Many small business owners may face significantly higher taxes for 2013, as a result of Washington’s last-minute deal to avoid the fiscal cliff. The fiscal cliff deal did not change the existing corporate tax rate, which is no more than 35%. However, the new bill will affect individual tax rates on income. For example, an individual will be taxed 39.6% on income exceeding $400,000 annually, up from 35% in 2012.

If the bill did not change the corporate tax rate, how will it impact small businesses? The fiscal cliff bill will affect small businesses that are taxed as partnerships or have elected s-corp status. LLC’s by default are treated as partnerships, or pass through entities, in the eyes of the IRS. The individual owners of the LLC claim the business income on their personal taxes. For example, New Co., LLC has two members, A and B, who both own 50% of New Co., LLC. In 2012, New Co., LLC netted $1,000,000 in revenue. Member A will report $500,000 as income and Member B will also report $500,000 as income. New Co., LLC does not pay taxes as a stand alone entity. Assuming Member A and Member B are both taxed at the highest rate, 35%, they will be responsible for paying 35% of their share of New Co., LLC’s income, or $500,000 each. Because of the new fiscal cliff bill, Member A and Member B will now be responsible for paying 39.6% of income exceeding $400,000, in this case $100,000 for both Member A and Member B.

The changes to individual income taxes are estimated to affect nearly 750,000 businesses organized as s-corps, partnerships and other small entities. Many businesses are combating the increased tax burden by spending less on overhead and expenses, hiring freezes, or converting full-time employees to part-time employees or sub-contractor positions. In addition to combating increasing cost of doing business, companies with 50 or more full-time employees are now required to offer health insurance by 2014 or potentially pay a penalty.

Not all hope is lost. With careful and strategic tax and business planning, you may be able to reduce your tax burden and increase your business and individual income. If you would like to discuss your tax and business plan, goals, and objectives, feel free to reach out to me to set up a time that we can discuss. I look forward to hearing from you and best of luck in 2013!