U.S. GOVERNMENT PRINTING OFFICE

61–230 WASHINGTON : 2000

SETRA: FAIR AND SIMPLE TAX RELIEF

FOR SMALL BUSINESS

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS

HOUSE OF REPRESENTATIVES

ONE HUNDRED SIXTH CONGRESS

FIRST SESSION

WASHINGTON, DC, JUNE 9, 1999

Serial No. 106–18

Printed for the use of the Committee on Small Business

(

(II)

COMMITTEE ON SMALL BUSINESS

JAMES M. TALENT, Missouri, Chairman

LARRY COMBEST, Texas

JOEL HEFLEY, Colorado

DONALD A. MANZULLO, Illinois

ROSCOE G. BARTLETT, Maryland

FRANK A. LOBIONDO, New Jersey

SUE W. KELLY, New York

STEVEN J. CHABOT, Ohio

PHIL ENGLISH, Pennsylvania

DAVID M. MCINTOSH, Indiana

RICK HILL, Montana

JOSEPH R. PITTS, Pennsylvania

MICHAEL P. FORBES, New York

JOHN E. SWEENEY, New York

PATRICK J. TOOMEY, Pennsylvania

JIM DEMINT, South Carolina

EDWARD PEASE, Indiana

JOHN THUNE, South Dakota

MARY BONO, California

NYDIA M. VELA ́ZQUEZ, New York

JUANITA MILLENDER-MCDONALD,

California

DANNY K. DAVIS, Illinois

CAROLYN MCCARTHY, New York

BILL PASCRELL, New Jersey

RUBE ́N HINOJOSA, Texas

DONNA MC CHRISTENSEN, Virgin Islands

ROBERT A. BRADY, Pennsylvania

TOM UDALL, New Mexico

DENNIS MOORE, Kansas

STEPHANIE TUBBS JONES, Ohio

CHARLES A. GONZALEZ, Texas

DAVID D. PHELPS, Illinois

GRACE F. NAPOLITANO, California

BRIAN BAIRD, Washington

MARK UDALL, Colorado

SHELLEY BERKLEY, Nevada

HARRY KATRICHIS, Chief Counsel

MICHAEL DAY, Minority Staff Director

(III)

C O N T E N T S

Page

Hearing held on June 9, 1999 ................................................................................. 1

WITNESSES

Wordsworth, James, Owner, J.R.’s Steakhouse of Virginia ................................. 4

Joseph, Frank, Owner, Key Communications Group, Inc. ................................... 6

Wallace, Eric, CPA, Carbis Walker and Associates .............................................. 8

Neese, Terry, Chief Executive Officer, Terry Neese Personnel Services ............ 20

Reardon, Brian, Manager, Federal Public Policy, National Federation of Independent Business ................................................................................................. 22

Sinclaire, William, Senior Tax Counsel and Director of Tax Policy, Economic

Policy Division, Chamber of Commerce of the United States .......................... 23

Coleman, Dorothy, Director of Tax Policy for the National Association of

Manufacturers ...................................................................................................... 25

APPENDIX

Opening statements:

Talent, Hon. James M ...................................................................................... 32

McCarthy, Hon. Carolyn .................................................................................. 34

Sweeney, Hon. John ......................................................................................... 35

Prepared statements:

Wordsworth, James .......................................................................................... 37

Joseph, Frank ................................................................................................... 40

Wallace, Eric ..................................................................................................... 45

Neese, Terry ...................................................................................................... 48

Reardon, Brian .................................................................................................. 53

Sinclaire, William ............................................................................................. 58

Coleman, Dorothy ............................................................................................. 63

Additional material:

NFIB Business Capital Expenditures ............................................................. 68

Letter to Hon. Vela ́zquez from Dorothy Coleman .......................................... 69

Written Statement of the National Alliance of Sales Representatives Association ......................................................................................................... 70

Written Statement of Roger Harris, President, Padgett Business Services 73

Written Statement of David Goodreau, Quatum Manufacturing ................. 77

Written Statement of National Society of Accountants ................................. 82

Written Statement of the American Farm Bureau Federation .................... 86

(1)

HEARING ON SETRA: FAIR AND SIMPLE TAX

RELIEF FOR SMALL BUSINESS

WEDNESDAY, JUNE 9, 1999

HOUSE OF REPRESENTATIVES,

COMMITTEE ON SMALL BUSINESS,

Washington, DC.

The Committee met, pursuant to notice, at 10 a.m., in room

2360, Rayburn House Office Building, Hon. James Talent (Chairman of the Committee) presiding.

Chairman TALENT [presiding]. Good morning. I want to apologize

to the Committee for being late. When I was in school, we used to

give the professors about 15 minutes, and you gave me 10. I imagine I was at the end of the rope there.

Over the last few years, largely through the determined and

united efforts of the members of this Committee, we have succeeded in convincing the rest of the Congress to give some modest

tax relief to America’s small businesses and family farmers, including restoring the home-office deduction, increasing the deductibility

of health insurance premiums, and modest estate tax relief.

Clearly, more is needed. Small entrepreneurs are the backbone

of our economy. They run local, national, and international businesses. They provide the bulk of the services we need. They raise

our children. They care for the elderly, and they grow our communities. They unambiguously need fair and simple tax relief from today’s complicated tax code.

I am introducing a bill today, the Small Employer Tax Relief Act

of 1999, called SETRA, on which we’re going to have a hearing

today, and I want to recommend it to my colleagues. It squarely

faces the realities that small businesses confront under today’s tax

code. SETRA calls for deducting 100 percent of small employer’s

health insurance costs, restoring the meal deduction, increasing expensing, lowering taxes, including payroll taxes, and simplifying

complex tax accounting IRS rules.

The bill tackles these important changes to complement, not compete with, leading proposals by other Members of Congress to

eliminate the death tax and to reduce taxes across the board for

all Americans.

In particular, I think that repealing the death tax, or eliminating

it gradually, as proposed by Representatives Dunn and Tanner in

H.R. 8, is essential. We should protect small farmers, family-owned

businesses, and women business owners from having their life’s

work confiscated by the Internal Revenue Service after their demise.

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In addition, there is no reasonable justification, in my mind, for

denying small businesses healthcare, business meal, and other

business expenses to run their business, so they can keep more of

their hard-earned money, create more jobs, and grow the economy.

High taxes, a complex tax code, and IRS tax traps, now penalize

unnecessarily an otherwise vibrant small business economy. Small

business Americans should be able to afford to save and invest in

their children, in their communities, and in their future. I hope

that SETRA, or legislation like it, will simplify and lower small

business taxes and help small businesses continue to excel.

I want to now yield to my friend and distinguished colleague, the

ranking member, for any statement she may wish to make.

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

Ms. VELA ́ZQUEZ. Thank you, Mr. Chairman. Before we begin, I

would like to take this opportunity to introduce our new member

of this Committee, Ms. Shelley Berkley, from Nevada. She has a

law degree and has worked extensively in the private sector. As

such, she is bringing with her a strong background in business

issues and a knowledge of trade groups. Representative Berkley

also comes from one of the fastest-growing cities in the Nation, and

I look forward to having her insights on what small businesses on

the front line need to succeed.

Over the past few years, America has experienced an unprecedented economic boom, and no one can deny the importance of

small businesses in helping create this growth and strengthening

our communities. Our Nation’s entrepreneurs provide jobs, represent a major tax base for our schools and roads, and embody the

spirit of entrepreneurship that has made this country great.

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

to grow. They do not have enough money at the end of the day to

make being their own boss a reward. One of the reasons for this

is that our tax system often creates disincentives for our Nation’s

small businesses.

An easy way to ensure that small businesses continue to grow

and are able to compete with large corporations is to provide them

with some sort of tax relief. The additional revenue, although small

by the standards of Wall Street, can often be the difference between a successful, growing firm and one that fails.

I would like to take this opportunity to commend Mr. Talent on

his continued efforts to relieve the tax burden on the small business community. He has been a strong advocate of tax relief for

small business and I am glad that I have been able to join him in

this fight.

One of the most important roles of this Committee is to educate

the rest of Congress about tax relief for small business. Today we

will be looking at the Small Employer Tax Relief Act of 1999, introduced by the chairman. I am a strong supporter of many of the provisions contained in this legislation, and I would like to thank Mr.

Talent for providing us with the opportunity to examine some of

the other tax relief proposals which haven’t been as thoroughly examined.

Both last year and again this year, I have joined Mr. Talent as

an original co-sponsor of legislation that calls for an immediate,

100 percent deduction for small businesses of their healthcare exVerDate 20-MAR-2000 10:59 Mar 28, 2000 Jkt 062232 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 E:\HEARINGS\61230A.TXT pfrm07 PsN: 61230A
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penses. This is crucial, not only for our small businesses, but for

millions of Americans who are currently without health insurance.

Since large corporations can already deduct 100 percent of their

healthcare insurance, small firms are suffering from an unfair tax

burden, and this must stop.

Small businesses also do not have the million dollar advertising

budgets that larger corporations do. Much of their advertising is

done face to face over lunch or dinner. The value of this type of

marketing should not be underestimated and it is a legitimate

business expense. To help small businesses offset this portion of

their marketing, I am a strong supporter and co-sponsor of legislation to increase the meal expense deduction from 50 percent to 80

percent.

Increasing this deduction is a common-sense proposal that

should be made a priority by Congress. It is a win-win situation for

everyone involved. Our small businesses win because they will be

able to compete with the million dollar advertising budgets of large

firms, and our restaurants, most of which are small businesses run

by families, will also benefit. This is a practical thing that we can

do, and it is also a smart, common-sense initiative that will help

strengthen our small businesses.

I would like to thank the chairman for providing the Committee

with an opportunity to examine other aspects of the tax relief to

small businesses. One of the proposals that we are examining

today would repeal the temporary Federal surtax added in 1976 to

repay loans from the government to the unemployment trust fund.

Even though this loan was repaid in 1987, the surtax is still in effect. Today we will be able to examine why this still exists and determine whether it is fair to small businesses.

Additionally, we will hear about possible changes to small business accounting rules to make it simpler and more cost effective for

small firms to comply with current tax laws. Today the Committee

will have the opportunity to examine these simplified accounting

rules. I believe that we should take a serious look at any proposal

which simplifies the accounting procedures for small business.

