Don’t gut the small business deduction

Lois Hartman can’t afford a tax hike. She’s the owner of a brush dispenser manufacturer in Iowa. The small business was founded in 1925, but it barely came through the COVID-19 pandemic and government-mandated restrictions. She took out loans and drew down her savings to keep the business afloat. Without the Small Business Deduction that allows her to deduct 20 percent of income — a policy created in the 2017 Tax Cuts and Jobs Act — Hartman’s small business may not have survived. The tax deduction is equally important as she aims to recover and rebuild.

Yet that deduction soon could be limited or gone for Hartman and more than 21 million other small business owners. On June 15, news broke that Sen. Ron Wyden (D-Ore.) — the chief tax-writing lawmaker in the Senate — plans to substantially curtail the Small Business Deduction in upcoming legislation. Such a tax hike wasn’t included in President Biden’s plans, unveiled in April and May, and it shouldn’t be considered now. If not stopped, small businesses from mom-and-pop stores to farmers to engineers to daycare centers and more soon could face new struggles to hire, expand and even stay open. 

The Small Business Deduction is one of the most important small business tax reforms in decades. The 2017 tax law provided pass-through businesses — S-corporations, partnerships, sole proprietorships and LLCs — significant relief, contributing to the economic boom of 2018-2019. Members of the National Federation of Independent Business (NFIB) routinely tell us that it allowed them to invest in new equipment and expand their workforces. More than 80 percent of members say the deduction is important to their business. More than 90 percent want it to be made permanent, so small business opposition to rolling back or repealing the deduction is overwhelming.

The reported Wyden proposal rejects that consensus. While the senator’s framework wouldn’t eliminate the deduction, it would erode it by phasing it out for “high earners,” defined as business income above $400,000. At $500,000 in business income, the deduction would disappear entirely. But what looks like a high-earner on tax returns can be nothing of the kind. 

When small business owners pass through business income to their personal tax returns, it doesn’t equate to their take-home pay. Instead, that money usually is the primary source of business investment, especially if they’re in a capital- or labor-intensive industry — such as  Hartman’s family-owned manufacturing business. On the tax return, it’s income. In real life, that money goes back into the business as investments in future workers, machinery, reserves and other pressing needs. 

Taxing this money will mean less investment on every front. In 2019, the Small Business Deduction created more than $66 billion in savings for small business owners who could be hit by the Wyden proposal. That money’s best uses include wages for new hires, down payments on new trucks or assembly lines, and a thousand other worthy things. It belongs in the businesses, not with the tax collector. While the Wyden proposal wisely would reduce certain industry limitations on the deduction, its tax hike on all industries is still a great danger to small business success. 

Any tax hike would arrive when small businesses can least afford it. Nearly a quarter of small businesses say taxes already are the single biggest problem they face, and coming off the economic devastation of the pandemic and shutdowns, Main Street is struggling. Labor shortages are rampant. Historically high levels of small businesses are raising prices to cover supply chain disruptions and other challenges. With a tax hike, many would consider raising prices higher still. That’s no recipe for recovery. It’s an invitation to greater pain — for small businesses, their workers, and their customers alike. 

Perhaps that’s why the White House has refused to propose this dangerous tax hike. Eroding the Small Business Deduction would set a terrible precedent, opening the door to further tax hikes on small business, meaning further strain on the engine of our economy. If President Biden wants to protect small businesses, he can start by rejecting Wyden’s tax hike.

Brad Close is president of the National Federation of Independent Business.