The advocates over at the Center for Budget and Policy Priorities (CBPP) issued a new study last week demonstrating, once again, how few “real” small businesses would be adversely affected by raising the top two income tax rates back to their old 39.6 and 36 percent levels. As their study states:

“Some critics of the President’s budget charge that his proposals to roll back tax breaks for taxpayers with incomes over $250,000 would harm small businesses. In fact, only 8.9 percent of people with any small business income have incomes of over $250,000 and, thus, would even potentially be affected by these provisions.”

As S-Corp readers know, this is old ground. One side says only a tiny portion of small business owners pay the top two rates. The other side says that small business owners make up a large percentage of those affected. Back and forth, over and again.

Missing from the debate is a sense of scope. For example, there are only six million or so employers in the United States while there are about 30 million businesses. Under the CBPP’s approach, then, a policy to raise taxes on every single employer in America could be dismissed because it “only” affects twenty percent of all businesses. It’s not the number of taxpayers affected that matters, but rather the amount of total economic activity being taxed.

The reality is, as we’ve pointed out before, an enormous amount of business activity is subject to the top two rates. More than half of all business income is taxed at the individual rates (S corporations, partnership, and sole proprietorships), and more than two-thirds of that income is taxed at the top two rates, which means more than one-third of all business income earned in the United States will be subject to higher tax rates under the President’s plan. As the Tax Foundation points out, more than half the new revenues collected from the higher rates would come from business income.

Moreover, those higher rates are going to be applied to a larger tax base. Under proposals put forward by the President and/or the Chairman of the House Ways and Means Committee, the business tax base will be broadened by eliminating or restricting deferral, LIFO accounting, Section 199 deductions, and many other deductions used by business.

Finally, the President’s budget proposes to reinstate the old PEP and Pease rules. These rules phased out the personal exemptions and capped itemized deductions, respectively. Their net impact is to raise the base on which tax rates apply and would increase the number of taxpayers subject to the top two rates, including those who are small business owners.

So the cumulative result of these proposals would be to dramatically raise both the tax rate and tax base for a large percentage of business income earned in the United States. There’s no way to minimize the negative effect of that.

Obama Budget Limits LIFO

Speaking of base broadening, the budget outlined last week by the Obama Administration calls for repealing LIFO. Exactly how he would structure this repeal is unclear — the only reference to the policy is back in the revenue tables.

According to the revenue score, the proposal would increase tax collections by $61 billion beginning in 2012, or just about half of the projected tax increase from the provision included in the 2007 Rangel -Mother of All Tax Bills’ legislation ($105 billion).

The Rangel provision applied to all businesses — large and small — using LIFO inventory accounting rules and gave them an eight year period to pay taxes on their accumulated LIFO reserves. (Keep in mind, repealing LIFO is a double whammy for LIFO businesses — their annual taxes go up moving forward but they are also on the hook to pay back-taxes on their accumulated LIFO reserves.)

Until the Treasury Department issues its “Blue Book” to describe all the tax provisions in the Administration’s budget, we won’t know for sure how the Obama repeal differs from the Rangel repeal. They might have limited the change to publicly-held companies, or eliminated the retroactive tax on LIFO reserves.

At this point, however, such differences are meaningless, since whatever President Obama proposes will have to go through Chairman Rangel’s committee anyway.

The headline here, which should be noted by every LIFO business and their accountants, is that the President of the United States, the Chairman of the Ways and Means Committee, the Securities and Exchange Commission, the Financial Standards Accounting Board, and the Joint Committee on Taxation have all weighed in recently against LIFO in one form or another.

The case against LIFO is a wholly contrived money-grab, but with that lineup against us, you might want to begin making contingency plans.