Finally, the legislation before us today would lower the maximum individual income tax rate from 39.4 percent to 34 percent

on productive income of small and family-owned businesses and the

self-employed. The net result of this change will be to reduce the

highest tax bracket for a small business to that of larger corporations. I believe that we must provide a level playing field between

small firms and large corporations, and this may be one of the

ways of doing just that.

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

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

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

chairman again for his hard work on this issue.

Chairman TALENT. I thank the gentlelady for her comments, and

we’ll go right to the first panel. We have two panels today, and the

first witness in the first panel is Mr. James M. Wordsworth, who

is the owner of J.R.’s Steakhouse of Virginia, in Fairfax, Virginia,

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who is testifying on behalf of the National Restaurant Association.

Mr. Wordsworth.

STATEMENT OF JAMES WORDSWORTH, OWNER, J.R.’S

STEAKHOUSE OF VIRGINIA

Mr. WORDSWORTH. Yes, good morning. Mr. Chairman, members

of the Committee, thank you for the opportunity to testify before

this Small Business Committee on legislation that would help thousands of restaurateurs across the country, the Small Employer Tax

Relief Act.

I am pleased to see that the Committee is addressing such an extensive package of tax issues that have long been a burden on

small business. My name is Jim Wordsworth. I have been a small

business employer in this area for a quarter of a century.

In 1974, I was a marketing manager for a large, high-tech corporation, and decided to open my own restaurant. So I did that, in

Fairfax, Virginia, and we called it J.R.’s Steakhouse. With a lot of

hard work and probably miracle upon miracle, we were successful.

That enabled me to open another restaurant and catering businesses shortly thereafter. Today, we employ 250 people, both parttime and full-time.

Privately, I am proud of the success of our business, and

throughout the years I have learned many, many lessons, too numerous to mention. One of the lessons is that you do everything in

your power to treat your employees well, to serve quality meals to

your customers, and to give back to the community. That is within

your building. Yet, you will never have total control over whether

or not you succeed, and that is outside your building.

There are barriers that hurt your business and keep you from

breaking even. These barriers can make or break your business, regardless of your own efforts. One of the barriers, one of the largest

barriers, is the heavy hand of the Federal Government. To those

of you in the business world, and to us in the business world, the

Internal Revenue Code is probably the thing we fear most.

It is not just the rules that can’t be deciphered without the aid

of lawyers and accountants, it is the tax burden itself. It is substantial, and it is constantly changing. Looking at the Small Employer Tax Relief Act, it is clear that Chairman Talent understands

the barriers that are caused by the tax code. In fact, almost every

provision will have a direct impact on my business.

However, it will not surprise any of you to hear that what I’d like

to focus on in my comments is the provision to increase the business meal deduction to 80 percent for small businesses and the

self-employed.

As most of you remember, in 1986, Congress lowered the business meal deduction from 100 percent to 80 percent. In 1993, it

was lowered again to 50 percent. As far as I can tell, the reason

it was lowered, aside from bringing a large amount of revenue to

the Federal Government, was that Congress really considered it

some sort of fat-cat tax loophole that people used so that they could

have three martini lunches. I would like to assure you that Congress could not have been further from the truth.

When I walk around my restaurant at noon on a day like today,

here is what I see. At one table I see a salesman up here from

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North Carolina trying to sell his outdoor signage to a guy who is

down the street who has a shop in a strip mall that is down the

street from our restaurant.

At another, I see a female who is new in business and is venturing into her own human resources consulting business talking

to a guy from a start-up high-tech firm in Tysons Corner about how

they can work together.

At still another is a friend of mine, Monty Coleman, a former

Redskin, who is with an emerging high-tech company, meeting

with the president of United Cerebral Palsy to arrange a sponsorship and a golf tournament. That is not really a direct business to

business, but it is an effective thing that is happening.

But, in short, the business men and women who are having

lunch in my restaurant are the same people that you see testifying

here today. They are traveling sales representatives that they pull

off the Beltway, the start-up business working on new clients, or

the self-employed. Each one of them considers my restaurant his

or her conference room. For many of these small business people,

this is the best—and sometimes the only—way they can do business. There is no less legitimate business expense than any other

form of marketing, but right now the tax code is telling them that

it is just 50 percent legitimate.

When Congress first reduced the business meal deduction, I, like

restaurateurs throughout the country, saw an immediate impact on

my business. And while that is very important to us in the restaurant business, what is even more important is to look at the impact of Congress’ decision on the business meal user.

Since Congress first dropped the allowable business expense in

1986, our association’s research shows that the number of business

meal users has declined by more than 2 million. A great majority

of these were small businesses.

Let me take a minute to talk about who really uses the business

meal, because it is important not to generalize or stereotype based

on any misconceptions, and I think you’ll be surprised. On the

chart over here, if I can direct your attention, two-thirds of the

business meal users make less than $60,000 a year, with almost 40

percent making less than $40,000. One-fifth of the business meal

users are self-employed. One-half of all business meal spending occurs in small towns and in rural areas. The average cost of a business meal per person is $11.60.

For people in the business world, a business meal is just that;

it is business. They are not trying to scam the system for a tax

break. They are not out to waste a hard-earned marketing budget

on something that won’t help them grow their business, and they

are not out to eat a meal for their own personal enjoyment, and

to heck with the business. They are business people simply trying

to drum up business.

Clearly, it was the small business that was hardest hit by the

cut in the deduction. I think it was part of TEFRA–86. That is

why, on behalf of the National Restaurant Association, I applaud

the inclusion of the business meal provision to increase deductibility from 80 percent for small businesses and self-employed. This

mirrors the stand-alone bill introduced by Congressman McCrery

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and Congressman Tanner, H.R. 1195, which has received strong bipartisan support.

Ideally, we would like to see the deduction go back up to 100 percent for everybody, because we believe that conducting business

over a meal is a 100 percent legitimate cost of doing business. However, we also realize that the revenue impact of such an increase

would be very difficult to enact in one bite, and that is a pun.

Again, Mr. Chairman, I would like to thank you and all of the

members of the Committee for the opportunity to tell you my story

and hopefully provide some insight on this tax issue. The thing I

would like to end with, and I think is so appropriate, is the Department of Commerce has declared this year, 1999, this is the second

time now, as the year of the restaurant. It is an acknowledgement

of what restaurants have been in our business community. I think

it would be appropriate, since we are the industry of the first experience for so many Americans, this is the year of the restaurant,

that if the sweeping changes that this bill would have on all of us

were passed in this year, I think that would be extremely appropriate, and I thank you.

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

Chairman TALENT. Thank you, Mr. Wordsworth, for your testimony.

Our next witness is Mr. Frank S. Joseph, who is the owner of

Key Communications Group of Chevy Chase, Maryland. He has

testified before this Committee before, and we welcome him back.

I urge the members to take a look at the re ́sume ́ of each of these

witnesses. Mr. Joseph’s re ́sume ́ is quite impressive, both as a

businessperson, and, before that, as a reporter, and we’re happy to

have him here.

STATEMENT OF FRANK JOSEPH, OWNER, KEY

COMMUNICATIONS GROUP, INC.

Mr. JOSEPH. Thank you. Thank you, Mr. Chairman. Chairman

Talent, members of the Committee, good morning. I am Frank Joseph. I am a publisher and publishing consultant in Chevy Chase,

Maryland, six miles from here.

My wife and I have been the self-employed owners of Key Communications Group Incorporated for 17 years. We publish the Federal Personnel Guide. You may be familiar with it.

Key has been a home-based business for the last eight of those

years. I am very happy to endorse your bill, the Small Employer

Tax Relief Act of 1999, speaking both personally and on behalf of

the National Association for the Self-Employed.

There are many good ideas in the bill. But, above all, I commend

this bill for keeping up the effort to immediately raise the health

insurance deduction for the self-employed to 100 percent. For millions of self-employed Americans, this deduction represents the difference between having no health insurance, being under-insured,

and having real health insurance. Almost six million self-employed

people and their dependents are uninsured. That includes nearly

two million children. This is a very real national problem. Thank

you for fighting to get those people insured.

It is also a fundamental issue of tax fairness. When I worked for

a larger company, my employer provided my health insurance. I

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had a policy that covered my family. A small premium was deducted each month from my gross pay, and I barely noticed the

cost. My employer excluded his entire cost for that health insurance from his taxable income, 100 percent.

Now I am self-employed. My wife and I operate Key as an S corporation under the tax law. I can only deduct a fraction of my

health insurance cost. It is same thing for other self-employed people, like sole proprietors and partners. Sometimes it seems like the

smaller your company, the less the government wants you to have

health insurance. A mile or two away from me is Phillips Publishing International. Like me, Phillips publishes newsletters. Tom

Phillips is an acquaintance of mine, friend of mine. He has done

very well. Last year they recorded gross revenues of about $600

million. That is orders of magnitude larger than my publishing

business, which is in my basement.

Yet, when it comes to health insurance, Congress has legislated

an advantage for Phillips over me, lower taxes. But, thanks to your

past efforts, Congressman Talent, as well as those of a few other

Members of Congress, like Senator Bond, we self-employed are finally on a schedule to deduct 100 percent of our health insurance

costs by the year 2003.

Still, as the SETRA bill acknowledges, people without health insurance should not be asked to wait four years to get sick, and the

many people who struggle to get by with 60 percent deduction now

should not have to wait four years to get a tax advantage that General Motors has enjoyed for half a century.

I would like to add one other personal note. When I came before

you in this Committee two years ago, I said that if Congress increased the health insurance deduction for the self-employed, I

could use the money to hire more part-time help for my company.

Well, you did, and I did. Today I use more part-time help than I

did then, thanks, in part, to the higher health insurance deduction.

I also have one full-time person working for us, and, because I try

to be a good employer, I provide her with 100 percent of her health

insurance.

But think about this: Since she is an employee of my business,

the insurance that I offer her is fully excludable from my business’

taxable income. That is a better deal than I can get for my own

family. The insurance that I purchase for my own family, same policy, same providers, same everything, because my wife and I are

self-employed, still is only 60 percent deductible. Luckily, I can afford to buy health insurance for my family, but I’m sure that there

are many self-employed people who cannot.

