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94–397 2016

SMALL BUSINESS AND PASS-THROUGH 

ENTITY TAX REFORM DISCUSSION DRAFT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

OF THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED THIRTEENTH CONGRESS 

FIRST SESSION 

MAY 15, 2013 

Serial 113–SRM02 

Printed for the use of the Committee on Ways and Means 

( 


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COMMITTEE ON WAYS AND MEANS 

DAVE CAMP, Michigan, Chairman 

SAM JOHNSON, Texas 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

DEVIN NUNES, California 

PATRICK J. TIBERI, Ohio 

DAVID G. REICHERT, Washington 

CHARLES W. BOUSTANY, JR., Louisiana 

PETER J. ROSKAM, Illinois 

JIM GERLACH, Pennsylvania 

TOM PRICE, Georgia 

VERN BUCHANAN, Florida 

ADRIAN SMITH, Nebraska 

AARON SCHOCK, Illinois 

LYNN JENKINS, Kansas 

ERIK PAULSEN, Minnesota 

KENNY MARCHANT, Texas 

DIANE BLACK, Tennessee 

TOM REED, New York 

TODD YOUNG, Indiana 

MIKE KELLY, Pennsylvania 

TIM GRIFFIN, Arkansas 

JIM RENACCI, Ohio 

SANDER M. LEVIN, Michigan 

CHARLES B. RANGEL, New York 

JIM MCDERMOTT, Washington 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

EARL BLUMENAUER, Oregon 

RON KIND, Wisconsin 

BILL PASCRELL, JR., New Jersey 

JOSEPH CROWLEY, New York 

ALLYSON SCHWARTZ, Pennsylvania 

DANNY DAVIS, Illinois 

LINDA SA ́ NCHEZ, California 

JENNIFER M. SAFAVIAN, Staff Director and General Counsel 

JANICE MAYS, Minority Chief Counsel 

SUBCOMMITTEE ON SELECT REVENUE MEASURES 

PATRICK J. TIBERI, Ohio, Chairman 

ERIK PAULSEN, Minnesota 

KENNY MARCHANT, Texas 

JIM GERLACH, Pennsylvania 

AARON SCHOCK, Illinois 

TOM REED, New York 

TODD YOUNG, Indiana 

RICHARD E. NEAL, Massachusetts 

JOHN B. LARSON, Connecticut 

ALLYSON SCHWARTZ, Pennsylvania 

LINDA SA ́ NCHEZ, California 


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C O N T E N T S 

Page 

Advisory of May 15, 2013 announcing the hearing .............................................. 2 

WITNESSES 

Mr. Roger Harris, President, Padgett Business Services, Testimony ................. 8 

Mr. Willard Taylor, Former Partner, Sullivan & Cromwell, Testimony ............. 14 

Mr. Blake Rubin, Partner, McDermott Will & Emery, Testimony ...................... 44 

Mr. Thomas Nichols, Meissner Tierney Fisher & Nichols, Testimony ................ 55 

PUBLIC SUBMISSIONS FOR THE RECORD 

AdvaMed ................................................................................................................... 78 

AIA ............................................................................................................................ 85 

AICPA ....................................................................................................................... 87

American Council of Engineering Companies ....................................................... 107 

American Farm Bureau Federation ....................................................................... 109 

Alliantgroup ............................................................................................................. 113 

BIO ............................................................................................................................ 117 

CBSI .......................................................................................................................... 123 

FAIR Coalition ......................................................................................................... 126 

Florists Coalition ..................................................................................................... 133 

Independent Community Bankers of America ...................................................... 137 

National Association for the Self Employed .......................................................... 140 

National Pork Producers Council ........................................................................... 145 

National Retail Federation ..................................................................................... 149 

Real Estate Roundtable ........................................................................................... 151 

SBLC ......................................................................................................................... 156 

Small Business Investor Alliance ........................................................................... 159 


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SMALL BUSINESS AND PASS-THROUGH 

ENTITY TAX REFORM DISCUSSION DRAFT 

WEDNESDAY, MAY 15, 2013 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON WAYS AND MEANS, 

SUBCOMMITTEE ON SELECT REVENUE MEASURES, 

Washington, DC. 

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

1100, Longworth House Office Building, the Honorable Pat Tiberi 

[chairman of the subcommittee] presiding. 

[The advisory of the hearing follows:] 


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HEARING ADVISORY 

FROM THE COMMITTEE ON WAYS AND MEANS 

Chairman Tiberi Announces Hearing on 

Ways and Means Small Business 

and Pass-Through Entity 

Tax Reform Discussion Draft 

1100 Longworth House Office Building at 10:00 AM 

Washington, May 7, 2013 

Congressman Pat Tiberi (R–OH), Chairman of the Subcommittee on Select Revenue Measures, today announced that the Subcommittee will hold a hearing on the 

small business and pass-through entity tax reform discussion draft released on 

March 12, 2013, by the Committee on Ways and Means (‘‘the Committee’’). The 

Committee released the discussion draft to solicit feedback on the details of the 

draft proposals, which the Committee intends to include as part of comprehensive 

tax reform legislation that broadens the tax base, lowers tax rates, and simplifies 

the Code for households, small businesses, and corporations. The hearing will 

take place on Wednesday, May 15, 2013, in Room 1100 of the Longworth 

House Office Building at 10:00 A.M. 

In view of the limited time available to hear witnesses, oral testimony at this 

hearing will be from invited witnesses only. However, any individual or organization 

not scheduled for an oral appearance may submit a written statement for consideration by the Committee and for inclusion in the printed record of the hearing. A 

list of invited witnesses will follow. 

BACKGROUND: 

As part of its pursuit of comprehensive tax reform, the Committee released on 

March 12, 2013, a discussion draft of one specific component of broader tax reform 

legislation involving tax provisions affecting small businesses and pass-through entities (including partnerships and S corporations). The Committee released this draft 

because it hopes to achieve simpler, more uniform tax treatment for small businesses and pass-through entities, and in the interests of transparency, seeks feedback from a broad range of stakeholders, taxpayers, practitioners, economists, and 

members of the general public on how to refine these proposals. Ways and Means 

Committee Chairman Dave Camp (R–MI) asked Chairman Tiberi to schedule this 

hearing to gather analysis from outside experts on the details of the discussion 

draft. 

The discussion draft contains several core components intended to simplify tax 

compliance for small businesses and to provide certainty with respect to the ability 

of small businesses to recover certain costs immediately. The draft also includes two 

separate options designed to achieve greater uniformity between S corporations and 

partnerships—one that revises current rules and a second that replaces current tax 

rules with a new unified pass-through regime. The Committee and Subcommittee 

are soliciting comments from stakeholders on both options. 

In announcing the hearing, Chairman Tiberi said, ‘‘Small businesses employ 

half of the private sector workforce and earn about half of all business income in the United States, so it is a major concern that nine out of ten 

small businesses are forced to rely on paid tax preparers because the Tax 

Code is too complicated for them to understand. We need our entrepreneurs using their capital to invest and create jobs, not to fill out paperwork and tax forms, and one of the Committee’s top priorities in tax reform 

is to help them do that.’’ 


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FOCUS OF THE HEARING: 

The hearing will focus on the Ways and Means small business discussion draft 

released on March 12, 2013. For purposes of this hearing, the Subcommittee is interested in comments and analysis relating to the basic architecture of the draft proposals including, in particular, the implications of the changes to the cash accounting rules, the questions that must be answered in designing a workable unified 

pass-through regime, and the real-world ramifications of the incremental proposals 

to modify the rules governing S corporations and partnerships. 

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS: 

Please Note: Any person(s) and/or organization(s) wishing to submit written comments for the hearing record must follow the appropriate link on the hearing page 

of the Committee website and complete the informational forms. From the Committee homepage, http://waysandmeans.house.gov/, select ‘‘Hearings.’’ Select the 

hearing for which you would like to submit, and click on the link entitled, ‘‘Click 

here to provide a submission for the record.’’ Once you have followed the online instructions, submit all requested information. ATTACH your submission as a Word 

document, in compliance with the formatting requirements listed below, by the 

close of business on Wednesday, May 29, 2013. Finally, please note that due 

to the change in House mail policy, the U.S. Capitol Police will refuse sealed-package deliveries to all House Office Buildings. For questions, or if you encounter technical problems, please call (202) 225–3625 or (202) 225–2610. 

