Why Tax the Wealthy is Unfair to Business Owners

I have received strong positive and negative feedback on my blog entries regarding increasing tax rates on the "wealthy."  After seeing these reactions, I understand why our Congress is unable to reach agreement on this issue.  Based the feedback, it appears that business owners have the strongest objection to proposed tax increase.

Although I have many problems with increasing taxes, my biggest one is subjecting business owners to higher tax rates on income that they never receive.  Since a significant 1987 tax law change concerning the tax on the sale or dissolution of a business, it has made sense for most closely held businesses to operate as a flow through entity for tax purposes.  Flow through entities are S corporations, partnerships, and limited liability companies.  In these entities, the business generally pays no federal income tax.  The taxable income of the business is passed through to the owners for inclusion on their personal income tax returns.  In this framework, the business owners are taxed on all company income, whether or not such income is actually received by the owner.  In a growing business, it is common that business profits are reinvested in the business, in order to fund the growth.  To the extent the profits are reinvested, they are not received by the business owner, although he (or she) is responsible for paying tax on this phantom income.  My concern is that although it is not received by the business owner, this income will put him in the wealthy 2% category and subject him to higher tax rates.

Where will the money to pay the increased taxes come from?  It is likely that it will come from the business.  And if this money is used to pay taxes, it cannot be used to hire employees or be reinvested for business expansion.  What is the solution to this problem?  My proposal is that in determining who is a wealthy taxpayer, the only business income that should be considered is the income that was actually received by the business owner.  Income that is reinvested in the business  should be disregarded for the purpose of calculating the tax rates.

Unfortunately, the very few of the politicians who determine who and how much tax tax have ever faced the challenges of running a business.  That is why this issue has never even been discussed.