Media stretch definition of "small business" to claim Obama is raising taxes on 50% of their income

From Media Matters Conservative media have claimed that 50 percent of "small business income" would be taxed at a higher rate if Democrats allow the Bush tax cuts for the top brackets to expire. However, the apparent sources for that claim, the Tax Policy Center (TPC) and the Joint Committee on Taxation (JCT), explained that business income on individual tax returns does not necessarily reflect what most consider small businesses, but includes such enterprises as law partnerships and real estate investments.

Conservative media claim 50% of "small business" income would be hit under Obama's plan

Wallace claimed that "50 percent of small business income would be hit by raising taxes on the so-called wealthy." On the September 12 edition of Fox Broadcasting Co.'s Fox News Sunday, host Chris Wallace misleadingly told White House Council of Economic Advisers (CEA) chair Austan Goolsbee that TPC and JCT found that "50 percent of small business income would be hit by raising taxes on the so-called wealthy," a claim Goolsbee called "highly misleading." From the segment:

WALLACE: The president says that Republicans want to hold the tax cuts for the middle class hostage until they get also the tax cuts for the so-called rich.

But I want you to take a look at some numbers that we put together. Fifty percent of small business income -- and this comes from the Tax Policy Center and the Joint Committee on Taxation -- 50 percent of small business income would be hit by raising taxes on the so-called wealthy. That's 900,000 small businesses that employ millions of workers. Question: You don't think that a 13 percent hike in the taxes of small businesses is going to slow them down?

During the segment, Wallace aired the following graphic:

Brooks argues against letting tax cuts expire for "top 2 percent" because "It does remain a fact that the majority of small business profits are up at that income level." On the September 10 edition of PBS' NewsHour, New York Times columnist David Brooks suggested that the reason it is important to "fight over this -- the top 2 percent" is "[b]ecause it does remain a fact that the majority of small business profits are up at that income level. And small businesses are just completely uncertain right now." Brooks made a similar argument the week before, claiming that "if you raise taxes on those top rates, you will be increasing taxes on the majority of small business profits."

Rove: "50 percent of small business income ... will be taxed at a higher rate" if top brackets of tax cuts expire. On the August 9 edition of Fox News' Your World, Karl Rove claimed that "50 percent of small business income will pay -- will be taxed at a higher rate if they -- if they let the top bracket go up."

Krauthammer: "Half of small business income in the United States will end up in this bracket." On the September 10 edition of Fox News' Special Report, Fox News contributor Charles Krauthammer criticized President Obama's portrayal of the Bush tax cuts, claiming that "[h]e portrays it as, you know, a cut in taxes on the idle rich, the millionaires who sit around." Krauthammer argued that "[i]n fact, half of small business income in the United States will end up in this bracket. It will have its taxes raised by about 5 percent, which is relatively large."

Fox's Bream cites JCT for claim that "50 percent of small business income would be impacted." During the September 8 edition of Fox News Special Report, correspondent Shannon Bream reported that "[t]he nonpartisan Joint Committee on Taxation estimates that 50 percent of small business income would be impacted by the jump in taxation now proposed by the president. But the president says American businesses did just fine before the Bush tax cuts." [Accessed via Nexis]

Both TPC and JCT said taxpayers with business income are not necessarily "small" businesses

JCT: "These figures for net positive business income do not imply that all of the income is from entities that might be considered 'small.' " A July 12 analysis of Obama's FY2011 Budget Proposals by the Joint Committee on Taxation stated that "three percent of all taxpayers with net positive business income" would see higher taxes under Obama's plan, adding that "[t]hese figures for net positive business income do not imply that all of the income is from entities that might be considered 'small' ":

The proposal provides tax relief to a large percentage of taxpayers, which will provide incentives for these taxpayers to work, to save, and to invest and, thereby, will have a positive effect on the long-term health of the economy. The proposal also results in increased marginal tax rates on upper income taxpayers (as is provided for by the present-law sunset of EGTRRA), which will correspondingly reduce incentives for these taxpayers to work, to save, and to invest. Opponents of this latter aspect of the proposal often note that many small businesses, and a large fraction of small business income, will be adversely impacted by an increase in the top two tax rates. The staff of the Joint Committee on Taxation estimates that in 2011 just under 750,000 taxpayers with net positive business income (three percent of all taxpayers with net positive business income) will have marginal rates of 36 or 39.6 percent under the President's proposal, and that 50 percent of the approximately $1 trillion of aggregate net positive business income will be reported on returns that have a marginal rate of 36 or 39.6 percent. These figures for net positive business income do not imply that all of the income is from entities that might be considered "small." For example, in 2005, 12,862 S corporations and 6,658 partnerships had receipts of more than $50 million.

