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70–874 2011

SMALL BUSINESSES AND TAX REFORM 

HEARING 

BEFORE THE

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

OF THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

MARCH 3, 2011

Serial No. 112–SRM1 

Printed for the use of the Committee on Ways and Means 

( 


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COMMITTEE ON WAYS AND MEANS 

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

PAT TIBERI, Ohio, Chairman 

DEAN HELLER, Nevada 

PETER ROSKAM, Illinois 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

RICK BERG, North Dakota 

CHARLES BOUSTANY, Louisiana 

RICHARD E. NEAL, Massachusetts, Ranking 

Member 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

SHELLEY BERKLEY, Nevada 

JON TRAUB, Staff Director 

JANICE MAYS, Minority Staff Director 


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C O N T E N T S 

Page 

Advisory of March 3, 2011, announcing the hearing ............................................ 2 

WITNESSES 

Dr. Robert Carroll, Principal, Qualitative Economics and Statistics, Ernst 

& Young LLP, Washington, D.C. ........................................................................ 5 

Ms. Patricia A. Thompson, Chair, Tax Executive Committee, American Institute of Certified Public Accountants, Piccerelli, Gilstein & Co. LLP, Providence, Rhode Island ............................................................................................. 18 

Mr. Dennis Tarnay, Chief Financial Officer, Lake Erie Electric, Inc., Cleveland, Ohio ............................................................................................................. 29 

Dr. Donald B. Marron, Director, Tax Policy Center, The Urban Institute, 

Washington, D.C. ................................................................................................. 34 

SUBMISSIONS FOR THE RECORD 

Alvin S. Brown ......................................................................................................... 67 

National Association of Small Business Investment Companies ......................... 75 

Small Business Legislative Council ....................................................................... 79 

The National Association of Home Builders .......................................................... 81 

U.S. Chamber of Commerce .................................................................................... 86 


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SMALL BUSINESSES AND TAX REFORM 

THURSDAY, MARCH 3, 2011 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON WAYS AND MEANS, 

SUBCOMMITTEE ON SELECT REVENUE MEASURES, 

Washington, DC. 

The subcommittee met, pursuant to call, at 9:05 a.m., in Room 

1100, Longworth House Office Building, the Honorable Pat Tiberi 

[chairman of the subcommittee] presiding. 

[The advisory of the hearing follows:] 


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Chairman TIBERI. Now that we have finished our organizational 

meeting, I would like to call today’s meeting to order. I want to 

welcome our witnesses to the hearing to discuss the taxation of 

small businesses and passthrough entities as part of a broader discussion on comprehensive tax reform. 

I believe there is a window of opportunity to enact comprehensive tax reform, and we must take advantage of it. Last November, 

the American people sent a strong message to Washington. They 

told Washington to stop putting off tough decisions, start making 

the decisions that will ensure future generations of Americans will 

prosper. 

Whether it will be reducing the national debt, ensuring entitlements will remain solvent, or reforming our Tax Code to encourage 

economic growth, saying it is too difficult isn’t an excuse anymore. 

Our current system of taxation was written for an economy that 

was very different from the competitive global economy of today. It 

is time to enact a Tax Code that is competitive with the rest of the 

world, that is fairer, and that is simpler. 

Small businesses must be included in comprehensive tax reform. 

Reforming corporate taxes means only reforming roughly 10 percent of Federal revenues. That is not comprehensive. Many small 

businesses pay taxes under the individual income tax rates as 

passthrough entities, which we will hear more about today. 

The last thing we want to do as part of tax reform is create a 

situation where we are putting small businesses at a competitive 

disadvantage. I fear leaving them out of tax reform will do just 

that. Small businesses are the engine of economic growth in our 

economy. As we move forward with tax reform, the question we 

must ask ourselves is how we reform the code in a manner that 

empowers small businesses to grow and create jobs. 

I look forward to hearing from our witnesses on those issues 

today. 

With that, I will yield to the ranking member, Mr. Neal. 

Mr. NEAL. Thank you, Mr. Chairman. 

And I want to thank you for calling this hearing this morning. 

I hope that it will be the first of many on the topic of tax reform. 


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Earlier, I commented on how this subcommittee always hears diverse points of view, and certainly this morning is no exception. We 

have one witness who is complaining that there are too many special provisions for small businesses and that the clutter is overwhelming. We have another saying that these special provisions 

make for a code that favors small businesses over large, and yet 

another tells us that we need to lower income taxes on the upperincome to save small businesses. 

But one thing that we can agree on is that the U.S. offers some 

of the most flexible rules on structuring your business in the developed world, offering limited liability without the requirement of a 

corporate-level tax. As one witness tells us today, we are second 

only to Mexico in the size of the unincorporated businesses as a 

total share of business, and that this self-help integration is a step 

toward reform. 

While this hearing is intended to explore special tax issues on 

passthrough entities, much of the discussion will involve smallbusiness incentives. We should note that the two are not necessarily the same. As one witness tells us, less than 1 percent of 

all passthroughs are large businesses with more than $10 million 

in receipts but they accounted for almost 60 percent of the total 

revenues of all passthroughs. 

Confucius noted that a journey of a thousand miles begins with 

a single step. I want to thank you, Mr. Tiberi, for taking that first 

step this morning on the road to tax reform. And we hope the journey does not take a thousand hearings. 

Thank you. 

Chairman TIBERI. Thank you, Mr. Neal. 

I ask unanimous consent that all Members’ written statements 

will be included in the record. 

Without objection, so ordered. 

Chairman TIBERI. We will now turn to our panel of witnesses, 

whose bios are in your packages. I will introduce them, and then 

we will begin after I have introduced them all. 

Dr. Robert Carroll is from Ernst & Young. Ms. Patricia Thompson is a tax partner at Piccerelli, Gilstein & Company and chair 

of the AICPA Tax Executive Committee. Mr. Dennis Tarnay is the 

CFO of Lake Erie Electric and a former board member of the Ohio 

Society of CPAs and from the great Buckeye State. And Dr. Donald 

Marron is director of the Urban-Brookings Tax Policy Center. 

Thank you all for joining us this morning. 

Dr. Carroll, you may begin your testimony. 

STATEMENT OF ROBERT CARROLL, PRINCIPAL, QUALITATIVE 

ECONOMICS AND STATISTICS, ERNST & YOUNG LLP, WASHINGTON, D.C. 

Mr. CARROLL. Thank you, Chairman. 

Chairman Tiberi, Ranking Member Neal, and distinguished 

Members of the Subcommittee, I thank you for the opportunity to 

testify today regarding the taxation of flow-through businesses and 

tax reform. 

I have had the opportunity to consider the taxation of flowthrough businesses from a number of different perspectives inside 

and outside of government in the context of broad reform of the 


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code and narrow reform of the business tax system. More recently, 

I have been analyzing the flow-through sector in the course of preparing a report on behalf of the S Corporation Association. Today 

I would like to share my perspectives and provide some preliminary results from the study on the flow-through sector we are preparing for release in the near future. 

Flow-through businesses, S corporations, partnerships, limited liability companies, and sole proprietorships play an important role 

in the U.S. economy. The vast majority of businesses in the United 

States have chosen to organize as flow-through businesses. 

Today, flow-through businesses comprise more than 90 percent of 

all business entities, employ more than 50 percent of the workforce, 

and report more than one-third of all business receipts. Individual 

owners of flow-through businesses report 40 percent of all business 

net income. These individual owners also pay 43 percent of business taxes when filing their individual tax returns. 

The flow-through sector in the United States differs markedly 

from other developed nations. The business forms available in 

many other countries tend to push businesses toward the corporate 

form in pursuit of limited liability, whereas in the United States 

such limited liability is attainable through various organizational 

forms outside of the corporate sector. 

This has resulted in a flow-through sector with considerable 

flexibility in how they organize and how they structure their operations. Businesses can choose between several different organizational forms which may provide a better match to their management needs and capital requirements. 

The unincorporated business sector in the United States is also 

larger than in most other developed nations. Of the countries responding to a 2007 OECD survey, the unincorporated business sector was larger as a share of the total number of businesses in the 

U.S. in all but one country. 

With the increasing prominence of flow-through businesses, it is 

important to carefully consider how the flow-through form fits into 

the U.S. tax system and how any particular reform might affect 

flow-through businesses. 

Flow-through businesses are subject to a single level of tax on 

the income earned and allocated to their owners. Thus, it is the tax 

rates faced primarily by individual owners of flow-through businesses that affect decision-making and the economic health of these 

businesses. 

In contrast, the income of C corporations is subject to two levels 

of tax: first when income is earned at the corporate level and again 

when the income is paid out to shareholders in the form of dividends or retained earnings and later realized by shareholders as 

capital gains, hence the phrase, ‘‘the double tax on corporate profits.’’ 

The double tax affects a number of important economic decisions: 

First, by increasing the cost of capital, it discourages investment 

and, thus, economic growth and job creation. Second, it leads to a 

bias in firms’ financing decisions between the use of debt and equity. And, third, it distorts the allocation of capital within the economy. The flow-through form provides an important benefit to the 


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economy by reducing these economically harmful effects of the double tax. 

Recent focus on the need to lower the corporate income tax has 

also drawn attention to how flow-through businesses might be affected by tax reform. With substantial evidence that the U.S. corporate tax rate is out of step internationally, corporate tax reform 

is an important component of an overall approach to improving the 

current tax system. 

As with any such endeavor, however, it is important to keep in 

mind the potential for undesirable side effects. Corporate reform 

that eliminates business tax expenditures would have the unintended impact of raising the taxes of businesses organized using 

the flow-through form without offering the benefit of the lower corporate tax rate. Flow-through businesses would lose the benefit of 

widely used and longstanding provisions such as accelerated depreciation and the charitable-giving deduction. In total, flow-through 

businesses use about 22 percent of the roughly $100 billion in annual business tax expenditures. 

