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SUBCOMMITTEE HEARING ON S-CORPS:

ENSURING PARITY, GROWTH AND

DEVELOPMENT FOR SMALL BUSINESSES

SUBCOMMITTEE ON FINANCE AND TAX 

COMMITTEE ON SMALL BUSINESS 

UNITED STATES HOUSE OF 

REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

JUNE 18, 2008

Serial Number 110-100

Printed for the use of the Committee on Small Business

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/house 

HOUSE COMMITTEE ON SMALL BUSINESS 

NYDIA M. VELA ́ ZQUEZ, New York, Chairwoman 

HEATH SHULER, North Carolina 

CHARLIE GONZALEZ, Texas 

RICK LARSEN, Washington 

RAUL GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

MELISSA BEAN, Illinois 

HENRY CUELLAR, Texas 

DAN LIPINSKI, Illinois 

GWEN MOORE, Wisconsin 

JASON ALTMIRE, Pennsylvania 

BRUCE BRALEY, Iowa 

YVETTE CLARKE, New York 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JOE SESTAK, Pennsylvania 

BRIAN HIGGINS, New York 

MAZIE HIRONO, Hawaii 

STEVE CHABOT, Ohio, Ranking Member 

ROSCOE BARTLETT, Maryland 

SAM GRAVES, Missouri 

TODD AKIN, Missouri 

BILL SHUSTER, Pennsylvania 

MARILYN MUSGRAVE, Colorado 

STEVE KING, Iowa 

JEFF FORTENBERRY, Nebraska 

LYNN WESTMORELAND, Georgia 

LOUIE GOHMERT, Texas 

DAVID DAVIS, Tennessee 

MARY FALLIN, Oklahoma 

VERN BUCHANAN, Florida

MICHAEL DAY, Majority Staff Director 

ADAM MINEHARDT, Deputy Staff Director 

TIM SLATTERY, Chief Counsel 

KEVIN FITZPATRICK, Minority Staff Director

Subcommittee on Finance and Tax

MELISSA BEAN, Illinois, Chairwoman 

RAUL GRIJALVA, Arizona 

MICHAEL MICHAUD, Maine 

BRAD ELLSWORTH, Indiana 

HANK JOHNSON, Georgia 

JOE SESTAK, Pennsylvania 

VERN BUCHANAN, Florida, Ranking 

BILL SHUSTER, Pennsylvania 

STEVE KING, Iowa

(II) 

C O N T E N T S 

OPENING STATEMENTS 

Page

Bean, Hon. Melissa .................................................................................................. 1

Buchanan, Hon. Vern .............................................................................................. 2

WITNESSES

PANEL I: 

Blankenship, Ms. Cynthia L., Vice Chairman and Chief Operating Officer, 

Bank of the West, Irving, TX, On behalf of the Independent Community 

Bankers of America .............................................................................................. 3

Klahsen, Mr. Rick, Managing Director/Partner, RSM McGladrey, Bloomington, MN, On behalf of the S Corporation Association ................................. 5

Kerr, Mr. Bob, Senior Director, Government Relations, National Association 

of Enrolled Agents ................................................................................................ 7

Anderson, Mr. Kevin D., Partner, National Tax Office, BDO Seidman, LLP, 

Bethesda, MD ....................................................................................................... 9

Shinn, Mr. Byron, President, Shinn & Company, P.A., Certified Public Accountants and Consultants, Bradenton, FL ....................................................... 11

APPENDIX 

Prepared Statements: 

Bean, Hon. Melissa .................................................................................................. 25

Buchanan, Hon Vern ............................................................................................... 27

Chabot, Hon. Steve .................................................................................................. 28

Blankenship, Ms. Cynthia L., Vice Chairman and Chief Operating Officer, 

Bank of the West, Irving, TX, On behalf of the Independent Community 

Bankers of America .............................................................................................. 29

Klahsen, Mr. Rick, Managing Director/Partner, RSM McGladrey, Bloomington, MN, On behalf of the S Corporation Association ................................. 40

Kerr, Mr. Bob, Senior Director, Government Relations, National Association 

of Enrolled Agents ................................................................................................ 47

Anderson, Mr. Kevin D., Partner, National Tax Office, BDO Seidman, LLP, 

Bethesda, MD ....................................................................................................... 50

Shinn, Mr. Byron, President, Shinn & Company, P.A., Certified Public Accountants and Consultants, Bradenton, FL ....................................................... 60

(III) 

(1)

SUBCOMMITTEE HEARING ON S-CORPS: 

ENSURING PARITY, GROWTH AND 

DEVELOPMENT FOR SMALL BUSINESSES 

Wednesday, June 18, 2008

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON SMALL BUSINESS, 

Washington, DC. 

The Subcommittee met, pursuant to call, at 10:02 a.m., in Room 

1539, Longworth House Office Building, Hon. Melissa Bean [chairwoman of the Subcommittee] presiding. 

Present: Representatives Bean, Ellsworth, and Buchanan. 

OPENING STATEMENT OF CHAIRWOMAN BEAN 

Chairwoman BEAN. Good morning. We are calling this hearing to 

order. Thank you all for being here today. 

Entrepreneurs face many challenges when starting their businesses. Small-business owners must secure capital, develop their 

products and services, identify markets, secure a workforce and 

keep their customers happy. One of the most important decisions 

they will make is how to structure or incorporate their company. 

In the Small Business Committee, we have explored business 

concerns about scarce capital, rising insurance and gas costs, but 

what sometimes gets overlooked is how disparities in the tax rules 

for different types of company entities can have long-term impacts 

on its business and its owners. 

Today’s hearing will examine one of the most common business 

classifications in the tax code, the S Corporation, and review suggestions for potential reforms that might better reflect the intentions of our tax code and more effectively support a growth economy. 

In 1958, Congress created a corporate structure known as the 

Subchapter S Corporation to promote the growth of small businesses. As the S Corporation has evolved, it has become a cornerstone of the small-business community. Currently there are approximately 4 million S Corporations nationwide, up from 500,000 

in 1985. These companies range from local community banks to 

home businesses to manufacturing firms. 

Despite the growth in the number of S Corps, there are concerns 

that certain requirements are either unnecessarily burdensome or 

create obstacles to expansion. Many of these provisions were written almost 60 years ago, and it is important that Congress revisit 

these measures to see that they are still best serving our Nation’s 

economic objectives. 

2

One of the challenges for S Corps, as with many small businesses, is raising capital. For instance, S Corps have limitations on 

eligible shareholders and investors, and these regulations provide 

little flexibility in obtaining equity financing. 

Small businesses also face challenges in offering health and retirement benefits. Currently, the tax code provides C Corps tax advantages unavailable to S Corps when it comes to these types of 

programs. Would providing equal tax treatment improve the ability 

of small businesses to offer health insurance coverage and reduce 

the number of Americans without health insurance, or should S 

Corps change their corporate structure if they want to provide 

those types of benefits. 

Today we will hear testimony to examine these questions and explore where changes might be advantageous. With our economy 

facing serious difficulties, it is more important than ever to ensure 

that our tax policy does not unnecessarily impede small firms’ 

growth potential. 

I would like to thank our witnesses for coming here to share your 

experience and your expertise on the issue of tax code disparities, 

and look forward to your testimony. 

I will now yield to Ranking Member Buchanan for his opening 

statement. 

OPENING STATEMENT OF MR. BUCHANAN 

Mr. BUCHANAN. I want to thank the Chair for calling this important hearing to examine the challenges and the possibilities facing 

S Corps as they strive to compete in the modern, global marketplace. 

I would also like to extend my thanks to our witnesses, who have 

taken their valuable time out of their schedule to provide the Subcommittee with the benefits of their experience and testimony 

today. 

Today we meet on the 50th anniversary—I didn’t know that, but 

that is interesting—the 50th anniversary of the passage of legislation permitting the formation of S Corporations. For the past halfcentury, S Corps have offered small-business owners around the 

Nation the ability to benefit from limited-liability corporation. 

And myself, my wife and I started our first company in 1976, and 

we had C Corps, and then a lot of things rolled into S Corps, which 

were huge because the double taxation, as you know, and the liability factor, both of those. So it was a big thing for us because it provided us capital on our company’s gross, so it was important. 

