The Treasury Department’s Office of Tax Analysis has released a paper that considers changing the way to identify small businesses and their owners, along with their tax characteristics.

The paper points out that while small business owners are frequently the subject of tax policy debate, there is no consensus about the specific attributes distinguishing small businesses from other firms.

“Previously, the Office of Tax Analysis had counted a small business owner as any individual who receives flow-through income from a sole proprietorship, partnership, S corporation, farming operation or miscellaneous rental activity,” said the paper. “This overly broad definition was used because, for the majority of flow-through business income (partnerships and S corporations), it was not possible to trace income from the business entity to the respective owner(s). Due to newly accessible tax data, this technical constraint has been overcome.”

The paper presents a methodology based on the new tax data that would tighten the definition of small business owner.

The revised methodology looks at six tax forms and schedules filed by individuals or firms that could potentially represent business activity—Form 1040 Schedules C, E and F, along with Forms 1065, 1120 and 1120S. The authors found that 54 percent of the taxpayers who filed one of the six forms or schedules would be considered to qualify as both a business and a small business for tax year 2007. Those small businesses reported approximately 17 percent of total and net business income. Slightly more than one-fifth of small businesses conformed to their definition of an employer.

Using other criteria, they further narrowed down the definition. For tax year 2007, their previous methodology counted 34.7 million filers reporting $662 billion of net flow-through business income as small business owners. However, under a revised methodology under which the Office of Tax Analysis stopped considering businesses with over $10 million in income or deductions as small businesses, they would count 20.0 million filers reporting $376 billion of net business income as small business owners under a broad measure of small business owner. But under a narrower definition, they would count only 9.4 million filers reporting $335 billion of net business income as small business owners.

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