U.S. GOVERNMENT PRINTING OFFICE

65–508 WASHINGTON : 2000

HEARING ON CASH VERSUS ACCRUAL: THE POLICY IMPLICATIONS OF THE GROWING INABILITY OF SMALL BUSINESSES TO USE SIMPLE TAX

ACCOUNTING

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

WASHINGTON, DC, APRIL 5, 2000

Serial No. 106–49

Printed for the use of the Committee on Small Business

(
(II)

COMMITTEE ON SMALL BUSINESS

JAMES M. TALENT, Missouri, Chairman

LARRY COMBEST, Texas

JOEL HEFLEY, Colorado

DONALD A. MANZULLO, Illinois

ROSCOE G. BARTLETT, Maryland

FRANK A. LOBIONDO, New Jersey

SUE W. KELLY, New York

STEVEN J. CHABOT, Ohio

PHIL ENGLISH, Pennsylvania

DAVID M. MCINTOSH, Indiana

RICK HILL, Montana

JOSEPH R. PITTS, Pennsylvania

JOHN E. SWEENEY, New York

PATRICK J. TOOMEY, Pennsylvania

JIM DEMINT, South Carolina

EDWARD PEASE, Indiana

JOHN THUNE, South Dakota

MARY BONO, California

NYDIA M. VELA ́ZQUEZ, New York

JUANITA MILLENDER-MCDONALD,

California

DANNY K. DAVIS, Illinois

CAROLYN MCCARTHY, New York

BILL PASCRELL, New Jersey

RUBE ́N HINOJOSA, Texas

DONNA M. CHRISTIAN-CHRISTENSEN,

Virgin Islands

ROBERT A. BRADY, Pennsylvania

TOM UDALL, New Mexico

DENNIS MOORE, Kansas

STEPHANIE TUBBS JONES, Ohio

CHARLES A. GONZALEZ, Texas

DAVID D. PHELPS, Illinois

GRACE F. NAPOLITANO, California

BRIAN BAIRD, Washington

MARK UDALL, Colorado

SHELLEY BERKLEY, Nevada

HARRY KATRICHIS, Chief Counsel

MICHAEL DAY, Minority Staff Director
(III)

C O N T E N T S

Page

Hearing held on April 5, 2000 ................................................................................ 1

WITNESSES

Mikrut, Joseph M., Tax Legislative Counsel, United States Department of

the Treasury, Washington DC ............................................................................ 5

Mieras, Shane, Project Manager, Mid-Ceitling and Drywall, Rockford, Michigan ......................................................................................................................... 28

Wulkopf, David E., CPA, Treasurer, Beckner Painting Midwest, Inc., St.

Louis, Missouri ..................................................................................................... 30

Harris, Roger, President, Padgett Business Services, Athens, Georgia .............. 33

Olson, Pamela F., Chair-Elect, Section of Taxation, American Bar Association 34

Satagaj, John S., Managing Partner, London and Satagaj, Washington, DC .... 36

Schneier, Abraham L., Partner, McKevitt & Schneier, Washington, DC ........... 40

APPENDIX

Opening statements:

Talent, Hon. James .......................................................................................... 50

Vela ́zquez, Hon. Nydia ..................................................................................... 53

Manzullo, Hon. Donald A ................................................................................. 55

Tubb-Jones, Hon. Stephanie ............................................................................ 56

Prepared statements:

Mikrut, Joseph M ............................................................................................. 61

Mieras, Shane ................................................................................................... 68

Wulkopf, David E ............................................................................................. 73

Harris, Roger .................................................................................................... 77

Olson, Pamela F ............................................................................................... 82

Satagaj, John S ................................................................................................. 93

Schneier, Abraham L ....................................................................................... 103

Additional material:

Written statement of American Dental Association ...................................... 108

Written statement of the Associated General Contractors of America ........ 113

Written statement of Anthony Shaker, President, Air Conditioning Contractors of America ....................................................................................... 116

Written statement of the Plumbing-Heating-Cooling Contractors-National

Association ..................................................................................................... 122

(1)

HEARING ON CASH VERSUS ACCRUAL: THE

POLICY IMPLICATIONS OF THE GROWING

INABILITY OF SMALL BUSINESSES TO USE

SIMPLE TAX ACCOUNTING

WEDNESDAY, APRIL 5, 2000

HOUSE OF REPRESENTATIVES,

COMMITTEE ON SMALL BUSINESS,

Washington, DC.

The Committee met, pursuant to call, at 10:00 a.m., in Room

2360 Rayburn House Office Building, Hon. James M. Talent,

[Chairman of the committee] presiding.

Chairman TALENT [presiding]. We will now call the hearing to

order. I want to welcome our witnesses here today and take a moment to thank, in particular, Mr. English and Mr. Manzullo and

Mr. Sweeney of the Committee for their legislative efforts on the

small business issues before us today.

It’s easy for our eyes to glaze over when we hear the terms ‘‘cash

versus accrual’’ or ‘‘installment method of accounting.’’ These terms

are the rules that govern and determine when, not if, small businesses and other taxpayers have to pay taxes on their income.

The cash method is a simple method of accounting allowed by the

tax code that most closely mirrors the way many small businesses

operate. It allows them to pay taxes on income in the year that

they actually receive the income. This is, at best, a brief deferral

of tax, not any special exemption or waiver.

In contrast, forcing small businesses, including small contractors

and service providers and, especially including small contractors

and service providers, to switch to the accrual method of accounting means that they have to pay now and collect later on their accounts receivable. In reality, most small entities are willing to forego deductions to use simple accounting and have used the cash

method consistently for years, if not for decades. An example is

Beckner Painting, a constituent of mine who will testify later

today, who has used cash accounting consistently since 1965.

Accounting issues have become increasingly important and controversial because of the underlying implications of recent Treasury

proposals and consequent IRS enforcement activities that are hurting small businesses. We will explore these policy implications and

the pending regulatory guidance that the Treasury Department

plans to issue on who must use accrual accounting.

Unfortunately, the Treasury Department’s recent policy statements and proposals demonstrate an increasingly aggressive position designed to deny American small business taxpayers the abil-
2

ity to use simple and lawful tax accounting, including the installment method repeal successfully advocated into law by the Treasury Department last year.

Similarly, the Treasury Department has announced it will soon

issue guidance regarding the rules related to the cash and accrual

methods of accounting. Specifically, the Department intends to

issue guidance regarding when merchandise used by a taxpayer requires the use of inventories and, thus, the accrual method of accounting. The Treasury’s plans, therefore, are critical in determining whether small businesses will find real relief or increasing

controversy in their ability to use simple accounting in paying their

taxes.

When testifying here today and moving forward on any regulations, I urge the Department to keep in mind that tax policy is distinct from financial accounting. Many important considerations, including fairness and simplicity, outweigh the need, if any, for

mathematically precise matching of income and expenses for tax

collection purposes.

Moreover, what you may consider in your accounting changes inside the Beltway harshly affect the lifeblood of small contractors

and service providers, their cash flow. Having to pay taxes on income small entrepreneurs have not received strangles their cash

flow and their businesses. Accordingly, the use of Treasury and IRS

resources to litigate and audit small business contractors and service providers who regularly use cash accounting seems both cost ineffective and unreasonable.

Congress has made great strides in the last few years to provide

tax relief for small businesses and to reform the Internal Revenue

Service. I may say this Committee has been at the forefront of

those efforts. The Committee appreciates the new direction the

Commissioner is obviously taking the IRS in its responsiveness to

the small business community. I hope any new policies, regulations, or legislation that the Treasury Department proposes and

the Congress considers will make this important job easier.

In this regard, I want to make two more points. First of all, I

appreciate Treasury’s recognition of the damage last year’s installment change is causing small business. I believe its policy position

on installment sales is fundamentally flawed. I urge the Department to support H.R. 3594 to fully reverse last year’s repeal of the

installment method of accounting for accrual basis taxpayers.

This bill would restore the ability of small businesses to sell their

businesses without losing between 5 to 20 percent of their value,

8.2 percent on average. In many cases, this value represents the

small business person’s life’s work and retirement savings, which

are now unexpectedly slashed.

Two, I urge the Treasury to support a proposed legislation to

allow small businesses with gross receipt of $5 million or less to

use the cash method of accounting without limitation. In the current law, Congress explicitly recognizes that allowing small business C corporations to use cash accounting outweighs any inherent

distortions in the timing of their income and expenses. Setting a

lower-than-$5 million threshold for other small businesses, including sole proprietors, partnerships, and S corporations makes no

sense and would lead to additional and unnecessary complexity.
3

I’m happy now to recognize the distinguished gentlelady from

New York for any comments that she may wish to make.

Ms. VELA ́ZQUEZ. Thank you, Mr. Chairman. Over the past few

years, America has experienced an unprecedented economic boom.

And no one can deny the importance of small business in creating

this growth and supporting our communities. Our nation’s entrepreneurs provide jobs and represent the major tax base for our

schools and roads, embodying the spirit of entrepreneurship that

has made this country great.

However, too often small businesses lack the capital they need to

grow or they don’t have the money at the end of the day to make

being their own boss a reward. One reason for this is that our tax

system often creates road blocks for our nation’s small businesses.

Today’s hearing is a continuation of what I believe is one of the

most important roles that this Committee plays to educate the rest

of Congress about the tax challenges facing our nation’s small businesses.

I would like to commend the Chairman for bringing before this

Committee an issue essential to small businesses, the issue of tax

simplification and specifically the cash versus accrual methods of

accounting.

With no two small businesses facing the exact set of issues, the

sides on this debate are clear. Many small businesses argue that

the accrual method is too complicated and requires many small

businesses to retain an accountant, tax expert, or hire a full-time

employee who is skilled enough to use this accounting method.

I believe that there is one component of this debate that the

Committee specifically has a responsibility to highlight, because it

is a perfect example of the rule of unintended consequences, that

is the repeal of the installment method of accounting, a variation

of cash accounting.

The issue arose last year when Congress passed the Work Incentives Improvement Act. This legislation has many vital tax provisions, like the R&D tax credit, work opportunities tax credit, and

alternative minimum tax credit, all significant provisions. As an

offset to pay for this, the installment method was done away with.

The result was to force most small businesses to use the accrual

method. Unfortunately, this change created more problems than it

solved. Forcing small businesses to use the accrual method placed

an especially disproportionate burden on those small business owners attempting to sell their businesses.

Unlike the installment method that allowed the owners to pay

the taxes as the payment was received, the accrual method forces

them to be liable for the full amount immediately, even if they only

have partial or no payments. This has created an unintended burden on the business owner and a disincentive for business sales.

I am pleased Congress recognized this and corrected it through

the repeal of the prohibition on the installment method.

Clearly, given this chain of events, we need to do much more

educating our colleagues about the tax challenges facing small

business owners. We need to continue to push for a tax system that

is progressive but does not place the disproportionate burden on

small business.
4

One again, I would like to thank the Chairman for holding today’s hearing. Creating a fair and equitable tax structure for our

nation’s small businesses is crucial to their long-term success. At

the same time, we must work to ensure that, by solving one problem, we do not create a more serious problem elsewhere. I look forward to hearing the testimony of today’s witnesses and I thank the

Chairman again for his hard work on this issue.

[Ms. Vela ́zquez’s statement may be found in appendix.]

Chairman TALENT. All right. Before we get to our first panel, and

while it’s our practice for only the ranking member and I to have

opening statements, in this case, Mr. Manzullo, who does chair the

Tax Subcommittee wanted to make a brief opening statement, so

I’ll allow him to do it.

Mr. MANZULLO. Thank you, Mr. Chairman. I commend you for

holding this hearing today. As Chairman of the Tax Subcommittee,

I realize this issue is perceived by some as being very dry, but it’s

really a matter of life and death for thousands of small businesses

which have to sell some product associated with their services or

at least use a product associated with their services.

I first became aware of this issue in 1996 when a dentist in the

district that I represent became an IRS, ‘‘test case,’’ forcing him to

move from the cash method of accounting to the accrual method.

This changeover required him to pay cash on income he had not

even received. Medical professionals have no problem paying taxes

on what they collect on their billings, but they object to paying

taxes on outstanding invoices, particularly unpaid bills. This is another illustration of the IRS trying to collect taxes early.

In 1998, I offered legislation to give physicians and dentists the

choice to remain with the cash method of accounting. It was reintroduced as H.R. 1004 in this Congress. I ask unanimous consent

that the Chairman include in the hearing record a written statement of the American Dental Association on this issue.

[American Dental Association’s statement may be found in appendix.]

Mr. MANZULLO. Over the past few years, I’ve learned that this

issue impacts more than the small business community, such as

landscapers, building contractors, and plumbers. That’s why I’m

proud to be a cosponsor of your bill, Mr. Chairman, that would

allow any small business with gross receipts of up to $5 million the

choice to remain with the cash method of accounting.

I could not have said it better than Judge Power when she

reached a decision by the U.S. tax court. She said the IRS, ‘‘abused

its discretion when it required the contractor to change from the

cash method to the accrual method of accounting.’’ I was pleased

to have a few conversations with Commissioner Charles Rossotti.

I observed he was sympathetic to the plight of small business owners on this issue.

I understand from previous testimony, the Treasury Department

announced that small business owners with gross receipts of $1

million or less will be free to use the cash method of accounting.

Mr. Chairman, it’s a good step in the right direction, but I trust,

after this hearing, that the new administration policy will be more

in the direction of Chairman Talent’s bill.
5

Chairman TALENT. I thank the gentleman. And the gentlelady

from Ohio has sought recognition. I’m happy to recognize her.

Ms. TUBBS JONES. Mr. Chairman, thank you. I was seeking

unanimous consent to have an opening statement on this issue submitted for the record.

Chairman TALENT. I thank the gentlelady and, without objection.

And without objection, any member who wishes to submit an

opening statement, it will be entered into the record.

And I truly thank the members for their interest in this issue

which is vital to small business. And we’ll just introduce the first

panel and we have one witness on the panel, Mr. Joseph M.

Mikrut, who is the tax legislative counsel for the United States Department of the Treasury. Mr. Mikrut, it’s your first time before

the Committee. We’re pleased to have you and thank you for coming in. You can give us your statement.

STATEMENT OF JOSEPH M. MIKRUT, TAX LEGISLATIVE COUNSEL, UNITED STATES DEPARTMENT OF THE TREASURY,

WASHINGTON, D.C.

Mr. MIKRUT. Thank you, Mr. Chairman. Mr. Chairman, Ranking

Member Vela ́zquez, distinguished members of the Committee,

thank you for inviting me today.

I appreciate not only talking about this issue, but at the Treasury we have come to understand the importance of tax issues for

the small business community and we hope this will be a continuing dialogue to discuss these matters with the Committee.

I especially appreciate the opportunity to discuss with you today

the important topic of the proper method of accounting as applied

to any small business. Indeed, the choice and use of a method of

accounting is one of the most fundamental aspects in determining

a taxpayers’ tax liability and these matters, although some may

have described them as dry and uninteresting, are matters of great

concern to the taxpayer.

This morning, I would like to focus on four main topics. One, I

would like to discuss with you the current law and rules regarding

the choice of accounting method; two, the tax policy rationale of

such rules; three, the administrative guidance that we and the IRS

are developing in this area; and four, recent developments with respect to the installment method.

Items of taxable income and deduction generally are taken into

account by a taxpayer in a taxable year based on the taxpayer’s

method of accounting. Code section 446 requires that the selected

method clearly reflect the taxpayer’s income and grants the Secretary of the Treasury broad discretion in determining whether a

method of accounting clearly reflects such income. Once a method

is established by the taxpayer, the taxpayer must continue to use

that method until he secures the consent of the Secretary to

change.

Permissible methods of accounting include the cash receipts and

disbursements method, known as cash method, accrual methods, or

any other method or combination of methods permitted under

Treasury regulations.