Today, however, in the last 7, 8 years, and being a new Member 

of Congress, last year and a half, we are doing a lot more with limited-liability companies. So I am interested to see if the S Corp, in 

some ways, has become a little obsolete and what we can do to fix 

it or, you know, where we are at on that. 

But, as everybody knows, times have changed, and what was 

right 50 years ago might not apply today. So that is why we have 

this hearing. Back then, it probably seemed good enough to make 

possible a business framework where a few owners would be able 

to prosper directly from investment while avoiding having their enterprise double-taxed by the Federal Government. But yet, we explore potential reforms that promote parity in growth and developVerDate 0ct 09 2002 16:24 Jul 17, 2008 Jkt 033615 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 G:\CLERK SB-LD\HEARINGS\TRANSCRIPTS\42526.TXT LEANN
3

ment for S Corporations, leading to some of the following questions 

I would like to have us talk about today a little bit. 

First is the Sub-S, should it be given additional expansion in 

terms of legal protection? 

Secondly, should the number of owners permitted an S Corp, 

which used to be 100, should that be expanded? I am not quite sure 

how they came up with 100, but I think even before maybe it was 

less than 100. But I know some people are thinking about it should 

be 200 or something. 

Thirdly, in a global economy where so much American business 

is financed by foreign investors, should S Corps have the same ability to raise the needed resources abroad as C Corporations do 

today? 

I don’t think we are talking about a matter that requires complete overhauling. It seems to me that we can achieve greater fairness, safety and opportunity by simply bringing the existing system 

into the modern age, the 21st century. 

Again, I would like to thank the chairman for holding this today, 

and I would like to thank our witnesses again for taking the time 

out of their schedule. And I look forward to your comments and testimony today. 

I yield back.

Chairwoman BEAN. Thank you. 

We are now going to move to testimony from the witnesses. 

Witnesses will have 5 minutes to deliver their prepared statements. The timer begins when the green light is illuminated. When 

1 minute of time remains, the light will turn yellow. The red light 

will come on when your time is up. 

And our first testimony is going to come from Cynthia 

Blankenship, who is vice chairman and chief operating officer of 

the Bank of the West in Irving, Texas. Bank of the West is a fullservice independent bank specializing in customer service and 

small-business financing. She is testifying today as chairman of the 

Independent Community Bankers of America. ICBA is the only national trade association that exclusively represents community 

banks. 

Thank you so much for being here. 

STATEMENT OF MS. CYNTHIA L. BLANKENSHIP, VICE CHAIRMAN AND CHIEF OPERATING OFFICER, BANK OF THE WEST, 

IRVING, TEXAS, ON BEHALF OF THE INDEPENDENT COMMUNITY BANKERS OF AMERICA 

Ms. BLANKENSHIP. Thank you. Madam Chairwoman, Ranking 

Member Buchanan and members of the Committee, Cynthia 

Blankenship, vice chairman, chief operating officer of Bank of the 

West in Irving, Texas. I am also chairman of the Independent Community Bankers of America. I am pleased to have this opportunity 

to present the views of the Nation’s community banks on S Corporation reform. 

ICBA represents 5,000 community banks throughout the country. 

Bank of the West is part of a two-bank holding company with assets of $250 million. We have eight locations in the Dallas-Fort 

Worth metroplex. 

4

Subchapter S businesses are found on Main Street, not Wall 

Street. Bank of the West itself is a Subchapter S entity. Many of 

our small-business customers are S Corps, as well. 

For decades, community banks were completely shut out of electing S Corp status. In 1996, Congress passed the Small Business 

Job Protection Act that allowed small banks to elect S Corp status 

for the first time, starting in tax year 1997. 

Unfortunately, many community banks continue to be obstructed 

from converting to S Corps and benefiting from Congress’s intended 

relief because of technical rules and community bank-specific regulations. 

Subchapter S is an important business option. There are more 

than 2,500 S Corp banks in the United States, representing onethird of the entire banking industry. My home State of Texas alone 

has 291 S Corp banks, which represents 44 percent of all the banks 

in Texas. Madam Chair, your home State of Illinois has 237 S Corp 

banks, which represents 35 percent of the banks in your State. 

We must ensure our tax code is simple and does not unnecessarily impair small-business vitality and opportunities. ICBA urges 

additional Subchapter S reforms be enacted to keep pace with the 

growing small-business sector in America. 

Currently, before making the S Corp election, community banks 

must first overcome difficult obstacles not faced by other corporate 

tax structures, such as the limited-liability corporations. The obstacles most often facing community banks include restrictions on the 

types of shareholders, the number of shareholders, the limitations 

on the options for raising capital, the complex treatment of the IRA 

shareholder, and the burden of the built-in gains tax. 

ICBA recommends several reforms that would simplify the tax 

code and provide more flexibility. We recommend the maximum 

number of S Corp shareholders to go to 150. For all small businesses, raising capital is critical to start, survival and growth of 

the business. Arbitrary and restrictive limits on the number of 

Sub-S shareholders can jeopardize the ability for S Corps to raise 

capital. 

By their nature, community banks were created by involving a 

large number of shareholders in the community. ICBA supports the 

bipartisan Community First Act introduced by Small Business 

Committee Chairwoman Velaquez that would increase the S Corp 

shareholder limit to 150 from 100. 

We recommend allowing new IRAs as eligible S Corp shareholders. S Corp community banks seeking to raise capital are excluded from allowing new IRA shareholders. ICBA supports the bipartisan S Corporation Modernization Act, introduced by Representative Kind in the House, to address the IRA shareholder 

issue. 

ICBA recommends allowing S Corp community banks to issue 

preferred stock. Current law only allows S Corps to have one class 

of stock outstanding. Community banks must maintain certain capital ratios to be considered well-capitalized for regulatory purposes. 

As a community bank grows in size, its earnings alone may not be 

sufficient to fund its growth. We recommend allowing a national 

limited-liability company bank charter. Community banks are 

5

small businesses, yet are often unable to use preferred business 

forms to other businesses such as the LLC. 

Congress should also work to preserve the 35 percent top marginal tax rate on Subchapter S income. Maintaining cash flow is 

vital to the survival of any small business, and taxes are typically 

the second-highest expense after labor cost. During this difficult 

economic period, at a minimum, the current top tax rate of 35 

should be preserved on both small-business Subchapter S and C 

Corporation income, not increased. 

ICBA is concerned with the overly aggressive of IRS regulations 

and the threat of encroaching payroll taxes. 

In conclusion, reforms to outdated and onerous Sub-S laws would 

provide a much-needed boost to many small businesses at a critical 

time. Additional simplification to the S Corporation area would go 

a long way in allowing community-based banks to convert to S 

Corp status, as Congress intended in 1996. 

Thank you for allowing me to be here today. 

[The prepared statement of Ms. Blankenship may be found in the 

Appendix on page 29.]

Chairwoman BEAN. Thank you for your testimony. 

And we are now going to move to Rick Klahsen, who is managing 

director and partner of RSM McGladrey in Bloomington, Minnesota. RSM McGladrey is a leading national business consulting, 

accounting and tax firm that focuses on mid-sized companies. He 

is here to testify on behalf of the S Corporation Association. The 

S Corporation Association is the only organization in D.C. exclusively devoted to promoting and protecting the interests of America’s 3.8 million S Corp owners. 

Thank you for being here today. And I apologize to you, and all 

of you, if I sneeze during your testimony. 

STATEMENT OF MR. RICK L. KLAHSEN, MANAGING DIRECTOR 

AND PARTNER, RSM MCGLADREY, BLOOMINGTON, MINNESOTA, ON BEHALF OF THE S CORPORATION ASSOCIATION 

Mr. KLAHSEN. Thanks. 

Chairwoman Bean, Ranking Member Buchanan and other members of the Subcommittee, thank you for the opportunity to testify 

today. 

My name is Rick Klahsen. I am a managing director in the national tax department of RSM McGladrey and the national service 

line leader for tax advisory and compliance. RSM McGladrey, when 

combined with McGladrey & Pullen, is the fifth-largest business 

consulting, accounting and tax firm that focuses on mid-sized companies. I also serve on the board of advisors for the S Corporation 

Association and submit my testimony today on their behalf. 