FORMATTING REQUIREMENTS: 

The Committee relies on electronic submissions for printing the official hearing 

record. As always, submissions will be included in the record according to the discretion of the Committee. The Committee will not alter the content of your submission, 

but we reserve the right to format it according to our guidelines. Any submission 

provided to the Committee by a witness, any supplementary materials submitted for 

the printed record, and any written comments in response to a request for written 

comments must conform to the guidelines listed below. Any submission or supplementary item not in compliance with these guidelines will not be printed, but will 

be maintained in the Committee files for review and use by the Committee. 

1. All submissions and supplementary materials must be provided in Word format and MUST 

NOT exceed a total of 10 pages, including attachments. Witnesses and submitters are advised 

that the Committee relies on electronic submissions for printing the official hearing record. 

2. Copies of whole documents submitted as exhibit material will not be accepted for printing. 

Instead, exhibit material should be referenced and quoted or paraphrased. All exhibit material 

not meeting these specifications will be maintained in the Committee files for review and use 

by the Committee. 

3. All submissions must include a list of all clients, persons and/or organizations on whose 

behalf the witness appears. A supplemental sheet must accompany each submission listing the 

name, company, address, telephone, and fax numbers of each witness. 

The Committee seeks to make its facilities accessible to persons with disabilities. 

If you are in need of special accommodations, please call 202–225–1721 or 202–226– 

3411 TTD/TTY in advance of the event (four business days notice is requested). 

Questions with regard to special accommodation needs in general (including availability of Committee materials in alternative formats) may be directed to the Committee as noted above. 

Note: All Committee advisories and news releases are available on the World 

Wide Web at http://www.waysandmeans.house.gov

f 

/. 

Chairman TIBERI. Good morning. This hearing will come to 

order. Thank you for joining us for our hearing today on the Ways 

and Means small business tax reform discussion draft. In March of 

2011, the Select Revenue Measure Subcommittee held a hearing on 


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small business and tax reform. We learned that the temporary 

complex nature of the Tax Code was forcing small business owners 

to invest their time and resource complying with the Tax Code instead of focusing on growing their businesses. The message was 

clear: simplifying the Code means more jobs created by small business owners. Indeed, comprehensive tax reform must result in a 

simpler, more stable code with lower statutory rates for small business owners. 

Today nine out of 10 small business owners rely on a tax preparer. There have been over 4,500 changes to the Tax Code over 

the last 10 years. And with the addition of the 3.8 percent 

ObamaCare tax, small business pass-through entities, which pay 

their taxes at individual rates, will have a top Federal tax rate of 

44.6 percent. 

Comprehensive tax reform cannot be limited to an exercise of 

only lowering the corporate rate, as the President has suggested; 

it must also focus on lowering rates for small business owners who 

employ over 50 percent of the private sector workforce and whose 

tax compliance costs are 65 percent higher than large businesses. 

The small business tax reform discussion draft is a step forward 

in creating a better Tax Code for small businesses, but that is not 

to say it can’t be improved upon, and that is why Chairman Camp 

has released this as a discussion draft to ensure that through a 

public, transparent process, stakeholders, including small business 

owners themselves, have the opportunity to tell us what they need 

from tax reform to help them create jobs, increase wages for their 

employees. 

Looking forward to a great bipartisan discussion today. I thank 

our witnesses for being here, taking time out of their busy schedules. And now I yield to Ranking Member Neal for his opening 

statement. 

Mr. NEAL. Thank you, Mr. Chairman, for calling today’s hearing 

on Chairman Camp’s small business tax reform legislation. Small 

businesses are the engines of job creation in the country, and nearly 60 million Americans work for small business. That is about half 

of our private sector workforce. 

When I travel around my district back in western Massachusetts, 

I am amazed by the entrepreneurial spirit of the small business 

owners that I meet. These businesses manufacture medical device 

equipment and sophisticated plastics and paper. They brew great 

lagers, or as we call it in western Massachusetts, great beer. And 

they provide hospitality and entertainment to many of our visitors. 

Small business owners in Massachusetts and throughout the 

country are certainly the backbone and strength of the American 

economy. 

As we tackle tax reform, it is critical that we implement tax policy that helps America’s small business grow and prosper. It is 

through that prism that I think we should review Chairman 

Camp’s proposals today. I also commend Chairman Camp for including so many proposals in his bill that are bipartisan. His draft 

would make permanent increases in expensing for small businesses, the proposal that has received much bipartisan support 

over the years. He has also included proposals based on legislation 


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introduced by our colleagues Ron Kind and Jim Gerlach, Mike 

Thompson and Aaron Schock. 

I think this once again demonstrates that there are opportunities 

for common ground in our approaches to tax policy, and that we 

can and should do tax reform on a bipartisan basis. So I thank you 

for calling the hearing, Mr. Chairman. 

And I am going to excuse myself for a brief period of time only 

to testify in front of Chairman Chris Smith’s committee on an issue 

that I have long been involved in this morning. So I will just be 

gone for a brief period of time and back. And with that said, I yield 

back my time. 

Chairman TIBERI. Thank you, Mr. Neal. And we thank you for 

your leadership on this issue. 

Now I would like to turn to the panel and welcome the four individuals who are here today. I will introduce the four and then we 

will begin the testimony with Mr. Harris, who I will introduce first, 

Mr. Roger Harris, president of Padgett Business Services in Athens, Georgia. Thank you for being here, sir. Second, Mr. Willard 

Taylor, former partner at Sullivan & Cromwell, and currently a 

professor of law at New York State—excuse me—New York University. Thank you for being here. 

Third, Mr. Blake Rubin, a partner at McDermott, Will & Emery 

here in Washington, D.C. Thank you, sir. And fourth, Mr. Tom 

Nichols, a shareholder at Meissner Tierney Fisher & Nichols in 

Milwaukee, Wisconsin. Thank you for being here, sir. 

With that, you will each have 5 minutes to present your oral testimony. Your full written testimony has been submitted for the 

record. And, Mr. Harris, you are recognized for 5 minutes. 

STATEMENT OF ROGER HARRIS, PRESIDENT, PADGETT 

BUSINESS SERVICES 

Mr. HARRIS. Thank you, Mr. Chairman. And thanks to the 

members of the Committee for the opportunity to be here today. 

I am Roger Harris. I am president and chief operating officer of 

Padgett Business Services. And I think to help understand my 

comments, it is good to understand what we as a company do and 

who we define as our small business customer. Padgett Business 

Services has provided accounting, income tax preparation, tax advice, payroll services to small businesses for almost 50 years 

throughout the United States through our network of offices. 

We have always defined our customer as a small business owner 

with fewer than 20 employees. And a lot of people look at those 

businesses individually and say they are mom-and-pop businesses; 

however, if you look at them as a group, they are a tremendously 

powerful force in this economy, and I think we need to make sure 

that their needs and their interests are addressed in any tax reform discussion. 

And I think it would be very difficult to find anybody in this 

room or this town or this country who doesn’t think the Tax Code 

that we currently have has seen its better days and needs to be replaced. 

I can tell you that our small business owners particularly want 

to find something new that they can work with. They want something that is simple. They want something that has some predictVerDate Mar 15 2010 02:28 Jul 01, 2016 Jkt 094397 PO 00000 Frm 00009 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\94397.XXX 94397

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ability to it. They would like something that encourages or increases their cash flow. And more importantly, they want something that mirrors their checkbook to some extent. They are tired 

of having to be explained what is the difference in their cash flow 

and their taxable income. So they want something that mirrors 

their checkbook as close as possible. 

I am happy to say that the draft proposal that the committee put 

out a few weeks ago, I think works towards these goals and is a 

great starting point for these people. Particularly beginning with 

the 179, if you look at the proposals for it to make permanent the 

$250,000 deduction limit and the $800,000 phaseout permanent in 

the sense that it is indexed, for our clients, those limits are very 

sufficient and would work wonderfully well, and would eliminate a 

lot of record keeping of tracking assets, because it would cover 

most of their purchases. 

I recognize, however, that for some industries, particularly heavy 

equipment industries, those values or those numbers may not be 

enough, but for our businesses, those values are great. And they 

also, because they have the ability to write them off currently and 

not have to track them, it mirrors cash accounting, which is the 

second part of the proposal that we are particularly pleased with, 

is that this proposal will expand the number of businesses who 

qualify for cash accounting. 

Again, getting down to the basic principle of a small business 

owner that when money comes in, it is income, when money goes 

out, it is an expense, and what is left is their income. Because if 

there is anything they hate more than paying taxes, it is having 

to pay taxes with money they don’t have. So the closer that we can 

mirror their checkbook, this proposal goes a long way to do that. 