The statistics show that somewhere between one-fifth and onefourth of us don’t have health insurance, and cost is, by far, the

most important reason. The current tax law undoubtedly is creating situations where self-employed people with employees can afford to buy health insurance only for their employees, but not for

themselves and for their own families. Certainly some people will

be selfless in such a situation. They will buy the health insurance

for the employee and not for themselves, but other people will

think, ‘‘How can I possibly explain it to my family that I’m buying

health insurance for someone else, and not even for us?’’ Therefore,

they might not offer the health insurance to their employees.

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Increasing the self-employed health insurance deduction to 100

percent could help more than the self-employed. It may well result

in more employees of small business getting employer-provided

health insurance, and in a time when an estimated 40 million

Americans don’t have health insurance, anything that could help a

few more Americans get health insurance would certainly be in the

social interest of the country.

Thank you again for all of your work to get this deduction up to

60 percent. I hope we can finish this job this year. Thank you for

allowing me to testify.

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

Chairman TALENT. Thank you, Mr. Joseph.

Our next witness is Mr. Eric Wallace, a CPA with Carbis Walker

and Associates, of Pittsburgh, Pennsylvania, who is testifying on

behalf of the Associated Builders and Contractors, Inc. Mr. Wallace.

STATEMENT OF ERIC WALLACE, CPA, CARBIS WALKER AND

ASSOCIATES, LLP.

Mr. WALLACE. Thank you. I know how loved attorneys are in

Washington, and apparently CPA’s are getting in the same light,

so thank you.

My name is Eric Wallace, CPA, and I speak on behalf of the Association of Builders and Contractors. ABC is a national trade organization representing more than 20,000 firms in the construction

industry. ABC’s diverse membership is bound by a shared commitment to the philosophy of rewarding work based on merit. With 80

percent of the construction today performed by open shop contractors, ABC is proud to be their voice.

I am a practicing CPA with over 20 years of experience serving

construction contractors and service providers from across the

country in the fields of taxation, accounting, and consulting. I recently researched, published, and authored an article titled, ‘‘The

IRS and Cash Basis Contractors,’’ that appeared in the Construction Financial Management Association, as well as the ABC publication. My extensive experience dealing with this issue enables me

to provide to you specific expertise and insight regarding the proposal in SETRA to clarify that small business taxpayers are allowed to use the cash method of accounting without limitation.

Ms. Vela ́zquez referred to the accounting rules, and I am trying

to bring some reality to what we are talking about here when we

talk about accounting. A lot of people seem to go into a gray matter

when we talk about accounting. I am trying to bring some perspective as to how this really affects a lot of contractors from across the

country and how serious this is from them.

The IRS is targeting just about all contractors and service providers who report their taxable income on the cash method of accounting. One of the most onerous audit adjustments a contractor

or service provider can face is an IRS initiated change in its accounting method from the cash to the accrual method. The IRS proposed audit changes typically subject the taxpayer to six figure assessment, with the majority of this based on accrued interest and

penalties, not necessarily a tax increase.

9

The difference between the cash method and the accrual method

is not that the accrual method necessarily results in a greater taxable income, and, therefore, greater revenue. It is a matter of timing. Under the cash method, we report all of our income as we collect it, and our deductions as we pay them. For example, if we collect our income earlier and don’t pay our payables, we actually report our income sooner.

But, now more than ever, the IRS is pushing their cash audit position change on a national level. They are basing this on a publication in late 1997, titled the Construction Audit Technique Guide,

or ATG, as part of its national market segment specialization program.

In their ATG, it states to the IRS examiners, that they should

generally conclude that a contractor or service provider should be

changed from the cash basis of accounting when their material

costs as a percentage of their receipts is 15 percent or more, and,

depending on the facts and circumstances, they can make this assessment when the ratio is less than 15 percent.

This position is not based on any code section, but is a result of

several court cases successfully litigated by the Service. This push

is based upon an IRS certain logic flow. Their foundation flow is

summarized as follows: materials are merchandise. If the cost of

merchandise is over 15 percent of the gross receipts, it is a significant income-producing factor. If material is a significant incomeproducing factor, the contractor or service provider must use inventories. If the taxpayer is required to use inventories, it is required

to use an accrual method of accounting.

The result of this arbitrary national push by the Service would

leave few, if any, contractors or service providers remaining on the

cash method of accounting. One of the IRS authors of the Audit

Technique Guide stated to me that the only type of cash basis contractor that the Service is permitting to stay on the cash basis is

an asphalt contractor who does not produce asphalt in their own

plant.

Think about that for a second. Of all of the potential contractors

and type of contractors there are, the IRS is saying there is only

one type left to be able to be on the cash method.

Chairman TALENT. Mr. Wallace, let me interrupt for just a second, because we’re going to have a vote and I don’t know if everyone will come back, and I want them to understand this issue, because they are probably being contacted by the contractors, so I am

going to take the unusual step of interrupting. A few of us up here

are not accountants. So, when you talk accrual method, that means

that if a guy or gal is a painting contractor and they paint your

house and finish the painting, the IRS says you have to report the

income from that job the day you finish the painting and are entitled to be paid, even if the homeowner doesn’t pay you for 60 days.

Is that correct?

Mr. WALLACE. That is almost correct. When you are invoiced is

where you recognize the revenue, even if it might take them six

months to pay you. So you are paying taxes prior to your collection.

Chairman TALENT. So they want you to pay taxes on income that

you have, admittedly, not received at that point?

Mr. WALLACE. That is correct.

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Chairman TALENT. Okay. Go ahead.

Mr. WALLACE. Thank you. Thank you for your question. The IRS

denies that there is a national coordinated effort to focus on construction contractors and service providers, and that they are merely enforcing the laws as they interpret it. I do believe, however,

that there is a national effort based upon the calls that I have received from across the country from contractors, service providers,

and other practicing CPA’s saying, ‘‘here is the situation I face,

what are my alternatives in this situation?’’

For example, a carpet installer from Michigan called me. He was being audited by the IRS, doing $1.2 million in revenue. He had

materials and supplies equaling 12 percent of his revenue, not very

significant at all. Again, this is less than that 15 percent. The IRS

only audit change was to change him from the cash to the accrual

method. The cost to him was over $100,000. The IRS auditor had

told him that, ‘‘I am basing this upon the new audit technique

guide.’’

I advised an underground utility pipeline contractor to voluntarily change before the IRS came after him. It would cost him

$100,000. It would put him out of business.

A window installer from Texas called me. He had 20 percent of

revenues in material cost of revenue. He was fearful of the IRS

coming in, and, if they do, based on mandatory assessed interest

and penalties, would literally put the guy out of business.

The Service believes that, based upon a series of court decisions,

their position to change all contractors and service providers from

the cash method to the accrual method is justified. That is in past

conflict with the congressional intent. I have a quotation in my testimony related to the Tax Reform Act of 1986 where Congress said,

‘‘The Committee recognizes the cash method is generally a simpler

method of accounting, and that simplicity justified its continued

use by certain types of taxpayers and for certain types of activities.

Small businesses should be allowed to continue to use the cash

method of accounting in order to avoid the higher cost of compliance which will result if they are forced to switch from the cash

method.’’

A head IRS construction industry specialist stated to me that

based upon the current IRS approach and court cases, cash basis

contractors and most service providers will not be able to maintain

the cash basis position or have it supported in court. ‘‘Their only

solution is a congressional change.’’

Section 7 of the SETRA would provide such a needed congressional solution. The IRS makes a statement in their audit technique guide that the use of an inventory accounting method is required in every case where the sale of merchandise is an income

producing factor. It doesn’t matter that inventory accounting methods may result in inventory balances that are zero or minimal.

They are not maintaining inventories. It is clear that the Service

position is inappropriate. The SETRA would stop the Service’s universal push against the cash basis contractors and service providers, and enable these small business to utilize the simpler cash

method without fear of IRS reprisal.

I want to thank you. I want to thank Chairman Talent and Representative Phil English for leading the effort to end IRS abuse of

11

the cash basis contractors, and for introducing this straightforward

legislation to solve this problem. Thank you for letting me present

ABC’s views on this important issue, and I welcome any questions

you may have.

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

Chairman TALENT. I’m going to ask a couple of questions and

then I will recess the hearing. I certainly understand if members

want to get over there and vote and get back. I will hurry.

I want to follow up on this subject a little bit, Mr. Wallace. What

they’re basically doing is taking a method of accounting that is appropriate when a business has a lot of inventory and applying it

to contractors who don’t keep any inventory, who only buy paint or

asphalt per job. And they call that inventory?

Mr. WALLACE. That is correct. That is a good observation. If I’ve

got a contractor who builds a building, say, for example, they put

up one of these pre-manufactured buildings, and the only thing he

does is put up the pre-manufactured building, he doesn’t have to

buy the material; maybe the owner supplies the material; the IRS

is coming in and saying, ‘‘I don’t care, you bought it for this job.

You still have to——

Chairman TALENT. That is, in effect, your inventory. The accrual

method, which means that you take your deductions and you report

your income, at that time where you have a legal obligation to pay

or a legal right to be paid, makes some sense when a business carries a lot of inventory because you’re getting your inventory. You

are not necessarily paying the cash for that right away, but you get

to take the deduction right away?

Mr. WALLACE. That is right.

Chairman TALENT. So, if you are not getting paid for the sale

right away, but you’re having to report when you have a legal right

to pay, at least there is a balance there. You’re getting your deductions earlier and you’re reporting the income earlier. That is the

logic behind it?

Mr. WALLACE. That is the logic. If I am buying inventory, I

should not be able to write off the cost of my inventory, because

I am not selling it yet. If you are a contractor, that is not what they

face. They are not doing inventory; they are doing job costing.

Chairman TALENT. Right. It doesn’t make any sense at all when

a business doesn’t have a lot of inventory, because then they don’t

have the accounts payable that they would not be paying for 30

days or 60 days, but taking a deduction on early.

Mr. WALLACE. That is correct.

Chairman TALENT. So there is an imbalance there. That is the

reason the people have done it on a cash basis all of these years.

Mr. WALLACE. That is right. A contractor faces a lot of obligations. People want to be paid, and they want to be paid quickly.

The cash basis really is a good reflection of what their income is.

Chairman TALENT. Would you, as an accountant, apart from the

tax consequences, recommend to these people a cash method for

these purposes just as the best way of keeping the books?