I want to thank you for holding this hearing, and I ask that my 

full testimony be inserted into the record. 

Before Congress created S Corporations, entrepreneurs had two 

basic choices: They could form a basic C Corporation and face two 

layers of Federal tax, or they could form a partnership and put all 

of their personal assets at risk. The creation of the S Corporation 

in 1958 gave small-business owners a better option: a single layer 

of tax with full liability protection. 

6

How significant was the creation of Subchapter S? Nearly a halfcentury later, S Corporations are the most popular corporate structure in America, with twice as many firms as C Corporations. 

This growth has created its own challenges. The number of S 

Corporation returns has increased from less than 500,000 in 1978 

to more than 4 million today. At the same time, the number of regular C Corporations peaked in 1986 at 2.6 million and has declined 

steadily since then. 

The growth of pass-through businesses, coupled with the decline 

of C Corps, has shifted an increasing amount of business income 

from the corporate tax code to the individual tax code. This means 

that tax policy for businesses is increasingly affected by changes to 

the individual tax code. We believe policymakers in Washington 

need to be acutely aware of the dynamic between the individual tax 

rates and business income as they consider broad-based tax reform. 

The growth of limited-liability companies and the need to update 

rules dating back five decades combine to make S Corporation reform an important part of any tax code reform. Over the years, the 

S Corporation Association has worked with policymakers and Congress, as well as allied trade associations, to develop a list of critical reforms Congress should consider. 

These legislative priorities are included in House Bill 4840, the 

S Corporation Modernization Act, and its companion bill, Senate’s 

3063. Introduced by Ways and Means Committee Congressmen 

Ron Kind and Jim Ramstad, the bill is designed to simplify rules 

under which S Corporations operate, and it is endorsed by an impressive group of business associations. 

Another bill is House Bill 3874, the Small Business Growth and 

Opportunity Act, introduced by Congressman Steve Kagen. The 

proposal would decrease the holding period of assets subject to the 

built-in gains tax from 10 years to 7 years. This latter provision is 

particularly important as Congress examines what provisions 

might be included in a possible stimulus package. 

The built-in gains tax applies to any appreciated asset held by 

a corporation converting to S Corporation. Under built-in gains, 

these firms are required to hold these assets for at least 10 years 

or be subject to a punitive level of tax. 

Hundreds of thousands of S Corporations nationwide are likely 

sitting on locked-up capital, as they cannot access or redeploy these 

assets due to prohibitive tax implications of built-in gains. In an 

economy where a 1 or 2 percent change in growth can mean the 

difference between a recession and moderate growth, eliminating 

that lock-in effect and allowing those assets to become fully productive could be significant. 

Another challenge to the S Corporation community is a proposed 

reduction in the tax rate to C Corporations. The approach outlined 

in Treasury and in Congress would reduce the marginal tax rates 

on corporations while broadening the tax base. 

The challenge is that many of the businesses that use Section 

199, LIFO accounting, IC-DISC and other tax benefits eliminated 

as part of the base broadening are not C Corporations. In other 

words, the effort to cut the marginal tax on C Corporations would 

also significantly raise taxes on S Corporations and partnerships. 

7

The S Corporation Association has met with the tax staffs at 

Treasury and Ways and Means Committee to discuss this adverse 

outcome for pass-through businesses. 

A final important issue to the S Corporation community is how 

to appropriately tax income earned by S Corporation shareholders 

who actively work at their business. The S Corporation Association 

appreciates the concern that certain taxpayers are paying less than 

their fair share of payroll taxes. However, the IRS already has the 

tools necessary to identify these taxpayers and to force them to pay 

the correct level of tax. 

While applying these rules may be time-intensive and costly, alternative proposals risk raising payroll taxes on family-owned businesses already fully compliant with the law. Getting the solution 

right to this challenge is important, and the S Corporation Association looks forward to working with the Ways and Means Committee and the Small Business Committee to ensure whatever reform is enacted does not adversely impact law-abiding business 

owners. 

Chairwoman Bean, the S Corporation Association and I greatly 

appreciate the opportunity to testify today and to highlight various 

issues of concern to the S Corporation community. I thank you for 

the opportunity, and I am happy to answer any questions you 

might have. 

[The prepared statement of Mr. Klahsen may be found in the Appendix on page 40.]

Chairwoman BEAN. Thank you for your testimony. You have 

raised some of the things I know we want to ask more questions 

about. 

And now we would like to introduce Mr. Kerr, who is senior director of Government relations at the National Association of Enrolled Agents. He represents the interests of enrolled agents who 

are tax practitioners licensed by the IRS and serves as their liaison 

to the IRS. The National Association of Enrolled Agents is the professional society that represents 40,000 enrolled agents nationwide. 

Thank you for being here. 

STATEMENT OF MR. ROBERT KERR, SENIOR DIRECTOR OF 

GOVERNMENT RELATIONS, NATIONAL ASSOCIATION OF ENROLLED AGENTS 

Mr. KERR. Thank you, Madam Chair, Mr. Buchanan, members of 

the Subcommittee, for the opportunity to testify before you today. 

My name is Bob Kerr, and I am the head of government relations 

at NAEA. 

Enrolled agents are the only tax practitioners for whom IRS directly attests to their competence and ethical behavior. NAEA represents the interests of some 46,000 enrolled agents across the 

country. Our members usually work with those on the smaller end 

of the small-business scale and more typically see gross incomes in 

the tens of thousands, rather than the tens of millions. 

I will discuss two issues today, reasonable compensation and 

record-keeping, and provide several approaches that would help S 

Corps and, to some extent, all small businesses operate more easily. 

8

One of the advantages of an S Corp is that shareholder employees can receive both wages and profit distributions, both of which 

are subject to the shareholder’s personal income tax rate, but only 

the wages are subject to payroll taxes. Not surprisingly, the tax advantage for distributions over wages leads to challenges for the corporation, namely in determining what constitutes the reasonable 

compensation required by IRS. 

In the absence of clear guidance, people disagree on what constitutes ′′reasonable,′′ and many EAs find themselves enmeshed in 

or refereeing, shall we call, spirited conversations with their S Corp 

clients as a result. Meanwhile, other small S Corps are completely 

unaware of the reasonable compensation requirements, which can 

lead to very unpleasant surprises during an audit. 

With respect to reasonable comp, EAs and others are in a quandary when asked what is reasonable or when suggesting to a client 

that his comp is in fact not reasonable. I know there are those who 

believe that treating S Corp and partnership income similarly 

would solve that problem. I am not at all certain that we would 

buy into that solution, however. 

At the same time, in the absence of a significant fix right now, 

we suggest that practitioners and S Corps could be helped by practical IRS guidance in determining what is reasonable compensation. This could take many forms, so we suggest an audit technique 

guide may be appropriate. 

As to my second point, I can’t imagine I am the first person to 

come before this Committee stating that record-keeping is the bane 

of a small-business man’s or small-business woman’s existence. 

Record-keeping is burdensome, and the code requires small businesses to keep a myriad of records. For instance, Section 274(d) requires stringent documentation for deductions both for cell phone 

use and for business use of an automobile. Section 280(a) requires 

in-home offices to be used for business activities solely and for deductions to be made as a proportion of the entire home. Further, 

there is no de minimis amount for expensing rather than depreciating business assets. 

At the end of the day, small-business owners are not tax experts, 

though the complexity of our tax code really does dictate that small 

businesses retain tax experts to advise them of their obligations 

and to help them take advantage of tax code provisions such as 

Section 179 expensing or the business provisions of the recently 

passed stimulus bill. 

NAEA has advocated for years for simplification wherever possible in the tax code. To that end, we applaud and encourage the 

conversations recently under way with respect to a safe harbor for 

in-home offices, and particularly note Chairwoman Velaquez’s bill, 

H.R. 46. Further, Chairman Rangel in H.R. 5719 recently proposed 

removing cell phones from the Section 274(d) listed property, which 

is a move that would dramatically lower record-keeping requirements. We enthusiastically support such provisions. 

