# ![](media/image1.png){width="1.78125in" height="0.84375in"} National Association for the Self-Employed

**NASE Legislative Offices 1200 G Street, NW, Suite 800 Washington, DC
20005**

**Phone: 202-466-2100 Fax: 202-466-2123 www.nase.org**

Submission to the

President's Advisory Panel on Federal Tax Reform

By

The National Association for the Self-Employed

# 

**March 16, 2005**

**Submitters Category:**

**Organizations and Associations**

**Contact Information:**

**Kristie Darien**

**Executive Director, Legislative Offices**

**Phone: (202) 466-2100**

**E-mail: <kdarien@nase.org>**

The National Association for the Self-Employed (NASE), representing
250,000 member businesses, is the nation's leading resource for the
self-employed and micro-businesses, businesses with ten or less
employees. This vital segment of the small business population within
our nation numbers more than 18 million. The last U.S. Census reported
that these firms employ more than 12.3 million workers with a total
annual payroll of more than \$309 billion.

Often, the chief speed bump faced by micro-business owners on the road
to their success is unfair, complex tax regulations which lead to
extensive compliance and paperwork burdens. And because big successes
usually have small beginnings, these costs loom large to
micro-businesses, which are capitalized chiefly on dreams and ideas.

The NASE has been very pleased with the recent efforts made by the
Internal Revenue Service to become small business friendly. However, the
self-employed and micro-business communities still face an overwhelming
regulatory burden in complying with IRS rules. According to a study by
the Tax Foundation, in 2002 businesses bore the majority of the tax
compliance cost with 52.8 percent of the total cost, or \$102.5 billion,
and spent an estimated 5.8 billion hours complying with the federal tax
code.

As the President's Advisory Panel on Federal Tax Reform hears various
testimony and reviews public comments, the National Association for the
Self-Employed would like to highlight four key tax issues that, if
resolved, would greatly assist the self-employed and micro-business
communities: 1) overall tax simplification in the form of simplified
forms and instructions; 2) deduction of self-employment tax on health
insurance premiums; 3) simplification and/or standardization of home
office deduction; and 4) clarification of independent contractor status.

**[Tax Simplification]{.underline}**

Due to their size, the self-employed and micro-businesses are
responsible for managing every aspect of their business. Every second
spent contending with burdensome record keeping and tax preparation
takes away from the time they expend running and growing their business.
Thus, the NASE urges the Advisory Panel to find ways to combine and
simplify tax forms and instructions.

Tax simplification would have numerous positive affects. First, easy to
understand tax rules would reduce the compliance costs of the
self-employed and micro-business owners, allowing them to reinvest that
time and money in the success of their business. Second, a simpler tax
code would raise compliance rates and lessen mistakes made in tax
filings thus reducing the administrative burden of both the taxpayer and
the IRS. Clarifying tax regulations allows those preparing their own
taxes to more readily understand the law and their responsibility of
complying. Lastly, simplifying the tax code would make it easier for
taxpayers to understand important tax code provisions, such as those
dealing with retirement and education savings; thus, increasing the
likelihood that they will be utilized.

**[Self-Employment Tax on Health Insurance]{.underline}**

Sole proprietors face a very significant inequity within the tax code
which affects their willingness and ability to purchase health coverage.
Schedule C and Schedule E filers do not receive a "business deduction"
for health insurance premiums. Thus, sole proprietor(s) and partners in
partnerships pay self-employment tax (15.3 percent on self-employment
income up to \$86,000) on the insurance premiums. According to the most
recent Kaiser Family Foundation study, the self-employed pay on average
\$9,950 for family health coverage. Because they cannot deduct these
premiums as an ordinary business expense, they are required to pay
\$1,522 in additional taxes that no other business entity must pay.
**The self-employed are the only segment of the business population that
has this extra tax burden.**

C corporations, on the other hand, receive a deduction for health
insurance premiums as an ordinary and necessary business expense for all
employees including owners. Since the premiums paid by a C corporation
for health insurance are not considered compensation to the employee or
owner, they are not subject to FICA (Social Security and Medicare) taxes
for either the employee or the employer.

To achieve tax equity between all forms of business entities, the
self-employed must receive exclusion of health insurance premiums from
self-employment tax regardless of the entity form under which they
choose to operate. Health insurance premiums of the self-employed should
be deductible on Schedule C or E as an ordinary and necessary business
expense rather than the deduction above the line on Form 1040. This is
an issue of equity and creating a fair and level playing field for all
business entities.