We would like to see it perhaps go a little bit farther, and I am 

sure we can talk about it more, but I think carving out something 

out like a safe harbor for the smallest businesses in this category 

to have to ignore—be able to ignore the tracking of inventory. I 

think at times, we think inventory is nothing but looking on a shelf 

and making calculations of how many of what sits on a shelf, and 

it is much more complicated than that, and I think we should be 

able to come out with a carve-out, again, for these small businesses 

that allows inventory reporting to be at their option if they are at 

the smallest end. 

The next part of the proposal talks about startup and organizational expenses. And it doubles the number from 5 to $10,000, 

which, again, for many of our clients will be sufficient and will 

have the impact of, in essence, making it cash accounting. However, here again, I would like to see for, again, the smallest of 

small businesses more leniency in that area, in that when you start 

a business, in the year that you start your business, all your expenses of startup should be deductible. 

From a personal standpoint, it is very hard to tell a small business owner that the expenses that you paid in July are fully deductible, but that exact same expense that you paid in February 

when you were trying to get your doors open may or may not be 

deductible. To them, it was the same check to the same purveyor, 

and they believe it should be deductible. 


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Finally, I will put on my practitioner hat and address the filing 

dates for these business returns. I want to commend the recommendation of moving the partnership date back to March the 

15th to create that 30-day window to still have the individual return prepared. I think that is long overdue. That used to be the 

date for the S Corp return. This proposal moves it up to March 

31st. I would like to see it stay at March 15th and have a unified 

date for pass-throughs so we all know that all pass-throughs are 

due the same day, and we all have the same 30-day window to get 

the individual return. I am not a sure partner or shareholder see 

themselves any different. 

With that, my time is about up. I want to thank the committee 

again for the opportunity to be here today and I look forward to 

your questions. 

Chairman TIBERI. Thank you, Mr. Harris. 

[The prepared statement of Mr. Harris follows:] 


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f 

Chairman TIBERI. Mr. Taylor, you are recognized for 5 minutes. 

STATEMENT OF WILLARD TAYLOR, FORMER PARTNER, 

SULLIVAN & CROMWELL 

Mr. TAYLOR. Thank you. Good morning. My name is—— 

Chairman TIBERI. Mr. Taylor, can you turn on the microphone? 

Mr. TAYLOR. I am sorry. 

Chairman TIBERI. That is all right. Perfect. 

Mr. TAYLOR. Okay. Good. Thank you. 

I am an adjunct professor at New York University Law School 

and I also teach at the Yale and the University of San Diego law 

schools, in each case, a course on the Federal income taxation of 

business pass-throughs. So it is a pleasure to be here to talk. 

The committee discussion draft has two basic structural reforms: 

one is specific changes to Subchapter S and Subchapter K, that is 

option one; and the other is a more fundamental revision resulting 

in a single system of tax rules for all pass-through entities, whether incorporated or not. 

I think what is proposed in option one is basically good. Many 

of the proposals have been around for a long time. I think you 

could add some to them, I think you could also expand them, but 

they are all basically good. However, they are really just improvements, if you will, to the system and not fundamental tax reform. 

So I think the focus ought to be on option two, the single passthrough regime. 

And I think that the most compelling argument for that is that 

there really is no difference, apart from tax, between a limited liability company and a corporation. One’s incorporated, the other is 

not, but the choice between the two has huge tax implications, including the treatment of foreign and tax exempt investors, the different treatment for payroll tax purposes, and we could go on and 

on about it. 

Subchapter S came in in 1958 at a time when it was necessary 

to give limited liability to small businesses. That is not necessary 

today. You can form a limited liability company and not incorporate and get the same advantages. 

Now, option two, then, offers the opportunity to address those 

differences. It also offers the opportunity for small businesses 

trapped in Subchapter C to move into Subchapter S, and it also 

provides a simplified regime. 

There is a huge amount of work that has to be done if option two 

is going to be implemented, and the draft notes a lot of that, and 

I won’t go over it, but I want to mention four items that I think 

in particular should be focused on. One is achieving parity among 

investors. There really should be no difference in the treatment of 

a foreign investor in a partnership and a foreign investor in a privately held corporation. And if you don’t straighten that out, you 

distort investment decisions and capital raising. And the same is 


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true with respect to tax exempt investors. You should have a single 

set of rules. 

Now, on tax exempt investors, inevitably you are going to hear 

from ESOPs, who love S Corporations, as to why they shouldn’t get 

that treatment continued, both for S Corporations, or if you have 

a single regime, for Subchapter K. That is a different issue, but I 

don’t think you ought to neglect it. 

A second issue that deserves attention is payroll tax. If you have 

got a single regime for Federal income tax purposes, no difference 

between a partnership and a small privately held corporation, then 

why in the world would you have a difference in payroll taxes, but 

you do today, because the base for SECA, the self-employment tax, 

differs from the base for FICA. So you would have to address, how 

do we resolve that? How do we come to grips with it? 

The third issue is determinations of tax liability and do you do 

that at the entity level with a withholding tax, as has been proposed in the draft, or do you let each owner make his or her own 

determination? I personally think doing it at the entity level makes 

sense, but, again, it is an issue that has to be come to grips with. 

The fourth and final issue I would mention is foreign income. If 

you have a 95 percent dividends received deduction and a lower 

rate on dividends from the C Corporation, you are going to have 

to compare the effective tax rate for the pass-through entities, 

which may be higher if you don’t do something about it. 

So I will end there. I have sent in longer written comments. I 

agree with Chairman Tiberi that this is a hugely important subject, 

and that is the last word I will say on the subject. Thank you. 

Chairman TIBERI. Thank you, Mr. Taylor. 

[The prepared statement of Mr. Taylor follows:] 


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f 

Chairman TIBERI. Mr. Rubin, you are recognized for 5 minutes. 

STATEMENT OF BLAKE RUBIN, PARTNER, MCDERMOTT WILL 

& EMERY 

Mr. RUBIN. Thank you. Chairman Tiberi, Ranking Member Neal 

and distinguished Members of the Subcommittee, thank you for the 

opportunity to testify today. My name is Blake Rubin, and I am 

global vice chair of the U.S. and International Tax Practice at 


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McDermott, Will & Emery, a law firm of approximately 1,100 lawyers. 

I support the effort to reform the Internal Revenue Code and also 

applaud the committee for the robust and transparent process that 

it is following. I also congratulate the committee leadership and 

staff for producing a detailed and thoughtful set of options. 

I will focus my comments primarily on the proposed changes to 

the taxation of partnerships. I support most of the changes in option one. As detailed in my written statement, however, I believe 

that three of the changes in option one are unwarranted: eliminating the 7-year period for application of the so-called partnership 

anti-mixing bowl rules, making upward basis adjustments in the 

context of partnership interest transfers and distributions mandatory, and eliminating the substantial appreciation requirement in 

the partnership hot asset rules. 

Option two proposes much more sweeping changes, merging the 

current tax regimes for partnerships and S Corporations. This is an 

approach that has been proposed by some academic commentators 

primarily for reasons of simplicity. There is no denying the conceptual appeal of a single unified regime for pass-through entities. If 

one were designing a tax system from scratch rather than reforming a tax system that is now 100 years old, a single unified regime 

might well be the way to go. Given where we are today, however, 

I believe that option two would significantly increase complexity, 

upset settled expectations of taxpayers and cause substantial economic dislocations. 

Current law provides taxpayers with a choice. Businesses that 

want a relatively simple pass-through regime and can tolerate a 

certain amount inflexibility can operate as S Corporations. Other 

businesses need greater flexibility, perhaps because debt is a bigger 

part of their capital structure, or because they anticipate the need 

to distribute property in kind, or they want a more complicated 

economic sharing arrangement. For those businesses, the partnership tax rules provide the needed flexibility to operate without incurring an entity level tax, but at the cost of greater complexity 

and compliance burdens. 

Option two would eliminate this choice. Worse, it would do so by 

creating a single unified regime that effectively combines the complexity of the current partnership regime with the inflexibility of 

the current S Corporation regime. 

Many of the provisions of the current partnership tax regime 

that create the greatest complexity are retained and even expanded 

in option two. At the same time, option two imports inflexibility 

from the S Corporation regime by restricting the ability to effectuate complex economic sharing arrangements and triggering gain 

on distributions of property in kind, even though the taxpayer receives no cash. 

I would like to briefly address two of the most significant 

changes proposed by option two. The first is the three-basket rule 

under which an owner is restricted to a single percentage share of 

all items in each of three baskets: ordinary income items, capital 

gain items and tax credit. The summary states that the reason for 

this rule is to reduce the use of complex structures to engage in tax 

avoidance. 


