President Obama’s proposed budget, presented to Congress on February 26th, provides a concept of how he intends to raise taxes on what he perceives to be the wealthiest of Americans to pay for significant changes in education, healthcare and energy, and improve the economy. Without providing details on how these concepts would be implemented, there has been growing concern over the potential implications of tax increases for mid-sized businesses. With corporate and individual taxation as the primary tool for increasing federal revenue, small and mid-sized businesses could incur a large part of the tax burden, possibly hindering their capacities for growth—and even stability—in an already challenged economic environment.
Provisions for Businesses Operating Internationally
More mid-sized businesses are operating in both the U.S. and foreign markets in an effort to tap into cheaper labor and reduce raw material and transportation costs for their products by having production facilities in closer proximity to customers overseas.
The proposed budget calls for $210 billion in federal revenue from reforming our tax laws’ treatment of tax deferrals for income earned abroad, international enforcement of regulations aimed at intercompany transfers of products across international borders, and “other tax reform policies.” Most of this revenue would come from eliminating U.S. businesses’ ability to defer recognition of foreign-earned income until those monies are repatriated to the U.S. These types of changes in international tax policy could erode the ability of U.S. companies to compete in the global economy.
Elimination of Last-in First-Out (LIFO) Inventory Accounting
The proposed budget seeks to generate $61 billion between 2012 and 2019 by eliminating LIFO accounting for all businesses. LIFO is a long-established accounting principle that allows businesses to more accurately match expenses with receipts by valuing inventory sold at its most recent price, as opposed to its oldest price.
LIFO has been around since the 1930s, and is commonly used by businesses of all sizes in retailing, wholesaling and manufacturing. Repeal would have a dramatic negative impact on many of these businesses.
LIFO accounting has already been the subject of considerable debate as the U.S. moves closer to adopting International Financial Reporting Standards (IFRS), which does not permit the use of LIFO reporting. A business’ ability to use LIFO for tax reporting purposes is dependent on its use of LIFO for financial accounting and reporting purposes. Businesses required to use IFRS for financial reporting to shareholders or lenders will lose the ability to use LIFO for tax reporting. The Obama budget proposal steps up the pressure on small and mid-sized businesses wanting to keep the use of this potentially tax-beneficial inventory valuation method.
Individual Tax Provisions
The 2011 sunset of the Bush-era tax cuts stands to have a significant impact on small and mid-sized sole proprietorships, partnerships and S corporations paying taxes at the individual rate. Increased tax rates on ordinary income and capital gains are coupled with a new limitation on itemized deductions for charitable contributions and state and local taxes. President Obama expects these changes to result in $636 billion in new tax revenue over a 10-year period. For business owners, this means increased taxes on revenues used to expand their businesses or to simply stay afloat.
In 2009, single and married individuals reach the highest marginal federal tax rate of 35 percent at $372,100 of taxable income, compared to the budget proposal’s highest tax rate of 39.6 percent applying to taxable income of $200,000 for single individuals and $250,000 for married individuals beginning in 2011. The Obama budget would also raise the tax rate on long-term capital gains from 15 to 20 percent. The promised elimination of capital gains tax on startup and small businesses to encourage innovation and job creation doesn’t begin until 2014, well into the president’s potential second term. iBi