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24–070 2017

START-UPS STALLING? THE TAX CODE AS A 

BARRIER TO ENTREPRENEURSHIP 

HEARING 

BEFORE THE

COMMITTEE ON SMALL BUSINESS 

UNITED STATES 

HOUSE OF REPRESENTATIVES 

ONE HUNDRED FIFTEENTH CONGRESS 

FIRST SESSION 

HEARING HELD 

FEBRUARY 15, 2017 

Small Business Committee Document Number 115–003 

Available via the GPO Website: www.fdsys.gov 

SBREP-219A with DISTILLER


Congress.#13
(II) 

HOUSE COMMITTEE ON SMALL BUSINESS 

STEVE CHABOT, Ohio, Chairman 

STEVE KING, Iowa 

BLAINE LUETKEMEYER, Missouri 

DAVE BRAT, Virginia 

AUMUA AMATA COLEMAN RADEWAGEN, American Samoa 

STEVE KNIGHT, California 

TRENT KELLY, Mississippi 

ROD BLUM, Iowa 

JAMES COMER, Kentucky 

JENNIFFER GONZA ́ LEZ-COLO ́ N, Puerto Rico 

DON BACON, Nebraska 

BRIAN FITZPATRICK, Pennsylvania 

ROGER MARSHALL, Kansas 

VACANT 

NYDIA VELA ́ ZQUEZ, New York, Ranking Member 

DWIGHT EVANS, Pennsylvania 

STEPHANIE MURPHY, Florida 

AL LAWSON, JR., Florida 

YVETTE CLARK, New York 

JUDY CHU, California 

ALMA ADAMS, North Carolina 

ADRIANO ESPAILLAT, New York 

BRAD SCHNEIDER, Illinois 

VACANT 

KEVIN FITZPATRICK, Staff Director 

JAN OLIVER, Deputy Staff Director and Chief Counsel 

ADAM MINEHARDT, Minority Staff Director 

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(III) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Hon. Steve Chabot ................................................................................................... 1 

Hon. Nydia Vela ́zquez ............................................................................................. 2 

WITNESSES 

Mr. Kyle Pomerleau, Director of Federal Projects, Tax Foundation, Washington, DC ............................................................................................................. 4 

Mr. David Burton, Senior Fellow, Economic Policy, Institute for Economic 

Freedom and Opportunity, The Heritage Foundation, Washington, DC ........ 5 

Mr. Tim Reynolds, President, Tribute Inc., Hudson, OH, testifying on behalf 

of the National Small Business Association (NSBA) ........................................ 7 

Troy K. Lewis, CPA, CGMA, Tax Executive Committee Immediate Past 

Chair, American Institute of CPAs, Provo, UT ................................................. 9 

APPENDIX 

Prepared Statements: 

Mr. Kyle Pomerleau, Director of Federal Projects, Tax Foundation, Washington, DC ..................................................................................................... 31 

Mr. David Burton, Senior Fellow, Economic Policy, Institute for Economic 

Freedom and Opportunity, The Heritage Foundation, Washington, DC . 37 

Mr. Tim Reynolds, President, Tribute Inc., Hudson, OH, testifying on 

behalf of the National Small Business Association (NSBA) ...................... 49 

Troy K. Lewis, CPA, CGMA, Tax Executive Committee Immediate Past 

Chair, American Institute of CPAs, Provo, UT .......................................... 78 

Questions and Answers for the Record: 

Questions and Answers from Representative Radewagen to David Burton 96 

Questions and Answers from Representative Radewagen to Kyle 

Pomerleau ...................................................................................................... 97 

Additional Material for the Record: 

The Like-Kind Exchange Stakeholder Coalition ............................................ 100 

Statement for the Record from Karen Kerrigan, President & CEO, Small 

Business & Entrepreneurship Council (SBE Council) ............................... 104 

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(1) 

START-UPS STALLING? THE TAX CODE AS A 

BARRIER TO ENTREPRENEURSHIP 

WEDNESDAY, FEBRUARY 15, 2017 

HOUSE OF REPRESENTATIVES, 

COMMITTEE ON SMALL BUSINESS, 

Washington, DC. 

The Committee met, pursuant to call, at 11:00 a.m., in Room 

2360, Rayburn House Office Building. Hon. Steve Chabot [chairman of the Committee] presiding. 

Present: Representatives Chabot, Luetkemeyer, Brat, 

Radewagen, Kelly, Blum, Schneider, Bacon, Fitzpatrick, Vela ́zquez, 

Evans, Murphy, Lawson, Chu, Adams, Espaillat, and Gonza ́lezColo ́n. 

Chairman CHABOT. Good morning. I call the Committee to 

order. 

We want to thank everyone for being here. A special thanks to 

our witnesses who have taken time away from their busy schedules 

to be here with us today; we greatly appreciate that. We will introduce them here very shortly. 

In the coming weeks and months, Congress will have a once-ina-generation opportunity to pass comprehensive tax reform, the 

likes of which we have not seen since Ronald Reagan’s historic tax 

reforms back in the 1980s. 

While economic indicators remain mixed at best, there is no denying that new business creation remains in a long-term decline. 

We hear it from our constituents back home and from the witnesses who come to this hearing room to testify every week. 

The current Tax Code discourages entrepreneurs from taking the 

kinds of risks they once did, and this will have serious economic 

consequences, both in the short-term and in the long-term. 

Entrepreneurs face any number of challenges as they try to start 

a new business, but a recent National Small Business Association, 

NSBA, survey found that tax regulatory compliance is the number 

one most burdensome area. 

While there are many reasons for this aversion, including 

Obamacare and overregulation, today’s hearing will focus on what 

is perhaps the greatest barrier to entrepreneurship, our broken Tax 

Code. 

For instance, there are a number of specific provisions in the current Tax Code that directly penalize the risk-taking entrepreneur. 

In my view, these provisions prioritize government growth through 

revenue collection over economic growth, and that is exactly the 

wrong approach. We need to keep the bigger picture in mind. 

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America’s entrepreneurs are crying out for tax relief and this 

Committee is listening to them. They want a Tax Code that is simpler, fairer, and flatter, so they can start and grow their businesses 

and turn their dreams into reality. As we work closely with Chairman Kevin Brady and our colleagues on the Ways and Means Committee, this Committee will ensure that small business and entrepreneurship is front and center for any tax reform effort this time 

around. 

The bottom line is that our current tax system is working against 

entrepreneurs too often when it should be working for them. We 

have to do better. And fortunately, with A Better Way agenda as 

our roadmap, we will do better. 

Today we will examine specific barriers in the Tax Code to entrepreneurship. We will also explore some possible solutions to tear 

down those barriers. 

I am looking forward to hearing from our witnesses here today, 

and I would now like to yield to the ranking member, Ms. 

Vela ́zquez, for her opening statement. 

Ms. VELA ́ ZQUEZ. Thank you, Mr. Chairman. 

Today, one in ten Americans are self-employed. As we speak, another seven percent of American workers are actively trying to 

start a business. These trailblazers provide significant benefits to 

the economy. They take risks to start new businesses, bring new 

products to market, and ultimately, create new jobs, or even industries. As a matter of policy, we should be encouraging this type of 

risk-taking. Unfortunately, outdated and increasingly complex tax 

provisions create obstacles to success rather than a means of stimulating growth and job creation. Today’s tax code contains thousands of provisions from the ordinary, like deductions for office 

supplies to tax credits to advance public policy goals, like the use 

of renewable fuels. This level of complexity makes complying with 

the law difficult and expensive, a burden that hits America’s entrepreneurs hardest. 

This committee is well aware of the challenges created by the Internal Revenue Code and the major complications it has on business planning. Unlike their larger counterparts, many small firms 

cannot afford to spend significant resources on tax experts to assist 

them. Instead, many entrepreneurs spend countless hours trying to 

comply with an arcane tax code drawing them away from their 

usual business operations. These difficulties bring us to something 

that everyone on this committee likely agrees upon: importance 

and value in reforming our tax code. Of course, doing so will be a 

significant undertaking and the devil will be in the details. 

I agree with the chairman that in any comprehensive tax reform, 

small businesses must be front and center and not an afterthought. 

One important detail is making sure corporate tax reform also includes changes for our nation’s 28 million small businesses. Successful tax reform that simplifies the code will give small businesses greater certainty and allow them to spend their time and resources on what they do best: launching new products and creating 

new jobs in their local communities. 

There have been areas of progress that suggest we may be able 

to find other common ground in reforming the tax code. This committee was particularly supportive of making permanent a number 

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3 

of tax extenders, such as the R&D tax credit and Section 179 expensing. Solidifying these changes for the long term gave small 

businesses certainty, allowing them to plan for the future. 

Mr. Chairman, I think all of us understand the vast array of tax 

compliance challenges facing entrepreneurs. The difficulty will be 

identifying viable solutions we can all get behind and hopefully implement. This will not be an easy task, but I do hope there is room 

down the road for cooperation and progress. I look forward to today’s testimony, and I thank all the witnesses for the time that you 

are taking away from your businesses or jobs to be here today. 

Thank you. 

Chairman CHABOT. Thank you very much. Thank you. The 

gentlelady yields back. 

If Committee members have opening statements, we would ask 

that they be submitted for the record. 

And before I introduce our distinguished panel here this morning, just a brief overview of our timing and our rules, which is the 

5-minute rule. Each of you will get 5 minutes. The green light will 

be on for 4 minutes. The yellow light will come on to let you know 

you have got a minute to wrap up, and the red light will come on, 

and we would ask that you try to stay within that if at all possible. 

We will give you a little leeway, but not a whole lot. 

So again, thank you for being here this morning. Our first witness is going to be Kyle—is it Pomerleau? Pomerleau, okay, thank 

you, director of Federal Projects for the Tax Foundation in Washington, D.C. In that capacity, he leads the tax modeling team, oversees the center’s research, and researches and writes on a variety 

of Federal tax issues. His work has been cited in most major media 

outlets throughout the country. 

Our second witness will be David Burton, senior fellow in Economic Policy at The Heritage Foundation. He focuses on a wide 

swath of economic issues, including tax, securities, entrepreneurship, financial privacy, and regulatory and administrative issues. 

Prior to joining The Heritage Foundation, Mr. Burton’s long career 

includes serving as general counsel to the National Small Business 

Association; CFO and general counsel to a startup, Alliance for Retirement Prosperity; partner in the Argus Group; vice president 

and general counsel to a multinational manufacturer; and manager 

of the U.S. Chamber of Commerce’s Tax Policy Center. 

Our third witness today is Tim Reynolds, president of Tribute, 

Inc., a small software company located in Hudson, Ohio. Prior to 

purchasing Tribute in 1994, Mr. Reynolds held a variety of management positions with British Petroleum and BP America. He has 

also held a number of board and leadership positions in small business advocacy and economic development organizations, including 

previously chairing the Board of the National Small Business Association, NSBA. He is testifying today on behalf of the NSBA. 

We welcome all three of you, and I would now like to yield to the 

ranking member for the purpose of introducing our final witness. 

Ms. VELA ́ ZQUEZ. Thank you, Mr. Chairman. 

I am pleased to welcome Troy Lewis. Mr. Lewis is an associate 

teaching professor at Brigham Young University, where he received 

both a bachelor’s and a master’s degree in accounting. He is also 

a sole tax practitioner and the immediate past chair of the AICPA 

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Tax Executive Committee. He is testifying today on behalf of 

AICPA. Welcome, Mr. Lewis. 

Chairman CHABOT. Thank you very much. 

Mr. Pomerleau, you are recognized for 5 minutes. 

STATEMENTS OF KYLE POMERLEAU, DIRECTOR OF FEDERAL 

PROJECTS, TAX FOUNDATION; DAVID BURTON, SENIOR FELLOW, ECONOMIC POLICY, INSTITUTE FOR ECONOMIC FREEDOM AND OPPORTUNITY, THE HERITAGE FOUNDATION; TIM 

REYNOLDS, PRESIDENT, TRIBUTE, INC.; TROY K. LEWIS, CPA, 

CGMA, TAX EXECUTIVE COMMITTEE IMMEDIATE PAST 

CHAIR, AMERICAN INSTITUTE OF CPAS 

STATEMENT OF KYLE POMERLEAU 

Mr. POMERLEAU. Thank you, Chairman Chabot and Ranking 

Member Vela ́zquez, for the opportunity to speak about the U.S. tax 

system and entrepreneurship. 

There are millions of entrepreneurs in the United States, spread 

across nearly every major industry. While every entrepreneur has 

a different business model and unique concerns, there are a few 

key characteristics that apply to many entrepreneurs throughout 

the country. 

Entrepreneurs tend to run losses for some time before turning a 

profit, and some never turn a profit at all. As a result, entrepreneurial ventures tend to be especially risky investments for outside 

investors. 

If they do develop a successful business model, entrepreneurs 

often seek to rapidly expand their operations and scale. 

Ideally, the U.S. Federal Tax Code would be neutral with regard 

to each of these characteristics. However, this is not the case under 

current law. I am going to outline four ways in which the Tax Code 

discriminates against entrepreneurial investment. 

First, the tax treatment of business losses. It is often the case 

that entrepreneurs run losses for several years before turning a 

profit. Unfortunately, the current Federal Tax Code is particularly 

detrimental to businesses whose earnings fall into this pattern. 

The reason for this is the fundamental asymmetry in the U.S. 

Tax Code between the tax treatment of business profits and losses. 

A business that makes a profit is subject to an immediate tax liability in the same year the profit is earned; however, a business 

that turns a loss is not always entitled to an immediate tax benefit. 

This is because businesses whose losses exceed income are required 

to carry over those losses into future tax years when they finally 

have income. 

Importantly, the longer a business has to wait to deduct its net 

operating losses, the smaller a tax benefit the business receives. 

As a result, the Tax Code is inherently disadvantageous to businesses that run losses for many years before turning a profit. 

Second, the tax treatment of capital losses. Entrepreneurs often 

rely on outside investors to provide financial capital for their businesses. Investments in entrepreneurial ventures tend to be risky, 

and investors may experience a long string of capital losses before 

finding an investment that produces a substantial capital gain. 

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5 

diately deductible, creating a situation that penalizes risky investment. 

In general, taxpayers are only allowed to deduct their capital 

losses in any given year up to the extent of their total capital 

gains. Individual taxpayers are also allowed to deduct up to $3,000 

in capital losses beyond those losses. Otherwise, they have to carry 

forward the remaining into future years where they would be deducted against future capital gains. 

Here again, the Tax Code contains an asymmetry. Capital gains 

are subject to an immediate tax liability, while losses do not necessarily yield an immediate tax benefit. 

Third, the tax treatment of business investment. Entrepreneurs 

that develop a successful business model are often interested in 

scaling their operations as rapidly as possible. However, the current U.S. Tax Code is especially burdensome on businesses that undertake significant capital investments due to the tax system’s 

treatment of capital investment, or specifically, depreciation. Under 

current Tax Code, businesses are not allowed to deduct the full cost 

of capital investments in the first year. Instead, they are required 

to deduct their investment cost over long periods of time according 

to a set of over two dozen depreciation schedules. 

Because businesses value immediate deductions more than deductions in the future, the longer a business has to wait to write 

off the full cost, the less likely the business is to undertake a new 

investment. 

Fourth, high tax rates on business income. All three of the previous distortions in the Tax Code are exacerbated by the high marginal tax rates on businesses in the United States today. 

Entrepreneurs that choose to set up passthrough businesses, 

such as S corporations, partnerships, face a top Federal tax rate of 

44.6 percent, and the rate can exceed 50 percent when State and 

local income taxes are taken into account. 

Other entrepreneurs may choose to organize their businesses as 

C corporations. These businesses are subject to two layers of tax. 

First, a 35 percent corporate tax rate, which is the highest in the 

developed world, followed by a 25 percent capital gains and dividends tax. 

In conclusion, the U.S. code tends to impose higher burdens on 

businesses that run losses for many years, businesses that are 

risky investments, and businesses undergoing rapid expansion, all 

of which are typical characteristics of entrepreneurial ventures. 

Lawmakers interested in removing these barriers to entrepreneurship should consider ways to mitigate these distortions in the 

U.S. Tax Code. Thank you. 

Chairman CHABOT. Thank you very much. 

Mr. Burton, you are recognized for 5 minutes. If you could turn 

that mic on. That is all right. 

STATEMENT OF DAVID BURTON 

Mr. BURTON. Thank you, Mr. Chairman—that’s better—Ranking Member Vela ́zquez, and members of the Committee, for the opportunity to be here this morning. 

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The views I express in this testimony are my own and do not 

necessarily reflect the institutional position of The Heritage Foundation. 

Entrepreneurship matters. It fosters discovery, innovation, and 

job creation. Entrepreneurs develop new and less expensive products that improve consumer well-being and account for most of the 

job creation in the United States. Moreover, the vast majority of 

economic gains from the innovation that entrepreneurship creates 

accrues to the public at large rather than entrepreneurs. 

Most indicia of entrepreneurial health indicate that entrepreneurship is in decline. Accordingly, job creation, productivity improvements, and welfare enhancing innovation have slowed and 

the tax system is a major contributing factor. It is a factor both because of the direct impact of the tax system on small and startup 

firms, but also because of the adverse impact on the economy overall. It imposes high taxes on risk-taking, harms the international 

competitiveness of U.S. businesses, and impedes economic growth. 

Moreover, the tax system is monstrously complex, imposing inordinately high compliance costs on small and startup firms. 

Among the four major sources of complexity in the tax law are 

the Capital Cost Recovery System; inventory accounting; employee 

benefit taxation, particularly the rules governing retirement savings or qualified accounts; and international taxation. 

Given our time constraints, I will quickly outline 12 reforms to 

the current system designed to aid entrepreneurs and briefly discuss tax reform. Many of the incremental reforms proposed raise 

issues that need to be addressed in fundamental reform as well. 

First, Congress should amend Internal Revenue Code section 179 

(sic) to permanently allow capital expenses of up to $1 million to 

be deducted when incurred. Expensing would simplify small firms’ 

tax returns, reduce compliance costs, reduce small firms’ cost of 

capital, and aid cash flow. 

Very few small employers offer retirement accounts because of 

the complexity, high compliance costs, and regulatory risk of doing 

so. It is one of the most complex areas of the tax law and desperately in need of simplification. 

Evidence shows that capital gains rates much above 20 percent 

actually reduce Federal revenue. In addition, a high capital gains 

tax rate reduces the willingness of investors to invest in relatively 

risky startups and growth companies and impedes capital formation. 

Congress should also permit cash method accounting for firms in 

up to $10 million in gross receipts. 

Congress should liberalize the S corporation rules, particularly 

allowing S corporations to have more than one class of stock, nonresident alien shareholders, subject to 30 percent withholding, and 

more than 100 shareholders. This latter issue is particularly important for companies that are trying to take advantage of the recent 

JOBS Act provisions related to crowdfunding or Regulation A 

where they are trying to use the Internet to raise small amounts 

of money from a large number of people. Unless you change those 

rules, they will not be able to take advantage of it. 

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Obamacare imposes a health insurance tax that needs to be repealed. This is particularly focused on small companies rather than 

large companies that self-insure. 

We also need to reduce the tax rate paid on passthrough entities 

to no more than that paid by C corporations. 

We need to increase the threshold for ISOs, or incentive stock options. 

We need to provide full deductibility of health insurance purchased by the self-insured. 

We need to improve the rules and clarify the rules relating to 

whether distributions are subject to the self-employment tax from 

passthrough entities. 

We desperately need to clarify the rules governing the distinction 

between employees and independent contractors. That rule has 

been around there or that problem has been around since the 

1970s. It has never been fixed. 

And we need to increase the unified credit amount so that family 

businesses and farms do not have to be sold to pay the estate and 

gift tax. 

Now, briefly, on fundamental tax reform, under the leadership of 

Speaker Ryan and House Ways and Means Committee Chairman 

Brady, the House Republicans put together what they call a blueprint. This blueprint would have an extremely positive impact on 

the economy. Our friends at the Tax Foundation estimate it would 

increase GDP by 9.1 percent over 10 years, and I think that is 

about right based on other macroeconomic work that has been 

done. 

It would aid small businesses for at least two reasons. First, it 

would result in a dramatically stronger economy. And secondly, it 

would dramatically reduce the complexity and compliance burden 

experienced by small firms. And I would be glad to get into a lot 

of those details. 

Thank you very much for the opportunity to testify this morning. 

Chairman CHABOT. Thank you. You fit a whole lot into 5 minutes there, so thank you very much. 

Mr. Reynolds, you are recognized for 5 minutes. 

STATEMENT OF TIM REYNOLDS 

Mr. REYNOLDS. Good morning, Chairman Chabot and Ranking 

Member Vela ́zquez, and members of the House Small Business 

Committee. I want to thank you for inviting me to testify today. 

My name is Tim Reynolds. I am owner and president of Tribute, 

Inc., a software company located in Hudson, Ohio. Our 38-employee 

company develops and markets accounting and operations software 

for industrial distributors. 

I am pleased to be here representing not only my company, but 

also the National Small Business Association, NSBA, where I currently serve as an honorary trustee and am a past chairman. 

NSBA’s members consistently rank tax simplification and reducing the tax burden among their top issues for Congress and the administration address. The compliance burden on taxpayers, because 

of the complexity of our code, is truly staggering. 

My company is a Subchapter S firm. As such, the income of my 

company flows to my personal tax return. I have an MBA from the 

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University of Michigan. I run a company that develops and sells accounting software and have been in business for more than 20 

years. Yet, I would view it as taking an irresponsible risk to attempt to do my own taxes. The Code is so complicated that I feel 

certain I would inadvertently run afoul of the law. So I have to pay 

an accounting firm to do these taxes. 

In fact, according to the NSBA 2015 Small Business Taxation 

Survey, only 15 percent of small business owners handle their 

taxes internally. Eighty-five percent are forced to pay an external 

accountant or practitioner. This data point should send a strong 

message to the IRS and to Congress that the Tax Code is far too 

complex. 

I firmly believe the efforts to reduce the regulatory and administrative burdens on small businesses must focus on overall simplification, eliminating the inequities with the Tax Code and enhancing taxpayer education and outreach. 

My company has been audited by the IRS twice. In both cases, 

the eventual result was no errors found, and therefore, no penalties. In one case, the initial auditor did not understand the rules 

around deferring software sales revenue. After multiple appeals, 

we were finally referred to her supervisor, who agreed with our interpretation of the deferral rules. 

My point here is that in some cases, even the IRS cannot easily 

interpret the rules. Tax simplification would reduce not only the 

cost of compliance, but possibly also the cost of enforcement. 

As the tax laws have evolved over the last 30 years, it has become full of often contradictory rules with unclear policy objectives 

that have resulted in both unintended consequences and unrealized 

intended consequences. 

I will conclude my testimony with an example that has impacted 

my firm directly. This problem has to do with the impact that the 

alternative minimum tax has on the R&E tax credit. As a software 

development company, Tribute spends a significant amount of effort each year on research and development. As such, we are entitled to take advantage of the R&E tax credit, which can produce 

tax savings available then for more investment and development. 

However, because we are an S corporation, I am often subject to 

the alternative minimum tax. For years, this has prevented my 

company from taking the R&E credit. This credit is meant to encourage additional research and development, yet I am penalized 

for the way my business is structured. 

I should note that the PATH Act of 2015 fixed this problem, but 

only for C corps. As you may know, most small businesses, where 

much of our innovation happens, are S corps, and so the complicated Tax Code steps on its own foot yet again in this area. 

So in conclusion, the cost of compliance and the complexity and 

inconsistency within the Tax Code pose a significant and increasing 

problem for small business and our economy. A simpler, stable tax 

system dedicated to investment, savings, and economic growth 

must be put in its place. 

Again, I would like to thank Chairman Chabot, Ranking Member 

Vela ́zquez, and members of the Small Business Committee for the 

opportunity to speak today. I would be very happy to answer any 

questions that you might have. 

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Chairman CHABOT. Thank you very much. 

Mr. Lewis, you are recognized for 5 minutes. 

STATEMENT OF TROY K. LEWIS 

Mr. LEWIS. Chairman Chabot, Ranking Member Vela ́zquez, and 

members of the House Committee on Small Business, thank you for 

the opportunity to testify. 

We applaud the leadership taken by the Committee to consider 

ways to promote entrepreneurship by addressing barriers in the 

Tax Code. 

Today I would like to highlight a few tax reform issues that directly impact small businesses and their owners. First, it is important to recognize that tax relief should not mean a rate reduction 

for C corporations only. Congress should continue to encourage, or 

at least not discourage, the formation of sole proprietorships and 

passthrough entities. 

If Congress decides to lower corporate income tax rates, small 

businesses should receive a lower tax rate as well. 

We recognize that providing a reduced rate for income to small 

businesses will place additional pressure on the need to distinguish 

between profits of the business and compensation of the owner-operators. We should continue to use traditional definitions of reasonable compensation and judicial guidance for this purpose. 

To minimize controversy, the IRS should take additional steps to 

improve compliance in this area. Partnerships and sole proprietorships should be required to charge reasonable compensation. However, we should not treat partners and proprietors as employees, 

but rather as owners whose labor is also subject to withholding. Including partners and proprietors in well-defined payroll rules 

should enhance enforcement in this area. 

If Congress decides to move forward with the 70/30 rule—and 

that is treating 70 percent of passthrough income as employment 

income and 30 percent as return of equity—we urge you to make 

this proposal a safe harbor and not a hard and fast rule. A safe 

harbor would promote simplicity for many businesses without sacrificing potential fairness for others. 

Next, we are concerned with and urge you to oppose any new 

limitations on the use of the cash method of accounting. The cash 

method is a simpler application, has fewer compliance costs, and 

does not require taxpayers to pay tax before receiving the income, 

which is why entrepreneurs often choose this method. Forcing them 

to switch to the accrual method upon receiving a gross receipts 

threshold would unnecessarily discourage business growth and impose financial hardship on cash-strapped businesses. We appreciate 

that Chairman Brady, recognizing the importance of the cash 

method of accounting, did not restrict its use in the tax reform 

blueprint. 

Another important issue for small businesses is their ability to 

deduct interest expense. Owners borrow to fund operations, working capital needs, equipment acquisition, and even to build credit 

for future loans. We should not take away or limit this critical deduction for many small businesses who, with little or no real access 

to equity capital, are forced to rely on debt financing. 

