The “micro” end of the small business sector offers valuable opportunity for employment growth; policymakers interested in expanding employment in Minnesota should do everything they can to encourage microbusinesses, also called SOHO (small office/home office) businesses.
Use the term “small business” and many people think of a factory, store or professional services firm. These firms, which may employ dozens of people and collect millions of dollars in annual revenues, are actually among the larger businesses in the small business category. They are the exception more than the rule. Across the country, most businesses actually are much smaller. Twenty million businesses — or seven in ten — have fewer than five employees and less than $100,000 in annual revenue. It is this microbusiness category which is creating so much recent employment opportunity.
Since 2008, when the employment market tightened up, more people have ventured into entrepreneurial territory, launching their own business, typically out of their garage or spare bedroom. Many of these become vibrant businesses, selling or making everything from cosmetics to dog food to software. Some of these businesses will grow beyond the microbusiness classification, but most will not. Nonetheless, many will provide meaningful employment for their founders and others, not to mention great products and services to customers.
Microbusinesses are highly personal, get very close to their customers, and are free to attempt innovations that would be stymied in committee at a larger company. The smallest end of the small business sector is incredibly important to the overall health of our economy and even to the quality of living in our state.
Employment at many of the mid-size companies and larger firms in our state has fallen flat or is evening declining. Any incentive the state could offer these companies to boost employment would surely come at a high cost to taxpayers. Encouraging employment in the microbusiness sector, however, is much more promising.
Following are four things the state could do right now to encourage microbusiness employment at no taxpayer cost.
No. 1 – The state should work with municipalities to allow entrepreneurs to operate low-impact microbusinesses in their homes.
Currently, many municipalities have ordinances which prevent homeowners from operating a business in their home. Other ordinances prevent a homeowner from employing more than one person in their home. These ordinances were created a long time ago when operating a business typically meant manufacturing (which involved the use of loud, perhaps dangerous machinery) or retailing (which involved significant customer traffic).
It is appropriate for city ordinances to protect residential neighborhoods from noticeable commercial intrusion. However, many businesses are in no way noticeable to their neighbors. Thousands of businesses impact their place of business no more than the typical activities of a family of four. Many businesses today happen on laptop computers and telephones, involving no customer traffic, no deliveries, no industrial machinery or even on-site exchange of funds. Rules which discriminate against these kinds of businesses should be stricken from city codes throughout the state.
An entrepreneur running an internet business with two employees would not be allowed to operate in a home in Minneapolis, or many other municipalities in the state. This is a significant disincentive for many budding entrepreneurs. To force a nascent business into a commercial space is a needless economic burden. For most people, their home is their greatest asset; why prevent an entrepreneur from leveraging that asset for the start-up of their business?
No. 2 — Anyone starting a self-employment venture should be allowed to continue receiving their full unemployment benefits.
Getting laid off is a difficult experience for anyone; Minnesota’s unemployment insurance program provides some income for the person until he or she lands another job. But for some people, self-employment would be a much better fit than a job with another employer.
Our current unemployment system, however, discourages a person from entering entrepreneurial territory. If someone collecting unemployment earns money operating their own business, their unemployment benefit is reduced, typically by 55 percent of the amount they earned in the business. For example, if an unemployed person is receiving a $300 per week unemployment benefit, and then nets $200 selling hand-crafted birdhouses, his insurance income will be reduced by 55 percent of the $200, or $110. Instead of adding $200 to his $300 unemployment benefit for $500, he would add $200 to $190 in unemployment for a total of $390. In other words, his entrepreneurial work only yields $90 in this example. This kind of penalty on entrepreneurial work by recently-laid off workers is a huge disincentive for people to try entrepreneurial ventures.
Laid-off people should be able to collect the entire unemployment benefit for the duration of their unemployment insurance payment period, usually 26 weeks. This kind of a safety net would encourage many budding entrepreneurs to try ventures they otherwise might dismiss. People are much more likely to try something if they know the fruits of their work won’t diminish income they may already be receiving.
For some people a half-a-year’s income stream is sufficient for them to get a meaningful business venture off the ground. Income from the business, of course, would be subject to normal income tax, and standard payroll taxes would apply to any employees.
Minnesota’s unemployment insurance system is funded by private companies. It is true that if people are allowed to collect their full benefit while earning self-employment income, the fund will likely pay out more money, thus creating a need for it to charge higher premiums. However, the additional income tax generated by this kind of activity could be used to fund the difference in the unemployment insurance premium. This keeps this idea revenue-neutral for the state and for the companies that pay into the unemployment insurance fund. Most importantly, however, this idea creates an opportunity for a small but important group of people who simply need a little encouragement during a difficult time in their lives to try something entrepreneurial which may end up providing a valuable and useful product or service to the rest of the world.
No. 3 – Minnesota entrepreneurs should be allowed to take a tax deduction on fractional use of their home office for business.
Current federal tax law permits a business owner to deduct expenses for the maintenance of a home office only if the room in the home is used exclusively for business. So if a person works in a home office all day, but they sleep in it at night, they are not allowed to take any deduction for the home office. The tax code – at least in Minnesota — should be changed so the entrepreneur can deduct expenses proportional to business use.
For example, if a business owner figures that $1,000 per year are going toward the maintenance of his home office, which he uses 50 percent of the time for his business, he should be able to claim a $500 deduction against his income. Currently, the law would not permit any deduction because the home office is used only partially for business. Minnesota business owners should be able to take this deduction on their state income taxes, even if they are not allowed to take it on their federal income tax forms.
While it is difficult to predict the exact net tax effect of this concept, it is likely the net effect would be zero. While the creation of a partial home office deduction would encourage some people to take a new deduction, it would also encourage some people to reduce the deduction they currently are taking. With the law specifically permitting partial deduction, some people who currently are take the full deduction and foregoing personal use of their home office space, will decide that they now will use their home office space for personal use and take a corresponding smaller deduction. Many people who set aside a room in their home for business use either refrain from using the space occasionally for personal use because of the 100 percent business use requirement, or do in fact use the space for home use but take the full deduction anyway. This provision will allow them to align their actual intended use with the Minnesota state tax code.
No. 4 – Exempt online businesses less than three years old with less than $100,000 in annual revenue from collecting sales tax on internet transactions.
The legislature is very interested in requiring Minnesota businesses that sell online to collect sales tax, which they say would put them on parity with brick and mortar retailers. The collection of sales tax is a burden on small and start-up businesses. If the state decides to mandate the collection of such tax, it should give microbusinesses three years to get its sales-tax collection system in place.
Keep in mind it is the purchasers who technically are responsible for paying the sales tax to the state of Minnesota. This would not change. People who purchase items from small start-up businesses on the internet would continue to be responsible for paying sales tax.
It is presumed the Minnesota Treasury will see a significant increase in sales tax revenue should it mandate the collection of sales tax on internet transactions. It would help small businesses if they were given three years of start-up time to perfect their online sales processes before being required to forward sales tax onto the state.
These four ideas are modest but they would make a big difference in the minds of many people contemplating starting a new business. Many people have the experience, skills and knowledge to succeed in their own business venture. Many of them simply need a bit of encouragement to take the first step. Minnesota policymakers could be the ones to provide that encouragement.