Now, if I may be so bold, S Corps and small businesses would 

be greatly assisted if Congress measured complexity and gave it 

weight when considering various tax law changes. Further, both 

the IRS and tax professionals are well-placed to provide the information to S Corps and to small businesses as they organize. EAs 

9

far too often find these businesses in tax trouble not because of 

malice aforethought, but because of sheer ignorance or because of 

bad advice from unqualified preparers. 

Congress could act to improve competence in the tax preparation 

industry by enacting H.R. 5716, the Taxpayer Bill of Rights, introduced by Representative Becerra. We believe that greater competency leads to better advice and better compliance. 

For its part, in recent years, IRS has made decided efforts to 

educate small businesses, and should be supported and encouraged 

as it moves forward and as it continues to balance its compliance 

obligations with its assistance obligations. 

This concludes my testimony. I will be happy to answer questions. 

[The prepared statement of Mr. Kerr may be found in the Appendix on page 47.]

Chairwoman BEAN. Thank you for your testimony. You are certainly not the first one to bring up record-keeping as burdensome. 

Mr. KERR. Didn’t think I would be. 

Chairwoman BEAN. We would now like to hear from Kevin Anderson, who is partner of the National Tax Office of BDO Seidman, 

LLP, in Bethesda, Maryland. His practice is focused in the areas 

of mergers and acquisitions, corporate structure and related tax accounting issues. BDO Seidman, LLP, is a national professional 

services firm providing assurance, tax, financial advisory and consulting services to his client companies. 

Thank you for being here. 

STATEMENT OF MR. KEVIN D. ANDERSON, PARTNER, NATIONAL TAX OFFICE, BDO NEIDMAN, LLP, BETHESDA, MARYLAND 

Mr. ANDERSON. Thank you. Good morning, Madam Chair, Ranking Member Buchanan, members of the Committee. I am Kevin Anderson, and I am pleased to have this opportunity to present my 

own views on S Corporation reform and expansion. 

I do wish to emphasize that I am here to offer my own personal 

views based upon my own experience, and I am not here to advance the interests of any particular client or those of my firm. 

While it may come as a surprise to my other panelists, I am really not here to advance or oppose any particular provision but, really, to provide a little bit of guidance as to how I think Congress 

may wish to consider some of the proposals that are before them. 

I have an abiding interest in tax policy and have been a member 

of the Treasury Department Office of Tax Policy back in the 1990s. 

The S Corporation has always had some features common to both 

corporations and partnerships, as you can tell from the other testimony that we have heard this morning. The flow-through regime, 

of course, is borrowed from the partnership area, whereas many of 

the other provisions are borrowed from the C Corporation area, and 

many of the rules that apply to C Corporations also apply to S Corporations. 

And so, because an S Corporation has features that are common 

to both of the worlds, the partnership world and the C Corporation 

world, it is hard to know which of the provisions we would like to 

10

borrow from. Is it going to be a best-of-both-worlds scenario for S 

Corporations? 

With respect to the issue of parity, for example, one of the objectives of this hearing, I would simply ask, what it is do we want 

parity with? Is it parity with business income? Is it parity with 

partnerships? Is it a parity with C Corporations? Is it, as I mentioned before, sort of a best of both worlds? 

We have talked a little about tax rates. Other panelists have 

talked about the prospects for changes in the corporate or individual tax rates. And I think there is going to be some stress upon 

the S Corporation model if C Corporation rates go down or if individual rates go up after 2010, as they are scheduled to do, for example. So I think that those are one of the policy considerations 

that we will have to consider. 

Clearly, any provision which makes the S Corporation form more 

readily available is going to have revenue implications. And in this 

day and age, sometimes we try to pay for things with offsets; sometimes we don’t. But every provision in the last 10 years that has 

expanded the scope of the S Corporation model has been scored by 

JCT as a revenue loser. So that is also something that needs to be 

taken into account. 

We have talked a little bit about simplicity. Simplicity is evidenced by the single class of stock requirement for S Corporations. 

And many of the provisions, quite frankly, that we are talking 

about here may actually make S Corporations more complex to 

comply with. And so one must not lose sight of simplicity. 

Also would not like to lose sight of the small nature of S Corporations. They are, after all, in the code referred to as small-business 

corporations. But I think the documents that have been circulated 

for this hearing have made it clear, correctly, that the only way 

that S Corporations are kept small is through shareholder limitations and not by restrictions on their revenues or assets or their 

employees or the size of the business per se. So, at some point, we 

may have to consider thinking these are no longer small-business 

corporations, although many of them will continue to be. 

We need to make sure that S Corporation income is taxed currently, as most of the provisions in the code already do, even for 

tax-exempt organizations. But the only exception that is contained 

in the existing rules are for stock owned by an employee stock ownership plan, or an ESOP. 

Finally, we have talked a little bit about the built-in gains tax, 

which is a measure that addresses the so-called General Utilities 

repeal back from 1986. I think the big elephant in the room is that 

we do not tax conversions per se of C Corporations to S Corporations, whereas we would impose full measure of taxation on a conversion from C Corporation status to partnership status. And it is 

for that reason that we have a built-in gains tax. Quite frankly, 10 

years was arbitrary. Seven years is just as arbitrary. The only 

thing that it has to advance it is that it is shorter than 10 years. 

I will skip discussions about the specific proposals, although I 

would be happy to address them in questions and answers. I do appreciate the opportunity to provide my views. I think it is an important matter for the Committee, the Subcommittee to address. 

And I will be happy to address questions at a later time. 

11

Thank you. 

[The prepared statement of Mr. Anderson may be found in the 

Appendix on page 50.]

Chairwoman BEAN. Thank you very much for your testimony. 

And now Congressman Buchanan is going to introduce our last 

witness, Byron Shinn.

Mr. BUCHANAN. Thank you, Madam Chair. 

I am excited today we have someone from our congressional area. 

He has been a very highly regarded professional and business leader in Florida. He has worked as a public accountant for 30 years. 

He has his own firm, and his firm is a Sub S, so he knows a lot 

about Sub S’s. 

He is president of the CPA firm Shinn & Company located in 

Bradenton, Florida. He has been the past chairman and board 

member of the Florida State Board of Accountancy and also the 

past chairman of the Manatee Chamber of Commerce in our area, 

which is a good-sized county. 

I welcome your testimony today. It is great to see you. 

STATEMENT OF MR. BYRON SHINN, PRESIDENT, SHINN & 

COMPANY, P.A., CERTIFIED PUBLIC ACCOUNTANTS AND 

CONSULTANTS, BRADENTON, FLORIDA 

Mr. SHINN. Thank you. Good morning, Madam Chairman, Ranking Member Buchanan and members of the Committee. My name 

is Byron Shinn. I am a CPA in Florida. I graduated from the University of South Florida in 1979, and I have worked in public accounting since my graduation. 

I am currently a shareholder of a small-business S Corp, as Congressman Buchanan mentioned. I currently serve on the Probable 

Cause Panel of the State Board of Accountancy, where we have reviewed complaints against licensees. I am also on the advisory 

board of the University of South Florida’s School of Accounting, 

and I have previously served on the National Ethics Committee for 

the National State Boards of Accountancy. 

I wanted to talk to you as someone who is on the ground, in the 

trenches, dealing with small business. As a CPA that is face to face 

with those owners, over these last 30 years as we deal with what 

entity to be, once they have elected Sub-S, we have a distancing, 

if you will, between a C Corp and an S, and then you have partnerships. 

And several years ago, Wyoming started the LLCs. LLCs then 

were supported by the IRS in the late 1980s to be acted on and 

treated like a partnership. So for those older entities that are still 

S Corps that would like to go to an LLC, we have a tax trap. We 

have cured tax traps in most places to help the businessperson run 

their business. We have a situation where we are moved from a C 

to an S by an election. We have a built-in gains tax that prevents 

abuses. We have opportunities for owners to move from a sole proprietorship to a partnership. And there is the disguised sale rules 

that have a 7-year period. So the opportunity to move built-in gains 

to 7 years is a convergence of similarities, similar to what we have 

done with fringe benefits. 