Flow-through businesses are a large part of the U.S. business 

sector and important contributors to the economic vitality of the 

U.S. As reform progresses, it is important to understand and consider all of these issues with an eye toward bringing about the tax 

reform that is most conducive to increased growth and job creation. 

The path toward tax reform will need to take into account many 

features of our tax system and strike a balance between a number 

of sometimes conflicting and competing objectives. This committee 

should be commended for holding this hearing to better understand 

the role that the flow-through sector plays in the U.S. economy. 

I thank you, and I would be pleased to address any questions the 

subcommittee might have. 

[The prepared statement of Mr. Carroll follows:] 


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Chairman TIBERI. Five seconds to spare. Impressive. 

Ms. Thompson. 


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STATEMENT OF PATRICIA A. THOMPSON, CHAIR, TAX EXECUTIVE COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED 

PUBLIC ACCOUNTANTS, TAX PARTNER, PICCERELLI, 

GILSTEIN & CO. LLP, PROVIDENCE, RHODE ISLAND 

Ms. THOMPSON. Good morning, Chairman Tiberi, Ranking 

Member Neal, and Members of the Subcommittee. My name is Patricia Thompson. I am a CPA and chair of the AICPA Tax Executive Committee. My testimony today is based on my experiences 

with working with many small business clients. I am tax partner 

at Piccerelli, Gilstein & Company LLP, a CPA firm in Providence, 

Rhode Island, and have been with the firm for over 32 years. I 

would like to thank this subcommittee for the opportunity to appear today. 

Chairman Tiberi, I would like to start by thanking you for your 

work in trying to repeal the two 1099 provisions. As noted in our 

written testimony, these are significant burdens on small businesses. 

Today’s hearing focuses on the special burdens that the tax law 

imposes on small businesses. Business tax reform cannot merely 

change the corporate tax rates or other corporate provisions if the 

desired impact is to help small businesses, since many of them are 

not organized as corporations. I understand the challenges inherent 

in drafting tax legislation and appreciate your diligence in trying 

to do the right thing for taxpayers. 

My full written testimony discusses several burdens and complexities facing small businesses. In my brief time with you today, 

I would like to highlight just a few. 

The first is tax simplification—depreciation is the best example. 

Methods to compute depreciation are different for tax and financial 

accounting purposes. Depreciation rates can vary depending on the 

method. There are special types of depreciation, such as bonus, special straight line, and Section 179. Plus, there is a different method 

for AMT. So businesses have to maintain several different books of 

depreciation and update them annually for each individual asset. 

Let’s say a client places several pieces of equipment in service 

throughout the year. To determine the best depreciation method, 

they need to run a complex analysis: When was it purchased? Was 

it new? Was it used? What was the total amount purchased? Depending on the purchase date, they may be entitled to 50 percent 

depreciation; maybe it is 100 percent. If they purchase too much 

equipment, Section 179 isn’t available. If they don’t earn enough 

money, Section 179 is limited. The best depreciation method may 

not be clear without extensive analysis. 

My second point is uncertainty in the tax law. Many of the 

changes passed last year were designed to help employ more workers, help small businesses improve cash flow, and improve the 

economy. For example, the HIRE Act that passed last March provided an incentive to hire unemployed workers. This legislation 

was time-sensitive. If taxpayers did not know of the new incentive, 

the tax-saving opportunity was permanently lost. 

The increased use of temporary provisions has also created some 

uncertainty. While some measures may be appropriate for the short 

term, temporary tax provisions and incentives have become far too 

common. Often they are allowed to expire, then they are revived 


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after much debate, but only for another temporary period. It is inefficient and ineffective to make longstanding tax policy utilizing 

temporary provisions. 

Additionally, when changes occur late in the year, small-business 

owners have little time to evaluate the impact of those changes on 

their businesses. It is even harder to plan when the new tax law 

takes effect in the same year that it is issued. In that case, a smallbusiness owner can’t do long-term planning for growth, business 

development, or new hiring. It can be difficult to change course in 

response to a new, short-term expiring tax provision. 

The third issue I would like to highlight is the need to consider 

expansion of corporate provisions to help noncorporate entities. 

The Small Business Jobs Act passed last September expanded an 

existing provision to allow 100 percent gain exclusion on the sale 

of small-business stock if certain conditions were met. There are 

several requirements to qualify for this exclusion. It must be a C 

corporation of a qualifying business. The stock cannot exceed a certain value and must be held for more than 5 years. 

The key here is that this provision only benefits C corporations, 

so it excludes many small businesses that are conducted as sole 

proprietors or passthrough entities. This is an excellent example of 

a provision that was intended to help small business that will likely not have the desired impact. 

One final note: I would encourage you to review two of our recent 

publications, one on alternatives for tax reform, and the other is 

our report on penalty reform. Both are available online, and links 

are provided in our written testimony. 

Thank you again for the opportunity to testify, and I will be 

happy to answer any of your questions. 

[The prepared statement of Ms. Thompson follows:] 


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Chairman TIBERI. Thank you. Thank you, Ms. Thompson. And 

you came in under time, as well. 

Mr. Tarnay, welcome. 

STATEMENT OF DENNIS TARNAY, CHIEF FINANCIAL OFFICER, 

LAKE ERIE ELECTRIC, INC., CLEVELAND, OHIO 

Mr. TARNAY. Chairman Tiberi, Ranking Member Neal, and 

Members of the Subcommittee, thank you for inviting me to appear 

before you today to discuss the issue of fundamental tax reform, 

particularly as it relates to small businesses. 

I am the chief financial officer and a minority owner of Lake Erie 

Electric, a position I have held since 1987, and a former board 

member of the Ohio Society of Certified Public Accountants. I am 

speaking today on behalf of both Lake Erie Electric and the 

OSCPA. 

Lake Erie Electric, based in Cleveland, Ohio, is an electrical contracting company that was first formed as a C corporation in the 

1950s to primarily serve industrial customers in the automotive 

and steel sectors of the Midwest. 

My company has seen many changes since its inception, both in 

terms of its corporate structure and business strategies. In 1987, 

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changes that occurred at that time and because it was a better fit 

for us. When Cleveland’s industrial base contracted, we 

transitioned our customer base to be more heavily weighted to commercial businesses and the health-care sector. 

The main message I want to deliver to you today, gentlemen, is 

that simplifying the Tax Code for small businesses means creating 

jobs in places like Cleveland, Ohio. Predictability and stability 

within the Tax Code provides businesses, particularly small businesses, which typically have tighter profit margins, the necessary 

lens with which to make decisions regarding growth, investment or 

reinvestment of capital, and expanding new employee job opportunities. 

Further, a simpler Tax Code means small-business owners can 

spend less time on costly and burdensome compliance activities and 

invest more of their time on innovation and growing their businesses. Simplicity also helps to minimize taxpayer confusion over 

exactly what liability is owed and helps with financial planning for 

the future. 

Tax reform for small business is about one thing in America: jobs 

for all business sectors. 

Subchapter S corporations are structured so that net income or 

losses to the business are distributed to the shareholders of the 

company and are reflected on the individual’s Federal, State, and 

even local income tax returns. The tax is assessed at their individual income tax rates, meaning legislators should be conscious 

that discussions of assessing higher tax rates on individuals at the 

$200,000 level and families at the $250,000 level will have a direct 

impact on the ability of many small-business owners to reinvest in 

their businesses and keep or grow their workforce. 

In addition to Subchapter S corporations, other forms of passthrough entities that will be similarly impacted are limited-liability 

companies, partnerships, limited-liability partnerships, and sole 

proprietorships. Roughly 75 percent of small businesses are passthrough entities. As we know, the primary reason there are so 

many passthrough entities is because double taxation is eliminated, first at the entity level as earnings and then again at the 

individual level as dividend payments to shareholders. 

This data leaves little doubt that, in order for a significant economic recovery to take place, there must be a tax structure in place 

that will give small businesses the incentive to hire and thrive. 

Tax law does matter to small-business passthrough entities because they modify business practices to adjust for law changes. In 

recent years, tax-law changes have become a political tool, with revisions occurring far too often, sometimes more than once a year 

and sometimes so late in the year that it is retroactive in impact, 

causing business owners to be confused and uncertain on how to 

proceed. 

The frequency of tax-law changes affects small businesses in particular because the unpredictability often slows or discourages the 

hiring or rehiring of employees or investing in new capital or other 

products and services. While certainly businesses of all sizes are 

impacted by the frequency of tax-law changes, they have a far 

greater impact on small-business decisions because so many of 

them operate on very tight profit margins. 


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Predictability helps to keep costs down, as fewer changes equate 

to fewer compliance costs associated with changing practices and 

procedures that, in many cases, are longstanding and successful 

from a cost-benefit standpoint. Lower cost equals greater ability to 

reinvest in company and future growth. 

The current structure of passthrough entities, such as Subchapter S corporations, provides flexibility and control to smallbusiness owners and should be maintained in any tax reform proposal. Going forward, tax reform should help small business by reforming issues such as: simplifying compliance rules regarding EFiling and E-Verify; shifting the burden away from being the 

watchdog for various government entities on its employees; reforming the timing requirements for S-corporation formations; increasing the amount a small businesses may expense on the Federal tax 

returns; reasonable independent contractor rules. 

Gentlemen, the alternative minimum tax should be eliminated. 

If it can’t be eliminated, enact a more reasonable and consistent 

threshold for the alternative minimum tax. 

In a related matter, I do applaud your efforts to address the expanded 1099 requirements currently on schedule to become effective January in 2012. From a small-business perspective, this is 

the classic example of a compliance cost on both businesses and the 

Internal Revenue Service outweighing the benefits derived. 

Chairman TIBERI. Mr. Tarnay, if you can wrap up—— 

Mr. TARNAY. I am right now. 

Chairman TIBERI. Thank you. 

Mr. TARNAY. Meaningful tax reform that focuses on simplicity, 

predictability, and fairness that includes an emphasis on the related cost and compliance burden to small businesses is critically 

important so that we, as small-business owners, do our part to 

grow the economy. 