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Another potential barrier for small businesses involves changing 

the rules around the taxation of compensation. Congress should not 

reduce an employee’s ability to deduct the compensation paid to 

employees, whether in the form of wages or fringe benefits. 

At the same time, it is important to retain the employee fringe 

benefit exclusion. Changes in this area would impact the small 

business’ ability to build and retain a competitive workforce. 

Discussions on tax reform have also included border adjustment 

provisions, suggesting an exclusion of export sales revenue and a 

disallowance of the deduction for any imported goods or services. 

These provisions would impact businesses of all sizes, including 

small business. For example, a growing number of small accounting firms are locally owned and operated but must participate in 

global alliance networks in order to serve their clients on international tax matters. In other words, border adjustment provisions 

could have a substantial impact even on small local service providers. 

Unfortunately, there are many other tax provisions that hinder 

small businesses. For example, net operating losses. If passed by 

Congress, a 90 percent limitation on the use of an NOL imposes 

an artificial restriction on a company’s use of business losses, and 

it discriminates against companies with volatile income. These 

businesses could potentially pay more tax than companies with an 

equal amount of steady income over the same period of time. 

We urge you to consider increasing the startup business deduction to give entrepreneurs the startup support they need in the 

early years, as well as reforming laws for qualified retirement 

plans and for unfair penalty provisions. 

Congress should also repeal the AMT for both individuals and 

corporations. 

Finally, we recommend that Congress permit flowthrough entities to choose fiscal year ends for tax purposes, which would allow 

advisors to spread out their workloads during the year. This flexibility would help ease the burden on both taxpayers and their advisors. 

In my remaining time, I want to ask for your support on the mobile workforce legislation. Employer tracking and complying with 

all of the different State and local tax laws is complex and costly. 

We urge you to support mobile workforce legislation that provides 

a uniform national standard for nonresident State income tax withholding. That legislation would also provide a de minimis exemption from State income tax for nonresidents. 

Thank you, and I would be happy to answer any questions you 

may have. 

Chairman CHABOT. Thank you very much. 

I would comment that I think all four of the witnesses made 

great suggestions that I think we ought to seriously consider, and 

we will obviously pass these on to the Ways and Means Committee 

also in this process. 

So I will recognize myself for 5 minutes for questioning. And Mr. 

Reynolds, I will start with you if I can. You said that your company 

was audited twice and neither time did they find that you paid less 

than you were supposed to. I assume that that was a stressful 

process to go through, and I imagine it probably cost a lot. Can I 

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pry and ask you, do you know approximately how much you all 

ended up paying out of pocket? And also, was there an opportunity 

cost to you spending all this time doing this so you were not spending it on your business? If you could comment on that. 

Mr. REYNOLDS. Well, certainly. There was some level of opportunity cost. In both cases when we were audited, it was important 

for us to involve our accounting firm in order to represent us as 

they talked with the IRS. It was particularly important when we 

had the disagreement with the initial auditor around how to defer 

software revenue, which took several weeks to actually end up resolving. 

So in the first case where there was no dispute, I think it was 

probably a couple thousand dollars, and in the second case, it was 

more around $6,000 or $7,000 of cash outlay to my accounting firm 

for their time in representing me. 

Chairman CHABOT. Thank you very much. 

Mr. REYNOLDS. The audits also, of course, took not only my 

time but my controller’s time, bookkeeper’s time, so it was a significant—— 

Chairman CHABOT. So I am assuming it distracted you from 

your business. How many employees do you have? 

Mr. REYNOLDS. Pardon me? I have 38 employees. 

Chairman CHABOT. Thank you very much. 

Mr. Lewis, I will turn to you. I have been hearing from some of 

my constituents back in Cincinnati about business interest deductibility and the proposal in the Better Way agenda to eliminate, do 

away with it. How critical is interest deductibility to entrepreneurs 

as they try to launch or expand a business? And what impact could 

its repeal have on entrepreneurship in general do you think? 

Mr. LEWIS. That is a great question. I think you need to realize, 

to answer that question, a couple of things. Number one, the ability 

for a small business to flip a switch and grab equity capital is very 

limited. I know in theory you would like to say, well, you are indifferent. Someone can invest in your company with stock or you can 

go borrow, but the reality is borrowing is so much simpler and 

much easier. And that is the lifeblood of these small businesses. 

That is where they get it. 

So from their perspective, this notion that you are going to make 

it relatively neutral, that you cannot deduct dividends, you cannot 

deduct interest, will not ring true. 

Now, the tradeoff that you hear is you hear, well, you mentioned 

the Better Way, that you will be able to deduct all of your capital 

outlays, this million-dollar increase that Mr. Burton mentioned for 

section 179. 

But the reality is these small businesses already have that, by 

and large. Half a million dollars. It does not solve all the problems, 

as Mr. Burton said, but they are already expensing. So the only 

thing you would be gaining in this perhaps is a disallowance of 

that interest expense. And remember, these businesses run on incredibly thin margins. Most of them have an operating loss up 

front. There is a time where they know they are going to lose 

money until they can be profitable, so every dollar matters. 

So to answer your question, it is very critical for these businesses, particularly because on the other side they are not really 

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12 

picking up much in terms of immediate expensing which you might 

think with a larger company. 

Chairman CHABOT. Thank you very much. 

Mr. Pomerleau, I will move to you if I can. You mentioned that 

the current depreciation regime is very complicated, being comprised of more than two dozen depreciation schedules and requiring, I believe, 448 million hours each year for compliance. What is 

the impact of this on American businesses and the economy, and 

what do you suggest that we do about that? 

Mr. POMERLEAU. Yeah. So one of the big downsides with the 

current business Tax Code is this idea of depreciation. Requiring 

businesses to write off assets over a number of years basically reduces the amount they get back in those deductions. So if you could 

get a deduction of $100 up front, that is a lot larger of a deduction 

than if you took that $100 and spread it over 10 years. We find 

that if you move from this system to a system of full expensing, I 

mean, it would grow the economy by about 5 percent over a decade. 

So this is implying that depreciation under the current system is 

reducing the level of investment in the economy. 

Chairman CHABOT. Thank you very much. 

And I will conclude with you, Mr. Burton. You mentioned that 

repealing the excise tax imposed by Obamacare on health insurance premiums would be helpful to entrepreneurs. Did Obamacare 

impose any other taxes that are, in your view, hindering entrepreneurship? 

Could you turn the mic on again, please? That is all right. 

Mr. BURTON. The most obvious would be the Obamacare investment income tax, which is 3.8 percent. And so owners of passthrough entities or for, that matter, shareholders in C corporations 

would pay it. But there is a fairly long list of taxes that were a part 

of Obamacare. 

Chairman CHABOT. Thank you very much. 

My time has expired. The gentlelady, ranking member, is recognized for 5 minutes. 

Ms. VELA ́ ZQUEZ. Thank you, Mr. Chairman. 

Mr. Pomerleau, there seems to be agreement that the tax system 

is overwhelmingly complex. One of the main problems for businesses is deciding on which tax structure, which one of them offers 

the most advantages. Do you believe that the various options available make the tax law more complicated? 

Mr. POMERLEAU. Yeah, I think that that is true. So under current law there are several ways that you could form a business, 

and those have specific tax consequences. The big distinction, of 

course, is between passthrough entities, S corps, partnerships, sole 

proprietorships, and C corporations. So if you are deciding to make 

an investment, whether it is building a factory or buying a machine 

that is going to have a return for you, it matters what business 

form you go into. If you go into a C corporation, you may face a 

double tax. If you go into an S corporation, there are limitations 

there even if you do not face the double tax. So I do think that 

under current law there are a lot of calculations that business owners need to do that would not be necessary under a tax system that 

treats all investment equally. 

Ms. VELA ́ ZQUEZ. Thank you. 

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13 

Mr. Lewis, can you please describe the complications that passthrough entities may face in net operating loss calculation, and 

what can we do in Congress to address it? 

Mr. LEWIS. Okay. Thank you for the question. 

What happens, as has been said, when you have a passthrough 

entity, by definition that means the income of the business, although it is reported by the business, is passed through or, in other 

words, reported directly by the owners themselves. And most of the 

time, particularly in a small business setting, we are talking about 

individuals. 

So your question is if a business is owned by a bunch of individuals and they have a loss, how does that impact them individually? 

And the answer is when you file an individual 1040, a business return into a 1040, you have two aspects. You have sort of like their 

personal aspect and then you have the business. And it is that 

interplay in between those two that creates the complexity. 

In a C corporation, as has been mentioned, it is relatively 

straightforward. If you lose money, the number kind of falls out. 

But in an individual standpoint, there is an entire IRS publication 

that takes you through how to separate out the business side of 

your dealings from your individual side, from your personal side. 

So some of the things that you could do would be to simplify the 

rules and maybe just say, all right, whatever the loss is coming 

from the business, without making adjustments, just recognize that 

in simplicity sake you might give up some equality issues, but you 

would gain a lot by simplicity. I think the theme that I have heard 

from the panelists that bears repeating is simplicity is the key. A 

lot of these small businesses are drowning in regulation, particularly from the tax side, and they need relief. They need to have 

more time, as Mr. Reynolds said, to spend on developing the software and finding customers than trying to comply. 

Ms. VELA ́ ZQUEZ. Thank you. 

Mr. Reynolds, in your testimony, you make note of the tax extenders passed into law in 2015 under the PATH Act. We have 

heard that 100 percent exemption of capital gains on investment in 

qualified business stock passed under this act has catalyzed investment in innovative startups. Would you be in support of allowing 

small businesses operating as LLCs to qualify in addition to corporations currently allowed? 

Mr. REYNOLDS. For the section 179? 

Ms. VELA ́ ZQUEZ. Yes. 

Mr. REYNOLDS. Yes. Yes, ma’am. I certainly would. 

Ms. VELA ́ ZQUEZ. Mr. Pomerleau? 

Mr. POMERLEAU. Yeah, I think that treating businesses across 

the board in the same way is important. 

Ms. VELA ́ ZQUEZ. Mr. Lewis? 

Mr. LEWIS. That is a really fantastic question. The ability under 

1202 to exclude the 100 percent gain after 5 years—that is what 

you are referring to—yeah, I mean, there are several provisions in 

the Code where you should be entity neutral and this is one that 

is clearly patently not. And as a result, I think you have hit a very 

good point that should be explored. 

Ms. VELA ́ ZQUEZ. Okay. Thank you. 

Mr. Chairman, I yield back. 

SBREP-219A with DISTILLER

14 

Chairman CHABOT. The gentlelady yields back. 

The gentlelady from America Samoa, Mrs. Radewagen, who is 

the chairman of the Subcommittee on Health and Technology, is 

recognized for 5 minutes. 

Mrs. RADEWAGEN. Thank you, Mr. Chairman. 

I, too, would like to welcome the panel for being here today. Very 

interesting testimony. 

My first question is, and any one of you or all of you could answer it depending on the time, most of the proposals that are being 

talked about today will only affect the 50 States and the District 

of Columbia. What proposals do you have for the five territories? 

Guam, the U.S. Virgin Islands, the Northern Marianas, and America Samoa have a mirror Tax Code to the U.S., and Puerto Rico has 

a different Tax Code. 

Mr. Pomerleau? 

Mr. POMERLEAU. I think that I am not really an expert on any 

of the territories’ Tax Codes, but I think any of these issues can 

be applied to any of the territories’ tax systems. It would be worth 

considering in any reform to improve business taxation. 

Mr. BURTON. Puerto Rico and American Samoa have greater 

flexibility under the law than other territories. To the extent the 

Congress drafts a pro-growth Tax Code, it will benefit the possessions that have mirror systems. American Samoa and Puerto Rico 

have the opportunity to adopt pro-growth simpler Tax Codes on 

their own initiative. I have some familiarity with Puerto Rico, not 

so much with American Samoa. And Puerto Rico’s tax system is 

highly destructive and counterproductive and has had a very adverse impact in the island’s economy. And they really need to reform it. 

But the basic themes of what any good tax reform proposes to 

be is it should lower marginal rates. You should move towards expensing of capital, and you should have a simple system. If you get 

those basic three things right, you are likely to have a positive impact on entrepreneurs. 

Mr. REYNOLDS. I cannot speak as a tax expert, but what I 

would say as a business person is that anywhere in the world in 

business, complexity equals cost. And whether it is government or 

business or the Tax Code, complexity equals cost. And to the extent 

that you can simplify your Tax Code. I think you will greatly benefit your economy and the businesses there. 

Mr. LEWIS. Chairman Radewagen, I think from an America 

Samoa perspective there would be a couple things I would suggest. 

Number one, as the House is considering this so-called border 

adjustability, because America Samoa and Puerto Rico and the 

other possessions are sort of in this high-risk situation, I think it 

would be critical to define whether or not those would be treated 

for domestic or international purposes if you proceed with the border adjustability. In other words, is a sale into or outside of America Samoa going to be deemed to be a sale to a foreign jurisdiction? 

Or is it going to be within the United States? And I think you can 

have an appreciation of the kind of severity that that might have. 

I think that would be one key thing as you are looking. Because, 

again, as I testified, border adjustability will impact small businesses as well as large. We live in a very global society where all 

SBREP-219A with DISTILLER

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you need is an Internet connection and you are an exporter. So I 

think that would be the first thing. 

The second thing related to small business is the fact that the 

way the filings work, the fact that the citizens of the possessions 

have Social Security numbers and a couple of years ago we saw a 

lot of ID theft because crooks would figure out if I can grab those 

Social Security numbers, they are not going to be the ones filing 

a U.S. return if they do not have U.S.-sourced income. I think potentially what we could work towards with the IRS is making these 

so-called IP PINs, these identification numbers that are available 

in the event that you have had ID theft. Right now those are pilot 

programs only in Georgia, Florida, and the District, where it is voluntary. If you have been subject to theft anywhere else you can 

grab one, but I think that would go a long way to helping protect 

the citizens of your possessions. 

Mrs. RADEWAGEN. Thank you, Mr. Chairman. I yield back. 

Chairman CHABOT. Thank you. The gentlelady yields back. 

The gentleman from Pennsylvania, Mr. Evans, who is the ranking member of the Subcommittee on Economic Growth, Tax, and 

Capital Access, is recognized for 5 minutes. 

Mr. EVANS. Thank you, Mr. Chairman. 

I would like to thank all of the people on the panel today. 

Mr. Lewis, we have heard from small businesses the need to 

make certain tax credits permanent. How does this temporary nature of the tax provision affect small businesses? 

Mr. LEWIS. Mr. Reynolds spoke to it, particularly section 179. 

Let’s look at that expense first and it will answer your question. 

If you look at section 179, the last time it was passed with the 

PATH Act in 2015, December 18th. That left about as much time 

as the shelf life of a carton of milk. Okay? So just 2 weeks. It is 

really hard to react to that. And so what you find is that you find 

that your constituents will be paralyzed. They will not assume anything until it is passed, and then at that point they have got the 

holidays. It is very difficult to put stuff into place. 

One of the things about good tax policy is certainty. So to answer 

your question, if you give the taxpayers certainty and you give 

them a playing field that they know that they can rely upon, they 

will react to it. So if you are trying to motivate them with a credit, 

whether it is the R&D credit like Mr. Reynolds’s company, or some 

of the other credits, if you want to embrace energy credits or something else, the element of certainty is what trips the switch and allows people to react. If not, they will just sit back on the sideline 

and either discount what might happen or simply just be paralyzed 

and do nothing. 

Mr. EVANS. I kind of want to follow up to a degree. Deducting 

business startup costs can be complicated. What tax simplification 

methods could be taken to ease some of that complexity? 

Mr. LEWIS. Okay. So the Code section that deals with that is 

195. And what happens is, I think as you realize, is from the time 

a business is organized until they open their doors and get their 

first dollar, kind of on the shadowbox behind the register, between 

that time period, the Code currently now makes us capitalize all 

that and recover it over some period of time. Shockingly, that period of time is 15 years. So you could expense up to $5,000, but the 

SBREP-219A with DISTILLER

16 

rest of it you have to recover over 180 months. That is a long time 

to not receive that benefit back to an entrepreneur who is worrying 

about making payroll the next month. So one of the things you could do is—why is $5,000 the right 

number? Why not think about increasing that number? Five thousand seems arbitrarily low when you consider that just to get the 

doors ready to open it can be a big number, it can be a big amount. 

So one of the things you could do is expense. Allow these startup 

businesses to expense a lot larger than $5,000 and let them get immediate recovery for those costs to get the doors open. 

Mr. EVANS. Mr. Burton, how do you respond to concerns that 

lowering the corporate tax rate will disadvantage small businesses, 

perhaps stifle entrepreneurship? 

Mr. BURTON. I do not think lowering the corporate rate disadvantages small businesses in a sense. Some small businesses are 

C corps, but you want to try to have a tax system that treats passthrough entities and C corporations as closely as comparable as 

possible. Obviously, a disproportionate number of small businesses 

are passthroughs, so I have maintained that any tax reform plan 

has to take care of passthroughs as well as C corporations, and 

that the rate that passthroughs experience should be no higher 

than that of C corporations. 

And there was a period about 2 years ago where that was about 

to be forgotten. I do not think it is as serious a problem now. I 

think Congress has become much more conscious of that issue. 

Mr. EVANS. In your written testimony you stated that the Tax 

Code is riddled with special tax preferences. Please elaborate on 

the key tax preferences that put small businesses at a disadvantage. 

Mr. BURTON. Well, there is a list of them put out every year 

by the Treasury that is in the Federal budget, and by the Joint 

Committee. It is called the Tax Expenditure List. However—there 

is a really big however here—only some of them are what I would 

regard, and I think most tax experts would regard as genuine tax 

expenditures. Some of them relate on a very different conception of 

what is income, but they would include things like the various alternative energy tax credits. They would include things like the 

low-income housing tax credit. They would include things like the 

exclusion for employer-provided health insurance and all the various other employee benefits. And the list goes on in small micro 

type and it is probably several hundred long. 

Mr. EVANS. Thank you, Mr. Chairman. 

Chairman CHABOT. Thank you. The gentleman yields back. 

Thank you. 

The gentlelady from Puerto Rico, Ms. Gonza ́lez-Colo ́n, is recognized for 5 minutes. 

Ms. GONZA ́ LEZ-COLO ́ N. Thank you, Mr. Chairman. Thank all 

of you for coming to the hearing today. 

Small businesses make up a large part of Puerto Rico’s economy, 

as you may know. According to the SBA, about 80 percent of the 

private sector workers in Puerto Rico are employed at small establishments, which is slightly higher than the percentage of U.S. 

Mainland. Specifically, more than half a million workers are employed by 45,000 small businesses. In that account, as we draft a 

SBREP-219A with DISTILLER

17 

new tax plan, Congress should continue to be mindful of the fact 

that Puerto Rico and the other territories are U.S. jurisdictions and 

home to U.S. citizens who are nationals, and that jobs in Puerto 

Rico and other territories are American jobs. 

Mr. Burton, you are very familiar, as you already said minutes 

before, but some of the disadvantages that Puerto Rican businesses 

face vis-a-vis is their mainland counterparts, right? 

Mr. BURTON. Very familiar is probably too strong. Familiar, 

yes, although I do not think the vast majority of the problems come 

from the Internal Revenue Code. It comes from the Puerto Rican 

tax system itself. As you know, most Puerto Rican businesses are 

exempt from income taxes, and instead of that, the Commonwealth 

of Puerto Rico imposes very high corporate taxes, radically higher 

than any other State or territory. And in addition, there are a host 

of other taxes. So the Puerto Rican Commonwealth tax system has 

an extremely negative impact on businesses, entrepreneurs, but 

also the Puerto Rican people. And the Commonwealth government 

needs to fix that. 

Ms. GONZA ́ LEZ-COLO ́ N. I agree with you 100 percent. That is 

why the new government just filed a new tax reform system to the 

island that is supposed to help the small businesses. 

Mr. Pomerleau, you mentioned that the top rates on capital gains 

and dividends, both at 25 percent, are the highest there have been 

since 1997 and 2002. What will be the ideal rates for optimum 

growth? 

Mr. POMERLEAU. It all depends on how you structure your Tax 

Code. So one thing to remember is that capital gains and dividends 

is a second layer of tax on corporate investments specifically. So, 

depending on what you do on the corporate side is going to bleed 

into what you are going to want to do on individual investment income. For example, there are proposals that can lower the tax rate 

at the entity level, so lower the corporate tax rate, but then when 

that income is passed through, you may raise the tax rate on individual investors so the tax rate is equalized or treated more similarly to wage income. But it all depends on your proposal. 

Ms. GONZA ́ LEZ-COLO ́ N. Thank you. 

Mr. Chairman, I yield back. 

Chairman CHABOT. Thank you. The gentlelady yields back. 

The gentlelady from North Carolina, Ms. Adams, who is the 

ranking member of the Subcommittee on Investigations, Oversight, 

and Regulations, is recognized for 5 minutes. 

Ms. ADAMS. Thank you, Mr. Chair, and thank you, Ranking 

Member Vela ́zquez, for hosting this hearing on the complexity of 

the Tax Code and its impact on our Nation’s small businesses. 

The State of North Carolina has over 800,000 small businesses, 

and the City of Charlotte, which I represent, is a great example of 

an innovation hub for many startups. So guaranteeing that these 

companies and entrepreneurs have a good understanding of the 

Tax Code is extremely important. So my questions will focus 

around our discussions on tax reform and how it can help our Nation’s small businesses. 

So to start, I would like to give each of you an opportunity to 

share your thoughts on which elements of tax reform that promote 

SBREP-219A with DISTILLER

18 

startups and innovative businesses should be included in the discussions as we move forward here on Capitol Hill. 

Mr. POMERLEAU. Yeah, so I think that tax reform proposals 

that could help small businesses (1) expanding expensing which is 

in the House GOP blueprint; (2) better treatment of net operating 

losses. This is another proposal that is in the House GOP blueprint. Now, it does limit the amount you can take every single 

year, but it also allows you to carry forward those operating losses 

on an unlimited basis, so as far as you want, and it adjusts those 

losses for the cost of capital and inflation every single year so they 

do not ever lose value. Because one of the big problems here with 

the current code is the longer you have to wait to use your net operating loss, the lower the value is and that is important for entrepreneurs to have lots of losses over many years. 

Lower marginal tax rates would also be beneficial. Right now 

some business forms can face rates up to 44 percent or even higher 

in some States and lowering those rates down at the Federal level 

could help. 

Ms. ADAMS. Mr. Burton? 

Mr. BURTON. I agree with everything he said. I think there are 

some things he left off. Inventory accounting is a major complexity 

problem particularly for stores. It can get ridiculously complex, including the uniform capitalization rules, all the separate tracking, 

whether you are using LIFO or FIFO, and I am sure our friend 

from the AICPA could go into a great deal more detail. 

But also, I think capital gains rates matter a lot to the ability 

of entrepreneurs to be able to raise capital because they affect investors. And there is also the secondary factor: Once capital gains 

rates get above about 20, it actually costs the Federal Government 

revenue because people do not realize their gains. 

The other thing I would say is you sort of need to draw the distinction between small businesses that are not startups and others. 

And retirement savings and qualified accounts probably do not 

matter much to a guy who is rolling dice and starting a business 

those first couple of years, but a business like Tim’s that has been 

around for a while, has employees, trying to think through retirement savings for his workforce and himself, the current complexity 

of the qualified account area has been extremely destructive. It is 

why so many small businesses do not provide retirement savings 

vehicles for their employees or for their owners. And we need to address that. It has become genuinely monstrously complex and it 

serves no real policy objective, no matter what your political philosophy. 

Ms. ADAMS. Mr. Reynolds? 

Mr. REYNOLDS. I agree with everything, but if I were to pick 

one thing, I would say that the efforts to level the playing field between passthrough entities and C corporations is quite critical, particularly to startup and small businesses. But I would say the overall metric around the comprehensive tax reform needs to be about 

simplification. We have a Tax Code that is 70,000 pages. If you 

could take it down to 35,000, I still would not be able to read it 

all, but it would be a big improvement. 

Ms. ADAMS. Mr. Lewis? 

SBREP-219A with DISTILLER

19 

Mr. LEWIS. I would, of course, echo what others have said, but 

I think philosophical simplification is the right word. Let’s keep it 

simple. I think all of us would agree it is too complicated. 

What are some examples of that? Keep cash method of accounting. I think an entrepreneur can understand when I spend something, when I get something, that is when it is taxable. The complexity really comes into it when you start adding into this, well, 

when was it earned? They can follow their checkbook. It is much 

more harder, and that is where you start having to get additional 

people involved to help support. I think that is the philosophical 

view that would help with all of these issues. 

Ms. ADAMS. Thank you very much, gentlemen. I yield back, Mr. 

Chair. 

Chairman CHABOT. Thank you. The gentlelady yields back. 

The gentleman from Pennsylvania, Mr. Fitzpatrick, is recognized 

for 5 minutes. 

Mr. FITZPATRICK. Mr. Pomerleau, how are you? Regarding the 

tax rates for both capital gains and dividends, it is pretty high 

right now. What would you suggest a sweet spot would be to maximize growth and investment? What is the best rate based on your 

studies? 

Mr. POMERLEAU. So we have not studied this specifically, but 

David Burton has brought up that, at some point, the marginal tax 

rate on capital gains starts losing you revenue because people will 

delay realizing those gains in order to avoid the tax. So what you 

see looking at historical data, as David said, is the closer you get 

to 20, the better off you are. So if you start going higher than 

where we are now or, well, we are basically over 20 now, you may 

actually be losing revenue in the long run because people are delaying their realizations and pushing the gains into the future 

where they are going to yield less revenue for the Federal Government. 

Mr. FITZPATRICK. So no suggested rate to maximize investment? 

Mr. POMERLEAU. I do not think there is a specific sweet spot. 

I do not know if David may know. 

Mr. BURTON. Twenty percent should be the top. It is not the 

ideal rate because beyond that it not only has economically counterproductive effects, it costs the Federal Government revenue. 

Now, it might be 22, but that is an absolute top. 

In terms of the ideal rate, ideally, you are trying to move towards a consumption tax, or stated differently, a tax that does not 

double tax savings and investment. And it depends on the administrative structure that you choose how you treat it. If you treat all 

savings, for example, in an IRA-type treatment, then reinvesting 

capital gains would, in fact, pay nothing and it would only be when 

you withdraw it and do not reinvest it, and then you pay the ordinary income rate and other sales taxes like, for example, excuse 

me, other consumption taxes like, for example, what Chairman 

Brady has proposed. Financial transactions in principle are entirely 

disregarded. 