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I believe that the existing regulations governing allocations of 

partnership income and loss adequately police this area. I also believe that this change would create unwarranted restrictions on the 

ability of taxpayers to effectuate non-abusive commercial arrangements. For example, as detailed in my written statement, it is not 

clear that one pass-through owner could have a common interest 

akin to common stock and another, a preferred interest akin to preferred stock, because of the requirement that items of profit and 

loss in each basket be allocated in the same percentage. 

The second change I would like to focus specifically on is the recognition of gain on the distribution of appreciated property. This is, 

of course, the current rule in the context of corporations, including 

S Corporations, but extending that rule to partnerships would undeniably result in the taxation of non-economic gains in many 

cases. To take an example, assume a partner has a 50 percent interest in a partnership that has property with a $200 value and a 

zero tax basis. The partner’s interest is worth $100 and has a zero 

tax basis. The partnership distributes property worth $50, also 

with a zero tax basis, to the partner in redemption of his interest. 

Under option two, the partnership recognizes $50 of gain on the 

distribution and the distributee partner recognizes an additional 

$25 of gain on the distribution. 

So a distribution of property with a zero tax basis and $50 of 

value triggers not $50 of gain, but instead $75 of taxable gain. In 

this and many other common transactions, option two would create 

taxable gain that exceeds actual economic gain. 

I thank you again for the opportunity to present my views today 

and commend the committee leadership and staff for advancing the 

debate in this area. I look forward to answering your questions now 

and in the future. 

Chairman TIBERI. Thank you, Mr. Rubin. 

[The prepared statement of Mr. Rubin follows:] 


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Chairman TIBERI. Mr. Nichols, you are recognized for 5 minutes. 


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STATEMENT OF THOMAS NICHOLS, MEISSNER TIERNEY 

FISHER & NICHOLS 

Mr. NICHOLS. Chairman Tiberi, Ranking Member Neal and 

other members, thank you very much for the opportunity to testify 

today. 

I have been representing closely held businesses ever since I 

began practicing tax and business law in 1979. I have been a member since 1986, and am a past chair of the ABA Tax Sections Committee on S Corporations and am currently chairman of the Board 

of Advisors of the S Corporation Association. 

The views expressed today are informed by and benefit from all 

of these relationships. I will focus my comments primarily, though, 

on S Corporations. 

Let me begin by saying that I sincerely appreciate your ongoing 

bipartisan efforts to enact genuine tax reform. Seeking public comment on discussion drafts takes substantially more time and effort, 

but this more open and transparent process is much more likely to 

result in a long-lasting consensus on tax policy that will truly benefit our economy. 

Chairman Camp has identified several fundamental principles to 

help shape the course of tax reform, namely leveling the playing 

field for all U.S. employers, while at the same time ensuring that 

low income and middle income Americans pay no more in taxes 

than they do today. In this regard, the bipartisan Tax Reform Act 

of 1986 stands out as an excellent template. It expanded the tax 

base by eliminating numerous preferences and privileges, thereby 

creating room to dramatically decrease tax rates for C Corporations, pass-through businesses and individuals alike. 

As others have noted, the discussion draft before us today has 

three principle components: a more limited option one to address 

limitations of the existing S Corporation and partnership rules, a 

more aggressive option two that would replace the existing S Corporation and partnership rules with a new uniform set of rules; 

and finally, a set of core provisions that would apply to either option. 

I will begin with the core provisions and work from there. Generally speaking, the core provisions, such as establishing a higher 

permanent threshold for expensing equipment, are reforms that 

have been considered and vetted for years and should be included 

in any tax reform effort. 

One core provision that might not fit that description is the proposed mandatory use of accrual method for businesses with gross 

receipts of more than $10 million. 

S Corporations and partnerships that don’t have C Corporation 

partners are currently entitled to use cash basis accounting. This 

makes sense, because closely held businesses do not have access to 

the public markets to monetize illiquid assets on their balance 

sheets, so requiring them to pay tax on income they have not yet 

collected could create cash flow challenges where none exists today. 

For S Corporations, option one includes many provisions contained in the bipartisan S Corporation Modernization Act, introduced by Congressman Reichert and Kind, which are consistent 

with the goals of tax reform stated above. 


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The discussion draft would make permanent the shorter 5-year 

built-in gains tax recognition period. The built-in gains tax was initially intended to prevent C Corporations from electing S status 

simply to avoid double tax in connection with the sale of a business, but a 10-year period is much longer than necessary. Five 

years is much more appropriate. 

Other positive provisions in option one relate to the passive investment income tax, electing small business trusts, and charitable 

contributions. 

From the S Corporation perspective, option two would establish 

a better line of demarcation between pass-through businesses and 

those subject to the corporate tax, namely whether a business has 

chosen to access the capital markets and public ownership, and 

would bring this demarcation in line with the corresponding cut-off 

for partnerships. 

Updating the current limitations on types of shareholders eligible 

for S Corporation ownership as contemplated by option two also 

makes real sense. 

My basic concern with option two is that it would take two significantly different business structures, the simple and easily administered S Corporation structure, and the more flexible but also 

more complicated partnership rules, in attempts to meld them 

under a single unified regime. 

The details of option two are well thought out, but I am concerned that the benefit of a single unified regime may not be worth 

the cost. Option two would add additional complexity to existing 

partnership rules and then apply them to S Corporations. This 

means imposing new rules and compliance burdens on the more 

than 4.5 million S Corporations in existence today. 

As for new entities, S Corporation status is the most popular tax 

entity choice today, thus eliminating this structure could impede 

business formation. A better approach might be to take the positive 

reforms included in option two and combine them with the more 

modest ambitions of option one. 

Once again, I would like to thank Chairman Tiberi and the ranking member for inviting me to testify. I look forward to questions. 

[The prepared statement of Mr. Nichols follows:] 


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Chairman TIBERI. Well, thank all of you on behalf of the committee and the committee staff for being here today, for your written testimony, which I said would be part of the record. I don’t 

know about you, but I was excited that you were going to be here, 

and that we were having this hearing today. Unfortunately, most 

of Washington, including the press corps, I think is more excited 

about the hearing in 48 hours in this room, but this is pretty important, and this is going to be part of the process, the transparent 

process that Chairman Camp has had, and so your testimony is 

very, very helpful. 

Mr. Nichols, I want to start my questioning with you. As you 

know, for the last 12 years, S Corps and pass-through entities have 

had a statutory top rate of 35 percent. In January that changed, 

and we saw the top rate rise to 39.6 percent, but with the addition 

of the 3.8 percent tax from ObamaCare on investment income, the 

Pease Limitation, which adds another 1.2 percent, you have a reality of a tax rate much higher than that. 


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But something that I didn’t realize until recently that I would 

like you to comment on is that that 3.8 percent tax on investment 

income that—I didn’t realize actually falls on something much 

broader than investment income. So if I were selling—my understanding, if I were making widgets and then selling widgets, that 

3.8 percent investment tax would fall on the making and selling of 

those widgets as well. 

So in essence, this means that the top rate on an S Corp manufacturer in my home State of Ohio is now 44.6 percent and not 35 

percent; so a pretty large tax increase that is not just investment 

income. Can you expand upon that and expand upon how much 

broader this 3.8 percent tax is than many of us thought or think? 

Mr. NICHOLS. Yes. I would be happy to. Essentially what happens is there are two things at play here. One is if you have got 

any passive investors in the S Corporation itself, then that passive 

investor is going to require distribution of money to pay taxes 

based on the top rate, so you have got the 39.6 percent rate, you 

add on to that the Pease reduction another 1.2 percent, then you 

add on the 3.8 percent tax, you get up to approximately 45 percent, 

as you point out. 

And essentially what happens for S Corporations is that if you 

have got, let’s say, a 10 percent shareholder, let’s say a father who 

is no longer involved in the business that ends up paying that tax, 

most S Corporations have an obligation under shareholder agreements to distribute out an amount to pay the tax attributable to 

pass-through income. The combination of having one shareholder 

subject to that tax, that 45 percent tax rate, and the fact that the 

S Corporation rules require a single class of stock means that if 

you are going to distribute out 45 percent to one of the shareholders, you are going to have to distribute out 45 percent of the 

income to all of the shareholders, even though some of them may 

not have to pay that additional tax. All of that will have to come 

out of the corporation and won’t be available obviously for future 

use inside the corp. 

Chairman TIBERI. Thank you. So as you know, the 1986 Act reduced the top rate from 50 to 28 percent, and now we see the rate 

essentially going up to almost 45 percent; not quite 50, but 45. So 

over the last 27 years, we now have, since 1986, the highest rate, 

statutory rate for S Corps and pass-through entities, correct? 