On behalf of both Lake Erie and the Ohio Society of CPAs, I appreciate the opportunity to share my concerns and would welcome 

any questions you have. 

[The prepared statement of Mr. Tarnay follows:] 


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Chairman TIBERI. Thank you. 

Mr. Marron. 

STATEMENT OF DONALD B. MARRON, DIRECTOR, URBAN– 

BROOKINGS TAX POLICY CENTER, WASHINGTON, D.C. 

Mr. MARRON. Chairman Tiberi, Ranking Member Neal, Members of the Subcommittee, thank you for inviting me to appear 

today to discuss the tax system and small business. 


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America’s tax system is needlessly complex, economically harmful, and often unfair. Because of a plethora of temporary tax cuts, 

it is increasingly unpredictable. And it fails at its most basic task, 

which is raising enough money to pay our government’s bills. For 

all those reasons, the time has come for fundamental tax reform. 

Such reform could have far-reaching effects on every participant 

in the economy, including small businesses. To provide a foundation for thinking about these effects, my testimony discusses basic 

facts about the relationships between tax policy and small business. 

I make six main points. 

First, today’s Tax Code generally favors small businesses over 

larger ones. Provisions such as Section 179 expensing, graduated 

corporate tax rates, and special low capital gains taxes benefit 

businesses that are small in terms of investment, income, or assets. 

Second, many small businesses also benefit from the opportunity 

to organize as passthrough entities. S corporations, limited-liability 

companies, partnerships, and sole proprietorships all avoid the 

double taxation that applies to income earned by C corporations. 

Third, the benefits of organizing as a passthrough are not limited 

to small businesses. Some large businesses adopt these forms, as 

well. Although these large firms account for a tiny share of passthrough entities, they represent a substantial fraction of passthrough economic activity. For example, only 0.3 percent of S corporations had revenues above $50 million in 2005, but they accounted for more than a quarter of S-corporation income. The situation is even more extreme with partnerships. Only 0.2 percent of 

partnerships had revenues above $50 million, but they accounted 

for 57 percent of partnership income. Lawmakers should therefore 

take care not to assume that all passthroughs are small businesses. 

Fourth, small businesses face disproportionately high costs in 

complying with the Tax Code. They are also more likely to understate their income and underpay their taxes. High compliance costs 

thus disadvantage responsible small businesses, while the greater 

opportunity to evade taxes can advantage less responsible ones. 

Fifth, an ideal tax system would collect enough revenue to pay 

for government services while minimizing distortions to economic 

activity. To the extent possible, economic fundamentals, not tax 

considerations, should drive business decisions about organizational structure. By treating passthroughs and C corporations differently, our current tax system deviates from that ideal. 

Sixth, and finally, in discussing reform proposals, it is important 

to distinguish between businesses—a broad category that includes 

passthroughs—and corporations, which generally means C corporations. Many tax reform proposals would reduce business tax preferences and use the resulting revenue to cut corporate income tax 

rates. Such revenue-neutral reforms could lessen the disparity in 

tax treatment between passthroughs and C corporations. 

Passthroughs would see their tax burden increase since they would 

lose some tax preferences but not benefit from the rate reduction, 

while C corporations would, on average, see their taxes decline. 

Thank you. I look forward to any questions. 

[The prepared statement of Mr. Marron follows:] 


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f 

Chairman TIBERI. Thank you. 

Mr. Tarnay, in your written testimony and briefly in your verbal 

testimony, you mentioned a couple of things I would like you to exVerDate Nov 24 2008 02:50 Dec 02, 2011 Jkt 070874 PO 00000 Frm 00048 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\70874.XXX GPO1 PsN: 70874

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pand on, if you could. You mentioned simplifying compliance rules 

regarding E-Filing and E-Verify. And you also mentioned shifting 

the burden away from small businesses to be the watchdog for government on their employees. 

Can you expand on both of those issues? 

Mr. TARNAY. E-Verify—in our business sector, since our labor 

force comes from the unions, we have employees that come and go 

during the course of the year. And every time they come on, we 

have to E-Verify. 

So you can have an employee, an electrician, for example, that 

comes on the payroll for, let’s say, 3 weeks, 4 weeks, 3 months, and 

then goes back to the labor force because we don’t need that employee anymore. Well, the next time he comes on, we once again 

have to go through the E-Verify process, and we have to do that 

within 3 days of him being on the payroll. But when we do that, 

and since we have roughly 400 or 500 electricians and they rotate, 

we could have that same employee being E-Verified 3 or 4 times 

a year. 

It is time-consuming, and it takes away from other opportunities. 

Chairman TIBERI. And the other issue? 

Mr. TARNAY. E-Filing? We haven’t had much to do with E-Filing. But I know for small businesses it can be very difficult, simply 

because many of the small businesses are not that, I am going to 

call it, technologically—have those technological abilities. 

Chairman TIBERI. And your point about being a watchdog, 

small businesses being a—— 

Mr. TARNAY. Well, that isn’t just at the Federal level. That is 

at all levels of government. Garnishments, withholdings—— 

Chairman TIBERI. 1099s. 

Mr. TARNAY [continuing]. Child support. It goes throughout. It 

is a tremendous burden. 

Chairman TIBERI. Thank you. 

Dr. Carroll, if Congress decides to reduce business tax expenditures and cut the corporate tax rate, what are some ways that we 

could mimic a corporate tax rate cut for noncorporate businesses? 

I would note, and I know you are aware, for example, that the 

House Republican Pledge to America proposes a 20 percent deduction for small-business income, which would, I believe, be a similar 

rate cut from 35 percent to 28 percent for small businesses. 

Can you give us some thoughts on that? 

Mr. CARROLL. Yeah, sure. I think there are a couple of ways 

that that could be accommodated in our current tax system. One 

approach would be to put in place a separate rate schedule, similar 

to dividends and capital gains. Another approach would be to put 

in a deduction for a certain fraction of flow-through income. 

One of the complexities in extending a deduction or a lower rate 

to flow-through income might be trying to split up the return to 

labor and return to capital associated with that income. 

For S corporations, it is fairly—it is more straightforward, I 

would say. S corporations are required to pay the owners a reasonable level of compensation. But for other organizational forms, such 

as, you know—one would have to address that issue. Some of the 

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turn to capital, but they have come up with very, very complicated 

approaches for that. 

Chairman TIBERI. Last question, if you could all just comment 

on this. Some have said that if we can lower the rate and broaden 

the base and get rid of some of the other stuff within the Tax Code 

to simplify it—Ms. Thompson, starting with you—what would be a 

ballpark figure that you think you could lower rates for passthrough entities and get rid of some of the things that might benefit some passthrough entities but not all? 

Ms. THOMPSON. The AICPA actually doesn’t take a position on 

the best alternative to come up with. But what they have is the report talks about reform alternatives for the 21st century. 

And what they think about when evaluating the tax reform proposals, they would want to look for simplicity within the measure; 

whether it is fair; whether it has economic growth and efficiency; 

its neutrality; whether it is transparent to everybody; whether or 

not it is minimizing the noncompliance, because we all know that 

that is a significant issue, and the easier you make something, the 

more compliant people will be; whether it has the ability to have 

cost-effective collection and the impact on the government revenues; whether there is certainty in it; and whether there is payment convenience. 

So the AICPA really, at this point, doesn’t have a position, to answer your question, on it. But as proposals come up, we could take 

a look at them and see what—— 

Chairman TIBERI. We could probably move your bill right now, 

actually. I think everyone agrees with what you have said. 

Mr. Tarnay. 

Mr. TARNAY. Simplicity and predictability for a small business 

is essential so that they know what to do, moving forward. As we 

all know, in small businesses, it is usually the owner that leads it, 

and he is not necessarily the key in financial decision-making. That 

is why, many times, the CFO is known as an ‘‘OFO,’’ the ‘‘only financial officer.’’ 

If you make it simple and predictable, a small-business owner begins to understand it, and he can make decisions in his structure, 

in his decision-making, so that he can expand his business. It is as 

simple as that. 

Chairman TIBERI. Mr. Marron. 

Mr. MARRON. I was quite impressed with where the President’s 

fiscal commission came out. I served on the parallel DomeniciRivlin commission. 

Both of those did full-scale tax reform, individual and corporate 

at the same time. And in both of those, they came out in roughly 

the same place, saying that we should aspire to a system where 

both the top corporate rate and the top individual rate are the 

same and begin with a ‘‘2,’’ and it is 27, 28, somewhere in there. 

Chairman TIBERI. Thank you. 

And, finally, Dr. Carroll? 

Mr. CARROLL. Just following on Mr. Marron’s comments, both 

the fiscal commission and the Rivlin commission got down to about 

a 27, 28 percent. They would eliminate most, if not all, business 

tax expenditures, depending on the plan. They kept a few things. 


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If you go back to the 2007 Treasury competitiveness report, we 

were able to get the rate, at that time, down to about the same. 

If you eliminated all business tax expenditures, you could get the 

rate down to about 27, 28 percent. And that includes getting rid 

of provisions like accelerated depreciation, and so some provisions 

that are longstanding and, certainly, widely used. 

And one of the things I think you need to also consider is, when 

you add in the State rates, even if you got the business rate down 

to 28 percent for corporations and for flow-throughs, when you add 

in State rates you would still have a rate on the order of about 33 

percent, combined rate, for the U.S., which would still place us at 

a rate above the OECD and the G–7. 

Chairman TIBERI. Thank you. Thank you all. 

I will yield for questioning to the ranking member, Mr. Neal. 

Mr. NEAL. Thank you, Mr. Chairman. 

Dr. Marron, both you and Dr. Carroll discussed the problem with 

eliminating business tax preferences as part of an effort to lower 

the corporate rate. In fact, Dr. Carroll’s testimony highlights the 

annual cost of these preferences and which ones are used equally 

by both corporations and passthroughs. 

Since base-broadening, though, seems to be the best way to accomplish reform, how do you think that Congress should address 

this real concern? 