Mr. FITZPATRICK. I yield back. 

Chairman CHABOT. The gentleman yields back. 

SBREP-219A with DISTILLER

20 

The gentleman from New York, Mr. Espaillat, is recognized for 

5 minutes. 

Mr. ESPAILLAT. Thank you, Mr. Chairman. Thank you to the 

witnesses, Ranking Gentlewoman Vela ́zquez, for this opportunity. 

Mr. Lewis, startup businesses are often saddled with great cost, 

particularly since many of them are renters. And so when folks are 

about to start a new business they have to significantly invest in 

major capital improvement to the properties, which often leads 

them to have issues when they renew their lease because they 

have, in effect, invested in increasing the value of those properties. 

Do you see any real benefits, tax credits or other types of benefits, 

that can alleviate small businesses from this initial investment 

that very often leads to them shutting down before they even open? 

Are there any real practical proposals that you have that would alleviate that investment? 

Mr. LEWIS. Great question. From a policy standpoint, the 

AICPA does not have an official policy, but let me give you a sense 

of some ideas that you could look at, one of which is the section 

179 we mentioned. Historically, it was just for personal property, 

stuff that you could take with you for lack of a better phrase. But 

on top of that there is some liberalization of that rule where you 

can expense more of what you are talking about. Allowing entrepreneurs to immediately expense on those initial outlays would 

help a lot because really, when you are talking entrepreneurship, 

you are talking cash flow. I mean, all the rest of this is great, but 

that is what matters to them. Their ability to make payroll is dependent upon their ability to keep the cash coming in. So anything 

that you can do to give them an immediate benefit back would be 

well received. 

Mr. ESPAILLAT. Thank you. 

My second question is regarding the empowerment zone, so what 

created in the past and what created in distressed urban and rural 

areas, and they provided tax credit to the tunes of $3,000 per employee hired within the zone. It provided monies for bonding authority. It also provided a serial tax on capital gains and the sale 

of assets and other types of benefits for several regions throughout 

the country that were economically distressed and had high levels 

of unemployment rates. 

How do you feel about this policy to provide tax credits for employees that reside within economically distressed areas? And do 

you see this as a good policy for spurring businesses and job creation? 

Mr. LEWIS. Is that for me? 

Mr. ESPAILLAT. Yes. 

Mr. LEWIS. Okay. Thank you. 

The AICPA put out several years ago something called Good Tax 

Policy, and we just recently updated it last month. Many of your 

staffs might be aware of it, but we listed 12 ideas that as you approach any tax question you ought to think in terms of. Things like 

neutrality, simplicity, transparency, minimizing the tax gap, things 

that you would just say these are fundamental key components of 

what we should be doing. 

So your question is a good one in that you are asking a question 

about the balance between simplicity, neutrality, maybe even cerSBREP-219A with DISTILLER

21 

tainty and convenience of payment. So my answer would be you 

would have to weigh all of those together, because if you just isolate the one question and you just say, well, is it good from this 

policy or that, I think you may not get the right answer. But you 

have to ask yourself where does it fit in the purview of all of the 

good policies and evaluate it that way. 

Mr. ESPAILLAT. Thank you. I yield back my time. 

Chairman CHABOT. Thank you. The gentleman yields back. 

The gentleman from Iowa, Mr. Blum, who is the chairman of the 

Subcommittee on Agriculture, Energy, and Trade, is recognized for 

5 minutes. 

Mr. BLUM. Thank you, Chairman Chabot. Did I get that correct? 

Chairman CHABOT. You did. 

Mr. BLUM. I am slow but trainable. It took me 6 weeks to get 

that correct. 

Chairman CHABOT. I even got Blum right. Everybody else says 

‘‘Bloom,’’ so. 

Mr. BLUM. We are making progress. 

Chairman CHABOT. Excellent. 

Mr. BLUM. And thank you to the panel for being here today, 

particularly Mr. Reynolds. I happen to be an entrepreneur in the 

software business myself, and one of my basement companies in 

the 1990s went public in spite of the government. So I feel your 

pain. 

New business startups, 615,000 in the year 2005, 615,000. Ten 

years later, down to 450,000, down 40 percent. New jobs from new 

businesses, 4.7 million in the year 2000, down to 3 million 15 years 

later. U.S. startups are at 40-year lows. 

So I would like to back up and talk a little bit about the formation of small business as it relates to tax policy. The only two ways 

I know to start a small business as far as capital goes is owner’s 

equity; you put your own money into it and you go to the bank for 

capital. And if I walk through this—and I will take my own example—you are working for someone else, typically, unless you inherit 

money. You are working for someone else. You live beneath your 

means and you save some money. You put that money in a savings 

account in a bank and the interest is taxed. 

So then you put some of the money that you have saved over a 

lifetime, typically, maybe in the stock market. And then you sell 

those stocks and the capital gains, you are taxed. You are taxed on 

your interest. You are taxed on the capital gains. 

And then you think, okay, I have got some money here to start 

a business. Do I really want to go into it? Odds are I could get 

sued. Nuisance lawsuits. We need tort reform. Regulations are out 

of control. Do I want to deal with that? There is a multitude of 

things; also, taxes. 

So I would like to ask the panelists, and Mr. Reynolds, I would 

be interested in your personal story, what can we do as a Congress 

with tax policy to encourage savings? It seems to me that we discourage savings and encourage consumption in our tax policy. You 

cannot start a business without capital, and banks are not going 

to loan it all to you to start a business. So we need to go to the 

front end of this and say how does our tax policy encourage savings? Because that is where future businesses come from. 

SBREP-219A with DISTILLER

22 

And I will open it up to whoever wants to jump in. 

Mr. POMERLEAU. I think that that is an excellent question. 

There are a lot of places in the current Tax Code where the Code 

is discouraging savings, basically double taxing or triple taxing savings; the issue of dividend taxes, capital gain taxes. You say you 

earn $100 in wages. You save that money. Or you get taxed on 

those wages, you save that money, you earn a return, and then you 

are taxed again when you take that out as a gain. I think fundamental tax reform should move away from this system of double 

taxing savings towards a single layer of tax on saving and investment so people are not discouraged from saving. And that means 

it will not bleed into lower investment and lower economic growth, 

which is one of the big issues under the current Tax Code. 

Mr. BLUM. Would you agree our Tax Code discourages savings? 

Mr. POMERLEAU. Yes. I think—— 

Mr. BLUM. Not a good thing for business formation? 

Mr. POMERLEAU. Yes. I think the things that expand IRAs, 

401(k)s, that would encourage savings. I think that fundamental 

reform that moves to a consumption-based tax would do the same. 

I think the House GOP blueprint moves much closer to an ideal 

system there. 

Mr. REYNOLDS. I would just say that you cannot use an IRA 

or a 401(k) to start a business. And we can debate whether or not 

that is appropriate or not. 

Mr. BLUM. If I could interrupt, Mr. Reynolds, how did you finance your business when you started? 

Mr. REYNOLDS. A combination of savings and loans. And that 

was 22 years ago and it was considerably easier then. 

I think that the Tax Code is one part of the problem in that particular circumstance. I think certainly a shift towards consumptionbased taxing rather than taxing on income would go a long way to 

help that problem. 

I think that as a small business person, access to capital is an 

extremely important issue, and Congress over the last 8 years has 

done considerable damage to small businesses’ ability to get loans 

and access capital, and I think that that is something that needs 

to be addressed perhaps outside of the Tax Code, but it is a very 

vital issue to us. 

Mr. BLUM. And I was on a bank board, a billion-dollar bank 

back in Iowa, and I was chairman of the Director’s Credit Committee. Every business loan over a million dollars came through 

our committee. And part of the problem with extending or making 

loans to new businesses was they were not creditworthy because 

they did not have enough equity to put in it. But as we are talking 

about it here, we tax away a big chunk of this equity as people are 

saving, as capital is forming along the way. 

Chairman CHABOT. The gentleman’s time has expired, but, Mr. 

Burton, if you wanted to respond. 

Mr. BURTON. I just want to mention one thing. I released a 

paper yesterday that systematically walks through the reform 

agenda to improve entrepreneurs’ access to capital, both in the 

banking and securities regulation area. You might want to look at 

that. 

SBREP-219A with DISTILLER

23 

Mr. BLUM. Very good. I will. I yield back, I guess, the time I 

do not have. 

Chairman CHABOT. Thank you. The gentleman’s time has expired. 

And the gentleman from Florida, Mr. Lawson, who is the ranking 

member of the Subcommittee on Health and Technology is recognized for 5 minutes. 

Mr. LAWSON. Thank you very much, Mr. Chairman. 

My question will be do you think the intangible tax on property 

should be eliminated? On personal property in the office? 

Mr. BURTON. You are talking at the State and local level? 

Mr. LAWSON. Right. 

Mr. BURTON. In general, yes, I do. I think that particularly the 

way that they are usually administered, they are very complex and 

bordering on random. But of course, that varies tremendously State 

by State. 

Mr. LAWSON. Right. And the reason why I question it is because I have been in small business for 36 years and you pay more 

money to the CPA to do the reports than sometimes what it calls 

for the taxes. And I want to make sure that I was not the only one 

that felt that way. 

Mr. BURTON. Well, I think you are right. And then a lot of jurisdictions have these little gross receipts taxes, little inventory 

taxes, just little this, just little that, and the compliance costs relative to the money raised by the State and local government is 

very, very high, and the State and local governments need to simplify their tax systems as well. That is part of what guys like Tim 

experience. It is not any one rule or any one tax. It is the combined 

weight of hundreds of them. And basically, when you add it all up, 

they are overwhelmed. And we need you as a policymaker and your 

colleagues at the State and Federal level, you need to systematically try to reduce these burdens. And it is not you want to raise 

X dollars or Y dollars, just do it simpler. 

Mr. LAWSON. Right. Mr. Chairman, I have one more question. 

Back in I would say maybe July through September, there was 

a considerable amount of discussion about the minimum wage increase and there was some major corporation, like McDonald’s and 

some people, really were focusing in on it and said, you know, we 

can ask for as much as $15 an hour. The minimum wage increase, 

even though you want people to have a livable wage, increasing the 

minimum wage has sometimes a devastating effect on small business, and any of you all can respond to it. 

Mr. REYNOLDS. I am in the software business and none of the 

people that work for me make the minimum wage. They are all on 

salary. My customers, however, are industrial distributors and 

often have people who are working minimum wage jobs in the 

warehouse and all. I think that, if I can speak for them, which they 

may or may not want me to, but if I can speak for them, I think 

that they would say that raising the minimum wage impairs their 

ability to hire additional people in those kinds of jobs. 

Mr. LAWSON. And I think, Mr. Lewis, you have done research 

in that area? 

Mr. LEWIS. We have not. It might be more for the economists. 

SBREP-219A with DISTILLER

24 

Mr. BURTON. The minimum wage affects a relatively small 

hunk of our population, but the real question is do you want to 

make it illegal for typically young people or inexperienced people 

to work at a lower wage, lower than whatever minimum wage is 

you pick? It is necessarily going to result in some unemployment 

of those people. It is necessarily going to result in somewhat higher 

cost to the employers. But I think the right way to think about it 

is it is targeted at the people who most need employment experience to do better. And we want a system that lets people get on 

the first rung of the ladder, and, typically, the minimum wage affects the youngest and least experienced people in the labor market. 

Mr. LAWSON. Okay. I yield back my time. 

Chairman CHABOT. Thank you. The gentleman yields back. 

The gentleman from Nebraska, Mr. Bacon, is recognized for 5 

minutes, finally. 

Mr. BACON. I want to thank you all for being here today. As a 

30-year Air Force guy, you are really making it clear the complexity that our small businesses go through, so I really appreciate 

that. 

And I want to maybe just make a note to Mr. Pomerleau, too. 

I just thank you for your comments on capital gains. I find it fascinating that—or actually terrible that we have the highest capital 

gains tax since the 1990s and it has not only had a negative impact 

on our businesses, but it does not help out our tax revenues. Do 

I copy you right on that? 

Mr. POMERLEAU. No, I agree with that. 

Mr. BACON. All right. So that is important. We need to fix that. 

And Mr. Burton, I wanted to ask you about self-employed when 

it comes to ACA and health insurance. It is probably the number 

one thing I hear from our self-employed that that is the number 

one thing we have got to fix is the cost of premiums. And right now 

I believe it is partially deductible. Could you give us recommendations of how we could fix this better for self-employed when it 

comes to the ACA revisions? How can we get this right for the selfemployed? 

Mr. BURTON. One thing is the tax treatment. You just want a 

deduction for purposes of the self-employment tax, the 15.3 percent 

self-employment tax. But the other question is just the structure of 

the current health insurance market. Small employers and self-employed people are either not group insurance or very small group 

insurance and, therefore, tend to, given the structure of the current 

marketplace, have much higher costs. And part of that is the Affordable Care Act and part of it predates that. It was not as if a 

group of two or three people had it great before the Affordable Care 

Act. It is just worse now. 

And so that I think it is a matter of changing the structure of 

the health insurance market, making it less bureaucratic, more 

competitive. And my colleagues at The Heritage Foundation have 

put together a number of proposals to do that. I know enough 

about it to be dangerous, but I am not fully informed of the current 

state of play, if you will, so. 

Mr. BACON. Well, thank you. I talked to a self-employed couple 

yesterday, with some constituents. They are paying $30,000 a year, 

SBREP-219A with DISTILLER

25 

$12,000 deductible. It is the highest I have heard yet, and that is 

hard for a self-employed family. 

Mr. BURTON. It is. And I was on my own until about, I do not 

know, I guess it is going to be 6 years ago now. And the premiums 

then, and in a small firm were ridiculous. And now they are even 

more ridiculous. 

Mr. BACON. Mr. Reynolds, I wanted to follow up with a comment you made. You are right, about 70,000 pages of tax law. In 

fact, I think I read it was 78,000. How much time and money does 

it cost you and your company to work through all the—you know, 

to do your taxes? 

Mr. REYNOLDS. Well, as I said in my testimony, we simply cannot do our own taxes, and so we employ an accounting firm to prepare our taxes along with our annual review. Despite the fact I am 

a sub S, we have to do both corporate tax submission and a personal one as well, and they clearly have to relate to each other. 

And so my accounting firm does both. And I think for 2015, the bill 

came in at about $15,000. 

Mr. BACON. One last question. If you could immediately expense 

capital investments now rather than having to depreciate them 

over time, what additional investments would this allow your company to make? What kind of impact would it have if we fixed this? 

Mr. REYNOLDS. We are a services firm, so we do not have a lot 

of fixed assets. But what it would do if I can add, the kind of capital investments that we make generally are around the improvement of our facilities and making a better workplace would certainly accelerate our plans around that. I think, you know, we are 

a small business and we have to parcel things out over a period 

of time and it will allow us in general to act much more quickly. 

Mr. BACON. Thank you. Mr. Chairman, I yield back. Thank you. 

Chairman CHABOT. The gentleman yields back. 

The gentlelady from California, Mrs. Chu, is recognized for 5 

minutes. 

Mrs. CHU. Thank you, Mr. Chair. 

Well, there are many current tax policies that create inequities 

between small and large U.S. businesses, so I would like to address 

this question to Mr. Lewis. Certainly, the two most consistent burdens for small businesses are the cost of complying with tax provisions and the growing complexity of the Tax Code. I saw this firsthand as a member of the Board of Equalization in California, 

which was our State’s elected tax board. 

We saw that too many small business owners had difficulty taking advantage of credits that they qualified for because of the complications. The IRS National Taxpayer Advocate found that the requirements of the Tax Code were so difficult that individuals and 

businesses spent 6.1 billion hours a year and this resulted in $163 

billion spent in compliance costs. So how does this complexity create advantages for firms that can devote resources to identifying 

tax loopholes? 

Mr. LEWIS. Well, I think one of the fundamental things to recognize is that the complexity impacts not only the large companies, 

but also the small, and so it impacts them both. The severity would 

depend upon their circumstances and their industries. 

SBREP-219A with DISTILLER

26 

To give you an example, the Small Business Health Tax Credit 

that was part of ACA, relatively ineffective in terms of compliance 

because it is rather complicated. So even those who could qualify 

for that credit found it difficult to comply because of all the requirements and everything that went into it. So sometimes in our 

efforts I think to create incentives congressionally speaking, I think 

we need to always consider the implications of simplicity in them 

because right now to your point, there are a lot of credits out there 

and incentives that I think people do not avail themselves of because they simply are not aware. 

Mrs. CHU. And let me now ask about tax extenders and tax certainty, Mr. Lewis. Often Congress passes legislative modifications 

to this Tax Code in the form of tax extenders at the end of the 

year. However, the uncertainty surrounding which tax relief provisions will be renewed makes planning for startups and small businesses difficult. In fact, it was not until 2015 and the PATH Act 

that Congress finally extended some very important tax provisions, 

like the research and development credit and the section 179 expensing and made it, in fact, permanent. So how does this uncertainty impact small businesses and startups who are attempting to 

plan financially for the future? 

Mr. LEWIS. Yeah, you hit on a great point. Companies and individual owners of small businesses simply will not react. There are 

three ways you can do it. One, you can just be cavalier and go cowboy as it were, and you can just assume that Congress is going to 

do what they are going to do and go with it. But that is not most 

small business people’s fate. They live by cash flow. They cannot 

just guess. 

So to your point, in 2015, what I observed personally is I observed a lot of people sitting on the sidelines, waiting and waiting, 

constantly calling their CPAs or their tax providers and asking at 

what point are we going to have certainty? 

December 18th, and let’s be clear, for those purposes you mentioned, the section 179, it is not good enough to just simply charge 

the equipment and you are good for the year. You actually have to 

put it in service. So think about what your life is like on December 

18th or 19th and how much flexibility you have in those 2 weeks’ 

time period between then and the end of the year to buy, receive, 

and actually put into service some equipment when probably most 

of your staff is away for the holidays. It has a traumatic impact. 

At that point in the process, the way I would say it is rather 

than you proactively managing or motivating someone to behave, 

all you are doing is just sophistically scorekeeping. At that point 

it is just, well, what did I actually do? And did I take advantage 

of what was there now that it has happened? As opposed to January 1, knowing with assurance what you can rely upon. 

Mrs. CHU. And finally, Congress has created tax incentives to 

encourage business investment, but some tax experts have pointed 

that one-time tax breaks create complexity. Do you think there are 

times when there should be exceptions made for temporary targeted incentives? 

Mr. LEWIS. Well, I will say historically you are correct, that you 

have had times where there have been one-time off incentives. But 

I would go back to what I talked about with the good tax policy. 

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There are various elements that you have to balance. One is you 

want neutrality. You want to have it be neutral and not necessarily 

motivate one way or the other. You want it to be simple. You want 

it to be certain, easy to administer, equity, and fairness. It can be 

in some payment. 

So the answer to your question is you have got to consider all 

those in any one particular situation. And it would just depend. 

There is no perfect tax law. If you just listen to that list I just gave 

you, you will observe that there is this tradeoff. Right? And so at 

some point it might make sense to embrace one or the other because you are going to have to do that, but, again, it would be a 

fact-specific situation. 

Chairman CHABOT. The gentlelady’s time has expired. 

The gentlelady from Florida, Ms. Murphy, who is the ranking 

member of the Subcommittee on Contracting the Workforce, is recognized for 5 minutes. 

Ms. MURPHY. Thank you all for being here. I represent a district in Central Florida where small businesses are a significant 

part of the economy. But the district is also the youngest district 

in Florida, being home to the University of Central Florida, which 

is the second largest university in the country. And the millennial 

generation and the younger generation, there are studies that are 

showing that they are engaged in the gig economy more significantly and that that is going to grow significantly over the next 10, 

20 years. 

And as such, they are considered to be self-employed. With the 

Social Security and Medicare taxes, they are generally paid as a 

part of a combined rate of 15.3 percent, half paid by the employer, 

the other half paid by the employee. 

In the case of self-employed individuals, they paid both, as if 

they are both the employer and the employee. 

So I guess my question for you is that would you consider this 

an inequity to sole proprietorships? And then more broadly, what 

kinds of changes do you think are necessary in the Tax Code to 

support this growing gig economy, the growing prevalence of selfemployed individuals? 

Mr. BURTON. Well, let me just jump in real quick because I address that subject in my written testimony, and it is a problem that 

has been lingering since the 1970s that really needs to get fixed. 

There is a great deal of uncertainty about classification issues and 

whether someone should be treated as an independent contractor 

or an employee. And the IRS basically addresses this with a 20-factor test, and any test that has 20 factors is necessarily going to be 

arbitrary and uncertain because there is no real way to know how 

the IRS is going to weight the various factors. 

And so what I have proposed in principle is to have bright-line 

tests for who is an employee, bright-line tests for who is not an employee, i.e., is an independent contractor, and in the middle ground 

allow either the employer or potentially the employee to elect subject to backup withholding probably at a 25 percent rate. 

As to your other question about is it an inequity that self-employed people have to pay both the employer and employee share, 

the answer to that I think is no. The clear point is that there is 

a wedge imposed by the Social Security payroll taxes or Medicare 

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or any other tax between what the employer has to pay tax inclusive and what the employee gets after taxes. And that wedge 

should be the same whether you are an employee or whether you 

are self-employed. And that is what the self-employment tax does. 

Mr. LEWIS. I can tell you from a practical standpoint that when 

I teach a group of students about the self-employment tax, particularly most of them being in this economy that you mentioned, it 

comes as a—I think the word is shock because typically I am teaching them in the winter and they are recognizing that they have got 

a whole lot of reckoning from the summer prior that they have not 

necessarily thought about. So maybe part of it is an educational 

process if nothing else, but the first time that they get hit with this 

it is an eye-opener. And if you are in the UCF community, you are 

going to see this a lot. 

In terms of the equity of it, I think the Congress is going to have 

to deal with the fact that the tax base is moving. Right? The fact 

that we are so global and that you have got this economic shift between traditional going to work for the plant and manufacturing to 

this. Everyone is sort of self-employed, whether it be the driver for 

hires or the rentals that people have. We are just shifting to where 

people are more in tune with their own financial circumstances. 

You are going to have to address that somehow in the tax law and 

recognize that that is a big portion that is going to continue to 

grow. 

Mr. BURTON. I once got asked who is FICA when they saw their 

first paycheck. 

Ms. MURPHY. Thank you. And I yield back the rest of my time. 

Chairman CHABOT. FICA is a very important part of our life, 

is he not? Or she? Thank you very much. The gentlelady yields 

back. 

Our last questioner, I believe, will be the gentleman from Illinois, 

who was at the markup that I otherwise would have been at if I 

was not here because we are both on Judiciary, who is the ranking 

member on the Subcommittee on Agriculture, Energy, and Trade, 

Mr. Schneider. 

Mr. SCHNEIDER. Thank you, Mr. Chairman. 

Let me take personal prerogative. I am excited to be back on the 

Small Business Committee and working with you to make sure 

that we are helping what is the engine of our economy: small businesses that need to have the confidence and see the path to grow 

and prosper. So thank you very much. 

The first question, just a quick question for Mr. Pomerleau, you 

talked about the issue of capital losses being offset against capital 

gains. And my understanding is the reason that is, is because capital gains are treated at a different tax rate than ordinary income. 

And so just real briefly, how would you adapt that as you are recommending to allow unlimited capital losses be offset against income? 

Mr. POMERLEAU. Yeah. So I do not necessarily believe you 

need to offset on an unlimited basis, and one of the challenges here 

is that when you have run out of capital gains, the only thing left 

is say labor income, and that labor income is being taxed at a higher marginal tax rate than your capital gains. So if you get to deduct against that, you are actually receiving a larger benefit than 

SBREP-219A with DISTILLER

29 

you should. So I think it has to be done in the context of a larger 

reform that rethinks how income is taxed. Because one of the challenges with having special tax rates on special types of income, 

whether it is passthrough income versus wage income or wage income versus capital income, is you run into these little administrative snags. So I think it would have to be done in the context of 

a larger—— 

Mr. SCHNEIDER. I think that emphasizes the point all the witnesses made. Thank you for being here, first of all, because I know 

how busy you are, but the idea that any type of tax reform we do 

has to not just be corporate tax reform, but include passthroughs 

and individuals. 

Mr. Lewis, I am going to turn to you for as second, and you may 

have anticipated this question. I want to talk about cash accounting. And you talk about the importance of cash accounting for 

small business and entrepreneurs. But there are a whole group of 

businesses that are not typically considered entrepreneurial; for example, dentists and lawyers. Can you touch on who cash accounting affects besides the typical entrepreneurial startup business? 

Mr. LEWIS. Yeah. Cash accounting is critical to small business. 

One group of businesses where cash accounting is sort of mitigated 

is those that where inventory is a significant portion of what they 

are doing. So the idea is if you are buying a lot of stuff for resale, 

that is kind of a little different circumstance. But most of these 

startup businesses at some level will be entitled to use cash. 

But here is the key point. At some point, arbitrarily we set a 

deadline and say, okay, once you get beyond this point, now you 

need to move into accrual. And whether you set that limit at 10 

million or at 25 million or some other limit perhaps, you need to 

recognize that that is going to have implications. 

Specifically with respect to pass-through entities, such as CPA 

firms, because the profits are passed through to the owners’ individual tax returns a threshold at any level would directly impact 

an owner’s individual tax return because that owner would be required to pay tax on income he or she has not been paid for by the 

client. 

I mean, we are in a country where we want to say to somebody, 

you know, within reason, grow your business. That is what creates 

jobs. That is what creates opportunities for other people. And so 

whether it is the capital aspect we have been talking about or 

whether it is freeing them up through the Tax Code, but that is 

why I was so emphatic saying that we have got to keep the cash 

method of accounting. And perhaps even look at expanding it because to your point that at some level an arbitrary ceiling will restrict growth, whether that is through merger or organic growth. 

But at some point, if I know as an entrepreneur that once I get beyond a certain point I am disincentivized because now I am going 

to add complexity and add all the cost, I am not going to be that 

interested. 

Mr. SCHNEIDER. Thank you. I do not know if any of the other 

witnesses want to touch on that? 

