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78–663 2013

TREATMENT OF CLOSELY-HELD BUSINESSES IN 

THE CONTEXT OF TAX REFORM 

HEARING 

BEFORE THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

MARCH 7, 2012 

Serial No. 112–23 

Printed for the use of the Committee on Ways and Means 

( 


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COMMITTEE ON WAYS AND MEANS 

DAVE CAMP, Michigan, Chairman 

WALLY HERGER, California 

SAM JOHNSON, Texas 

KEVIN BRADY, Texas 

PAUL RYAN, Wisconsin 

DEVIN NUNES, California 

PATRICK J. TIBERI, Ohio 

GEOFF DAVIS, Kentucky 

DAVID G. REICHERT, Washington 

CHARLES W. BOUSTANY, JR., Louisiana 

PETER J. ROSKAM, Illinois 

JIM GERLACH, Pennsylvania 

TOM PRICE, Georgia 

VERN BUCHANAN, Florida 

ADRIAN SMITH, Nebraska 

AARON SCHOCK, Illinois 

LYNN JENKINS, Kansas 

ERIK PAULSEN, Minnesota 

KENNY MARCHANT, Texas 

RICK BERG, North Dakota 

DIANE BLACK, Tennessee 

TOM REED, New York 

SANDER M. LEVIN, Michigan 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

JIM MCDERMOTT, Washington 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

EARL BLUMENAUER, Oregon 

RON KIND, Wisconsin 

BILL PASCRELL, JR., New Jersey 

SHELLEY BERKLEY, Nevada 

JOSEPH CROWLEY, New York 

JENNIFER M. SAFAVIAN, Staff Director and General Counsel 

JANICE MAYS, Minority Chief Counsel 


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C O N T E N T S 

Page 

Advisory of March 7, 2012 announcing the hearing ............................................. 2 

WITNESSES 

Mr. Mark Smetana, Chief Financial Officer, Eby-Brown Company, Testimony 8 

Mr. Dewey W. Martin, CPA, Testifying on the behalf of the National Federation of Independent Businesses, Testimony ....................................................... 16 

Mr. Stefan F. Tucker, Partner, Venable, LLP, Testimony ................................... 25 

Mr. Jeffrey L. Kwall, Kathleen and Bernard Beazley Professor of Law, Loyola 

University School of Law, Testimony ................................................................. 47 

Mr. Tom Nichols, Meissner Tierney Fisher & Nichols S.C., Testimony ............. 57 

Mr. Martin A. Sullivan, Contributing Editor, Tax Analysts, Testimony ............ 76 

SUBMISSIONS FOR THE RECORD 

Carrix, statement ..................................................................................................... 121 

Center for Fiscal Equality, statement .................................................................... 125 

ESOP, statement ..................................................................................................... 128 

Kogod Tax, statement .............................................................................................. 132 

NAHB, statement .................................................................................................... 141 

National Beer Wholesalers Association, statement .............................................. 145 

RATE, statement ..................................................................................................... 148 


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wwoods2 on DSK499XVN1PROD with WAYS & MEANS
(1) 

HEARING ON THE TREATMENT OF CLOSELYHELD BUSINESSES IN THE CONTEXT OF 

TAX REFORM 

WEDNESDAY, MARCH 7, 2012 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON WAYS AND MEANS, WASHINGTON, DC. 

The committee met, pursuant to notice, at 10:04 a.m., in Room 

1100, Longworth House Office Building, the Honorable Dave Camp 

[chairman of the committee] presiding. 

[The advisory of the hearing follows:] 


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2 

HEARING ADVISORY 

FROM THE COMMITTEE ON WAYS AND MEANS 

Chairman Camp Announces Hearing 

on the Treatment of Closely-Held Businesses 

in the Context of Tax Reform 

Congressman Dave Camp (R–MI), Chairman of the Committee on Ways and 

Means, today announced that the Committee will hold the second of two hearings 

on how accounting rules cause different types of businesses—specifically, publiclytraded and closely-held businesses—to evaluate tax policy choices differently. 

Whereas the previous hearing focused on financial accounting rules and publiclytraded companies, this hearing will focus on the special challenges faced by small 

and closely-held businesses that are less concerned with financial accounting rules 

but must confront tremendous complexity in dealing with tax accounting and various choice of entity regimes. The hearing will take place on Wednesday, 

March 7, 2012, in Room 1100 of the Longworth House Office Building, beginning at 10:00 A.M. 