TPC: "We don't know how many of these businesses are really small." On August 4, the Tax Policy Center blog stated that 2.5 percent of taxpayers who report business income on their individual tax returns would pay higher rates under Obama's plan and that "we don't know how many of these businesses are really small":

Most small businesses report their income on individual tax returns, either on Schedule C (for self-employment or sole proprietorships), Schedule E (for S corporations) or schedule F (for farms). We don't know how many of these businesses are really small, but next year about 36 million taxpayers will report income from these sources on their 1040s. Only about 900,000, or 2.5 percent, would pay higher rates if the Bush tax cuts were allowed to expire for those in the top brackets. However, that relative handful of business owners will report $400 billion, or almost 44 percent of all the business income included in individual returns.

The TPC post further noted that "[a] half million top-bracket filers will report net positive business income averaging more than $700,000. These are the people--not the mom-and-pop business owners-- who would be hit by the expiration of the top bracket tax cuts. Who are they? Many are doctors, lawyers, and investors. Others are very successful entrepreneurs who may own a chain of grocery stores or dry cleaners, or a lot of real estate. Do they fit your image of a small business owner? That, I suppose, is in the eye of the beholder."

JCT: "There is no legal requirement of any correspondence between the size of the business and the form of business organization." In a June 2008 document, JCT noted, "While many small businesses are organized as a sole proprietorship, a partnership, or an S corporation, not all businesses organized in those forms are small and not all businesses organized as C corporations are large." JCT further stated:

In very general terms, it is not possible to relate the differences in tax consequences to any substantive non-tax attributes of these different legal forms of doing business, except that businesses that wish to access the public capital markets generally must be taxed as regular (so-called "C") 2 corporations. Indeed, the Code affords business enterprises and their owners the effective flexibility to elect one tax regime or another without varying any of the meaningful non-tax substantive relationships among the enterprise and its owners.

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All forms of entities may be used by business enterprises of any size, from very small to very large, whether measured by assets or revenues. S corporation rules restrict the number and type of shareholders, but an S corporation may have thousands of employees and unlimited equity valuation.

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While one may often associate small businesses with organization in the form of a sole proprietorship, a partnership, or an S corporation, there is no legal requirement of any correspondence between the size of the business and the form of business organization. While many small businesses are organized as a sole proprietorship, a partnership, or an S corporation, not all businesses organized in those forms are small and not all businesses organized as C corporations are large.

Other economists and fact-checkers agree income affected may not be what is normally considered a "small business"

TPC's Rosenberg: Data suggest "that the majority of affected income may not come from what we generally think of as a small business." In an August 13 TPC blog post, Joseph Rosenberg wrote that a 2008 JCT study found "61 percent of net income from partnerships and S corporations is earned by firms with gross receipts over $10 million" and that the data suggests that most of the income that would be affected by Obama's plan "may not come from what we generally think of as a small business":

The narrowest measure of small business income is that which is reported by nonfarm sole proprietors (on Schedule C of the IRS Form 1040). These would include the self-employed and many people running truly small family businesses, like the proverbial corner grocery store, but also would include some independent professionals (doctors, lawyers, independent consultants). The potential impact of raising the top two rates on these independent business owners is considerably smaller than the impact on taxpayers reporting business income from other sources. TPC estimates that fewer than 250,000 taxpayers, about 1.5% of tax units reporting positive Schedule C income, will fall within the top two income tax brackets in 2011. These high-income taxpayers will report $38 billion in income -- just over 11 percent of total positive sole proprietor income and only about 4 percent of all flow-through business income.

The vast majority of business income reported by taxpayers in the top two tax brackets comes from partnerships and S corporations and these taxpayers report most of the net positive income from these sources ($400 billion, or nearly 63 percent of net positive income from such businesses). Not surprisingly, that income is also highly skewed within the top bracket. For example, just 17 percent of the $133 billion of partnership income in the top bracket goes to business owners reporting less than $500,000 of income, and 46 percent goes to those reporting less than $1 million. Income from S corporations is even more concentrated -- 64% of the $211 billion subject to the top rate is for owners with more than $1 million in income.

What do we know about the types of businesses that are generating these large incomes? Unfortunately the answer is not as much as we would like. Individual returns provide very little information about the underlying businesses and the IRS does not release any firm-level data to the public. A 2008 JCT study (see Table 8a) reports that 61 percent of net income from partnerships and S corporations is earned by firms with gross receipts over $10 million and fully 43 percent by firms with gross receipts in excess of $50 million. Those data suggest that the majority of affected income may not come from what we generally think of as a small business, although we do not know whether large and small firms differ in how they distribute income among taxpayers in different income groups.