Mr. BURTON. Well, I agree it is very important, particularly for 

small firms. The principle underlying the Better Way plan is it is 

a cash flow tax, so it should address most of these issues when it 

SBREP-219A with DISTILLER

30 

is fully flushed out. I would hope it would do it both in terms of 

the general accounting method, also inventory and so on. It is a 

huge simplification to premise your tax accounting on cash rather 

than accrual. 

Mr. SCHNEIDER. So I will close with this and, Mr. Reynolds, it 

touches on something you talked about with your audits of having 

to explain to the IRS how your business works. Small businesses 

are different, but they are the engine. They are oftentimes familyowned businesses with multiple family members and they are pillars within the community. The time you take to come here to advocate on behalf of small business, to educate so many members of 

Congress, I cannot emphasize how important that is. The message 

has to be heard by our colleagues that we need to help small businesses have the confidence to step forward, to step up, and ultimately succeed to give us the growth we need. And with that I will 

yield back my time. 

Chairman CHABOT. Thank you. The gentleman yields back. 

And we want to thank the panel here for I think wonderful testimony here this morning and now this afternoon. I think the questions were great and we are obviously in the middle of tax reform, 

and we hope this is going to be a bipartisan process as much as 

possible. And as my colleague likes to say, there is no such thing 

as a Republican small business or a Democratic small business. 

They are just small businesses, and I think you all are getting the 

short end of the stick when it comes to the Tax Code right now. 

So hopefully, some of the reforms that we are able to implement 

will positively affect small business entrepreneurship and, therefore, job growth all over America. So thank you for playing a very 

important role in that here this morning. 

I would ask unanimous consent that members have 5 legislative 

days to submit statements and supporting materials for the record. 

Without objection, so ordered. 

And if there is no further business to come before the Committee, 

we are adjourned. Thank you. 

[Whereupon, at 12:36 p.m., the Committee was adjourned.] 

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A P P E N D I X 

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Designer Dan CarvaJal 

Written Testimony 

Of 

Kyle Pomerleau 

Director of Federal Projects 

Tax Foundation 

Before the Committee on Small Business 

"The Tax Code as a Barrier 

to Entrepreneurship" 

Thank you Chairman Chabot and Ranking Member Velazquez for the opportunity to 

speak about the U.S. federal tax system and entrepreneurship. 

There are millions of entrepreneurs in the United States, spread across nearly 

every major industry.' While every entrepreneur has a different business model 

and unique concerns, there are a few key characteristics that apply to many 

entrepreneurs throughout the economy: 

Entrepreneurs tend to run losses for some time before turning a profit, and many 

entrepreneurial ventures do not survive long enough to turn a profit at all. 2 

As a result, entrepreneurial ventures tend to be especially risky investments for 

outside investors, who typically see many of their investments in entrepreneurs 

fail.' 

If they do develop a successful business model, entrepreneurs often seek to rapidly 

expand their operations and scale' 

Ideally, the U.S. federal tax code would be neutral with regard to each of these 

characteristics. The tax code should not punish businesses for running sizeable 

losses in their early years, nor should it disadvantage investors that pursue risky 

investments. Certainly, it should not present additional barriers to successful 

businesses looking to expand. 

Bureau of labor Statistics "Busin.::.s~ Employment Dynamics:' hrtp>://www.bls.gov/bdm/#data 

Bureilu of Labor Stati>tics. "Entrepreneurshtp and the US Economy,' April2016, https"//www b!s gov/bdm/entrepreneurship 1 

bdm_chart3htm 
32 

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TAX FOUNDATION I 2 

However, this is not the case under current U.S. tax law. The federal tax code penalizes businesses 

with large, up-front losses; discourages investors from pursuing risky opportunities; and makes 

it difficult for successful companies to expand. All of these features of the U.S. tax code create 

disadvantages for new businesses and entrepreneurs. 

Lawmakers interested in improving the tax treatment of U.S. entrepreneurs would do well to consider 

ways to mitigate these three distortionary features of the current U.S. tax code. 5 

1. The Tax Treatment of Business Losses 

It is often the case that entrepreneurs run losses for several years before turning a profit. However, 

the current federal tax cqde is particularly detrimental to businesses whose earnings fall into this 

pattern, and imposes a larger tax burden on businesses that take longer to turn a profit. 

The reason for this is the fundamental asymmetry in the U.S. tax code between the tax treatment 

of business profits and business losses. A business that makes a profit is subject to an immediate 

tax liability, in the same year the profit is earned. However, a business that turns a loss is not always 

entitled to an immediate tax benefit. 

If a business has a net operating loss in a given tax year, but has made a profit in previous tax years, 

the business is often eligible to "carry back" a net operating loss deduction to its previous years' tax 

returns - a provision which does allow the business to receive an immediate tax benefit. However, 

if the business's losses exceed its recent profits, then it is required to "carry over" the net operating 

loss deduction to a future tax year- meaning that the business does not receive an immediate tax 

benefit.6 

Importantly, the longer a business has to wait to deduct its net operating losses, the smaller a tax 

benefit the business receives. A business that has a $1 million loss in its first year of operation, and 

does not turn a profit until its tenth year of existence will not be able to deduct its $1 million loss until 

the tenth year. By that time, the tax benefit from $1 million deduction will be worth significantly less 

to the business, due to inflation and the time value of money. 

As a result, the U.S. tax code is inherently disadvantageous to businesses that run losses for many 

years before turning a profit. As soon as these businesses become profitable, they are subject to 

an immediate tax liability- even though they did not receive an immediate tax benefit for all of the 

losses they incurred. Furthermore, if a company fails before it can ever turn a profit, then it will 

never receive a tax benefit for the losses it incurred, even though it would have been subject to a tax 

liability if it were profitable. 

6 26 U.S.C. §172. It should be noted that in the case of pass· through businesses owners are often able to deduct the net operating toss from one business 

against other persona! income 
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TAX FOUNDATION I 3 

To summarize, the longer it takes for a business to turn a profit, the greater the tax penalty for 

that business. This is a feature of the U.S. tax code that is likely very disadvantageous for many 

entrepreneurs. 

It is worth noting that the recently released House GOP "Better Way" tax plan would somewhat 

mitigate this issue by allowing businesses to increase their carried-forward net operating loss 

deduction by a factor reflecting inflation and the real return to capital? This measure should, in 

theory, make the net operating loss deduction equally beneficial to businesses whether claimed 

immediately or claimed far in the future. However, it would not provide any relief for companies that 

go out of business before they ever turn a profit.' 

2. The Tax Treatment of Capital Losses 

Entrepreneurs often rely on outside investors to provide financial capital for their businesses. 

Investments in entrepreneurial ventures tend to be risky, and investors may experience a long string 

of capital losses before finding an investment that produces a substantial capital gain. However, 

under the current tax code, these capital losses are not always immediately deductible, creating a 

situation that penalizes risky investment. 

In general, taxpayers are only allowed to deduct their capital losses in any given year to the extent 

of their total capital gains in that year; individual taxpayers are also allowed to deduct up to $3,000 

in capital losses beyond this limitation ($1,500 for married individuals filing separately). Otherwise, 

taxpayers are often required to "carry forward" all other capital losses to future tax years, when 

they can be deducted against future capital gains. In the case of corporations, capital losses can also 

generally be "carried back" up to three years! 

Here again, the tax code contains a fundamental asymmetry: capital gains are subject to an 

immediate tax liability, while capital losses do not necessarily yield an immediate tax benefit. To 

the extent that taxpayers are required to carry their capital losses forward many years before they 

are able to deduct them, the tax benefit of these losses diminishes each year that they are carried 

forward. 

As a result, the U.S. tax code penalizes some taxpayers that make risky investments, by denying 

them a full, immediate deduction for their capitallosses. 10 This feature of the tax code makes it less 

advantageous to invest in entrepreneurial ventures. 

7 "A Better Way: Tax," June 2016. https://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-Polit:yPaper.pdf 

8 It is difficult to design a measure that would provide businesses with an immediate tax benefit for losses mcurred. due to concerns that such a provision 

would create opportunit1es for gaming and tax shelters. 

9 26 u.s c. §1211. §1212 

10 Here. again. there is an administrative rationale for this feature of the tax code, which doses off opportunities for gaming of the tax system. 
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TAX FOUNDATION I 4 

That said, that the tax code does allow households to deduct up to $100,000 of capital losses on 

certain "small business stock" immediately against their ordinary income ($50,000 for non-joint filers). 

This provision provides an incentive for taxpayers to invest in risky small business ventures." 

3. The Tax Treatment of Business Investment 

Entrepreneurs that develop a successful business model are often interested in scaling their 

operations as rapidly as possible. This expansion phase typically requires a great deal of capital 

investment, such as the purchase of equipment, buildings, and factories. However, the current U.S. 

tax code is especially burdensome on businesses that undertake significant capital investments, due 

to the current system of tax depreciation. 

Under the current U.S. tax code, businesses are generally not allowed to deduct the full 'cost of 

their capital investments in the year that they are made. Instead, businesses are required to deduct 

their investment cost over long periods of time, according to a set of over two dozen depreciation 

schedules." This system is quite complicated: the federal government estimates that businesses 

spend about 448 million hours each year complying with depreciation and amortization rules." 

According to standard economic theory, the federal tax depreciation system is an important 

determinant of the overall level of U.S. business investment. Because businesses value immediate 

deductions more than deductions in the future, the longer a business has to wait to write off the 

full cost of its capital expenses, the less likely the business is to undertake a new investment. In 

fact, there is evidence that small and cash-strapped businesses, such as startups, are particularly 

responsive to changes in depreciation schedules: in a recent paper, Eric Zwick and James Mahon 

show that small firms responded 95 percent more to the introduction of bonus depreciation than 

large firms.'4 

In fact, the tax treatment of capital investment has the highest stakes for entrepreneurs, who often 

spend a significant portion of their profits on the capital investments needed to establish and grow 

their operations. It is new and expanding businesses that stand to gain or lose the most from changes 

to the tax treatment of capital investment. 

11 26 usc. §1244 

12 26U.S.C. §167 

13 Scott A Hodge, "The Compliance Cost of IRS Regulations," Tax Foundation, June 2016. https:t/taxfoundation.org/compllance-costs-irs-regu!ations/ 

14 Eric Zwick and James McMahon. 'Tax Policy and Heterogenous Investment Behavior." American Economic Review 107: 217-248. http://www.eriawick.com/ 

stimu!us/stimulus.pdf 
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TAX FOUNDATION I 5 

For the smallest businesses, the tax treatment of capital investment is generally favorable, due to 

section 179 of the tax code, which provides full expensing for many investments of small businesses. 

However, the rules for deducting capital investments can become much more burdensome for 

startup businesses in the "expansion phase," during which new businesses try to scale their model 

to new markets and broaden their offerings. During this phase in a business's lifecycle, the lengthy 

depreciation schedules of the tax code can serve as a barrier to investment, inducing businesses to 

pass up otherwise profitable investment opportunities due to tax considerations. 

As a result, there is strong reason to believe that moving toward full expensing would encourage 

more entrepreneurial investment and remove barriers to the growth of startups. Notably, the House 

GOP "Better Way" plan would do just this, allowing both small and large businesses to deduct the full 

cost of their capital investments immediately. 

4. High Tax Rates on Business Income 

All three of these distortions in the U.S. tax code are exacerbated by the high marginal tax rates 

on businesses in the United States today. In general, if a business faces a high marginal tax rate on 

its profits, it will also be subject to a higher tax penalty for running losses for many years, and the 

depreciation system will pose a larger barrier to its new investment. Similarly, the higher the tax rate 

on capital gains, the greater the tax disadvantage will be for pursuing risky investments. 

As such, it is important to note that income earned by U.S. entrepreneurs is generally subject to 

higher marginal tax rates today than in recent years past. 

Entrepreneurs that choose to set up pass-through businesses, such asS corporations or partnerships, 

face a higher top federal tax rate (44.6 percent) today than at any point since 1986. As a recent Tax 

Foundation report shows, the top tax rate on pass-through business income can exceed 50 percent 

when state and local income taxes are taken into account." 

Other entrepreneurs choose to organize their businesses as C corporations. These businesses can 

be subject to taxation on both the entity level and the business level. The corporate income tax, on 

profits earned at the entity level, is levied at a 35 percent rate, the highest in the developed world.16 

Meanwhile, the top tax rate on capital gains (25.0 percent) is the highest since 1997, while the top tax 

rate on dividends (25.0 percent) is the highest since 2002. 

15 Scott Greenberg, 'Pass-Through Businesses: Data and Policy," Tax Foundation. January 2017. https://taxfoundation.org/ 

pass-through-businesses-data-and-policy/ 

16 Kyle Pomerleau and Emily Potosky. "Corporate Tax Rates Around the World. 2016," Tax Foundation. August 2016. https://taxfoundatfon.org/ 

corporate-income-tax-rates-around-world-2016/ 
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TAX FOUNDATION I 6 

It should be noted, however, that for some entrepreneurs and investors, the high tax rates on capital 

gains can be mitigated by the favorable tax treatment of qualified small business stock. Since 2010, 

entrepreneurs and investors who hold "qualified small business stock" for more than five years are 

granted a 100 percent exclusion on the capital gains from their shares. This provision was made a 

permanent part of the tax code in 2015. 17 

Conclusion 

As this testimony has shown, the U.S. tax code tends to impose higher burdens on businesses that 

run losses for many years, businesses that are risky investments, and businesses undergoing rapid 

expansion - all of which are typical characteristics of entrepreneurial ventures. 

Lawmakers interested in removing these barriers to entrepreneurship should consider ways to 

mitigate these three distortions in the U.S. tax code: the limited deductibility of business net 

operating losses, the limited deductibility of capital losses, and lengthy depreciation schedules. 

17 26 u.s.c. §1202 
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214 Massachusetts Avenue, NE • Washington DC 20002 • (202) 546-440() • 

lteritage.org 

CONGRESSIONAL TESTIMONY 

"The Tax Code as a Barrier to Entrepreneurship" 

Testimony before 

The Committee on Small Business 

United States House of Representatives 

February 15,2017 

David R. Burton 

Senior Fellow in Economic Policy 

The Heritage Foundation 
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My name is David R. Burton. I am Senior Fellow in Economic Policy at The Heritage 

Foundation. l would like to express my thanks to Chairman Chabot, Ranking Member 

Velazquez, and members of the committee for the opportunity to be here this morning. 

The views l express in this testimony are my own, and should not be construed as 

representing any oftlcial position of The Heritage Foundation. 

Entrepreneurship matters. It fosters discovery, innovation and job creation. It leads to 

more productive production processes that improve productivity and real wages. 

Entrepreneurs develop new and less expensive products that improve consumer wellbeing. They make markets more efficient. New firms account for most of the net job 

creation in the United States. Moreover, the vast majority of economic gains from 

innovation and entrepreneurship accrue to the public at large, rather than entrepreneurs. 

Entrepreneurship is in decline. The rate of new business formation has seriously declined 

and barely exceeds business exits. Many other indicia of entrepreneurial health also 

indicate that the United States has placed an unprecedented burden on small and start-up 

businesses. Accordingly, job creation, productivity improvements and welfare-enhancing 

innovation have slowed. 

Although there are many reasons that entrepreneurs are stmggling, the tax system is a 

major contributing factor. This is both because of the direct impact of the tax system on 

small and start-up finns and because of its adverse impact on the economy overall. The 

current tax system reduces the incentives to work, save and invest. It raises the cost of 

capital and reduces access to capital. It imposes high taxes on risk taking, hanns the 

international competitiveness of U.S. businesses and impedes economic growth. 

Moreover, the tax system is monstrously complex, imposing inordinately high 

compliance costs on small and start-up finns. 

Entrepreneurship Matters 

Entrepreneurship matters. 1 It fosters discovery and innovation. 2 Entrepreneurs also 

engage in the creative destmction of existing technologies, economic institutions and 

business production or management techniques by replacing them with new and better 

ones. 3 Entrepreneurs bear a high degree of uncertainty and are the source of much of the 

1 For an introduction to the literature, see Paul Wcsthead and Mike Wright, Entrepreneurship: A Vel)' Short 

Introduction (Oxford University Press: 2013). 

' Israel M. Kirzner, Competition and Entrepreneurship (University Of Chicago Press: 1973); Israel M. 

Kirzner, "Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach," Journal 

of Economic Literature, Vol. 35, No. I (1997); Randal! Holcombe, Entrepreneurship and Economic 

Progress (Routledge: 2006); William J. Baumol, Tile Microtheory of Jmwmtive Entrepreneurship 

(Princeton University Press: 201 0). 3 See, e.g., Joseph Schumpeter, Capitalism, Socialism, and Democracy (1942), pp. 81-86 

http: digamD.frec.fr capisoc.pdf; W. Michael Cox and Richard Aim, "Creative Destruction," Concise 

Encyclopedia of Economics (Liberty Fund: 2007) 

http: '\I''" .econlib.org librarv Enc Creati\cDestruction.html; Henry G. Manne, "The Entrepreneur in the 

Large Corporation,'' in T7te Collected Works of Henry G. Manne, Vol. 2 (Liberty Fund: 1996). 

2 
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dynamism in our cconomy. 4 New, start-up businesses account for most of the net job 

creation in the economy. 5 Entrepreneurs innovate, providing consumers with new or 

better products. They provide other businesses with innovative, lower cost production 

methods and arc, therefore, one of the key factors in productivity improvement and real 

income growth. 6 In terms of the neo-classical growth model, entrepreneurship is an 

important factor affecting the rate of technological change and the marginal productivity 

of capital. 7 The vast majority of economic gains from innovation and entrepreneurship 

accrue to the public at large, rather than entrepreneurs. 8 Entrepreneurs are central to the 

dynamism, creativity and flexibility that enables market economies to consistently grow, 

adapt successfully to changing circumstances and create sustained prosperity. 9 

Entrepreneurship is in Decline 

Entrepreneurship is in decline. As the chart below illustrates, the business entry (or 

formation) rate has been steadily declining since 1977 but the business entry rate dropped 

very steeply in 2008 and has barely recovered. 10 While the business entry rate now 

exceeds the business exit rate, by historical standards the net business formation rate is 

very anemic. 

4 Frank H. Knight, Risk, Uncertainty, and Profit (1921) 

http: "" '' .econlib.om libraty Knight· knRUP.html. 5 Magnus Henrekson and Dan Johansson, "Gazelles as Job Creators: A Survey and Interpretation of the 

Evidence," Small Business Economics, Vol. 35 (2010), pp. 227-244 

http: papers.ssrn.com-sol.l·papcrs.ctin''abstract id··l 0919.\R; Ryan Decker, John Haltiwanger, Ron Jarmin, 

and Javier Miranda, "The Role of Entrepreneurship in US Job Creation and Economic Dynamism," Journal 

of Economic Perspectives, Vol. 28, No.3 (Summer 2014), pp. 3-24 

http: pub,_aeaweb.org doi pdfplus I 0.1257 jep.2R.3.3; Salim Furth. "Research Review: Who Creates Jobs? 

Start-up Firms and New Businesses," Heritage Foundation Issue Brief#3891, April4, ?013 

http: \\ W\\ .ht?ritav:c.org· research repo11~ ·:w 13·04 ·~iliQ-crej!J:~bs-::">Wl!lli-!~-:tirrp__':!-aqQ:!l~~!.:h~t~Ds:'~"e:-.. 6 Ralph Landau, '"Technology and Capital Formation," in Technology and Capital Formation, Dale W. 

Jorgenson and Ralph Landau, editors (MIT Press, 1989). 

'See, e.g., Robett M. Solow, Growth Theory: An E'position (Oxford, 2000). Legal institutions, human 

capital and other factors are also impm1ant determinants of economic growth. SeeN. Gregory Mankiw~ 

David Romer and David N. Wei!," A Contribution to the Empirics of Economic Growth," The Quarter~v 

Journal of Economics, Vol. 107, No.2 (May, 1992), pp. 407-437 

http: \\\\\\ .frn·dham.edtH:-cotwmic-; mcleod manki\\-romcr-w<..?i!-a-contribution.pdt; Robert J. Barro, 

Economic Growth (MIT Press: 2nd edition, 2003). 8 Yale economist William Nordhaus has estimated that 98 percent of the economic gains from innovation 

and entrepreneurship are received by persons other than the innovator. See William D. Nordhaus, 

"Schumpeterian Profits in the American Economy: Theory and Measurement,'' Cowles Foundation 

Discussion PaperNo. 1457, April2004 httbW et)\\les.econ.\ale.edu P cd d1-lb dl-l57.pdf. Even if he is 

wrong by a factor often, this would still mean that 80 percent of the gains from entrepreneurship go to the 

rublic rather than the entrepreneur. 

' See, Decker ct a/, supra; C. Mirjam van Praag and Peter H. Versloot, "What is the Value of 

Entrepreneurship'' A Review of Recent Research," Small Business Economics, Volume 29, Issue 4 

(December 2007), pp 351-382 http: linL,pringer.com,article IO.lll07",2FslllR7-007-907-l-x; G. R. 

Steele, "Laisscz.faire and the Institutions of the Free Market," Economic Ajji1irs, September 1999 

http: \\\\\\ .lancaster.ac.uk staff ccagrs Llissez ·n201~lir...:.pdf. 

10 Census Bureau, Business Dynamics Statistics, Establishment Characteristics Data Tables 

http: \\ \\\\ 2.censu:-..LJ:O\ ces bd:-. \?!1tab bd.., L' all rcka:-.c. '\!s\. 

3 
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-Entry Rate 

-Exit Rate 

6.0 

4.0 

2.0 

0.0 

"' "' '"' m U1 " "' '"' m "' "' "' '"' M "' "' "' .... M 

"' " co co co co co "' "' "' "' "' 0 0 0 0 0 .... '"' "' "' "' "' "' "' "' "' "' "' "' "' 0 0 0 0 0 0 a .... .... .... .... .... .... .... .... .... .... .... .-< N N N N N N N 

Source: Census Bureau, Business Dynamics Statistics, Establishment Characteristics Data Tables 

The share of firms aged 16 years or more has increased by 50 percent over the last two 

decades. 11 High-Tech companies are shedding more jobs than they are creating. 12 

Although recovering with the substantial increase in equity market values over the past 

several years and the regulatory improvements in the 2012 JOBS Act "IPO On-Ramp" 

provisions," 13 Initial Public Offerings (IPOS) remain substantially below the previous 

two decades. 14 Although there is improvement since the depths of the recession, small 

and start-up businesses continue to stmggle. 15 The decline in entrepreneurship is one of 

11 Ian Hathaway and Robert Litan, "The Other Aging of America: The Increasing Dominance of Older 

Firms," Brookings Institution, July 2014 

et supra. 

John Haltiwanger, Ian Hathaway and Javier Miranda, "Declining Business Dynamism in the U.S. HighTechnology Sector," Kauffman Foundation, February 2014 

http: \\\\\\ .kauffman.org , media kauffman on.! rescarch11 o20report-.;0 'n20andn n20con.'TS 2014 02 d.:cllninu 

bu~iness dvnamism in us high tech "ector.pdf. 13 Title!, The Jumpstart Our Business Startups Act, Public Law 112-106, AprilS, 2012 

http: ''""·~pll.U<\\ fds" pk~'PLAW-112publ106 pdfPLAW-l12publl06.pdL 

"David R. Burton, "Reducing the Burden on Small Public Companies Would Promote Innovation, Job 

Creation, and Economic Growth," Heritage Foundation Backgrounder No. 2924, June 20, 2014 

http: \\\\\\ .hcritagc.org rest•arch· rcpm1s ·::o 14 06· reducim!-the-burdt·n-t)n-~mall-public-companics-\\ ouldP:-romotc-inno\atil)!l-job-creation-and-economic-u.ro\\ th. 

'Wendy Guillies, "Kauffman Foundation2015 State of Entrepreneurship Address," February 11,2015 

http: \\\\\\ .kauffman.nn! ~- media kauffman org resources 20 l5 ~oe 2015 ~tate of entrepreneurship spee 

ch.pdt; John Dearie and Courtney Geduldig, Where the Jobs Are: Entrepreneurship and the Soul of the 

American Economy (Wiley: 20 13); William C. Dunkel berg and Holly Wade, "NFIB Small Business 

Economic Trends,"' August 2014 http: """ .nlib.com Portals 0 PDF ,bet 'bet20 1-+0k.pdL 

4 
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the key factors causing anemic U.S. economic performance. 

Helping to Restore Prosperity by Removing Impediments to Entrepreneurship 

There are multiple reasons for the decline in entrepreneurial activity. 16 The key to 

reversing the decline in entrepreneurship is to systematically reduce the legal 

impediments to entrepreneurship. There is not any one policy change - or even a few -

that will lead to a sudden renaissance in entrepreneurship. Since the decline is caused by 

the combined weight of many poor public policies, the solution requires systematically 

improving public policy in a wide variety of areas. It is clear, however, that the tax 

system is a leading reason for the poor economic perfmmance of recent years and that tax 

reform offers a means of substantially improving the economy, increasing wages and 

giving rise to a renaissance in entrepreneurship. 

The remainder of my testimony examines the sources of complexity in the tax code and 

its economic effects more generally. It then discusses proposed improvements to the tax 

system. My discussion of proposed refom1s is divided into two parts. The first section 

discusses reforms to the existing tax system that will aid entrepreneurship. The second 

section addresses more major or fundamental tax refom1. 

Sources of Complexity in the Tax Code 

The compliance costs 17 associated with the income tax have been estimated to be in the 

range of $67 billion to $410 billion. 18 The higher estimate, which is quite plausible given 

its derivation, is 2.2 percent of Gross Domestic Product (GOP) and about 12 percent of 

federal receipts. These high compliance costs have a disproportionately adverse impact 

on small and start-up businesses. Compliance costs do not increase linearly with size. 

Among the four largest sources of complexity in the tax law are (I) the capital cost 

recovery system; (2) inventory accounting; (3) employee benefit taxation, particularly the 

retirement savings (qualified account) rules; and (4) international taxation. 