In general, there are two main methods, those being the cash

method and the accrual methods. The cash method is the method
6

under which most individuals operate. The cash method of accounting generally requires an item to be included in income when actually or constructively received and permits a deduction for when

the expense is paid.

In contrast, an accrual method of accounting generally requires

that an item be included in income when all events have occurred

that give rise to that income, in other words, when the event occurs

that gives rise to the income. And similarly, a deduction is allowed

to the accrual-method taxpayer when all of the events have occurred that give rise to the liability that gives rise to such expenditure.

Certain restrictions are imposed on the use of the cash method.

Long-standing Treasury regulations provide that, in order to clearly reflect income, taxpayers that are required to keep inventories

for a particular trade or business must use an accrual method of

accounting. Inventory accounting is required whenever merchandise is a significant income-producing factor. Therefore, a taxpayer

who is required to keep inventories is also required to use an accrual method of accounting. Exceptions are provided for farmers,

even though such taxpayers generally are engaged in the production and sale of merchandise.

In addition, certain statutory provisions restrict the use of the

cash method of accounting. Section 448 enacted by Congress in

1986 requires that C corporations and partnerships that have C

corporate partners and have more than $5 million of average annual gross receipts may not use the cash method of accounting. An

exception is provided for certain qualified professional service corporations that are owned by the employees.

Legislative history of the 1986 Act makes it clear that taxpayers

that are not specifically, quote, ‘‘prohibited from using the cash

method of accounting,’’ for example, taxpayers with less than $5

million gross receipts, are not automatically eligible to use the cash

method. On the contrary, legislative history clearly states that

these taxpayers remain subject to other requirements, that their

methods of accounting clearly reflect income, and that an accrual

method must continue to be used by sellers of inventories.

The tax policy rationale underlying the use of an accrual method

of accounting is relatively straightforward. Accrual methods of accounting, when compared to the cash method, are acknowledged to

better reflect economic income and comport to generally accepted

accounting principles for financial accounting purposes.

The clear reflection of income standard is demonstrated by the

matching principle. Under the matching principle, gross receipts

from sales must be matched with related costs of goods sold. In

order to achieve such a matching of cost to revenue, it is necessary

to keep an inventory account reflecting the cost of goods available

for the sale so that these costs are not automatically deducted

when paid, but are deferred until the year when the merchandise

is sold.

Further, the taxpayer must report income under an accrual

method to ensure that the income from the sale, like the related

inventory costs, are reflected and matched with the year’s sales.

Treasury regulations issued in 1918 and have been continued in
7

force ever since, have contained these requirements. Their validity

has been upheld by the Congress and the courts several times.

However, as you mentioned in your opening statement, Mr.

Chairman, there are several factors that may override a tax policy

rationale for the use of an accrual method. The relative simplicity

of the cash method justifies its use by small, less sophisticated, taxpayers where an accrual method may be burdensome. In addition,

the cash method addresses the liquidity concerns of small businesses in that it provides for payment of tax at the time that the

taxpayer is most likely to have the cash and ability to pay the tax.

Although long-standing Treasury regulations require that inventories and accrual methods of accounting are required in order to

clearly reflect income when merchandise is an income-producing

factor, uncertainty exists as to when a taxpayer, and particularly

a taxpayer that provides both goods and services, is selling merchandise and when the sale of merchandise is an income-producing

factor. In addition, several small, unsophisticated, taxpayers that

do not use an accrual method of accounting for financial accounting

have complained that the requirement to account for inventories

and to use an accrual method is burdensome.

As you mentioned, Mr. Chairman, we intend to publish administrative guidance that will address these concerns. Specifically, we

will issue an exception for the use of the cash method of accounting

when the average gross receipts of the taxpayer are less than $1

million.

We believe such a rule is justified in that these taxpayers with less than $1 million in gross receipts are generally less sophisticated, less likely to use an accrual method of accounting for other

purposes, and that the results of using a cash versus an accrual

method of accounting will not vary very much. In addition, the resources of the IRS will be saved by not having to examine the returns of these taxpayers. We believe that this $1 million threshold will cover the majority

of small business. In 1997, the most recent year for which we have

data, approximately 78 percent of all C corporations, 85 percent of

all S corporations, and approximately 95 percent of all partnerships

and sole proprietorships had gross receipts of less than $1 million.

I would point out that this data that I just gave you is on a nonaggregated level, so that if one taxpayer engaged in multiple businesses, there would be some double accounting.

Finally, Mr. Chairman, I would like to discuss with you the installment method of accounting. The installment method of accounting provides an exception to the general rules regarding accrual and cash methods, by allowing the taxpayer to defer the recognition of income from the disposition of certain property until

payment is received.

Under the installment method, a taxpayer recognizes the gain resulting from a disposition of property proportionately as payments

are received on an installment note. As such, the installment method more closely resembles the cash method. It is primarily for this

reason that the Administration proposed and the Congress passed,

as part of the Ticket to Work and Work Incentives Improvement

Act of 1999, to limit the use of the installment method to cash

method taxpayers.
8

After the 1999 Act was passed by Congress, small business

groups began to express concerns that the repeal of the installment

method for accrual method taxpayers negatively impacted the sales

of small businesses. It is clear that the extent of the impact of the

provision on the sales of small businesses was unforeseen by policymakers and potentially affected taxpayers and their advisors during the legislative process.

Treasury’s Office of Tax Policy has met several times with interested industry groups, including the NFIB, NAM, AICPA, Small

Business Legislative Council, and the U.S. Chamber of Commerce,

and listened to their concerns about the effect of this recent legislative change. These groups have requested clarification on the effect

of the installment sales provision on particular transactions. We intend to issue such guidance in the near-term.

In addition, these groups have expressed a need for an exception for small businesses. We believe that a $1 million exception—that

we believe is a much broader approach that would deal not only

with the cash versus accrual method of accounting, but also with

the installment sales provision—will provide much of this relief.

However, we understand and we believe that to go further will require legislation.

Overall, we believe the policy underlying the installment sales

provision enacted in 1999 is appropriate. The installment method

is inconsistent with an accrual method of accounting. Indeed, Congress has several times cut back the use of the installment method,

most significantly in 1986 and 1987, when it disallowed the use of

the installment method for sales of inventory.

We now understand, however, that the legislation passed last

year has imposed financial burdens on small businesses that may

override this basic tax policy concern. As such, we are eager to

work with Congress to provide a legislative solution to alleviate

this unforeseen impact of the provision.

Any legislative response should be targeted to address the legitimate concerns of affected taxpayers. For example, to address the

liquidity concerns facing sellers of small businesses, we would suggest continued use of the installment method, perhaps with an interest charge, as provided under present law, for a certain defined

class of small businesses, regardless of the sellers’ method of accounting. There are other proposed solutions that we would be

happy to work with Congress to address.

Mr. Chairman, this concludes my prepared remarks. I ask my

entire written record be submitted for the record. We look forward

to working with Congress in developing legislative proposals in

these and other areas. And I’d be happy to respond to any of your

questions.

[Mr. Mikrut’s statement may be found in appendix.]

Chairman TALENT. I’m going to withhold my questions. But,

thank you, Mr. Mikrut. I’m going to withhold my questions for now

and defer to the gentlelady from New York for questions.

Ms. VELA ́ZQUEZ. Thank you, Mr. Chairman. Mr. Mikrut, many of

the small businesses, the small business advocates I hear from,

talk about the $5 million exception for businesses that want to use

the cash method of accounting. Yet it is my understanding that the

IRS does not interpret the law as containing a specific $5 million
9

exception. I would like for you to shed some light on this issue.

From the Treasury Department’s interpretation of the current law,

is there a $5 million exception for businesses who want to use the

cash method?

Mr. MIKRUT. Ms. Vela ́zquez, I’ve heard the same comment. In

1986, Congress enacted section 448 and what section 448 says is

that if a C corporation, which is a separate corporate taxpayer, or

a partnership that has a C corporation as a partner, has gross receipts in excess of $5 million, that entity must use an accrual

method of accounting. Some have interpreted that to mean that if

you’re under $5 million in gross receipts, that you may use the

cash method of accounting or you are no longer subject to requirements to use an accrual method of accounting.

However, when one looks at the legislative history to the 1986

Act, and this is contained in the House report of the Act, the Senate report to the Act, the Conference report to the Act, as well as

the General Explanation prepared by the Joint Committee on Taxation with respect to section 448, it is clear that Congress only

meant to affect taxpayers with gross receipts in excess of $5 million. And they made it very clear that an exclusion did not apply

if taxpayers were subject to then-current law.

And Congress recognized at that time that then-current law, pursuant, again, to Treasury regulations that had been issued since

1918, provide that if merchandise is an income-producing factor in

a trade or business, that that trade or business must use an accrual method of accounting.

So I think that the current state of the law, as provided in Treasury regulations and based on legislative history, is that corporate

taxpayers in excess of $5 million must use an accrual method of accounting and all other taxpayers must use a method of accounting

that clearly reflects their income and if merchandise is a significant

portion of that trade or business, then an accrual method is required.

Ms. VELA ́ZQUEZ. Do all the principals within the administration

support the $1 million threshold for small businesses who wish to

use the installment method?

Mr. MIKRUT. Yes, we do. Again, we have been trying to develop,

in the last several years, several safe harbors and exceptions to be

used with respect to small businesses in order to alleviate their tax

compliance concerns.

I think it is generally agreed that taxpayers with gross receipts

of $1 million or less, and this is average annual gross receipts, so

that as an averaging concept so if you have over $1 million one

year, you’re not automatically off, that those taxpayers have particular needs that may override general tax policy concerns. And

their compliance needs may mandate that they should be eligible

to use the cash method of accounting in certain instances.

Ms. VELA ́ZQUEZ. How, then, do you reconcile this $1 million

threshold with the $5 million threshold under current law for use

of the cash method?

Mr. MIKRUT. That’s a very good question, Ms. Vela ́zquez. Current

law in section 446 requires that a taxpayer’s method of accounting

must clearly reflect income. And that we think that taxpayers that

have gross receipts up to $1 million, that the results that they
10

would obtain in using a cash method, versus an accrual method,

are very similar. So the use of the cash method for those taxpayers,

in many instances, will clearly reflect their income.

Once you get to taxpayers that have greater gross receipts, approaching $5 million, it is less clear that the use of a cash method,

particularly when they hold inventories, will clearly reflect their income. And, therefore, if Congress wanted to change that result,

there should be a legislative change.

We think the tax policy considerations are such that the clear reflection of income standard is very important and that I think Congress should go carefully in considering such legislation. We do recognize, however, that it will create greater simplicity. The Administration is concerned with the complexities of tax compliance. In

1997, for instance, we proposed and Congress enacted a provision

that took businesses with less than $5 million of gross receipts off

of the corporate AMT and that provided considerable simplicity.

However, with respect to the overall method of accounting, one

has to wonder if many of these businesses use an accrual method

for other purposes: for purposes of reporting to their shareholders,

to their owners, for purposes of applying for bank loans. It is often

the case that a financial institution will ask them what their accounts receivables are, what their accounts payables are, and what

their inventory accounts are. So, again, to the extent that tax conformity is an issue, perhaps for taxpayers that use accrual methods

for other purposes, it is appropriate to use them for tax purposes

as well.

Ms. VELA ́

ZQUEZ. You spoke before about the fact that you will be

issuing guidance to all qualified small businesses with annual

gross receipts of $1 million who continue to use the installment

method. Can you tell me if the Treasury Department or IRS consult with representatives from the small business community prior

to developing the rules?

Mr. MIKRUT. Yes. Both last summer and last fall, the IRS and

Treasury had joint meetings with representatives of the small business community to discuss the cash versus accrual issues. In addition to IRSAC, which is an IRS advisory committee—a group of

practitioners and advisors that advise the Commissioner—we discussed this issue with them several times, and we discussed the

use of the installment with the small business community several

times. And all of these discussions went into our calculation in trying to develop guidance in these areas.

Ms. VELA ́ZQUEZ. Can you tell me the specific concerns by the

small business groups when you met them?

Mr. MIKRUT. Well, I think their specific questions are contained

in my testimony: the relative simplicity of the cash method of accounting, and their liquidity concerns. These are the ones that

arise the most.

Ms. VELA ́

ZQUEZ. And what about the $1 million?

Mr. MIKRUT. We have not had specific comments on that yet. We

have not yet published the guidance. We’re also looking if we can

develop anything else in this area. We’d like to come up with a

complete package. But we would expect that, as soon as we publish

this package, this will go through the normal process of notices and
11

proposed rulemaking so we will take any comments that they have

into consideration.

Ms. VELA ́ZQUEZ. And you would tell me that the guidance that

you will be issuing will reflect the concerns that have been raised?

Mr. MIKRUT. I believe the $1 million threshold will address many

of the concerns. As I mentioned in my testimony, the great majority of these businesses are under the $1 million threshold.

Ms. VELA ́ZQUEZ. Mr. Chairman, I’ll have some other questions,

but I’ll make them later. Thank you.

Chairman TALENT. Thank the gentlelady. I’ll follow in line and

then defer to other members.

Let me go back to the legislative history of section 448, which

was passed in 1986. First of all, Mr. Mikrut, the Act of 1986 was

supposed to be a tax simplification Act. I mean, that was the thrust

of it, wasn’t it?

Mr. MIKRUT. Yes, there were several simplification provisions in

the Act.

Chairman TALENT. Congress was interested in simplifying taxes.

Now, whether they actually did that or not is something we can all

argue about, but I mean that was—I remember watching at the

time and it was a big bipartisan deal and it supposed to simplify

taxes.

You made a point that the legislative history, I think you said,

clearly reflects that you still have the authority to impose the accrual method on small businesses. I’m going to take you through

the legislative history and particularly a part that I think takes

that authority away from you. And for the convenience of the members, can we distribute this page that I’m going to be working

from? Make sure Mr. Mikrut has a copy of it also.

Because I’m going to work through this and just what seems logical to me. I’m trying to put myself in the shoes of our predecessors

and maybe somebody—I don’t know if anybody here was here then

or not. I don’t think so.

This is Congress’ explanation of what it was trying to do with

section 448. And what section 448 says, for the members who have

not looked at it, is that it, on its face, appears to say that C corporations above $5 million in receipts can’t use the accrual method

unless it’s a farming operation or a personal service operation like

a lawyer or a doctor or something like that.

And on its face when I read it, I thought it was intended to say

that a C corporation below $5 million could automatically use the

cash method, at least if they had been using it in the past. Now

the Treasury believes that what I think and I believe Congress intended as an extra measure of freedom and simplicity and certainty for taxpayers was actually a prohibition. Mr. Mikrut, and I

don’t want to put words in his mouth, is saying, no, what Congress

was trying to do was prohibit taxpayers with above that amount

using it, not make it clear that taxpayers with below that amount

could use it. See?

So let’s look at the legislative history and the reasons for the

change. If you look at the bottom of the first column, that paragraph there, and I won’t read all of that, basically, it’s a statement

of Congress and an understanding that the cash method of accounting may not technically reflect a perfect match of income and ex-
12

penses. And Congress is saying we understand that the accrual

method might technically match this better and so, from the strict

accounting principle, yes, we’re conceding to the Treasury that this

might be better from that standpoint.

Then look under the exceptions point. On the other hand, and remember this is a tax simplification bill, ‘‘the Congress also recognizes that the cash method generally is a simpler method of accounting and that simplicity justifies its continued use by certain

types of taxpayers and for certain types of activities.’’ That Congress believes—look at this next sentence. I draw your attention of

the members to this—‘‘that Congress believes that small businesses

should be allowed to continue to use the cash method of accounting

in order to avoid the higher costs of compliance which will result

if they are forced to change from the cash method.’’

A pretty clear statement from Congress saying yes, we understand, Treasury, that in the policy role of Treasury among the big

eight accounting firms, this maybe doesn’t fit, but we’re not representing you all only; we’re also representing the small businesses. And, for simplicity’s sake, at least if they’ve been using it,

they should be allowed to continue to use the cash method. Okay?