Mr. NICHOLS. That is correct. 

Chairman TIBERI. And what do you see as the—as a practitioner, what do you see the reaction to that on the ground? 

Mr. NICHOLS. Well, realistically, very many, in fact, I would 

venture to say most closely-held businesses, they essentially earn 

their income; if they are pass-through business, they reserve to pay 

for the tax and then the vast majority of what is earned is essentially rolled back into the business. 

Essentially what happens if the tax rate goes up, and essentially 

it has gone up now potentially by a 10 percent increment from 35 

percent to 45 percent, and that is without taking State taxes into 

account, essentially that 10 percent used to stay inside the company and used to be reserved and used, either reserved for capital 

or used to actually grow the business, hire people, do whatever the 

business needs, that 10 percent is effectively just an additional 


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slice out of the capital that would otherwise be used in the business, for most of them. 

Chairman TIBERI. One last question, because I have taken almost all my time, is a fascinating point you made in your written 

testimony that a clearer—I am trying to get this right—a clearer 

demarcation between who may be an S Corp and who may be a C 

Corp is whether they are publicly traded, which is kind of a line 

of demarcation that is proposed in option two for pass-through entities. 

Can you elaborate on why you think a publicly traded, privately 

owned line is conceptually a correct way to distinguish between the 

two? 

Mr. NICHOLS. Well, it is a difference—it is a distinction that 

makes a difference. Unlike the fairly arbitrary 100-person limit 

that currently exists, it is a distinction that makes a difference. 

There are a number of things that are different about a publicly 

held entity. They are treated differently. And essentially, what the 

point I made in the written testimony is that essentially, if I am 

selling a closely held company, a privately held company, I am likely to get multiples, let’s say, you know, maybe in the neighborhood 

of 5, maybe 12 times earnings if you are lucky, whereas publicly 

traded companies regularly trade at 10 to 20 times earning. So that 

is a big difference, and it is something, frankly, I have to explain 

to some of my closely held clients that there is a difference being 

closely held. And so as a consequence, that and the other thing 

that is significant for a closely held clients, and that is, they don’t 

have the opportunity to turn around and go to the public markets. 

They don’t have that automatic price that they can sell stock for 

and they don’t—it is not easy for them to go to the public markets 

to borrow money, either, for publicly held securities, and so as a 

consequence, that demarcation line is one that does have some policy significance, and to the extent possible, the demarcation lines 

in the Code should reflect, you know, significant differences between the business entities, and that one does. 

Chairman TIBERI. Thank you. 

Mr. Neal is recognized for 5 minutes. 

Mr. NEAL. Thank you for your indulgence earlier today, Mr. 

Chairman, as well. And Mr. Nichols, if you can help to explain 

some of these things to us, too, it would be helpful. 

Mr. Rubin, could you describe for me the tax consequences for 

both partners involved and the partnerships of a merger of two 

partnerships, each of which contains appreciated property under 

current law? And can you describe the tax consequences for both 

partners involved and the partnerships under option two of Chairman Camp’s draft? Any potential administrative burden of the 

merger under option two as relative to current law. 

Mr. RUBIN. Sure. Under current—— 

Mr. NEAL. And this is very helpful, incidentally, to us, very, 

very helpful. 

Mr. RUBIN. Great. Under current law, if two partnerships want 

to merge, first under State law and Uniform Limited Partnership 

Act, the General Partnership Act, the LLC Act, that can be accomplished by filing articles of merger; so relatively convenient way to 

combine two companies operating in partnership form. 


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From a tax perspective, let’s say you have got the AB partnership merging with the CD partnership. For tax purposes, that is 

generally treated under current law when they file articles of merger as if the AB partnership contributed its assets into the CD partnership in exchange for an interest in the CD partnership and then 

the AB partnership liquidated and distributed the interest in the 

CD partnership out to the partners. 

What is important about that is that under current law, all of 

those deemed transactions are generally tax free, the transfer of 

the assets into the combined entity, if you will, that is deemed to 

occur and then the transfer of the interest in the combined entity 

that goes out. 

Under option two, that would no longer be the case, because 

when the AB partnership that is going out of existence, is deemed 

to distribute the interests in the CD partnership out to its partners, that is a distribution of appreciated property, it would trigger 

gain both at the AB partnership level, and then potentially a second gain at the AB partner level. 

So what can be consummated tax free under a carryover basis 

regime so that the built-in gain is taxed in the future on a disposition to a taxable disposition to a third party is taxed immediately 

under option two. 

Mr. NEAL. In Massachusetts, 92 percent of the firms are structured as pass-through entities, and there are nearly 90,000 businesses structured as S Corporations. The level of choice is pretty 

unique to the United States. 

Mr. Nichols, in your testimony, you indicated that there are benefits to offering entrepreneurs multiple options when choosing a 

business structure. On the other hand, option two of Chairman 

Camp’s draft proposes moving most S Corporations and partnerships into a single uniform structure. Could you go into a little bit 

more detail on what you see as the benefits of sticking with the 

current set of options of business entities as well as the potential 

costs of moving all of these businesses to a single new entity? 

Mr. NICHOLS. I would be happy to. Well, currently you have approximately 4.5 million S Corporations. It is the most popular format, it is the most popular tax structure for closely held businesses. You have got, well, a little more than 3 million partnerships also. But the S Corporation structure has the advantage of 

being simple and being easy to administer, and that is something 

for many, many corporations. They are not interested in sophisticated and flexible capital-raising mechanisms. All they want to do 

is make widgets. And when given a choice to simply have a simple 

structure, not do any sophisticated transactions, but just focus on 

their business, they like that. 

The partnership structure is much more flexible and as a consequence, it is much more complicated, and some of that complication is imposed by Congress in order to essentially rein in the flexibility so that abusive transactions don’t occur. 

What happens in option two potentially is the partnership rules 

are made somewhat more complicated and more restrictive, and all 

of the S Corporations that currently exist today essentially are 

being forced into that structure. And what happens then, you have 

got an unavoidable cost for a lot of just day-to-day businesses that 


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have been S Corporations for many times many years. They are 

forced into that new structure. They need to deal with both the 

transition, but they also need to deal with the ongoing complexity 

of the partnership rules. For example, under the proposal, and 

even under the current law, there are changes and adjustments 

that potentially need to be made whenever there is a sale of any 

interest in the business, even a minority interest. There is also the 

need to bifurcate transactions for distributions on sales to determine whether hot assets are applicable and treating that as a separate transaction. 

All of that complexity, it may be appropriate in the partnership 

regime, which is much more flexible; on the other hand, it has not 

been found necessary in the S Corporation regime, but you would 

be essentially requiring all of the current 4.5 million S Corporations to switch to that more complicated regime and the compliance 

costs, but also there would be ongoing compliance costs. And what 

I don’t see as a countervailing economic benefit, I don’t see any S 

Corporations engaging in more economic activity as a consequence, 

and so as a consequence, I see a cost, but I don’t see the benefit 

of that forced conversion. 

Mr. NEAL. Thank you, Mr. Chairman. 

Chairman TIBERI. Thank you. 

Mr. Young is recognized for 5 minutes. 

Mr. YOUNG. Thank you, Mr. Chairman. I appreciate you and 

Ranking Member Neal for holding this hearing. Very important to 

all of my colleagues, really to the country. 

Each of us has a plenitude of pass-through entities in our districts. I would like to begin just with a remark, respectfully reminding my colleagues and those who are paying attention, that we 

need to be attentive to one type of pass-through entity that has not 

been addressed yet, at least not in a specific way in some of the 

discussion drafts, and that is ESOPs, the employee stock ownership 

entities. And I do believe there will be consideration of this as we 

move forward, but I think we should strive to avoid any inadvertent damage we might do, as Mr. Taylor indicated, to these entities, seeing as they empower employee ownership. And per my 

briefing, they are four times less likely during a recession to lay 

off employees, so that is something for us to consider. 

My first question relates to withholding, something Mr. Nichols—we have got a sound issue here. There we go. Relates to 

with—it is not working. 

Chairman TIBERI. One, two. 

Mr. YOUNG. One, two. 

Chairman TIBERI. Why don’t you try another microphone. 

Mr. YOUNG. Here we go. I am Mr. Young. Thanks. As we say 

in the Marine Corps, adapt, improvise and overcome, so here we 

go. 

My question relates to withholding. Mr. Nichols, you touched on 

this briefly in your testimony, and I believe each of you are aware 

that in option two of the discussion draft, we suggest an entity 

level withholding rather than our current practice. 