12

I would like to point out that maybe, as we sit here and tinker 

with a lot of tax law and it becomes harder and harder, maybe we 

ought to just keep it simple. Why don’t we provide an opportunity 

for them to make an election to move from an S, which they did 

back in the 1970s or 1980s or 1960s—it goes back to 1958—and 

allow a bridge for them to move to an LLC and operate as a partnership? Why wouldn’t they want to do that? It is better raising 

of equity. You have disproportionate distributions. Or you can have 

a broader source of ownership. You can have partnerships. You can 

have IRAs. You can have other Sub-S’s as owners of an LLC. But 

a partnership can’t own a sub-S. So therein lies the trap. 

Now, how do you avoid the abuses? Put in something similar to 

a built-in gain, the disguised sale rules. Just basically say, move 

the assets from a Sub-S to an LLC. And if you do it and you do 

it in whole, as long as it stays in that sphere of business assets in 

that entity, if you want to take it out, you want to distribute it out, 

you want to reshape the business, yeah, you ought to tax the heck 

out of them, just like you would in a normal situation. But if you 

are keeping the business in a hole, trying to make a go of it and 

raise capital—the other thing that is a real problem with S Corps 

is the opportunity—every small business goes through its ups and 

its downs. 

You heard from the bigger S’s, the banks. Well, they are having 

losses right now. The limitation on shareholders taking losses is 

limited to the basis in their stock. I know that is a tax terminology. 

But in a partnership or an LLC world, you can share in the debt 

generally as part of their basis to take losses. In a Sub-S, the 

shareholder is guaranteeing those debts. Those guarantees don’t 

count as basis. That corporate debt doesn’t count as basis. Why is 

that? It doesn’t make sense. When I explain this to the owners of 

those companies that are S Corps, they scratch their head, and 

they say, it doesn’t make sense. 

Again, raising equity is very, very important. Whether we like it 

or not, there are pockets of prosperity right now, but we are in a 

recession. I am from Florida. It is real severe. In places it is worse 

than others. I am on the west coast of Florida. We are very realestate-oriented. And unfortunately it has taken its toll. 

As people look to try to get equities into their businesses, if you 

are an S Corp, it is really, really difficult because those investors 

want a preferred rate of return. They might want convertible debt. 

Those two items are not allowed in an S. They could trigger a termination. 

One thing that was mentioned earlier was the abusiveness of 

payroll taxes in an S Corp. And as I have seen taxpayers come to 

me asking for my help, I have seen situations that are abusive. 

And I don’t want to beat up on the small business. It is so hard 

to make a buck and do your part and make your payroll, pay the 

rent. A lot of my S Corps aren’t the really large businesses that you 

referred to. I am in the ditches with the smaller businesses. I don’t 

have any public companies as clients. I don’t want them. I want to 

have the big four and the BDO Seidmans do those. But they are 

doing smaller businesses too. 

Another thing I want you to think about is the passive loss rules. 

Right now in an S Corp, you maintain their identity. If you own 

13

your business and you have a building you are in, and you are 

renting out part of that building to a third party, your operating 

profits or losses are maintained separately. Those losses are currently limited. As real estate takes its hit and our banks go 

through their struggles, it is real important, I think, to allow for 

at least some tax savings to these small businesses. Because of the 

losses that are incurred, ought to be getting current tax benefits. 

It might take some of the pressure off the foreclosures we are seeing. 

And lastly I listed in some of my written testimony some items 

of accounting method changes, some of which are currently in bills 

and had been discussed. The bonus to appreciation I fully support. 

The increase in the 179 expense, absolutely. And please just don’t 

do it for 1 year. Make it stick; let it last for a while. The smallbusiness person keeping up, they have to pay for the accountants. 

And it is part of their—how many times have I been told I am just 

administrative overhead. 

Also, the write-off of bad debts. Banks are allowed to do reserves. 

Small businesses, we have to only write off the receivables when 

they go bad. But there is a history of percentages. We ought to 

think about it. 

And lastly, the restauranteurs. The ones that get hit really 

tough, the FICA tip credit. We have a wonderful area for opportunity, but it is so narrow. If the restaurant is losing money, they 

don’t get any benefit from it. If they are making too much, they 

can’t get to it. The window to use the FICA tax credit is so small 

that it is almost useless. It is really sad. 

So, lastly, I wanted to mention finances, since you are Finance 

and Tax. And I can get going on taxes, but as far as finances, the 

banking industry, because of the easy credit that was through the 

last few years and how we have gotten ourselves into this situation, the regulators have now come back and been very, very tough. 

And all these small businesses—remember, most of these small 

businesses had to personally guarantee these loans. They also probably had to put up their houses as collateral. Well, as these 

houses—excuse me.

Chairwoman BEAN. You are starting to run out of time.

Mr. SHINN. Sorry. 

So this equity is now gone. And they are really in a bad situation 

from a banking perspective. 

So thank you for this time. 

[The prepared statement of Mr. Shinn may be found in the Appendix on page 60.]

Chairwoman BEAN. Thank you for your testimony. 

I guess, Mr. Anderson, you reminded us of some of the potential 

perils of rushing toward change too quickly. The rest of our witnesses were mostly advocating for specific changes. And I guess 

what I would like to do is challenge those of you who are recommending changes, is there a change that you would recommend 

against, that you can understand the rationale for some of the existing structure. If you have one, I would like you to share that. 

14

And conversely, Mr. Anderson, any that you do think is antiquated by today’s standards and current situations that you would 

say is something that you think is worthy of consideration for 

change. I will go to you first. 

Mr. ANDERSON. I would be happy to go first and point to the 

written testimony that I had prepared and indicate that the passive income threshold is probably something that does merit an increase. 

And, in my testimony, I indicated that I thought if there was a 

reason for the tax in the first place, is that it has analogies to the 

personal holding company tax for C Corporations. And although, as 

I mentioned, the thresholds are different, the terminology is different, the PHC tax kicks in at a 60 percent threshold. And I believe that is really why folks are advocating an increase from 25 

to 60 percent. 

That is probably at the top of my list. 

Chairwoman BEAN. Okay. Thank you. 

Does anyone else have any that they would want to preserve that 

are important differentials between the different types of entities? 

Mr. Kerr? 

Mr. KERR. Absolutely. I mentioned in my testimony that some 

folks are interested in getting a real parity between partnerships 

and S Corps. Now, there are benefits to an S Corp; there are benefits to partnerships. And I think there is an attraction to the simplicity of the solution that we will just make them equal. But I 

would caution rushing in that direction without thinking real hard 

about why we have these two structures in the first place. And if 

we are going to move in that direction, then perhaps a semi-crazy 

notion is, well, let’s just have one instead of two. 

Chairwoman BEAN. Thank you. 

Ms. Blankenship? 

Ms. BLANKENSHIP. Well, I would like to recommend that 35 percent marginal tax rate be kept in place, because if you go back to 

lowering the tax rate on the C Corporations, then it really penalizes the S Corporations. And the S Corporations, by virtue of their 

entity structure, allow those small businesses to build greater equity and retain greater equity because of the tax structure. 

And if you go back to decreasing the C Corp top level tax rate, 

then it would encourage, you know, maybe a flip-flop. And that is 

the last thing that you would want the small-business community 

to have to deal with, is going back and making those conversions 

back and forth. 

So we need to continue to encourage that top marginal tax rate 

on the Subchapter S income and it not be increased, so we can continue to build our equity. 

Chairwoman BEAN. Thank you. 

Mr. Shinn? 

Mr. SHINN. That is why I made the comment, if you can’t—in 

trying to converge and bring together, like we have done with 

fringe benefits, it is going to be very, very difficult. But at the advent of the LLC, you have the corporate protection but you have 

the partnership flexibility from running the business and growing 

equity. And that is why I threw out the idea of trying to build some 

kind of a bridge where the S owner could think about—in certain 

15

situations, be allowed to go to an LLC form. Still a corporation for 

State charter purposes, but then give them the flexibility to operate 

its business. 

And as long as they do it where they are moving the whole business, defer the tax, similar to the built-in gains, similar to the disguised sale. So you can still avoid the abusiveness but still get to 

the business focus. 

And I challenge you to try to come up with something that would 

work, because that will open up a lot of opportunities for the smallbusiness person that is running their business. 

Chairwoman BEAN. All right. Thank you. 

Mr. Klahsen? 