And that’s what it appears to say.

Now you were saying, no, it doesn’t say that. Tell me why I’m

wrong in saying that. Why?

Mr. MIKRUT. Well, I don’t believe you are wrong, Chairman Talent, because it says that for taxpayers that have used the cash

method of accounting, nothing in this Act changes that. That if

they were properly using it before and if they’re under $5 million,

they can continue to use it.

I would point to a statement that I believe——

Chairman TALENT. Now you use the word ‘‘properly.’’ Congress

didn’t say, ‘‘if they’d been properly using it.’’ Congress says, ‘‘Even

if it’s improper, according to technical accounting.’’ That was the

whole lead-up. Congress was saying, look, we recognize that sometimes, according to technical accounting principles and technically

matching this and that and the other thing, it might not be proper.

On the other hand, Congress is saying it’s our decision to overrule

those that say if they’d been using it, they can continue to use it,

even though it’s not proper.

Mr. MIKRUT. I don’t believe, Mr. Talent, that section 448 stands

for the proposition that taxpayers that were using an improper

method of accounting could continue to do so. In fact, I think I

would turn the page, which isn’t here, but somewhere else in the

technical explanation, it says that under prior and present law,

taxpayers for whom the production, purchase, or sale of merchandise is a material income-producing factor are required to keep inventories and to use an accrual method of accounting with respect

to inventory items.

So I can reconcile those two statements. And the reconciliation

is that certain taxpayers have traditionally been able to use the

cash method of accounting and nothing in the 1986 Act disturbs

that. And that, in addition, certain taxpayers have been required

to use an accrual method of accounting and nothing in the 1986 Act

disturbs that.
13

So the question, then, is which taxpayers have traditionally been

required to use accrual methods of accounting and which are allowed to use the cash method of accounting? And this, again, harkens back to the regulations that have been in force since 1918 that

say that if merchandise is an income-producing factor, such taxpayers must use an accrual method of accounting.

Chairman TALENT. No. What you’re saying, in essence, is that

the sentence, ‘‘The Congress believes that small businesses should

be allowed to continue to use the cash method of accounting or to

avoid the higher cost of compliance,’’ that the term ‘‘should be allowed’’ is not strong enough to overrule the other evidence in the

legislative history which you cite. I would say there’s a conflict

there.

Mr. MIKRUT. No, I think they’re reconcilable. Again, I look at the

word ‘‘continue,’’ which suggests to me that if they were allowed to

use it before, nothing in the 1986 Act says that they cannot continue to use it. The question is: were they allowed to use it before?

And I think the legislation makes it clear that the regulations that

were then in force will continue to be in force—that if merchandise

is an income-producing factor, Congress recognizes an accrual

method is appropriate and required and did not change that area

as well.

Chairman TALENT. Now the next sentence says, ‘‘Congress believes that farming businesses, other than farming tax shelters and

certain corporate farming businesses required to use an accrual

method under the law, should be able to continue to use the cash

method in order to avoid the complexity.’’ Same language: ‘‘should

be able to continue to use the cash method.’’

And then it says, ‘‘Finally, the Congress believes that individuals, whatever the size of activities,’’ and this is, by the way, I

think the reason why we didn’t mention S corps, because S corps

report as individuals. So I think Congress is saying, look, C corps

are covered by the first paragraph here. And then S corps, S corps

individuals, should be able to continue, okay? Whatever the size of

their activities, should be able to continue to use the cash method.

Is Treasury taking the position that you can force the accrual

method on farming operations?

Mr. MIKRUT. No, we are not.

Chairman TALENT. Okay.

Mr. MIKRUT. I think it is the long-standing policy that farmers

are allowed to use the cash method of accounting unless they are

subject to section 447 which requires the use of the corporate

form——

Chairman TALENT. You’re not going after personal services corporations either, right?

Mr. MIKRUT. No, they’re not.

Chairman TALENT. No changes. Because what you’re doing in the

last three years is new. Now it may not be that—it’s a new application—you’re saying it’s a new application of an old policy, but as

far as small business is concerned and as far as the Congress in

1986 would have been concerned, this is new. What you’re doing

is new.

Now I guess the question I’ve got for you is if that language is

not adequate to make clear that Congress intended small busi-
14

nesses to be able to use the cash method if they had been using

it, even if it’s not proper, under your thinking, okay, then why

haven’t you been able to go after the farming businesses now or

personal services corporations? Because we used the same language in the legislative history with regard to all three and this

was a tax simplification bill.

You have read out the juxtaposition that Congress put in here.

We recognized that, yes, it may not be proper, okay, but we want

to allow it anyway. And now you’re saying we only intended to

allow it when it was proper.

Mr. MIKRUT. I think what the legislative history indicates is that

whether a cash or accrual method was allowable was once determined under regulations since 1918. Congress decided to overturn

those regulations for corporations with gross receipts over $5 million, but preserved the regulations for all other taxpayers.

And I think the interpretations——

Chairman TALENT. I know what you’re saying. You said, in fact,

Congress intended by this Act to restrict what you had been doing,

to pull back from cash accounting. What you’re saying, basically, is

that your regulations had been generous in certain instances as regards C corporations and big ones and this offended the Congress,

so Congress is now pulling back and is restricting taxpayers.

And I think you’ve turned it on its head. This is clearly intended

to provide some greater measure of freedom and simplicity to some

set of taxpayers, the small ones, which Congress went ahead and

defined as $5 million; now you’re trying to redefine as $1 million.

And you’re reasserting exactly the same considerations Congress

considered and rejected. It said we understand that you all, you

know, the very smart people like you and accountants who understand all this stuff, it may not fit your world precisely, but we’re

going to let small business people do it anyway.

And I don’t know how much more clear we could have made it.

Certainly your statement is at odds with this, your statement that

it’s clear Congress didn’t intend to permit this is an overstatement.

Mr. MIKRUT. I don’t think so, Mr. Talent, no. Because, again, I

look at the words ‘‘continue to use’’ and I believe it was congressional recognition of when the two methods were appropriate under

the existing law.

Chairman TALENT. Well, and I’m not on the Ways and Means

Committee. And that’s what’s frustrating because you think you do

something here and then you turn around and you find out you

didn’t do it.

I’ll recognize Ms. Kelly. And then, on our side it’s Mr. Sweeney

and Mr. Manzullo. And then on the Democratic Ms. ChristianChristiensen, Ms. McCarthy, Mr. Pascrell. And then the rest of

them are gone. Okay.

Mrs. KELLY. Thank you, Mr. Chairman. Mr. Mitrut, I am looking

at what you’re offering here and talked about. From the standpoint

of having been a small business owner, as a small business owner,

one of the most important things I could do for my business was

help it to grow.

And when I looked at the $1 million cap that you have, I know

full well that it’s the small businesses that are driving the economy

and you know this. This is driving the good, solid economy of the
15

United States right now. The increase in the economy and the increasing number of jobs is being caused by the ability of the small

businesses to grow. If you cap this at $1 million, I don’t see why that doesn’t act as

a chill factor on the small businesses. Because what you then do

is kick the small business, $1 million is small business, when you

kick them in having them file in the same manner that some large

corporation does, you’re costing them a lot of money. And what you

do is you cut into their profitability because they have to hire

somebody, then, to fill out an additional packet. It’s an additional,

basically, acts as an additional tax burden on them.

I want you to defend against what I just said. Because I don’t

see that in anything you’ve said in your statement.

Mr. MIKRUT. Mrs. Kelly, I may have been unclear in my oral statement. What the $1 million, as you said, cap is meant to be is

relief. What we are saying is that, notwithstanding Treasury regulations and notwithstanding what may be in the legislative history,

if a taxpayer is under $1 million in gross receipts and even if they

generally maintain inventories and if merchandise is an incomeproducing factor, the IRS will not question the use of a cash method of accounting. In other words, the $1 million is a safe harbor. We are not

changing the law with respect to taxpayers over $1 million or requiring them to use an accrual method of accounting. We’re saying

for those taxpayers that are under $1 million of average annual

gross receipts, we will not question the use of the cash method with

respect to their operations.

Mrs. KELLY. Mr. Mikrut, what’s your statutory authority for the $1 million?

Mr. MIKRUT. I think there are areas where—the Commissioner

has general discretion. His discretion is generally embodied in 446

that requires a clear reflection of income. There is a——

Mrs. KELLY. I’m sorry, sir, but I do not believe that the Commissioner’s discretion allows the Commissioner to create law. A cap of

$1 million, arbitrarily, pulled out of the air, is essentially creating

law and flies in the face of exactly what the Chairman was talking

about.

Mr. MIKRUT. Yes, but the $1 million is a safe harbor. If the Congress believes that the Commissioner doesn’t have that authority,

doesn’t have the authority to provide that safe harbor and has to

repeal the $1 million, that will force certain small businesses that

maintain inventories to use an accrual method of accounting. That

is something that we’re hoping to avoid, both for purposes of taxpayer compliance and IRS administrative concerns.

There has been developed in the case law what is known as the

SIR test which is Substantial Identity of Results test. And, basically, what the SIR test says is that if you compare your accrual

method to a cash method and get relatively the same answer, that

the Commissioner shouldn’t change that taxpayer’s method of accounting. And we think taxpayers that have less than $1 million

of gross receipts generally will qualify for the SIR test without having to go through all the calculations to make that determination.

So, again, the $1 million is a safe harbor. It is, we think, a significant liberalization of law and not a tightener.
16

Mrs. KELLY. The test you’re talking about only applies if you’ve

got inventory, if I understand. I’m sitting here with the tax code

sitting in front of me and I read it last night. And I want to tell

you, it’s really good bedtime reading. But it seems to me, from the

court decisions that I’ve read, there seems to be confusion about inventory that I don’t see any clarity and I don’t understand what

you mean by simplicity and I don’t understand how you call this

a safe harbor since it seems to me nobody really knows, right now,

what the courts and you are calling inventory.

Mr. MIKRUT. I think that, Mrs. Kelly, that’s why, with the $1

million test as it is, you don’t have to make those inquiries. You

don’t have to make a determination of what is inventory, what is

merchandise, when is it an income-producing factor. As long as

you’re under the $1 million threshold, the taxpayer can choose his

method of accounting.

Mrs. KELLY. But a lot of small businesses don’t have inventory.

My husband and three of my kids are in businesses that don’t qualify for inventory. But my husband’s business, for instance, would

be over your gap. And so all of a sudden you kick my husband and

two of my kids into a situation where you are arbitrarily changing

the law and I really think that you’re making law here in a way

that—I’m very concerned about the way you’re interpreting section

448 (b) and (c). Because, depending on how you interpret that, I

think you could allow that $5 million and not bring it back down

to $1 million. And that’s really what I’m getting at.

Mr. MIKRUT. I’m sorry, Mrs. Kelly, but let me be clear. Just as

we believe that the 1986 Act provision requiring corporations with

more than $5 million gross receipts to use the accrual method, had

no negative inference to taxpayers under that, our $1 million cap,

so that if taxpayers are under the $1 million they can use the cash

method, it will not have a negative inference to say that if you’re

over $1 million, you must use an accrual method of accounting.

We think present law will continue to apply in those cases and

that determination is made under current law and current regulations.

Mrs. KELLY. Mr. Chairman, I’m going to yield back the balance

of my time. I still feel I’ve got a lot of questions here, but I don’t

want to belabor the issue right now. I am going to submit some

questions to you and I want some real answers because I still don’t

feel that you’re doing anything with this except making law. And

I think that’s the right of Congress.

Chairman TALENT. I thank the gentlelady. Ms. ChristianChristensen’s next.

Ms. CHRISTIAN-CHRISTENSEN. Thank you, Mr. Chairman. One of

the next panelists, I believe it’s Ms. Olson, in her testimony is

going to say something to the effect that merchandise is still an unfair term because it’s not clearly defined and it keeps changing and

that should justify raising that ceiling.

Was the fact that merchandise is still an unclearly defined item

that is changing currently, was that something that was considered

when the ceiling was set and do you think it could justify changing

the ceiling?

Mr. MIKRUT. I believe that that was one of the main considerations. Just the general simplicity of cash versus accrual would
17

probably be important enough to liberalize the use of the cash

method. I would agree that recent case law has made it less clear

when something is or is not merchandise.

And we are continuing to look at trying to provide additional safe

harbors through some guidance in that specific area. And, again,

we would hope to try to address all of these as a combined package

of items so not only would we use a $1 million liberalization, but

also try to provide more specific guidance in the merchandise area.

Ms. CHRISTIAN-CHRISTENSEN. And you mentioned also and you

mentioned it again just now that you are considering additional exceptions and safe harbors that would allow the use of the cash

method. What would some of those be?

Mr. MIKRUT. Again, this would be, in determining what is merchandise and in determining when merchandise is significant. If we

could provide certain safe harbors so that taxpayers meet those

safe harbors, they wouldn’t have to go through any further analysis. I think that would be welcome relief. And that’s what we’re

trying to help along.

Ms. CHRISTIAN-CHRISTENSEN. Thank you, Mr. Mikrut. I yield

back the balance of my time.

Chairman TALENT. I thank the gentlelady. We have on the second panel an expert from the ABA who will be happy to clarify this

for us, I’m sure. And will do it, by the way, for nothing, whereas

if she was being hired to do it, it would cost hundreds of dollars

per hour, so it’s one of the advantages we have as Members of Congress.

I’ll recognize the gentleman from Illinois, Mr. Manzullo.

Mr. MANZULLO. Thank you very much. I would have a request,

Mr. Mikrut, that you remain present when this panel testifies.

Could you do that?

Mr. MIKRUT. Unfortunately, Mr. Manzullo, there is a markup in

the Ways and Means Committee this afternoon and I’ll have to be

on hand.

Mr. MANZULLO. But this is 11:00.

Mr. MIKRUT. Well, okay, I really can’t.

Mr. MANZULLO. I would like you to stay here. I think you need

to hear what these people are saying. I think you need to hear

about a lady from Rockford, Michigan, whose small company got

fined $80,000 in penalties and interest based upon the fact of the

confusion at IRS as to whether or not she’s on the cash method of

accounting. You need to hear these stories.

The purpose of this hearing is so IRS hears the clear message

that you are hurting the little people in America. Do you understand that?

Mr. MIKRUT. We have met several times, Mr. Manzullo, as I

mentioned——

Mr. MANZULLO. Can you change your afternoon so you can stay

here?

Mr. MIKRUT. I do not believe I can reschedule the Ways and

Means Committee.

Mr. MANZULLO. What time is that hearing?

Mr. MIKRUT. It’s at 1:30.

Mr. MANZULLO. What do you have to do before that?
18

Mr. MIKRUT. I have to sit in for the Assistant Secretary of Tax

Policy who was supposed to attend the mark-up. And I’ll be sitting

in for him at the desk. So I have to review the statutory language,

the revenue forecasts, and prepare for the questions that may come

up at the hearing, at the markup.

Mr. MANZULLO. What really bothers me is the cavalier attitude

of the IRS in all of this and you reflect it. I have thousands of

small businesses in the congressional district that I represent.

Small people. Some earning under $1 million a year who have been

terrorized by the IRS in this cash versus accrual business. And you

readily admit, don’t you, Mr. Mikrut, that there’s confusion as to

whether or not something is inventory or merchandise. Didn’t you

say that?

Mr. MIKRUT. Yes.

Mr. MANZULLO. Would the IRS consider a regulation, waiving

any interest or penalties on a company that has been audited

which, in good faith, operated on a cash basis which you say should

have operated on an accrual one? Wouldn’t that be fair?

Mr. MIKRUT. Mr. Manzullo, I think that the proposal we put

forth addresses that specific concern so that if you were, again, as

you said, less than $1 million, this would become a non-issue and

you will be able to use whatever accounting method you are allowed to use.