Now, as practitioners that deal with small businesses every day, 

can you talk a little, either Mr. Nichols, perhaps others have 

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comes that this change might create? Specifically, I am interested 

in how the provision might impact cash flow, whether it might create cash flow problems for any type of existing pass-through entity. 

Mr. NICHOLS. Yes. There are a number of considerations here. 

Obviously one is compliance. And the withholding system that is 

proposed is not a completely new item. There are a lot of S Corporations that have out-of-state operations. They actually have a 

withholding system that they need to deal with in order to withhold taxes for their out-of-state operations in the various states 

that they are operative in. 

Now, the withholding system at the Federal level potentially creates more of a cash flow situation. The amounts for the State systems are typically smaller. And the other thing that would need to 

be factored in, and I am not sure the proposal contemplates it, or 

I am not sure it does, I am not sure it doesn’t, but the other thing 

that would need to be factored in is the fact that tax rates at the 

corporate level, if they are to be uniform, are unavoidably going to 

impact cash flow. And I can give you two examples. One example 

would be if the taxpayers are in a lower tax bracket and you have 

got a mandated withholding rate that is above that tax bracket, obviously there is going to be an amount that is going to need to be 

withheld, and then the taxpayers are going to have to wait till next 

year to get that refunded to them. It is like any other withholding. 

You don’t get it until you file the return at the end of the year. 

The second one that I think is potentially more problematic, but 

maybe it could be dealt with, and that is the idea that you have 

got a taxpayer that runs or has interest in two different businesses, 

and they have got $100,000 of income in one business, and 

$100,000 of loss in the other business, but they are in two separate 

entities. 

Under the withholding regime, unless you can take into account 

the individual taxpayer’s facts, you would end up having to have 

withholding occur on the $100,000 from the profitable business, 

notwithstanding the fact that that shareholder, that owner is doing 

exactly what we hope they do in today’s economy: use those profits 

in another business, hire people and use that. Well, you can’t do 

that if you—some of those monies are siphoned off in the form of 

the withholding and you are not going to get them back until after 

the end of the year. 

Mr. YOUNG. Any other quick thoughts here? We have about 30 

seconds left. 

Mr. TAYLOR. Yeah. I think you are missing something in this 

whole picture. You could take withholding tax and put it in option 

one, and apply it to S Corporations and partnerships. 

The merit of option two is not the particular features, all of 

which can go in option one. The merit is it gets you to focus on the 

difference between the entities. I mean, take your ESOP point. 

Mr. YOUNG. Yeah. 

Mr. TAYLOR. You can have an ESOP as a shareholder of an S 

Corporation today. Okay? You cannot have an ESOP partner in a 

partnership and get the same tax consequences. 

Your point about the net investment income tax. If you are an 

S Corporation, you can eliminate a large part of that 3.8 percent 

tax on your S Corporation earnings, assuming it is not a passive 


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activity. You cannot do that generally if you have got a partnership. 

So the point here of option two and option one, I think, is option 

two forces you to ask the question, why is this different from the 

way it is here? 

Mr. YOUNG. Right. 

Mr. TAYLOR. And that is what you should be focusing on, I 

think, not the particular features, all of which, as I say, you could 

put in—— 

Mr. YOUNG. Great. 

Mr. TAYLOR [continuing]. Option one if you wanted. 

Mr. YOUNG. Thanks so much. I yield back. 

And if you have further testimony, maybe you can submit it for 

the record. 

Chairman TIBERI. Does someone else have a thought? Go ahead, 

Mr. Harris. I feel generous today. 

Mr. HARRIS. Thank you. 

Mr. YOUNG. Thanks, Mr. Chairman. 

Mr. HARRIS. I think one thing in addition to what has been said 

when you get to entity level withholding, we have to consider the 

complexity on the small business owner of understanding what are 

we going to withhold on and what records are they going to have 

to keep and what efforts are they going to have to go through to 

calculate the number that we are going to withhold on. 

So I think we have to be very cognizant of the fact that we could 

be adding complexity that may or may not benefit anyone for the 

other problems here, that it could be a wrong amount, it could be 

offset somewhere else, and yet we have imposed a burden. So I 

think we should always look, if we are going to look at entity level 

withholding, withholding on something that is easy to get to, perhaps like payments that are made to shareholders and partners, as 

opposed to a calculated income amount. 

Chairman TIBERI. Thank you. Let me just tell you, I can tell the 

difference between someone who is trying to filibuster an answer 

and someone who is trying to be substantively helpful, and I think 

the four of you, your testimony, both written and your testimony 

today, is great, very helpful, very interesting. And so help us by 

being substantive in your answers, and don’t feel pressure on the 

clock. Not everyone will always tell you that. 

Mr. Gerlach, you are recognized for 5 minutes. 

Mr. GERLACH. Thank you, Mr. Chairman. And, gentlemen, 

thank you for testifying today. 

Mr. Harris—and I would like to get the other three gentlemen’s 

thoughts on this as well—but I want to base my question on your 

testimony and in particular, your written testimony on the issue of 

the startup and organizational expense provisions that would increase the amount as a startup company you could deduct under 

the Code. And you approve of that proposed draft language, although you go on to say that you would suggest an even more aggressive approach to startup expenses for small business owners 

that qualify for the use of cash accounting. 

Can you expand a little bit more, if you would, on your thoughts 

on how the current discussion draft language could be improved 

upon relative to that particular expensing that we would like to see 


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startups be able to have so that encourages them to move forward 

with that initial business activity? 

Mr. HARRIS. Sure. I will be happy to, because I think one thing 

we can all agree upon, we want more businesses starting up. 

Mr. GERLACH. Right. 

Mr. HARRIS. And anything we can do to encourage that is going 

to benefit us all. 

Mine is more of really expanding the cash accounting rules to say 

when you start a business, in the year that you actually open your 

doors, I believe we should allow them to deduct any expenses they 

incurred through that process. Again, if it started in a prior year 

and it rolled into a current year, then that would be carried forward, but as I said in my opening statement, it is very hard to explain to a small business owner that the expense you pay in July, 

you can fully deduct, but the exact same expense that you paid in 

February, because it happened to come prior to the opening of your 

doors, may not be deductible or has to be capitalized, depending on 

the amount. 

And it really comes down to, again, the basic understanding, as 

I have heard a lot of discussions today, I think of it in terms of our 

clients and our small business owners, and they are sitting there 

going, this is what is wrong with the tax system. You know, if I 

paid the money and I started the business, why isn’t it a deduction. 

Mr. GERLACH. So if you start the business November 1st, but 

of course leading up to opening those doors on November the 1st, 

in February, March and April, you are incurring different organizational and other expenses that are justifiable for the startup of that 

entity on November 1st, all of that should be deductible for that 

tax year, is what you are suggesting? 

Mr. HARRIS. Right. Because all that money is gone and they 

have expended the funds. 

Mr. GERLACH. And it is out of the checkbook—— 

Mr. HARRIS. It is out of the checkbook. 

Mr. GERLACH [continuing]. Which is the basis for which they 

make decisions. 

Mr. HARRIS. Yes. 

Mr. GERLACH. Yeah. Gentlemen, the other folks on the panel, 

do you have a thought on that same issue? Mr. Nichols. 

Mr. NICHOLS. Well, I certainly agree. I would just add to that, 

and that essentially what you have got is the dichotomy between 

the accounting principles and the tax principles. And there are a 

number of provisions in the Code. I know over the course of its history, for example, for accounting purposes, you capitalize those 

startup costs because you want to communicate to your outside investors that it is not all wasted money, over time it is going to 

build up and you are going to have something of value, and it 

makes the first year not look as bad as it otherwise would. 

And so you have got the accounting principles that go in one direction, but you have also got the tax principles that essentially say 

from the standpoint of tax policy, is this really a time in which we 

want to allow somebody—put somebody in a position of paying expenses and not give them the deduction? And when you look at it 

from the standpoint of tax policy—— 


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Mr. GERLACH. Because the whole goal is you want them to be 

successful. 

Mr. NICHOLS. Exactly. 

Mr. GERLACH. And it is from a cash flow standpoint that they 

will or won’t be successful. 

Mr. NICHOLS. Exactly. 

Mr. GERLACH. Is that—okay. Great. Mr. Taylor, Mr. Rubin, do 

you have a thought on that? 

Mr. RUBIN. No. 

Mr. TAYLOR. No comment. 

Mr. GERLACH. Good. Well, thank you very much. I appreciate 

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

Chairman TIBERI. Thank you, Mr. Gerlach. 

