Despite the success of many entrepreneurs, a sizable number of small businesses fail every year. According to several studies, more than 30 percent of new businesses fail within two years and more than half go out of business within four years. Tax problems have been found to be a small but important contributor to business closures.

A newly released study from the U.S. Small Business Administration (SBA) Office of Advocacy examines the extent to which individual small-business owners, who have filed for bankruptcy, attribute their financial distress to tax problems. The research observes the demographics and financial characteristics of small-business owners who have pointed to the tax system as the cause of their financial demise.

The study found that tax problems constitute an important reason for bankruptcy filings for a sizable number of entrepreneurs. Data suggests that the magnitude of the tax burden is more pervasive among small-business owners in bankruptcy than among individual petitioners. While less than one-quarter of all individuals in the bankruptcy sample reported tax-debt, more than half of small-business owners reported owing some tax debts.

Small-business owners in bankruptcy proceedings who are encumbered with high tax debts are generally in a precarious financial condition and are worse off financially than small-business owners who have low or no tax debt. The typical entrepreneur with tax problems in the bankruptcy sample was facing enormously higher debt burden with more than five times as much debts as other entrepreneurs in the bankruptcy sample.

The research also suggests that additional financial factors have contributed to the bankruptcy filings of small-business owners. For example, small-business owners reported more than double the amount of credit card debt (about $55,000 on average) than individuals. Those surveyed said credit card debt was the source of as much as a third of their financing at the time they opened for business.

The study cited the pervasiveness and the magnitude of credit card use among the small-business bankruptcy filers in the sample as "striking."

Overall indebtedness was also significantly different between small-business filers and individuals. The small-business owner reported $259,134 in debts compared with $58,250 for individuals. Not surprisingly, most of those filing were sole proprietors or owners of firms with fewer than 10 employees. And most were in retail and service sectors--industries that are highly competitive.

Although this study doesn’t provide all the answers as to why businesses fail, it does illustrate the pitfalls that excessive debt poses to a small business. It is unclear from the study whether small-business owners amassed their debt in a desperate effort to keep their business going, or started out too deep in the hole to succeed in the first place. But one thing is clear: high-interest credit cards were a common link.

The fact that so many entrepreneurs must rely on credit cards to start their business speaks to the desperate need for greater access to capital. As the research points out, a lack of adequate working capital is almost always fatal for small businesses.

NSBA argues that this is just more evidence that we need to reform both the current income tax code as well as the credit-card industry, and will continue to advocate for responsible reforms.

For more information on NSBA's tax reform proposal, the Fair Tax, please click here.

For more information on NSBA's credit-card reform proposal, please click here.