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

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

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

list of invited witnesses will follow. 

BACKGROUND: 

Unlike publicly-traded companies, closely-held companies often rely less on Generally Accepted Accounting Principles (‘‘GAAP’’) to report information to owners and 

creditors, although there are exceptions. (For example, a non-public entity with outside investors or a closely-held entity that issues debt instruments might be required to provide GAAP-compliant statements.) Instead, closely-held entities tend to 

focus almost exclusively on how tax policy changes affect cash flows. Closely-held 

companies, however, face their own set of challenges with regard to tax complexity 

and uncertainty. These challenges range from compliance with complicated rules on 

inventory accounting and cost recovery to numerous sets of tax rules governing different business forms. 

The three major business forms from which closely-held companies must choose 

for federal tax purposes are C corporations, S corporations, and partnerships, although a number of other types of business entities exist to serve specific purposes. 

While C corporations are subject to entity-level tax and shareholders are again subject to tax on dividends and capital gains, S corporations and partnerships are 

‘‘pass-through’’ entities that do not pay entity-level tax—rather, partners and shareholders pay tax on their share of the entity’s income on their individual tax returns 

(and therefore under the individual rate schedule). Companies must choose to operate under one of these regimes, and this choice can have significant tax consequences. Many commentators recommend modifications to the choice of entity 

rules to reduce the potential distortions introduced by such rules—with ideas ranging from consolidating existing pass-through rules into a ‘‘unified pass-through regime,’’ making it easier for closely-held C corporations to convert to pass-through 

status, or even subjecting some existing pass-through entities to double taxation as 

C corporations. On the other hand, tax reform proposals that create too large a 

spread between the top corporate rate and the top individual rate risk exacerbating 

these distortions rather than reducing them. 

In announcing this hearing, Chairman Camp said, ‘‘Closely-held businesses— 

including millions of small and family-owned businesses—form the backbone of our economy, but our current Tax Code imposes a variety of burdens on them that public companies do not face. Tax compliance costs are 


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especially high for small and closely-held businesses, and complex rules 

often prevent them from maximizing their ability to invest and create jobs. 

Higher marginal rates on individuals, as have been proposed by others, 

would stunt their growth even more. As part of comprehensive tax reform, 

the Committee must determine how best to reduce tax compliance costs 

and tax rates on closely-held businesses so that they can devote their resources to innovation and job creation, rather than to tax compliance and 

tax planning.’’ 

FOCUS OF THE HEARING: 

The hearing will examine how the Tax Code affects closely-held businesses in particular, and how tax reform might improve their ability to grow and create jobs. To 

this end, the hearing will consider how and under which sets of rules closely-held 

entities should be taxed, as well as general burdens imposed on closely-held businesses such as high compliance costs and tax rates. 

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS: 

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

of the Committee website and complete the informational forms. From the Committee homepage, http://waysandmeans.house.gov, select ‘‘Hearings.’’ Select the hearing for which you would like to submit, and click on the link entitled, ‘‘Click here 

to provide a submission for the record.’’ Once you have followed the online instructions, submit all requested information. ATTACH your submission as a Word document, in compliance with the formatting requirements listed below, by the close 

of business on Wednesday, March 21, 2012. Finally, please note that due to the 

change in House mail policy, the U.S. Capitol Police will refuse sealed-package deliveries to all House Office Buildings. For questions, or if you encounter technical 

problems, please call (202) 225–3625 or (202) 225–2610. 

FORMATTING REQUIREMENTS: 

The Committee relies on electronic submissions for printing the official hearing 

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

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

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

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

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

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

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

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

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

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

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

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

by the Committee. 

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

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

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

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

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

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

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

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

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

f 

/. 


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Chairman CAMP. Good morning. Before we begin, I just wanted 

to say that I was saddened to learn that a former staff member of 

the Joint Committee on Taxation, Cyndi LaFuente, passed away 

earlier this week. I know she was a valued colleague and friend to 

many people in this room, and I want to express my deepest condolences to her family and her friends for their loss, and just to say 

Cyndi will be missed. 