Mr. MARRON. I would start with broad principles. And from the 

security of being a think-tank economist kind of guy, the numberone principle I start with is a leveling the playing field. That the 

first order, the goal of our tax system should be not to play favorites among different types of activities, different organizational 

forms. And that when you have business tax preferences that are 

clearly skewing the field in one direction or another, that those are 

ones that ought to get close attention. 

A second one—and this one I want to highlight just because it 

doesn’t come up as much. We often talk about a strategy of rolling 

back tax preferences, and lowering rates as a strategy for doing 

corporate reform and business reform. There is another strategy, 

which is to keep favorable depreciation policies, possibly even move 

toward expensing, but then pay for that by walking back the deductibility of interest. 

And an attraction—I would recommend that as a strategy to 

keep in mind, because the attraction of that is that it would eliminate some of the distortions in our current system that favor leverage and favor debt. And, in principle, it could be a way that it 

would have favorable business incentives but in a paid-for way. 

Mr. NEAL. Uh-huh. 

Dr. Carroll. 

Mr. CARROLL. Yeah, I think the challenge is—there has been 

some discussion of corporate reform focused on trying to bring the 

corporate rate down, primarily due to the pressures from abroad, 

with the corporate rates coming down quite a lot over the last couple of decades among our major trading partners. And I think, you 

know, tax reform—I think business tax reform needs to be somewhat more broadly considered. 

I think it is very hard to lower the corporate rate and pay for 

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ness tax expenditures for both flow-throughs as well as C corporations. I think one needs to pursue not just reform of the corporate 

income tax but, more broadly, reform of the business tax system 

and look at that in a more holistic fashion. 

And the tax system is very intertwined. There are a lot of interrelationships between, as I have discussed in my written testimony, between C corporations and the flow-through sector, but also 

in the taxation of investor-level income, in the form of capital gains 

and dividends. You have the part of the double tax on corporate 

profits. 

These things are very interrelated, and I think it is very difficult 

to take a small piece of the Tax Code and try to reform that in isolation. I think pursuing it in a much broader way is more constructive. 

Mr. NEAL. Uh-huh. 

Off-script for a moment: But a few moments ago in your comments, you spoke to depreciation allowance. While I think, in my 

own instance, having rejected the idea, the theology that tax cuts 

pay for themselves, I do subscribe to the notion, as Chairman 

Tiberi offered at the outset, that the use of the NOL last year was 

very important, further suggesting that, at certain times, some tax 

cuts are better than others. 

And I think there is some evidence over the years that acceleration of depreciation allowance has worked, in terms of changing behavior in an economic downturn. Are you prepared to suggest that 

that ought to be eliminated as a possibility? 

Mr. CARROLL. Yeah, I am not really here to suggest what 

should be eliminated or kept. 

With respect to accelerated depreciation and expensing, I think 

it is a pretty common view among economists that expensing and 

accelerated depreciation are constructive provisions that help encourage investment. Both in times of economic downturns—the 

bonus depreciation and 100 percent expensing enacted in late December can be very constructive to help stimulate business investment during periods of economic weakness—but it is also, I think, 

very helpful in terms of longer-term tax policy. Accelerated depreciation and expensing help to reduce the tax on capital income in 

the economy, which can help encourage capital formation and promote growth in the longer term. 

Mr. NEAL. And, Ms. Thompson, it was dizzying just to read your 

client scenarios with all the complex depreciation options, but I am 

sure you understand that Congress was trying to help small business, even though the result was a patchwork of generous rates 

and confusing expiration dates. 

And I share the argument that the four of you seem to be unified 

around, with respect to the need for predictability, in our tax rules. 

That is a given. 

But since you mentioned how tax accounting here differs from financial accounting, is conformity a recommendation that you would 

make? 

Ms. THOMPSON. We are not really saying that the tax rules 

need to be the same as the financial accounting rules. But what we 

are thinking is that it is just one area that could be analyzed to 

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cause, as we had said, during 2010 there were quite a few tax provisions that came in and actually were changing depreciation. So 

it just adds to the complexity of it. 

I don’t think that anybody is opposed to accelerated depreciation; 

my small-business clients aren’t. But they would like to know 

ahead of time so that they could have time to plan for it. So that 

is really what they are asking for. 

Mr. NEAL. Just lastly, Rep. Phil English and I, at one time, 

worked on that, as you know. And there was substantial evidence 

that it was an effective approach. And, certainly, tax receipts were 

up, based upon that initiative. 

Chairman TIBERI. Thank you, Mr. Neal. 

Mr. Heller is recognized. 

Mr. HELLER. Thank you, Mr. Chairman. And I appreciate your 

comments and holding this hearing. 

I appreciate all of you being here. 

I am from Nevada. So when you think of Nevada, a lot of times 

you think of gaming properties, and I can understand that. But I 

think the fact remains that small businesses make up almost 96 

percent of the employers in Nevada. 

And just some other statistics, only because I think Nevada is a 

microcosm of what is going on economically in the country as a 

whole. In 2004–2005, it created nearly 68,000 new small-business 

jobs. In 2005 to 2006, we created 77,000, so an increase of nearly 

10,000. But in 2006–2007, going from 77,000, it was reduced to 

40,000 new small-business jobs. And, clearly, economic factors have 

everything to do with it. 

In 2009, Nevada averaged 3,300 new small-business startups 

each quarter. The down side is that we averaged 3,700 small businesses being closed each quarter. So, clearly, those that are closing 

are unfortunately outpacing those new jobs that are being created. 

In the Obama fiscal year 2012 budget, he raises taxes on small 

businesses. He does it in three ways: He raises the top 2 individual 

income tax rates from 33 percent to 36 percent and then from 35 

percent to 39.6 percent. He reinstates the personal exemption 

phaseout and the Pease limitations on itemized deductions. And, finally, he raises taxes on dividends and long-term capital gains, 

hoping to raise in his budget $709 billion. 

Now, the theme—and I appreciate Mr. Tarnay’s comments about 

what businesses need—and I think it has been a theme for all of 

you, and that is predictability, stability, and simplicity. 

I guess my question, Ms. Thompson, since you alluded to these 

issues and the importance of planning, long-term planning, as you 

know, last year we extended the 2001–2003 tax cuts for only 2 

years. And you were talking about the ability of a small business 

to be able to plan long-term, a 5-year plan, a 10-year plan. 

With these potential increased taxes of $709 billion and the extension for only 2 years, the 2001–2003 tax extension, how does a 

small business today put together a 5-year plan or put together a 

10-year plan? 

Ms. THOMPSON. They don’t. Or, they can’t. Because you are absolutely right, it was very helpful that the 2001 tax rates were extended for a 2-year period. But what we would like to see is to 

know either this year or as soon as we can what the rates are 


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going to be beyond 2012 so it will help that small-business owner 

know what his tax liability is going to be in the future. Because 

if he knows that his taxes are going to increase, it is going to have 

an impact on his cash flow. If it has an impact on his cash flow, 

there are going to be potentially cuts in other areas, and, unfortunately, that might be workers. It is hard to say. 

But they will definitely need to know what their tax liability is 

going in the future to make business decisions now. 

Mr. HELLER. Mr. Tarnay, since those were your words, ‘‘predictability, simplicity, and stability,’’ how does a business today plan 

under the current tax rates that we have? 

Mr. TARNAY. I would agree it is very difficult, because for years, 

for decades, it used to be we understood what the tax rates were, 

what the law was moving forward, accelerated depreciation, the 

whole nine yards. Then I would say, in the past 10 to 15 years, 

laws changed annually, sometimes retro. It is very, very difficult 

for small businesses to do that. They have to bring in their experts, 

their tax advisors, and that is costly. 

If small-business owners understood what it is going to be for a 

5-year period, a 10-year period, they can plan. That is what they 

are good at. That is what we need. 

Mr. HELLER. The President’s deficit-reduction commission, is 

there anything that you disagreed with? There were a lot of tax 

structural changes talking about deductions and removing—Dr. 

Marron, you are talking about moving forward with a different 

type of tax structure. 

What in the President’s deficit-reduction commission—were there 

any principles in there that you agreed or disagreed with? You said 

you sat on a similar commission yourself. 

Mr. MARRON. Yes. So, in terms of things agreed with, I very 

much endorse the idea that, if you are going to do reform, A, it 

makes sense to do the whole tax system at once, if you possibly can 

politically, to take into account all of the interactions. That there 

are a lot of tax preferences out there that really look a lot like 

spending programs; they have just been dressed up to appear as 

tax cuts. And that, as a result, if someone is interested in making 

the government smaller, there are actually some things you can do 

that will be recorded as tax increases that actually are functionally 

the reduction of spending, from any sort of economic or budget 

point of view. And that, as a result, there are ways, basically, to 

increase revenues that, you know, are not that troubling, frankly. 

I am very much encouraged by the idea of bringing down rates, 

kind of broaden the base, lower the rates. As Dr. Carroll mentioned, a little bit of concern that the plans do raise dividend rates 

and capital gains rates. And so there is an issue that, while for the 

corporate form you are reducing rates with one hand, on the other 

hand you are raising rates, and you are not getting as much of a 

net incentive for investment as you might get with a slightly different form. 

Mr. HELLER. Thank you. 

I have run out of time. Thank you, Mr. Chairman. 

Chairman TIBERI. Thank you. 

Mr. Roskam is recognized for 5 minutes. 

Mr. ROSKAM. Thank you, Mr. Chairman. 


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Well, the good news is we all agree on something, and we all 

agree that the status quo has to change. There is no voice here on 

this panel and there is no voice among the witnesses that says, 

let’s stick with the status quo. And that is, actually, good news. I 

mean, there is this shared premise that we can move forward from. 

What I am interested—you know, we are all products of our environment, and we are all reflecting our districts today. Mr. Heller 

talked about Nevada. I am from suburban Chicago, and my district 

has an extraordinary number of manufacturers, small manufacturers, tool-and-die types that are selling into foreign markets and are 

selling around the world, selling to the Caterpillars of the world 

and so forth. 