Mr. WALLACE. Yes, that is how they manage their business. It is

really difficult for me to sit down with an owner, contractor, or

service provider and say, ‘‘You manage your business on the cash

method, but the IRS is going to ask you to pay taxes a lot earlier

12

based upon the accrual method.’’ They look at me and they get very

frustrated.

Chairman TALENT. I took the member’s time to go into that before we go voting in case people didn’t come back. That is the aspect of this that I think may be the most difficult to understand,

if you are not familiar with it. But, certainly, these other issues are

important.

And I will recognize the gentlelady from New York as soon as we

come back. We’ll recess the hearing to be able to go and vote.

[Recess.]

Chairman TALENT. We’ll reconvene the hearing.

I want to ask one more question, very briefly, and then I will recognize the ranking member. I have a press conference at 11:30, so

I just want to make sure I have a chance to explore this a little

bit.

Mr. Wordsworth, the provisions in the bill relating to the meal

deduction apply to smaller businesses. I, personally, would like to

expand it and apply it to everybody, but there is a reason for that.

You talked about it a little bit in your testimony how small business people, I don’t mean the size of the person; I mean the size

of the business. [Laughter.]

People who run smaller businesses or participate in small business use restaurants like yours to develop business in a way that

larger companies might use a corporate conference room or the golf

course, or something like that. Go into how restaurants are used,

maybe especially by the smaller-type businesses.

Mr. WORDSWORTH. My colleague here, for example, has his business in his basement. You couldn’t go out and meet with a large

company and invite them over to your basement through the back

lawn. I believe what you would do is pick a lunchtime, and you

would make a reservation for 4:00 to 6:00 or 8:00, and it gives you

a window of time. If you work intently at this—and as a small

business person, everything you do has to be intent, because you

can’t fool around—you will set the meeting for two hours, and it

is four to six people, and you can do that over lunch—in somebody

else’s real estate, and in an office that you don’t have to maintain

that has public accommodations, that is geographically located, so

you have the largest number of people. So, it is the ideal way to

conduct a business.

If I can just take a moment to contrast it, put a box around it—

to run an ad in The Washington Post, a small ad, for one day, let’s

say it is $424.60, one time. That is a shotgun approach to meeting

with people. If you take a rifle approach, because as a small business you can’t just throw out shotgun approaches, a luncheon at

my restaurant in Tysons Corner, which is a fine dining, tablecloth

restaurant, at lunch averages $11.85. So, it is far more effective for

you to have an eye-to-eye contact with the principal at $11.85

capped cost, and that includes everything—desserts, beverages,

whatever you have—versus this shotgun approach. So, people have

done that for years that can’t maintain meeting facilities. You just

can’t do it for an occasional meeting—if that is a good example.

Chairman TALENT. That is exactly what I am getting at. It is a

fitting point to recognize the young lady from New York because

of her excellent work on all of these subjects. In particular, I think,

13

I know she has a very powerful interest in the meal deduction, and

I am very pleased to recognize her for such questions that she may

wish to ask.

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

Mr. Joseph, I just would like to say that, based on the kind of

support that we have seen here in this Committee, where it is pretty even Republicans and Democrats supporting 100 percent deductibility, it is important that we understand that the only way we

could enact this legislation is by getting bipartisan support, and we

are going in that sense to make sure that we pass such legislation.

I would like to ask you, do you have an idea of how many of

these 6 million people would be covered by health insurance if we

had 100 percent deductibility?

Mr. JOSEPH. I don’t have any idea. There is no doubt that it

would be more people.

Ms. VELA ́ZQUEZ. I’m sorry. I’m sorry. I wasn’t listening, please.

Mr. JOSEPH. I said I don’t have any numbers or estimates, but

it stands to reason that more people would be covered.

Ms. VELA ́ZQUEZ. Have there been any surveys or other attempts

to quantify the likely impact of this change?

Mr. JOSEPH. I am not aware of any, but I will ask the people at

NASE to inquire about that and get back to you.

[The information may be found in the appendix.]

Ms. VELA ́ZQUEZ. Well, I guess that you answered that question.

I would like to ask some questions to Mr. Wallace.

First of all, Mr. Chairman, I would like to point out the fact that

I wish that we had an IRS representative here, and I hope that in

the next occasion that we have such an opportunity that we have

a witness such as Mr. Wallace, that we bring in a person from the

IRS to be able to react to your testimony, and in some way your

accusations.

Chairman TALENT. If the gentlelady will yield for just a second,

I agree totally. When he was saying what he was saying, which

personally I agree with, we should have had the IRS to respond

and to allow the Committee to inquire into how they’ve conducted

things. If we have a hearing on this subject again, we definitely

will have somebody from the IRS here.

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

Mr. Wallace, I used to be a college professor, and I have to tell

you that, if I had a student who reached the conclusions in the way

you did, I would have failed him. Having said that, I would like

to ask you, your testimony seems to indicate that the IRS is guilty

of unreasonably forcing small businesses to use the accrual method

of accounting, as opposed to the cash method. My question to you

is, if the IRS has won most of the court tests involving the accrual

versus cash basis question, fair to accuse or imply that the IRS of

being on some sort of vendetta in this area? It seems to demonstrate to me that the IRS is simply carrying out the law as Congress intended.

Mr. WALLACE. I appreciate the opportunity to respond to that. I

have watched the IRS for 20 years go after construction contractors

and service providers. They first tried it from an inventory approach and were consistently knocked down in court cases. There

was a specific court case that was decided. It was a court case that

14

came out and said, ‘‘If your merchandise is 15 percent or more of

your revenue, it is a significant income-producing factor and you

should be on the accrual method.’’ That court case was a casket

case in a funeral parlor. The IRS has taken that case and has applied it to various industries, and because of their success, they

have tried it in the construction and service-related industries, and

they have been successful.

Ms. VELA ́ZQUEZ. That is one court case compared to the many

court cases that IRS won?

Mr. WALLACE. That is the foundation in their logic flow.

Ms. VELA ́ZQUEZ. Mr. Wallace, I take it that you think the accrual

method costs more to maintain, putting aside the tax consequences? Do you have an estimate of the relative costs of each

method?

Mr. WALLACE. I appreciate that type of comment, and as a CPA,

I should probably be here supporting the IRS. I should probably be

here supporting their actions, because I make more money. I make

more money when the IRS comes in and says, ‘‘You have to be on

the accrual method, and because of that, you have to hire an experienced CPA who understands that.’’

But, coming down to what is common sense and how the industry can better function, I have to side with the contractor to say

that, when we start in our business, we want to start and give our

costs, whether they are attorney costs, CPA costs, insurance costs,

whatever those obligations are, for the starting contractor or service provider to keep their costs as low as possible. The cash method

can best make that happen.

Ms. VELA ́ZQUEZ. Can you tell me how much it would cost a busi- ness with $4 million in gross receipts to use the cash method, and

how much more to use the accrual method?

Mr. WALLACE. From a tax and reporting—because we now have

to hire personnel inside and outside to take care of that. If I was

a guessing individual, based upon my experience, I would say

$20,000 more a year.

Ms. VELA ́ZQUEZ. What about the tax implications of changing

from the accrual method to the cash method? Does one method

produce more tax savings than the other? Is one method potentially

more easily abused than the other?

Mr. WALLACE. That is a good question. There are four basic

methods a contractor can apply. There are two of them that we

have talked about today; the cash and the accrual. The other one

is the completed contract and the percentage of completion.

Depending on the type of contractor, depending on when they invoice, depending on when their jobs are completed, any of those

four methods can—I don’t want to say manipulate, but can change

your income reporting. It is clearly only a matter of time—if we

start the year and end the year with all of our monies collected and

billed, every method produces the same result. It is only a matter

of timing. So, from an IRS perspective, they will get their money.

They do get their money. It might not be this year. It might be the

year following. Where the IRS is coming in and going after the

cash method, they are getting their money on that timing, and because of the mandatory law requiring interest and penalties, that

is where they’re looking for their funds.

15

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

Mr. Wordsworth, I would like to ask you, in terms of the meal

deductibility. Do you know what percentage of the typical small

firm’s marketing budget will be devoted to meals and expenses?

How does this compare to large firms?

Mr. WORDSWORTH. I’m not sure I can answer your question in exactly that way. But, as I said before, and I want to comment, I enjoyed your comments so much in the beginning. I think you really

have a handle on things.

If you are a small business, your contracts and your contacts are

made one-on-one. If you’re one-on-one, you must meet somewhere.

You must have a contract. You must have a presentation. So, I

would say, not necessarily in numbers of occasions, but in the importance of the occasion, that you be able to sit down somewhere.

You couldn’t do it in the drycleaners. You couldn’t do it in the

metro. So, that is why restaurants are chosen as the chosen venue.

Ms. VELA ́ZQUEZ. Have you done any analysis of what an increasing meal deductibility might mean for those it benefits?

Mr. WORDSWORTH. I haven’t done an analysis myself, but I am

aware of one that I sincerely agree with. In my State of Virginia,

tourism is a great cash-flow item for us, which I have chaired for

several years. I know that the Bureau of Economic Analysis, I believe, using their formula, the National Restaurant Association has

determined that in my State the impact for the life of this increase

would be about $145 million. Now, tourism annually in Virginia

does about $11 billion. So it is a significant increase, and it is mostly vested in smaller businesses.

Ms. VELA ́ZQUEZ. Thank you.

Mr. MANZULLO [presiding]. Mr. Hill.

Mr. HILL. Thank you, Mr. Chairman.

Mr. Wallace, I particularly enjoyed your testimony, having

worked with construction people most of my life. I want to visit

with you a little bit about the issue with regard to the cash basis

accounting.

First of all, accrual accounting methods are far more complex.

The reason that it is a good thing for small businesses to be able

to do cash basis is that they can basically keep their records out

of a checking account, or a very simple accounting system. In accrual accounting, you have to put receivables and payables and all

that sort of thing. But, there are two kinds of accrual accounting

systems that you made reference to. One is completed contract, and

the other is percentage of completion.

The IRS forces contractors—I think it is $5 million or more now

have to go to percentage of completion method. The percentage of

completion method is really complicated, isn’t it?

Mr. WALLACE. Absolutely.

Mr. HILL. Would you just comment about the added complexities

that come from the percentage completion accrual method of accounting?

Mr. WALLACE. The thresholds are $5 million and $10 million.