Today we are continuing our series of hearings on comprehensive 

tax reform and how a flatter, simpler, and fairer Tax Code can lead 

to economic growth and job creation. Our last hearing focused on 

publicly traded companies’ use of generally accepted accounting 

principles, GAAP, when compiling their SEC-required filings. For 

these companies, both earnings results and cash flow are important 

to investment decisions and performance measurement. 

During today’s hearing, we will shift gears to examine the other 

side of the coin, closely-held businesses. The complexion of these 

businesses varies greatly. They range from mid-size manufacturers 

to local law firms to the Main Street restaurants that sponsor local 

Little League teams. In this hearing, we will examine the rules 

that dictate how these entities should be organized for purposes of 

taxation, as well as general burdens imposed on closely-held businesses such as high compliance costs and tax rates. 

The difference between individual and corporate tax rates has an 

important effect on a business and how it is organized. For example, if individual income tax rates are substantially higher than 

corporate income tax rates, there is a clear incentive for taxpayers 

to organize business activity in corporate form. In addition, businesses that are subject to the higher individual rates may face a 

competitive disadvantage. 

There is little doubt that economic distortions can be created by 

a Tax Code that tilts too much in any one direction, and naturally 

one of the most effective ways to prevent that distortion is to create 

a neutral Tax Code in which the individual tax rates are similar 

to corporate tax rates. 

This is an approach that the Republicans have taken by calling 

for a top rate of 25 percent for both individuals and corporations. 

It also mirrors one of the most important achievements of the 1986 

Tax Reform Act, cementing the principal of closely aligning individual and corporate rates to eliminate abuse and economic distortions related to business structures. 

According to the Joint Committee on Taxation, in 2007 passthrough entities earned 56 percent of total net business income, 

which is taxed under the individual tax rate structure. Census data 

reveals that in 2008, pass-through entities employed more than 54 

percent of the private sector workforce. Both statistics point to the 

strong role pass-through entities play in our economy, and recent 

proposals have raised concerns from many in the pass-through 

community. 

For instance, under the President’s budget and other corporate 

reform proposals, the top statutory rate on individuals would rise 

to roughly 40 percent. At the same time, however, President 

Obama proposes to lower the corporate rate to 28 percent. Corporate taxpayers would enjoy a tax rate that is 12 percent points 


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lower than the top rate faced by pass-through businesses, and this 

will create more harm than good. 

As we continue to consider ways to transform the code from one 

that inhibits to one that spurs job growth, we must take steps to 

ensure that corporate reform is not financed on the backs of those 

who we have historically depended on the most to move us out of 

recessions, and that is small business. 

Adding to the challenges posed by a disparate rate is the everincreasing tax complexity facing closely-held businesses. Unlike 

large, publicly-held companies that have armies of accountants and 

lawyers, the complexity of the Tax Code disproportionately hits 

small businesses, which tend to be closely-held businesses. 

The Small Business Administration found that small businesses 

face a tax compliance burden at $74.24 per hour. That is 67 percent higher than that faced by large businesses. This burden results from reporting requirements, such as 1099s, as well as complex accounting rules for inventories, depreciation, and other business activity. 

In addition to the many tax rules a business must contend with, 

it is the first tax-related decision that businesses make, the manner in which they should organize themselves. That will affect all 

other tax decisions from that day forward. 

Whether a business organizes as a C corporation, an S corporation, a partnership, or some other form of business entity, that decision should not be driven by tax considerations. Instead, it ought 

to be driven by what form of organization best suits that business 

and its needs. 

As we move forward on reform, this committee should ask when 

it is appropriate to tax business income on a pass-through basis 

and when, if ever, it is appropriate to subject business income to 

entity-level taxation. And given the importance of pass-through entities to the U.S. economies and the prevalence of closely-held businesses, the treatment of job creators is critical to tax reform. 

Our goal with comprehensive tax reform remains clear, to create 

an environment that is ripe for economic growth and job creation. 

And I look forward to hearing from our witnesses about how we 

can best achieve that goal. 

And I now yield to Ranking Member Levin for his opening statement. 

Mr. LEVIN. Thank you very much, and welcome to all of you. 

And I know the chairman always wants you to have your testimony 

in in advance, and you all did that, and that was really helpful, 

though in one case your testimony was 12 pages and I am curious 

how you are going to do that in five minutes. 

[Laughter.] 