Mr. KLAHSEN. In some respects my comments will echo those of 

Ms. Blankenship, in terms of the change that I would propose not 

be implemented is the change of the corporate rate to a lower rate 

than it currently is. I think the parity of the rates, the highest individual tax rates and the corporate rate, cause people to do things, 

you know, for more appropriate reasons. They aren’t influenced 

solely by tax reasons. 

And if you look at the proposed drop in the corporate tax rates 

and the offsets to pay for that, it has the potential impact of—if 

the individual rates increased to, say, 39.6 percent, you lose some 

of the benefits: the domestic manufacturers deduction, LIFO accounting, IC-DISC. The combination of those would result in a significantly higher rate of tax for S Corporations and other passthroughs as compared to C Corporations. And we would, as a result, influence people’s behavior, I believe, in inappropriate means. 

Chairwoman BEAN. All right. Thank you. 

Mr. Buchanan? 

Mr. BUCHANAN. I am just going to open it up with the same 

thing. One of the things I think that with pass-through incomes on 

S Corps and LLCs, that we have to have a better understanding 

up here. I happened to be chairman of the Florida Chamber. We 

represented 137,000 businesses. Most of those businesses, 95 percent, were 50 employees or less. So you have a lot of LLCs, you 

have a lot of Sub S corporations. 

But one of the things I try to get people to understand—some do 

understand—if we raise taxes in general, up from 35 percent, that 

a lot of people that are in these small businesses that are personal 

tax rates up to 40 or 45 or 43 percent, a lot of this money, you 

know, ends up affecting all the small businesses. In turn, they can’t 

buy the equipment and capital. 

Most people I know—and I have seen zillions of them, as you have—have made $400,000, let’s say, at the bottom line. But when 

you really look at it, by the time they spend some money on capital 

and some other things, maybe some debt, the capital are retiring, 

debt in their business and other things, they really end up maybe 

with $100,000. They have added, you know, a couple other employees, that type of thing. 

So I would like to first just have you comment on the impact it 

would have on small business, of any kind of a tax increase on personal income, you know, your thoughts on that. If we went from 

35 to 39 or 45 to 44, what does that do to your businesses, your 

clients, small business in general? 

16

And you start off wherever you would like to start there. Mr. 

Kerr? 

Mr. KERR. I was really rather hoping not to go first on this one. 

Mr. BUCHANAN. Yeah. 

Mr. KERR. In the main, of course, it is difficult to sit here and 

ever advocate for higher taxes in any sense. So I don’t think that 

I am going to start doing so. 

I certainly see the concerns and the interest in keeping the marginal rates the same, the 35 percent. It could be an environment 

to consider, well, is there a way to broaden the base and lower the 

rates on both sides? Now, obviously, that is an issue that is decided 

elsewhere, but I just want to throw that out for consideration. Otherwise, I don’t really have anything to add to that. 

Mr. BUCHANAN. Okay. 

Anybody else want to add a comment on that? 

Mr. KLAHSEN. Mr. Kerr referred to the broadening of the base 

and potentially lowering the rates. I think we need to be careful 

of the end result of that. And I believe that is perhaps where you 

were going, Mr. Buchanan. 

There is a great appeal to the sound of reducing a tax rate from 

35 to 30 percent. But if the result of that is that a great number 

of things are taken out of the tax code in terms of deductions or 

potential benefits and ultimately the tax burden increases, that is 

the burden that the small-business owners feel. They don’t attach 

so much to what is the rate; it is, what am I paying. 

Mr. BUCHANAN. I guess what I was trying to get at, I have just seen over the years, someone makes $500,000 and they always say, 

well where is my liquidity? Where is my cash? Well, they have paid 

out a third in taxes. They have made some additional investments 

in equipment that they write off over 5 years, that is gone. They 

have added some additional inventory. Before you know it, they 

have made $500,000 in a sense on their tax return, but they have 

$50,000 in the bank. That is what happens, I have seen over the 

years. 

Mr. Shinn, do you want to comment any more on that? 

Mr. SHINN. Yes. I think where you are headed with the bonus depreciation and the increase in the 179 deduction is a great start. 

But some of the opportunities for more installment sales on sale inventory, things like that, would allow them that opportunity where 

the cash flow and the payment of the taxes are more in sync. 

Mr. BUCHANAN. Okay. 

I want to shift over to the other thing on the S Corp and the 

LLC. It just seems like there is—I know there are benefits on both 

sides, and I haven’t paid as much attention on the S Corp, because 

it seems like everything I have done in the last 8, 10 years, we 

have been pushed—everything has been LLC, because of I think 

the flexibility. 

But what is the biggest difference? Is the S Corp, is there any 

sense that that could be obsoleted? Or is it because of the shareholder’s ability to raise capital? You know, it just seems like the 

LLC, everybody I am talking to—now, maybe it is because there 

are only two, three owners—everybody is moving to LLC. That is 

just what my tax attorneys and tax people have been pushing me 

to, and I hear a lot of my friends are moving to that. They own 

17

businesses. I would be interested to see what the S Corp was 10 

years ago, the numbers, and then what it is today. And maybe it 

is because of business, in general, it is up. 

But, Byron, what is your feeling? What is the big difference? 

What do you find with small business from the S Corp and the 

LLC? Because everybody used to do the S Corp; now everybody, it 

looks like, is in the LLC. 

Mr. SHINN. Once the States have had some litigation and people 

see how the safety of that corporate insulation, they have gotten 

comfortable with it. And you see more and more people going with 

they are operating companies that way. If they are in LLLPs or 

LPs, they still might do a LLC that is going to be the general partner and they will elect S as the general partner. So there are still 

opportunities for S as a managing partner of a large, limited-liability partnership or an LLC that is, for tax purposes, being treated 

as a partnership so the managing member might end up being an 

S Corp. 

The other thing that really stands out with that, small businesses usually lose money when they first start out, and losing 

money cash-flow-wise. That is the investment you talk about of the 

assets and the loans and the inability to deduct those losses. And 

the IRS has time and again held true to S Corps. They don’t want 

to allow guaranteed debt as basis. They don’t want to have co-makers. So if Byron signs a loan, Byron Shinn and Shinn & Company, 

it is not allowed. They want me to borrow the money individually 

and then put it into the business. It has to be that refined. 

And there has been so much case law on this. It is abusive from 

a standpoint of really hamstringing those S Corporate owners. So 

why do they go to the LLCs? Just because of that. 

Mr. BUCHANAN. Mr. Anderson, any comment? Just in term of 

your thought on S Corps and LLCs, I am sure they have a different 

role, but is the shift in general for small businesses and entities 

with three, four, five, 10 shareholders, are they doing more of an 

LLC? Or does it just depend? 

Mr. ANDERSON. Well, I think the advice that we give to our clients really depends upon whether we are talking about an existing 

entity or a newly formed entity. 

From my perspective, although I love S Corporations, I am the 

first to acknowledge that an LLC taxed as a partnership is probably the most flexible vehicle for a newly formed entity. 

But when you are converting an existing C Corporation, I think 

the S Corporation is the only game in town, quite frankly, for the 

reasons that I mentioned this in my testimony. And that is that 

when you convert a C Corporation to an S Corporation, there are 

no immediate—and I emphasize immediate—tax consequences. But 

if you were to convert an existing C Corporation to an LLC taxed 

as a partnership, the consequences could be disastrous. 

And so we preserve the C Corporation attributes by converting 

to S Corporation status. 

Mr. BUCHANAN. Is that something that should be looked at? I 

mean, should a C Corp have the same opportunities as an LLC? 

I mean, in terms of that conversion? I mean, you can move to an 

S Corp but you can’t move to an LLC. Is that something that 

makes any sense? 

18

Mr. ANDERSON. Well, I think that there had been proposals floated over the past several years that would go either way. For example, some proposals would say if you are going to make an S Corporation conversion, a C to S conversion, and you are of a particular size, we will tax that as a fully taxable liquidation. Great 

for simplicity but terrible for the business itself, if you happen to 

be the one converting. 

On the other hand, there have been proposals that would cause 

a C to S conversion to be treated as a nonrecognition event. There 

are partnership provisions that would be built into those provisions 

that would preserve the gains at the entity level so that they are 

ultimately taxed somewhere. 