Mr. Larson, you are recognized for 5 minutes. 

Mr. LARSON. Thank you, Mr. Chairman. And I want to thank 

our panelists as well for being here today. And, again, want to 

thank Chairman Camp for putting out his proposal. 

And obviously in the case of small businesses, especially the notion of simplicity is something that we all want to strive for. In 

looking at the two options that are before you, and I would be interested in your responses, in real terms, real life, anecdotal or otherwise, how does this—what does simplicity mean to you and what 

could we best do to assist small business in the Tax Code? Is it, 

as my colleague often suggests, not having to have an accountant 

12 months of the year, but only that 1 month when you actually 

need them? Is it the less reporting? What is it in the overall simplification that we could do to make you more entrepreneurial, as 

Mr. Harris said, and to grow businesses and encourage people to 

get involved? And we will start with Mr. Harris. 

Mr. HARRIS. I think from the perspective of our clients, what 

simplicity means to them is that to the extent that it is possible, 

that the tax system can follow the records that they have to keep 

to run their business, that they aren’t being forced to keep records 

solely to comply with the tax law, that the basic records that we 

all need to keep to run our business should be sufficient for filing 

taxes. It shouldn’t require a lot of complexity. 

And it should also, I think, allow them to operate in a real world. 

As I was listening to the example of partner A and B merging with 

partner C and D and all that, in the real world, those are just four 

guys that came together to start a business, and yet if they heard 

this discussion, their head would explode, because they are saying, 

what do you mean? I mean, we just decided to work together. 

So I think what we have to do is we try to mirror the records 

they keep and recognize what they are doing every day to run a 

business, and try to make that our tax law as best we can. 

Mr. LARSON. Thank you, Mr. Harris. Mr. Taylor. 

Mr. TAYLOR. Let me just add one thing without disagreeing in 

any way with what you said. It seems to me—— 

Mr. LARSON. Could you speak into the mic? 

Mr. TAYLOR. Yeah. I am sorry. Thank you. It seems to me great 

simplicity would be that you did not need to come and talk to us 

before deciding whether you were going to be a partnership or an 

S Corporation. 


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And that is the merit of option two, you know, there is only one 

system. And we can disagree as to what the features of that system 

should be, and I think there is disagreement, but, you know, not 

having your fundamental choice being something that is dictated 

can only be sensibly made from a tax point of view if you have an 

accountant or a lawyer, you know, that is crazy. 

And the differences between limited partnerships—I am sorry— 

limited liability companies and S Corporations from a tax point of 

view are huge and pervasive. And so if you could get to a single 

regime where you didn’t need that accountant or lawyer upfront, 

that would be simplicity, I think. 

Mr. RUBIN. And I guess I would argue that that is only conceptual simplicity rather than practical simplicity; that under current 

law, the regime really provides a choice, that people who want 

greater simplicity and less flexibility can achieve that through an 

S Corporation, people who need greater flexibility to distribute 

properties, need to have debt included in basis and so forth, they 

can deal with the more complicated rules. 

You know, again, in concept, combining them means you don’t 

have a choice, and maybe that is simple in a way, but I think as 

a practical matter, it means that a lot of people who currently are 

happy with the S Corp regime have to deal with a much more complicated set of rules. 

Mr. NICHOLS. And actually I would agree with Mr. Rubin. I 

guess if you look at this from the standpoint of the small business 

owner, watch what they do, what they want to do and what they 

have done. And 4.5 million of them, the plurality of them have chosen to be S Corporations. Don’t disrupt what they are doing unless 

there is good reason to do so. And moving that—changing—what 

one of the things that does keep lawyers and accountants busy and 

employed is changes. And if you have got a system that seems to 

be working and seems to satisfy the needs of both the—the revenue 

needs and the needs of the individual businesses, and they have 

grown accustomed to it, don’t change that without, you know, solid 

underpinning of reasons to do so, just because the disruption alone 

slows business down. 

Mr. LARSON. Thank you. 

Chairman TIBERI. Thank you. Mr. Schock is recognized for 5 

minutes. 

Mr. SCHOCK. Thank you, Mr. Chairman, and thank you to the 

witnesses. A couple quick follow-up questions, one on cash accounting. I am pleased that the chairman included the framework of Mr. 

Thompson in my bill that increased the threshold from $5 million 

to $10 million permanently, however, I am aware of specific groups 

in my district who were exempted from current law that allow for 

unlimited amounts to be used on cash accounting, particularly in 

the ag industry. I have got some large pork producers that currently are allowed to use cash accounting. 

So I am wondering, from your perspective, if you are aware of 

other folks who may be exempted currently that will not be exempted under the chairman’s proposal, and if you could talk a little 

bit about what effect this will have on perhaps accountants or others in the service sector, or a large pork producer like the ones in 

my district that have to go from an accrual basis to a cash basis 


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if, in fact, there are no exemptions for folks over $10 million. Mr. 

Nichols? 

Mr. NICHOLS. I am assuming people being forced to essentially 

go from a cash basis to an accrual basis? 

Mr. SCHOCK. Correct. I am sorry. Yes. 

Mr. NICHOLS. And that—well, one of the big exemptions that 

currently exists in that is closely held—S Corporations are exempt 

currently, and this essentially would eliminate that exemption for 

all S Corporations below the $10 million level, and so as—and 

that—I think any time you vary from the cash being in the door 

to pay the tax and you are requiring tax to be paid perhaps before 

it—in this case, before it is collected, you should take into account 

that you are creating a cash flow situation that is potentially problematic. 

Under the current rules, there are a number of corporations, S 

Corporations and partnerships that don’t have C Corporations as 

partners that are eligible for the cash basis method of accounting. 

This would eliminate that. It would essentially create another one 

of these demarcation lines that is somewhat arbitrary, unavoidably. 

If it is, you know, $10 million, you know, if they move $1 million 

above $10 million for 3 years in a row, then suddenly they are on 

a completely different system. 

And there I would focus on is there a policy reason that is important enough to require enterprises that haven’t collected the cash 

right away, they haven’t collected the cash already, is there a policy reason important enough to require them to pay the tax on that 

income that they haven’t received yet. And that is—if there is—it 

is kind of if it is not broken, don’t fix it. Be careful if you change 

things so as not to disrupt the business. 

Mr. SCHOCK. Mr. Harris. 

Mr. HARRIS. Just to add to that, I think we have to understand 

that the only real difference between cash and accounting is when 

the income shows up, not if it shows up. So to his point, what is 

the incentive to require the perhaps accelerated reporting of the income, what is the benefit of doing that, as opposed to waiting until 

it actually shows up, because it will eventually show up and be income when the money is paid. 

So unless there is a real policy reason, as he said, to force that 

acceleration into income, I don’t know why we don’t just wait until 

they actually have it. 

Mr. SCHOCK. Okay. It may have something to do with the CBO 

score. 

The second question really is just genuinely interested in your 

view on this effect on small businesses. A lot of times we focus on 

the big C Corp guys. We have got a few of those important ones 

in my district. But we also recognize that the majority of Americans work for small companies. And it is the startups, really, who 

are the engine of our economy. And some of the things we do, like 

179, raising that threshold to 250, making that permanent, is there 

anything else you guys are aware of that maybe we aren’t doing 

that we should be doing, or perhaps we should look at, particularly 

for small startup companies? You think about the Apples, the 

Microsofts. They started in garages. They didn’t have your traditional framework. You are not going to use R&D incentives for a 


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small startup like that. Are there other things that we could be 

looking at for some of those organic startups? 

Mr. HARRIS. I think we have discussed a lot of the things that 

we should do. Again, when you are starting up at the smallest of 

small businesses, cash flow is of critical importance. They don’t 

have access to capital. They are probably doing it from maybe even 

credit cards or living on a spouse’s salary. 

So we should do everything we can to allow them to keep as 

much of their cash as they can and not get into complicated, broadening base exercises, if you will, which is basically saying something you spent can’t be reported yet, can’t be deducted yet, is to 

allow them to keep the money in their startup years when it is the 

most critical. Because if they can get through those 1 or 2 startup 

years, they tend to have a chance to survive. 

So we should be very careful to do everything we can in a startup 

mode to allow their tax return to mirror their cash flow as closely 

as possible. Because cash is at a premium at that point. 

Mr. SCHOCK. Anyone else? 

Mr. Nichols. 

Mr. NICHOLS. Well, I am finding myself agreeing with Mr. Harris more and more. But, essentially, to a great extent what I am 

going to do is repeat what he just said, but essentially there are 

two ways; one is by recognizing income only when it is collected, 

and the other is by giving the benefit of deductions to startup businesses when they actually pay it as opposed to over time. And both 

of those, frankly, help small businesses, especially startups, who 

are cash starved. 

