Joe "the plumber" and the $250k threshold

[Eric5273]

Only 1.9% of small businesses (660k out of 35 million) earn more than $250k.

http://economix.blogs.nytimes.com/20...e-the-plumber/

Tax Advice for ‘Joe the Plumber’


“Joe the Plumber” — the Ohio man who played a big role in last night’s presidential debate — may now have the most famous tax bill in the United States. But there are also several unknowns about that tax bill. Here, we try to lay out the biggest issues and offer some answers.


Was Joe the Plumber talking about revenue or profit when he said how much his company makes?

Joe said: “I’m getting ready to buy a company that makes $250,000 to $280,000 a year. Your new tax plan is going to tax me more, isn’t it?”

If he was talking about revenue, then Senator Obama’s plans probably will not affect him. Taxes on corporations are based on profit, not on revenue, and so Senator Obama’s $250,000 threshold refers to profits above $250,000. (Which Joe’s company cannot be making if it is bringing in $250,000 in revenue but has even 1 cent in expenses.) Senator Obama’s reply bungled this point. He said, “If your revenue is above 250, then from 250 down, your taxes are going to stay the same.”

But let’s assume Joe and Senator Obama really meant to refer to profit instead.


How is the company structured?

Most small business are incorporated as “S-corporations” (named after section S of the Internal Revenue Code). These companies do not pay corporate income taxes; instead, the profit is taxed on the company’s shareholders’ personal income tax returns. In other words, if Joe’s company is an S-corporation, Joe will essentially report the company’s profit as personal income, and it will be taxed at personal income tax rates.

So, assuming he does not take any deductions, Joe’s taxes might go up under Senator Obama’s plan, which would raise taxes on any personal income above $250,000. Only the amount above $250,000, though, would be taxed at a higher rate; tax rates on the first $250,000 remain the same or go down under Senator Obama’s plan. (These rates apply to people who are married, by the way, which for the sake of simplicity I am assuming Joe to be.)


What if Joe’s company is not an S-corporation?

Some small businesses are instead structured differently. They may be, for example, “C-corporations,” named after a different section of the International Revenue Code.

Under this legal structure, the company pays taxes on its profits at the corporate income tax rate, not the personal income tax rate (unlike in an S-corporation). Senator Obama has not proposed to raise corporate income tax rates on businesses of this size. Therefore, the taxes Joe pays would remain unchanged. Unless, that is, he pays himself a salary of more than $250,000, or pays himself a dividend.

Joe’s total tax liability may even go down, if he pays himself a salary of less than $200,000 and does not pay himself a dividend. This is because his corporate tax rate would stay the same, but the tax rate on this salary (personal income) would likely decrease under Senator Obama’s plan.


How would Joe’s taxes change under Senator John McCain’s plan?

Under Mr. McCain’s plan, it probably does not matter whether Joe’s company is structured as an S-corporation or a C-corporation; in either case, Joe would likely see a tax decrease because Senator McCain’s plan cuts both corporate and personal income taxes.


How relevant is Joe’s company to most small businesses in America?

If Joe’s company really makes over $250,000 and is an S-corporation, it might see a tax increase, but it does not reflect the majority of American small-owned businesses.

This is because most small businesses earn much less in profit. In 2009 about 35 million tax returns will report some income from small businesses, according to Roberton Williams, principal research associate at the non-partisan Tax Policy Center. Of these only about 660,000 tax units — or 1.9 percent — would see an increase under Senator Obama’s tax proposal.

Joe probably overstated how much his company makes, though. According to the Bureau of Labor Statistics, the mean wage for a plumber is $47,930 per year. A plumber in the 90th percentile earns $73,500.

If Joe’s business is less successful than he claims (which it probably is), then it likely won’t see a tax increase under Senator Obama’s plan — and in that respect, is a more relevant model for most Americans who own small businesses.