Illinois has a unique dynamic that I am concerned about. It is 

nothing that we are going to do anything about today. It was a bad 

decision, I think, that was made. But it is having an impact on this 

larger conversation about passthroughs. 

Let me just give you a couple of quick facts on Illinois. Illinois 

just raised its taxes, right? So the individual rate went from 3 to 

5 percent, a 67 percent increase. The corporate income tax rate 

went from 7.3 to 9.5, a 30 percent tax increase. Illinois now has the 

fourth-highest combined national-local corporate income tax rate. 

And according to The Tax Foundation, we have dropped from 23 

to 36 in the country among States. 

Now, that is not your problem; that is my problem, because I am 

an Illinois resident. But it is also the problem of a lot of companies 

and businesses that I represent. 

So if we are making changes at a macro level, in terms of U.S. 

tax policy, that have an impact on driving more businesses into a 

corporate structure, you see what that does to the employers that 

I represent. They are jammed, right? They have to go into this position. And what we don’t want to do is move them so that they 

have to go that route. 

Dr. Carroll, I am interested in your perspective. A lot of times, 

when we talk about corporate tax rates and, sort of, corporate tax 

conversations or general tax reform, we tend to shun passthroughs 

as a little bit of a sideshow. 

You mentioned three key points, and I just want to yield you 

some time. Could you go through those key factors on the distortions within the marketplace, the debt equity distortions and so 

forth? Because I think that is an important part of the calibration 

that this subcommittee needs to take into consideration as we move 

forward. 

RPTS MERCHANT 

DCMN MAGMER 

[10:00 a.m.] 

Mr. CARROLL. Yeah. As I mentioned in my oral statement and 

explained in some detail in the written testimony, one of the major 

differences between the taxation as a C corporation and as a flowthrough is the double tax on corporate profits, the notion that a 

dollar investment in the corporate sector, the return to that investment is first subject to the corporate income tax and then taxed 

again at the individual level, either when it is paid out as a dividend or if the return is retained then it would be taxed as a capital 


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gain eventually when the shareholder disposes of the stock. So 

when you combine those two levels of tax you wind up with a double tax, and that distorts economic decision-making in a couple of 

ways. 

Dr. Marron had mentioned that economic fundamentals should 

drive decision-making, not tax considerations. One of the things 

that the corporate tax does, because it is tax on equity financed investment, interest expenses are deductible but dividends are not, 

and so it is tax on equity finance investment which creates a bias 

or adds to the bias for debt finance investment, increases the overall leverage within the economy to the extent that firms are more 

highly leveraged. Because of this tax bias, they are going to be 

more susceptible to financial distress during times of economic 

weakness. So that is one of the distortions. The tax bias for debt 

finance, the tax bias for greater leverage, that is an issue. 

Another issue is you have a different treatment of investment in 

the corporate sector versus elsewhere in the economy, in the noncorporate, in housing, other sectors in the economy, and that 

causes a misallocation of capital within the economy. Again, you 

have investment decisions throughout the economy being made for 

tax considerations, not economic fundamentals. When you have 

that misallocation of capital, the capital stock will not be allocated 

to its best and highest use, and that is going to reduce economic 

growth. 

And then, third, it raises the cost of capital. The double tax and 

corporate profits, you know, it is another layer of tax on capital formation, that that higher cost of capital discourages capital formation and investment and, again, would reduce the overall growth 

rate of the economy. 

Mr. ROSKAM. Thanks, Dr. Carroll. 

Thanks, Mr. Chairman. 

Chairman TIBERI. Thank you. 

Mr. Thompson, you are recognized for 5 minutes. 

Mr. THOMPSON OF CALIFORNIA. Thank you, Mr. Chairman. 

Thanks for holding this hearing and thanks to all the witnesses for 

being here. I concur with everyone else who said that this is an 

issue that we all agree on. We just need to figure out how to get 

there. 

Just a real quick question, Ms. Thompson. On the 1099 issue 

that you raised, do you have any suggestions on how this Congress 

should deal with the underlying issues that brought the 1099 matter to the forefront? And that is, the $30 billion or $25 billion worth 

of tax evasion that is going on, how do you address that? 

Ms. THOMPSON. I think that would probably be on enforcement 

side, which the IRS does have the ability to—— 

Mr. THOMPSON OF CALIFORNIA. But they don’t have the 

data. You can’t put an IRS person at every point of purchase. 

Ms. THOMPSON. I think that the existing rules that are in 

place cover services, and I don’t think that everybody is even in 

compliance with that one. So we might start working on that area 

first. 

I think the way the legislation is written right now it is covering 

goods and it is covering corporations, and that is not realistic on 

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body is talking about is if a small business owner goes into Staples 

and purchases their office supplies and they happen to spend more 

than $600 in a year, they are going to be required to send a 1099 

to Wal-Mart and Staples, and it just doesn’t seem like it is the 

right target that you are looking for. 

Mr. THOMPSON OF CALIFORNIA. A couple of you have raised 

the whole issue of complexity, and for those of us who were in the 

meeting that we had in the full committee when we got a briefing 

on the U.S. tax structure it is pretty hard to argue that the system 

isn’t just overwhelmingly complex. 

In another life, I chaired a tax committee in the State legislature 

in California, and I had business people tell me just, you know, 

lower the heck out of our taxes. We understand things need to be 

revenue neutral, and that you need money to do all the things that 

government does. But the lower our tax rate is, the more people we 

will hire, the higher wages we will pay, the better off everybody 

will be. Get it at the employee. We are paying them well. They 

should pay taxes. Do you think that is a pretty accurate approach? 

To any of you, do we have too many tax options for business? I 

think Mr. Neal said it earlier, that everything that is there that 

makes it complex was there to address a certain issue or, in most 

cases, to help business. Do businesses have too many tax options 

on the table? 

Mr. TARNAY. The answer is yes. Also, the answer is, if it can 

be done so that the law is something that people can understand 

for a significant period of time, as opposed to things changing yearto-year or less than 5 years, people can plan that. I can plan it. My 

company can plan that. We understand that. We can move forward. 

Okay? That is the difficulty that we have. 

And the other thing is, simply law changes that are retroactive. 

When you hear that, you don’t do things because you don’t know 

when that retroactive application is. If we knew that, we can plan. 

That is what we need. 

Mr. THOMPSON OF CALIFORNIA. So if there were fewer options, if you didn’t have the LLC, didn’t have the corporate election, 

and you had just a business tax? 

Mr. TARNAY. Well, I am not saying the type of entity. I am saying within that type of entity that you understand what the law 

is. It is simple. It is fair. 

Mr. THOMPSON OF CALIFORNIA. I get that part. 

Mr. TARNAY. That is it. 

Mr. CARROLL. I guess I would say that I think one of the distinguishing features of the U.S. business tax system is we do afford 

businesses with different choices on how to organize themselves, 

and I have always thought of that as a virtue. It allows companies 

to make the choice that best fits and suits their capital requirements and their management needs. It is probably one of the many 

distinguishing features of the U.S. economy in comparison to our 

major trading partners. That flexibility probably adds to the dynamism of the U.S. economy. 

Mr. THOMPSON OF CALIFORNIA. To follow up on that, Dr. 

Carroll, are there certain anti-avoidance measures that would have 

to be put in place if you were to devise a system that pushed the 

rate down and lessened the options? 


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Mr. CARROLL. Yeah, that is a very, very interesting question, 

and it is kind of an extension of your earlier question in some sense 

in terms of how tax rates affect decision-making. 

Typically, from an avoidance or a compliance perspective, one 

would think higher tax rates would encourage greater avoidance 

and noncompliance activity. Because the benefit of avoiding and 

the benefit of not complying to the taxpayer is greater with the 

higher rates. So one of the benefits of lowering rates generally 

would be that you would help mitigate and reduce avoidance behavior. 

Chairman TIBERI. The gentleman’s time has expired. 

Mr. Thompson, just a side note we tried to find Grandma Thompson to come testify. When we couldn’t, we had Ms. Thompson instead. 

Mr. THOMPSON OF CALIFORNIA. That is why I cautioned 

you, you better lay off the Grandma Thompson jokes today. 

Chairman TIBERI. Mr. Paulsen is recognized for 5 minutes. 

Mr. PAULSEN. Thank you, Mr. Chairman. It is nice to be having 

a hearing that is focused on small business entities, and I appreciate your testimony here today. 

Knowing that we are in a very globally competitive economy, absolutely, and, you know, today we have to have a Tax Code that 

has not only the predictability in the long-term thinking, but, I 

mean, I really do believe it also has to spur innovation, spur the 

whole idea of entrepreneurship, and also capital formation and investment. I think there are a lot of staff people in the administration or even Members of Congress that don’t understand the allocation of capital, and that is really what this is about, how you allocate capital in the global environment. 

One of my concerns with the administration’s proposal on tax reform is that it is centered more on the corporate tax side, at least 

in the President’s State of the Union proposal, and he talks about 

having a revenue-neutral basis for corporate tax reform. I want to 

make sure that is not going to be an expensive trap for small business entities and pass-through entities such as S corps, LLCs, sole 

proprietorships, partnerships, et cetera. 

If that is the track that is ultimately pursued and a lot of our 

Nation’s employers are going to see tax increases because we eliminated certain tax business, the expenditure side like deductions for 

depreciation, et cetera, which you talked about, you know, what 

would be some of the ramifications of that from the standpoint of— 

while there might be not be any offsetting benefit, in essence, for 

small employers—and, on top of this, we also heard Secretary 

Geithner actually, just last week I think, float the idea of having 

some pass-throughs be pushed more into the C corporation model, 

actually, ensuring they would also be hit with this inefficient double tax. 

So let me ask Mr. Carroll first maybe, if the purpose of tax reform is to actually make the U.S. government more competitive or 

our economy more competitive, I should say, and encourage job creation, does it make sense to push more people into the C corporation tax model? 