Mr. SCHOCK. And what is proposed in the rough draft you feel 

is sufficient. 

Mr. NICHOLS. It is an improvement. I don’t disagree with Mr. 

Harris that the idea of allowing startups to actually expense, at 

least maybe up to a cap, actually expense immediately startup expenses. I am not sure that is bad policy. I understand cost revenue, 

but it is putting the incentives towards starting up businesses right 

where they should be. At least, I am going to get my deduction 

when I am paying the cash out. 

Mr. SCHOCK. Okay. Thank you guys. 

Chairman TIBERI. Thank you, Mr. Schock. 

Mr. Marchant, you are recognized for 5 minutes. 

Mr. MARCHANT. Thank you, Mr. Chairman. 

I would like to follow up on some of the chairman’s earlier questions. Partnerships draw their earnings through K1s, don’t they? 

And Sub-S. Basically, it is a straight pass-through. So going back 

to the ObamaCare tax and the Pease tax that is attached to that, 

is it going to provide a disincentive for an investor to look at a 

small business, a Sub-S or a partnership, and know that they possibly could get a K1 or pass-through income, that there will be no 

cash following those documents, so that they can be taxed? Normally, in small businesses there is no requirement, is there, that 

the amount of income that you have to show on your income taxes 

as a pass-through is followed by any cash. Is that correct? 

Mr. TAYLOR. That is correct. You would normally make sure 

that it was followed by cash as a contractual matter. If you were 


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just an investor, you would make sure the cash distributions were 

at least equal to what you thought the tax liability was. 

Mr. MARCHANT. But in a C Corp, you can have earnings—— 

Mr. TAYLOR. In a C Corp, you are perfectly right. You can have 

earnings and nothing to report. Unless you get a distribution, you 

just report your distribution. If you are in an S Corp or a partner 

in a partnership, you report your share of the income or loss of the 

S Corporation or partnership, whether or not you got it, on the one 

hand. On the other hand, typically you would make sure that, either because you were part of the management or you thought 

about this in advance, that they did make distributions sufficient 

to cover your liability. 

Mr. MARCHANT. Well, if you are a passive investor in a partnership, then you usually don’t have a lot to say about the general 

day-to-day—— 

Mr. TAYLOR. Okay, fine. But would have a lot to say about the 

terms of your investment. You want my money, here’s the circumstances under which I will make it. 

Mr. MARCHANT. In the discussion draft, it sets a $250,000 limit 

on the cost of new property and equipment that a small business 

can expense during the tax year, and immediate expense begins to 

phase out once the taxpayer places more than $800,000 of that 

property into service in a year. These levels parallel those that 

were in effect prior to the stimulus. Do you think that these levels 

reasonably reflect the need of small businesses? 

Mr. HARRIS. Well, as I said in my opening statement, from our 

client perspective, it is going to get most of them. Those limits 

would be sufficient for most. But it is very clear you can go buy 

a printing press if you are in a printing business that is going to 

exceed $800,000, or it can be $1 million. So no matter what the 

limits are, there is always going to be someone who wants more. 

And I guess that is the beauty that we have on this panel. We don’t 

have to consider revenue impacts. In a perfect world, I would say 

let everybody write off their equipment no matter how much they 

buy in a year. But we can just say that because we don’t have to 

balance a budget in Washington. But I think that is going to depend on the kind of business you are in. But I can say for a lot 

of our clients, $250,000 and $800,000 would cover most of our clients’ acquisitions in a year. 

Mr. MARCHANT. Mr. Chairman, in the spirit of the Chairman 

Camp’s intent that the Tax Code be simplified and that the rates 

get lowered and that we encourage formation of small business, I 

think this is a very important hearing. I do think that the whole 

issue of the additional 5 percent tax on the K1 and the Sub S income is a very significant thing in this whole formula. And I don’t 

want to see us do anything in the Tax Code that will encourage 

people to go into C Corps instead of partnerships and Sub S’s, because in my district probably three-quarters of the businesses organize at that level. 

Thank you. 

Chairman TIBERI. Ditto. Thank you, Mr. Marchant. 

Mr. Young brought up earlier ESOPs. And I know Mr. Neal is 

a big supporter of ESOPs as well. And you all know that in the 

draft, option two, going to a single entity, we don’t address the 


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issue of S Corp ESOPs in terms of how we go forward on that. 

Have any of you thought of a way to do that? The reason why I 

ask is what we don’t want to do is have a detrimental impact on 

something that I think there is bipartisan agreement on that it has 

been successful in our communities and in our districts. 

Mr. Nichols, do you want to start? 

Mr. NICHOLS. I would be happy to. S Corporation ESOPs have 

actually been very successful in essentially expanding the base of 

ownership, essentially, and moving, frankly, both the profit and 

loss and risk to the business among the entire employee base, 

which from the standpoint of inclusion in the American economy, 

has a pretty fundamental function. And so as a consequence, doing 

what can be done in order to encourage that, it doesn’t surprise me 

that there is bipartisan support. 

You are right, I am not sure I read anything in one way or another in the proposals. I am not quite sure I would tinker with 

that. In order to have an ESOP, you would have to have a corporation. But the proposals don’t seem to change that. So if the policy 

is along the lines of if it is not broke, don’t fix it, it seems to be 

working very well. I am not quite sure I would try to change that 

as part of these proposals. 

Chairman TIBERI. Mr. Rubin, anything to add? 

Mr. RUBIN. I guess I would say that I agree that in general S 

Corp ESOPs have certainly broadened ownership of S corporations 

and allowed employees to participate in that. I guess, with a nod 

to Mr. Taylor, I would say there is probably no conceptual reason 

why you couldn’t craft a regime that allowed an ESOP to own interest in an LLC. But on the other hand, I don’t think that there 

is a great need to do that, given where we are today. 

Chairman TIBERI. Mr. Taylor. 

Mr. TAYLOR. To just reiterate what I said, if you have a special 

rule for ESOPs, it ought to be across the board. You shouldn’t have 

people saying well, I have got to form an S Corporation because it 

is the only way I can do an ESOP, as opposed to setting up a limited liability company. So it ought to be across the board. 

I do think there is a fundamental issue about ESOPs. You give 

them treatment that you do not give to other tax exempts, including regular pension plans. Because there you would have so-called 

unrelated business income for many of these investments, and you 

do not when it is done through an ESOP. So you have another 

issue not related to this small business reform, if you will, about 

whether or not you are not giving ESOPs an advantage from a tax 

point of view that should not be given to other tax exempt organizations, including other benefit plans. 

Chairman TIBERI. Mr. Harris. 

Mr. HARRIS. I really don’t have much to add to what has already been said other than, again, if we have got something that 

is working, the last thing we want to do is do anything to make 

it not work. So I would defer to their judgment. But I think it is 

working, so let’s just don’t hurt it. 

Chairman TIBERI. Okay. Any other members have any questions with our expert witnesses here? 

You want to ask us a question? I defer to Mr. Neal. 


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Mr. TAYLOR. I don’t have the courage to do that. But I would 

make one point here; that it is not working, to start right there. 

The system is conceptually enormously messed up. I am not talking 

specifically about ESOPs or anything like that. 

Chairman TIBERI. You are talking about the Tax Code? 

Mr. TAYLOR. The Tax Code and the particular provisions we are 

talking about, they don’t work. And you ought to start from the assumption that there are serious flaws in them. And that is why, 

as I said, there is great deal of merit in focusing on option two. 

Even if you decide in the end you are not going to do it, you are 

just going to take the ideas and build them into option one, it has 

the merit of making you focus on what is wrong. 

Chairman TIBERI. Thank you. Anybody else want to add a comment? That is why we are having this hearing. That is why the 

chairman has decided to do these drafts. And we appreciate you 

four being here today and adding your input to this process. I appreciate the time that you have taken. 

That concludes today’s hearing. Please be advised that members 

may submit written questions to the witnesses. Those questions 

and the witnesses answers will be made part of the record. 

Again, thank you all for your time for appearing today, for the 

thoughtfulness and for our wonderful, educational discussion that 

we have had. I think this helps us continue to move the ball forward. Thank you. 

This hearing is adjourned. 

[Whereupon, at 11:12 a.m., the subcommittee was adjourned.] 

[Public Submissions for the Record follows:] 

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AdvaMed 


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American Farm Bureau Federation 


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BIO 


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National Association for the Self Employed 


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National Pork Producers Council 


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Small Business Investor Alliance 


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