Under current law, there are generally five different capital cost recovery or depreciation 

systems with which businesses must contend. They are: (!) the Modified Accelerated 

16 For an international survey of regulatory impediments to entrepreneurship and a literature survey, see 

Doing Business 2014: Understanding Regulations for Small and Medium-Size Enterprises (World Bank: 

201 3) http: \\ \\\Y.doin!!bu~inL:-,,_org ~,media G!A \VB, Doin:.!0 .)::OBusincss Oocument:-., A_nnua!-

Repcll1' En dish DB 1-1-Fuii-Repon.pdr ; for a list of regulatory impediments to entrepreneurship in the 

United States and proposed reforms to address them, see David R. Bmton. ·'Building an Oppottunity 

Economy: The State of Small Business and Entrepreneurship." Testimony before The Committee on Small 

Business, United States House of Representatives, March 4, 2015 

http: :-;ma!lbusincss.hou:-.c.go\·Up!oadedtiks 3-4-2015 tinal burton te:-.imon\ tina!.pdf. 17 Compliance costs include legal, accounting and administrative costs but not lost economic output (i.e. the 

dead weight loss or excess burden of the tax system). 18Scott A. Hodge. '"The Compliance Costs of!RS Regulations,·· Tax Foundation Fiscal Fact No. 512, June 

2016, htqh: lik,.taxt(1undatio11.0rg k;;ac\ doc' Ta\Foundation FF512.pdf and Jason J. Fichtner and 

Jacob M. Feldman, "The Hidden Costs ofT ax Compliance." Mereatus Center, May 20, 2013. 

https: \\\\\\.mercatu-;.nrt!: sv-.;tcm fik ... Flchtn-.::r Ta\t'omp!ianct..• \3.pdf. 

5 
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Cost Recovery System (MACRS) using the General Depreciation System (GDS); 19 (2) 

the Modified Accelerated Cost Recovery System (MACRS) using the Alternative 

Depreciation System (ADS);20 (3) the depreciation rules under the alternative minimum 

tax (AMT);21 (4) the depreciation rules applicable for determining earnings and profits22 

and (5) expensing. 23 As discussed below, for economic and administrative reasons, 

capital expenses should simply be deducted in the year incutTed (i.e. expensed). 

Inventory accounting also introduces a high degree of complexity24 The Internal 

Revenue Code section 263A uniform capitalization rules are especially complex. Firms 

with gross receipts under $10 million annually are allowed to use less complex rules. But 

for any size firn1 that maintains inventory, these rules are a major burden. 

The taxation of employee benefits is a major source of complexity. The tax treatment of 

qualified plans is absurdly complex. But the rules governing health insurance, FSAs, 

HSAs, tuition assistance, life and dental insurance and a host of other matters introduce 

complexity and costs. 

And for firms that operate internationally, the income souring and expense allocation 

rules, the intercompany pricing rules, the foreign tax credit rules (especially the separate 

basket limitations), the controlled foreign corporation rules and subpart F, the export 

sourcing rule and many other provisions introduce a very high degree of complexity. 

The incremental reforms outlined below address all of these sources of complexity except 

the international tax provisions. Major tax reform would address all of them. 

Primary Impediments to Economic Growth in the Tax Code 

The current U.S. tax system has a very substantial negative impact on the economy. It has 

high marginal tax rates that reduce the incentive to work, save and invest. The U.S., for 

example, has the highest corporate tax rate in the industrialized world. It substantially 

raises the cost of capital by double, treble or even quadruple taxing savings and 

investment. It place U.S. businesses and at competitive disadvantage in international 

markets. It is riddled with special tax preferences. And it imposes large compliance costs 

on U.S. businesses, which has a disproportionately negative impact on small firms. 

The solution is to reduce marginal tax rates, particularly on businesses, to expense 

19Internal Revenue Service, "4. Figuring Depreciation Under MACRS," 

llttps: \\1\\\.irs.gm publication, p94o ch04.html. 20 Ibid. 21 See "Instructions for Form 4626, Alternative Minimum Tax- Corporations," 

https:- '' \\w.irs.gO\ -pub irs-pdf i4626.pdf. For shareholders, pa;1ners or members of pass-through entities, 

the individual AMT would apply. 22 26 CFR 1.312-15. Earnings and profits is primarily used to determine if a corporate distribution is a 

taxable dividend or a return of capital. 23 Internal Revenue Code § 179 and various special expensing provisions. 

~ Accounting Periods and Methods, Inventories, IRS Publication 538 bttps: ·\\1\\\'.irs.gcl\ pub irspdf p53R.pdf. 

6 
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capital, to eliminate true tax preferences and to simplify the tax systcm. 25 Major tax 

reform along these lines can be expected to increase GDP by about I 0 percent over I 0 

years. Truly fundamental tax reform would increase GDP by about 15 percent over I 0 

years. 

Incremental Reforms to the Current Tax System 

Incremental improvements to the current tax system that Congress should consider are 

outlined below. 

I. Expensing of Investment in Machinery and Equipment. Amend Internal Revenue 

Code § 179 to permanently allow annual capital expenses of up to $1 million to be 

deducted when incurred. Expensing would simplify small firms' tax returns, 

reduce compliance costs, reduce small firms' cost of capital and aid cash flow. 26 

2. Retirement Account Simplification. Very few small employers offer retirement 

accounts because of the complexity, high compliance costs and regulatory risk of 

doing so.27 This makes it more difficult for them to attract employees and more 

difficult for both the small business owners and their employees to save for 

retirement. This is one of the most complex areas of the tax law and desperately in 

need of simplification. 28 

One possible solution would be to amend the Internal Revenue Code to create a 

Small Business Uniform Retirement Account as a voluntary alternative for 

employers with 500 or fewer employees to replace: ( l) simplified employee 

pensions (SEPs), (2) salary reduction simplified employee pensions, (3) SIMPLE 

IRA plans, (4) SIMPLE 401(k) plans, (5) Keogh plans, (6) regular 40l(k)s (with 

respect to employers with 500 or fewer employees), (7) profit-shaling plans (with 

respect to employers with 500 or fewer employees), (8) money purchase pension 

plan (with respect to employers with 500 or fewer employees), and (9) employee 

stock ownership plans (with respect to employers with 500 or fewer employees). 

The Small Business Uniform Retirement Account would (I) have check the box 

25 For a more complete discussion, see David R. Burton, "A Guide to Tax Reform in the !15th Congress," 

Heritage Foundation Backgrounder No. 3192, February 10, 2017 

!mr: :ww\1 .heritage.org sites default Jiles 2017-02 BGJ l92.pdf 26 David Burton. "Constructive Small Business Expensing Bill Introduced," The Daily Signal, April ll, 

2014 http: dailvsiuna!.cum 2014 0-t l! constructi\l>-;mal!-busine:-.s-cxpen~inn-bil!-introduced; Curtis 

Dubay, "Ways and Means Committee following Right Approach on Tax Extenders," The Dailv Signal, 

May 27.2014 http: dailv,iunaLcom 2014 05 27 \\avs-m~ans-committce-follo\\inu-right-3pproach-ta\­

c\tenders. 

27 Kathryn Kobe, "Small Business Retirement Plan Availability and Worker Participation," Small Business 

Administration, Oftice of Advocacy, March 2010, Table 2 (only 28 percent of firms with under 100 

employees offered some kind of retirement plan in 2006) 

llltps:' '"'" .sba.gm site' dd'ault tiks rsJ61 tot.pdL 28 See generally, David C. John, "Pursuing Universal Retirement Security Through Automatic IRAs and 

Account Simplification,'' Testimony before The Committee on Ways and Means, United States House of 

Representatives, April 17, 2012lmP.;._\\ "" .heritage.org rc,carch tcstirQ<)f\.)':2()1 2 04 purs!J.il1~-uni 1 ersa!-

rl?tl rcrnent -~~.?..:urit \·-t hroul!h -automatic-i ra:-.-and-acct. ntnt -.-..i mrl i !katton. 

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eligibility, (2) uniform employee eligibility, (3) automatic enrollment of 

employees with an option to opt-out, (4) no non-discrimination, coverage or key 

employee rules, (5) allow contribution levels to be chosen by the employee, (6) be 

maintained tlu·ough a financial institution and (7) be available to employees and 

self-employed persons (including partners and LLC members). 

3. Reduce the Top Long-term Capital Gains Tax Rate to 20 percent or Less. 

Evidence shows that a capital gains rate much above 20 percent actually reduces 

federal revenues. In addition, a high capital gains tax rate reduces the willingness 

of investors to invest in relatively risky start-up and growth companies and 

impedes capital formation. The top long-term capital gains tax rate should not 

exceed 20 percent (including the Obamacarc investment income tax). 29 

4. Permit Cash Method Accounting for Firms with up to $10 million in Gross 

Receipts. Cash method accounting is simpler and aids cash f1ow. 30 

5. S Corporation Liberalization. Permit S corporations to have more than one class 

of stock, non-resident alien shareholders (subject to 30 percent withholding on 

dividends) and more than 100 shareholders. The latter is particularly important if 

S corporations arc going to have practical access to the crowdfunding or 

Regulation A+ provisions in the JOBS Act which allows companies to raise small 

amounts from a large number of investors using provision enacted by the JOBS 

Act 31 It is preferably for the S corporation rules to emulate the partnership rules 

so there would be no shareholder limit but S corporation status would not be 

available to publicly traded corporations. See Internal Revenue Code §7704. 

6. Repeal the Obamacare Health Insurance Tax. Obamacare imposes an excise tax 

on health insurance premiums that effectively is aimed at small businesses 

because larger firms self-insure (with or without stop-loss insurance) and 

therefore do not pay health insurance premiums. It is roughly equivalent to a 2.5 

percent tax. This tax should be repealed. 32 

29 J.D. Foster, "Obama·s Capital Gains Tax Hike Unlikely to Increase Revenues," Heritage Foundation 

Backgrounder #2391, March 24, 2010 http: 'W\\ w.heritage.oruresearch reports 20 I 0 lU obamas-capital· 

uains-tax-hikc-unlikcl\-to-incrcase-re'cnucs; Stephen J. Entin, 'President Obama's Capital Gains Tax 

Proposals: Bad for the Economy and the Budget," Tax Foundation January 21,2015 

http: ta.\ foundation .org bl og ·president-obama-s-.:apita!-gai ns-tax -proposa!..;-bad-economv-and-budget. 30 Then Ways and Means Committee Chairman Dave Camp proposed this in his Tax Reform Act of2014 

discussion draft. See section 330 I 

Rep. French Hill introduced H.R. 4831 (1141

h Congress) which would disregard crowdfunding and 

Regulation A shareholders for purposes of the subchapter S shareholder limit count. See David Burton, 

"The Tax Law Makes It Almost Impossible for ·s Corporations' to Use Equity Crowd funding," Dailv 

Signal, April19, 20!6 http: dailvsiunal.com 20160419 the-lax-law-rnakc>-il-alm,,st-imp<"sibk-for-'-

cotl!L1rat lt)!1S-tO-USt'-Cl] U it'v -CrD\\ d fundi IH! 

32 David R. Burton. "Obamacare's Health Insurance Tax Targets Consumers and Small Businesses." 

Heritage Foundation Issue Brief#4075, October 31,2013. 

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7. Reduce the Tax Rate of Pass-Through Entity income to the Corporate Tax Rate. 

Reduce the tax rate paid on income from S corporations and other pass-through 

entities (e.g. LLCs) to no more than the top corporate tax rate (currently 35 

percent). Ideally, however, the tax rate on pass-through entity income and other 

income would be both low and the same. Otherwise, Congress must draft rules 

distinguishing between pass-through entity income, on the one hand, and labor 

and portfolio investment income on the other. Such rules will inevitably lead to 

complexity. 

8. Increase the Incentive Stock Option (ISO) Cap Limitation .fi"om $100,000 to 

$250,000. Internal Revenue Code section 422(d) limits incentive stock options to 

$100,000 in aggregate stock value (not gain). This limits the utility of ISOs as a 

means to attract talent. 

9. Full Deductibility for Health Insurance Purchased by the Self-Employed. 

Currently, health insurance costs incurred by the self-employed (which includes 

partners and LLC members) are deductible for income tax purposes but not for 

purposes of the 15.3 percent self-employment tax. This creates a special tax 

burden on the self-employed not borne by anyone else in the economy. There 

should be parity for the self-employed with those who are employed. Internal 

Revenue Code § 162(1)( 4) should be repealed. 

10. Clar!fy Rules Governing to What Extent Distributions/rom Pass-Through Entities 

are Subject to Payroll Taxes. This issue has existed since at least the 1980s and it 

has never been adequately resolved. It causes a lot of audits and a lot of 

uncertainty. Reasonable, clear and uniform rules governing "reasonable 

compensation"' and investment income should be adopted for partnerships, S 

corporations and C corporations. 

II. Clar!fy Employee/Independent Contractor Rules. This issue has existed since at 

least the 1970s and it has never been adequately resolved. Current law involves 

evaluating 20 factors and any test with 20 factors is inherently ambiguous and 

will be arbitrary in application. 33 The current state of the law causes a lot of audits 

and a lot of uncertainty. Provisions should be adopted providing bright line tests 

for determining who is definitely an employee and who is definitely a contractor 

and allowing the employer to choose whether a payee is an employee or a 

contractor in ambiguous cases, subject to 1099 reporting and moderate backup 

withholding if contractor status is elected34 

For general background see "Present Law and Background Relating to Worker Classification for Federal 

Tax Purposes," Joint Committee on Taxation, [JCX-26-07] May 8, 2007 hltp: "\1 \I .jet. gO\ x-2~-07.pdf. 

See also "Independent Contractor or Employee," IRS Publication No. 1779 https: · 1111 v1 .i".gov pub ir'-

pdf pl779.pdf; IRS Rev. Rul. 87-41 (1987); Treas. Reg. ~ 31.3121(d)-l Who are employees. 

·'"A withholding rate of25 percent would reflect the 15.3 percent payroll tax plus an approximately 10 

percent average income tax liability. 

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12. Estate and Gift Tax Reduction. The unified credit should be increased so that $10 

million is effectively excluded from the estate and gift tax. For 2017, the amount 

that is effectively excluded is $5.5 million. Family farms and businesses should 

not either have to be sold to pay estate taxes when parents die or incur huge life 

insurance premiums to provide the means of paying the tax. 35 Ideally, of course, 

the estate and gift tax should be repealed entirely. 

Major Tax Reform 

Fundamental tax reform would reduce compliance costs considerably and result in 

dramatically higher rates of capital formation, economic growth and job creation. The 

goal of fundamental tax reform is a simple, flat rate, territorial consumption tax to replace 

the individual and corporate income tax and the estate and gift tax. This can take one of 

four fom1s. (l) A Hali-Rabushka-Am1ey-Forbes flat tax, (2) A consumed income tax 

(also known as an expenditure tax, cash-flow tax, inflow-outflow tax or the new flat tax), 

(3) a national sales tax or (4) a Business Transfer Tax (BTT) (also known as a business 

flat tax, business consumption tax or business activity tax) or, potentially, some 

combination of these36 Major tax reform is a major step towards fundamental tax refotm 

and would therefore reduce compliance costs considerably and result in higher rates of 

capital formation, economic growth and job creation. 

Under the leadership of House Speaker Paul Ryan (R-WI) and House Ways and Means 

Committee Chairman Kevin Brady (R-TX), House Republicans released a blueprint for 

their tax reform initiative in June 2016.37 Since that time, the Ways and Means 

Committee has been drafting legislation and working toward a consensus among 

Republicans on the committee. This plan is cettainly major tax reform and would have a 

substantial positive impact on the economy and entrepreneurs. 

35 William W. Beach, '"Seven Reasons Why Congress Should Repeal, Not Fix, the Death Tax," Heritage 

Foundation Web Memo 112688, November 9, 2009 

http: \\ '' '' .hcrita!.!c.on! re'\t:arch reptH"ts 2009 1 l '-'C\ en-reasnns-\\ h\ -congress-~hould-n:pcal-not-ti\-thl'­

death-tax; John L. Ligon, Rachel Greszler and Patrick Tyrrell, "The Economic and Fiscal Effects of 

Eliminating the Federal Death Tax." Heritage Foundation Backgroundcr #2956, September 23, 2014 

http: \\ '' '' .hcritage.oru re..;carch report:-. ~01-1- 09 thc-economic-and-li-.;cal-eftl:ct.-.,-of-eliminatim::-thet\:deral-ckath-tax. 

36 David R. Burton, "Four Conservative Tax Plans with Equivalent Economic Results," Heritage 

Foundation Backgrounder No. 2978, December 15,2014 

http: '' '' \\ .herita:ze.oru research rqJLWh 20 1-l l 1 four-con~en ati\ e-ta \-plan~-\\ ith-equi\ aknt-economicr,"ulh; David R. Burton, "A Guide to Tax Reform in the !15th Congress," Heritage Foundation 

Backgrounder No. 3192, February 10, 2017 http: \\1\ '' .heritagc.c>r!! ,itcs default tiles 2017-

02 BG_1192.pdt: 37Paul Ryan and Kevin Brady, "A Better Way; Our Vision for a Confident America, Tax," June 24, 2016, 

http-.;: abdten\av.~pea~er.go\ a~~cb pdf ABetter\Va\-Tax-Po!icvPaper.pdf 

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The Ryan-Brady .. Better Way" blueprint would provide the lowest marginal tax rates 

since the 1920s, and expense machinery, equipment and structures. The top individual tax 

rate would be 33 percent (compared to 43.4 percent today); the top tax rate on C 

corporations would be 20 percent (compared to 35 percent today); and the top tax rate on 

pass-through businesses would be 25 percent (compared to 43.4 percent today). Many 

other changes would be made. It would have a dramatic positive economic impact. The 

Tax Foundation estimates it would increase GDP by 9.1 percent over 10 years, and 

reduce revenues by $191 billion over l 0 years. 38 The federal govemment is expected to 

raise $43 trillion in tax revenue over the next 10 years. 39 Thus, the Brady plan is 

projected to reduce revenues by less than one-half of one percent. 

This plan is most succinctly understood as a graduated rate version of the HallRabushka flat tax.40 The two primary differences between the Better Way plan and the 

traditional Hall-Rabushka flat tax are that the Better Way plan has a border-tax 

adjustment and, instead of taxing only wages at the individual level, it has an additional 

tax on dividends, interest, and capital gains at half the statutory rate. It is therefore a 

very large step toward the right tax base with much lower marginal tax rates than those 

of the current system. 

It would aid small businesses for two reasons. First, it would result in a much stronger 

economy. Second, it would reduce the burden of the tax system on entrepreneurs. 

Corporate and pass-through tax rates would decline sharply. All capital and inventory 

acquisition expenses would be immediately deductible. Capital gains tax rates would 

fall to 16.5 percent or less, depending on the tax bracket. It would substantially simplify 

the tax system. Thus, small and start-up firms can expect to see their marginal tax rates 

decline and their cost of capital decline. They will incur lower compliance costs. And 

their investors will pay lower marginal tax rates as well. 

Thank you. 

*** 

38Kyle Pomerleau, "Details and Analysis of the 2016 House Republican Tax Reform Plan," Tax Foundation 

Fiscal Fact No. 516, July 2016, http,: tile,.taxl(>undation.org legacv doc' TaxFoundation FF516.pdf. 39 Congressional Budget Office, The Budget and Economic Outlook: 2017 to 2027, January 2017, 

Summary Table 1, CBO's Baseline Budget Projections, 

~; 2, https: \\ "'' .-:bo.go\ 'itcs. default Ilks ll4th-congre"-20 15-2016 repor.ts 51 ~ 29-20 I omnh,k.pdt: . 

"Graduated rate versiOns of the Haii-Rabushka flat tax are often called an '·X Tax' after Davtd Bradford s 

proposal. See David F. Bradford, Untangling the Income Tax (Cambridge, MA: Harvard University Press, 

1986). See also Report of the President's Advismy Panel on Federal Tax R~(orm, 2005, 

http: go, int().librarv.unt.edu taxrd<>rmpancl final-reporT index.html. 

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******************* 

The Heritage Foundation is a public policy, research, and educational organization 

recognized as exempt under section 50l(c)(3) of the Internal Revenue Code. It is 

privately supported and receives no funds from any govemment at any level, nor does it 

perform any govemment or other contract work. 

The Heritage Foundation is the most broadly supported think tank in the United States. 

During 2014, it had hundreds of thousands of individual, foundation, and corporate 

supporters representing every state in the U.S. Its 2014 income came from the following 

sources: 

Individuals 75% 

Foundations 12% 

Corporations 3% 

Program revenue and other income l 0% 

The top five corporate givers provided The Heritage Foundation with 2% of its 2014 

income. The Heritage Foundation's books are audited annually by the national 

accounting firm ofRSM US, LLP. 

Members of The Heritage Foundation staff testify as individuals discussing their own 

independent research. The views expressed are their own and do not reflect an 

institutional position for The Heritage Foundation or its board of trustees. 

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Testimony of Tim Reynolds 

President 

Tribute, Inc. 

On behalf of the National Small Business Association 

NSBAl4-

National Small Business Association ' 

House Small Business Committee 

"Start-ups Stalled? The Tax Code as a Barrier to Entrepreneurship" 

February 15,2017 

1156 15th Street, N.W., Suite 502 

Washington, DC 20005 

202-293-8830 

W\\w.nsba.bit 
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Good Morning. Chairman Chabot, Ranking Member Velazquez and members of the House 

Small Business Committee, I want to thank you for inviting me to testify today on the biggest tax 

problems facing America's small businesses, and discuss ways the tax code operates as a barrier 

to business creation and growth. 

My name is Tim Reynolds, owner and President of Tribute Inc., a software company located in 

Hudson, Ohio. Our 38 employee company develops and markets software for industrial 

distributors. The company focuses primarily on distributors of hydraulic and pneumatic 

equipment, specialty and industrial hose and rubber, and gasket products. By way of example, 

many customers arc Eaton or Parker Hanni fin distributors. Tribute develops and markets two 

Enterprise Resource Planning (ERP) products: the Tribute Software System, a UNIX-based 

solution, and TrulinX, a Windows-based solution. Both provide a tully integrated business 

system supporting virtually all of the distributors' business system needs. 

I am pleased to be here representing not only my company, but also the National Small Business 

Association (NSBA), where I currently serve as an Honorary Trustees member and Past 

Chairman. NSBA is the nation's oldest small-business advocacy organization, with over 65,000 

members representing every sector and industry of the U.S. economy. NSBA is a staunchly 

nonpartisan organization devoted solely to representing the interests of the small businesses 

which provide almost half of private sector jobs to the economy. 

In recent years,,therc have been ambitious policy efforts in Congress to replace the current U.S. 

Tax Code. I welcome the eagemess oflawmakers to fix America's broken tax system. but I also 

recognize there are significant challenges with enacting comprehensive tax reform legislation in 

the near future. Therefore, in the interim, simplification of the most complex provisions of the 

Code may help to significantly reduce the burden on individual taxpayers and small businesses. 

While there arc many obvious problems with the current tax system, there are two paramount 

issues that must be addressed. The first major problem with the system is the generally high 

marginal rates of taxation on income. The other, oftentimes more significant dilemma is the 

almost impossible task of compliance with all the rules and regulations. It is time that Congress 

acts to reexamine the tax code and simplify or repeal some of its most complex provisions. 

Compliance Costs 

Although NSBA's members operate a wide variety of businesses. they all consistently rank tax 

simplification and reducing the tax burden among their top issues for Congress and the 

administration to address. The compliance burden on taxpayers, because of the complexity of our 

Code, is tmly staggering. While the actual tax liabilities tor small finns is a huge issue, the sheer 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

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complexity of the tax code--along vvith the mountains of paperwork it necessitates~ is actually a 

more significant problem for America's small businesses. For a small business, such as Tribute, 

Inc., the proportionate cost is significant, and the investment of time is even more consequential 

because it takes away from our productivity and growing the finn. Unlike larger corporations 

which have in-house accountants, benefits coordinators, attorneys, personnel administrators, etc. 

at their disposal, small businesses often are at a loss to keep up with, implement. afford, or even 

understand the overwhelming regulatory and paperwork demands of the federal government and 

Tax Code. 

My company is a Subchapter S lim1. As such, the income of my company flows to my personal 

tax retnrn. I have an MBA from the University of Michigan, run a company that develops and 

sells accounting software and have been in business for more than 20 years. Yet, I would view it 

as taking an irresponsible risk to attempt to do my own tax returns. The Code is so complicated 

that I feel certain I would inadvertently run afoul of the law. So I have to pay an accounting firm 

to do these taxes. No doubt the CEO of a Fortune 500 company feels the same way. But as a 

small-business person, the cost of compliance is disproportionately large. 

According to the NSBA 20 I 6 Mid-Y car Economic Report, federal taxes are a huge issue facing 

small business--and we have seen the administrative burden outpace the financial burden. This 

year is no different with 56 percent citing administrative burdens as their largest issue with 

federal taxes and 38 percent citing the actual financial cost. 

19'§111116% 

WiLl 614% 

112 ]011% 

IWI 111111111111o% 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

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hours per year to comply with federal taxes, and nearly 

one-in-three spend more than 80 hours-two full work 

weeks each year. The majority of small businesses, 68 

percent, spend more than $1,000 per year on the 

administration alone of federal taxes. More than half 

say that federal taxes have a significant to moderate 

impact on the day-to-day operation of their business. 

Just imagine the collective business and job grmvth 

that could be done absent that burden. My company 

pays our accountants more than $14,000 each year to 

prepare 

our 

taxes. In addition, we spend about 40 hours a 

year preparing ,various fom1s and making various 

estimated pay1nents required to comply with tax 

law. 

More than half ofNSBA members have fewer 

than 11ve employees-few, if any of \vhom is a 

tax specialist-leaving business owners such as 

myself with no other choice but to hire outside 

help to keep track of all their additional reporting 

and filing requirements. In fact, according to the 

NSBA 2015 Small Business Taxation Survey, 

only 15 percent of small-business owners handle 

their taxes internally-meaning 85 percent are 

Reynolds, President, Tribute, Inc. 

National Small Business 1\sS()ciation 

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forced to pay an external accountant or practitioner-this data should send a strong message to 

the IRS and Congress that the Tax Code is far too complex. 

In addition to outside consultants, our company controller and bookkeeper spend significant time 

each week in the administration and filing of monthly and quarterly income and payroll reports, 

as well as trying to stay informed of changes to the Tax Code, changes to regulations, the status 

of current and expired tax extenders that may affect my business and so on. The aggregate cost 

of this represents thousands of dollars per employee and time away from doing more productive 

work to manage and grow my business. 