Mr. CARROLL. My view is that that is problematic. As I already 

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cision-making in some fairly fundamental ways. It is kind of widely 

recognized among economists in the policy community that the double tax on corporate profits is a significant problem. It contributes 

to the leverage among businesses. It misallocates capital, and it 

raises the overall cost of capital for the economy. 

Most other developed nations have provided some relief from the 

double tax on corporate profits in some way. They have shifted a 

little bit in the last 10 years in how they do that, whether they do 

it at the shareholder level, whether they do it at the corporate 

level, the mechanism in which they deliver it. But the U.S. tends 

to have fairly—even after the lower rates on dividends and capital 

gains were enacted in 2003, we still have a fairly high double tax 

on corporate profits such that a dollar of investment in the corporate sector that is paid out as dividends is taxed pretty highly 

relative to most other things. 

I think that is a problem. It kind of complicates—and I think it 

really complicates if you try to redraw the line between the flowthrough sector and the C corporation sector. To raise more revenue 

to lower the corporate rate, I think it would make the double tax 

problem larger, not smaller. 

Mr. PAULSEN. And, Ms. Thompson, I am just curious, what 

would happen to your clients if they got pushed into a C corp 

model? 

Ms. THOMPSON. I think it is really too early to say what would 

happen if they moved into the corporate form because it hasn’t 

been worked out on what all the details of that are. Are there going 

to be changes to the expenses? Is there going to be a double tax? 

So it is really too early to answer that question. 

Mr. PAULSEN. Mr. Chairman, I follow up in a different angle 

to what Mr. Carroll—I know that you looked at the economic issues 

that are associated with S corporations and with the subset of S 

corporations, namely, employee owned or ESOP S corporations, in 

particular. These are companies essentially that are employee 

owned and they fared much better in tough economic times in 

terms of actually growing their companies during these trying 

times and also putting people back to work, providing retirement 

security, actually, for their employees. If the administration’s proposal to move and eliminate some of those pass-throughs on S 

corps became a reality, for instance, what would this mean for privately employee-owned companies potentially? Who would be affected by such changes within those organizations? 

Mr. CARROLL. Yeah, I think the S corp ESOP structure is very 

interesting. The employee ownership aspect is very interesting, and 

the performance of those companies based on some work that I 

have done suggest that those companies performed better during 

the economic downturn than the rest of the economy in the sense— 

although it is not a huge segment of the economy, they did in effect 

provide, in some sense, a backstop during the economic downturn. 

They tend to pay their workers higher average wages, and they 

tend to provide a fairly high level of retirement security. So the 

ESOP provides that benefit as well. 

Mr. PAULSEN. Thank you, Mr. Chairman. 

Chairman TIBERI. Thank you. 

Mr. Berg is recognized for 5 minutes. 


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Mr. BERG. Thank you, Mr. Chairman. I appreciate you being 

here. 

As a small businessman, it is kind of over the years going 

through the 1986 tax reform and everything else, small business 

tends to make decisions, first of all, on the economics, but they are 

really influenced by the taxation. And it seems to me—I enjoyed 

the OFO, only financial officer. I think that is what a lot of these 

small businesses are. 

And when there is laws that are passed, they are either convoluted or complicated. They are trying to look at that and figure 

that out. And the point of having a third party analyze this for the 

business, I mean, those are things that, again, specifically help at 

little moments in time but I think overall really cause a lack of 

focus in what maybe a small business should be focused on. 

So one of the things that I heard you saying that potentially 

when you eliminate some of the accelerated depreciation and other 

things that you could probably bring the rate down to 28, 27 percent. I wonder if you ever looked at just the silo of pass-through 

entities. If you said just looking at this group of pass-through entities, if we eliminated, again, or changed this to simplify it, what 

could that overall rate be brought down to? Would that be the 28 

percent? Whoever would like to—— 

Mr. CARROLL. I think if you were looking at just the flowthrough sector by itself, I haven’t done the calculations in terms of 

how low the rate could be brought down. As I mentioned, flowthrough entities use about 22 percent of the business tax expenditures, and they report about 40 percent of the net income and pay 

about 43 percent of the business taxes. So, in that sense, the C corporations kind of make somewhat greater use of business tax expenditures. So that might give you some sense of kind of the relative reduction of the rates. 

But I would point out that if one tried to just do corporate reform 

and tried to draw a line in the various business tax expenditures 

or business tax provisions so that they would only be reduced or 

eliminated for C corporations or did the same for pass-throughs, I 

think that would be a very, very complex, complicated system. Trying to make those distinctions on something like accelerated depreciation that is probably available to all business forms in trying to 

have one system for C corporations and another system for flowthroughs I think would be an extraordinarily complex system. 

Mr. BERG. Ms. Thompson, you had mentioned the 100 percent 

gain exemption, and that was a little bit new to me. Could you explain that briefly and how that could benefit if it were implemented 

for pass-through entities? 

Ms. THOMPSON. The provision is that if you have a gain on the 

sale of a small business stock you can exclude 100 percent as long 

as you purchased the stock between September, 2010, and December, 2011; and starting in January, 2012, it is going to drop down 

to 50 percent gain exclusion. 

But what happens with that provision right now is it is only 

available to C corporations; and, as we had talked about, most of 

the small businesses are running as pass-through entities. And so 

if that is a C corporation provision, it automatically excludes everybody who has been running this small business as a pass-through 


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entity. The value has to be less than $50 million, and it has to be 

in certain types of businesses, and it can’t be any type of personal 

services. It can’t be restaurants, hotels, motels, those types of 

things. So it is really very narrow, and it is even more narrow because it is only C corporations, which most of the small businesses 

aren’t. 

Mr. BERG. Thank you. 

The other issue that has come up time and time again is the uncertainty and unpredictability. I mean, I think whatever our tax 

rates were, whatever our deductions were, if they were set in stone 

for 15 years, that would be a good thing for small business and 

probably all business, as long as it is competitive. And so I guess 

looking at that—and I am asking myself—what are the taxes out 

there that are on like a short-term trigger that need to be renewed 

that create this uncertainty out there? In our current Tax Code, as 

it relates to the pass-through entities, what are those either deductions or what are those things that you are aware of that creates 

that uncertainty that could be addressed in this Congress? 

Again, I am not, I guess—— 

Ms. THOMPSON. The first one could absolutely be the tax rate. 

Because we do know that they are set until the end of the next 2 

years, through 2012. But then once you get beyond that depreciation we do know that this is a business incentive that you put in 

place more when the economy isn’t really good. But having that 

come in and out as frequently as it does, that is causing quite some 

challenges. 

Mr. BERG. Thank you. 

So tax rates and depreciation. Is there anything else? 

Ms. THOMPSON. From the small business perspective, I think 

those are the major ones that we come across. 

Mr. BERG. Dr. Carroll. 

Mr. CARROLL. I think if you look broadly at the tax system, you 

have a large fraction of the Tax Code that is really in flux from 

year to year. You have the sunset of the Bush tax cuts at the end 

of 2012 which raises a considerable uncertainty, and you also have 

the various expiring provisions, including the R&D credit that is 

used by small businesses as well as large businesses, and that expires periodically. There is a long list of expiring provisions. All of 

these things create a lot of uncertainty and instability in the Tax 

Code and make it very, very difficult for both individual and business taxpayers to make decisions. 

Mr. BERG. Thank you. 

Chairman TIBERI. Thank you. Thank you, Mr. Berg. 

Dr. Boustany is recognized for 5 minutes. 

Mr. BOUSTANY. Thank you, Mr. Chairman, and thank you for 

holding this hearing. This is a very important hearing. 

Some time ago, I was back home doing a town hall meeting and 

I was talking about American competitiveness and the need to 

lower the corporate tax rates so we could compete in the global 

economy. And after some lengthy discussion about all of that, I had 

a small business owner who I had happened to know, a gentleman 

by the name of Paul Fontana, who owns an occupational therapy 

business, and he stood up and he said, what about me? What does 


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this get me? And it got me to thinking and I said, well, you know, 

you are right, because you have a pass-through entity. 

And as we go through this discussion it becomes apparently clear 

to me that we really have to focus on our small businesses and 

pass-through entities as we do tax reform. Otherwise, I think we 

will be negligent in the approach. 

Dr. Carroll and Dr. Marron, the administration is talking about 

reducing the corporate tax rate, which I think we all agree we need 

to do, and we are looking at targeting it down into the 20s, you 

know, 20, 25 percent, if we can get it down that low, to be really 

competitive. But, at the same time, the administration is talking 

about raising the top level for pass-through entities, the top rate 

for pass-through entities and individuals to almost 40 percent. So 

what is going to be the economic consequence if that is allowed to 

go through? Dr. Carroll. 

Mr. CARROLL. Yeah. I think our corporate tax system is very 

much out of step in the global economy. Most other developed nations within the OECD have lowered their corporate tax rates significantly over the last—certainly since the mid-1980s, and we now 

have the second highest corporate tax rate exceeded only by Japan. 

Japan is likely to reduce their corporate tax rate in April, in which 

case we will have the highest. So that kind of provides a backdrop 

for why there is an interest in corporate tax reform. You know, we 

want the U.S. to be able to compete in a global economy, and the 

world has really changed. It is very different now than it was. 

Mr. BOUSTANY. What is the economic consequence here in the 

U.S. with this disparity if we have a top rate of almost 40 percent 

for our pass-throughs and for individuals as we lower the corporate 

tax rate? 

Mr. CARROLL. I think it is a very problematic. I think it is very 

problematic. The flow-through sector, as I said, is a very large segment of the economy, employs 54 percent of the private labor workforce, and to have a very different treatment of pass-throughs relative to C corporations is a problem. 

Mr. BOUSTANY. Thank you. 

Dr. Marron. 

Mr. MARRON. Again, I would go back and reference what the 

fiscal commission came up with, the Domenici-Rivlin Commission 

came up with. There was a reason they chose in the end to try to 

have the top rates on the individual side and the corporate side be 

the same, and one of those key reasons is to avoid all the distortions that would arise. If you have one rate that is 40 and you have 

another that is 25, you have created a gigantic incentive for creative people to think about how do I exploit this to best advantage, 

and that is thinking that would be better deployed doing something 

else in the economy. 

