Editor’s note: At press time, the U.S. Senate had just passed a revised version of the Build Back Better Act, known as the Inflation Reduction Act of 2022. Although that legislation excised some of the provisions discussed in this article, action in the House of Representatives is still pending, and therefore, readers are invited to contact their representatives and voice their opinions on the presented.
According to recent media reports, two tax increases under consideration would fall entirely on small, individually owned, and family-owned businesses: 1) expanding the 3.8% net investment income tax (NIIT) to individuals and families who actively participate in their business, and 2) limiting the ability of small, individually owned, and family-owned businesses to fully deduct their losses during an economic downturn by expanding and extending the so-called “excess business loss limitation” for “noncorporate taxpayers.” Combined, these would increase revenues by more than $400 billion over 10 years, shouldered entirely by small, individually owned, and family-owned businesses.
While expanding the NIIT is sometimes characterized as closing a tax loophole and it is stated that it would increase Medicare funding, neither of these claims is true. When the NIIT was created as part of the Affordable Care Act, it was meant to apply to investment income only. The business income of small, individually owned, and family-owned firms in which the owners ran the business was specifically exempted. This exemption was intentional and in no way constitutes a loophole.
Moreover, the revenue raised by the NIIT does not fund Medicare. As the NIIT initially was adopted as part of a reconciliation bill, attributing the funds of this new tax to the hospital insurance trust fund would have violated the Byrd Rule, a Senate rule that prevents a reconciliation bill from containing nonbudgetary provisions or provisions that directly affect Social Security. That is why the NIIT did not fund Medicare when it was adopted in 2010, and that is why attributing the revenues raised by its expansion to Medicare would violate the Byrd Rule today.
Because it does not close a loophole and does not fund Medicare, expanding the 3.8% NIIT represents nothing more than an 11% increase in the rates imposed on family-owned businesses. Based on U.S. Treasury data, an estimated 1 million small and family-owned businesses, representing more than half of all pass-through business activity, would be at risk of having their rates increased under this policy.
While expanding the NIIT would raise taxes on small and family-owned businesses when they are profitable, extending and expanding the excess loss limitation rules would hurt them in the next economic downturn. During the Great Recession of 2008–2009, many businesses were able to survive, in part, by policies that allowed them to offset the losses they were incurring against taxes they had previously paid. This assistance was particularly important for cyclical industries such as construction, manufacturing, and travel and tourism. Extending and expanding the excess loss limitation rules into the future would prevent pass-through businesses from having this relief in the next recession, increasing the odds that they don’t survive.
This is ill-advised tax policy, and it is being considered at a moment when the economy is no longer growing. First-quarter GDP fell by 1.6%, and many economists and forecasters predict that second-quarter GDP will also be negative. Meanwhile, the small business sector may already be in recession, as those businesses have lost employment in three out of the last four months, even as large companies have increased their employment.
AICC recently joined 130 other associations representing small and medium-size businesses in opposing these taxes, and I urge you to use the QR codes on this page and contact your legislators. Tell them that raising taxes on small and family-owned businesses with the economy on the brink of a recession harms not only these businesses but also the families and communities who rely on them.
Click the following links to contact your local representatives and senators.