According to a U.S. Small Business Administration (SBA) Office of Advocacy report entitled, 

.. The Impact of Regulatory Costs on Small Firms," the compliance costs incurred by businesses 

are estimated to be about $95 billion annually but may be as much as 50 percent higher. 

Individual and not-for-profit compliance costs are, of course, quite substantial as well. 

In the case of small businesses these costs include the time of small-business owners and their 

accounting staff devoted to collecting necessary infmmation and filling out Internal Revenue 

Service (IRS) forms and the costs incuJTed hiring outside accountants and lawyers for advice 

about how to comply with the tax law. Small-business compliance costs relative to income, 

revenues or per employee is disproportionately high. The SBA study quantifies this 

disproportionate impact, showing that the impact on small firms in terms of per employee costs 

is three times that of larger firms. 

Tax Compliance Cost per Employee by Firm Size, According to SBA Office of Advocacy 

All Firms Firms with Finns with Firms with 

<20 20-499 500+ 

Employees Employees Employees 

Tax Compliance $800 $1,584 $760 $517 

Cost per Employee 

There will always be some compliance costs in any tax system. But today these costs arc very 

high and if there is one thing the NSBA membership is almost universally agreed on, it is that the 

cuJTcnt compliance costs arc too high and that the tax system needs to be simplified. 

We should aim to raise the revenue needed by the federal government in the least costly way. 

The costs of the current system represent a huge waste of resources that could be better spent 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

Page 5 of 12 
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gro\ving businesses, creating new products, conducting research and development, or purchasing 

productivity enhancing equipment. 

These costs also represent a significant drag on the economic growth, on job creation and on the 

international competitiveness of U.S. businesses. Compliance costs must be recovered by 

businesses in the sales price of their goods or services. Otherwise, the businesses will fail. 

Reducing these costs is within our control and it should be a priority of Congress. 

Regulatory Burdens 

I firmly believe cffm1s to reduce the regulatory and administrative burdens on small businesses 

must ft>cus on overall simplification, eliminating inequities within the Tax Code, and enhancing 

taxpayer education and outreach. A simpler tax code that is more easily understood by taxpayers 

would have many benefits, not the least of which would be reduced cost of compliance and 

reduced unintentional errors. Small businesses struggle to deal with the complexity of ambiguous 

tem1s, intricate technical language and difficult sentences. The increased burden causes us to 

have trouble understanding the requirements. This forces us to spend more time trying to 

interpret the rules and ensure we are completing the forms accurately thus avoiding being fined 

by the agency for noncompliance. 

My company has been audited hy the IRS twice. In both cases the eventual result was no errors 

found and therefore no penalties. In one case, the initial auditor did not understand the mles 

around deferring software sales revenue. After multiple appeals we finally were referred to her 

supervisor, who agreed with our 

interpretation of the defeJTal rules. My 

point is that in some cases even the IRS 

eannnt easily interpret the mles 1 Yet, the 

cost of compliance falls on us. 

The impact of regulatory burden cannot be 

overstated, according to the recently 

released 2017 NSBA Small Business 

Regulations Survey, more than one-third 

of small businesses have held off on 

business investment due to unccriainty on 

a pending regulation, and more than half 

have held off on hiring a new employee 

due to regulatory burdens. 

Testimony of Tim Rey11olds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

Page 6 of 12 
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Furthermore, the average small-business owner is spending at least $12,000 every year on 

regulations, and nearly one-in-three spends more than 80 hours each year dealing with federal 

regulation. We spend at least this much and more trying to understand and comply with IRS 

regulations, Department of Labor regulations as well as those of other agencies. Our biggest fear 

is that we don't know what we don't know! It is nearly impossible for us to keep up with new 

regulations and new rules. 

It should come as no surprise, then, when NSBA asked what areas of regulations are most 

burdensome, the federal Tax Code and Affordable Care Act (ACA) were the top two. More 

specifically, three-in-four small firms say that federal Tax Code regulations are very or 

somewhat burdensome, and two-in-three say that the ACA regulations are somewhat or very 

burdensome. At Tribute, we have put tremendous efiort into understanding and dealing with the 

ACA and ensuring that we offer a competitive and cost effective health care plan for our 

employees. Every single year we need to restart that effort because of the turbulence in the 

healthcare market place. 

What makes regulatory compliance even more challenging for smaller firms, is that the smallbusiness owner is the number one regulatory expert in most businesses and handles the bulk of 

federal regulatory compliance. My controller and I easily spend 10 hours each month ensuring 

that we stay in compliance with federal regulations. At the end of each quarter and at year-end 

the time spent nearly doubles as we scramble with filings. 

Accurate tax reporting and compliance is extremely important to small business but vague rules 

and poorly defined regulations-often driven by vague, poorly defined and sunsetting 

legislation-understandably result in mistakes. Those who make a good faith effort, yet are 

inaccurately complying should be assisted through education and tax simplification efforts. 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

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Those willfully disregarding their tax liability should be held accountable. However, increased 

enforcement at the expense of taxpayer education will not in the long term accomplish sustained, 

improved compliance. The more assistance offered to taxpayers and the simpler it is to 

understand and comply with tax laws, the more taxpayers will accurately meet their tax 

obligations. The 1act that "complexity ofru!es'' and "difficulty interpreting and understanding 

rules" combined to compose nearly half of all regulatory difficulties in NSBA 's regulations 

survey, is clear indication of the need for eased complexity, overall streamlining and adherence 

to plain language statutes. 

With the complexity facing many taxpayers, NSBA believes the development and 

implementation of initiatives to improve IRS guidance and assistance is impmiant The best 

thing for small businesses is simplicity: simplicity in instmctions, in requirements, in 

consequences and an overall reduction in the size of the paperwork and the time necessary to 

complete the forms. 

All Tax Credits are Not Created Equal 

According to NSBA 's tax 

survey, the majority of small 

businesses, 67 percent, say that 

federal taxes have a significant to 

moderate impact on the day-today operation of their business 

and 59 percent say credits and 

deductions have a signi ticant to 

moderate influence over their 

decisions about their company 

and employees. 

The discussion of tax policy 

must not occur in a vacuum. 

NSBA is fim1ly committed to 

""mrnc;.nr impact 

IVliDOI>I'<HQ impaCt 

Small impact 

II impact 

seeing the deficit reduced and, as such, we believe it is important to promote those tax credits 

that stand to offer the most benefit to the most people, both directly and indirectly. 

While there are a number of tax deductions. credits and exclusions that are very beneficial to 

small-business growth and overall economic stimulation, some do little to promote economic 

growth. They may have other policy objectives and may or may not achieve those objectives, but 

they do not materially a!Iect the incentives to work, to save or to invest. One in particular that, 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

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while good-intentioned, does not offer broad relief is the hiring tax credit whereby a firm would 

receive a credit for hiring a previously unemployed individual. Small fitms are unlikely to hire a 

new person simply for that tax credit those that arc in a place to hire will likely do so regardless 

of a temporary, one-time credit, and they will look for the person best suited with the appropriate 

skills. Unfottunately, if that person is not among the long-term unemployed that will not likely 

be a factor in the employer's decision making process. Tax credits play no role in our decision to 

hire. The cost of a new hire must ultimately be covered by additional revenues or reduced overall 

costs over the long run. Tax credits arc temporary, unreliable and, for us, irrelevant. 

Adequate capital cost recovery allowances, preferably expensing, are critical to maintaining a 

reasonable cost of capital and to firms of all sizes being able to afford the capital investment 

necessary to compete in the intemational marketplace. It is hard to overstate this point. Capital 

formation is critical to maintaining long-term competitiveness and preserving relatively high 

U.S. wage rates. Unless U.S. fitms invest in productivity-enhancing or innovative cutting-edge 

equipment that provides new capabilities, U.S. firms will only be able to compete by accepting 

lower returns and by paying workers less. If, of course, they fall far enough behind their 

domestic and foreign competitors, the fim1s will simply fail. 

Not only do these kind of investment-spurring tax credits and deductions help the qualifying 

firm, it helps promote economic growth by encouraging finns to make investments and purchase 

equipment from other firms. These tax provisions are the epitome of stimulatory. 

Disadvantage at Tribute, Inc. 

As a software development company, Tribute spends a significant amount of time, money and 

resources each year on research and development. As such, we are entitled to take advantage of 

the Research and Experimentation (R&E) tax credit, which can produce significant tax savings to 

innovative companies such as mine. As most small innovators, we are always trying to improve 

what we do, be more competitive, reduce costs and increase market shares. However, because we 

are a sub chapterS corporation and the income of the business passes thru to my personal 

income taxes, I am often subject to the Alternative Minimum Tax (AMT). For years, this 

prevented my company from taking the R&E credit, or we were limited to such a small amount 

each year that our accounting firm did not take the time to calculate what the credit might be. In 

fact, the costs of calculating the credit usually would exceed the allowable credit. The R&E tax 

credit is meant to encourage additional research and development, yet I am penalized for the way 

I structured my business. Small businesses arc often America's greatest innovators. and yet the 

complicated tax code steps on its own foot in this area. 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

Page 9 of 12 
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There is an ironic twist to this story. In 2015, Congress passed and the president signed into law, 

the Protecting Americans from Tax Hikes (PATH) Act, which made over a third of the so-called 

"tax extenders" into permanent law. The R&E tax credit was among the nineteen of the tax 

provisions that were made permanent parts of the Tax Code. Since 1981, this credit has expired 

and been renewed 16 times, making it one of the most unstable parts of the Tax Code. In doing 

research for today' s hearing, I learned that the PATH Act contained a provision which allowed 

small businesses (under $50 million in gross revenue over the prior three years) to offset the 

AMT with R&E tax credits! So, I immediately thought-great, problem solved, BUT quickly 

learned it was too good to be true. Unfortunately, Congress limited the offset to C corporations, 

and as noted earlier in my testimony, most small businesses, including Tribute, are Sub(s) 

corporations. So with good intentions, the PATH Act missed the target on this provision. As 

complicated as the tax code is, this is not surprising. Often small businesses suffer from both 

unintended consequences and unrealized intended consequences. Further proving we desperately 

need to simplify. 

Taxation of Pass-through Entities 

As I previously mentioned, most small 

businesses are sole proprietorships, 

subchapter S corporations-such as 

Tribute, Inc.-or limited liability 

companies. Most of the remainder are 

partnerships (either limited or general). 

There also are some business trusts. All 

of these businesses (83 percent, 

according to NSBA data) pay taxes on 

their business at the personal income 

level, or are so-called "pass-through" 

entities that are subject to individual tax 

rates- not corporate tax rates. For my 

1. Payroll taxes 

2. Income taxes{! am a pass-through entity) 

3. State and local tax compliance 

4. Salestax 

5. Property taxes 

6. Corporate taxes (I am a c-corp} 

7. Alternative Minimum Tax 

8. Capttal gains taxes 

9. Medicare surcharge under Affordable Care Act 

10. Changes to deductibility of tangible property repairs 

11. Estate tax 

12. Excise Medical Device Tax) 

13. taxes {I export) 

14. Import taxes (I import) 

company, the pass-through tax implications are a our tax strategy 

no surprise then, that income taxes and payroll taxes were ranked the top two most burdensome 

taxes by small firms. 

Some small businesses are C corporations that are subject to the corporate income tax, but these 

are a relatively small percentage and a large portion of these companies' net income before 

compensating the owners' is usually consumed by paying the owners' salary. This salary is also 

subject to the individual tax rates as, of course, are any dividends paid by the corporation to its 

shareholders. Thus, even for small C corporations, individual tax rates are key. 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

Page 10 of 12 
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Broad refonn of the entire tax code is necessary, not just for corporate entities. Many proposals 

have called for reducing the corporate tax rate while eliminating various business deductions and 

credits, which-if not examined more closely-sounds like a fine plan. However, many passthrough entities utilize these tax benefits that would be on the chopping block. So now I would 

be facing the same, high tax rate on my business income, but I could no longer take advantage of 

some important tax credits ancllor deductions. The result is a tax increase on my finn while large 

corporations would be given a tax cut. Allowing the smallest businesses to pay a much higher tax 

on their business income than a multinational, multi-billion corporations undercuts any 

semblance of fairness. 

I finnly believe that addressing just one piece of the puzzle-such as corporate tax rcfonn-will 

only lead to even greater complexity and a massive tipping of the scales in favor of the nation· s 

largest companies at the expense of small businesses. 

Imposing higher tax rates on small !inns will stymie any growth from what is widely recognized 

as the source of much ofthe economic growth and dynamism in the U.S. economy: small 

business. For the overwhelming majority of small businesses, individual marginal tax rates are 

much more important than corporate marginal tax rates. Since small businesses 

disproportionately contribute to job creation, raising individual marginal tax rates can be 

expected to have a disproportionate negative impact on job creation. It is this kind of 

shortsightedness that has made the IRS a major foe of small firms and why so many of us 

support broad tax refonn. 

If Congress overhauls the tax system by dramatically broadening the base -cutting the breaks 

that litter the tax code-and lowering ALL rates, we would see real economic growth and raise 

revenues. 

Principles of Tax Reform 

While NSBA supports the Fair Tax as a viable option for tax refonn, NSBA understands the 

political landscape and need to move forward on broad refonn, even if in a different iteration. As 

such, NSBA has developed nine principles as part of the NSBA Tax Refonn Checklist to which 

any broad tax refom1 package ought to adhere. The nine principles are: 

./ Designed to tax only once 

./ Stable and predictable 

./ Visible to the taxpayer 

./ Simple in its administration and compliance 

./ Promote economic growth and faimess between large & small businesses 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

Page II of\2 
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../ Use commonly understood finance/accounting concepts 

../ Grounded in reality-based revenue estimates 

../ Fair in its treatment of all citizens 

../ Transparent 

This kind of broad reform is what small firms want: according to NSBA 's 2015 Small Business 

Taxation Survey, a large majority, 70 percent, expressed support broad refotm of the tax system 

that reduces both corporate and individual tax rates, coupled with reducing both business and 

individual deductions. 

Conclusion 

Complexity and inconsistency within the lax code pose a significant and increasing problem for 

small businesses. The ever-growing patchwork of credits, deductions, tax hikes and sunset dates 

is a roller coaster ride without the slightest indication of what's around the next corner. To 

promote economic growth, job creation, capital formation, and international competitiveness, 

fundamental tax refonn is required. However, unless and until Congress agrees upon a 

replacement, we must fix tax problems with the current Tax Code by developing simplification 

measures that are fair and fiscally responsible. 

Weighing in at more than 70,000 pages, the Tax Code punishes work, investment, risk-taking 

and entrepreneurship. The Tax Code is unfair to small businesses, biased against savings and 

investment, and impossibly complex. A tax system dedicated to investment, savings and smallbusiness growth must be put in its place. 

Again, I would like to thank Chairman Chabot and the members of the Small Business 

Committee for the opportunity to speak today. I would be happy to answer any questions you 

may have. 

Testimony of Tim Reynolds, President, Tribute, Inc. 

On Behalf of the National Small Business Association 

Page 12 of 12 
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2 

I FOREWORD 

The National Small Business Assoc1at1on (NSBA) IS the nation's ftrst small-business advocacy organization, 

celebratmg 80 years of smal!-busmess representation 1n Washmgton. D.C. Focused on federal advocacy and 

operatmg on a staunchly nonpart1san bas1s. NSBA IS a recogntzed leader of Amenca·s small-busmess community. 

Throughout the year. we conduct a senes of surveys. including two Economic Reports and a senes of ISSue-based 

surveys. Now, for the first t1me, NSBA has conducted a comprehensive survey on regulations and how they 1mpact 

Amenca's small busmesses. 

The 2017 NSBA Small Busmess Regulat1ons Survey provides quant1tat1ve support for the need to greatly reduce 

regulatory complexity, streaml1ne the web of federal. state and local regulations, and adhere to pla1n language 

statutes. Both the need for regulatory reltef-as well as a road~map to ach1eve 1t-are laid out 1n thiS survey packet. 

Among the most compelling data 1n the survey. we found that the average small-bus1ness owner is spending at 

least $12,000 every year on regulations, and nearly one-m-three spends more than 80 hours each year deal1ng 

w1th federal regulation. We suspect these 1nd1cators would be much htgher the survey spec1f1ed the Inclusion 1n 

calcu!at1ons of even long-standing regulat1ons such as the 40-hour work week. It 1s highly l1ke!y that most smal! 

f1rms who took the survey stmp!y considered such long-standtng regulations a general cost of doing bus1ness rather 

than a regulatory burden, Simply because they've dealt wtth them for so long. 

No surpnse, when asked what areas of regulat1on are most burdensome, the federal tax code and Affordable Care 

Act were the top two. \Ve also found that the sma!l-bus1ness owner IS the number one regulatory expert 1n most 

bus1ness and handles the bulk of federal regulatory compltance. Astoundingly, 14 percent of small-busmess owners 

report they spend more than 20 hours per month on federal regulat1ons. 

Most small businesses say they really started worry1ng about regulattons w1thin the first year of their busmess. 

When coupled w1th the s1gntftcant regulatory costs assoCiated w1th a business' first year, 1t's clear that regulatory 

burden IS a maJor hurdle l1ke!y keeping many would-be entrepreneurs from startmg their own busmess. 

The Impact of regulatory burden cannot be overstated: more than one-third have held off on busmess mvestment 

due to uncerta:nty on a pendmg regulat1on, and more than half have held off on htnng a new employee due to 

regulatory burdens. 

The 2017 NSBA Small Business Regu!attons Survey was conducted on-line Nov. 28. 2016- Jan. 10,2017 among 1.000 

small-business owners. We hope you ftnd thts survey mformat1ve and usefuL Please contact NSBA's med1a offtce 

for inqu1nes at press@nsba.biZ. 

Sincerely, 

Pedro Alfonso 

NSBA Chair 

Todd McCracken 

NSBA President and CEO 
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Scientific and Technical Services 11% 

Agriculture, Forestry, Fishing and Hunting 8% 

Information {IT) 6% 

Health Care and Socia! Assistance S% 

TransPortation ':and Warehousing 5% 

4% 

'Edw:;aW:mal Services 4% 

Real Estate, Rental and Leasing 3% 

Accommodation and ftood Services 2% 

Finance 2% 

Administrative and Support 1% 

Arts, Entertainment, and Recreation 1% 

Manag~ent of Companies and Enterprises 1% 

Utilities 1% 

$150,000,000 or more 11% Insurance 

N/A Waste Management and Remediation Services 1% 
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'llllll!lllililll Ill llllllllll !I 

3 Payroll & employee compensation 

'1 Retirement/pensions 

4 
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I 

5 

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jgf~l~e.e ltifR\\1 1:1:1G:Ie ~li'lanll:illi'l~BI liiiB! &al'. ~ " \ \ \ \ 0 

' ' ••~ ~i\1~~- a•lll\1l~lli a•IJ l.. 'l~telul&tiieRs:l lli'tl nmli'e~r llr:a11 

s;I,IJillla ~~ IBRS~lti W:it'e,$1,\lBill ~~~~~lilts:~ 1:1:1~1.8 ~~~~~ear. 

,, ' 
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c?!!TW7 1171 

I 
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I 

7 
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8 
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I 

9 

When I started it 

About six months in 

About two years in 

About five years in 

About 10 years in 

f am, not worried abotiNegulatOry 

compliance 

14% 

15% 

12% 

•. · ... 

.. · ~% 
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Bm!!t<>i~~~~~maltl!l•ll!!!lmll!'<>nl:!li!ll{n"ss a~!!Qi'!!fi<~I!Sl 

S!!ll!>!!!! ~li!'~ llli!itl ttiell<lfi\ltnflf !!~ !!:t!l!!r 1:\!!WS\ S<!l;!!:D~ 

'l~<~\ll's:llli! t~!lc!lla~<~lils fll;!t ma~tl~attt fl\<~1• fitms. 
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I 

Too time consuming 

11 

a 

Too confusing to read 

through regulation 

I i 

I re!y on trade Uttle to no impact on 

associations like NSBA to my business 

comment on my behalf 
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I 

12 
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I 

More Than SIS% T1mes 0 

13 
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lUll ll!lliUI II !£ 

I 

14 
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I 

lncreased Decreased Stayed the Same 

15 
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I 

16 

IS 

To achieve meaningful relief and a 

rational regulatory regime, NSBA urges 

the adoption of a national regulatory 

budget, which would strict, 

enforceable constraints on the ability of 

federal to regulatory 

costs on the public. Additionally, NSBA 

urges lawmakers to support policies that: 

Require that agencies consider indirect costs and 

detailed alternatives to minimize any significant 

adverse impact 

Require Regulatory Flexibility Analyses as a 

prerequisite to a final rule being issued 

Require increased economic analyses and the Office 

of Information and Regulatory Affairs (OIRA) to 

enhance its oversight efforts 

Require that agencies use plain writing when 

revising or drafting new regulations 

Allow for increased enforcement flexibility and the 

ability to grant common-sense exemptions for firsttime offenders 

Streamline paperwork. consolidate forms and 

harmonize data and due dates 

Require a cost-benefit analysis on proposed 

regulations and paperwork 

Improve information collection by: 1) strengthening 

the Paperwork Reduction Act's requirement that 

agencies' chief information officers review and 

certify information collection requests; 2) requiring 

OIRA to develop stricter approval criteria: and 3) 

limiting the number of information requests an 

agency can issue year 
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WRITTEN STATEMENT 

OF 

ofCPA-s 

Pennsylvania Av>&nue, NW 

Washington, 20004-1081 

THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS 

FOR THE RECORD OF THE 

FEBRUARY 15,2017 

HEARING OF 

THE UNITED STATES HOUSE OF REPRESENTATIVES 

COMMITTEE ON SMALL BUSINESS 

ON 

STARTUPS STALLING? THE TAX CODE AS A BARRIER TO 

ENTREPRENEURSHIP 
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A!CPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page I of 17 

INTRODUCTION 

Chairman Chabot, Ranking Member Velazquez, and Members of the House Committee on 

Small Business, thank you for the opportunity to testify today at the hearing on ''Startups 

Stalling? The Tax Code as a Barrier to Entrepreneurship." My name is Troy Lewis. I am 

an Associate Teaching Professor at Brigham Young University. I am also a sole tax 

practitioner and the Immediate Past Chair of the Tax Executive Committee of the American 

Institute of Certified Public Accountants (AICPA). I am pleased to testify today on behalf 

of the AICPA. 

The AICPA is the world's largest member association representing the accounting 

profession with more than 418,000 members in 143 countries and a history of serving the 

public interest since 1887. Our members advise clients on federal, state, local and 

international tax matters and prepare income and other tax returns for millions of 

Americans. Our members provide services to individuals, not-for-profit organizations, 

small and medium-sized businesses, as well as America's largest businesses. 

We applaud the leadership taken by the Committee to consider ways to promote 

entrepreneurship by addressing potential batTiers in the Internal Revenue Code (IRC or 

"Tax Code''). Small businesses are the foundation of the U.S. economy, employing over 

half of the private-sector workforce and creating nearly two-thirds of this nation's net new 

jobs over the past decade and a half. 1 

GOOD TAX POLICY 

First, we should consider the features of an ideal tax system for small businesses. The 

AICPA urges the Committee to consider comprehensive tax reform that focuses on 

simplification and other Principf<:s o(Good Ten Polict 2 as explained in a report we recently 

updated and issued. Our tax system must be administrable, stimulate economic growth, 

have minimal compliance costs, and allow taxpayers to understand their tax obligations. 

We believe these features m·e achievable if the following twelve principles of good tax 

policy are considered in the design of the system: 

• Equity and Fairness • Certainty 

• Convenience of Payment • Effective Tax Administration 

1 Small Business Administration Office of Advocacy, Frequently Asked Questions, September 2012; 

Imps: W\\\\.sba.gm ,sit~sdcfault ilks f'AO Sept 20!2.pdf. 2 AICPA, Guiding Principles for Good Tax Policy: A Framework for Evaluating Tax Proposals, 2017; 

httP: W\Y\\ .aicpa.or!! Ad\ocacv Tax Down!oadableDocuments tax-po!icv-concept-statt'ment-nl)-1-

global.pdf. 

1 
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AI CPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on '·Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 2 of 17 

• Information Security • Simplicity 

• Neutrality • Economic Growth and Efficiency 

• Transparency and Visibility • Minimum Tax Gap 

• Accountability to Taxpayers • Appropriate Government Revenues 

Our profession has long-advocated for a transparent tax system. For example, we urge 

Congress to use a consistent definition of taxable income without the use of any phaseouts. Provisions, such as phase-out rules, that limit or eliminate the use of certain 

deductions and exclusions for those taxpayers in higher tax brackets, perpetuate the flaws 

of the cunent system, cause tax consequences of business decisions to be nontransparent 

and hinder the ability for new entrepreneurs to grow their businesses. The use of phaseouts in order to increase the efiective tax rate contributes to the complexity and lack of 

transparency of the present tax system. These rules also unfairly create marginal rates in 

excess of the statutory tax rate. We urge Congress to use tax reform as an opportunity to 

remove phase-outs and develop the best definition of taxable income or adjusted gross 

income by creating simple, transparent, tax rate schedules that are applied consistently 

across all rate brackets, eliminating additional hidden taxes. 

We also urge you to make tax provisions pe1manent. For all businesses, and small 

businesses in particular, unee1tainty in the Tax Code creates unnecessary confusion, 

anxiety, and financial burdens that impact cash flow, and, thus, a business's ability to hire 

and expand. Complexity can also result in taxpayers not taking full advantage of provisions 

intended to help them, resulting in higher taxes and greater compliance costs. While our 

Tax Code has always had a tendency to change, in recent years the rate of change has 

accelerated. New regulations, revenue procedures and notices come out daily, providing 

guidance on enacted laws. Extender bills pass annually only to expire, often within less 

than a month of enactment, leaving taxpayers unable to avail themselves of intended tax 

breaks and benefits. When a small business client asks a simple question such as "what is 

my tax rate," CPAs have to explain how it is not quite that simple to answer because there 

is the regular tax, the alternative minimum tax (AMT), the net investment income tax and 

the variety of phase-ins and phase-outs for numerous provisions that all impact an overall 

blended rate. America's entrepreneurs need a Tax Code that is simple, transparent, and 

certain. 