Mr. LEVIN. But it let us read rather late into the evening. 

Again, welcome, all of you knowledgeable people. 

Today’s hearing on closely-held businesses covers a vitally important topic. One of the measures of tax reform should be how well 

it promotes economic growth and job creation. So-called passthrough businesses represented over a third of business receipts in 

2008 and just under half of business income. They are a major part 

of our economy and a major source of growth and jobs. 


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Because pass-through entities do not pay corporate income tax at 

the entity level, and because they range in size from very small 

businesses to very large ones, they face a different set of issues 

with respect to tax reform than do C corporations. To understand 

how pass-through businesses will be affected by reform, we have to 

understand—and that is one of the purposes of the hearing today— 

who exactly they are. 

It used to be that pass-throughs were a reasonable proxy for 

small businesses. But with the growth both in number and size of 

S corporations and especially LLCs, this identity is breaking down. 

This is vitally important, among other issues, as we debate the 

question of whether to continue the upper income Bush tax cuts. 

Some have sought to continue to draw a straight line between 

pass-throughs and small business to justify continuing the tax cut 

for the highest earners. But pass-throughs are often quite large. 

For instance, in 2008, 64 percent of partnership income was earned 

by partnerships with more than $100 million in assets. 

Small business income is also a small fraction of the income that 

would be affected by an expiration of upper income tax cuts. Only 

a small fraction, 8 percent, is associated with small business employers. 

This has implications for how this committee approaches the universal, or nearly universal, desire to encourage small businesses. 

We need to keep in mind that if this committee contemplates the 

repeal of provisions that affect the cash flow of small businesses, 

such as accelerated depreciation or the domestic manufacturing deduction, in order to finance a corporate tax reduction, pass-through 

entities will not benefit from a reduction in the corporate rate. 

Pass-throughs also would not benefit from some of the international changes that the committee has discussed. 

One area where I think most of us agree where we can help 

small business is complexity. In reading through your testimony 

and the excellent Joint Committee pamphlet, I think there is plenty of complexity for us to explore. I look forward, therefore, and all 

of my colleagues on the Democratic side do, to your testimony. 

Thank you. 

Chairman CAMP. Well, thank you very much. 

We are pleased to welcome the excellent panel of experts assembled before us today. And as we tackle the special challenges faced 

by small and closely-held businesses, I believe their experience and 

insight will help us to shed some light on this complex area of the 

Tax Code. 

To introduce our first witness, from Naperville, Illinois, I yield to 

the chief deputy whip, Mr. Roskam. 

Mr. ROSKAM. Thank you, Mr. Chairman. And Mr. Chairman, I 

want to thank you for extending an invitation at my request to Mr. 

Mark Smetana. Mark is the chief financial officer of Eby-Brown, a 

100-year-old family-owned business, that is a wholesale distributor 

to the convenience store industry. And they are located in 

Naperville, Illinois, and they operate out of seven locations 

throughout the United States. They employ roughly 2500 employees, distribute goods to over 13,000 retail locations, and have $4.5 

billion in annual sales. 


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Mark previously served as the chairman of the Private Company 

Policy Committee of Financial Executives International, a 15,000- 

member company organization. And of course, he is a proud graduate of the University of Notre Dame. 

Chairman CAMP. All right. Thank you, Mr. Roskam, and welcome, Mr. Smetana. 

Second, we will hear from Mr. Dewey Martin. Mr. Martin is a licensed CPA, the sole owner of a public accounting practice, and the 

director of the School of Accounting at Husson University in Maine. 

He is testifying today on behalf of the National Federation of Independent Business. 

Third, we welcome Mr. Stefan Tucker, a partner at Venable LLP 

here in Washington, D.C. Mr. Tucker is a former chair of the ABA 

Section of Taxation and has lectured as a professor at the George 

Washington University Law School and the Georgetown University 

Law Center. 

Fourth, I would like to yield to Mr. Gerlach to welcome our next 

witness. 

Mr. GERLACH. Thank you, Mr. Chairman. I appreciate it very 

much. We are pleased to have today Dr. Jeffrey Kwall with us on 

the panel. Dr. Kwall is the Kathleen and Bernard Beazley Professor of Law at the Loyola University School of Law in Chicago, 

Illinois. He also teaches at Northwestern University School of Law. 