There are a couple of different thresholds, if you’ll permit me to

make that statement. Like I’m saying, there is the cash, the accrual, the completed contract, and the percentage of completion.

The percentage of completion and the completed contract are acVerDate 20-MAR-2000 10:59 Mar 28, 2000 Jkt 062232 PO 00000 Frm 00018 Fmt 6633 Sfmt 6602 E:\HEARINGS\61230A.TXT pfrm07 PsN: 61230A
16

crual methods, in that you first have to have an accrual method to

recognize your basic accounting methods. The completed contract

and percentage of completion deal with the accounting related to

the contracts. So, in addition to the accrual method, we now have

to track accounting for each individual contract.

Mr. HILL. It is like having a profit-and-loss statement for every

job.

Mr. WALLACE. Correct. That is a good observation.

Mr. HILL. One of the things that I discovered working with construction companies, or small business in general, is that cash is

key. Most small businesses struggle for cash. Many small businesses show profits but don’t show cash. In fact, one of the most

troubling things I’ve ever experienced is watching people borrow

money to pay their taxes, rather than borrowing money to build

their business. I think one of the reasons Congress supports the

cash method of accounting is for that reason; that is wants small

business to succeed.

Under the cash system—and you made this point in your testimony—it is a matter of timing. You don’t avoid the tax. In fact, if

you don’t manage it well, you could wind up with a big tax problem. It could work the other way; you actually pay more in taxes.

So, this isn’t a tax avoidance; it is a tax timing. What it does is

allow the business to pay the tax when it has the cash to do it.

Mr. WALLACE. That is correct. That is a good observation. So, if

you look at the revenue, it is a neutral part of the provision when

we talk about what it is going to cost the taxpayer to enact this.

It is revenue-neutral.

Mr. HILL. I would agree with that.

Mr. Wordsworth, I happen to agree with you with regard to the

deductibility of meals. I had a business where I had salesmen, and

I decided when the IRS made this change that I was going to continue to pay those meal expenses, and that really made my accounting system complex, because then I had to do two profit and

losses, one for the IRS and one for the bank, because of what was

a deductible expense and what was not a deductible expense.

I just ask you this: Is another potential to get to the 100 percent

to maybe put some limit on what is a deductible meal? Is that

something that would make some sense as well?

Mr. WORDSWORTH. As a matter of fact, that is what I have

thought many times as an approach that should be used. I think

the inception of the original act itself was to stop abuse. I think

abuse would occur more in higher numbers. If you had a $50 lunch,

I don’t think that is middle America. I don’t think that is small

business. I think that is something else. But we, small business,

and a reasonable lunch and a reasonable dinner got taken in the

wake of pursuing the $50 lunch, and I don’t recall in my 25 years

that lunch occurring in my business.

Mr. HILL. Your prices aren’t that high? I can remember when I

started my business, we had a two-room office. We had four people

in those two rooms. When we had a customer come in, we took

them to the coffee shop or we took them to the restaurant. As you

said, that is where we did our business. The last thing you want

to do, if you’re prospecting, is let them pay the bill. So, the idea

that we’ve taken that away, I mean, it is a legitimate business exVerDate 20-MAR-2000 10:59 Mar 28, 2000 Jkt 062232 PO 00000 Frm 00019 Fmt 6633 Sfmt 6602 E:\HEARINGS\61230A.TXT pfrm07 PsN: 61230A
17

pense and it is important, particularly to small businesses, I think.

So, I certainly will do whatever I can.

Mr. MANZULLO. Mrs. Christian-Christensen.

Ms. CHRISTIAN-CHRISTENSEN. Thank you, Mr. Chairman. I really

don’t have any questions. I want to thank the witnesses for coming,

and let me just say, as a member of the travel and tourism caucus,

we supported the increase in the meal deduction last year, and we

are pleased to support it again this year. As a physician, it really

just makes good sense to allow the self-employed to deduct their

full insurance. The other issue is very, very complex, but I think

what we’re reaching for is simplicity and lifting burdens from small

business. Thank you, Mr. Chairman, and thank you for your testimony.

Mr. MANZULLO. Mr. Pitts.

Mr. PITTS. I yield back to Mr. Hill. I was enjoying his questions.

[Laughter.]

Mr. HILL. I apologize. I really don’t have any more specific questions, other than—and any of you might want to address this—that

Congress has been explicit in the past with regard to its intention

for small businesses, and the IRS has consistently, in its interpretation, tried to shift that away from the intent of Congress. Do you

believe that the language that is in this bill is sufficient to make

adequate clarity to the IRS to deal with the concerns and issues

that you have raised here? I would like to ask each of you to respond to that, and then I will yield back my time to the chairman.

Thank you.

Mr. MANZULLO. Okay. Mr. Moore. Where are we? Oh, I’m sorry.

Mr. WALLACE. I believe there is adequate clarity, and if I have

reading this from a CPA perspective, certainly the provisions for

business meals, there is nothing left to doubt. The deduction for

health insurance, there is nothing left for doubt there. I am sure

that this cash-versus-accrual issue for the small service providers

and contractors will, no doubt, continue to be—I know that there

are some feelings that I have been overly aggressive in my comments, but I am more than able or willing to sit in front of an IRS

representative, including the top dogs, because I have sat with

them on many panels and had these same discussions, and I am

adamant about my conversations related to this. I think this is absolutely needed,

Mr. JOSEPH. I’ve been brought here to talk about health insurance, but I have to tell you, listening to my colleagues here talking

about these other things, these are issues for us, too. We’re on the

accrual basis. I would much rather be on the cash basis. I used to

be on the cash basis when we weren’t a subchapter S corporation.

It was better. It was easier. It was less complicated. A big part of

my business is consulting, and I was talking during the break to

my colleague here. Consulting clients think nothing of waiting four

to six months or so to pay you. You bust your brains out for them,

and six months later maybe the check comes. By that time, it is

the new year and you’ve paid the taxes in the old year.

Restaurants? I was in a restaurant yesterday in a business meeting. I’ll be meeting a client in a restaurant tomorrow for probably

four hours or so for a business meeting. It couldn’t be more true.

I used to have a larger business. I sold most of the business eight

18

years ago and moved the business into the house for a lot of reasons; personal reasons were large among them. We have to use my

dining room as a conference room. Luckily, we have a very nice

dining room and it works pretty well. But, most of the time, if I

am having a meeting, I will go to Clyde’s in Chevy Chase, or something like that, and we will meet there. It is not an extravagance.

I am not trying to beat the system or anything; it just works better.

As far as health insurance goes, we aren’t publishing in

healthcare now. We used to publish in healthcare more, so I know

a fair amount about uninsured Americans and stuff like that, and

I think anything that will bring some more people into the tent will

be good. I saw trends operating 10 years ago that I thought were

going to bring more Americans under health coverage, and instead,

it is going in the opposite direction. There are 5 or 10 million more

Americans today than there were 10 years ago, when it was viewed

as more of a crisis, it seemed.

So, I just want to associate myself with the other witnesses here

and say that these are all important issues, not just for small business, but for America.

Mr. WORDSWORTH. I certainly hope there is clarity. I remember

the Family and Medical Leave Act. Coming out of Congress, I think

the bill was 47 pages. The legislation and the code ended up being

something like 900 pages, and it was interpretation upon interpretation versus the spirit versus the letter. So, I hope there is great

clarity in this. The reason that I do hope there is great clarity is

because these items affect so many people. It is such good that can

be done. I hope that in the implementation, that the regulators, the

people who write the code, carry out the intent of your act.

Mr. MANZULLO. Mr. Moore.

Mr. MOORE. Thank you, Mr. Chairman.

Mr. Wordsworth, you and some of the other witnesses have made

the point that, for small businesses, a lot of times a restaurant or

other dining facility is the office, and I guess my question to you

is that you also made the point that Congress, several years ago,

addressed the issue of abuses by placing limitations on lunches or

dinners.

My question to you, then, is: If a cap is appropriate, what would

you suggest would be an appropriate cap? I guess I’m agreeing with

you that for somebody to go out and have a three-martini lunch

and spend $50 or $75 is probably abusive. But, what would be an

appropriate cap? Twenty-five or $30? Do you have an idea?

Mr. WORDSWORTH. Well, if you try to think about that comprehensively, geography has a lot to do with it. In North Carolina,

a $25 lunch is extravagant. In New York, it might just buy you a

hot ham and cheese. [Laughter.]

Mr. MOORE. What’s wrong with hot ham and cheese?

Mr. WORDSWORTH. Without mayonnaise. Hold the roll. But, I

think a $50 lunch almost anywhere is pretty extravagant. I think

$125 dinner is pretty extravagant, I would think. I would go so far

as to say, I don’t want to alienate my colleagues who may have

those kinds of lunches, but small business, that people who qualified, and were covered under this act, if you were willing to spend

$50 for that lunch or $125 for that dinner, it would have to be for

a magnificent reason. This is the ultimate contract signing that

19

will give you two years of revenue. So, in that case, that might be

an appropriate reason. In that case, I would be willing to lose the

deduction if it were that magnificent. But what is impaired by this

is the ordinary, everyday, fact-of-life, pedestrian kind of marketing

activity, is what got caught in the wake of the ship.

Mr. MOORE. Well, I understand that, but if the fact brought up here is correct and the average lunch is $11.60, the question is, if

we are going to allow people to take 80 percent of $125 meal deduction without any limitation, and asking the United States taxpayers to subsidize that——

Mr. WORDSWORTH. Well, in that case, as I said, in that case, if

you had a $50 lunch, I would say you don’t get to deduct it at all,

because it would be such a small occasion and be worth it. I

wouldn’t even cover it.

Mr. MOORE. I want to apologize to the other Committee members. I am the new kid on the block here, a relatively new Member

of Congress, I guess five months now, but I don’t know what discussion there has been regarding limitations placed on this, but I

would think that might be an appropriate consideration. Thank

you.

Mr. MANZULLO. Okay. We want to thank the first panel. But before we do, Jim, do you remember when I first got elected, I went

to your restaurant when I think your dad was there with the finest

barbecue ribs in the world. Do you remember that? [Laughter.]

Mr. WORDSWORTH. I think I have your picture in our lobby. I do

remember that very well, and I appreciate that.

Mr. MANZULLO. It wasn’t a $92 lunch. It was very reasonable.

