Are higher rates and surtaxes coming

January 9, 2012
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After the ball dropped on 2011 last week and the much-despised Michigan Business Tax and its equally despicable surcharge became scrapheap history, business owners weren’t exactly dancing jubilantly in the streets.

Following years of railing against the old tax, the new tax, which exempts most business owners and relegates them to the personal income tax, entered rather quietly into the financial-planning picture when 2012 arrived. Only the state’s largest corporations and those who will stay with the MBT because they have credits coming will file a state business tax return next year, while upward of 85 percent of businesses won’t.

So what accounts for the serenity?

“To be honest, I haven’t heard much directly. Overall, I sense they are pleased about the one level of taxation for Michigan purposes. But the response, in some ways, is a bit reserved,” said Bill Roth, a partner at BDO and an international tax specialist.

“The reserved reaction may be, in part, due to the uncertainty on tax rates and tax policy and tax reform in Washington,” he added.

Uncertainty about rates at the federal level could very well center on what Congress decides to do this year with what is commonly referred to as the Bush-era cuts. The reduced rates on income and capital gains that business owners have enjoyed since 2001 and 2003, respectively, are set to expire at the end of this year after being extended for two years at the end of 2010.

“It is a big issue. Whether it’s been the stimulus or the health care or some of the other things, I think the biggest complaint people have is they just don’t know where things exactly are going for certain on some of these items. We tend to have temporary things and not longer term. In terms from a planning standpoint, it’s a little bit easier if you think something is a little more permanent than something that is a temporary one- or-two-year item,” said Roth, who writes the monthly Money Matters column for the Business Journal, which can be found in this issue.

Another source of uncertainty is the possibility that Congress could enact a 2 percent surtax on individuals who earn $1 million and more. Last month, Democrats suggested doing that as a way to pay for the cost of a year’s worth of cuts to the payroll tax that received a two-month extension. But the party’s leaders dropped that idea when Republicans refused to go along because they felt it would hinder job creation. However, Democrats could bring up the issue again this year — especially during an election year with a majority of Americans showing support for it in the polls.

“Not to say that all would be under that, but a good share of small businesses are LLCs or S corporations, which means whatever the individual rates are, that is what they are going to pay on their business profits,” said Roth.

Another surtax is just over the horizon and has received little press. Beginning next year, a 3.8 percent federal surcharge goes into effect for some individuals, trusts and estates on net unearned income gained from investments. The tax revenue will go to the Medicare program as part of The Patient Protection and Affordable Care Act that Congress passed in 2010. It will be levied on single filers with an adjusted gross income of $200,000 annually, on married couples filing jointly with an AGI of $250,000, and on married couples filing separately with an AGI of $125,000.

“Sometimes, not all the owners will be actively involved in a business, and it kind of defines whether someone is active or not active in the business. Certainly, some of those who are more passive but still are owners could see themselves having that surtax apply to their income — not just on their interest and dividends, but also to their income from other investment activities, which may include their interest in, maybe, some smaller businesses,” said Roth.

Roth said a lot of business owners will find themselves ahead this year because the state has ended what they felt was a dreadful double-taxation situation. But the point he makes is that the gains they will receive from the state could be erased by the federal government. Roth noted that some small-business owners can have a sparkling revenue year and, because they pay taxes as individuals, could be pushed into a higher 1040 bracket, even though their previous two or three years were mediocre or even bad. And tacking on higher rates and surtaxes could take a toll.

“It’s great that we’re getting one level of tax at the state level and we’re not hitting everyone with a business tax and another tax on their individual returns, essentially on the same income,” said Roth. “The difficult part here is, within the year, if some of these Bush cuts sunset or if they institute this surtax some people in Congress and the president seem to want, any benefit out of that state savings may just end up back in the hands of the federal government.”

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