One of the most common tax complaints I hear from small business owners is about filing their taxes. Paying isn’t their biggest objection, though they surely don’t love that. But they hate the time and money they spend on the paperwork.
In a campaign season marked by many questionable tax ideas, Democratic presidential candidate Kamala Harris has acknowledged the filing problem and offered a solution, though one missing key details. Her idea: A new standard deduction for small businesses that would supplement the existing standard deduction available to all tax filers.
While it may not be the ideal fix—more on that later—she has done a service by prioritizing an issue that really matters to business owners. The IRS Taxpayer Advocate Service estimates a typical small business spends 82 hours and $2,900 on tax compliance. Then add the cost of aggravation, anxiety, and confusion.
A Concept Not A Plan
Harris is proposing a concept rather than a plan. For example, she hasn’t said how she’d design her standard deduction, how big it would be, or what businesses would be eligible. These seemingly technical details distinguish a good proposal from a bad one.
The idea isn’t new. Hillary Clinton proposed a small business standard deduction in her 2016 presidential campaign. And Harris aides point to a 2019 paper by University of North Carolina tax law professor Kathleen DeLaney Thomas as a possible model.
DeLaney Thomas would allow firms to claim a standard deduction if their gross business receipts are less than $100,000, their total adjusted gross income is less than $150,000, and their income is reported on Form 1099. Cash businesses or labor-only businesses with few expenses, such as some consultants, would be ineligible.
Small business owners would have the option of subtracting the new standard deduction from their gross receipts instead of tracking and deducting all of their actual expenses. They still could itemize their business deductions, if they prefer.
The small business deduction could be a fixed dollar amount, just like it is for the individual income tax. Or it could be a percentage of gross receipts, which DeLaney Thomas prefers.
As an alternative, she suggests separate standard deduction thresholds. A very low one of perhaps 10 percent of gross receipts for labor-intensive businesses and a higher one of say, 60 percent, for firms with significant expenses. That version, of course, would introduce additional complexity into a simplification plan.
Tracking Expenses
Any good business owner wants to keep close tabs on expenses, so they’d maintain records in any event. And most would want to track expenses so they’d know whether to claim the standard deduction or itemize.
Still, a small business standard deduction would reduce the cost of figuring exactly what expenses are deductible and to what extent.
Harris still must answer many questions, even beyond the basic structure.
For example, the vast majority of small businesses are organized as pass-throughs, such as sole proprietorships and partnerships, where owners pay taxes on their business income through their individual Form 1040s.
How would Harris’s idea fit with the Section 199A special 20 percent deduction for pass-through businesses that was included in the Tax Cuts and Jobs Act (TCJA). Harris has not said whether she’d extend that provision after 2025, though many independent analysts have been extremely critical of the provision.
DeLaney Thomas also includes guardrails aimed at preventing taxpayers from gaming the new deduction, such as limiting the idea to firms with 1099 income. And she acknowledges the need for better information reporting, especially for gig workers, a controversial issue on its own.
A fixed dollar deduction could discourage investment. At the same time, it likely would create a windfall for businesses with expenses that are lower than the new standard deduction.
Alternatives
There are other solutions for small business filers. For example, back in 2005, President George W. Bush’s tax reform commission (see page 109) proposed cash accounting for small business tax purposes.
Under that long-forgotten plan, small firms simply would have reported receipts less cash expenses, excluding buildings and land, and pay tax on the difference. That would be consistent with the way most small firms do their financial accounting today and not require businesses to keep a separate set of books for taxes.
Let’s not kid ourselves, much business tax complexity results from special provisions that lower taxes for these firms such as 199A, extra-generous rules for depreciating equipment, and a loophole that allows small business owners in many states to avoid the cap on the State and Local Tax (SALT) deduction.
A small business standard deduction would be just a tiny piece of whatever Congress does to address the expiration of the TCJA next year. But including a measure to ease tax filing would make a lot of small business owners very happy.
