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Promoting Entrepreneurship by Fixing a Broken Schedule C Tax Filing System [GUEST POST]

Wednesday, February 17, 2010

Posted by Kristie Arlsan - With policymakers pinning their hopes on small business to create jobs and improve our sluggish economy, our guest blogger Gene Severens responds to an opinion piece in the New York Times calling for a greater focus on entrepreneurship.  Gene highlights the challenges new entrepreneurs face when dealing with their first encounter with our federal government -- the dreaded IRS -- and discusses what could be done to faciliate the tax filing process for those newly entering self-employment. Gene is a private consultant, currently serving as Senior Advisor to the Self-Employment Tax Initiative, a project of the DC-based Corporation for Enterprise Development.

    

“Win-Win-Win” – Fixing a Broken Schedule C Tax Filing System

A recent New York Times op ed (January 24, 2010) by Thomas Friedman has called on President Obama to make his version of a presidential “moon shot” a “Start-up America” movement that focuses on supporting entrepreneurs who can jumpstart the economy with new jobs.  A great idea, but what Mr. Friedman apparently did not know was that the Administration could kick this off right now by using the new “Making Work Pay” credit as a start-up tax credit for entrepreneurs.  Every year roughly 1.5 million new self-employed sole proprietor business owners file business taxes for the first time using Form 1040 Schedule C.  During the “jobless” recovery, we can only expect these numbers to increase as dislocated workers and hard-pressed households turn increasingly to starting their own jobs.  There is considerable anecdotal evidence that this is happening. One article quantifies this by reporting that in 2009, 8.6% “laid-off managers and executives” grew tired waiting to be hired and started their own businesses.  The rate for 2008 was 5.1%

Unfortunately, for most of these new start-ups, their first encounter with the tax code as a business is a rude awakening.  Filing for the first time as business owners, new entrepreneurs are blindsided by the unexpected lump sum liability of a year-long double share of self-employed Social Security and Medicare contributions—often with a tax penalty to boot plus, of course, state income tax variations.  Unfortunately, this startling tax liability comes at a time when, as new businesses, their cash flow is likely to be at its most vulnerable. The net effect is to drive many otherwise vital new businesses into a Catch 22 limbo of keeping their business alive only by avoiding taxes.  This is a lose-lose-lose scenario.  First, the business flirts with non-compliance which has a long list of unintended consequences, including reducing the business owner’s access to Social Security and Medicare.  Second, our local communities lose promising businesses that get forced into the underground, non-compliant economy. Third, as taxpayers, the rest of us, including fully complying self-employed businesses, have to make up the lost tax revenue.

The goods news is that, now, with the Making Work Pay tax credit, there is, for the first time, a meaningful tax credit that helps these start-ups cover their unexpected liabilities.  The Making Work Pay tax credit provides an $800 refundable tax credit (joint filers; $400 others) that reduces their tax liability including Social Security taxes, dollar for dollar. But the bad news is hardly any one knows this credit applies to the net profits of unincorporated business start-ups.  At a time when a “jobless” recovery has yielded chants of  “jobs, jobs, jobs” from the Administration and Congress alike, why aren’t federal agencies like SBA’s SCORE and Small Business Development Centers joining up with IRS to market these tax credits to the self-employed. 

The first job created by an entrepreneur is his/her own job.   One by one, these jobs add up – at least 1.5 million every year rain or shine and probably many more that remain in non-filing status. The DC-based Corporation for Enterprise Development estimates that there may be as many as 4 million non-filing unincorporated businesses each tax year.

Filing taxes as a new business is the single largest institutional connection our government has with new start-ups.  Unfortunately, the Schedule C tax interface is broken.  Instead of welcoming and recognizing the job-creation contributions of first-time filers, it discourages businesses and nudges them into non-compliance.  One way of implementing Mr. Friedman’s “Start-up America” initiative now is to re-market the Making Work Pay tax credit into a “Making New Business Pay” tax credit and creating a whole new tax prep experience – one that welcomes and acknowledges start-ups’ contributions. 

For more information on the Making Work Pay tax credit, visit the IRS web site.

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