We want to thank you for coming here. Is your father still involved

in the restaurant?

Mr. WORDSWORTH. Yes, he is. He is 79 years old.

Mr. MANZULLO. Is he down in North Carolina with your brothers?

Mr. WORDSWORTH. Down in North Carolina with my brothers,

who started a distribution company as a small business, and now

they are the fourth largest in the U.S.

Mr. MANZULLO. That is great. That is a great example of a small

business that was started by your grandfather. Is that right?

Mr. WORDSWORTH. Actually, by my father, J.R. We call him ‘‘Big

Foot.’’

Mr. MANZULLO. That is great. We appreciate you taking your

time to be here. Thank you for the courtesy of coming to testify before us.

If we could have the next panel, please? We have our next panel,

and what I would like to do is to introduce each of you and then

put on the five-minute light. Please try to abide by that light, because I’m going to try to keep the members up here to the fiveminute light, also.

The first panelist is Terry Neese, who is the CEO at Terry Neese

Personnel Service in Oklahoma City, Oklahoma, a corporate and

public policy advisor for the National Association of Women Business Owners in Washington, D.C. She will be followed by Brian

Reardon, who is Manager of Federal Public Policy for the NFIB,

here in Washington. Then Bill Sinclaire, Senior Tax Counsel and

Director of Tax policy, Economic Policy Division, at the U.S. ChamVerDate 20-MAR-2000 10:59 Mar 28, 2000 Jkt 062232 PO 00000 Frm 00022 Fmt 6633 Sfmt 6602 E:\HEARINGS\61230A.TXT pfrm07 PsN: 61230A
20

ber of Commerce will testify, and then Dorothy Coleman, Director

of Tax Policy for the National Association of Manufacturers in

Washington, D.C.

Ms. Neese.

STATEMENT OF TERRY NEESE, CHIEF EXECUTIVE OFFICER,

TERRY NEESE PERSONNEL SERVICES

Ms. NEESE. Good morning, Mr. Chairman and Congresswoman

Vela ́zquez, and members of the Committee. I am Terry Neese. I

own a business in Oklahoma City, and am past national president

of the National Association of Women Business Owners, and currently serve as a consultant to NAWBO on corporate and public

policy issues.

NAWBO represents this country’s 9 million women business

owners. We are employing about 27 million workers today, and

generating $3.2 trillion in annual revenues.

I want to discuss today the simple tax relief proposals for small

business, what they mean, and why they’re important, especially

for women-owned businesses and minorities.

First, I want to talk about the increased small business expensing. Small businesses continue to invest in property and equipment

in order to maintain growth and efficiency in the market place.

Typically, small business owners will choose to pay for these assets

in advance rather than finance the acquisition over time. This decision is based on the difficulty of obtaining term loans for small

equipment acquisitions from lending institutions, as well as the

business owners’ desire to re-invest the profits back into the business for long-term growth, development, and stability.

The current expensing limit of $19,000 is not allowing small

business to keep up with the increasing costs of equipment and

technology. An increase to $35,000 would enable the small business

owner to maintain their equipment acquisition needs by reinvesting profits. They would also not incur a tax burden on the difference between cash expended and tax deduction allowed. This

provision will assist in maintaining the wherewithal-to-pay concept, whereby taxable income is essentially equal to cash flow.

Providing tax accounting relief to small business. Under current

law, small businesses are required to use the accrual method of accounting for income tax reporting if they are involved in merchandise sales and maintain an inventory. Although this provision provides for a clear reflection of income earned, it does not necessarily

result in a matching of taxable income to cash flow. Typically, the

small business owner must maintain a material amount of inventory, as well as float a large amount of accounts receivable.

On the other side, the small business owner will acquire the inventory with COD or 30–day payment terms. This timing difference creates a need for flexible financing from lending institutions who are not particularly interested in writing up small business credit lines to finance inventory and accounts receivable.

In addition, funds must be borrowed in order to pay the respective income taxes on merchandise sold and included in taxable income, even though the proceeds from the sale have not been collected. This provision under the Small Employer Tax Relief Act will

21

again assist in maintaining the important wherewithal to pay concept for small business.

Repealing the Federal Unemployment Payroll Surtax. The 0.2

percent surtax was intended to be a temporary increase to repay

government loans from the Federal Unemployment Trust Funds.

These loans were paid 11 years later, in 1986; yet, the surtax has

continued to be assessed and collected.

The fact that this surtax has continued 12 years past its original

intended and represented purpose is truly an inequity that unfairly

burdens the small business community. The Federal Unemployment Tax is assessed on the first $7,000 of wages per employee per

year. Thus, the turnover of employees and the hiring of temporary

employees or seasonal employment further escalates the employment tax burden on the small business owner. This 0.2 percent surtax should be repealed now.

The 80 percent tax deduction for entertainment and meal expenses. Small minority and women-owned businesses typically rely

on close personal relationships and customer service to compete for

sales, rather than on expensive advertising campaigns. Expenditures for meals and entertainment are often an important part of

this effort. Relationship marketing is key to women-owned businesses. Being able to sit down across the table from a client or prospective client is the best form of sales and marketing techniques

available.

The prior changes in the tax laws that disallowed 50 percent

down to 30 percent of these expenditures for tax purposes have disproportionately increased the selling costs for many small and

women-owned businesses. Ten years ago, business and travel meals

were 100 percent tax deductible, as ordinary and necessary expenses. Looking for revenue, Congress lowered the tax deduction to

80 percent in 1987, and 50 percent in 1994. This results in an unfair and disproportionate tax increase on the restaurant and entertainment industries and the business customers they serve.

This cutback has been particularly punitive for the small business community, and this is evidenced by the fact that the White

House Caucus on Small Business cited its restoration as one of its

top two priorities. So, reinstating the 80 percent, and ultimately

100 percent, tax deduction for meals and entertainment expenses

is the right thing to do for this Congress, and the fair thing to do

for women-owned business.

One hundred percent deductibility of health insurance for the

self-employed. This is a no-brainer. The fact that the self-employed

can not deduct 100 percent of healthcare premiums is a glaring inequity between large corporations and the self-employed. The 100

percent deductibility of health insurance for the self-employed is favored by large majorities of both parties in both houses of the Congress, spanning every region of the country and every political philosophy, including the White House. Now, we need a strong political will to find the formula that can make the change happen.

Over 16 million Americans could benefit from this tax relief.

I would be remiss if I didn’t also mention the onerous death tax

issue in this testimony. Relief from the current death tax enables

children to keep what they rightfully inherit, such as the farm that

has been in their family for generations, or the small business that

22

has helped them live the American dream. Now, many have to sell

their family legacy just to pay the taxes. This is an issue near and

dear to my heart. My daughter recently joined my firm. I want her

to carry on my legacy. She, in turn, may want her daughter, my

granddaughter, to carry on my legacy. Will we be able to do that

without selling the company to pay the death taxes? Only this Congress can answer that question, and that is a huge burden that you

can eliminate this year. Thank you very much for allowing me the

opportunity to present this testimony.

[Ms. Neese’s statement may be found in the appendix.]

Mr. MANZULLO. Thank you very much.

Mr. REARDON, IF YOU COULD PLEASE FOLLOW THE LIGHTS ON

THERE. I want to get the testimony in before we get a huge series

of votes on the defense bill.

STATEMENT OF BRIAN REARDON, MANAGER, FEDERAL PUBLIC POLICY, NATIONAL FEDERATION OF INDEPENDENT

BUSINESS

Mr. REARDON. Okay, I will go very quickly. Good morning, my

name is Brian Reardon. I am the Manager of Federal Public Policy

at the National Federal of Independent Businesses. We represent

600,000 independent businesses nationwide, and I appreciate the

opportunity to represent or present the views of small business

owners on the legislation outlined by Chairman Talent today.

NFIB supports all of the provisions contained in this legislation,

including the reduction in small business tax rates, 100 percent deductibility for the self-employed on their insurance costs, and increasing the business meal deduction.

Right now, though, I would just like to focus on two provisions

within the bill. That is the repeal of the FUTA surtax, and increasing small business expensing.

NFIB supports comprehensive reform of the Federal unemployment system. Right now, the Federal Government collects payroll

taxes to fund the administrative and extended benefits of the Nation’s unemployment system, and the States collect payroll taxes to

fund the regular benefits. There are four good reasons why this

system should be reformed.

First, payroll taxes at the Federal level have never been cut.

Since their enactment in 1937, they have only gone up, and while

Congress, when it has a tax bill before it, tends to focus on the income tax side of the burden, for most small employers, for most

workers, the payroll tax burden is significantly higher than income

taxes.

The second reason is, Federal taxes collected by the Federal tax,

the FUTA tax, are about twice as much as is necessary to finance

the system. In 1997, FUTA collected $6.1 billion from FUTA, but

Congress only spent $3.5 billion. FUTA taxes should be cut to reflect the costs of the system.

Third, the system is simply too complex. Right now, employers

pay both a Federal unemployment tax and a State unemployment

tax. That is twice the collection points, twice the complexity, twice

the paperwork burden, and twice the opportunity for errors in fines

from the IRS. There should only be one point of collection.

23

Finally, there is the FUTA surtax. As Terry mentioned, this temporary tax was enacted in 1976 to repay the borrowings from the

unemployment trust funds. It was fully repaid back in 1987, and

Congress has extended this surtax five times. Chairman Talent’s

bill would repeal this surtax, and we certainly support that. This

temporary tax has survived the Carter Administration, the Cold

War in the Soviet Union, and NIFB’s hope is that it won’t survive

the millennium.

Expensing. Chairman Talent’s bill would also raise the cap on small business expensing from $19,000 to $35,000. The purpose of

small business expensing is two-fold. First, simplification, and second, cash flow.

Regarding cash flow, small business expensing encourages small

businesses to invest by reducing tax liability and increasing their

cash flow. Almost 70 percent of our members report having made

a capital expenditure in the last three months. Expensing allows

those members to recoup some of the cost in the first year that

they make the expenditure.

For those members who report having a capital expenditure in

the last three months, almost half of them report having a capital

expenditure that exceeds the current cap of $19,000 for small business expensing. By raising the cap, Chairman Talent’s bill helps reduce the cost of investment for many of those small businesses.

