Small-business owners are facing significant tax challenges as the upcoming election looms. If Vice President Kamala Harris is elected president with the necessary congressional support, many small-business owners could see their tax bills nearly double. The potential impact stems from three major changes: the expiration of key tax deductions and an increase in tax rates.
The Loss of the Qualified Business Income Deduction
One of the most important deductions for small-business owners is the qualified business income (QBI) deduction, also known as the pass-through deduction. This was introduced under the Tax Cuts and Jobs Act (TCJA) in 2017 and provides a 20% deduction on business income before it passes through to the individual tax return.
- How it works: For businesses structured as S corporations or partnerships, the income passes directly to the owners’ personal tax returns. The QBI deduction allows owners to deduct 20% of their business income before it’s taxed.
- Expiration: This deduction is set to expire after 2025 unless Congress intervenes. Despite efforts from business groups to extend or make the deduction permanent, Harris has not indicated any plans to maintain it.
Without this deduction, many small businesses will face a larger tax burden. The elimination of the QBI deduction could have a significant financial impact on small-business owners who have benefited from it since 2017.
The Shrinking Standard Deduction
Another tax break set to expire under the TCJA is the standard deduction, which significantly reduces taxable income for individuals and families.
Current and Future Standard Deduction
| Filing Status | 2024 Standard Deduction | Post-2025 Standard Deduction |
|---|---|---|
| Married Filing Jointly | $14,600 | $7,300 |
| Single Filers | $7,300 | $3,650 |
The reduction in the standard deduction will especially hurt small-business owners who rely on it to lower their taxable income. Once the current standard deduction expires, it will be cut in half, making it harder for small-business owners to offset their tax liabilities without itemizing their deductions.
Tax Rates on the Rise
The most concerning change for small-business owners is the potential reversion of tax rates to pre-TCJA levels. When the TCJA expires after 2025, tax rates could revert to levels last seen in 2016, which were much higher for many taxpayers.
For small-business owners, this means that:
- Higher Tax Brackets: Some tax brackets could almost double, which would significantly increase the amount of tax paid on business income.
- Fewer Tax Breaks: The expiration of the QBI deduction and the reduction of the standard deduction means that more of their income will be taxed at higher rates.
Comparing Tax Rates: 2024 vs. 2016
| Income Bracket | 2024 Tax Rate | 2016 Tax Rate |
|---|---|---|
| $100,000 – $200,000 | 24% | 28% |
| $200,000 – $400,000 | 32% | 39.6% |
| Over $400,000 | 37% | 39.6% |
As you can see, small-business owners in higher income brackets will face steeper taxes if the 2016 tax rates return. The combination of losing key deductions and higher tax rates could result in a significant tax increase for small-business owners.
What This Means for Small-Business Owners
For small-business owners, this potential tax hike presents a difficult situation. Many businesses have grown accustomed to the benefits provided by the TCJA, and the expiration of these provisions could put financial strain on their operations. The impact could be felt in various ways:
- Lower Take-Home Pay: Without the QBI deduction and with higher tax rates, small-business owners could see less of their income after taxes.
- Increased Tax Planning Complexity: Business owners will need to revisit their tax strategies, possibly itemizing deductions or restructuring their businesses to minimize the tax impact.
- More Difficult Business Decisions: Higher taxes could lead to tough decisions on hiring, expansion, or reinvestment in the business.
Calculating the Impact
Let’s break down how these changes could affect a typical small-business owner:
- Current Income: A business owner with $150,000 in qualified business income currently benefits from a 20% QBI deduction, lowering their taxable income to $120,000.
- Post-2025: Without the QBI deduction, the full $150,000 would be taxable, and with higher tax rates, the owner could see a much larger tax bill.
For small-business owners already operating on thin margins, these changes could significantly reduce profitability, making it more challenging to grow their businesses or even maintain current operations.
Preparing for the Future
As the political landscape evolves, small-business owners must stay informed about potential tax changes and plan accordingly. Working closely with tax advisors and financial planners will be crucial to navigating these uncertainties and minimizing the impact on their businesses.
While the final outcome depends on future legislative decisions, one thing is certain: without the continuation of key tax deductions and lower tax rates, small-business owners could face a much more challenging financial environment after 2025.
