(This column originally appeared in The Washington Times)
Over the past few years, President Biden has introduced tax proposals that he stresses to say are targeted at “the wealthy.”
Those are the “high earners” who make more than $400,000 per year. But here’s the reality: Many of the people I know in that category — small-business owners — may be showing that they’re a “high earner” on paper. But the reality is much, much different.
For example, I have a client that earned a million dollars in net profits in 2022. A million dollars! Ka-ching! The company has two equity partners, so their tax returns will show earnings of $500,000 for each of them. According to the Biden administration, they’re the wealthy ones. But just how wealthy are they? Let’s dig down because their cash flow shows something a lot different.
When looking at their cash, that million dollars didn’t exactly find its way to their bank accounts. In fact, even though the company had profits of $1 million, the amount of cash left at the of the year was much, much less. Why? Here’s a summary of their cash activities.
If you’re not an accountant like me, here’s a quick explanation. The above summary shows that even though the company made $1 million, it spent $150,000 on inventory that hasn’t been sold and $200,000 on machinery and other equipment. Its accounts receivable increased because the economy slowed, and some customers are paying later — even though these receivables are considered sales, the cash hasn’t been collected. Estimated taxes were paid throughout the year. There are other items that I’m not showing because they mostly netted one another out.
The takeaway is that even though these wealthy business owners, these rich kids, and these privileged people earned a million dollars in 2022, they saw their cash increase by only $400,000. But they’re going to pay taxes on that million dollars of income because, on paper, they’re each earning $500,000. How much in taxes? The two partners at this client each saw tax bills from their federal, state and local governments totaling about $200,000, which were covered by their estimated payments made throughout the year (they have a good accountant, ahem).
That’s a lot of taxes. But they can handle it. Unfortunately, what terrifies them is that the Biden administration wants them to pay much, much more.
Mr. Biden sees these two owners as “wealthy.” To them, they’re “highly compensated,” even “rich.” And for the honor of being included in that category, Mr. Biden believes they should be subject to many new taxes that he’s repeatedly proposed in budgets, campaign papers and legislative initiatives over the years.
For example, according to the bipartisan Tax Foundation, the “small-business tax deduction” that the owners of pass-through businesses enjoy (we accountants know it as the qualified business income deduction) would scale back for those earning more than $400,000 per year. Those same business owners would have to pay more in Medicare and Social Security taxes. Their individual rates would increase to 39.6%. Regardless of whether those proposals go forward, one thing’s for certain: They’re going to be subject to more audits under the IRS’ new $80 billion budget windfall. Even Treasury Secretary Janet Yellen acknowledges this.
You could make the argument that if the partners sold their business, they would certainly reap millions from the value of their equity, and that would be true. They’re pretty rich on paper. But that’s not reality, is it? This business is their livelihood that provides an income to themselves and to their employees. Neither partner is at an age to sell. This isn’t a share of Amazon. It’s their business. So they carry on, and each year is the same, with paper profits significantly outweighing their cash. They choose to use their cash to invest and spend and hire people. They do this to build value and to grow. And as a result, their vendors, suppliers, partners and employees benefit.
And yet they would be penalized because even when a small business “earns” $1 million in a year, they would be subject to taxes for the “wealthy” even though the actual take-home cash for the owners is much, much less — as low as $200,000 each for these two clients of mine. And after paying for their mortgages, car leases, summer vacations, children’s clothing, food, gas and all the other expenses common for a middle-class family there’s little left after that.
I wish the president would stop calling these people “wealthy.” They’re not. I wish the president would leave these small-business owners alone and allow them to continue to do whatever they feel is necessary to build value in their companies. That means jobs and increased investments. Going after them to serve a political narrative may help win some votes, but that strategy certainly won’t help the country over the long term.