Mr. MANZULLO. What about over $1 million, though? $1 million to $5 million?

Mr. MIKRUT. Again, I think, looking at the authority that we do

have——

Mr. MANZULLO. Do you have the authority to waive any fines or interest on people who have in good faith and grossing between $1

million and $5 million who are forced to go from a cash method to

an accrual basis based upon an IRS audit? Do you have the authority to waive the interest and penalties?

Mr. MIKRUT. We have the authority to waive penalties, but Congress has restricted the ability to waive interest.

Mr. MANZULLO. Thank you. Would you be in favor of Congress

restricting the ability to collect interest in a situation like that?

Mr. MIKRUT. It’s funny that you mention it, because the markup

this afternoon is on the interest and penalty provisions of the Internal Revenue Code. And when one looks at interest, there is a

distinction between interest and penalties and it is appropriate

that penalties be waived for reasonable cause. And, quite frankly,

more penalties are waived than imposed.

With respect to interest, however, interest is a function of time,

value, and money. So, to the extent that a court, for instance, determines that a taxpayer’s liability is higher than it is, it seems appropriate to charge interest to that taxpayer, to treat him as fairly

as a taxpayer that was——

Mr. MANZULLO. That’s really fair. She’s going to testify it’s cost

her $100,000 in interest because of the confusion of the IRS whether or not her business should be based on the cash or the accrual

system. And you are sitting here justifying the imposition of interest in that situation. Is that correct?

Mr. MIKRUT. What I’m saying is that there is no ability for the

IRS currently to waive interest in that situation.
19

Mr. MANZULLO. Would you take a position that IRS should be

able to waive the interest if Congress gave you that authority?

Mr. MIKRUT. I think each case, with respect to the interest/penalty provisions, stand on their own. The IRS has——

Mr. MANZULLO. Let me reiterate this. You’ve got a business here between $1 million and $5 million dollars. These people are strictly

honest. Books are open. They’ve done nothing wrong. All of a sudden, they get audited by the IRS that says, oh, by the way, you

should be on the accrual method and not the cash method. You

never cheated on your taxes and no one’s saying you did anything

wrong. And we’re going to impose $80,000 in fines plus $100,000

in interest.

And you can sit there and you can justify the imposition of that

interest? That’s what you just did.

Mr. MIKRUT. Well, Mr. Manzullo, not knowing the other facts

than those you just said——

Mr. MANZULLO. That’s the facts. That’s all you need to know.

That’s what’s going on here nationwide. When I met with Commissioner Rossotti on this issue, I told him this dentist was a test case

to put all dentists on the accrual system because the little bit of

gold that they may use and some of the dentures that they may

use. And it’s part of a nationwide pattern because now the IRS is

test-casing MDs throughout the nation, trying to force everybody to

go on the accrual system.

I’m saying here today that this is your mission to put as many

people on the accrual system as possible to collect as much money

upfront as possible and, sir, that is bringing terror into small businesses. And I would suggest that you, if you issue more regulations

and issue more guidelines, all you have to do is say, look, we’re just

going to back off. We’re going to make a recommendation that anything under $5 million, we’re going to leave the small business people alone.

Do you realize how much easier that would make life in America

for the hundreds of thousands of small business people?

Mr. MIKRUT. I think in developing our proposal at $1 million, we

did take that into account. Again, I believe the $1 million threshold

takes care of the bulk of them.

Mr. MANZULLO. When you met with the small business groups

when you formulated the last policy, you mentioned that, which

groups were those?

Mr. MIKRUT. I believe the last time we met was, again, it was

on the installment sales provision which was the last time we did

meet. It was the NFIB, it was Chamber of Commerce, the

AICPA——

Mr. MANZULLO. Did you contact the Journal of Small Businessmen?

Mr. MIKRUT. No, we did not.

Mr. MANZULLO. You didn’t. The dentist in my State that you

forced to go on the accrual system is earning under $1 million. So

the IRS, and I want you to listen very closely, the IRS is forcing

small business people earning under $1 million to go on the accrual

system. I want you to take that back to headquarters. Thank you.

Chairman TALENT. I thank the gentleman. Let me state for the

record, because it’s just confusing, I don’t know that in my opening
20

statement or the gentlelady’s we laid out maybe as well as we

should have why this makes a practical difference to small business people.

If you’re, say, an asphalt contractor, you’ve probably been using

the cash method of accounting, which means that you report income as you actually receive it, not at the time when you’re entitled to receive it. And what the Department is now saying, as I understand it, is that if the asphalt you use is more than 15 percent

of your receipts in a given year, then that’s merchandise or inventory so that you are required to report your income as if you were

a store, as if you were a 7–11 or a Walgreen’s or something. Which

means that you have to report the income when you’re entitled to

receive it.

Now, this makes a difference when an account receivable is acquired in a different year than the cash is actually received. So, if

you’re entitled to payment on December 1st but you don’t get it

until January 15, then under the cash method you report that income in the following year; in the accrual method you report it in

the previous year. That doesn’t matter so much if it’s only applied

prospectively in that sense.

But this is the point Mr. Manzullo was making. They come in

and audit and then they go back a few years and say, ‘‘Oh, you reported income in 1998 that you should have—or 1999 that you

should have reported in 1998. So, you owed it for 1998.’’ Even that

is not so bad, but in the interest in penalties then add up to tens

and tens of thousands of dollars.

The other problem is if you report—then those businesses are

forced to treat that as individual rate, and the accrual method is

a harder method from an accounting standpoint. It is more expensive, it is more complex, particularly since it doesn’t really fit the

inventory thing. And, so it is just another hassle.

And, Mr. Mikrut, we are still searching here for some overriding

policy reason that is advanced through some reason of equity or

something other than what accountants learn about matching income with expenditures that requires doing this to these people.

Again, if this was some kind of fraud or quasi-fraud that you needed to—this was a preventative method, you know, we’re going to

make certain they don’t run. But nobody’s—you’re not claiming

that, are you, that these are people trying to get out of it?

[Mr. Mikrut shakes head no.]

Chairman TALENT. So, it comes down to some fairly technical

things about—for the record, the witness shook his head saying no

on that; he is not saying it is a fraud. So, what is the reason to

put these people through all of this?

Mr. MIKRUT. I think, again, the statutory impetus behind methods of accounting are under section 446. Section 446 requires that

the method of accounting clearly reflect income. There are certain

instances where the use of the cash method of accounting will

clearly reflect the income of the taxpayer. However, financial accounting literature, which has been developed well before tax accounting rules, generally acknowledge that an accrual method of

accounting better reflects income, particularly where inventories

and merchandise are involved, and I think that has been the evolution of the law, again, since the very beginning of the income tax.
21

Chairman TALENT. I recognize Mr. Hinojosa for questions he may

have.

Mr. HINOJOSA. Thank you, Mr. Chairman. I am going to refrain

and ask my questions after I hear the second panel.

But before I do that, I do want to echo the same concerns that

my friend, Mr. Manzullo, has voiced for the small business community. We are in the 21st century, and Mrs. Kelly also pointed out

to you that the economy is as strong as it is because of so many

small businesses stepping in and starting up new businesses and

expanding them to create the jobs and give us the economic boom

that they contribute to.

I hope that when this Committee finishes with this issue that we

can come forth with a national policy that will make this a much

more friendly environment for the small business firms, and that

the IRS is cut down to size so that they will not be the big giant

that oftentimes imposes their authority on small businesses and

keeps them from doing their job.

So, again, I am going to wait until we finish with the second

panel, Mr. Chairman, and ask the questions then.

Chairman TALENT. I will finish up with a couple of questions,

one of them I alluded to. And, first of all, Mr. Mikrut, let me just

say that one of the kind of joint objectives we have on the Committee is to prevent—oh, I am sorry, Mr. Bartlett. I didn’t see you

there, Roscoe, you are normally so much more vocal. I am sorry,

Mr. Bartlett, let me recognize him.

Mr. BARTLETT. Thank you very much.

In another life I was a small business person. I ran a land development home construction company. At the end of the day when

I liquidated my company, would I have paid any more or less total

taxes regardless of whether I reported on an accrual basis or a cash

basis?

Mr. MIKRUT. Mr. Bartlett, that would have depended on whether

tax rates had changed over the course of your business.

Mr. BARTLETT. That is correct, but presuming that tax rates did

not change, at the end of the day I would have paid exactly the

same amount of taxes no matter which way I reported, correct?

Mr. MIKRUT. That is correct. What we are discussing here is a

timing issue.

Mr. BARTLETT. Okay. I built spec homes and sold them. If at the

end of the year I had five spec homes sitting there that I had not

been able to sell and I had to use an accrual method of accounting,

I would have to go borrow money to pay those taxes. I didn’t have

the money. Isn’t it true that in the long run the taxpayer, the IRS,

the totality of taxpayers will get as much money regardless of

which accounting method is used? That is true, is it not?

Mr. MIKRUT. Yes.

Mr. BARTLETT. Then, why in God’s Earth do we want to harass

these small businesses? Because at the end of the day—you know,

next year we are going to have as much trouble balancing our

budget as we did this year. Why do you want to harass these small

businesses when at the end of the day we are going to get exactly

the same amount of money from them no matter which accounting

method is used? Why do we want to harass them? I am having difficulty understanding this.
22

Mr. MIKRUT. Mr. Bartlett, that was one of the considerations

again with the broad relief.

Mr. BARTLETT. But my question is, why do you want to harass

them? At the end of the day you get exactly the same amount of

money no matter which accounting method is used. Why do we

want to harass them and increase their costs of doing business,

which is what you are doing?

Mr. MIKRUT. Mr. Bartlett, in a case that you just hypothesized

where you had five homes built but did not sell, would you have

to pay taxes on that? The answer would be no, because you hadn’t

sold the homes yet. It is only in the case where you have sold the

homes where you have to pay.

Mr. BARTLETT. But I improved the value of those homes. They

are there. You could call them inventory.

Mr. MIKRUT. They would be inventory. We would not, though,

however, require a market-to-market type system where the value

that was in those homes would be subject to tax. We would not require taxation until the homes were actually sold and a realization

had occurred. However, again, it is when the event occurs is at the

crux of the issue of a cash versus accrual method of accounting.

Mr. BARTLETT. On several of those homes that I sold I held the

mortgage. I didn’t get that money except by little dribs and drabs

over a 30-year period. If I was on an accrual method, then I would

have to pay the tax on that total sale at the time of sale, wouldn’t

I?

Mr. MIKRUT. Whether you are on a cash or accrual method, if

you took back paper, which you did in your case, it would be a constructive receipt, and you would have had to pay tax in either

event, cash or accrual.

Mr. BARTLETT. How can I pay taxes on money I haven’t gotten?

If I sold all those and held the mortgages myself, I would obviously

have no money with which to pay the taxes. But, again, my question is, why do we want to throttle the most important part of our

economy, small businesses? At the end of the day your responsibility to the taxpayers is achieved—because exactly the same

amount of money is extracted from these small businesses, whether

you harass them or not. Now, why don’t we just let them alone and

use what accounting method they wish, realizing at the end of the

day we get exactly the same amount of money from them?

Mr. MIKRUT. Mr. Bartlett, nothing we are proposing today or any

other guidance would restrict use of the cash method of accounting.

If anything——

Mr. BARTLETT. Well, then you need to sit through our next witnesses here. You really do need to sit through and see what is happening to them as a result of what you are now doing.

Mr. MIKRUT. Again, what we are now doing is trying to provide

guidance, broad guidance, that would allow the use of the cash

method to address some of the concerns we have raised.

Mr. BARTLETT. One of the witnesses will be a drywall contractor.

I build houses. I know who drywall contractors are and what they

do. He now owes you, you say, $80,000. It may be $100,000 when

it is finished, because he chose to use the cash method rather than

the accrual method of accounting. You found nothing else wrong

with his books, nothing wrong with his books at all. Now, I don’t
23

understand why we are doing this to small business. At the end of

the day you get exactly the same amount of money from them no

matter which method they use. Why don’t we just let them alone?

Thank you, Mr. Chairman.

Chairman TALENT. Let me just inquire of a couple areas as we

wrap this up for this panel, because we do have another panel

waiting. One of them is the $1 million figure in your proposed regulation. Now, Congress thought fit to use a $5 million figure as a cut-off,

and whatever that cut-off was intended to signify, and I understand we disagree with that, clearly Congress intended a $5 million

figure to be the cut-off between the small businesses for whom simplicity more likely would be allowed to override other concerns depending on how we interpret that. Congress felt the $5 million figure was good.

We have in the Small Business Act certain definitions of what

a small business is, and it varies depending on the sector. I am not

familiar with $1 million as a test in any statute of which I am

aware. So, would you enlighten me and tell me where you got the

$1 million figure?

Mr. MIKRUT. Again, looking at the $1 million, we looked at the number of taxpayers in existence, and again, $1 million covers the

bulk of those. We also had an income test called a Substantially

Identical Results Test, and we thought $1 million would comport

with that. We also looked at taxpayers as they get larger, in excess

of $1 million, often use the accrual method for financial accounting

purposes, and we thought full tax conformity might be achieved in

those cases.

Mr. MANZULLO. I don’t believe that; I am sorry.

Chairman TALENT. Let us let the witness finish. I mean I understand that—a lot of this is, if I can say, is a cultural thing. I mean

you develop your policy over at the Treasury, and it is important

to have all these considerations in mind. And, of course, we are

dealing, I think it is fair to say, on a more regular basis with the

real people who are having to deal with this. So, Mr. Mikrut is trying to do what he thinks is right from his perspective also.

So, you go ahead and finish. If you have an additional question,

Don, I will recognize you.

Mr. MIKRUT. And, finally, Mr. Manzullo, I do believe because it

was Congress that put in the $5 million threshold for purposes of

corporations required to use the accrual method of accounting, that

this is something that would be best handled legislatively, and I

understand you and other Members have bills, so this is something

that is clearly, I believe, within the purview of Congress to provide

a threshold as far as $5 million.

The $5 million threshold has been used in many instances. For

instance, the Administration proposed, and the Congress passed,

the $5 million exemption from the corporate AMT. So, I mean $5

million is——

Chairman TALENT. Well, why don’t we just use $5 million. I

mean $1 million—there is no reference point for getting $1 million,

and it comes out thin air. And I will tell you, our experience has

been, and I understand why you can’t—typically, I will also say in

defense of the witness because we have given you a hard time, we
24

don’t tell people to come and be prepared to stay for the second

panel. It would be nice if somebody from Treasury were here to listen. And I understand Ways and Means is the Committee you typically report to. But Congress did use the $5 million. The $1 million comes out

of no place, and our experience has been that people that you

would just instinctively think of as small business people—do the

old Justice Stuart test, we will know them when we see them—

often have receipts above $1 million. I think both witnesses on the

second panel who have really been hurt by this have receipts that

are above $1 million.

So, since that is what Congress used, and that is, as you mentioned just a minute ago, that is a test that is out there for a number of different things, for simplicity’s sake, if we don’t overrule

this, you may want to consider the $5 million. And if the point is

to make this simple and consistent, that, seems to me, would be

better. The $1 million comes out of no place. I mean there is no

statutory reference to a $1 million figure, is there?

Mr. MIKRUT. No, there isn’t. Again, the statutory reference is to a clear reflection of income. We thought that taxpayers under $1

million, whether they use cash or accrual, their income would be

clearly reflected in either event.

Chairman TALENT. Yes, and of course, just I will say for the

record, it is something for Congress to deal with, and it is my position that that is exactly what Congress did in 1986, and your interpretation of it is incorrect, but I understand we have a difference

of opinion there.

Let us go to the installment method issue, which I don’t think

we have had many questions on, and is of even greater, I think,

immediate and urgent importance in the small business community. You recognize we have a problem out there with small businesses not being sold that we want to be sold from a policy standpoint because of this installment change. You recognize there is a

problem, don’t you?

