Congressional Democrats are now contemplating a “sweat equity tax.” They don’t call it that, of course, preferring the more innocent-sounding name “Enterprise Value Tax.” Regardless of the semantics, it takes direct aim at small businesses in Maine and across the country to pay for massive spending increases in Washington.
The impact on job creation could be severe. With high unemployment now considered the “new norm,” the government should be doing everything possible to remove barriers for job-generating entrepreneurs and other company builders. Instead, the Democrats in Congress are moving to impose huge new financial penalties on the very people who could help lead us out of recession and back to prosperity.
What is this sweat equity tax? For small businesses in Maine that are structured as partnerships or limited liability companies (LLCs), it is a harsh new tax on gains earned through the sale of those businesses. Targets of the tax would include companies that buy, sell, manage or finance the purchase of real estate, lumber, potatoes, seafood and electricity, among other commodities.
Let’s consider an example of how this proposed tax could directly impact small businesses in Maine established as partnerships or LLCs, which comprise a large portion of the state’s business community. Imagine a local lumber company set up by two longtime friends who formed a partnership. They make their money financing and buying lumber from the logging companies, milling it into usable lumber and selling to retailers who then market it to consumers and contractors.
In the company’s early days, the owners forgo some or all of their cash income in return for equity in the business or deferred compensation. These individuals put at risk their personal finances in starting the business, thereby creating risk for themselves equivalent to the risk an investor takes when putting cash into a start-up. Without the devotion of such folks, many businesses would never get off the ground, because it is the exception that outside financing is available at the creation of a new company. Over many years, they build up the business with their hard work and sweat equity.
Businesses like these often become valuable members of their community. They sponsor Little League teams, work with local charities and support civic causes. The value of their business is more than the bricks and mortar of the business; it is also their reputation. That’s part of the “enterprise value” of the company.
As time goes by, one of the owners would like to retire, so they decide to sell the business. Under current law, they would be taxed by the federal government on the enterprise value at a capital gains rate of 15 percent. Now, congressional Democrats want to tax them at the rate of ordinary income, which is currently 35 percent and could rise to 39.6 percent next year. Instead of being able to retire and spend their money locally in Maine, they would be forced to ship a huge portion of it to Washington to be spent on new programs.
Natural resource-based industries and other small businesses are crucial to Maine’s economy. We cannot afford to discourage our most talented and hardworking citizens from engaging in these enterprises and continuing to grow them. Increasing taxes on these Maine businesses during today’s economic times should not even be on the table.
With the sweat equity tax, the federal government would be creating a whole class of American businesses that will be treated differently than others. After years of building a lumber company, overnight it could be treated differently simply by the way it was set up long ago.
As we often say in Maine, small businesses are the engine of our economy. They should have the expectation that when they sell, they will receive the same tax treatment as all other businesses. Changing the rules in the middle of the game is not only unfair, it actually inflicts serious economic harm on the risk-takers in our society who hire Maine residents and provide the foundation for the state’s economy.
This is a wide departure from the well-settled general rules that business interests are capital assets and the sale of those assets is, and should be, taxed at capital gains rates. The sweat equity tax ensures that those same partners who built their business from the ground up with their knowledge, ingenuity and hard work, and whose efforts created local jobs, will be punished upon the sale of their business with a significantly higher tax rate. An entrepreneur who starts up a normal operating business that also invests in real estate creates the potential for the entire gain on a sale to be taxed as ordinary income, even if all of the gain is attributable to the operating business.
While the Enterprise Value Tax proposal did not make it into the latest version of federal tax legislation considered last June, it is expected to return as soon as this month to help fund Washington’s unprecedented spending surge. If Congress truly wants to encourage job growth, it should be encouraging the people who create the jobs — entrepreneurs and investors. It should not be imposing punitive taxes that snuff out the entrepreneurial spirit and squelch the economic activity that is vital to the Maine economy.
Josh Tardy, R-Newport, is leader of the House Republicans in the Maine Legislature.