The second reason is simplification. Deducting investments immediately is simply simpler than depreciating them over a number

of years. For relatively small capital purchases, maintaining

records and calculating depreciation schedules is perhaps the most

complicated exercise a small business has to go through. They have

to determine appropriate categories and schedules; they have to

keep extensive records. By raising the cap on small business expensing, Congressman Talent’s bill would allow our members to

sidestep much of the unnecessary complexity, allowing them to

focus more on their businesses.

In conclusion, taken as a whole, the Talent bill goes a long way

towards creating a simpler, fair tax code for small business, and

NFIB applauds the efforts of this Committee to move this forward.

If I can make just one final point, and that is today is June 9,

and that is the 46th anniversary of what is perhaps the most onerous small business or small employer tax, which is employee tax

withholding. Forty-six years ago, Congress enacted withholding in

order to accelerate tax receipts to pay for World War II. We still

have withholding with us, and I think that it is appropriate on this

day that Chairman Talent and other members of this Committee

are introducing this bill and attempting to simplify tax complexity

for small employers. Thank you very much.

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

Mr. MANZULLO. Thank you, Mr. Reardon.

Mr. Sinclaire.

STATEMENT OF WILLIAM SINCLAIRE, SENIOR TAX COUNSEL

AND DIRECTOR OF TAX POLICY, ECONOMIC POLICY DIVISION, CHAMBER OF COMMERCE OF THE UNITED STATES

Mr. SINCLAIRE. Good morning. I am Bill Sinclaire, and I am with

the U.S. Chamber of Commerce. The U.S. Chamber appreciates

24

this opportunity to express its views on the Small Employer Tax

Relief Act of 1999, and we would like to thank Chairman Talent

for introducing this legislation, and the co-sponsors for their endorsement.

The U.S. Chamber is the world’s largest business federation, representing more than 3 million businesses and organizations of

every size, sector, and region. More than 96 percent of the Chamber’s members are small businesses with 100 or fewer employees,

71 percent of which have 10 or fewer employees. Accordingly, we

are particularly cognizant of the problems of smaller businesses, as

well as issues facing the business community overall.

Simply stated, taxes should be levied in ways that minimize their

negative impact on taxpayers, economic growth, and the international competitiveness of American business. The tax bias

against work, savings, and investment should be minimized. The

tax system should be made as simple and easy to comply with as

is consistent with equitable administration of the tax laws. Particular emphasis should be placed on monitoring and reducing the

administrative and paperwork burdens on small businesses.

Small business is the backbone of America’s economy. They contribute almost one-half of all sales in this country and 50 percent

of private gross domestic product. Small businesses also provide

more than half of all employment and about two-thirds of all new

jobs. In recent years, the number of new businesses has been at

record levels, and the interest in starting and owning a small business has been dramatic. Nonetheless, parity with large businesses

does not exist for small businesses under the tax law. It is time to

remove inequities between small and large businesses and to provide small businesses with incentives to grow and create jobs.

The Small Employer Tax Relief Act of 1999 brings together several small business tax provisions and would provide substantial

tax relief for America’s small businesses. The bill would remove inequities between small businesses and large businesses, foster savings and investment, and bolster job growth. Specifically, this legislation would modify six areas of the Federal tax code. Namely, it

would increase the deduction for health insurance costs for the selfemployed. It would increase the expense deduction for meal and entertainment expenses. It would increase the expensing allowance

for small businesses, the Section 179 expensing amount to $35,000.

It would repeal the FUTA surtax. It would create parity on the

maximum tax rate at 34 percent between small businesses and corporations, and it would provide accounting relief to small businesses by allowing them to use the cash method of accounting

without limitation.

Our long-term economic growth depends upon sound economic

and tax policies. Today, we are critically shortchanging ourselves

and, more importantly, our children, as we commit too many of our

scarce resources into consumption and away from prudent investment. Our tax system encourages waste, retards savings, and punishes capital formation, all to the detriment of long-term economic

growth. As we prepare for the economic challenges of the next century, we must orient our current fiscal policies in a way that encourages more savings, more investments, more productivity

growth, and, ultimately, more economic growth.

25

The Chamber believes the tax reforms for small businesses specified in the Small Employer Tax Relief Act of 1999 would reduce the

tax burden, create jobs, and increase the savings, investment, and

productivity growth. The Chamber therefore wholeheartedly supports this legislation.

Mr. Chairman, members of the Committee, thank you for allowing me to testify today, and I would ask that my written comments

by incorporated into the record. Thank you.

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

Mr. MANZULLO. We will incorporate all of the written comments

from all of the witnesses unless there is any objection to it. Thank

you, Mr. Sinclaire.

Ms. Coleman.

STATEMENT OF DOROTHY COLEMAN, DIRECTOR OF TAX POLICY FOR THE NATIONAL ASSOCIATION OF MANUFACTURERS

Ms. COLEMAN. Thank you. My name is Dorothy Coleman. I am

the Director of Tax Policy at the National Association of Manufacturers. Mr. Chairman, members of the Committee, thank you for

the opportunity to come before you today to talk about tax rate relief for S corporations.

The NAM is the largest broad-based industry trade group in the

United States. Our 14,000 members include over 10,000 small and

medium manufacturers. About 41 percent of our small and medium

manufacturers are organized as S corporations.

Mr. MANZULLO. If I could interject?

Ms. COLEMAN. Sure.

Mr. MANZULLO. The new president of the NAM is a small business person in suburban Chicago, is that correct?

Ms. COLEMAN. You’re right. Tink Campbell.

Mr. MANZULLO. Tik.

Ms. COLEMAN. Tink.

Mr. MANZULLO. He does have under 50 employees at his manufacturing facility?

Ms. COLEMAN. Yes.

Mr. MANZULLO. Thank you.

Ms. COLEMAN. You are welcome.

The NAM’s 1999 agenda includes a number of pro-growth tax incentives, including a reduction in S corp tax rates. For our small

and medium manufacturers, S corporation tax rate relief is one of

the top tax issues that would have the most positive impact on

their company’s ability to grow.

We applaud you for including S corp tax rate relief in the Small

Employer Tax Relief Act of 1999. This morning I would like to

briefly outline the history of S corps, discuss some recent tax law

changes, and, finally, describe why S corp rate relief is so important to our members.

Congress created subchapter S corps more than 40 years ago to

give owners of small and medium companies more flexibility in setting up and operating their businesses. This hybrid mix of a partnership and corporation was specifically designed to encourage the

growth and stability of small and medium businesses by allowing

owners to maintain control of their companies while benefiting

from the liability protections afforded corporate shareholders.

26

For more than four decades, American business owners, particularly small and medium companies, have recognized the value of

this unique corporate structure. Presently, there are more than 2

million businesses in the United States operating as S corps.

Over the years, lawmakers have passed additional laws to encourage the creation of S corps. Legislation enacted in 1982, 1996,

and 1997, simplified and eased many of the S corp rules, making

it easier for companies to form S corps, and also more difficult for

companies to inadvertently terminate their S corp status.

S corps received a real boost in 1986 when legislators lowered

tax rates, and the individual rate ended up below the C corp rate.

The rate differential provided an additional incentive for businesses to organize as S corps, since S corp income, which flows

through to shareholders, was taxed at the lower individual rate.

By 1993, nearly half of all U.S. corporations were S corps. However, legislation enacted that same year dealt a major blow to S

corporations. The 1993 Omnibus Budget Reconciliation Act raised

the highest marginal tax rate for individuals from 31 percent to

39.6 percent, almost six percentage points higher than the comparable C corp rate, which remained at 34 percent.

Consequently, S corporations, as pass-through entities, now pay

a higher tax rate than C corps on income that is reinvested in their

businesses. The tax rate changes enacted in 1993 represent a stark

departure from Congress’ strong support for S corps, since they actually discourage small business owners from reinvesting earnings

back to their corporations.

To put it simply, S corp owners now pay a higher tax than C corporations on money used to develop new products, enter new markets, and hire additional employees. The higher tax rate is particularly harmful to S corp manufacturers who have to make large capital investments to grow their business and improve their competitive position. These companies typically do not have access to capital markets that C corporations have, and have to finance capital

investment from their cash flow. Increased investment translates

into additional jobs. It is estimated that, for every $100,000 that

is reinvested, a small manufacturer can create three to four new

jobs.

Recent surveys conducted by the NAM support these conclusions.

In particular, the surveys show a dramatic decline in investment,

R&D, and employee hiring among small manufacturer S corporations after enactment of the 1993 tax law. For many companies,

changing from S corp to C corp status is not an option, in part because of administrative costs and planning problems.

There are ways to address the problem. One proposal advocated

by the NAM would level the playing field for S corps by applying

a maximum tax rate of 34 percent to the first $5 million of S corp

income that is reinvested in the business or used to pay taxes. Providing rate relief for S corps is an opportunity for Congress to continue the mission it began in 1958 when lawmakers first established S corporations. In fact, given the critical role of small and

medium business in the United States economy, it is imperative

that Congress correct the economic injustice of the 1993 tax increases. Now is the time to level the playing field for S corporations

27

and encourage entrepreneurs who are trying to grow their business.

Thank you for your time.

[Ms. Coleman’s statement may be found in the appendix.]

Mr. MANZULLO. Thank you very much. I have just a couple of

questions.

Ms. Neese, you mention that by increasing the deductibility of

health insurance to 100 percent, there could be up to 16 million

people added to the rolls of the insured. Was that in your statement?

Ms. NEESE. Actually, those figures came from a research firm in

California. For me, personally, I have 12 employees and I pay 80

percent of their health insurance premiums today. If I had 100 percent deductibility of those insurance premiums, I would cover it

100 percent and I would also cover their spouses and their children. I don’t cover spouses and children today.

Mr. MANZULLO. You can deduct the full cost of health insurance

policy. If they were self-employed, they could only deduct a certain

percentage of it. Isn’t that correct? Did I get that right?

Ms. NEESE. I’m——

Mr. MANZULLO. For yourself? For your own policy?

Ms. NEESE. Right.

Mr. MANZULLO. Brian.

Mr. REARDON. If I could jump in, I think there are about 16 million self-employed individuals in the United States.

Mr. MANZULLO. That don’t have insurance?

Mr. REARDON. No, just 16 million. There are about 3 million that

do not have insurance. So, out of the 16 million people who would

benefit from increasing the deduction for self-employed insurance

costs, 3 million right now don’t have any insurance at all. So, this

provision would represent about a 10 or 15 percent health insurance cut for them, which is significant.