So if you can do fundamental reform of the entire system, that 

means touching all sorts of other tax preferences that are purely 

on the individual side and have nothing to do with business, much 

better to end up with rates being—you know, they don’t literally 

have to be identical but close to each other. 

Mr. BOUSTANY. Close. Thank you. 

One of the common refrains I hear from small business owners 

is about the issue of accelerated depreciation, and we saw this after 


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the hurricanes. It was probably the single most important thing 

Congress did to spur the Louisiana economy after hurricanes 

Katrina and Rita; and I appreciated your comments earlier, Dr. 

Carroll, about both the short-term and long-term consequences that 

are positive with this type of approach. 

And, Ms. Thompson, in your testimony you highlighted a number 

of the complexities, the varying in rules and everything else, which 

I read with great interest; and I am going to look at the report that 

you all have as well. But how could tax reform simplify some of 

these rules related to capital investment that would allow for small 

businesses to actually see capital formation? 

Ms. THOMPSON. I think the best thing you could do with the 

depreciation is have it for a longer period of time and put it in 

place prior to the time that you are thinking about it. 

For example, if you wanted it to be effective January 1, 2011, put 

it in place, if you could, in 2010 and don’t have it just for a 1-year 

period, have it for a much longer period of time. Then that gives 

the ability to the small business owner to plan their investments 

better, their purchases, and that would really add a lot to the simplification of the system because everybody does like the accelerated. It is just that it comes in too frequently at various times during the year. It is just challenging. 

Mr. BOUSTANY. Does anyone else want to comment on the 

issue of depreciation versus expensing and, you know, the concerns 

about debt financing before we conclude this? 

Mr. MARRON. If I could just second something I said before, is 

I am sympathetic to approaches that would move towards expensing if at the same time you think about walking back the deductibility of interest. Otherwise, you accidentally end up in a system 

where, if interest is deductible, you can have a situation in which 

we effectively have negative tax rates on capital investment, which 

I think is going too far. But if you, you know, keep accelerated depreciation and move towards expensing but then think about rolling back interest deductibility, you can have a system that reduces 

that debt equity distortion and provides incentives for investment. 

Chairman TIBERI. Anybody else care to answer? 

The gentleman’s time has expired. 

Mr. BOUSTANY. Thank you. 

Chairman TIBERI. Ms. Berkeley, recognized for 5 minutes. 

Ms. BERKLEY. Thank you very much, Mr. Tiberi, and thank you 

for holding this hearing. I thank all the witnesses. I have learned 

a lot this morning, and I appreciate that. 

I agree with my colleagues that reforming the tax system is critical to the long-term health of our economy. I don’t think you need 

to be a genius to figure out that the Tax Code is bloated and it is 

very complex. It adds unnecessary costs to business operations and 

distorts business investment decisions. 

That the Code is unnecessarily complex is a complaint that I 

hear often from my constituents in Las Vegas, and I worry that it 

poses an additional hurdle to my district getting back on its feet 

economically. We are in a world of hurt in Nevada, particularly in 

Las Vegas, which is the community that I represent. Half of the 

businesses—although I know everybody thinks of Las Vegas as the 

glitz and the glitter and the big hotels, and in fact that is part of 


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our persona and has served us well until the latest economic 

crash—about half of the people that are employed in the State of 

Nevada are employed by small businesses. So what we are talking 

about today is very important. I know that this is the beginning 

of a very long process. 

In the State of Nevada, pass-through entities outnumber C corporations by almost three to one. So what we are talking about 

here today is very important to the people I represent. 

There are a number of questions that I have. The first one is just 

some musings. I know that we are all talking about budget neutrality and if we could bring down the corporate rates to 27, 28 percent across the board, get rid of all the tax extenders, the tax 

breaks, the tax credits, it would add to predictability and simplicity, which everybody believes would be better for small businesses. If you know what is happening, what you can plan for 10 

years from now, 5 years from now, obviously, it impacts on your 

business decisions and gives you an opportunity to make better 

ones. 

But having been through the tax extender debate and having everybody that I knew that owned a business of some kind coming 

into my office and asking for an extension of their tax break, no 

matter what business they are in, if it is propane gas or speedways 

throughout the United States, I am wondering how willing businesses are going to be to give up these tax breaks that we have 

extended over the years? 

And I would imagine that if we lowered the tax rate—and I 

agree with you, when you look at our tax rate on paper in comparison to other industrialized countries, it seems very, very high. But 

when you factor in all the tax breaks, tax credits, tax extenders, 

I think it generally lowers our overall corporate tax rate dramatically. 

I can tell you in my congressional district, without naming 

names specifically, I have one gaming company that pays overall 

about 8 percent after they take advantage of all their tax breaks, 

and I have another that pays over 30, and they are both pretty big 

companies. Now, I wonder how the company that is now paying 

about 8 percent of their taxes is going to feel when we pass legislation that kind of stabilizes everybody at around 27, 28 percent 

while eliminating the tax breaks. Can you comment on that? 

Mr. CARROLL. Yeah. A lot of points that you have raised there 

that are all I think very important. One point is, you know, how 

do we compare to other nations? And there are different ways of 

measuring that. We do have a high statutory corporate tax rate. 

We also have a high—what economists call a marginally effective 

tax rate relative to other nations. There is a recent study that was 

released by an academic in Canada, Jack Mintz, that makes that 

point. 

We also have a very high effective tax rate and measured on a 

financial statement basis based on some work by an academic, 

Doug Shackleford down in North Carolina. 

There are a number of ways of thinking about effective tax rates 

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ferent metrics the U.S. looks like it is pretty out of step relative 

to other countries. So that is I think one point to keep in mind. 

Ms. BERKLEY. Mr. Marron, you pointed out in your testimony 

the connection between the complexity of the Code and the tendency of small businesses to underpay their taxes. Can you share 

with us some areas of the Tax Code where simplification would 

have the highest effect on boosting compliance? 

Mr. MARRON. Well, in my remarks I was very careful to use— 

what was the word I used—responsible and irresponsible just to 

distinguish small business as a whole, vast array of different kinds 

of firms, some of which face very high compliance burdens and try 

to pay the taxes they do; and then, unfortunately, there are other 

ones who are able to avoid. 

You know, unfortunately, I don’t have any good recommendations 

for you. I mean, again, some of these things have to do with, you 

know, cash transactions which are hard to monitor. It is just sort 

of a fundamental nature of some of these transactions that they are 

going to be more difficult to reach to. 

There was the effort with the 1099 which has gotten a lot of understandable pushback, and that is that the burden it placed on 

folks seems to be disproportionate to the additional revenue it is 

going to raise. 

Maybe some of my colleagues have some suggestions for you, but 

I do not, sorry. 

Chairman TIBERI. The gentlelady’s time has expired, but any of 

the other witnesses care to answer her question? 

Ms. BERKLEY. So no suggestions on how we can, in fact—what 

we can do with the Tax Code where simplification would have the 

highest effect on compliance? No help? 

Chairman TIBERI. The gentlelady’s time has expired. 

We are going to one more round, if the witnesses would care to 

indulge us, for just one question from each of the members, if they 

wish. I will start out by asking all four of you—well, two of you— 

a question; and then I will follow up with the other two. 

Earlier this week, in a publication called Tax Notes, an article, 

a gentleman by the name of Marty Sullivan, who the minority actually invited as a witness a couple of weeks ago on tax reform, argued that double-taxing on corporate income is bad economic policy; and let me quote what he wrote in the article: We should recognize that the movement from double taxation to flow-through taxation is a step in the direction of sound policy. Tax reformers and 

professors will tell anyone who will listen that all business income 

should be taxed on a flow-through basis. 

I would like to get opinions from Dr. Carroll and Dr. Marron on 

Dr. Sullivan’s point that double taxation on business income is bad 

for jobs and the economy, and good policy means moving toward 

taxing business income once. Do you agree or disagree or and why? 

Mr. CARROLL. I do agree with that. As I have already alluded 

to or stated in my comments, the double tax on corporate profits 

distorts economic decision-making in a number of very important 

ways. It leads to a higher degree of leverage in the economy, which 

is problematic; it leads to a misallocation of capital throughout the 

economy, which is problematic; and it raises the cost of capital, 

which discourages capital formation. That is also problematic. 


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Using something Donald said earlier, you know, economic fundamentals, not tax considerations, should drive decision-making, 

and the double tax I think violates that principle. 

Chairman TIBERI. Thank you. 

Dr. Marron. 

Mr. MARRON. I agree as well. There are lots of plans over time 

that said, you know, if you could go back to the beginning and redesign a tax system from scratch, how would you want to design 

it? And there are different ways of doing it, but they all have this 

feature that you eliminate the double tax. 

Chairman TIBERI. Mr. Tarnay, if you were forced to go and become a C corp, how would that impact your ability as a CFO to create jobs from your current tax system? 

Mr. TARNAY. I think it would diminish it greatly. A small business owner thinks one way: I made a dollar. I should pay tax on 

that dollar. Not a dollar and then, after I get some money from it, 

then pay tax at the individual level. This is how they think. Onetime tax on that earnings. Flow-through entities allow for that. 

Chairman TIBERI. Ms. Thompson, you had mentioned that you 

do tax returns for a variety of clients, a lot of small business owners. How would a majority of your clients be impacted if we forced 

all businesses to pay at a C corp rate? 

Ms. THOMPSON. Without knowing all of the details of the tax 

reform and if you were purely to say everything is going to stay 

in place except you are now going to be corporations and you are 

going to need to double-tax employees, they would be hurt tremendously. I have had clients who have been C corporations in the past 

who, when they went to sell their business, they end up paying 

more than 50 percent in taxes, and it was overwhelming to them. 

So it would really hurt them significantly if they had to go a C corp 

level tax and pay double. 

Chairman TIBERI. Thank you. 