AI CPA PROPOSALS 

We appreciate the opportunity to provide input as Congress develops tax reform policy for 

small businesses and their owners. In the interest of good tax policy and effective tax 

administration, we will address the following issues: 

1. Tax Rates for Pass-through Entities 

2 
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AI CPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling') The Tax Code as a Barrier to 

Entrepreneurship" 

Page 3 of 17 

2. Distinguishing Compensation Income 

3. Cash Method of Accounting 

4. Limitation on Interest Expense Deduction 

5. Definition of"Compensation" 

6. Net Operating Losses 

7. Increase of Startup Expenditures 

8. Alternative Minimum Tax Repeal 

9. Border Adjustment Provisions 

10. Mobile Workforce 

11. Retirement Plans 

12. Civil Tax Penalties 

13. Tax Administration 

I. Tax Rates for Pass-through Entities 

As Congress moves forward with tax reform, it is important to recognize that a rate 

reduction for only C corporations is inappropriate. The vast majority of businesses are 

structured as pass-through entities (such as, partnerships, S corporations, or limited liability 

companies) 3 In 2014, there were almost 25 million individual tax returns that included a 

non-farm sole proprietorship4 

IRS data for 2012, the most recent data publicly available, indicates the following mix and 

numbers of business entity filings. 5 

3 Census Bureau, County Business Patterns, http: "" '' .ccnsus.g,,, .ccor1 cbp ; Census Bureau, 

Nonemployer Statistics; http:·""" .census.gov econ nonemplo1er. 

'IRS, Sole Proprietorship Returns, Tax Year 2014; https: 11\\ '' .irs.gov pub irs-,oi soi-a-inpr-id l6l4.pdf. 5 IRS, SOl Tax Slats- Integrated Business Data, Table I: Selected financial data on businesses; 1980-20 12; 

https: \\\\ 11.irs.go1 uac soi-tax-stats-intcgrated-bu,ine"-data. Table created by the AI CPA using IRS data. 

IRS data on nonfarm sole proprietorships indicates the number has grown to 23,631,831 for 2014, a 4.6% 

increase from 2012. See IRS, Sole Proprietorship Returns, Tax Year 2014, Figure L; 

http~: \\\\\\.irs. go\ ·pub, ir~-:-.oi· soi-a-inpr-1d 1614.pdL 

3 
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AICPA 's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 4 of17 

-2012 

1,617,739 IIi Corps 

S Corps 

(583,007) 

LLC 

Congress should continue to encourage, or more accurately- not discourage, the formation 

of sole proprietorships and pass-through entities because these business structures provide 

the flexibility and control desired by many new business owners as opposed to corporations 

which are subject to more formalities. Entrepreneurs generally do not want to create 

entities that require extra unnecessary legal obligations (such as holding annual meetings 

of a board of directors) or offer limited liability. They prefer business structures that afford 

immediate tax advantages, such as the flow-through of early stage losses and a single layer 

of taxation. As a business grows, however, it may need to change its structure to raise 

additional equity funding or bring on more shareholders (including employeeshareholders). 

If Congress decides to lower income tax rates for C corporations6 (which are generally 

larger businesses), small businesses should also receive a rate reduction. Tax reform 

should not disadvantage sole proprietorships and pass-through entities at the expense of 

furthering larger C corporations. 

2. Distinguishing Compensation Income 

We recognize that providing a reduced rate for active business income of sole 

proprietorships and pass-through entities will place additional pressure on the distinction 

6 House Republican's Tax Reform Task Force, A Better Way: Our Vision/or a Cotifident America- Tax, 

June 24, 2016; http:/ abetterway.speaker.gov·' assets/pdf ABetterWav-Tax-PolicvPaper.pdf. 

4 
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AI CPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling'1 The Tax Code as a Barrier to 

Entrepreneurship·· 

Page 5 of 17 

between the profits of the business and the compensation of owner-operators. We 

recommend detennining compensation income by using traditional definitions of 

"reasonable compensation'' supplemented, if necessary, by additional guidance from the 

Secretary of the Treasury. Changes to existing payroll tax rules, such as a requirement for 

partnerships and proprietorships to charge reasonable compensation for owners' services 

and to withhold and pay the related income and other taxes, will also facilitate compliance 

for small businesses. 

We encourage Congress to consider the extstmg judicial guidance on reasonable 

compensation that reflects the type of business (for example, labor versus capital 

intensive), the time spent by owners in operating the business, owner expertise and 

experience, and the existence of income-generating assets in the business (such as other 

employees and owners, capital and intangibles). There is existing law developed by 

judicial decisions relating to reasonable compensation. 

We acknowledge that reasonable compensation has been the subject of controversy and 

litigation (hence, the numerous court decisions helping to define it). Therefore, we suggest 

that the Internal Revenue Service (IRS) take additional steps to improve compliance and 

administration in this area. For example, the creation of a new tax fonn (or preferably, 

modification of an existing f01m, such as Form 1125-E, Compensation of Officers) or a 

worksheet maintained with the taxpayer's tax records, would allow businesses to indicate 

the factors considered in determining compensation in a consistent manner. These 

potential factors include: 

a. Approximate average hours per week worked by all owners; 

b. Approximate average hours worked per week by non-owner employees; 

c. The owner's years of experience; 

d. Guidance used to help detennine reasonable compensation for the geographic 

area and years of experience (such as, wage data guides provided by the U.S. 

Bureau of Labor Statistics); and 

e. Book value and estimated fair market value of assets that generate income for 

the business. 

Changes are also necessary for existing payroll tax rules to require partnerships and 

proprietorships to charge reasonable compensation for owners' services and to withhold 

and pay the related income and other taxes. These types of changes to existing payroll tax 

rules will facilitate small business compliance. The partners and proprietors are not treated 

as "employees,'' but rather owners subject to withholding a new category of taxpayersimilar to a partner with a guaranteed payment for services. Similar rules requiring 

reasonable compensation currently exist in connection with S corporations and such 

owners are considered employees of the S corporation. The broader inclusion ofpm1ners 

5 
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AI CPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Banier to 

Entrepreneurship" 

Page 6 of 17 

and proprietors in more well defined compensation rules, should facilitate and enhance the 

development of appropriate regulations and enforcement in this area. 

The AICP A believes there arc advantages of this reasonable compensation approach for 

owners of all business types. These advantages include: 

a. Fairness that respects the differences among business types; 

b. A reduced reliance by both taxpayers and the IRS on quarterly estimated tax 

payments for timely matching of the earning process and tax collection; 

c. Diminished reliance on the self-employment tax system (since businesses 

would include payroll taxes withheld from owners and paid for owners along 

with their employees); and 

d. Simplification from uniformity of collection of employment tax from business 

entities, and an ability to rely on a deep foundation of case law (in the S 

corporation and personal service corporation areas) to provide regulatory and 

judicial guidance. 

In former Ways & Means Chairman Dave Camp's 2014 discussion draft,7 a proposal was 

included to treat 70 percent of pass-through income of an owner-employee as employment 

income. While this proposal presents a simple method of determining the compensation 

component, it would result in an inaccurate and inequitable result in too many situations. 

If Congress moves forward with a 70/30 rule, or other percentage split, we recommend 

making the proposal a safe harbor option. Small businesses need simplicity and clarity in 

the rules. For example, the proposal must make clear that the existence and the amount of 

the safe harbor is not a maximum amount pctmitted but that the reasonable compensation 

standard utilized for corporations will remain available to sole proprietorships and passthrough entities. These mles will provide a unifotm treatment among closely-held business 

entity types. 

3. Cash Method of Accounting 

The AICP A supports the expansion of the number of taxpayers who may use the cash 

method of accounting. The cash method of accounting is simpler in application than the 

accmal method, has fewer compliance costs, and does not require taxpayers to pay tax 

before receiving the income. Therefore, entrepreneurs often choose this method for small 

businesses. We arc concerned with, and oppose, any new limitations on the usc of the cash 

method for service businesses, including those businesses whose income is taxed directly 

on their owners' individual returns. such as partnerships and S corporations. Requiring 

businesses to switch to the accmal method upon reaching a gross receipts threshold 

unnecessarily creates a barrier to growth. A required switch to the accmal method affects 

7 H.R. 1, "The Tax Reform Act of2014," 

http" 1\U'Sandmcan,.h,,usc.""' UoloadedFiles HR FINAL.pdt'. 

6 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a BmTier to 

Entrepreneurship" 

Page 7 of 17 

many small businesses in certain industries including accounting fitms, law firms, medical 

and dental otlices, engineering firms, and fanning and ranching businesses. 

The AICP A believes that limiting the use of the cash method of accounting for service 

businesses would: 

I) Discourage natural small business growth; 

2) Impose an undue financial burden on their individual owners; 

3) Increase the likelihood of borrowing; 

4) Impose complexities and increase their compliance burden; and 

5) Treat similarly situated taxpayers differently (because income is taxed directly on 

their owners' individual returns). 

As the AICP A has previously stated, 8 we believe that Congress should not further restrict 

the use of the long-standing cash method of accounting for the millions of U.S. businesses 

(e.g., sole proprietors, personal service corporations, and pass-through entities) cunently 

utilizing this method. We believe that forcing more businesses to use the acctual method 

of accounting for tax purposes increases their administrative burden, discourages business 

growth in the U.S. economy, and unnecessarily imposes financial hardship on cashstrapped businesses. 

4. Limitation on Interest Expense Deduction 

Another important issue for small businesses is the ability to deduct their interest expense. 

New business owners have interest from small business loans they incur to fund operations 

prior to revenue generation, working capital needs, equipment acquisition and expansion, 

and even to build credit for larger future loans. These businesses rely on financing to 

survive. Equity financing for many start-up businesses is simply not available. A 

limitation in the deduction for interest expense (to the extent of interest income) would 

effectively eliminate the benefit of a valid business expense for many small businesses, as 

well as many professional service firms. If a limit on the interest expense deduction is 

8 AI CPA comment letter on the "Continued Availability of Cash Method of Accounting," August 15, 20 13; 

http: \\\\W.aicpa.or~ Advocacv Tax DownloadabkDocumcntsC:WIJ.OX.IS Comments on Continued Av 

ailabilitv uf Cash Method of /\ccou11tin~.pdt~ AICPA written statement before the House Committee on 

Ways And Means, dated May 15, 2013, Small Business and Pass-through Entity Tax Reform Discussion 

Draft; 

STATEMENT-Mav-15-20 I J-hwmc-srsubcomtc-camp-small-bus-submiLpdt~ and AI CPA statement 

before the House Committee on Small Business, Subcommittee on Economic Growth, Tax and Capital 

Access, dated July I 0, 2014, Hearing on "Cash Accounting: A Simpler Method for Small Firms?"; 

7 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on ''Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 8 of 17 

paired with a proposal to allow for an immediate write-off of acquired depreciable 

property, it is important to recognize that this combination adversely affects service 

providers and small businesses while offering much larger manufacturers, retailers, and 

other asset-intensive businesses a greater tax benefit. 

Currently, small businesses can expense up to $500,000 of acquisitions per year under 

section 179 ($51 0,000 for 20 17) and deduct all associated interest expense. One tax reform 

proposal 9 under consideration would eliminate the benefit of interest expense while 

allowing immediate expensing of the full cost of new equipment in the first year. However, 

since small businesses do not generally purchase large amounts of new assets, this proposal 

would not provide any new benefit for smaller businesses (relative to what is currently 

available via the section 179 expensing rule). Instead, it only takes away an important 

deduction for many small businesses who are forced to rely on debt financing to cover their 

operating and expansion costs. 

5. Definition of"Compensation" 

Tax refonn discussions have recently considered whether the tax system should use the 

same definition for taxable compensation of employees as it does for the compensation that 

employers may deduct. In other words, should businesses lose some of their current 

payroll-type deductions if employees are not required to report those same compensation 

amounts as income? 

We are concerned, particularly from a small business perspective, about any decrease of 

an employer's ability to deduct compensation they have paid to employees, whether in the 

form of wages or fringe benefits (health and life insurance, disability benefits, deferred 

compensation, etc.). We are similarly concerned about expansion of the definition of 

taxable income for the employees, or removal of the exclusion for tnnge benefits. Such 

changes in the Tax Code would substantially impact the small and labor-intensive 

businesses' ability to build and retain a competitive workforce. 

6. Net Operating Losses 

Congress should also provide tax relief to small businesses in the calculation of benefits 

related to net operating losses (NOLs). An NOL is generally the amount by which a 

taxpayer's business deductions exceed its gross income. Corporations currently operating 

at a loss can benefit from canying these NOLs back or forward to offset taxable income in 

prior or future years. According to the current rules, these losses are not deducted in the 

9 House Republican's Tax Reform Task Force, A Better Way: Our Vision for a Confident America, June 

24, 2016; http: abcttcl·\\av.spcakcr.gov asseh pdf ABcttcrWav-Ta,-PulicvPaper.pdC 

8 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 9 of 17 

year generated, but carried back two years and carried forward 20 years to of1set taxable 

income in such years. 

One of the purposes of the NOL carryback and carryover mles is to allow a corporation to 

better reflect its economic position over a longer period of time than generally is allowed 

under the restraint of the annual reporting period. Since 1987, our experience with the 90 

percent AMT limitation on the use ofNOLs shows that this limitation often imposes a tax 

on corporations, especially small businesses in their early growth years, when such 

businesses are still stmggling economically. Therefore, a proposali 0 for a 90 percent 

limitation on NOLs imposes an artificial restriction on a company's use of business losses 

and discriminates against companies with volatile income which could potentially pay 

more tax than companies with an equal amount of steady income over the same period. 

For sole proprietors, the calculation of the NOL is overly complicated. Congress should 

simplify the calculation while retaining the carryback option for small businesses. Most 

startup businesses arc forn1ed as pass-through entities II and the initial startup losses 

incuned are "passed down" and reported on the owners' tax returns. Because individual 

taxpayers report both business and nonbusiness income and deductions on their returns, 

the required calculations to separate allowed business losses from disallowed personal 

activities is complex. I

2 Individual business owners would benefit from more specific 

guidance on NOL computations. 

7. Increase of Startup Expenditures 

In the interest of economic growth, we encourage Congress to consider increasing the 

expensing amount tor startup expenditures. Section 195 allows immediate expensing of 

up to $5,000 of startup expenditures in the tax year in which the active trade or business 

begins. This amount is reduced dollar for dollar once total startup expenditures exceed 

$50,000, with the excess amortized ratably over 15 years. Thus, once startup expenditures 

exceed $55,000, all of these expenditures are amortized over 15 years. The rationale for 

the $5,000 expensing was to "help encourage the fotmation of new businesses that do not 

require significant stat1up or organizational costs."I 3 These dollar amounts, added in 2004, 

are not adjusted for inflation. Only for tax years beginning in 2010, the $5,000 was 

10 House Republican's Tax Reform Task Force, A Better Way: Our Vision for a Cot!fident America - Tax, 

June 24, 2016; http: abclter\\av.spcaker.gov assets pdfABctter\Vav-Tax-PolievPaper.pdL 11 Center for American Progress, "Ending the Pass-Through Tax Loophole for Big Business," August 20 16; 

http": ·cdn.amcricanpn.h!J\.~ss.oru \\ p-content uoload~ 20 l6:0S OS0703Y l PassthrutaxationAuLJ:.pdf. 12 IRS Publication 536; Imps: ''" \1 .irs.gov pub irs-pdr'p5~n.pdf. 

Ll P.L. 108-357 (10/22/04), American Jobs Creation Act, Sec. 902; Joint Committee on Taxation, General 

Explanation ofT ax Legislation Enacted lnthe 108'" Congress, JCS-5-05, May 31,2005, p. 504. 

9 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on '"Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 10 of 17 

increased to $10,000 and the $50,000 phase-out level was increased to $60,000. This 

change was described as "promoting entreprencurship." 14 

The AI CPA reconuncnds increasing the $5,000 and $50,000 amounts of section 195 and 

adjusting them annually for inflation. These changes will further simplify tax compliance 

for small businesses by reducing (or eliminating) the number of such businesses that must 

track and report amortization of startup expenses over a 15-year period. In addition, as was 

suggested for the 2004 and 2010 legislative changes, the larger dollar amounts will better 

encourage entrepreneurship. Higher dollar amounts also reflect the costs for legal, 

accounting, investigatory, and travel that are frequently incuned when starting a new 

business. Also, in light of the increased, inflation-adjusted dollar amounts under section 

17915 to help small businesses, it is appropriate to similarly increase the section 195 dollar 

amounts and adjust them annually for inflation. 

8. Alternative Minimum Tax Repeal 

Congress should repeal AMT for both individuals and corporations. The current system's 

requirement for taxpayers to compute their income for purposes of both the regular income 

tax and the AMT is a significant area of complexity of the Tax Code requiring extra 

calculations and recordkeeping. AMT also violates the transparency principle in masking 

what a taxpayer is allowed to deduct or exclude, as well as the taxpayer's marginal tax rate. 

Owners of small businesses, including those businesses operating through pass-through 

entities and C corporations of a size beyond the AMT exception for small C corporations. 

are increasingly at risk of being subject to AMT. 

The AMT was created to ensure that all taxpayers pay a minimum amount of tax on their 

economic income. However, small businesses suHer a heavy burden because they often 

do not know whether they are affected until they tile their taxes. They must constantly 

maintain a reserve for possible AMT, which takes away from resources they could allocate 

to business needs such as hiring, expanding, and giving raises to workers. 

The AMT is a separate and distinct tax regime from the "regular·• income tax. IRC Sections 

56 and 57 create AMT adjustments and preferences that require taxpayers to make a 

second, separate computation of their income, expenses, allowable deductions, and credits 

under the AMT system. This separate calculation is required for all components of income 

including business income for sole proprietors, partners in pm1nerships and shareholders 

in S corporations. Small businesses must maintain annual supplementary schedules used 

to compute these necessary adjustments and preferences for many years to calculate the 

14 The one year change to the § 195 dollar amounts was made by P.L. 111-240 (9/27/1 0), the Small Business 

Jobs Act of 20!0, Sec. 2031(a); Joint Committee on Taxation, General Explanation of Tax Legislation 

Enacted in the 111'" Congress, JCS-2-11, March 201 I, p. 474. 15 P.L. 114-113 (12118115), Sec. 124(a). 

10 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on ''Startups Stalling? The Tax Code as a Banier to 

Entrepreneurship'' 

Page II of 17 

treatment of future AMT items and, occasionally, receive a credit for them in future years. 

Calculations governing AMT credit carryovers are complex and contain traps for unwary 

taxpayers. 

Sole proprietors who are also owners in pass-through entities must combine the AMT 

information from all their activities in order to calculate AMT. The computations are 

extremely difficult for business taxpayers preparing their own returns and the complexity 

also affects the IRS's ability to meaningfully track compliance. 

9. Border Adjustment Provisions 

It is important to consider how border adjustment provisions (alkla destination-based cash 

flow tax) would impact small businesses. Recent tax reform discussions have included 

suggestions to exclude export sales from revenue and disallow a deduction for imported 

goods and services. These provisions could impact businesses of all sizes, including small 

businesses. 

Many service providers, such as accounting fim1s, are locally-operated small businesses. 

However, the demands on our profession have evolved over the last 20 years as more of 

our clients are engaging in global markets to remain competitive. As a result, small 

accounting fim1s frequently participate in global alliance networks to service their clients 

since they do not have in-house expertise on international tax issues and treatises or 

knowledge of the tax rules of foreign countries. The forced reliance on such services. 

which may be considered "imported'' and therefore nondeductible, may impact their ability 

to continue to service their clients in the U.S. 

10. Mobile Workforce 

The AICP A supports legislation similar to H.R. 2315, the Mobile Workforce State Income 

Tax Simplification Act of 2015, from the !14th Congress, which provides a uniform 

national standard for non-resident state income tax withholding and a de minimis 

exemption from the multi-state assessment of state non-resident income tax. 16 We expect 

the same cosponsors to soon introduce a similar bill. 

The current situation of having to withhold and file many state nonresident tax retums for 

just a few days of work in various states is too complicated for both small businesses and 

their employees. Businesses, including small businesses and family businesses that operate 

16 AICPA testitied at the U.S. House Committee on Small Business Subcommittee on Economic Growth. 

Tax, and Capital Access hearing: "Keep It Simple: Small Business Tax Simplification and Reform, Main 

Street Speaks," on April 13. 2016, available at 

11 
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AICP A· s Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 12 of 17 

interstate, are subject to a multitude of burdensome and often bewildering non-resident 

state income tax withholding rules. These businesses currently face unnecessary 

administrative burdens to understand the variations from state to state. The issue of 

employer tracking and complying with all the different state and local tax laws is quite 

complicated and costly. The documentation takes a lot oftimc, not to mention the loss in 

economic productivity for small businesses. 

Legislation very similar to H.R. 2315, which passed in the !14th Congress, would provide 

long-overdue relief from the cun·ent web of inconsistent state income tax and withholding 

rules on nonresident employees. Therefore, we urge Congress to pass this type of 

legislation that provides national unifonn rules and a reasonable 30 day de minimis 

threshold before income tax withholding is required. 

11. Retirement Plans 

Small businesses are especially burdened by the overwhelming number of rules inherent 

in adopting and operating a qualified retirement plan. Currently, there are four employee 

contributory deferral plans: 40l(k), 403(b), 457(b), and SIMPLE plans. Having four 

variations of the same plan type causes confusion for many plan participants and small 

businesses. Congress should eliminate the unnecessary complexity by reducing the 

number of choices for the same type of plan while keeping the desired goal intact: 

affording employers the opportunity to offer a contributory deferral plan to their employees 

and allowing those employees to use a uniform plan to save for retirement. 

Startup business owners are inundated with a myriad of new business decisions and 

concerns. These individuals may have expertise in their business product or service, but 

rarely are they experts in areas such as retirement plan mles and regulations. We encourage 

Congress to consider creating a unif01m employee contributory deferral plan to case this 

burden for small businesses. 

12. Civil Tax Penalties 

Congress should carefully draft penalty provisions and the Executive Branch should fairly 

administer the penalties to ensure they deter bad conduct without detening good conduct 

or punishing innocent small businesses owners (i.e., unintentional errors, such as those who 

committed the inappropriate act without intent to commit such act). Targeted, 

proportionate penalties that clearly articulate standards of behavior and are administered in 

an even-handed and reasonable manner encourage voluntary compliance with the tax laws. 

12 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February !5, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship'' 

Page 13 ofl7 

On the other hand, overbroad, vaguely-defined, and disproportionate penalties create an 

atmosphere of arbitrariness and unfairness that can discourage voluntary compliance. 

The AICPA has concems 17 about the current state of civil tax penalties and offers the 

following suggestions for improvement: 

a. Trend Toward Strict Liability 

The IRS discretion to waive and abate penalties where the taxpayer demonstrates 

reasonable cause and good faith is needed most when the tax laws are complex and 

the potential sanction is harsh. Legislation should avoid mandating strict liability 

penalties. Over the past several decades, the number of increasingly severe civil 

tax penalties have grown, with the Tax Code cunently containing eight strict 

liability penalty provisions (for example, the accuracy penalty on non-disclosed 

reportable transactions). 18 

b. An Erosion of Basic Procedural Due Process 

Taxpayers should know their rights to contest penalties and have a timely and 

meaningful opportunity to voice their feedback before assessment of the penalty. 

In general, this process would include the right to an independent review by the IRS 

Appeals office or the IRS's FastTrack appeals process, as well as access to the 

courts. Pre-assessment rights are particularly important where the underlying tax 

provision or penalty standards are complex, the amount of the penalty is high, or 

fact-specific defenses such as reasonable cause are available. 

c. Repeal Technical Termination Rule 

We recommend 19 the repeal of section 708(b)(l)(B) regarding the technical 

termination of a partncrship. 20 A technical te1mination most often occurs when, 

during a 12-month period there is a sale or exchange of 50 percent or more of the 

17 See the "AJCPA Tax Penalties Legislative Proposals," submitted to Congress in April 2013; 

http: \\11 vv .aicpa.org /l.thocacv 1 en TaxLegislationPolicv D011 nloadablcDocuments AICP.-\-Iegislativeproposals-penalties-20Ll.pdt; and the ''AICPA Report on Civil Tax Penalties," submitted April 2013; 

http: \\ \\~\\ .a!cpa.org Ad\ ocacv ·1 ax TaxLcv:is!ationPolicv Dt)\\ n!oadabld)ocumenh AICPA-reporl-Ci\ iltax-penaltv·rcft,rm-20! .i.pd r. IS Section 6662A, 6664(d). 19 AI CPA submitted comments to the House Committee on Ways and Means on the Tax Refonn Act of20 14, 

dated January 12, 2015; http: "'"' .aicpa.org'Advocacv Tax Do\\nloadabkD,,cuments AICPA-Commenhon-20! 4-Cam p- Ora t\ -General-Comments-Final .pdf. 20 AICPA submitted letters and written statements on Option 1 and Option 2 of Chairman Camp's Small 

Business Tax Reform Draft: See Option 1 comments at "AlCPA testimony on Small Business and Passthrough Tax Reform," dated May 17, 20 13; 

13 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 14ofl7 

total interest in partnership capital and profits. Because this 12-month time frame 

can span a year-end, the partnership may not realize that a 30 percent change (a 

minority interest) in one year followed by a 25 percent change in another year, but 

within 12 months of the first, has caused the partnership to terminate. 

In practice, this earlier required filing of the old partnership's tax return often goes 

unnoticed because the business is unaware of the accelerated deadline due to of the 

equity transfer. Penalties arc often assessed upon the business as a result of the 

missed deadline. This technical termination area is often misunderstood and 

misapplied. The acceleration of the filing of the tax return, to reset depreciation 

lives and to select new accounting methods, serves little purpose in terms of abuse 

prevention and serves more as a trap for the unwary. 

d. Late Filing Penalties of Sections 6698 and 6699 

Sections 6698 and 6699 impose a penalty of $200 per owner related to 'late-filed 

partnership or S corporation returns. The penalty is imposed monthly not to exceed 

12 months, unless it is shown that the late filing is due to reasonable cause. 