Mr. MIKRUT. Yes.

Chairman TALENT. And the Department recognizes that. And I

will tell you that I had a—after we do this, it is quite embarrassing, because this is something Congress did, and I smiled when

I read my opening statement, because my staff was kind enough

to say that the Department recommended this and got us to do

this. But Congress did it, and we should have caught it, I think,

and not done it last year as a revenue raiser. A fellow came up to

me, and he has got a classic thing. He has got a plumbing wholesale business. He wants to sell it, and he can’t now. Because you

recognize that very often small business people sell to other small

business people, right? If you want to say yes, you——

Mr. MIKRUT. Yes, I’m sorry.

Chairman TALENT. Okay. And the purchaser is not able to get a

bank loan financing to buy the whole business all at once; you understand?

Mr. MIKRUT. Yes, sir.

Chairman TALENT. And, so therefore they pay in installment

notes, or notes with the installment payments to the original

owner; you understand that? In essence, the owner finances it and
25

gets a stream of payments over time. And the record will show the

witness is nodding for all this. I am going to start asking some

other questions like, aren’t we right about all these things? [Laughter.]

And, so the effect of the law Congress passed is to make people

pay taxes on the whole amount of the sale when they have only received a fraction, like 10 percent. That is the problem, right?

Mr. MIKRUT. That is the problem.

Chairman TALENT. And I just suggest to you that here there is

no reason even in accounting principles to do this, because just because you are an accrual taxpayer in an ongoing business, we want

to match income and expenses. When you are selling the business

and shutting it down, from your perspective, there is no reason, is

there, from an accounting standpoint to require that you treat the

whole amount as paid even though only a downpayment has been

paid. Even from an accounting standpoint that is not necessary, is

it?

Mr. MIKRUT. Mr. Talent, I think the effects of the repeal of the

installment method for accrual method taxpayers upon small business was unforeseen, and I think that is something that is appropriate for us, and working on that is something where I think the

legislation is very clear, that we need them simply——

Chairman TALENT. Well, I agree. This is not something where

you have discretion, but—and if this is above your pay grade, just

tell me—but can’t the Department just come out in favor of repealing this?

Mr. MIKRUT. I think we, too, believe that the installment method

is very much like a cash method. It should be restricted to cash

method taxpayers. However, we do believe that that overriding tax

policy—that type of tax policy concern can be overridden by the

concerns of small businesses. We think there are going to be concerns, as you mentioned. Liquidity concerns override tax policy concern, so we look forward to working with you to develop something

to take small businesses out of last year’s bill.

Chairman TALENT. Was that a yes?

Mr. MIKRUT. That is a long yes.

Chairman TALENT. A long yes, very good. Well, with that in the

record—and I will just say that I can’t believe that if I had Secretary Summers here or if the head of the administration, the

President, were favoring us with an appearance here that he would

not say yes. I mean this is just this unintended negative hit on people, accrual and other kinds of taxpayers. I mean these are people

who have accrued, they have done all this. They are not involved

in all the rest of this stuff, and all they want to do is sell their

business, and they have to treat large amounts of—they get large

amounts of tax bills, and they don’t have the money. I don’t have

to tell you it is quite embarrassing to go home in a town hall meetings and other meetings, Kiwana or rotary meetings, and have

these people come up to you and have to say we didn’t foresee this.

Can you tell me why—and Congress shares in this—why we didn’t

foresee this? I mean to me it would seem to me to be obvious.

Mr. MIKRUT. It is hard for me to prove the negative, Mr. Talent.

Chairman TALENT. Yes. Well, you all have pushed this, and I

just think we have—when did this get in, in the Conference Com-
26

mittee? The House didn’t do this, did it? Well, the Senate did this;

that explains a lot. [Laughter.]

All right. Don, did you have a further question you wanted to

ask?

Mr. MANZULLO. I have a follow-up question. You stated, Mr.

Mikrut, that one of the policy reasons underlying the use of the accrual methods is that a small business person will sign for a loan,

and the loan application provision will rely on the accrual method.

You said that.

Mr. MIKRUT. I believe what I said, Mr. Manzullo, was that one

of the policy considerations on whether to pick a cash or accrual

method of accounting is simplicity, and to the extent that a taxpayer is not using an accrual method for other purposes, it would

seem that simplicity would indicate they should that tax method

for tax purposes as well. But to the extent that they perhaps are

using an accrual method for other purposes——

Mr. MANZULLO. What are these other purposes?

Mr. MIKRUT. Financial accounting purposes, reporting to shareholders, reporting to creditors.

Mr. MANZULLO. Do you have actual proof of that?

Mr. MIKRUT. Well, I do not get involved with an individual taxpayer applying for a loan, but, yes, I have——

Mr. MANZULLO. I mean do you have actual proof of what you just

said?

Mr. MIKRUT. Yes, there are instances where creditors will ask for

supplemental statements with respect to the accrual method of accounting.

Mr. MANZULLO. Creditors.

Mr. MIKRUT. Yes.

Mr. MANZULLO. Well, what has this got to do with the small

business person? Do you think he determines the questions that

are asked of him by his creditors?

Mr. MIKRUT. No, Mr. Manzullo. I was just stating that there are

instances where the accrual method is used for purposes other than

tax purposes.

Mr. MANZULLO. State that again for me.

Mr. MIKRUT. The accrual method is generally accepted—comports

with generally accepted accounting principles. It is generally used

to report the financial results of a business.

Mr. MANZULLO. Wait a second. Financial results? Now, this is a

business under $5 million.

Mr. MIKRUT. I believe the accrual method is used and inventory

methods are used for businesses under $5 million, yes.

Mr. MANZULLO. This is for a widely held corporation.

Mr. MIKRUT. They are mandated for widely held corporations.

Mr. MANZULLO. There are a lot of widely held corporations that

have assets, sales under $5 million. There are just millions of them

across this country, would you agree?

Mr. MIKRUT. No, I would not.

Mr. MANZULLO. Yes. Well, that is the whole point. So, what you

have done is you have taken a few isolated occasions where someone may have used the method other than the cash method, and

you penalize that small business person. That is what you have

just done.
27

Mr. MIKRUT. Well, Mr. Manzullo, I was simply suggesting that

there are instances where full book and income tax conformity are

appropriate, and accounting methods are one of those instances.

And that can be done on a case-by-case basis, not——

Mr. MANZULLO. But you said that as a matter of policy. You said

one of the reasons that you want to impose an accrual system is

that many of these businesses use an accrual system for purposes

other than filing their income tax returns. You made that statement.

Mr. MIKRUT. The statement I made was that an accrual method

of accounting, if it is used for book purposes, does not require any

additional complexity for a small business, at least not for tax purposes.

Mr. MANZULLO. I want you to refer to a document in writing with

your name on it the number of companies in this country that are

using a cash method of accounting to the IRS, at the same time

using an accrual method of reporting anything else to their shareholders. Do you have any idea how many there are across the nation?

Mr. MIKRUT. I can provide you with information as to how many

taxpayers are using the cash method or the accrual method for tax

purposes, but that does not necessarily then tell us for

financial——

Mr. MANZULLO. You don’t have the answer to my questions, and

you have just made a very bold statement that a policy reason for

using the accrual method is that people on the cash basis are out

there using the accrual methods for something else, and you have

no proof. You have none.

Mr. MIKRUT. Mr. Manzullo, I do not believe that is what I said.

Mr. MANZULLO. I know what you said. I want you to furnish a

letter to my Subcommittee on Taxation and put—write this down—

down the number of small businesses in this country that have receipts under $5 million, gross receipts under $5 million, that are

on the cash method, and then the number that are on the accrual

method. And those that are on the cash method, how many outside

activities they are doing including whatever you mentioned that

they are using the accrual method of taxation.

Chairman TALENT. If the gentleman will yield. I think it is a

fruitful line of questioning. We have another panel. So, what I

would ask the gentleman, encourage him to do is to file in his Subcommittee, and maybe I am sure Mr. Mikrut would be pleased to

come back and appear before——

Mr. MANZULLO. I will have you meet my Subcommittee along

with the drywall man, along with the tax lady from the ABA.

Chairman TALENT. And then follow that up, and I would encourage the gentleman to do it. And this is something that the Committee is going to pressure on, both without and within the Congress.

Mr. Mikrut, thank you for coming and for your patience, and we

will look forward to working with you in the future.

And I will adjourn the first panel and ask the witnesses for the

second panel to come forward.

[Recess.]
28

What I am going to ask the witnesses to do is to summarize your

testimony if your written testimony is of any length. And that is

not because we are not interested but really because we are, and

members are going to want to ask questions and have plenty of

time for that. So, I imagine the questioning here may be a little

bit less adversarial than it was in the last panel.

Our first witness today is Mr. Shane Mieras, a project manager

for Mid-Ceilings and Drywall in Rockford, Michigan, who is here on

behalf of the Associated Builders and Contractors.

Mr. Mieras.

STATEMENT OF SHANE MIERAS, PROJECT MANAGER, MIDCEILINGS AND DRYWALL, ROCKFORD, MICHIGAN, ON BEHALF OF THE ASSOCIATED BUILDERS AND CONTRACTORS,

WASHINGTON, DC

Mr. MIERAS. Good morning, Mr. Chairman, and members of the

Committee. My name is Shane Mieras, and I am co-owner of MidMichigan Ceilings and Drywall, located in Rockford, Michigan. Associated Builders and Contractors is a national trade association

representing more than 22,000 contractors, subcontractors, material suppliers, and related firms from across the country including

all specialties in the construction industry. ABC has 82 chapters

across the country.

Chairman TALENT. Shane, if you put the microphone a little closer to you, it would be better.

Mr. MIERAS. Mid-Michigan Ceilings and Drywall has been a

member of ABC for approximately three years. We would like to

thank Chairman Talent and House Small Business Committee

members for hosting this hearing today.

Mid-Michigan Ceilings and Drywall is a small commercial

drywall company that was established in 1990. I currently employ

22 people. I came to Washington today to testify on my real-life experience of currently being audited by the Internal Revenue Service

based on my company’s use of the cash method of accounting. As

many of you know, the cash basis method allows deductions for expenses to be taken in the year paid and reporting of income in the

year the cash is received.

Approximately two years ago, the IRS called on Mid-Michigan

Ceilings and Drywall and initiated an audit for tax years 1996 and

1997. Our sales at the time of audit were only $1.7 million. We

have always kept our books on the cash basis, because it is a simple and easy method of accounting. There is really no need to hire

outside professional accountants when using this method. My business never had any intention of converting to the more complex

and time-consuming accrual method, because we are such a small

company.

In October 1998, the IRS informed us that we owed approximately $80,000 in interest and underpayments as a result of using

the cash method of accounting. Our case is in the final stages of

appeal, and I have been advised that the final assessment could be

as high as $100,000.

At Mid-Michigan Ceilings and Drywall we keep a clean set of

books. No other tax problems were identified during the audit other

than the fact that we were using the cash method of accounting.
29

The IRS’ reason for this assessment on Mid-Michigan Ceilings and

Drywall is because they feel we are merchandisers. We disagree.

We are not merchandisers. We install commercial drywall and have

never sold drywall to the public without installing the drywall. The

IRS concedes that we do not have inventory on hand. However,

that is not good enough to refute the IRS’ use of the merchandise

argument.

What is troubling is that the IRS can force small businesses to

change from a legal, simple accounting method to the accrual method. Mid-Michigan Ceilings and Drywall is a small business and

pays taxes on cash we collect minus expenses paid. By forcing us

to the accrual accounting method, we will now incur an added expense of having to hire professionals to maintain our books. Speaking of professional help, we have also hired a tax attorney to fight

this unfair assessment by the IRS. This has resulted in approximately $5,000 in legal fees to date, in addition to the assessment

made by the IRS.

Of course the obvious problem now for my company is determining how we are going to pay the IRS. Since this money is not

available to us through the business, we will have to seek a bank

loan to pay the assessed taxes, penalties, and interest. The bank

interest payments alone will cost us between $10,000 and $15,000

per year. A $100,000 tax burden is a huge sum of money to a small

business such as ours. This huge arbitrary assessment by the IRS

will definitely hurt my company’s growth potential and limit my

ability to hire new employees.

A couple of goals we have set up for year 2000 are now in jeopardy. We need to purchase new work trucks, and new equipment

such as scaffolding and tools. Most importantly, we would like to

build our own building so we can expand the business, and hopefully hire more employees. This tax burden imposed by the IRS will

take away money that we could use for growing the business. Our

bank also is withholding a line of credit to the tune of $50,000 until

the final outcome of this case is determined.

We all know that business investment is what is driving this

economy right now. We will be forced to sit on the sidelines due

to lack of capital because of this unfair tax assessment. Lastly, this

tax payment will make it harder for us to improve our wages and

benefits to our employees and is also forcing us to rethink charitable giving until our financial solvency is determined.

I understand that any corporate business that does over $5 million has to use accrual accounting. Someday at Mid-Michigan Ceilings and Drywall we hope to reach $5 million threshold and will

plan on converting to the accrual method at that time. Right now

it is unfair to treat Mid-Michigan Ceilings and Drywall any differently from other small businesses by converting us to big business accounting.

The IRS’ position on which businesses should be using the cash

method or accrual accounting is not based on any specific section

of the Internal Revenue Code, but on a series of court cases successfully litigated by the service. Hence, the IRS is not enforcing

the law, they are making it. Congress should amend the Internal

Revenue Code to clarify that small businesses can keep using the
30

cash method of accounting even if the IRS argues that they have

inventory or merchandise as a material income-producing factor.

Two legislative proposals before Congress would permit small

contractors like Mid-Michigan Ceilings and Drywall to continue to

use the cash method of accounting without fear of audit, penalties,

and interest. H.R. 2273, introduced by Small Business Committee

Chairman Talent and Ways and Means Committee member, Phil

English, and S. 2246, introduced by Senate Small Business Committee Chairman Christopher Bond and Senate Finance Committee

member, Charles Grassley, have both been endorsed by the ABC

National Tax Committee and would provide relief to small businesses like Mid-Michigan Ceilings and Drywall.

Mid-Michigan Ceilings and Drywall joins ABC in urging members of the Committee to advance these proposals in the next tax

bill considered by Congress. Small businesses are the backbone of

the economy and our country’s economic engine. We urge you to

enact this legislation into law to ensure that small contractors can

operate their businesses without living in fear of the IRS.

I would like to thank Chairman Talent and the Committee members for allowing me to present Mid-Michigan Ceilings and

Drywall’s concerns regarding this important issue. I stand ready to

answer any questions the Committee may have.

[Mr. Mieras’ statement may be found in appendix.]

Chairman TALENT. Thank you, Mr. Mieras. If you pay the whole

$80,000, you at least have the pleasure of knowing you kept the

Federal Government open for a nanosecond.

Mr. Dave Wulkopf, who is a CPA and the treasurer of Beckner

Painting, where he began working as a painter in 1986, continued

working the summers until 1992, and now handles all tax and accounting issues. And you were promoted to treasurer in 1993. Appreciate your coming here, David.

We’ll go ahead with this. We haven’t had the second bell yet,

have we? I don’t think so. Go ahead, and we may have to recess

this in the middle of your testimony, but go ahead, please, David.

STATEMENT OF DAVID E. WULKOPF, CPA, TREASURER,

BECKNER PAINTING MIDWEST, INC., ST. LOUIS, MO

Mr. WULKOPF. Okay. My father is actually the owner of the company. I am the treasurer.

Chairman TALENT. Go ahead.

Mr. WULKOPF. Beckner Painting was founded—we are a small

painting company located in St. Louis, Missouri. The primary focus

of our work is interior and exterior apartment painting. We also do

some limited residential and commercial work. We employ up to 80

people in the summers and as few as 15 during the winter months

as the workload slows down.

