The business press is buzzing about the impending “The Fiscal Cliff”, painting a daunting picture of the tax increases slated to go into affect on midnight, January 1st. Seemingly every year, our elected officials find a way to overt the latest disaster such as the perpetual raising of the debt ceiling. It is like something from a Batman movie, where the hero pulls a rabbit out of his hat at the last minute. It appears as though there is no hero in this story, and tax rates for small business owners are certainly primed to be dramatically higher, regardless of the outcome of the election.
At year’s end, when the Budget Control Act and other legislation takes affect, it will bring about the[i]:
- End of various business tax breaks
- End of the temporary payroll tax
- Escalation of the alternative minimum tax
- Conversion of Qualified Dividends to Ordinary Income
- Escalation to marginal tax rates, capital gains, and gift taxes
- Imposition of various fees from the Patient Protection and Affordability Act (Obama Care)
- Automatic cuts to over 1,000 federal programs from defense to Medicare
In total, the estimate for “Taxmaggedon” (as some have put it) is a tax increase of more than $300 Billion, the largest in the history of the United States. To make matters worse, the federal government faces an unnerving choice; it must see through deficit reduction or renege on promises to pare debt. [ii] Failure to reduce the deficit could affect confidence in the U.S. government. Moody’s has indicated it could further cut its rating of U.S. debt if a budget compromise is not reached this year. The Congressional Budget Office is predicting a recession in 2013 should the current slate of tax increases go into affect. What a tangled web we weave.
Even if Mitt Romney should close the gap and win the so called “battle ground states”, his ability to reverse these trends will be limited. A more likely scenario is that the Obama administration makes last minute deals to keep the government operating, which will require negotiation with Republicans on things such as military spending and a harder line with Iran. If Obama wins the election, he will be emboldened to preserve his tax policy, including higher marginal rates, and capital gains. Business owners are clearly on the wrong side of reform.
So it is time for us to face the reality that regardless of the outcome of the election, tax policy is going to look very different than it has in the past. While several economic indicators such as real estate demand have turned more positive of late, business owners will clearly have to earn more to keep less.
In particular, the net cost of capital will be higher, as new depreciation rates will apply, having a material affect on profit and tax liabilities. It is said that higher tax rates restrict investment, but there is a flip side to the argument. While one may not feel incented to invest, each incremental dollar of investment offsets earnings taxed at a higher rate.
Clearly entrepreneurs should be consulting with their advisors to consider any tax implications within their business and individual investments. There are many nuances and implications for estate planning, tax planning and the like. This is a time when entrepreneurs have to be proactive and prepared.
Holy tax increase Batman! Where is Robin when you need him?
[i] What is the Fiscal Cliff by Thomas Kenny at Ask.com
[ii] The Kiplinger Letter September 21st, 2012