Soaking the rich means soaking small businesses

I recently wrote an article explaining how John Kerry's proposed tax hike on "individuals" making $200,000 or more would cost jobs. In a nutshell, the reason is that most "individuals" filing their tax returns as making $200,000 or more are actually small businesses, not individuals.

It didn't take long for people to get confused about that. That's because many people really don't understand the tax system of the United States. Not that it stops them from yelling loudly about "the rich". It's not very complicated once you get over the basic hump of confusion that there are many different types of companies and they get taxed differently.

Let's start with Joe Entrepreneur.  Joe wants to start a company selling pet rocks. He calls his business "Joe's Pet Rocks". Simple enough. Legally, he files in his state as a DBA (Doing Business As). So at this point, Joe's Pet Rocks is, the company, is just Joe.

And Joe's business prospers. It does so well that Joe hired 3 people to help sell the pet rocks. His business makes $150,000.  He pays  his 3 employees $30,000 each. He also has $30,000 in expenses (rock procurement). And that leaves $30,000 left.  He's not paying "himself" as much as he's simply keeping what is left.  After all, Joe's Pet Rocks is just Joe Entrepreneur still.

At tax time, Joe's business is taxed like any other individual because he is just an individual still. In 1991, I founded Stardock Systems. It was a DBA of Brad Wardell. The money it made was part of my personal income tax return.

The United States has millions of "companies" that are just DBAs of individuals. They often have employees. Many of these companies make more than $200,000.  The owner of the company is taxed just like any other individual.

Continuing...

So one day one of Joe's customers is unhappy with his rock. He threatens to sue Joe. Luckily, Joe is able to avoid a lawsuit. Because as a DBA, Joe has no real protection. If Joe were sued, all his personal assets (his house, his car, his furniture, his clothes) are on the line.  But Joe is still wary so he decides to become a "real" company. He has 3 options:

1) He can become a Limited Liability Company (LLC). LLCs are nice because they're very simple. They're quite new. LLCs can file for bankruptcy and the person running the company isn't going to lose their house and home and other non-company related assets.  However, income to an LLC is treated just as it was before -- as the individual income of the owner.

2) He can become an S-corporation. This is similar to an LLC. It's designed for slightly bigger companies because it's easier to do partial ownership. But ultimately, the income is still treated as the income of the principle owner of the company. The income flows into the 1040 forms of the owners.

3) He can become a C-corporation. This is the "big" company type. This is where the company actually files as itself. It becomes a new entity. If you're a guy, this probably the closest you'll ever come to literally giving birth to a new individual. These new entities have their own tax structure. So when you hear politicans talking about "Taxing corporations" this is what they're talking about. Big business.

Most businesses, in the United States, are DBAs, LLCs, or S-corporations. This is important because the income they bring in goes directly to the individual's 1040. It has nothing to do with how much money the "CEO" makes.

Let's use Joe Entrepreneur's example.

Joe's Pet Rocks becomes "Joe's Pet Rocks, Inc." It's an S-corporation. He now has 5 employees and his "company" brings in $250,000.  Just like before, he pays his 5 employees $30,000 apiece and has rock procurement costs of another $30,000 and misc. expenses now of say $30,000.  That's $210,000.  He pays himself a salary of $40,000 per year. But tax-wise, it's dealing with the income of the company. Not his personal salary.

Like regular individuals, he has deductions. They don't take on gross income any more than you get taxed on gross income. But the important thing here is that Joe is being taxed based on how much "Joe's Pet Rocks, Inc." is netting. not what he pays himself.

So let's say Joe's Pet Rocks, Inc. nets $201,000. Under John Kerry's tax hike on "rich individuals", this "company" gets taxed. What do you think Joe is going to do? He could lower how much he pays himself. And most entrepreneurs will try to do that because, contrary to what people who have no business experience claim, most entrepreneurs are very ethical, compassionate people (I borrowed on my own house to avoid laying off people at Stardock when the OS/2 market collapsed in 1998 -- and I'm typical). But at a certain point, he's going to have to lay someone off.

Each company is different. But what people need to understand is that most companies are taxed as individuals. Not as companies. So when you raise the tax on "the rich" you're really raising taxes on small companies. And more to the point, you're sucking out the capital of small companies. Capital that could have gone to hire more people.

I'm not saying you should never have taxes or never raise them. But there should be a bloody good reason to do it. Not simply because you don't want to cut the "Outhouse" budget of some national park or because you want to pass another entitlement.

Bush's "tax cut for the rich" was designed to help small businesses as well as provide more money for people to spend money on things. Bush has done a pretty bad job of explaining this stuff to people but I can see why. Even after having explained this, I'm sure some (sorry) dumb ass is going to comment on this without a hint of understanding of how most businesses are actually individuals.  If you want them to create jobs, you want them to have as much capital as possible.