This week marked the 51st annual National Small Business Week. Started in 1963, National Small Business Week is a series of events nationwide to recognize and celebrate small business owners. In his statement on Monday to kick off the week, President Barack Obama highlighted how small businesses are the backbone of the American economy, creating two out of every three jobs. He also pointed out the administration’s record of cutting taxes 18 times for small businesses and efforts to simplify the business tax code.
The President’s statement harkens back to images of family owned shops in local neighborhoods. This is the image that most of us think of when we think of a small business. The local grocer, the family that invested in the sandwich shop franchise, or the local mechanic “and sons” that has existed for generations. These are also the images politicians use when discussing policy or, more often, debating tax policy. They remind us that we must always remember the small businesses of America.
Except in politics, it depends on what the definition of “small” is.
Since the creation of the U.S. Small Business Administration in 1953, it has been an ongoing challenge to determine what constitutes a small business. The Small Business Act that created the SBA defined a small business concern as “independently owned and operated and which is not dominant in its field of operation.” It also states that the definition of small business shall vary from industry to industry to reflect the differences.
It is within those industry differences where the numbers can vary dramatically.
There are some common technical definitions that apply to all small business, such as being organized for profit and independently owned and operated. The numerical definitions are based on the average number of employees over the previous year or the average annual receipts of the previous three years. The qualifying amounts represent the largest size a company can be to still be considered a small business. These size standards set by the SBA, which they use to determine eligibility for SBA financial assistance programs, and by all federal agencies for contracting purposes. While they are considered regulations, they are really just guidelines and carry no legal weight.
The standard is to define a small business as one with no more than 500 employees for manufacturing and mining industries, and an annual average of $7 million in gross receipts for all non-manufacturing industries. However, there are more exceptions than rules. Certain manufacturers are still considered small with as many as 1,500 employees. Small businesses in various industries can have anywhere from $10 million in annual receipts to grossing as much as $35.5 million per year to qualify as a small business contractor.
These are not your local mom and pop shops.
These definitions get even murkier when considering policy. In spite of the SBA’s definition, there has been no clear definition of what is a small business for the purposes of tax policy. A report issued in 2011 by the U.S. Department of Treasury’s Office of Tax Analysis found that after analyzing data from previous tax years, the definition used for small business was too broad, largely due to technical constraints of accessing data from various tax forms. With improved data collection, the OTA was able to more narrowly define a small business for tax purposes. To create their definition, they looked at data from six specific tax forms and set the threshold for income and deductions at $10 million.
With this new methodology, the number of small business owners fell from 34.7 million filers reporting $662 billion of net income to a little more than 9 million small business owners reporting $335 billion of net business income. Under the OTA’s more narrow definition, 8 percent of small business owners had an adjusted gross income of more than $200,000, which was the same under the previous methodology.
In politics, $200,000 is a magical number.
When politicians talk about tax cuts for small business owners, the tax cuts relate to personal income. During the contentious budget talks in 2012, there was great deal of discussion regarding the extension of the tax cuts put in place under the President George W. Bush’s administration. Democrats wanted to extend the tax cuts for those making less than $250,000 but end them for incomes above that. Republicans wanted them to remain in place, arguing that it would hurt small businesses the most.
Except as the OTA showed, only 8 percent of small business owners earned more than $200,000.
When the OTA’s report came out in 2011, two Republicans sent a letter to then Treasury Secretary Tim Geithner saying it was “not helpful to inject yet another definition into an already muddled field.” They felt that the Treasury’s new definition was “misguided.” Of course, the fiscal cliff and budget talks were looming and the mantra of “protecting small business” was going to be a very important talking point.
If 92 percent of small business owners earn less than $200,000, it would be difficult to argue for higher thresholds.
For their part, the SBA still holds on to the spirit of the true small business. On Friday, May 16, they honor several small businesses in various industries all across the country in the 2014 National Small Business Awards. The winners include a New York City coffee shop owner who used an SBA disaster relief loan to rebuild his business after Hurricane Sandy and a “management and medical administrative services” consultant who began her business in her bedroom 15 years ago and now has 122 employees.
In the end, Congress agreed to keep the tax cuts in place for those making less than $450,000. Still, whether its industry regulations or the Affordable Care Act, politicians often cite the harm caused to small business. When listening to them, it’s important to remember that when it comes to politics, small may be bigger than you think.