CBPP: Much "business income" does not go to "what most Americans think of when they hear the term 'small business.'" In an August 3 post, Chuck Marr and Gillian Brunet of the Center on Budget and Policy Priorities wrote that extending the tax cuts for high-income taxpayers "would do little for small business because only the top 3 percent of people with any business income, let alone income from a small business, would benefit." The post further stated that "large amounts of 'business income' go to concerns like large corporate law practices, accounting firms, and wealthy people who invest in financial and real estate partnerships. These are not what most Americans think of when they hear the term 'small business.' " Also from the post:

Those who claim that raising the top rates would seriously harm small businesses also tend to rely on an extremely broad definition of "small business." Because the IRS does not publish specific, satisfactory data on the taxes that small businesses pay, analysts are left to examine various sources of business income that individuals receive. Some analysts define any taxpayer who shows any business income on a tax return -- including passive income that very wealthy investors secure -- as a small business. Defining small businesses in this manner greatly overstates the actual number of small businesses, particularly among households with very high incomes.

For example, most Americans would not describe the nation's wealthiest 400 individuals, some of whom are billionaires, as small businesses. Yet the "Top 400" individuals have a great deal of money to invest and consequently receive significant business income -- which means that they qualify as "small business owners" under the broad definition of the term. The 400 highest-earning taxpayers received nearly $17 billion in S corporation and partnership income in 2007 (the most recent year for which we have these data) -- an average of $83 million each, according to the IRS. In addition to the wealthiest 400 taxpayers, the following types of individuals are commonly included in the definition of "small business" used in tax debates:

• partners in very large corporate law firms,

• partners in lucrative medical practices, and

• Wall Street bond traders who receive multi-million dollar bonuses and invest some of their income in investment partnerships.

The commonly used definition of "small business" also includes many wealthy executives of the nation's largest corporations and financial institutions, who are considered "small business owners" if they rent out their vacation homes.

FactCheck: It's "not clear how many who report business income actually employ any workers." On July 14, 2008, FactCheck.org stated that more than 600,000 taxpayers with business income fall into the top two tax brackets, adding, "Not all of those can properly be called 'small-business owners,' however. Some are farmers. Many are lawyers, accountants or other professionals who get some of their income in the form of partnership distributions. Others may be passive investors in real-estate partnerships or similar investment arrangements and not really persons who own and manage a business." FactCheck further noted:

It is also not clear how many who report business income actually employ any workers. In 2004, the Tax Policy Center found that hundreds of thousands of individual taxpayers who had business income from partnerships or subchapter-S corporations (whose owners pay taxes as individuals) did not claim any tax deductions for employee expenses.

PolitiFact: "It's impossible to know how many of these high earners are what most people think of as small business owners." PolitiFact.com stated on July 27:

The U.S. Treasury Department found in 2007 that many of the wealthiest tax filers report some type of non-wage income, such as income from a sole proprietorship, a partnership or an S corporation. (An S corporation is simply a corporation that chooses to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes.) The Treasury Department estimated that 75 percent of tax payers in the top bracket reported this type of income.

Does this mean that all those wealthy taxpayers were small business owners? Probably not. This kind of income could be reported from anyone who earned money from a source other than a regular job, such as consulting or public speaking. It could also be reported by those who make most of their income from partnerships, such as law firms and medical practices. And it could include investors who have little involvement in the day-to-day operations of a company.

It's impossible to know how many of these high earners are what most people think of as small business owners. One indication, however, might be if these wealthy taxpayers reported that most of their income was from this business-type income. The nonpartisan Tax Policy Center analyzed IRS data in March 2009, looking to see how many wealthy tax filers could say that half of their income or more came from business income. The center found that, among the wealthiest filers -- the top 1 percent -- only 25 percent earned more than half their income from business-type income. The percentages for non-wage income were even smaller among taxpayers earning less. (Editor's note: After we initially published this item, the Tax Policy Center released a new analysis looking at business income by tax bracket. They found that in the top bracket, only 32.5 percent earned more than half their income that way.)

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In conclusion, do many wealthy tax payers report types of business income that might be from owning a small business? Sure. But it's impossible to tell how many meet the definition of what most of us think of when we think of small business owners.

TPC: "[M]ost people in the top income brackets don't rely mainly on small-business income." William Gale of the Tax Policy Center wrote in an August 1 Washington Post op-ed that "just as most small businesses aren't owned by people in the top income brackets, most people in the top income brackets don't rely mainly on small-business income":

And just as most small businesses aren't owned by people in the top income brackets, most people in the top income brackets don't rely mainly on small-business income: According to the Tax Policy Center, such proceeds make up a majority of income for about 40 percent of households in the top income bracket and a third of households in the second-highest bracket. If the objective is to help small businesses, continuing the Bush tax cuts on high-income taxpayers isn't the way to go -- it would miss more than 98 percent of small-business owners and would primarily help people who don't make most of their money off those businesses.