The realm of small businesses in the United States is often hailed as the backbone of the nation’s economy; but it is now under threat from a subtly implemented tax adjustment. As the economy faces challenges from inflation and shifting monetary policies, the recent change in tax rules threatens to place an undue burden on entrepreneurs and small business owners, potentially resulting in widespread closures and reduced economic vitality.
Traditionally, small and midsized businesses have played a pivotal role in fostering innovation, providing local employment opportunities, and contributing to the overall economic prosperity of communities. However, the under-the-radar tax change, which involves adjustments to the way interest deductions are calculated, has the potential to erode the very foundation upon which these businesses stand.
Prior to 2022, businesses were allowed to deduct interest paid on loans and other debt up to 30% of their earnings before interest, taxes, depreciation, and amortization (EBITDA). This practice enabled small and midsized companies to make necessary investments in technology, equipment, and other critical projects without straining their financial resources. However, this ability has been curtailed, leaving businesses struggling with the aftermath.
The tax rule revision has limited businesses’ deductions to a mere 30% of their earnings before interest and taxes (EBIT), excluding depreciation and repayment. The consequences of this change are far-reaching and significant. For instance, equipment-intensive industries, such as food services, will bear a substantial pressure.
Reports indicate that changing EBITDA to EBIT could lead to nearly a three-fold increase in incremental taxes for business owners. In the case of food services, this change could translate to a staggering 35-fold increase in taxes.
The timing of this shift compounds the challenges faced by the hospitality sector, which was already reeling from the adverse effects of the COVID-19 pandemic. As government-imposed restrictions constrained operations and reduced customer demand, many businesses hemorrhaged cash. This tax adjustment, by maintaining an EBIT-based interest deduction rule, further multiplies the struggles faced by these enterprises.
The impact of this tax change is not limited to a single business owner or a specific sector; it resonates through the fabric of the whole economy. Entrepreneurs, who have tirelessly served their communities and fostered economic growth, now face unexpected and significantly higher tax obligations. Consequently, many businesses are forced to reconsider their investment plans, undermining economic growth, labor productivity, and potentially leading to stagnated wages.
As urgent measures are essential for the small business to survive and prosper, Congress holds the key to rectifying this precarious situation. One proposed solution is to restore depreciation and amortization into the deduction equation, effectively reverting EBIT to EBITDA. This adjustment can provide much-needed relief to businesses grappling with rising interest rates and debt, allowing them to continue making essential investments in their operations.
The government’s role extends beyond just providing relief. The tax system, as it stands, disproportionately favors large multinational corporations over their smaller counterparts. The tax reform proposed in President Biden’s Build Back Better Agenda seeks to level the playing field by introducing measures such as raising the corporate income tax rate and enacting a 15% minimum tax on book income of large corporations. These steps aim to create greater tax fairness and foster an environment where small businesses can compete on an even footing.
While it may leave a bitter taste, the reality of this inconspicuous tax adjustment casts a long shadow over the small business landscape in the United States. Left unchecked, it could spell the demise of countless enterprises, resulting in economic contraction and diminished opportunities.