I will yield time to Mr. Neal. 

Mr. NEAL. Thank you, Mr. Chairman. 

Dr. Carroll, you mentioned that ESOP entities tended to do better in the recession in terms of retirement savings, and you know 

that is something I have in interest in. 

Mr. CARROLL. Yeah. In a number of different metrics, based on 

some analysis that I have done, it looks like the ESOPs did fare 

better during the recession than—S corp ESOPs fared better during the recession. They grew at a faster rate. They added more 

jobs. Generally, they have higher average wages; and, generally, 

they have a greater retirement security. 

Mr. NEAL. Let me follow up on the point Mr. Thompson was 

making to you about anti-abuse rules. You pointed out that if the 

corporate tax was significantly lowered, that the lower rates don’t 

usually foster abuse, I think what he was trying to get at was that 

abuse might arise if the corporate rate was at 15 percent and the 

highest individual rate was at 35 percent. In this scenario, would 

you see some movement of earnings to the corporate form? 

Mr. CARROLL. Oh, there is movement between—at a high level, 

there is movement between the flow-through sector and the C corporation sector, depending on the relationship of the individual tax 

rate and the corporate tax rate. We saw that after the 1986 Act 


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with the repeal of the general utilities doctrine and as well as the 

change in the relationship of the rates, we saw a movement that, 

some research that I did a while back, ascribed to the change in 

the rates. Austan Goolsbee has done some research in the area as 

well that has found that the number of businesses or the level of 

activity within each sector is sensitive to the relative taxation. 

Mr. NEAL. Thank you, Mr. Chairman. 

Chairman TIBERI. Thank you. 

Mr. Paulsen is recognized. 

Mr. PAULSEN. Thank you, Mr. Chairman. 

And maybe I will just follow up with Mr. Tarnay. I didn’t get to 

ask you a question before, but you listed several items as a part 

of your testimony that were important for tax reform to be in consideration. And, you know, we all agree tax reform is necessary. 

You have got the corporate component, you have got the passthrough entities which we are talking about today, but can you just 

discuss in greater detail a couple of the items or maybe the top 

handful of the most important issues that should be focused on 

that would be the best—I mean, the absolute best, actually, to help 

spur economic growth and capital formation and investment, if 

there is just sort of a top wish list that should absolutely be focused on. 

Mr. TARNAY. I think the timing in the requirements of an S corporation, because it is complex because of the levels of—if you have 

certain stock structures, you can’t be an S corporation, certain 

number of shareholders, you couldn’t be—I think that could be simplified. I don’t agree with the alternative minimum tax, but I think 

that if you can’t take it away then I think it needs to be revised 

and simplified. 

Mr. PAULSEN. Okay. 

Mr. TARNAY. Those are the two. 

Mr. PAULSEN. Do you have any idea how many small business 

entities end up falling into sort of the alternative minimum tax because of their pass-through income? And maybe, Mr. Carroll, you 

may know. You kind of nodded your head. 

Mr. CARROLL. I actually don’t know the answer to that question, but it is a very interesting question. 

Mr. PAULSEN. Okay. Well, Mr. Chairman, if we can somehow 

have tax staff to look into that, too. Because I know the alternative 

minimum tax is something that keeps trapping more and more people, and a lot of these people—small businesses that pay also under 

the individual rates obviously would get trapped in that. So I yield 

back. 

Chairman TIBERI. Thank you. 

Mr. Berg is recognized. 

Mr. BERG. Thank you, Mr. Chairman. 

We have seen a lot of statistics that show our corporate rate relationship to other countries across the world. My question is, tell me 

about the pass-through entities in these other countries; and, 

again, maybe, Dr. Carroll, you could start. 

Mr. CARROLL. Yeah. A lot of other countries push businesses 

into the corporate form in pursuit of limited liability. That is one 

of the distinguishing features I think between the U.S. and other 

countries, is it is much easier to get limited liability in this country 


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because of the flow-through form and the various organizational 

forms in that sector. And so that is one of the reasons we have a 

much larger flow-through sector than most other nations. 

You know, I think that is—one could also do a comparison of the 

kind of the tax rates that the flow-through income received by individuals in the U.S. is subject to as compared to other nations. I am 

less familiar with those statistics. 

Mr. BERG. Mr. Chairman, my question, kind of here in America 

we are trying to keep those two rates pretty close. I argue that we 

should look at the net rate and not the gross rate. But my question 

related to other countries, is their pass-through rate similar to 

their corporate rate or is there a disparity in these other countries 

that we are aware of? 

Mr. CARROLL. I think there does—without having looked at the 

data in detail, my sense would be that there tends to be some disparity. The corporate tax rates tend not to be particularly high relative to individual tax rates. There are a few countries that have 

tried to apply, in a sense, separate tax systems, particularly in the 

Nordic countries where they treat partnership income, you know, 

very differently than the income of wage earners in order to coordinate the corporate sector tax and the flow-through sector tax. 

Mr. BERG. Let me, Mr. Chairman, wrap up just—my question, 

when that nets out to the individual, the stockholder, where we are 

competing with another country that has a low corporate income 

tax, are they paying a very high personal income tax so that net 

that that person is paying, you know—— 

Mr. CARROLL. Yeah. So looking at it a different way, if you look 

at kind of the net after-tax amount received for a dollar invested 

in the corporate sector abroad, you know, kind of what is the sum 

total of the double tax on corporate profits, for a dollar paid out as 

dividends, that tax bite when you look at both levels, the corporate 

and individual level, tends to be higher abroad than here. The U.S. 

tends to have a higher level of tax on a dollar invested in the corporate sector and paid out as dividends than our major trading 

partners. And if the rate were to go up, the dividends and capital 

gains rates were to go up, then that difference would become fairly 

substantial. 

Mr. BERG. Thank you. Thank you, Mr. Chairman. 

Chairman TIBERI. Thank you, Mr. Berg. 

Ms. Berkeley is recognized. 

Ms. BERKLEY. Thank you, Mr. Tiberi. 

I kind of caught something, Ms. Thompson, that you said, and 

I just wanted to make sure that I understand it completely. Secretary Geithner has suggested that some pass-through entities 

are—in fact, very large firms, not the traditional small businesses, 

at least I think of it—these large firms have revenues in the tens 

of millions of dollars. Mr. Paulsen, I think, asked you what the impact of being taxed as a C corporation would be on your clients. 

Could you share with us what percentage of your clients are of the 

size that Secretary Geithner was referring to? 

Ms. THOMPSON. That is not the level of my clients. My clients 

are very small businesses. They have probably four to six members 

and revenues are probably—— 

Ms. BERKLEY. You mean employees or members? 


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Ms. THOMPSON. No, owners of the company. So you are talking 

about either C, S, or pass-through entity owners. There is probably 

four to six of them. So they are very small from the measure of 

owners. As far as revenue, they are probably, I am going to say, 

$25 million or less. 

Ms. BERKLEY. Okay. So the comments that Secretary Geithner 

made would not—— 

Ms. THOMPSON. It is not typical of my firm. 

Ms. BERKLEY. All right. 

And, Mr. Marron, in your opinion, what percentage of passthroughs are of the very large size that Secretary Geithner was referring to? 

Mr. MARRON. It is a very small percentage of the population 

but a significant fraction of the economic activity. 

Ms. BERKLEY. Please say that again. 

Mr. MARRON. If you do it by counting the number of firms or 

the number of businesses, the number that are in that size range 

appears to be very small. But because they are large, they account 

for a fairly large fraction of the economic activity, whether it is assets or revenues or income that are accounted for by pass-throughs 

as a whole. 

Ms. BERKLEY. All right. Thank you very much. 

Chairman TIBERI. Thank you. 

Dr. Boustany is recognized. 

Mr. BOUSTANY. Thank you, Mr. Chairman. 

Dr. Marron’s testimony talked about partnership activity conducted through large partnerships and not small businesses, but 

aren’t many of these large partnerships actually joint ventures 

whose partners happen to be corporations themselves? Dr. Carroll. 

Mr. CARROLL. Yeah. There is a significant fraction of partnership income where—stated a different way, the owners of partnerships can be individuals or corporations, unlike, say, an S corporation where there is a restriction. Only individuals can own an S 

corporation. A sole proprietor, by definition, is an individual. But 

for partnerships, based on the statistics I have seen, roughly 50 

percent of partnership income results from partnerships that have 

corporate owners. So you could think of two companies that engage 

in a partnership, a joint venture to do something, build a project, 

and then they distribute the income to the two corporate owners. 

So about half of the partnership activity seems to be owned by corporations. 

Mr. BOUSTANY. So if we were to tax those entities, those large 

partnerships or joint ventures like C corps, then in effect we are 

subjecting them to triple taxation; is that correct? 

Mr. CARROLL. Yeah. If you did that, there is a long tradition 

of having flow-through treatment of partnerships for that very reason that, you know, if they are owned by the other businesses, just 

as if a C corporation owned another C corporation, then you 

wouldn’t want to kind of have multiple layers of tax in the same 

activity. There is usually a dividends-received deduction associated 

with income that flows from one part of a complex business unit 

to another. 

Mr. BOUSTANY. So, in effect, a joint venture is being taxed, the 

corporate partners are being taxed, and then the shareholders of 


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the corporate partners would be taxed. So, in effect, really triple 

taxation. 

Mr. CARROLL. Right, that was the change. 

Mr. BOUSTANY. Thank you. I yield back, Mr. Chairman. 

Chairman TIBERI. Thank you, Dr. Boustany. 

Thank you all, all the witnesses who are here today; and members are advised that members may submit written questions to 

our witnesses. Those questions and the witnesses’ answers will be 

made part of the record of today’s hearing. 

Again, thank you to the four of you for appearing today. It has 

been an educational discussion, and I hope just the beginning, and 

it is hopefully helpful in moving the conversation forward on comprehensive tax reform. 

This hearing is adjourned. 

[Whereupon, at 10:42 a.m., the subcommittee was adjourned.] 

[Submissions for the Record follow:] 


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