Mr. MANZULLO. Plus members of their family?

Mr. REARDON. Very much so.

Mr. MANZULLO. So, this figure could be—what?—10 million? Five

to 10 million? Somewhere in there?

Ms. NEESE. And their children and spouses. If you look at the 16

million self-employed—and they’re not all covered 100 percent—

plus their spouses and children, you are looking at a huge number

that we could take off of the uninsured rolls.

Mr. MANZULLO. I think it is very difficult to come up with the

actual figure of self-employed people who don’t have insurance.

There is no reporting form from the government, at least on that

one yet. The best figures I saw are based on some pretty rough estimates. Obviously, the more people who become insured, the lower

the premiums become.

I have a question with regard to expensing of equipment. Obviously, those businesses that have a lot of equipment, such as restaurants, are in different positions. But those who don’t have such

a heavy investment, can anyone estimate the average costs of annual equipment purchases for the typical small business owner?

Any real rough guesses out there? The purpose of the question, obviously, is with regard to increasing the amount that is expensed

as opposed to amortized. Anybody want to take a stab at that?

28

Mr. REARDON. The best numbers I have are the survey I mentioned in my testimony. We have the whole range here, but, essentially, 48 percent of our members who had capital expenditures in

the last three months, and that was 7 out of 10 of our members

had capital expenditures exceeding $20,000. So, I can provide these

numbers.

[The information may be found in the appendix.]

Mr. MANZULLO. Exceeding by how much? Do you have an idea?

Mr. REARDON. Twenty-two percent were between $20,000 and $50,000. Twelve percent were between $50,000 and $100,000. Eleven percent between $100,000 and $500,000, and then 3 percent

were above that.

Mr. MANZULLO. Thank you.

Ms. Neese, did you want to comment on that?

Ms. NEESE. In my business specifically, you look at the $19,000

and you look at the Y2K problem, and replacing the computers and

trying to get Y2k compliance, $19,000 is minuscule. I just brought

my company up to speed on the Y2K problem, and hopefully, I am

Y2K okay at this point, but I am a small business and I spent close

to $40,000.

Mr. MANZULLO. The service industry is particularly being hit

with the extreme cross of computers and computer technology. Mr.

Sinclaire, did you want to comment on the question?

Mr. SINCLAIRE. We do not have any specific numbers; however,

on the issue, there are other aspects. Many of the small business

people that I speak with, their largest asset—as was mentioned

earlier, they don’t have offices; they meet in restaurants; they are

also very mobile—so, their biggest investment is in their motor vehicle, and under section 179, motor vehicles are excluded, and that

is something that should be thought about being added for the

small business person. That can be their largest investment. Also, the Section 179 amount phases out at $200,000. That $200,000 cap has been there for a number of years, and we would

submit that there should be some thought about changing that cap

or indexing it, and they both would be helpful to small businesses.

Mr. MANZULLO. Mrs. Coleman.

Ms. COLEMAN. Since manufacturing is such a capital-intensive

industry, the vast majority of our members, can’t take advantage

of the current expensing provisions, specifically, for what Mr.

Sinclaire mentioned, because it phases out after you invest

$200,000 a year.

Mr. MANZULLO. Okay. Ms. Vela ́zquez.

Ms. VELA ́ZQUEZ. Thank you.

Mr. Reardon, the bottom line in regards to assisting business

through tax breaks is to enable them to expand. Increasing the expensing allowance will certainly allow a business to expand. Are

you aware of any analysis that shows what type of job creation we

can expect through the enactment of the increased expensing to

$35,000?

Mr. REARDON. I’m not, but I will search the records and see if

I can come up with something.

[The information may be found in the appendix.]

Ms. VELA ́ZQUEZ. Have any of you done any analysis? Do you have

any numbers? Thank you.

29

Ms. Coleman, one of the bill’s provisions would reduce the top individual income tax rate from 39.4 to 34 percent for productive income derived from small businesses. This means that individuals

with the same income, but derived from different sources, will be

taxed at different rates. My question is, isn’t a proposal which

would tax similarly-situated taxpayers at different rates potentially

both confusing and unfair?

Ms. COLEMAN. Well, we are looking at it more from the business,

the S corporation being taxed at the same rate that the C corporation is. Right now, if you are an S corporation and you are trying

to buy a piece of equipment, and a C corporation is trying to buy

the same piece of equipment, you are actually paying more, simply

because the money that you are using to buy that equipment to

make that investment is taxed at a much higher rate than the C

corporation.

Ms. VELA ́ZQUEZ. Isn’t this proposal unduly complex in an era

when many are seeking greater simplicity in the tax code? Could

this go too far in the opposite direction?

Ms. COLEMAN. I don’t think that I’m prepared to answer that

right now.

Ms. VELA ́ZQUEZ. When you are prepared, can you send it?

Ms. COLEMAN. I certainly will.

[The information may be found in the appendix.]

Ms. VELA ́ZQUEZ. Does this change potentially give rise for conversion from C corporations to S status, or some other form of ownership, which will qualify for the next tax treatment?

Ms. COLEMAN. Pardon me?

Ms. VELA ́ZQUEZ. Does this change potentially give rise to conversion from C corporation to S status or some other form of ownership, which would qualify for the next tax treatment?

Ms. COLEMAN. I don’t know that that is necessarily true. I think

businesses decide whether to become an S corp or a C corp for nontax reasons. There are also State law ramifications. There are restrictions on S corps, restrictions on the number of shareholders,

and who can be shareholders. So it is not a form of business that

works for every company.

Ms. VELA ́ZQUEZ. What specifically are the administrative costs

and planning problems that make conversion from S to C status so

difficult? Is this the real problem, or is it that profits that are

through-in are taxed at both the corporate and individual levels?

Ms. COLEMAN. Well, as I mentioned in my testimony, Congress

set up S corporations specifically for small businesses to give them

the flexibility and the control of ownership, and also the limited liability protections. The C corporation can be publicly traded. There

are less restrictions on shareholders. The tradeoff for becoming an

S corp, there is a tradeoff in that you are limited on the number

of shareholders, and there are also, again, some State law limitations on a state-by-state basis. I don’t think you can really compare. It is not easy to move from one to the other. There are a lot

of factors that go into that decision.

Ms. VELA ́ZQUEZ. Your proposal to limit a rate reduction only to

reinvested profits is interesting. This is quite a bit more targeted

than the provision in the SETRA bill, isn’t it?

Ms. COLEMAN. Yes, it is.

30

Ms. VELA ́ZQUEZ. It also seems to me to be less complex and probably less costly.

Ms. COLEMAN. I believe so. Most of our members are S corporations. In fact, that is why I’m testifying specifically on their problem. Certainly, Mr. Talent’s bill would address our concerns and

provide the relief, but as far as the other types of entities, I can’t

comment on that.

Ms. VELA ́ZQUEZ. Ms. Neese, other witnesses have suggested that

the problem with regard to the cash-versus-accrual accounting

method is a narrow issue centering on alleged stretching of the definition of inventory by the IRS. Yet, your testimony seems to say

that small firms of all types, including those that do carry meaningful inventories, suffer from having to use the accrual method.

Do this mean that the issue is a larger one than what people are

saying here?

Ms. NEESE. I think it is a larger issue. Let me refer to my tax

accountant here for a second because I want to be succinct to your

question, so that I can get it right.

Ms. VELA ́ZQUEZ. Ms. Neese? If you want, she could provide the

explanation.

Ms. NEESE. We’ll get you some information in writing.

Ms. VELA ́ZQUEZ. Thank you.

[The information may be found in the appendix.]

Ms. NEESE. But if I could go back to the S corporation question

just a moment that you were talking about, an S corporation is

first a C corporation. So you can go back to it by giving up the election to be taxed as a C. It is complicated. We can also send you

some things back in writing on that. I just wanted to put that in

for the record.

[The information may be found in the appendix.]

Ms. VELA ́ZQUEZ. I’m finished with my questions, Mr. Chairman.

Mr. MANZULLO. Well, that is pretty good timing. I pushed you

along and then the bells went off for what I think will be a series

of votes. We want to thank you for coming before us. 6

I do have a very short question. On this issue of the inventories,

the actual amount of tax that is paid is really not any more, if you

use the accrual versus the cash basis. It is just that there is more

of an accounting function and more papers that have to be filed.

Is that a correct statement?

Mr. SINCLAIRE. It is a timing question. If you boil the Federal Income Tax Code down to its basics, there are two parts: What is income, and when is it income? Going from cash to accrual, you determine when it is income. Generally, you would pay the same

amount of tax, but it is spread over a different period of time or

different tax years. In that sense, there is no difference. Now, you

have the time value of money. You are giving your money to the

government earlier and you don’t have your money available, so it

is a cash-flow problem also.

Ms. NEESE. The other issue is—and my inventory are people. I

am in the human resource business.

Mr. MANZULLO. So you’re on the cash basis?

Ms. NEESE. Yes. But, many times you have to pay taxes before

you ever receive your money, based on what you think might come

in.

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Mr. MANZULLO. Based upon billing?

Ms. NEESE. Yes, and that is pretty tough.

Mr. MANZULLO. Mr. Reardon.

Mr. REARDON. I also think that, under the accrual method, there

is the opportunity to overpay your taxes one year and then you

have to go back and get a refund. You have to file a form, and it

takes a long time to get your money back, which is what Bill referred to.

Ms. NEESE. If I could comment on that for just a second?

Mr. MANZULLO. Sure.

Ms. NEESE. I cannot tell you how many thousands of dollars that

I have overpaid, and it takes sometimes two years to get the money

back. It takes forever. And when you are talking thousands and

thousands of dollars, you are talking thousands of dollars that I

could have been using for advertising or other things in my business to continue to build my business when it is sitting at the IRS.

Mr. MANZULLO. Okay. Again, we want to thank you. I want to

leave the record open for a week. Let’s see, who is giving additional

information? Are you, Ms. Neese? In a couple of weeks? Can you

get that to us within a week? We will make that part of our permanent record. Again, thank you for coming. We appreciate it very

much.

Ms. NEESE. Sure.

Ms. COLEMAN. Sure.

[Whereupon, at 12:10 p.m., the Committee was adjourned.]

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