He specializes in corporate and pass-through taxation, and has 

authored many publications on the subject. He is an undergraduate 

from Bucknell University in Pennsylvania, as well as getting his 

J.D. and his Masters in Business Administration from the University of Pennsylvania. 

But what is extra-special about the opportunity to introduce Dr. 

Kwall this morning is that he and I grew up in the same home 

town in Western Pennsylvania. We are boyhood friends. We were 

in the same Cub Scout troop, and we have many memories of our 

childhood. And I have sworn him to secrecy on any of those stories, 

Mr. Chairman. 

[Laughter.] 

Mr. GERLACH. But we are really pleased to have Dr. Kwall 

with us, and I appreciate the opportunity to introduce him this 

morning. Thank you. 

Chairman CAMP. Well, thank you, Mr. Gerlach. And you come 

very well credentialed, Dr. Kwall. 

Fifth, we will be hearing from Mr. Thom Nichols. Mr. Nichols is 

a shareholder at Meissner Tierney Fisher & Nichols in Milwaukee, 

Wisconsin, and serves as the vice chair on the Committee on S Corporations for the ABA Section on Taxation. 

And finally, we do like to welcome back Mr. Martin Sullivan. Mr. 

Sullivan has served at the Treasury Department, the Joint Committee on Taxation, and since 1995 has been a contributing editor 

for Tax Analysts. 

Thank you all again for your time today. Thank you for being 

here. The committee has received each of your written statements 

and they will be made part of the formal hearing record. Each of 

you will be recognized for five minutes, and I will hold you pretty 

tightly to those five minutes, for your oral remarks. 


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So Mr. Smetana, we will begin with you. You are recognized for 

five minutes. 

STATEMENT OF MARK SMETANA, CHIEF FINANCIAL OFFICER, 

EBY–BROWN COMPANY, NAPERVILLE, ILLINOIS 

Mr. SMETANA. Good morning, Chairman Camp and Ranking 

Member Levin and Members of the Committee. It is a privilege to 

testify at today’s hearing regarding the treatment of privately-held 

businesses in the context of tax reform. This hearing comes at an 

important time as America’s businesses continue to struggle with 

lingering economic uncertainty. This proves especially true for the 

thousands of privately-held and family-owned businesses in the 

United States. 

As Mr. Roskam noted, I currently work for a privately-held company. The current family ownership is in its second generation, and 

it employs about 2500 people. The longevity of the company has 

largely resulted from the family’s reinvestment of its after-tax 

earnings and traditional financing. 

America’s privately-held businesses are the backbone of our economy. Forbes Magazine estimates that the 441 largest private companies in the United States employ 6.2 million people and account 

for 1.8 trillion in revenue. Recognizing the importance of private 

companies is vital since any workable tax reform must address 

businesses, regardless of their form of organization. 

All forms of business use GAAP-based financial statements to 

measure financial performance and the financial position of the 

business. However, there are fundamental differences between privately-held businesses and corporations. 

Owners of privately-held companies are typically limited in number and have long-term investment horizons, years to generations, 

whereas investors in publicly-held corporations are short-term renters of the securities they own, frequently trading them for cash. 

Capital used to finance privately-held businesses are after-tax cash 

earnings and transactional forms of debt financing. Public corporations raise capital via offerings of debt and equity-traded securities 

to the public. 

The owners of privately-held businesses typically measure the 

value of their business in terms of free cash flows the business generates, EBITDA or earnings before taxes, interest, depreciation, 

and amortization, times a market multiple; whereas public companies measure valuation in terms of market capitalization, price-toearnings ratio, and earnings per share. 

Most privately-held companies evaluate investment opportunities 

on an after-tax cash flow basis, whereas public companies evaluate 

the impact on the price of its stock. Tax policy plays a material role 

in evaluating those investment decisions for privately-held businesses. 

The recent framework for business tax reform released jointly by 

the Administration and Department of Treasury strongly implies 

that those organized as pass-through entities are advantaged in the 

current Tax Code over corporations. This is simply not the case. 

According to a report from Robert Carroll and Gerald Prante of 

Ernst & Young, America’s pass-through businesses reported 36 perVerDate Mar 15 2010 15:08 Oct 21, 2013 Jkt 078663 PO 00000 Frm 00012 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\78663.XXX 78663

wwoods2 on DSK499XVN1PROD with WAYS & MEANS
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cent of all business net income but paid 44 percent of all Federal 

business income taxes. 