But I have to submit that those are very, very complex. There 

is nothing really more complex than the partnership gain and loss 

allocation provisions. And, again, do we want complexity? Do we 

want it to be simple? We are really caught here, because we have 

lots of history and just, quite frankly, no way to go. It would be 

tremendously complex, I think, to allow conversions from C to S 

status and give them the equivalent of partnership status. 

Mr. BUCHANAN. Mr. Klahsen, let me just ask you your thought. 

You are the S Corporation Association. What is happening with the 

trend lines? Because I still have probably some of the old S Corps, 

but are people, new entities, are they moving more to the LLC? 

Mr. KLAHSEN. Actually, the numbers are quite interesting. The 

number of S Corporations continue to increase, as Mr. Anderson 

points out. A number of those are conversions of C Corporations. 

But, as I recall the most recent numbers, the annual increase in 

S Corporations are about evenly split between newly created S Corporations and those that have converted from C Corporation status. 

And the reasons are varied. I think Mr. Anderson touched on a 

number of them why certainly that conversion, that is the way to 

go if you are currently a C Corporation. There are other instances 

where S Corporations provide a simplicity and a clarity. And I 

know that is a little bit contrary to what we have been talking 

about today. But if your alternative is partnership, things can become very, very complex very, very quickly. And so for some entities, the creation of an S Corporation, as opposed to an LLC or specifically a partnership, is still an appealing way to go. 

Mr. KLAHSEN. Mr. Kerr, I want to just touch real quick on the 

bookkeeping, the IRS. How does the IRS treat, you know, a SubS over another entity, in terms of auditing? Is there a difference 

from your standpoint? Just out of curiosity. 

Mr. ANDERSON. I don’t think our members see a difference when 

IRS selects an entity for audit, whether it be a partnership or 

whether it be an S Corp. As an aside, I think it is interesting--

Mr. BUCHANAN. I am thinking, like, a sole proprietor or just a 

small partnership or an S Corp. Do they treat an S Corp differently? 

Mr. ANDERSON. Oh, okay. I was looking at the selection criteria. 

Mr. BUCHANAN. I am not looking so much at the C Corp, comparing that. I am just curious, an S Corp, how that compares to 

a—

Mr. ANDERSON. I don’t think so. Because, at the end of the day, 

many of the tax code provisions apply regardless of the entity that 

19

you have chosen. And IRS tends to be interested in those provisions, and they apply without respect to the structure of your company. 

As an aside, the other interesting thing is that IRS is in the process of what they call an NRP, a national research project, in which 

they are focussing on S Corps. And they have selected 2 years of 

returns, I think, with 2002-2003. And I would expect that those results are coming out imminently. And I think that it may be interesting for those of us in this room to pay attention to what IRS has 

found in its rather detailed audits of about 5,000 S Corps. 

Mr. BUCHANAN. Let me, just in my last question in general, is 

just the attraction, will a lot of companies, S Corps, be able to attract capital. You know, this is something we set up 50 years ago 

now today. There is probably opportunities, a lot of opportunities 

for foreign companies or foreign investors into S Corps, which I 

think is not allowed, I guess, from my understanding. 

You know, what is your thought on that? Is that something that 

you think we have to consider and give them more capability, like 

a C Corp, to look at foreign investors and S Corps, in terms of them 

having access to capital? 

Do you want to comment, Mr. Klahsen? 

Mr. KLAHSEN. I would. I certainly would encourage consideration 

of measures that would increase the access to capital for S Corporations. And it can be done through a variety of ways. Increasing 

the number of share holders is certainly a possibility. Implementing procedures or changes to allow certain types of other equity investments, so-called quality. A qualified preferred stock 

would be another option. 

Certainly, you know, going back to some earlier comments, some 

built-in gains and the implications of that, when those assets are 

subject to tax for 10 years, it causes the S Corp owners to hold 

those assets for an extended period of time and causes even greater 

complications in terms of their access to capital. In many respects, 

S Corporations are left with very vanilla means of accessing capital. And any provisions that could expand upon that I think would 

be certainly appreciated by the S Corp community. RPTS 

MERCHANTDCMN HOFSTAD[11:05 a.m.] 

Mr. BUCHANAN. Any other comments on that that you want to 

add. 

Mr. Shinn, I just wanted to ask one last question about passive 

losses. And I was interested, I know that Florida and I am sure 

Vegas and parts of California have been devastated about the 

whole concept, in terms of real estate values falling, the idea that 

a lot of people probably have passive losses they can’t use, which 

would be helpful if we are able to free them up. 

Give me your thoughts on passive loss in terms of S Corps. You 

know, would it make a big difference? 

Mr. SHINN. Just like the one example I gave you where a business owns their building and they are renting out part of building, 

that particular loss is trapped in 469 part of the code. And I think 

that either allowing it to be part of—if the business is in the building, give them a break. 

The other thing is with 469, as we sit here and we watch—that 

is because of the section for passive losses—we have really deVerDate 0ct 09 2002 16:24 Jul 17, 2008 Jkt 033615 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 G:\CLERK SB-LD\HEARINGS\TRANSCRIPTS\42526.TXT LEANN
20

stroyed the opportunity for people to take the cash-flow losses that 

they have on their rental property. And let’s say the person has 

their tile business and they lay tile in houses and commercial property, and so they decide to buy a couple of rental houses. Well, they 

have huge losses now, and some of those houses are maybe going 

to go back to the lenders. Instead, maybe give them the opportunity to take more of the loss. There is a $25,000 limit right now 

for low-income people. Maybe increase that amount. 

But I think that our passive loss rules have created a real tax 

blunder, so that now we are faced with this real estate issue. Now, 

how does it spin with the small businesses? I have tried to give you 

some examples of two situations where small businesses—of a doctor office, they bought a bigger building, they only needed a quarter 

of it, but they put up the capital for the full building. And as they 

try to find tenants and the tenants can’t pay and they are 2 

months slow, they are incurring losses. And those losses aren’t allowed to be deducted against their other income because of the passive loss rules. 

Mr. BUCHANAN. Thank you. 

I yield back. 

Chairwoman BEAN. Thank you. 

I would like to recognize the gentleman from Indiana, Mr. Ellsworth. 

Mr. ELLSWORTH. Thank you, Madam Chair. 

Just a couple questions. What do we know? We hear, in this 

Committee and the other Committees, about cash flow for small 

businesses. And I was wondering, Mr. Anderson and anybody else 

that wants to comment, if you have specific changes that might 

allow for more cash flow for small businesses and changes to the 

S Corp rules that would better help corporations, small businesses. 

And anybody can comment, but if you have specifics please. 

Mr. ANDERSON. Well, I think we have alluded to some of those 

provisions before, but I will be the first to acknowledge that the 

things I would talk about are not unique to the S Corporation area. 

These are issues that are common to partnerships and also to C 

Corporations. 

The examples that went back and forth between Mr. Buchanan 

and Mr. Shinn dealt with an entity that has to invest, make capital 

expenditures to grow its business. Those capital expenditures are 

not deductible for tax purposes but must be depreciated. And the 

two relief provisions are the bonus depreciation for 2008 only and 

the first-year expensing, which also has limitations. 

Those are two provisions that more closely tie a corporation’s taxable income to its cash flow. And it seems to me that if there is 

an interest in those provisions, perhaps they ought to be expanded, 

increased, in the case of the bonus depreciation made permanent, 

subject to revenue constraints and other similar considerations. 

Chairwoman BEAN. Could you repeat the last part? You said expanded, increased? 

Mr. ANDERSON. The point about the bonus depreciation is that it 

was enacted as stimulus only for 2008, and it will expire for property that is acquired after the end of 2008. It was part of the 2008 

stimulus package. So, next year, a business making capital expendVerDate 0ct 09 2002 16:24 Jul 17, 2008 Jkt 033615 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 G:\CLERK SB-LD\HEARINGS\TRANSCRIPTS\42526.TXT LEANN
21

itures will have the first-year expensing under Section 179 but will 

not have the bonus depreciation under current law. 

Mr. KERR. And then the 179 also is not permanent, so then you 

still have the problem of not knowing from year to year, which is 

frustrating and difficult for a small business or for any taxpayer to 

plan, if you don’t know what the tax law is going to be. 

