By Paul N. Gada, Business Owner's Toolkit Staff Writer

If you have been following our reports, 2001 has been a very busy year in terms of tax changes. The Economic Growth and Tax Relief Reconciliation Act of 2001 (Tax Relief Act), enacted June 7, 2001, provides the largest tax cut since 1981, with $1.35 trillion in tax cuts being phased in throughout the next ten years. Although many are seeing an immediate benefit in 2001 through a tax rebate check, most of the new tax provisions do not begin to affect taxpayers until 2002.

Although geared primarily toward individual taxpayers, we reported right from the start that the Tax Relief Act also benefits small business owners. With its immediate income tax reductions, new retirement planning provisions, employee benefit tax relief, and changes in the estate tax law, the Tax Relief Act provides small businesses with the opportunity to reduce their tax obligations and divert the savings to other activities that can help them prepare for the future, retain their employees, and build their businesses.

Our initial analysis of the impact of the Tax Relief Act on small businesses is proving to be right on target. An August 20, 2001, Senate Finance Committee press release confirms our prediction that small businesses stand to benefit from the tax breaks that will be phased in over the next several years.

The centerpiece of the Tax Relief Act is a $958 billion consolidation and reduction of the marginal tax rates for individuals that will gradually be phased in through 2006. In 2006, the highest four income tax brackets will be reduced from the current 28, 31, 36 and 39.6 percent to 25, 28, 33 and 35 percent.

According to the press release, a new U.S. Treasury Department analysis shows that farms, small businesses and entrepreneurs will receive most of the tax relief from cutting the top marginal tax rates. The Treasury Department's Office of Tax Analysis calculated the impact of the Tax Relief Act on small businesses at the request of Sen. Max Baucus (D-Mont.), chairman of the Senate Finance Committee, and Sen. Chuck Grassley (R-Iowa), ranking member.

When fully phased in, entrepreneurs and small businesses--owners of sole proprietorships, partnerships, S corporations and farms--will receive 80 percent of the tax relief associated with reducing the top income tax rates. Such business owners make up 62 percent (about 500,000) of the 800,000 tax returns that will benefit from the new 33 and 35 percent rates, according to the Treasury Department's analysis.

Baucus and Grassley said individual rate cuts are important relief for small businesses because most small business owners and farmers operate their businesses as sole proprietorships, partnerships, limited liability companies or S corporations. The income of these types of entities is reported directly on the individual tax returns of the owners. A rate reduction for individuals directly reduces rates for farms and small businesses.

"I'm pleased this analysis shows the tax cut we passed will provide relief for farmers and ranchers and our agriculture community, as well as small businesses and entrepreneurs throughout our country," Baucus said. "My state is an agriculture and small business state, and it's heartening to know that this tax cut will put money back in the economy and help create more jobs."

Echoing these statements, Grassley said, "One of the goals of our bipartisan tax cut was reducing the tax burden for small businesses. That's important because small businesses create most of the jobs in this country. The new analysis shows that we succeeded in our desire to re-kindle the fire fueling the small business engine."

Baucus and Grassley said most of the job growth over the past decade has come from small businesses, noting that 80 percent of the 11.1 million new jobs created between 1994 and 1998 were from businesses with fewer than 20 employees, and 80 percent of American businesses have fewer than 20 employees. Experts agree that lower taxes increase a business' cash flow, which helps with liquidity constraints during an economic slowdown and could increase the demand for investment and labor, the senators said.

As further support, the senators cited an October 2000 report by the National Bureau of Economic Research, a well-regarded non-partisan organization. The report, entitled "Personal Income Taxes and the Growth of Small Firms," says plainly that when a sole proprietor's marginal tax rate goes up, the rate of growth of his or her business enterprise goes down, the senators said.

Small business owners, therefore, can rejoice that the tax cuts will make a meaningful impact on their lives. While you daydream of what to do with the extra money in your pocket, we will bask in the warm glow of being reassured that we continue to keep small business owners well informed on such issues.

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House Approves Tax Cut Plan; Senate Action Likely in May