Furthermore, the pass-through tax regime recognizes that there 

is a fundamental difference between closely-held businesses enterprises and corporations, especially publicly traded ones. Among 

them are: 

Owners of pass-through privately-held companies are taxed on 

business income, whether distributed or retained in the business, 

at one level of taxation, whereas corporations pay taxes on all income; and their owners pay a second tax on after-tax earnings that 

are distributed to its owners, creating a double-tax event. 

Pass-through entities are flexible, allowing a disproportionate allocation of earnings to its owners based upon the agreed-upon equity contribution among them. Corporations are inflexible in the allocation of earnings to its stakeholders. 

In order to fairly treat all businesses and provide a consistent 

policy with which business can operate in the U.S. economy, tax reform must address both forms of organization. The stated goal of 

providing a competitive business tax environment is important. 

However, it should not result in discriminating against closely-held 

businesses by widening the amount of marginal taxes the pay on 

business source income, forcing them into an inappropriate investor/owner relationship with their business, double-taxing their 

business income as if they were merely an investor trader of the 

business, or forcing them to pay a second level of tax on the sale 

of their business. 

Financial professionals are already making decisions based on increases in marginal rates set for January 2013, expiring AMT fixes, 

increases in the tax rate on investment income, and an increase in 

death taxes on closely-held companies. Certainly none of these 

prospects can be welcome at a time when our economy desperately 

needs increased private sector investment. 

In closing, it is vital that private companies are recognized as 

critical for America’s economic future. When tax reform does take 

place, we hope that their importance in our economy is understood 

and not penalized. 

I want to thank the chairman and ranking member for giving me 

the opportunity to speak before the committee today. I am happy 

to discuss these issues further and answer any questions you may 

have. 

[The prepared statement of Mr. Smetana follows:] 


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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.001

Mark Smetllna - House Committee on Ways and Mean$, March 7, 2012 

Good morning Chairman Camp and Rallking Menlher levin and mCl11her~ of 

the committee. II is an honor :lnd privilege to be invited to leslifyal tooay's hearing 

regarding Ihe treatment of privately·held businesses ill the context of lax reform. 

This h~aring come~ at an important time as Amerlca's bu~lne~~es continue to 

srh..ggle with lingering e<:o nomicuncertainly. This proves especiany lrue ror the 

thousands of privately-held and family·oWIll'd businesses across thl' United States. 

My·na,/lll' Is Mark SlIletllml and I am Chlefl'inan(]al Oftkn for Eby·Srown 

Company, a 100 y'J!3rold family·owned broadline distributor to the convenience 

store industry. The curr~llt f<lmily ownership is ill lIS second gelleraliull and 

employs about 2,500 pec~fe(rhe longevity of the company has largely resllited fmlll 

the family's reinvestment of its c<!rtllngs into the business coupled with traditional 

bank financing. 

, 1 am also an active member uf FlnanclalJlxeculives In ternanonal (HiI). FEl"s 

15,000 members represt'n! cO [llp~l\ie s from every IU3jof industry, hall of which are 

privat<,ly·held comp~nie$. As p~rt of my involv<'ment witb fEI, I have previously 

served as Chairman of th" FEl's COIlIl1tltt~ all Prlvatl! Compaoy Pulley. This 

committ~e has helped Congressman Peter Ruskam and Congressm.an Juon Altmire 

form th~ Privmely·Hcld (md Family·Owned IJII~iMS$ Caucus. 

America's prlvately·held businesses aTe the backbone ta our eCllnomic:... 

sliccess SIOIY. Forbes Mag~zine estill!3led that the 223 largest prlvate companies in 

the UnIted StlI e~ employ 4.4 million people and accnunt for SI,3 trillinn in 
11 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.002

Mark S'oetana - House Committee on Ways and Means. Mar<;h 7, lO l l 

revenues.' Ret:ognl zl'lg the Importance o(private companies is vital sfn<;e any 

workable tilx reform must address businessru; regardless "ftheir rorm of 

organization. 