Mr. ANDERSON. Well, the provision is permanent, but the dollar 

amounts will go up and down. 

Mr. KERR. Yes, I am sorry. Yes, that is right. 

Mr. SHINN. I would like to add that I concur that the bonus depreciation needs to be more than just a one shot, 1 year or 2 years, 

because, as Representative Buchanan made reference to, the businesses, you want them to reinvest to grow the business. That 

brings jobs. And, as we know, that is a big part of our GNP here. 

I would like to point out, though, that, during those periods when 

you make large improvements to your business, you will incur a 

loss. And right now the 179 rules prevents you from creating a loss. 

I think you need to take that off. If they are going to make the investment, the bank is behind them, they are not going to make the 

loan right now, especially today, unless you have plenty of equity 

and you are signing on it personally. 

That is why I come back to say, in an S Corp world, you need 

to allow that to be a basis and you need to take off the income cap 

limit for 179. 

Mr. ELLSWORTH. Thank you. 

It is my understanding that in S Corp they are only allowed one 

class of stock. Is that a problem? If it is a problem, what are the 

problems, and what can we do to rectify that? 

And, Mr. Shinn, you are shaking your head. I will give you the 

first—

Mr. SHINN. Oh, absolutely. Right now you can have just voting 

and nonvoting. And when you look for a passive investor to infuse 

capital, let’s say the banks just aren’t there—and I have a situation 

right now with a marine business. The banks are scared to death 

of the marine business, and it is a big part of our business community. And so we are looking at equity to come in in a passive investment. 

They want preferred guaranteed returns. They want convertibility of the debt to equity. And either of those cases would create 

a taxable event. That is why I am saying maybe it would be nice 

for them to bridge into an LLC or release those limitations so they 

walk and talk more similar to an LLC partnership environment. 

So giving them the opportunity for preferred stock and allowing 

them to have disproportionate distributions. That is the terminology you will see in the court cases. Because right now it is just 

pro rata. If you are a 30 percent owner, you have to get 30 percent 

of the dividend. 

Mr. ELLSWORTH. Ms. Blankenship? 

Ms. BLANKENSHIP. Yes, for community banks this is critically important, because I heard today 2,400 banks in the Nation are subS. But when they want to go out and raise capital, they either have 

to dilute their current ownership, which sometimes would threaten 

their independence and the Main Street presence, you know, on 

Main Street America, in the community, or they have to sell out. 

22

You know, because you have to give banks the ability to raise capital, because the more capital they can grow, the more they can infuse back into the community, of course. 

And so, by extending that, by allowing a preferred stock or the 

conversion to the limited-liability charter in a tax-free transaction, 

particularly for community banks, would be very beneficial to the 

economy of Main Street. 

Mr. ANDERSON. Mr. Ellsworth, I would just add that an S Corporation, even under current law, is not limited to simply issuing 

either common stock or plain vanilla debt, if you will. The current 

regulations promulgated by the Internal Revenue Service permit S 

Corporations to have a variety of, what I might call, equity-flavored 

instruments. There are some lenders who will lend if they can get 

options or warrants to acquire stock of the company. Obviously, if 

those warrants were ever exercised, there might be a terminating 

event for the S Corporation. 

But lenders can participate in the upside potential of a company 

through acquiring some of these equity-flavored securities or instruments that do not violate current regulations. Employees can 

be incentivized through stock appreciation rights or stock options, 

and they are generally not considered to be shareholders and so 

don’t violate any of the requirements applicable to S Corporations. 

Mr. KLAHSEN. I would offer that while I agree with Mr. Anderson’s comments, that there are certainly other things other than 

simply voting or nonvoting stock and access to equity in some respects in that manner, the introduction of an opportunity for investors to invest in preferred stock would greatly expand that capital 

access pool. 

The opportunity to use some of the instruments that Mr. Anderson mentioned are honestly quite limited, and some of them do 

have the potential for terminating the S election, as he referred to. 

So the introduction of a preferred equity instrument greatly expands the investment community and improves the access to capital for S Corporations. 

Mr. ELLSWORTH. Thank you. 

Thank you all. 

Madam Chair, I yield back. 

Chairwoman BEAN. Thank you for your questions and your testimony. 

I had a last question for Mr. Anderson. Under current law, certain shareholders of an S Corporation, as we heard many of you 

talk about, are taxed on their fringe benefits, while larger corporate entities, both for employees and owners, those are nontaxable benefits. 

What do you think this does to the ability of those smaller S 

Corps to provide such benefits? 

Mr. ANDERSON. Let me try to articulate what I think are the 

rules that apply to S Corporation shareholder employees. These are 

rules that apply to shareholder employees who have 2 percent or 

more of a company’s stock, and they are simply treated as partners 

for fringe benefit purposes. 

The biggest fringe benefit that most companies seem to provide 

to their employees would be health insurance. And under current 

law at least, there is, quite frankly, no significant distinction beVerDate 0ct 09 2002 16:24 Jul 17, 2008 Jkt 033615 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 G:\CLERK SB-LD\HEARINGS\TRANSCRIPTS\42526.TXT LEANN
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tween the treatment of S Corporation shareholder employees and 

the treatment of C Corporation employees. While the fringe benefit 

is taxable to the shareholder employee, there is also an offsetting 

deduction that the individuals are entitled to claim. So, at the bottom line, if you will, there is probably no net impact to the shareholder employees. 

The same cannot be said of the other type of fringe benefits that 

are provided. They are less significant, I think, in the mainstream 

than health insurance. And they would apply to such things as 

group term life insurance, disability insurance, some de minimis 

fringe benefits. 

Beyond that, I don’t think I can really comment. I don’t see that 

S Corporations are coming to me, at least, or our firm and saying, 

this is a tremendous burden or a disincentive to conversion. 

Mr. BUCHANAN. Just one question. I wanted to ask Ms. 

Blankenship, you had mentioned on behalf of the Independent 

Community Bankers that it is important or you would like to have 

considered going from 100 shareholders to 150 shareholders. I 

think I understand where you are going with it, but why don’t you 

explain to myself and everybody else your thought there. 

Ms. BLANKENSHIP. Well, I think I stated it in my testimony, but 

typically when community banks go out to raise capital, they go out 

into their communities, and they raise capital from a large number 

of shareholders in the community. Because they are not going to 

a broker on Wall Street. They are going to be partners with those 

people in the community. The community invests in the bank, and 

the bank invests, in turn, in the community. 

And, you know, 100 shareholders typically is—it would take 

more than 100 shareholders in a typical community bank capitalraising transaction. So it just allows the viability of that Main 

Street community bank to be able to continue to partner in their 

community. And that is why it is so important for us to have the 

expanded number, expanded types of shareholders, because our 

own bank couldn’t convert for 10 years because of those very restrictions. 

Mr. BUCHANAN. I was just curious why you picked 150 and not 

300 or 200? Is there any particular reason? 

Ms. BLANKENSHIP. We would take 300. 

Mr. BUCHANAN. Yeah, okay. Okay. 

Ms. BLANKENSHIP. No, there is not a particular reason. You 

know, we were trying to be respectful about the limits and realistic. 

Other small businesses may not need that number because of the 

types of investors, but for community banks it is a little different 

animal. 

Mr. BUCHANAN. We have in our area, and I am sure around the 

country, but in Florida it just seems like we have a new community 

bank a week opening up. And they do raise the capital, most of it, 

in the community. 

Mr. BLANKENSHIP. Yes. 

Mr. BUCHANAN. Thanks for your comment. 

Ms. BLANKENSHIP. Thank you. 

Chairwoman BEAN. Well, I want to thank you all for your testimony today. I think it provokes further questions, but we will probVerDate 0ct 09 2002 16:24 Jul 17, 2008 Jkt 033615 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 G:\CLERK SB-LD\HEARINGS\TRANSCRIPTS\42526.TXT LEANN
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ably have to ponder a little before we come up with those, and hope 

to follow up with some of you in the future. 

I ask unanimous consent that members will have 5 days to submit statements and supporting materials for the record. 

Without objection, so ordered. 

And this hearing is now adjourned. Thank you. 

[Whereupon, at 11:15 a.m., the Subcommittee was adjourned.]

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