small Business Updates