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What, Exactly, is a ‘Small Business’? The Hidden Tale Before Taxes and Job Creation Talks

First rule in debate: Define your terms. Yet when debating the potential of various tax policy proposals on small business and job creation, both sides gloss over the most important term: What, exactly, is a small business?

That’s partly because the legal definition itself is obscured by technical jargon, some of which we’ll discuss in a momentThis intentional ambiguity makes it difficult for the average person to understand, which enables each Party to advance their agenda.

The Democrats argue that 97 percent of small businesses will see no increase in their tax rates if tax cuts are rolled back to pre-Bush era rates, hence a positive effect on jobs.

Republicans counter that half of all small business income comes from the remaining 3 percent.  They are the engine of job growth, they say.  If the Bush tax cuts are eliminated, they will not add new jobs.

The irony is that both Parties rely on the same numbers generated by the non-partisan Joint Committee on Taxation to make their case.

So who is right?

The legal definition of a small business as determined by the U.S. Small Business Administration (SBA) is “a concern that is organized for profit; has a place of business in the U.S.; operates primarily within the U.S. or makes a significant contribution to the U.S. economy through payment of taxes or use of American products, materials or labor; is independently owned and operated; and is not dominant in its field on a national basis.”

Of course,  as is typical with legalese, words like “primarily” and “significant” leave lots of wiggle room for interpretation. Yet the SBA’s website gives the distinct impression that the original intent of this definition was to include only really small, generally local companies, as opposed to mega-organizations with international, let alone national dominance.

Title 13, Part 121 of the Code of Federal Regulations sets forth in detail the criteria to be used by the SBA in making small business determinations. These include the average number of workers employed over the past 12 months and average annual receipts over the past 3 years. SBA’s Table of Small Business Size Standards  lists size standards by six-digit North American Industry Classification System (NAICS) industry codes and varies industry-by-industry

Some of the criteria are listed below. The full list would likely surprise Joe the Plumber because size standards for some industries like manufacturing and revenue limits for others like heavy construction  are really quite large.

NAICS Industry Sector

Size/Revenue Standard

  Manufacturing   500 employees
  Wholesale Trade   100 employees
  Agriculture   $750,000
  Retail Trade   $7 million
  General & Heavy
  Construction (except
  Dredging)   $33.5 million
  Dredging   $20 million
  Special Trade Contractors   $14 million
  Travel Agencies   $3.5 million
  (commissions & other
  Business and Personal
  Services Except:   $7 million
  Architectural, Engineering,
  Surveying, and Mapping
  Services   $4.5 million
  Dry Cleaning and Carpet
  Cleaning Services   $4.5 million

But here’s where the definition really falls apart: According to the Federal Small Business Association: “The business may be a sole proprietorship, partnership, corporation, or any other legal form” e.g. an S-corporation.  The problem with this definition is that it opens up a giant loophole- any entity that can “pass through” income using a partnership or S corporation, could conceivably be considered a small business, even if the actual revenues are well in excess of the standards in the SBA’s list.

According to a report issued by the JCT in June, 2008, “in 2005, 12,862 S corporations and 6,658 partnerships had receipts of more than $50 million.”

This explains how the 2010 JCT report included 750,000 (or 3 percent) of “small businesses” like the management team at Wall Street buyout firm Kolberg, Kravis and Roberts (KKR), which just reported over $54 billion in assets managed by 14 offices around the world; Auditing firm PricewaterhouseCoopers, with operations in more than 150 countries; and the Tribune Corporation, which owns the Chicago Tribune, the Los Angeles Times and the Baltimore Sun. KKR, PricewaterhouseCoopers and the Tribune, it turns out, are all organized as “pass-through” entities. These are companies that typically avoid corporate taxes by reporting profits on the individual tax returns of their owners, managers or shareholders. Some of the major players who are similarly organized and thus fall under the “small business” rubric are corporate executives earning income from rental property, multi-millionaire athletes, hedge funds, billion-dollar private equity funds,  and large Washington lobbying firms.

When Senator Orin Hatch (R, Utah) rails that “The top 2 or 3 percent” of all small businesses would see their taxes go up under the Obama plan, he is technically correct. He is being disingenuous, though, because most of these are anything but small. That’s how only 750,000 “small businesses” can represent 50 percent of  all small business income.

We live in a world of short attention spans and 140 character tweets. Perhaps that’s why neither Party will take the time to explain how the definition has become so distorted. However, until everyone understands what we all mean when politicians talk about “small business”, there can be no real debate about how various tax proposals might affect their ability to create jobs.

Americans love to root for the “little guy”. As long as we are left to believe that “small business” is the corner pizza shop or dry cleaners, the claim that rolling back tax rates will hurt small business creates a visceral “that’s not fair” response.

We live in a world of short attention spans and 140 character tweets. Perhaps that’s why neither Party will take the time to explain how the definition of small business has become so distorted.

Bottom line: Until everyone understands what we all mean when politicians talk about “small business”, there can be no real debate about how various tax proposals might affect their ability to create jobs.

About Deborah Shlian

Deborah Shlian is a physician, medical consultant and author of numerous non-fiction articles and books as well as three published novels co-authored with her husband Joel (Double Illusion, Wednesday’s Child and Rabbit in the Moon). Rabbit in the Moon, an international thriller, won the 2008 Gold Medal, Florida Book Award, ForeWord Magazine's Silver Award for best mystery, the Royal Palm Literary Award and Honorable Mention for best Audiobook for the San Francisco Book Festival. Deborah is co-author with Dr. Linda Reid, of the Sammy Greene thriller series. Dead Air, the first in the series won the 2010 Royal Palm Literary Award for Best Thriller. Devil Wind, the second in the series, won the Hollywood Book Award for best Audiobook and the 2011 Royal Palm Literary Award for Best Thriller. Her latest nonfiction book, "Lessons Learned: Stories from Women in Medical Management" will be released in March, 2013. After 25 years in Los Angeles, Deborah and her husband now reside in Boca Raton, Florida.

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