All forms ofbuslnru;s use GM!' basl.'<l financial statements to measure 

fimoncialperforrnance and the finandalpusition "fthe business. However, there are 

funda 'ocntal djrferen ~s between privately-held businesses and CtlrpOrMion~ in tbM 

holders of privately-held companics are typically limited in number and have longer 

term InVe5tment'~o jwn~ - years. decades, generations - whereas investor.; in 

puhhcally·held corpotatlons are short-term renters of the secUrities they own, 

frequently trading them for cash. Capital used to (jnallce prlvately-held businesses 

pOSt start IIPJTe after-tax casb earqi ~ and traditional forms of deht borrowings. 

Publk corporations mise capital via ofrenllgs of debt and equity-traded securlties to 

the publil;. Theowners of privatl'!y-h~ld busll1e~ses typirnlly l1leasure the value of 

their business in !erms of the cash nows the bllsine~generates - EBITDA, or 

eal't!ings b~rort.· taxes. interest, depre~ia tio'l and ~rnorti7.allo\1 - times ~ lI'arket 

multiple. Whereas public I;ompanies measure valuation in terms ofmarkel 

capit~li1J1tion, price 10 e317lings ratio and earnings per share. Most privately-held 

corporJtlons evaluate investment opportunities on 31l after tax cash now basis 

whereas public companies eyaluate the Impact on the price of its stock. 

Tax policy plays a materia! role in evaluating thos"investment dedsions for 

privately held bUSinesses. The recent framework for business tax r<'form released 

jointly by the Obama Administration and the Department of Treasury strongly 

, DeC~r!o. SCOtt, Andrea D. Murphy aml/ohn I. Ray, America 's LorgeJlt Privott 

Companies, Forbes Maga'tine, Nov. 3, lOIO. 
12 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.003

Mark Smetana - House Committee on Ways and MeallS, March 7, 2012 

implies thatlhose organized as pass through emities are advantaged in the cUlTem 

tax code liver corporations, This is ~imply not the case, Acrordlng to J report from 

Dr. Robert Carrollalld Gerald f'r.mte of Ernstand Young, America's pass-through 

businesses reported 36 percent orall business net income but paid 44 percent of all 

feiJeral business illcome taxes. l furthermore, the pass·through talC !"('gime 

recog\:lttes thatlhere is a fundamental difference between closely·held busineSs 

enterprises and corporations, especially publitally·traded ones. Among them are; 

Owners of pass through priv;ltely-held companies ;Ire taxed 01\ 

business in'ime whether distributed or retained in the business at 

one level or!;Il(ation whereas corporations pay tli)[es all all income 

and their owners pay jI semnd tax on after tax earnings that are 

distributed to Its owners reating a double 13)[ evell!. 

p~ss·throllgh entities afe ne~ib~ ~lIowlng a disproponiollalC 

aliocatlon of earnings In its oWl1ers based on the agreed upon equity 

Ctllltribution among them. Corporations r~ innexible in the 

allocadon of e .. mings to iLS stockholders. 

III oruer to fairly treat all businesses and pNlvide a consistent Itolicy with 

which businesses can op~rate in the US economy. ta~ reForm must .. duress both 

forms of nrganl1.ation. The st"ted gO,'l1 of providing a competitive business ta 

l'nvironm~nt is important, however, it should not result in discriminating against 

closely-held businesses by, widening the amounl of marginal \'axes Ihey pay on 

l Cilrroll, Dr. Robert and Gerald Pronte, The Flow-Through Busiues.l Sectorofld Tax 

Reform. Ernst & Young. April 20] 1. 
13 

f 

Chairman CAMP. Thank you very much. 

Mr. Martin, you are recognized for five minutes. 

STATEMENT OF DEWEY W. MARTIN, CPA, HAMPDEN, MAINE, 

TESTIFYING ON BEHALF OF THE NATIONAL FEDERATION OF 

INDEPENDENT BUSINESS 

Mr. MARTIN. Good morning, Chairman Camp, Ranking Member 

Levin, and Members of the Committee. I am very pleased to be 

here on behalf of NFIB as the committee continues its series of 

hearings on tax reform. I appreciate that the committee invited me 

here today to discuss tax reform from the perspective of someone 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.004
14 

who is a small business owner, a tax advisor to many closely-held 

businesses, and a university professor of taxation for 32 years. 

I would like to discuss how taxes affect small business structure 

and propose a number of ideas for reform. Additionally, I will lay 

out some goals that I believe the committee should adopt when considering the impact of tax reform on small businesses. 