The AICP A proposes that a partnership, comprised of 50 or fewer partners, each of 

whom are natural persons (who are not nonresident aliens), an estate of a deceased 

partner, a trust established under a will or a trust that becomes in-evocable when the 

grantor dies, and domestic C corporations, be considered to have met the reasonable 

cause test and not be subject to the penalty imposed by section 6698 or 6699 if: 

• The delinquency is not considered willful under section 7423; 

• All partnership income, deductions and credits are allocated to each partner 

in accordance with such partner's capital and profits interest in the 

partnership, on a pro-rata basis; and 

• Each pat1ncr fully reported its share of income, deductions and credits of 

the partnership on its timely filed federal income tax return. 

e. Failure to Disclose Reportable Transactions 

Taxpayers who fail to disclose a reportable transaction are subject to a penalty 

under section 6707 A of the Tax Code. The section 6707 A penalty applies even if 

there is no tax due with respect to the reportable transaction that has not been 

disclosed. There is no reasonable cause exception to this penalty. 

Under section 6662A, taxpayers who have understatements attributable to certain 

reportable transactions are subject to a penalty of20 percent (if the transaction was 

disclosed) and 30 percent (if the transaction was not disclosed). A more stringent 

reasonable cause exception for a penalty under section 6662A is provided in section 

6664, but only where the transaction is adequately disclosed, there is substantial 

14 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on ·'Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page15ofl7 

authority for the treatment, and the taxpayer had a reasonable belief that the 

treatment was more likely than not proper. In the case of a listed transaction, 

reasonable cause is not available, similar to the penalty under section 6707 A. 

For example, a company that engaged in a "listed" transaction which gave rise to a 

deduction of$25,000 over the course of two years and inadvertently failed to report 

the transaction may be subject to a $200,000 penalty per year, for a total penalty of 

$400,000. The penalty can apply even if the deduction is allowable. 

We propose an amendment of section 6707 A to allow an exception to the penalty 

if there was reasonable cause for the failure and the taxpayer acted in good faith for 

all types of rep01table transactions, and to allow for judicial review in cases where 

reasonable cause was denied. Moreover, we propose an amendment of section 

6664 to provide a general reasonable cause exception for all types of repOiiable 

transactions, iJTcspcctive of whether the transaction was adequately disclosed or the 

level of assurance. 

f. 9100 Relief 

Section 9100 relict~ which is cun·ently available with regard to some elections, is 

extremely valuable for taxpayers who inadvertently miss the opportunity to make 

certain tax elections. Congress should make section 9100 relief available for all tax 

elections, whether prescribed by regulation or statute. The AI CPA has compiled a 

lisi! 1 of elections (not all-inclusive) for which section 9100 relief cuiTently is not 

granted by the IRS as the deadline for claiming such elections is set by statute. 

Examples of these provisions include section 17 4(b )(2), the election to amortize 

certain research and experimental expenditures, and section 280C(c), the election 

to claim a reduced credit for research activities. 

g. Form 5471 Penalty Relief 

On January 1, 2009, the IRS began imposing an automatic penalty of$10,000 f()f 

each Fotm 5471, lr1{ormation Return of U.S. Persons with Respect to Certain 

Foreign Corporations, filed with a delinquent Form 1120 series return. When 

imposing the penalty on corporations in particular, the IRS does not distinguish 

between: a) large public multinational companies, b) small companies, and c) 

companies that may only have insignificant overseas operations, or loss companies. 

This one-size-fits-all approach inadvertently places undue hardship on smaller 

corporations that do not have the same financial resources as larger corporations. 

21 AICPA letter on ·'Tax Reform Administrative Relief for Various 

23, 2015; 

15 
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AICPA's Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on "Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 16 of 17 

The AI CPA has submitted recommendations22 regarding the IRS administration of 

the penalty provision applicable to Fonn 5471. Our recommendations focus on the 

need for relief from automatic penalties assessed upon the late filing of Form 5471 

in order to promote the fair and efficient administration of the international penalty 

provisions of the Tax Code. 

13. Tax Administration 

Our profession is committed to improving the taxpayer and tax preparer experience when 

interacting with the IRS. The AICPA Council passed a resolution regarding tax 

administration23 and fully supports rebuilding the agency into a modem and efficient 21st 

century administrator of the nation's tax system. 

In order for small businesses and their tax practitioners to receive the assistance they need 

on tax issues, it is essential for the IRS to focus on: 

a. Utilizing modem and secure technology; 

b. Developing and continuing to hire and train knowledgeable employees; and 

c. Tailoring their processes and systems around the needs and wants of their 

"customers.'' 

By focusing on the factors listed above, the IRS will become a ''Service First'' agency that 

meets the needs of small business owners. 

CONCLUDING REMARKS 

Small businesses and their tax practitioners are interested in, and need, tax simplification. 

Compliance burdens for entrepreneurs and small businesses are currently too heavy, both 

in tenns of time required and out-of-pocket expense. While there are certainly costs 

associated with simplifying tax legislation, it is important to recognize that reforming our 

tax system will eliminate significant compliance burdens. 

The proliferation of new income tax provisions since the 1986 tax refotm effort has led to 

compliance hurdles for taxpayers, administrative complexity, and enforcement challenges 

for the IRS. We encourage you to examine all aspects of the Tax Code to identify barriers 

AI CPA submitted comments to the IRS, dated March 26, 2013; 

16 
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AI CPA ·s Written Statement for the Record 

U.S. House of Representatives, Committee on Small Business 

February 15, 2017 Hearing on ·'Startups Stalling? The Tax Code as a Barrier to 

Entrepreneurship" 

Page 17 of 17 

for small businesses and their owners. The AICP A has consistently supported tax reform 

simplification efforts because we are convinced such actions will significantly reduce small 

businesses' compliance costs and fuel economic growth.24 We look forward to working 

with the Committee in the ll51

h Congress as you continue to address the needs of small 

businesses. 

The AICPA maintains a tax reform resource center website 

http: \\\\ \\· .aicpa.org, lntere~tArea"' Tax Rc~ources SpecialiLcdguidance Ta\.reform. Pai!es ·tax-refonnresou rce-cent cr. asp\. 

17 

at: 
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Questions from Representative Radewagen to David Burton 

1. In your opinion, should the territories have a standardized tax code (Where all 5 territories 

share one common tax code) or should each territory have its own separate tax code that is 

tailored to each of the territories? 

No. Tax competition at the subnationallevel is positive. Moreover, state, territorial and local 

governments should determine their own tax and spending levels and maintain control over the 

structure and financing of their government. 

2. In your opinion, should the territories receive a territorial tax credit or special dispensations to 

encourage outside investment/ development? 

No. Tax preferences generally reduce rather than enhance social well-being. 

3. What are the pros and cons of income earned in the territories being treated as foreign earned 

income? 

I do not have a well-developed position on this issue. 

4. What are the pros and cons of income earned in the territories being treated as domestic 

earned income? 

I do not have a well-developed position on this issue. 

5. Supposing that the IRC does not change, what reforms can be made to the IRC that could help 

entrepreneurs and small businesses in the territories? 

Lower marginal tax rates, permitting the immediate deduction of capital expenses (expensing) and 

simplification that reduces compliance costs would do the most to help small businesses. 

David Burton 

Senior Fellow, Economic Policy 

Institute for Economic Freedom and Opportunity 

The Heritage Foundation 

214 Massachusetts Avenue, NE 

Washington, DC 20002 

202-608-6229 

heritage_Q[g 
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March 28. 2017 

Chairman Steve Chabot 

Committee on Small Business 

U.S. House of Representatives 

TAX. 

FOUNDATION 

2361 Rayburn House Office Building 

Washington. D.C. 20515 

Dear Chairman Chabot: 

620C • WV'vV'i taxfoundJtion 

Thank you for sending the questions submitted by Representative Radewagen. My 

answers are below: 

1. I do not have a strong opinion on whether all five inhabited US territories 

should have a standardized tax code. 

Under current law, three of the five territories have "mirror code" tax systems. 

and are required to use the U.S. Internal Revenue Code (LR.C) as the basis 

for their tax collections. However. all three territories Guam. the Northern 

Mariana Islands, and the US Islands - have varying levels of authority to 

enact different tax rules. or in place of the LR.C 

Meanwhile, the remaining two territories, American Samoa and Puerto Rico, are 

not required to use the LR.C as the basis for their tax collections. Nevertheless. 

American Samoa has chosen to structure its tax laws in a manner broadly similar 

to the LR.C 

Lawmakers interested in the question of a standardized tax code for the 

territories would do well to examine the case study of Puerto Rico, the only 

territory to extensively decouple its tax system from that of the U.S. federal 

government 

More generally, because all five US territories have significantly different 

economic conditions and revenue requirements, it could potentially be 

advantageous for each territory to have a separate tax code. tailored to its 

needs. On the other hand. it is likely that the territories with "'mirror code'' tax 

systems derive significant administrative advantages from having a tax code 

that is based off of the I.R.C 
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2 In my opinion, the U.S. federal income tax code should not contain a 

"territorial tax credit" for conducting business in US territories. 

Ideally, lawmakers should endeavor to make the federal tax code neutral 

between different economic activities, so that taxpayers make decisions based 

on the economic merits, rather than tax considerations. If a tax code deviates 

from the principle of neutrality, taxpayers may be discouraged from engaging 

in socially beneficial activities because of an especially high tax burden: on 

the flip side, they may be encouraged to engage in socially wasteful activities 

because of tax incentives to do so. 

Adding a "territorial tax credit" would likely move the U.S. tax code further 

away from neutrality, by encouraging U.S. businesses to conduct economic 

activities in the territories because of tax considerations. 

Under current law, income earned in U.S. territories is generally considered 

3. "foreign" income for the purposes of the federal income tax. This means that, 

when a business or individual earns income in one of the five U.S. territories. 

the income is generally subject to taxes by the territory in question. rather 

than by the U.S. federal government. 

An important exception to this rule occurs when a business or individual that 

resides in the U.S. mainland earns income in one of the five U.S. territories. 

In this case, when the income is brought back to the U.S. mainland, it may be 

subject to a second layer of tax by the U.S. federal government. This is because 

the U.S. federal income tax is "worldwide": designed to tax income earned 

anywhere in the world by residents of the U.S. mainland. 

The principal advantage of treating income earned in U.S. territories as 

foreign-source income is that each territory is able to collect revenue from 

the economic activities in its jurisdiction. rather than having the U.S. federal 

government collect revenue on these activities. 

The chief disadvantage of the current situation is that income earned in 

U.S. territories by businesses or individuals residing in the U.S. mainland 

is potentially subject to two layers of taxation: once by the territorial 

government, when the income is earned, and once by the federal government. 

when the income is brought back to the U.S. mainland. This creates a 

disadvantageous tax climate for U.S. mainland companies to invest in the 

territories. 

It is not entirely clear to me what it would mean for income earned in the U.S. 

territories to be treated as "domestic" income for the purposes of U.S. tax law. 

4. Perhaps this means that the U.S. federal government would end the deferral of 

income earned by U.S. mainland individuals and businesses in the territories. 

In this scenario, the income in question would be taxed by the federal 

government in the year it is earned, rather than when it is brought back to 

the U.S. This would likely be an economically disadvantageous policy change, 

which would discourage investment by U.S. mainland companies in the 

territories. 
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5. 

Sincerely, 

Another interpretation is treating income earned in the U.S. territories as 

"domestic" means that the U.S. federal government would effectively replace 

the territorial governments as tax administrator. collecting taxes on economic 

activity in the territories and remitting the revenues to each territorial 

government. This would likely be an economicaliy advantageous policy change. 

as it would end the double tax on income earned in U.S. territories by mainland 

businesses. However. it could remove autonomy from territorial governments. 

particularly those without "mirror code" tax systems. 

One change that could help entrepreneurs and small businesses in the 

territories would be moving away from the federal "worldwide" tax system, 

as it applies to income earned in the U.S. territories. By removing the layer 

of tax levied by the U.S. federal government on income earned by U.S. 

mainland businesses in the territories. this change would help create a more 

advantageous investment climate for mainland companies operating in the 

territories. 

Kyle Pomerleau 
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The Honorable Steve Chabot 

Chairman 

House Small Business Committee 

2371 Rayburn House Office Building 

Washington, D.C. 20515 

March 2, 2017 

The Honorable Nydia Velazquez 

Ranking Member 

House Small Business Committee 

2302 Rayburn House Office Building 

Washington, D.C. 20515 

Dear Chairman Chabot and Ranking Member Velazquez: 

In connection with the House Small Business Committee's recent hearing on Start-ups 

Stalling? The Tax Code as a Barrier to Entrepreneurship, we are submitting as a statement for 

the record the attached letter urging you to preserve the current availability of like-kind exchange 

treatment as part of any business tax refotm. Thank you for your consideration and your 

leadership on these important issues. 

Sincerely, 

The Like-Kind Exchange Stakeholder Coalition 
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THE LIKE-KIND EXCHANGE STAKEHOLDER COALITION 

November 29, 2016 

Mr. Jim Carter 

Tax Policy Lead 

Presidential Transition 

1800 F Street NW 

Washington, DC 20006 

Dear Mr. Carter: 

As you consider ways to create jobs, grow the economy, and raise wages through tax reform, we 

strongly urge that current law be retained regarding like-kind exchanges under section l 031 of 

the Internal Revenue Code ("Code"). We further encourage retention of the current unlimited 

amount of gain defetTal. 

Like-kind exchanges are integral to the efficient operation and ongoing vitality of thousands of 

American businesses, which in tum strengthen the U.S. economy and create jobs. Like-kind 

exchanges allow taxpayers to exchange their property for more productive like-kind property, to 

diversify or consolidate holdings, and to transition to meet changing business needs. Specifically, 

section I 031 provides that taxpayers do not immediately recognize a gain or loss when they 

exchange assets for "like-kind" property that will be used in their trade or business. They do 

inunediatcly recognize gain, however, to the extent that cash or other "boot" is received. 

Importantly, like-kind exchanges are similar to other non-recognition and tax defen·al provisions 

in the Code because they result in no change to the economic position of the taxpayer. 

Since 1921, like-kind exchanges have encouraged capital investment in the U.S. by allowing 

funds to be reinvested back into the enterprise, which is the vety reason section l 031 was 

enacted in the first place. This continuity of investment not only benefits the companies making 

the like-kind exchanges, but also suppliers, manufacturers, and others facilitating them. Likekind exchanges ensure both the best use of real estate and a new and used personal property 

market that significantly benefits start-ups and small businesses. Eliminating like-kind exchanges 

or restricting their use would have a contraction effect on our economy by increasing the cost of 

capital, slowing the rate of investment, increasing asset holding periods and reducing 

transactional activity. 

A 2015 macroeconomic analysis by Ernst & Young found that either repeal or limitation of likekind exchanges could lead to a decline in U.S. GDP of up to Sl3.l billion annually. 1 The Ernst & 

Young study quantified the benefit of like-kind exchanges to the U.S. economy by recognizing 

that the exchange transaction is a catalyst for a broad stream of economic activity involving 

businesses and service providers that are ancillmy to the exchange transaction, such as brokers, 

appraisers, insurers, lenders, contractors, manufacturers, etc. A 2016 report by the Tax 

1 Economic Impact of Repealing Like-Kind Exchange Rules, ERNST & YOUNG (March 2015, Revised November 

20 15), at (iii), available at http://www.1031 taxrefonn.com/wp-contentiuploads/Ling-Pctrova-Economic-lmpact-ofRepea\ ing-or-Limiting-Section-1 031-in-Reai-Estate. pdf. 
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Foundation estimated even greater economic contraction a loss of 0.10% of GDP, equivalent to 

$18 billion annually2 

Companies in a wide range of industries, business structures, and sizes rely on the like-kind 

exchange provision of the Code. These businesses-which include real estate, construction, 

agricultural, transportation, farm I heavy equipment I vehicle rental, leasing and manufacturingprovide essential products and services to U.S. consumers and are an integral part of our 

economy. 

A microeconomic study by researchers at the University of Florida and Syracuse University, 

focused on commercial real estate, supports that without like-kind exchanges, businesses and 

entrepreneurs would have less incentive and ability to make real estate and other capital 

investments. 3 The immediate recognition of a gain upon the disposition of property being 

replaced would impair cash flow and could make it uneconomical to replace that asset. This 

study fur1her found that taxpayers engaged in a like-kind exchange make significantly greater 

investments in replacement property than non-exchanging buyers. 

Both studies support that jobs are created through the greater investment, capital expenditures 

and transactional velocity that are associated with exchange properties. A $1 million limitation of 

gain deferral per year, as proposed by the Administration4

, would be particularly harmful to the 

economic stream generated by like-kind exchanges of commercial real estate, agricultural land, 

and vehicle I equipment leasing. These properties and businesses generate substantial gains due 

to the size and value of the properties or the volume of depreciated assets that are exchanged. A 

limitation on defenal would have the same negative impacts as repeal of section I 031 on these 

larger exchanges. Transfers of large shopping centers, office complexes, multifamily properties 

or hotel properties generate economic activity and taxable revenue for architects, brokers, leasing 

agents, contractors, decorators, suppliers, attorneys, accountants, title and property I casualty 

insurers, marketing agents, appraisers, surveyors, lenders, exchange facilitators and more. 

Similarly, high volume equipment rental and leasing provides jobs for rental and leasing agents, 

dealers, manufacturers, after-market outfitters, banks, servicing agents, and provides inventories 

of affordable used assets for small businesses and taxpayers of modest means. Turnover of assets 

is key to all of this economic activity. 

In summary, there is strong economic rationale, supported by recent analytical research, for the 

like-kind exchange provision's nearly I 00-year existence in the Code. Limitation or repeal of 

section I 031 would deter and, in many cases, prohibit continued and new real estate and capital 

investment. These adverse effects on the U.S. economy would likely not be offset by lower tax 

rates. Finally, like-kind exchanges promote unifmmly agreed upon tax reform goals such as 

economic growth, job creation and increased competitiveness. 

2 Options for Reforming America's Tax Code, Tax Foundation (June, 2016) at p79, available at 

http://taxfoundaiion.org/article/options-reforrning-americas-tax-code. 

3 David Ling and Milena Petrova, The Economic Impact of Repealing or Limiting Section 1031 Like-Kind 

Exchanges in Real Estate (March 2015, revised June 2015), at 5, ami/able at http://www.l03ltaxreform.com/wpcontent/up loads/Ling-Petrova-Economic-Impact -of-Repealing -or-Li mi ti ng -Section- 1 031-in-Real-Estate.pd f . 

..f General Erpfanations of the Administration's Fiscal Year 2017 Revenue Proposals, at 107, available at 

https://www. trcasUJy .gov 1rcsou rce-center!tax -pol icy !Documents/General-Explanations· FY20 1 7 .pdf. 

2 
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Thank you for your consideration of this important matter. 

Sincerely, 

Air Conditioning Contractors of America 

American Car Rental Association 

American Rental Association 

American Seniors Housing Association 

American Truck Dealers 

American Trucking Associations 

Associated Equipment Distributors 

Associated General Contractors of America 

A vis Budget Group, Inc. 

Building Owners and Managers Association (BOMA) International 

C.R. England, Inc. 

Equipment Leasing and Finance Association 

Federation of Exchange Aceommodators 

International Council of Shopping Centers 

NAIOP, the Commercial Real Estate Development Association 

National Apartment Association 

National Association of Home Builders 

National Association of Real Estate Investment Trusts 

National Association of REAL TORS® 

National Automobile Dealers Association 

National Business Aviation Association 

National Multifamily Housing Council 

National Ready Mixed Concrete Association 

National Stone, Sand and Gravel Association 

Truck Renting and Leasing Association 

3 
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Start Ups Stalling? The Tax Code as a Barrier to 

Entrepreneurship 

February 15, 2017 

Statement for the Record 

Karen Kerrigan 

President & CEO 

Small Business & Entrepreneurship Council 

Committee on Small Business 

United States House of Representatives 

The Honorable Steve Chabot, Chairman 

The Honorable Nydia Velazquez, Ranking Member 

PROTECTING SMALL BUSINESS, PROMOTING ENTREPRENUERSHIP 
105 

The Small Business & Entrepreneurship Council is grateful that 

the Committee on Small Business is investigating the challenges of 

the U.S. tax code as they related to entrepreneurship and small 

business growth. Small business owners are excited about the prospect for tax reform in the coming year. We are hopeful that the 

Congress will move forward with a modern framework that brings 

simplicity, fairness and lower taxes to our nation’s small businesses 

and entrepreneurs. As committee members well know, strong and 

sustainable economic and job growth is dependent upon a successful small business sector, as well as healthy startup activity. 

The Small Business & Entrepreneurship Council (SBE Council) 

is a nonpartisan advocacy, research and education organization 

dedicated to protecting small business and promoting entrepreneurship. For twenty-four years, SBE Council has worked to advance a range of initiatives and policies to strengthen the ecosystem for startups and small business growth. Our organization 

and its members deeply appreciate the work and dedication of 

Small Business Committee members, and we have been honored to 

work with the committee since our founding. 

While entrepreneurship in the U.S. has improved over the last 

several of years, the downward trend in new business creation remains. This started well before the Great Recession but obviously 

new business creation tumbled hard during this dark economic period. Unfortunately, entrepreneurship has never fully recovered. 

From 2009-2011 there were more business closures than startups, 

according to the SBA Office of Advocacy. The trend has slightly reversed course, but our economy does not have near the volume of 

entrepreneurial activity and business entities (as a share of the relevant population) that existed prior to the Great Recession. 

According to an analysis published by SBE Council’s chief economist Raymond Keating, the significant decline in new business creation during the last decade has been felt across the board—among 

unincorporated and incorporated self-employed, startups and employer firms. Mr. Keating’s ‘‘gap’’ analysis finds an estimated 

shortfall of anywhere from 867,000 to 4.8 million businesses over 

the past decade, with ‘‘3.7 million missing businesses being quite 

reasonable based on a combination of the most often cited self-employed and employer firms data.’’ 

Economic conditions and uncertainty, access to capital, regulatory uncertainty, and the aversion to risk are some of the reasons 

as to why individuals have not pursued, or are not pursuing, entrepreneurship. From SBE Council’s perspective, making policy 

changes that help to reduce risks along with reforms that lower 

government costs and burdens is especially critical to enabling 

higher startup activity. The tax code is one such area that requires 

an overhaul, with small business health and growth being a priority for how this is accomplished. 

SBE Council is on record supporting various principles and proposals for tax reform, including: lower rates for all businesses entities, full expensing, low capital gain taxes, the elimination of AMT 

and death taxes, and making reporting and compliance as simple 

as possible. 

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106 

It is our hope that members of Congress also use this opportunity to update or modernize various measures in the tax code 

that advance simplicity and cut compliance costs, which are especially painful for startups and new business owners. 

Here are some of those ideas: 

Update the Threshold for Self-Employment Taxes: When I 

talk to people who help teenagers and young entrepreneurs start 

businesses, they continually report that these risk-takers are totally turned off by a complex tax code that immediately eats their 

profits. Self-employment taxes kick in at $400, which is 15.3 percent of profits. The $400 threshold has not been changed since the 

1950s, yet the standard deduction on federal income tax is adjusted 

annually. If the self-employment tax floor has been adjusted at the 

same rate as the standard deduction, it would be more than $6,000. 

It makes sense to update it, and relieve entrepreneurs of the burden that hits their businesses at such low business revenue levels. 

Liberalize the 100% Capital Gains Exclusion for Startups: 

SBE Council fully supported efforts that made the 100% capital 

gains tax exclusion permanent for startups. But the exclusion 

needs to be improved upon so that more startups benefit from it. 

First, the exclusion is limited to C corporations, and SBE Council 

believes it should be made available to S corps, LLCs and other 

business entities. Secondly, the exclusion is disallowed in ventures 

involved with personal services, law, banking, finance, leasing, hospitality, health, farming and mining. There is innovation occurring 

in all these spaces, and in several of these sectors consumers and 

small businesses would benefit from more competition and choices. 

The targeted and limited exclusion, as it now stands, is picking 

winners and losers in the marketplace and ignores how most businesses—and in this case new businesses—are organized. Ideally, 

capital gains taxes would be eliminated altogether, but if the current exclusion is going to be retained it can be made more robust 

to help drive startup activity across all industry sectors. 

Update and Clarify the Independent Contractor Test: SBE 

Council believes it is important to modernize the current test given 

the prevalence of the ‘‘gig’’ economy and the need for clarity. The 

current 20-factor test is arbitrary, but can be simplified to three or 

four factors. We believe there is an approach to reforming the 20- 

factor test that demonstrates contractor independence through 

written contracts, how the contractor is compensated, expenses incurred by the contractor, and how the work is performed. Businesses should be encouraged to do business with individuals who 

want to contract on a per-project basis, and on their own terms. 

The ‘‘gig’’ economy supports this freedom, and the government 

should not deter opportunity through the subjective and outdated 

20-factor test. 

Indexing 1244 Small Business Stock to Inflation to Boost 

Capital in Startups: Again, here is an opportunity to update existing law, which has not been done since 1978. This minor change 

could unlock and mobilize more capital toward startups. Qualified 

small business tax (loss) treatment under Section 1244 of the tax 

code allows for investors to deduct losses taken on investments in 

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107 

C Corp startups to be deducted against ordinary income. This 

measure was passed as part of the Small Business Investment 

Company Act of 1958, the aim of which was to mobilize more capital into job-creating startups. 

The current thresholds under Section 1244 were last updated in 

1978, which are: First $1,000,000 of outside, individual tax payer(s) 

(angel investors) capital gets 1244 treatment; $100,000/yr of 1244 

losses deductible against ordinary income (for joint tax return); and 

$50,000/y of 1244 losses deductible against ordinary income (for filing single). 

The Consumer Price Index has risen 363% since 1978. If the 

above thresholds were inflation adjusted, the levels would be: 

$3,630,000 of outside investors’ capital would qualify for de-risking 

under 1244; $363,000/yr of 1244 losses could be deductible for joint 

filers; and $181,500/yr for single filers. 

Conclusion 

Tax reform is a key opportunity to help startups grow and thrive, 

existing small businesses to better compete and take more risks 

through smart investments, and encourage greater levels of entrepreneurship. SBE Council and our team of experts and small business member-advisors look forward to working further with the 

Small Business Committee to identify additional opportunities to 

fix the tax code for entrepreneurs, and advance a bill to the President’s desk for his signature. Thank you for the opportunity to submit this statement for the record. 

SBE Council 

301 Maple Avenue West, Suite 100 • Vienna, VA 22180 • (703)- 

242-5840 

sbecouncil.org • @SBECouncil 

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