**[Home Office Deduction Simplification]{.underline}**

#### According to research commissioned by the SBA Office of Advocacy, home-based businesses represent 52 percent of all firms and provide 10 percent of the total revenue of the economy. As the number of home-based businesses continues to rise, tax deductions for home offices are an important benefit for self-employed individuals and micro-businesses. To qualify for a home office deduction, a business owner must use an area of their home regularly and exclusively for business purposes and must meet an array of conditions. 

#### 

#### Many home-based business owners prepare own their taxes. Thus, the complexity and paperwork burden of this deduction forces many home-based business owners, who could qualify, to not employ this benefit. There is also a perception that claiming the home office deduction is an instant trigger for an IRS audit which leads to many owners forgoing this deduction.

The NASE believes the home office deduction must be simplified and
contain less rigid restrictions. For those who feel that itemizing their
home office expenses is too burdensome, we also support offering home
business owners the option of selecting a \$2,500 standardized
deduction, which will greatly simplify their tax filing process. This
amount represents the average amount taken by home office tax filers
each year. Additionally, tax code provisions that require homeowners to
\"recapture\" their depreciation when they sell their homes should be
repealed. These current tax provisions prevent home based business
owners from taking full advantage of capital gains tax exclusions, which
exempt \$250,000 (\$500,000 for married couples) on the gain of the sale
of a primary residence.

**[Worker Classification Regulations]{.underline}**

Another specific IRS regulation that is exceedingly burdensome to the
micro-business and self-employed communities is the employee vs.
independent contractor classification. Many micro-businesses either
utilize independent contractors or are themselves independent
contractors. Disputes about who is an employee and who is an independent
contractor have cost small businesses more than three-quarters of a
billion dollars in IRS penalties and back-taxes during the past 10
years.

The IRS has a complicated 20-point checklist the can be used as a
guideline in determining whether or not an individual is an employee or
an independent contractor. Yet, using this checklist does not guarantee
that a person is correctly classified. Other IRS materials published to
assist in classification are equally as convoluted. Our NASE members
have indicated when utilizing the IRS's tax assistance help line on this
issue, they have gotten different answers from different agents on this
same issue. A large issue is that there is no one, single, homogenous
definition of the term \"employee.\" Thus, there is no clear and concise
manner for a self-employed individual or micro-business owner to easily
determine when an individual should be classified as an independent
contractor or an employee.

Also, if a micro-business owner has been selected for an audit, the IRS
is supposed to provide employers with relief from potential IRS
reclassification of a firm's independent contractors as employees, by
prohibiting the IRS from reclassifying such workers if the employer has
met various relief requirements as laid out by Section 530 of the
Revenue Act of 1978. Section 530 was enacted in response to complaints
regarding increased enforcement and aggressive application of the
employment tax laws by the IRS.

Over the years, the IRS has chipped away at many of these supposed "safe
harbors" for reclassification. Is it "reasonable" to believe that a
micro-business owner would have the ability and time to research IRS
rulings and judicial precedent to make certain they have a "reasonable
basis" for classifying someone as an independent contractor?

With more and more individuals conducting a business out of their home
as \"independent contractors\" and the economic incentive to employers
to use independent contractors rather than employees, this issue of
worker classification must be addressed. The NASE strongly feels that
the IRS regulation must be updated to provide straightforward rules for
classifying workers and relief from reclassification. We support
**clearly** defining the rules for classification of workers, providing
certainty for businesses that enter into independent contractor
relationships, and minimizing the risk of huge tax bills for back taxes,
interest, and penalties if a worker is misclassified after the parties
have entered into an independent contractor relationship in good faith.

**[Conclusion]{.underline}**

The ultimate hardship faced by the self-employed and micro-businesses
when dealing with IRS regulations is the complexity, vagueness,
inconsistency and at times, unfairness of these regulations. The simple
difficulty of understanding and then complying with any and all tax
regulations affecting their business is overwhelming for a
micro-business owner. This burden imposed on the self-employed and
micro-business is disproportionate to that of larger businesses because
smaller firms cannot spread the overhead costs associated with hiring
accountants and attorneys needed to comply with the maze of tax
regulations.

The majority of micro-business owners, while not fond of taxes imposed
on them, want to do what is right and comply with tax regulations. Yet,
our current tax code does not in any way facilitate compliance or
exemplify equality and consistency. The National Association for the
Self-Employed hopes the research and efforts of the President's Advisory
Panel on Federal Tax Reform will help to transform and modernize our tax
system to embody these attributes.