Since the company was founded over 30 years ago, we pay our

taxes on the cash basis of accounting, as permitted by section 446

of the Internal Revenue Code. The company has annual revenues

of $2 million to $3 million, and we do not maintain inventories.

Therefore, at least we thought the company qualified as a small

business, as defined by section 448, and we thought we were permitted to use the cash method of accounting.
31

In 1995, we were the subject of a random audit of our 1992 Federal income tax return. The IRS did not find any changes that

needed to be made as a result of this audit. Then again in September of 1998 we were notified that we were going to be audited

on our 1996 Federal income tax return. Once again, there were no

changes that needed to be made with the exception of this cash

basis issue that is before us today.

The reasoning behind the proposed changes is kind of a stretch.

Even though we provide a service and do not sell anything directly

to the public, because our material cost, such as the paint, is more

than 15 percent of our revenues, the IRS claims that we have merchandise which is an inventoriable item. Since we have an

inventoriable item we are required to use the accrual method of accounting even though we do not carry any physical inventory.

The reason for the change can be masked in a number of different ways, but the bottom line is obvious. The motive behind the

Treasury Department policy is to speed up the collection of tax revenues and to collect the tax on the accounts receivable. If we had

accounts payable that were higher than our accounts receivable, we

would not be in a position of having to defend ourselves from this

proposed change.

It is understandable that the Treasury Department would want

to expedite the collection of tax revenues, but it seems no thought

is given to how unfair this policy is to small businesses.

Chairman TALENT. Well, David, what they basically did was they

took an enactment, section 448, which was intended to make clear

that businesses like yours could use the cash method if you had intended to do it, interpreted it as saying that you can only use the

cash method when they would otherwise have said you could use

the cash method anyway, and then changed their interpretation of

when you could use the cash method so as to substantially restrict

it and treat people who are not in the business of merchandising

or do not have an inventory as if they do. So, they interpreted the

law and are trying to make it consistent with their practices, and

then they changed their practices in order to go back and fleece you

out of, what, $200,000?

Mr. WULKOPF. Yes.

Chairman TALENT. That is a good days work. Go ahead.

Mr. WULKOPF. Under this new policy, accelerating the collection

of tax revenues is done at the expense of small businesses who

have been allowed to report on a cash basis for years. These companies are currently being selected for audit and forced to change accounting methods. This change in accounting methods causes an

enormous tax liability that is a result of years of cash basis reporting to come due. Most small business do not have large sums of

cash available to pay taxes on money that is not yet received.

The effects of this proposed change would be devastating to

Beckner Painting. We operate in a very competitive industry, and

cash flow is always a concern. There are numerous sole proprietors

in the painting industry that operate with little overhead and can

undercut the prices of established companies like Beckner Painting. As an established company we do offer higher quality work

and tend to be more reliable, but if our prices get too high many
32

customers will switch to these sole proprietors in order to save

some money.

Therefore, we must constantly keep our costs down and our cash

flow is usually tight. There is rarely a payroll period that goes by

that we are not concerned about having cash needed to make the

payroll. With the minimum wage increasing seemingly everyday,

this cash flow gets even tighter. In addition, the company has to

continually repair and replace painting equipment, like power

washers, sprayers, ladders, trailers, and vehicles, and these costs

further limit cash flow.

Should the IRS succeed in making us change our method of accounting, the amount of tax due is well beyond the cash we have

on hand. Therefore, we would be required to borrow money to pay

the tax. Not only is forcing the company to borrow money to pay

tax fundamentally unfair, but it would put us in a very vulnerable

position. The amount of money we would need to borrow, close to

$200,000, would max out our borrowing resources and put us a bad

year away from bankruptcy.

The primary unfairness of this new policy is that we have paid

our taxes on a cash basis since the company was founded. We were

not even asked to change during the 1992 audit. Then in 1996,

when our receivables had grown, we were told that we needed to

change accounting methods. The difference between paying our

taxes on a cash basis versus an accrual method is minimal year by

year, but it is the one-time hit of the change that is damaging.

Our case has not yet been resolved. It has been going on for more

than a year and a half now, and the time and money spent on trying to defend the case has put a serious strain on our resources.

We have spent countless hours examining invoices, preparing

schedules, and researching position guidelines. We are afraid to invest in any new equipment, because we may need the money to try

to pay the tax resulting from the proposed change.

Beckner Painting has grown from a small summer hobby to a

successful small business. Being a small business it is hard enough

to comply with the seemingly endless stream of Federal, State,

local, and industry regulations. Policies like this makes it even

more difficult. Small businesses face many unique challenges in defending themselves from policies such as this. It is not only unfair,

but it could jeopardize our continued existence. That is why we are

here to support Congressman Talent’s bill, H.R. 2273.

[Mr. Wulkopf’s statement may be found in appendix.]

Chairman TALENT. All right. I have to thank you, David. I have

to recess the hearing now, because I have got to go vote, but as

soon as I think Mr. Sweeney gets back we will just have him reopen the hearing, and then you all can begin testifying so we can

expedite this.

I recess the hearing.

[Recess.]

Mr. MANZULLO [presiding]. We are reconvening the hearing. The

next witness is Roger Harris, who is president of Padgett Business

Services in Athens, Georgia.

Mr. Harris.
33

STATEMENT OF ROGER HARRIS, PRESIDENT, PADGETT

BUSINESS SERVICES, ATHENS, GA

Mr. HARRIS. Thank you, Congressman Manzullo. It is a pleasure

to be here and to have the opportunity to speak to the Committee

about cash versus accrual and the installment sale. As you mentioned, my name is Roger Harris of Padgett Business Services, and

we have been providing accounting and tax services to small business for over 30 years. I have been involved in that for over 25

years. We have about 15,000 businesses that we represent, and the

topic of this hearing has become of great importance to our clients.

I don’t think we can have any discussion about this topic without

reiterating what has been said before. What we are talking about

here is nothing but an issue of timing. Income and expenses will

always get reported under any method of accounting. And I think

we also have heard this morning that there is no debate about the

fact that the cash method is a much simpler method of accounting.

Therefore, it seems strange to me that there is any argument that

when all we are talking about is timing, why are we not looking

for a way to have a broad definition of business that can use the

simplest method of accounting as opposed to trying to find a way

to narrow the definition.

I think the problem we face today in most taxation is complexity,

and yet we are hearing arguments that we should make things

more complicated for some unknown reason when taxes are not

really the issue. It is just the timing of paying the tax. We became

aware of the difficulties in this area when we, through our foundation, did a survey of our client base to look at the effect that the

current regulations would have, which is based on the 30-year old

Wilkinson-Beane case, and we found many cases where people

would be forced to change their method of accounting if the current

regulations were continued to be enforced. That has a short-term

cost, as you may have heard here, in taxes, interest, and penalties,

but it also has a greater long-term cost in the complicated accounting procedures that must go on forever.

Another thing I find interesting that we have not heard here

today in any of the testimony up to this point is that changing from

cash to accrual can also produce a refund. It is very possible that

the change can have an effect that lowers income. I would challenge anyone here—if the IRS and Treasury are so concerned about

the accurate reflection of income, produce the number of cases

where they forced a change that produced a refund. I think you will

find very few, if any, of those cases.

So, I am not sure that the reflection of income is the real issue.

I am also amazed when I listen to the inside the Beltway explanation from Treasury that a clear reflection of income requires our

clients to pay tax on money they don’t have yet. I don’t think they

will understand that logic.

I also have to refer directly to—Mr. Manzullo, you asked a question about two sets of record, one for lending institutions, one for

the business, and the answer related to the fact that this is done

to report to the shareholders. I think that shows a clear lack of understanding in Treasury about how small business operates. In

most small businesses, all the shareholders live in the same house.

It doesn’t require a separate set of statements to explain how the
34

business is doing. They live it, and they breathe it. And I know in

our client base it is extremely rare that we produce a second set

of records for a bank. Small business operates a lot of different

ways, and they don’t have to produce two sets of records except in

very rare occasions.

I want to change the subject a minute to the installment sale,

because, clearly, this was something that when the rule changed in

December, created a real ripple effect through our offices and small

businesses in terms of how serious an effect this change could

have. As everyone, I think, recognizes on this Committee, people

sell their business as part of their retirement. And it is very difficult to find someone who will pay cash for a small business. Financing over a number of years is almost a necessity.

But in the meetings when I hear Treasury state that since you

are using the accrual method of accounting, the only accurate way

to bill your business is to report all the income up-front in the year

of sale. I don’t understand why they don’t understand that selling

an inventory item off the shelf and waiting 30 days for a payment

is nothing like selling their business and waiting 10 years to get

paid. I think the only real fix to this serious problem is the repeal

of the installment sale bill that was passed, and go back to something that had worked extremely well for a number of years.

I see my time is about up. I realize I deviated completely from

what I had written, but I welcome any questions that you many

have. Thank you.

[Mr. Harris’ statement may be found in appendix.]

Mr. MANZULLO. Thank you very much.

Our next witness is Pamela Olson, who is the Chair-elect of the

Section of Taxation of the American Bar Association. She is also

partner in the Washington law firm of Skadden and Aarps.

Ms. Olson.

STATEMENT OF PAMELA F. OLSON, CHAIR-ELECT, SECTION OF

TAXATION, AMERICAN BAR ASSOCIATION

Ms. OLSON. Good morning. Thank you. I appreciate the opportunity to be here.

My name is Pam Olson, and I am Chair-elect of the ABA Section

of Taxation. I am testifying today on behalf of the Section of Taxation. I have another tax expert with me. Her name is Helen Hubbard. She is the immediate past-Chair of our Tax Accounting Committee and was a principal drafter of our testimony.

We appreciate the opportunity to appear before the Committee

today to address issues causing both considerable complexity for

small business and continuing controversy between small businesses and the IRS. Our prepared statement addresses both the

use of the cash method of accounting by small business and the repeal of the installment method of accounting.

Since the House has passed legislation retroactively reinstating

the installment method, I am going to limit my remarks this morning to small business use of the cash method of accounting, but I

would be happy to respond to questions on either topic.

Over the past year, the Tax Section has testified twice on simplification of the tax law. In February, we joined with the AICPA

Tax Division and TEI in releasing a list of proposed simplification
35

items. Permitting the use of the cash method of accounting for

small business, which we would define as those with gross receipts

of $5 million or less, was included in our testimony and on our February list of proposed simplification items.

The Treasury Department recently announced that it intended to

issue guidance permitting businesses with gross receipts of $1 million or less to use the cash method of accounting. We applaud the

Treasury Department for taking this step, but we do not believe $1

million in gross receipts provides sufficient relief from the complexity the accrual method of accounting creates. So, we would go

further than they have gone.

Requiring small businesses to use the accrual method of accounting subjects them to complex rules and recordkeeping, substantially increases the cost of compliance for these taxpayers, and creates cash flow problems. The characterization of a taxpayer’s income as income from the purchase, production, or sale of merchandise requires that the taxpayer use the accrual method, which increases income for the year of change by the excess of the taxpayer’s accounts receivable over its accounts payable, and follow

the inventory accounting rules, which defer deduction of the cost of

merchandise on hand. If a change to the inventory and accrual

methods is required on audit, small businesses are likely to face

substantial adjustments attributable to the deferral of deductions

and acceleration of income, plus, as we have heard this morning,

interest and, in many cases, penalties.

Generally, the permissibility of the cash method varies depending on the type of entity, the business and activities of the taxpayer

and the gross receipts of the taxpayer. Current law requires businesses that purchase, sell, or produce merchandise to apply the inventory accounting rules and use the accrual method of accounting.

Although taxpayers and the Service have spent considerable resources contesting whether particular items constitute merchandise, the issue has never been consistently resolved.

For example, last week, in a case that was noted earlier this

morning, the tax court in a deeply divided opinion held that concrete used by a construction contractor was not merchandise. This

result may have appeared obvious to the IRS following the Tax

Court’s decision, we noted in our prepared statement, but it was

not in fact obvious to them. It was also not obvious to the six

judges of the Tax Court who dissented in two separate dissenting

opinions. If the Tax Court cannot agree on whether a particular

item constitutes merchandise, imagine how difficult it is for small

businesses to make this determination.

This problem will only increase with the growth of the new economy. For example, is electronic information inventory or is the

business providing a service? If the business is providing a service,

are its materials supplies or are they merchandise?

There are other complications. Under the regulations, any taxpayer receiving any income from the production, purchase, or sale

of merchandise must use the accrual method of accounting for its

purchases and sales unless the Commissioner determines that another method of reporting will clearly reflect income. But the courts

have compared the cost of merchandise with the taxpayer’s total
36

gross receipts in determining whether merchandise is an incomeproducing factor.

The decisions suggest that de minimis inventory purchases do

not necessarily make merchandise an income-producing factor.

While this provides relief for some taxpayers, it also adds additional complexity and is a source of controversy between companies

and the IRS trying to figure out whether or not they fit in that category. The result of all of this is some businesses cannot easily determine if they have merchandise inventory that requires them to

keep inventories and consequently whether they must use the accrual method of accounting.

We have several recommendations in our prepared statement. I

would just note that we do recommend that small business be allowed to use the cash method. We also recommend that small businesses not be required to keep inventories and not be subject to the

rules of section 1.162–3 of the regulations that defer the deduction

of supplies.

We believe the adoption of these proposals would achieve considerable simplification for small businesses and eliminate the considerable controversy that currently exists between taxpayers and the

Service regarding inventory accounting and the use of the accrual

method of accounting.

We appreciate your interest in this matter. We would be pleased

to answer your questions and to work with the staff.

[Ms. Olson’s statement may be found in appendix.]

Mr. MANZULLO. Thank you very much. Our next witness is John

Satagaj?

Mr. SATAGAJ. Satagaj. I have been a witness for the last 20

years, and no one has gotten it right, Mr. Congressman.

Mr. MANZULLO. Well, try Manzullo. I was 14 before I could pronounce it myself.

Mr. SATAGAJ. That is right. My wife kept her maiden name, 25

years.

Mr. MANZULLO. Okay. All right, that is good. Anyway, John

Satagaj is the managing—you have got a name like Talent that is

very easy. Do you want to introduce the next witness?

[Laughter.]

Would you like to pronounce—why don’t you pronounce his last

name.

John Satagaj is the managing partner from London and Satagaj

in Washington, on behalf of the Small Business Legislative Council.

Mr. Satagaj.

STATEMENT OF JOHN S. SATAGAJ, MANAGING PARTNER, LONDON AND SATAGAJ, WASHINGTON, D.C., ON BEHALF OF THE

SMALL BUSINESS LEGISLATIVE COUNCIL

Mr. SATAGAJ. Thank you very much.

Mr. MANZULLO. Thank you.

Mr. SATAGAJ. Mr. Chairman—see that is how you get around it.

I am happy to be here. As you noted, I am John Satagaj, president

of the Small Business Legislative Council, and also a tax lawyer.

Unlike Skadden and Aarps, our firm is London and Satagaj, and
37

we are the two partners. So, we are on the other end of the size

spectrum of a tax law practice.

I want to address a couple of specific issues that we talked about

here today rather than what is in my statement. Pam just mentioned a moment ago about one tax case that was recently decided

and the precedent that was set in that case, all regarding this

whole issue of the inventory.

There has actually been three cases recently on this. There was

a case in November in the medical field, there was this case that

involved the concrete construction company, and there was another

one the day after. The concrete case was released on Thursday;

there was another case reported on Friday of a sand and gravel

hauler that came out in favor of the IRS. The first two decisions

were in favor of the taxpayer; the third one was in favor of the IRS.

The court is split, each half feels very strongly a different way. It

does illustrates that you can’t fix this by the regulations, the administrative process, or letting this go through the courts, because

it just is an unresolvable issue. That is why we have asked Congress to set the bright line, make the decision, and say this is the

way it is going to be. We are kidding ourselves if we think we are

ever going to resolve this through the courts.

