Much has been written about Joe Biden’s tax plan over the past several months. While Mr. Biden has assured the public that he would only tax “the rich,” what would a Biden tax plan mean to a successful small business owner? Let’s look at his proposals in the context of a successful small business.
How much do taxes increase under the Biden Plan?
Let’s say Mary owns a business that has $1.5M of gross revenue, $400,000 of wages to employees, and net income for the owner of $800,000. Let’s assume this small business operates as a sole proprietorship and Mary files her business tax information on Schedule C of her 1040. She also has a little bit of interest and dividend income that is offset by her itemized deductions. What is the consequence of the Biden tax plan on Mary’s income taxes?
Impact to deductions
First, let’s look at the Qualified Business Income Deduction, or QBID. Under current law, Mary receives a deduction equal to the lessor of 50 percent of the wages she paid out ($400,000 x 50 percent = $200,000) or 20 percent of her net income ($800,000 x 20 percent = $160,000). This reduces her taxable income from $800,000 to $640,000. Under the Biden plan, she would not receive a QBID, so her taxable income would remain at $800,000.
On $640,000 of taxable income, Mary would pay income tax of $200,890 (ignoring the deduction for 50 percent of self-employment taxes addressed below and using the 2021 tax rate schedules released by the IRS). Biden proposes raising the tax rates back to the pre-2018 rates which would result in a tax on Mary’s $800,000 of taxable income of $272,619 (ignoring the deduction for 50 percent of self-employment taxes addressed below) for an increase of $71,729.
Increased Social Security and Medicare taxes
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Under current law, social security taxes will phase out after $142,800 in 2021. This means that Mary would pay $17,993 of social security tax and $28,600 ($5,800 + $22,800) of Medicare tax. Medicare doesn’t phase out under the current law and the first $200,000 of income is taxed at 2.9 percent and the rest at 3.8 percent. Under Biden’s plan, social security would jump back in at $400,000. This means that instead of the current total social security and Medicare tax bill of $46,593, Mary would now pay an extra 12.6 percent on the amount of her self-employed income above $400,000 or $50,400 for a total of $96,993. Mary would get an income tax deduction for 50 percent of this increase, for a benefit of $9,979 and net increase in tax of $40,421.
Total tax increase
Under the Biden plan, Mary’s tax bill will go up $112,150 ($71,729 + $40,421).