Interestingly enough, and it brings me to my second point, in all three of those cases, guess the size of the taxpayer. Between $1

million and $5 million. All three of them are in that area. And that

brings me to the point about the $1 million. First of all, we never

heard a clear explanation today of how you can do this administratively at $1 million—and you went along this line of questioning—

but not do it for $5 million. And the truth of the matter is when

you put the faces on these businesses such as we got right next to

us, these businesses between $1 million and $5 million, a very important part of the small business constituency.

The administration talked percentages, the number of businesses that would be exempt under $1 million. There are a million, business taxpayers, between a $1 million and $5 million—a million taxpayers. That is a lot of taxpayers. But more importantly, not only

are those, just by their numbers, important, those are the ones you

see in the Kiwanas, the rotary, the local chamber, the ones who are

creating the jobs in your communities. Those are the ones who are

going to be in this no-man’s land between $1 million and $5 million.

There are another 750,000 with between $500,000 and $1 million

in receipts. Those are all the businesses that Ms. Kelly was talking

about who will look and say, ‘‘Do I grow my business?’’ Seven hundred and fifty thousand taxpayers with gross receipts between

$500,000 and $1 million. So, you have got a million seven hundred

fifty thousand, and those are the small businesses that you see in

your district.

Chairman TALENT [presiding]. Let me jump in, John, because I

am going to have to leave, and I wanted to ask the witnesses—and

you will have a chance to give your statement too, and you can answer this too—is my reading—in your judgment, is my reading of

section 448 correct, that Congress already tried to address this?

Ms. Olson, if you would like to jump in on this too. I mean what

is——
38

Mr. SATAGAJ. Abe and I were here in 1986. Unfortunately, the

bad news, we have been representing small business a long time,

and I would say your reading is what we believe to have happened.

But it also illustrates how we can argue this thing till the cows

come home, and they are never going to concede the point and why

we need your legislation. Because we will debate this forever. We

believe, like you, that is what it was, but there is no sense in beating them over the head.

Chairman TALENT. Well, I am going to talk to Mr. La Falce who

was here and I am sure he took an interest in this issue and would

be able to give us his opinion.

Ms. Olson, do you have an opinion on what section 448 is intended to do, and don’t hesitate to——

Ms. OLSON. I must admit that I actually think that section 448

was intended as a revenue raiser; in other words, that it was supposed to provide clarity as to when people had to be on the accrual

method as opposed to permission. So, I am afraid I sort of fall into

Treasury’s view on that.

Chairman TALENT. Sure, that is all right. I recognize that there

are other points of view, although I am kind of looking at it less

from a legal stand as if I were there at the time. And I am reading

that language and I am thinking the sensible thing would have

been to establish these bright line tests, and also there is some language in there that just is not consistent really with believing that

it was intended to restrict the ability of taxpayers rather than free

taxpayers.

Abe, do you have a comment?

Mr. SCHNEIER. Mr. Chairman, I happened to bring my tax reform

and a conference report, and as you were reading this morning, it

is a section from the Conference Committee report: The House bill

generally provides that the cash method of accounting may not be

used by any C corporation, by any partnership that as a C corporation was a part of any tax exempt trust. Exceptions are made for

foreign businesses, qualified personal service corporations, and entities with average annual gross receipts of $5 million or less for

all prior taxable years. I didn’t think it had to get much clearer

than that.

Chairman TALENT. Yes, and this was a point I tried to make. The

same language is used with regard to the farmers and the personal

service corporations as is used with regard to C corporations under

$5 million. So, if the service is correct, or the Department is correct, it didn’t provide any extra rights to C corporations under $5

million, then it certainly did not provide any extra certain rights

or certain safe harbors to the farmers or personal service corporations, which means they can go after farming operations next

under that theory. But they haven’t done it. They are starting to

go after the personal service corporations like the dentists.

So, maybe that is their view, but, clearly, I would say—knowing

how this Congress typically feels about agricultural operations, I

don’t think—you know, when we need to find a safe harbor for the

farmers, by heaven, we provide the safe harbor for the farmers.

And I read all three of those the same. And, so let us just get rid

of this issue. And I understand how they get into the corporations—Mr. Harris, do you have——
39

Mr. HARRIS. Yes, I think you can also look at the repeal of the

installment sale provision. I remember when it first passed and everybody ran around and said, ‘‘How could you do this to small business?’’ The common answer we were given was that if your revenues were under $5 million, you are case basis, therefore you are

exempt. So, when it is convenient, I think that is a good definition

to use.

And that would be why counsel over at Ways and Means would

have felt this would not have a big impact on small business. If

they are assuming that everybody under $5 million is cash basis

that would explain, why they felt it would not have a big impact,

and I don’t have any gripes about the Ways and Means staff, they

are not telling us something they didn’t believe. And that would explain it, wouldn’t it. Because they are thinking if you are under $5

million, you are reporting on the cash basis anyway, so the installment repeal doesn’t apply to you.

Mr. SATAGAJ. The important thing I think about the law is what

you talked about regarding the interest and the penalties. Aside

from how we interpreted it all and whether they meant that or not,

look at all the taxpayers that have been following that rule as the

way of doing business. Literally hundreds of thousands of small

businesses continued on the cash accounting since 1986, and now

they get whacked. They get hit with the interest and the penalties.

So, even aside from our interpretation, just look at the practical

impact on those businesses since 1986 that have continued with

that type of tax accounting.

Chairman TALENT. Yes, you guys can jump in if you want. Abe,

I guess we will let you give your statement at some point, and I

want to hear what you have to say. I think we all understand the

issues pretty well, and I think we understand what we need to do

with regard to both issues.

Mr. SATAGAJ. Do you want me to continue finishing up my statement.

Chairman TALENT. Oh, I am sorry. Yes, John, you can.

Mr. SATAGAJ. Okay. I will be quick.

I just want to make a couple of other points. We just talked

about the audit. I want to talk about the installment sale method

briefly, because there has been continuing confusion. It was mentioned again here today why don’t we use this $1 million test also

for use of the installment sale method. This is mixing apples and

oranges. When you sell the business you are talking about the

sales of assets. What we are talking about in their debate on cash

accounting is gross receipts in a year. There is no way to compare

these two things, and in fact to the case of installment sales of the

business even the $5 million limit doesn’t make sense.

I prefer repealing the installment repeal outright. But if I was

going to do something I would look at IRC section 1202 where

there is a definition, for venture capital purposes, of small business: the limit is $50 million, based on assets. If you are going to

do limit asset sales, let us use a definition based on assets. That

would make more sense than $1 million or $5 million. Repealing

the darn thing would be best.
40

Chairman TALENT. By the way, can this raise any revenue? I

don’t think it is going to raise revenue, is it, because people just

aren’t going to sell or they are going to find some other way to sell.

Mr. SATAGAJ. You are going to structure around it. We all know

the advice we start giving to folks when this happens. It is not the

best way. You are losing some money or you are going to lose a little bit of a premium.

Final thing I wanted to bring up is I did sit in on a couple of

meetings at the IRS about cash accounting, not the installment

method repeal. This has gotten blurred here. I can tell you when

the idea of $1 million was brought up, we said there is no way this

makes any sense. We believe you must go with the $5 million limit.

It makes the most sense for many reasons. We believe they should

have done so in 1986 and perhaps drafted a little more clearly.

And that concludes my statement, Mr. Chairman.

[Mr. Satagaj’s may be found in appendix.]

Chairman TALENT. Abe, we will go on to you.

STATEMENT OF ABRAHAM L. SCHNEIER, PARTNER, MCKEVITT

& SCHNEIER, WASHINGTON, D.C., ON BEHALF OF THE NATIONAL FEDERATION OF INDEPENDENT BUSINESS

Mr. SCHNEIER. Thank you, Mr. Chairman.

Mr. Chairman, my name is Abraham Schneier. I am a partner

in the firm of McKevitt & Schneier, and I am a consultant on tax

issues to the National Federation of Independent Business. On behalf of the 600,000 members of the NFIB I appreciate the opportunity to present the views of small business owners on this short

subject of the cash method of accounting.

I would like to address a couple of points that were made earlier.

First of all, in terms of Mr. Mikrut claiming that 97 percent of all

small businesses fell into the category of $1 million or less, the

problem with Treasury statistics of income is they are highly aggregated. The real measure includes many part-time businesses

and many businesses that have no employees. If you really look at

the number of small businesses that have employees, you come up

with a population closer to six million in total, and of that population I think we would find that the numbers would diverge quite

a bit from that $1 million threshold.

The $5 million number was clearly what we thought we achieved

in 1986. It was clearly the intention of the proposals that took

place during the committee. I was as distressed as anybody to find

out later on that, well, the provision did not mean exactly what we

thought it meant.

In terms of how the regulations are being pursued, the IRS has,

obviously, an enforcement issue involved here, and I think that the

biggest point we can make is that enforcement would be assisted

by a clearer line. The last thing the IRS can afford right now is

to have a lot of agents who are just focusing on these very small

accounting method issues. They really need to be focusing their resources in areas that are more productive in terms of policy issues

and their impact on small business.

This approach does not gain the IRS, it doesn’t gain the Federal

Treasury anything. As we have said several times here today, we

are talking about timing shift, whether the inventory is deductible
41

in 1999 or 2000. The typical small business owner in these circumstances clearly believe that cash flow is their biggest problem,

day-to-day, week-to-week operations. He is looking to pay his rent;

he is looking to pay his employees; he is looking to pay for supplies;

he is looking to pay for the needed costs of running his business.

Cash flow is where he goes.

The accrual method of accounting puts him in a very difficult position, especially as you get to the end of fiscal years where you

have artificial numbers coming into play, creating an artificially

high tax situation. We believe, as you do, that the $5 million

threshold really should be where the line should be drawn and that

the rules, as they apply to businesses under $5 million, should be

much clearer than they are right now. The efforts in terms of trying to define when a business actually has inventory, whether or

not to impose percentages of gross profit as some kind of a line of

demarcation really would help specific industries, but I think we

need to really sort of clarify it across the board for all small businesses.

I would be happy to answer any other questions. We have covered so much ground. And I want to compliment the members of

the Committee for an excellent discourse on this issue, which can

be pretty complex, and, frankly, I haven’t heard as good a discussion on the Ways and Means Committee.

[Mr. Schneier’s statement may be found in appendix.]

Chairman TALENT. All right, I will recognize the gentlelady from

New York, and thank her for her patience.

Ms. VELA ́QUEZ. Sure. Thank you, Mr. Chairman. Mr. Harris, in your testimony you indicate that the $1 million

gross receipts threshold, which is being proposed by Treasury, is

inadequate to prevent hardship to small businesses, and that even

a $5 million threshold may not be suitable in some cases. What

standard would you propose or recommend?

Mr. HARRIS. Well, certainly, there has to be a reality check of

what is reasonable, but revenue is not always the best way to determine the size of the business. That, in large part, has to do with

what it is that you sell—the smaller the item, the smaller the

price. I think total assets could be used, it could even be a combination of things: Assets of under a certain amount, sales of under a

certain amount. You meet one of two tests.

And I think the danger is that we try to find a very simple solution to a very complex issue of what is a small business, and I really don’t know where $1 million came from. That just came out of

nowhere. I guess if I was going to be stuck with a revenue number,

I would use $5 million, because there is already some precedent.

But I think we should look for a real definition of how to define

a small business, and I think assets may be better in some cases,

as I mentioned in my testimony, that an insurance agency could

have $25,000 worth of assets and one employee and do over $1 million in revenue, and that is not a large business under any definition. So, I would like to see a definition that truly defines small

business and doesn’t eliminate a true small business.

Ms. VELA ́QUEZ. Thank you.

Mr. Schneier, with regard to installment sales, do you believe it

necessary to repeal the restriction on the use of installment method
42

as proposed in H.R. 3594 or would you support trying to find some

sensible middle ground? For example, can we say that businesses

with gross sales of less than $5 million should be allowed to choose

whether they can use the installment method?

Mr. SCHNEIER. Given the confusion that this provision has sort of engendered, I believe that repeal really is the way to go. The $5

million threshold only creates, I think, an additional barrier for

some businesses in terms of understanding where they are going

to be when they go and sell their business. The issue for most businesses is who can I sell to? And I can only sell to another small

business owner who is going to pay me over a period of time.

You don’t want to create a situation where the small business

owner is going to be taxed on income he has yet to receive, and I

think the $5 million threshold really doesn’t achieve that for a

large number of small businesses who would not fall into that category.

Ms. VELA ́QUEZ. Thank you.

Mr. Satagaj.

Mr. SATAGAJ. Satagaj.

Ms. VELA ́QUEZ. Thank you. Is it a problem with regard to the

cash versus accrual accounting method and now an issue that primarily affects businesses which do not have large inventories of

goods for sale or is it broader?

Mr. SATAGAJ. Well, it certainly affects a lot of folks in that it goes

beyond the people who commonly think if they have goods, because

when you get into, for example, the osteopathic case I mentioned

earlier, the one in the fall, or a veterinarian who is giving a shot

to an animal and the IRS considers the material in the needle as

merchandise. Never in their wildest mind would they think that

that material is at issue here. It would have never occurred to

them. So, the answer is it is much broader than just folks who

would normally think of themselves as selling merchandise.

Ms. VELA ́ZQUEZ. If Congress were to legislate in this area, are

there competitive implications where our decisions might either tip

or level the playing field in a particular field of owners?

Mr. SATAGAJ. That is a good question. The answer is probably no

in that this is a timing issue primarily, not competition vis a vis

another business. This has to do more with your personal survival.

Abe talked about cash flow, and this is the ability of a particular

taxpayer to be able to pay his/her taxes when he/she has to pay

them. So, I don’t know if it has a competitive advantage or disadvantage. It is more related to the direct survivability of that particular firm.

Ms. VELA ́ZQUEZ. Thank you.

Ms. Olson, as a tax expert, are there cases where you would recommend to small business clients that they use the accrual accounting method instead of the cash method? And can you give specific examples of where the use of the accrual method might be

beneficial to a small business?

Ms. OLSON. Quite frankly, no, I cannot think of a situation when

I would recommend that a small business use the accrual method

of accounting.

I also want to note that there were questions about companies

keeping books for financial purposes that would be kept on the ac-
43

crual basis versus the cash basis. And I just want to note that for

financial accounting purposes there are very different rules that

apply to how you accrue your income and expenses versus what the

tax rules are. And so just because a company may be keeping some

financial books and records on the accrual basis for purposes of

showing a bank or whatever wouldn’t necessarily mean that those

books and records would be the books and records that they would

need in order to properly prepare their tax returns on the accrual

basis.

So, the answer to your question is no, and I also wanted to add

that other highlight.

Ms. VELA ́ZQUEZ. I want to address resolve the non-taxed costs associated with the small business using the accrual method of accounting as opposed to cash method. From your experience, is the

average small business equipped to handle the necessary paperwork that goes with it?

Ms. OLSON. I think the answer is no. Most small businesses are

not equipped to either do the accrual accounting or to keep the inventory accounting or to keep the supply accounting that might be

required by the section 162 regulations. And that is why we recommended that small businesses be allowed to use the cash method and to not keep inventories and to not inventory supplies as

well.

In addition to the costs of doing so, the controversy costs have

to be taken into account, because to the extent that you end up at

some point fighting with the IRS about whether or not you have

to do it, you also obviously significantly increase the cost to small

business.

One other point I want to note is that with regard to the question about section 448 and what Congress thought they were doing

in 1986, the IRS’ administrative practice doesn’t always stay constant; in fact, it probably generally doesn’t stay constant. So some

of the things that I think are going on today that have excited the

gentlemen at the table with me probably weren’t happening in

1986, because I don’t think the IRS at that point in time was aggressively pursuing dentists or veterinarians or contractors.

So while Congress may have done one thing in 1986, they might

not have appreciated what the IRS might do with those rules subsequently, and so we may end up with different results today were

Congress to look at what is happening today in IRS administration

rather than what was happening in 1986.

Ms. VELA ́ZQUEZ. Can you tell me if a small business is forced to

seek assistance from a tax lawyer or a CPA to comply with the accrual basis accounting requirements, what other kinds of additional

expense would that person incur?

Ms. OLSON. I wonder whether this gentleman might not be in a

better position to answer that question than I am.

Mr. HARRIS. Are you talking about the direct cost of the service

that they would incur versus the——

Ms. VELA ́ZQUEZ. Yes.

Mr. HARRIS. Certainly, the size of the business would have a lot

to do with it, but I think it is very unlikely that a small business

owner is going to understand accrual accounting well enough to do

most of what is needed. Maybe they can do some basic internal rec-
44

ordkeeping. But, clearly, at the end of the year and on a regular

basis they are going to have to solicit an outside firm to make all

the proper adjustments and end up with statements that they don’t

understand, because they understand the in and out of money, the

money in the checkbook. And when all of a sudden you bring them

a set of financial statements that have no bearing whatsoever to

their money in their bank account, they wonder what they just

paid for.

Ms. VELA ́ZQUEZ. Mr. Olson, can you tell us what will be the average payment if a person has to seek a tax expert or a tax lawyer

or a CPA to comply?

Ms. OLSON. Yes, to prepare the return? I am not sure—again, we

probably should have had somebody here from the AICPA to try to

answer that question, but I would guess that the fee is going to be

something between—for a very small business, something between

$5,000 and $10,000, probably closer to the high end of that. And

that is probably a minimum kind of number. It might in fact be

considerably more than that.

Ms. VELA ́ZQUEZ. Thank you. Thank you very much.

If the person is doing the work, using the cash method, how

much it would be instead of the accrual?

Ms. OLSON. So, it is the difference between keeping it—I mean

I think that to a certain extent there is probably not a real big difference in the cash method versus the accrual method. The additional work is probably going to be attributable to the recordkeeping that that taxpayer had to do him or herself in order to

make sure that they have all of the additional information.

So, what you are probably talking about is, as opposed to somebody who, as he mentioned, can pretty much look at their checkbook and say, okay, it is December 31, this is my balance, therefore, this is my taxable income for the year. Instead you have got

to keep all the records on the accounts payable and the accounts

receivable and perhaps inventory, perhaps supplies, and factor

those in as adjustments to what you see as the balance in your

checkbook. So, I think it is going to be more of a burden on the

taxpayer, him or herself, to keep records as opposed to the additional cost for the accounting.

Mr. HARRIS. Yes, I would just like to second that, and say I think

the real cost is during the year internally as opposed to the actual

preparation of a document or tax return at the end of the year. And

the only way I think you would see a substantial increase there is

when people have not done a good job during the year, and now

it is left to the firm to come in at the end of the year and correct

all the mistakes. But I think the real cost is during the year as opposed to at the end of the year.

Mr. SATAGAJ. I might make one point on this. One of the great

ironies is you can have what I call phantom inventory. You can actually begin and end the year with no inventory and have the internal responsibility in the course of the year because the IRS says

even if you have zero liability you still have to do this during the

course of the year. So, you can be incurring this cost, the internal

cost, of maintaining inventory. Mr. Bartlett was talking about his

five houses. You could clean your inventory out. You could have

zero houses at the beginning of the year, zero at the end of the
45

year, but go through the year and still be required by the IRS to

be on inventory accounting. So, you still get to go through that

whole game for zero at the end of the year.

Ms. VELA ́ZQUEZ. Thank you.

Chairman TALENT. Dave, did you want to respond to that same

question? Here is a guy, grew your family business and became a

CPA, and now you are going to law school to fight the IRS.

Mr. WULKOPF. I was just going to say——

Chairman TALENT. Especially with a name like David.

Mr. WULKOPF. For a cash basis taxpayer, it is just like paying

your individual taxes. A person who can do their taxes regularly

can probably do the cash—their business taxes on a cash basis. But

when you have to convert to an accrual basis where you have to

report prepayment of expenses, accrued vacations, and you have to

accrue expenses and payables and receivables, it gets a little complicated, and the average taxpayer probably could not, and that is

when you are going to have to hire the outside counsel which is

going to cost at least $5,000 to $10,000.

Chairman TALENT. That would be during the course of the year

to keep those records——

Mr. WULKOPF. You could have a firm come in on a quarterly

basis or monthly basis and help you out, but if you convert it at

the year end, that is a $5,000 to $10,000 expense every year that

you have to incur just to report. And like we said all along, there

is no difference in the amount of tax that is going to be paid. This

is all a timing difference.

Chairman TALENT. I want to ask a question of Ms. Olson, but before I do that, Dave, I am sorry that I missed your testimony. I was

running off to exercise my constitutional obligation to vote on that

particular rule that we had. My understanding is that the IRS has

come against—this is your family painting company?

Mr. WULKOPF. Correct.

Chairman TALENT. And how many employees do you have?

Mr. WULKOPF. During the summers, we can get up to around 80,

90 painters, but in the winter months it is pretty lean, probably

around 15, maybe 20.

Chairman TALENT. And they want $200,000?

Mr. WULKOPF. Correct.

Chairman TALENT. Including interest?

Mr. WULKOPF. They have said that they know it is a gray area,

so——

Chairman TALENT. Have they waived penalties?

Mr. WULKOPF. They waived the penalties, but they are not going

to waive the interest.

Chairman TALENT. So, they can’t waive the interest.

Mr. WULKOPF. Correct.

Chairman TALENT. Because of the United States Congress. I

would be interested in knowing if somebody could research the

amount of penalties and interest that the IRS has collected from

attacking cash payers that it forced to go from the cash basis to

the accrual basis. Does anybody have any idea how much—just on

this table here, Shane, it is $100,000 for you; David, it is $200,000,

and, Shane, I have referred to you as the drywall man, forgive

me—but you have 22 employees.
46

Mr. MIERAS. That is correct.

Chairman TALENT. And, David, you have normally 15, blossom

up to 80 with the college painter signs and everything. That is

$300,000, and you guys are little. But I would be interested in finding out how much is out there, and maybe that is what the IRS

is trying to do. Where they make the money is not on the cash

versus the accrual basis but on screwing the taxpayer with the interest and the penalties.

Mr. WULKOPF. And it is the one-time hit. I mean they have let

us report on a cash basis for years and your accounts receivable

continue to grow, and then all of sudden they want the tax in one

lump sum payment, which is close to $200,000, which obviously

most small businesses don’t have that kind of money laying

around.

Chairman TALENT. Don’t keep that on hand.

Pam, my question here is—could you expand on the tax section

simplification recommendation to allow small businesses at or

below $5 million to use cash method even if they use merchandise

or inventory? This is Mr. Talent still. Do you understand my question?

Ms. OLSON. Yes. Well, for purposes of simplifying the law, which

is something that the ABA Tax Section has tried hard to be an advocate for, for a number of years, and we are making a big push

again now, because we really think that people have become just

overwhelmed by the complexity in the law, we think that the value

to small business of being able to essentially look at that business

checkbook on December 31 and know what their taxable income is

for purposes of figuring out how to pay their taxes is the right way

to go. Now, granted, they will have to go through and segregate

things for purposes of putting them on the tax return, but we really think that is the right way to go.

And we also think that inventory accounting is too complicated,

that most small businesses just don’t keep adequate records in

order to properly do that. We think that the questions that have

been raised over the last few years, in particular about whether or

not things that might be called supplies in fact are merchandise

and therefore require inventories, could be taken care of by eliminating the requirement that small businesses keep inventories.

And then the final piece is the regulations under section 162,

which would defer deductions for supplies. We think that similarly

should be addressed, because you don’t want to end up with the

IRS reversing course from saying, ‘‘well, it is merchandise, and

therefore you have to keep inventories, and since you have to keep

inventories, you have to be on the accrual method of accounting’’,

to saying, ‘‘well, okay, but we still got you on the supplies, because

really these things aren’t merchandise. Now we think they are supplies, and so since they are supplies you can’t deduct them under

section 162’’.

There is obviously some possibility for people to play games in

this area, but we, frankly, don’t think that the possibility is significant, because there are too many costs. If you are on the cash

basis, you have to shell out the cash in order to buy the inventory.

You have to defer getting the payment. We don’t think that people

are going to incur over $1 in expense in order to save 35 cents in
47

taxes. We just don’t think that is going to happen. So we really

think you could achieve significant simplification for small business

by going this way.

Chairman TALENT. I appreciate that.

Let me ask you a question about our friend, the dentists. There

is really no one from the IRS here. No one has been here from the

IRS that knew anything today or answered any questions except of

trying to come up with these different explanations as to what Congress intended. But do you feel that if a dentist is forced to go on

the accrual system that this is going to make him less willing to

do pro bono cases? I mean people that come in that he ordinarily

would do as charity, they are going to say, hey, your services are

done. You are entitled to be paid, and whether or not you get paid

for a person who is indigent that is totally irrelevant.

Mr. SATAGAJ. Interestingly, if you apply the textbook, you would

end up with a liability in certain cases, I suppose an offsetting deduction later on for a charitable contribution of some kind.

Chairman TALENT. But you can’t use your service, render it as

a charitable contribution, obviously.

Mr. SATAGAJ. Right, and there would be no way to do it, therefore it would be ridiculous.

Chairman TALENT. When I practiced law years ago, probably 20

to 30 percent of my practice was pro bono. I mean these were just

very unfortunate people who lived literally across the track. They

couldn’t afford an attorney, and if I had to report my income based

upon the value of my services to them as finalized, that would

make me less willing to do it. But I think this a real hit on professionals that want to help out the people that are faced with real

problems in society.

Mr. HARRIS. I think the real danger there if people are going to

be required to report their income when they provide the services,

there are people who could come into the dentist office and say,

‘‘Look, I need this work, but I can’t pay you today,’’ the dentist

won’t accept them, because they are going to have to report the income even though they did not get any payment. They are only

going to be able to accept people who either have insurance that

will provide full payment or people that have the capability to provide full payment. It is going to discourage the dentists ability to

work with people that need time to pay for the dentist services. I

think that the real danger is that these people will find it very difficult to go out and have services provided, because they don’t have

the ability to pay for it up-front.

Mr. SATAGAJ. There is an interesting point here with this also in

the African trade bill. There is a provision about eliminating the

ability of accrual taxpayers to write off based on experience some

bad debts. And when we talk about pro bono, we are essentially

talking about what would be a bad debt. Right now, in the current

tax law, if you are on accrual, you do have a cash-like provision

that allows you to write off a certain amount of bad debts based

on what your experience is. The provision in the African trade bill

eliminates that for many folks.

So, now here is the kicker: If we move all these taxpayers that

are currently taxpayers in the $1 million to $5 million range, from

cash to accrual, not only do they go on accrual, they find out that
48

they have lost the ability which you had in the past to adjust for

that bad debt. So, you have double whammy, as if it were, because

with cash bad debts don’t matter from a tax standpoint.

So, that is one of the ironies of this thing, how complex it is getting. Not only are we changing it here, but it will have that effect

on that accrual provision in the African trade bill. We have the impact on the installments sales, so it is getting pretty complicated

in terms of where we are driving these businesses and what they

are willing to do, and I think the net result would be as you suggest, that you are going to look hard at whether you are going to

provide any lenient terms for anybody that comes into your business, because you are going to say, ‘‘Wait a minute. I am an accrual

taxpayer, and I can’t write off the bad debt. Forget it, I am not providing service unless you can pay for it.’’ So, I think you have got

a good point.

Mr. MANZULLO. In the case of Shane with the drywall, someone

would give you a call and say, ‘‘I need—’’ is it commercial or residential?

Mr. MIERAS. It is commercial.

Mr. MANZULLO. Commercial. They would say I want my building

done. And you would keep no drywall on hand.

Mr. MIERAS. None.

Mr. MANZULLO. None whatsoever. You have no storage, because

essentially you operate the business out of a home if you wanted

to.

Mr. MIERAS. Yes, you could. We would call a supplier and they

deliver the materials, and we place them.

Mr. MANZULLO. And does the supplier bill directly the cost of the

drywall to the owner of the building?

Mr. MIERAS. No, that is billed to us.

Mr. MANZULLO. That would be billed to you. Would the situation

be different if there had been a direct bill from the supplier to the

owner of the building? Suppliers don’t want to do that, because

they want to get paid, of course, and they rely upon you. But would

that have made any difference in the kind of value of that drywall

as inventory? Anybody?

Mr. SATAGAJ. From the interpretation of the law, the issue is

timeliness. You wouldn’t have to include it in an inventory if it was

truly billed directly to the consumer or the customer, because it

wouldn’t come into your inventory. But that means he doesn’t take

any title. Most of it is drop-shipped.

Mr. MANZULLO. Yes, you just show up.

Mr. SATAGAJ. And it shows up, and it is under the case law here

that is considered taking title in that case. So, only if it went

straight to the site and was billed directly to the owner of that

building or whoever is building it, then it would not show up.

Mr. MANZULLO. But if it was billed directly to the contractor,

then the contractor would have to show that as inventory, and it

would be shift from the sub to the contractor.

Mr. SATAGAJ. Exactly, exactly.

Mr. MANZULLO. So, everybody gets screwed.

Mr. SATAGAJ. Right. It gets even worse. And, actually, under current circumstances that is a little bit of the problem, building down

the process.
49

Mr. SCHNEIER. This also shows the importance of the regulatory

process and how it affects the law, how the regulatory review process is so important to small business to be involved when the IRS

is going to reinterpret a particular area, saying whether or not inventory is applied here or whether or not it should be applied in

this particular circumstance. And the concern that we have had

over the years of the fact that IRS has always exempted itself from

the regulatory review process, claiming that they were simply interpreting the statute. Obviously these changes in interpretations

have the effect of changing the law in many circumstances.

Mr. SATAGAJ. That is a commercial message for Congressman

Talent bill stuck in the House. Let us move that one forward too.

Mr. MANZULLO. That is what we were discussing here. I am trying to think back as to when I practiced law from 1970 to 1992

when I was elected to the House of Representatives. And I represented a number of small business people. I am trying to look

back at the qualitative and quantitative distinction as to what difference does it make if you have inventory on hand? I mean, it just

sits there. We have problems back home—McHenry County is the

fastest growing county in the State of Illinois; it is in my congressional district. And we do have lots of nurseries, and you nod your

head.

Mr. SATAGAJ. One of my favorite clients, keep going.

Mr. MANZULLO. And there they are with their stock on which

they have to pay taxes even though it is stuck in the ground growing for six months. Is that correct?

Mr. SATAGAJ. Well, they actually have a whole separate provision. I have been fighting that for 20 years. The IRS would like to

shut that down as well. No inventory whether they are on cash or

accrual. They are not required to inventory, because it is impossible to do it. So, they have a special exemption.

Mr. MANZULLO. Okay. Well, I would—if any of you has any questions that you would like me to convey in my official letterhead to

the IRS witness, please contact Phil Eskeland from my staff or

Ligia here, and I will be glad to work with Mr. Talent to formulate

questions, not with regard to particular cases but perhaps general

principles and answers that they have never given you. I would

like to see how they would respond to a Member of Congress who

asked that same question.

Did you have anything further?

Ms. VELA ́ZQUEZ. No.

Mr. MANZULLO. Okay. Well, listen, we really appreciate your

coming here, appreciate your sitting through the bells and our voting. Don’t give up. You can tell that this really is a non-partisan

movement in order to bring some resolution to this problem. I

would encourage you to continue to stay in contact with your member of your House of Representatives and your two Senators to

keep this issue hot and not to stagnate it.

This Committee is adjourned.

[Whereupon, at 12:50 p.m., the Committee was adjourned.]
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