Nearly 75 percent of small businesses choose the pass-through 

business structure. And, by the way, that occurred because of the 

Tax Reform Act of 1986; prior to that time, you could have one 

level of taxation at the time of liquidation of a C corporation. The 

Tax Reform Act of 1986 enforced double taxation that pushes everybody towards S corporation status. 

From a from a tax perspective, the pass-through model makes 

sense for the typical small business. But while many small businesses start as sole proprietors or as partnerships, the liability protection that a corporation offers is not available to these business 

structures. As a small business grows in size, they are very likely 

to elect to change to an LLC or a corporate form. 

While there are important liability protections offered to incorporated businesses, taxation that pushed C corporations toward ongoing costs associated with that structure versus non-corporate 

structures, such as filing articles of incorporation, paying registration fees with States, drawing up corporate bylaws, and establishing a board of directors. 

Incorporation makes sense for some businesses and would serve 

as a barrier to entry for other businesses. The various models provide the business owner with more flexibility and choice to organize 

their business in a way that best suits their needs. 

As I discuss in my written testimony, I believe that three 

changes to the current law would provide additional flexibility to 

small businesses in choosing that alternative: 

First, allow corporations to own shares in S corporations, or at 

the very least, allow S corporations to own shares in S corporations. 

Second, allow owners of S corporations to have fringe benefits, 

just like employees of C corporations can have fringe benefits. 

And finally, reduce the holding period for built-in gains. For 

2011, it is five years, 2012 going back to 10 years. Reduce it. Eliminate it. But take care of it. It is a difficult problem for conversions. 

Regarding tax reform, as the committee considers various proposals, I would encourage you to keep these goals in mind: Permanent reduction of tax rates. Do not create disparities between the 

various forms of entities. Reduce complexity—big one for me, especially in the classroom. And do not separate the business owner 

from the business; they are really one and the same. 

Small businesses need permanency in the Tax Code to make important business decisions, such as when to hire workers and when 

to make capital investments. And one of the main sources of capital 

for expanding a business is earnings retained from business profits. 

While small businesses would no doubt welcome the opportunity 

to reduce individual income tax rates from their current levels, at 

a minimum, NFIB members overwhelmingly support extending the 

current tax rates. In addition, NFIB members strongly support repeal of the AMT and the estate tax. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
15 

Pass-through businesses must be included in any reform of the 

Internal Revenue Code. If the rates were to go down for C corporations but remain unchanged for pass-through businesses, it would 

put pass-through businesses at a competitive disadvantage or encourage businesses to change to a less favorable business structure 

simply for tax reasons. Additionally, this could lead to higher taxes 

for pass-throughs, perhaps as much as $27 billion a year. 

NFIB strongly recommends that tax reform be pursued comprehensively, addressing both individual and corporate taxes. The 

typical small business spends about $18 billion on tax compliance 

costs, some of it to me, a small piece. There are some areas of the 

tax law that are significantly more complex than necessary, such 

as the small business health insurance credit, which requires me 

to do a five-page worksheet in a tax return before I can even tell 

whether the business qualifies for the credit or not. Ridiculously 

complex, in my opinion. 

Additionally, in recent years, the IRS and Congress have attempted to close the tax gap by forcing small business owners to 

become information collectors for the IRS or through increased 

withholdings. Two such efforts, the 1099 paperwork mandate in the 

health care law and the 3 percent withholding requirement, were 

so onerous that they were rightly repealed in 2011 before even 

going into effect. Both of those requirements would have significant 

impact on my clients. 

Congress can build on the success of some reforms to the code 

that have made tax filing easier for small business. Two examples 

are the increased Section 179 deduction to the $500,000 level, making it permanent, and expanding the use of cash accounting, making it available to any business with less than $10 million in sales. 

That would be a big help to my clients. 

Finally, do not think of the business owner as separate from the 

business itself. Attempts to tax small business or pass-through income and salary income at different tax rates would have a significant problem for small business owners. The recordkeeping required to determine qualified income and to allocate expenses 

would increase the cost and burden of compliance for small businesses. 

Thank you very much for the opportunity to testify here today. 

I very much appreciate the fact that the Committee on Ways and 

Means is taking a serious look at reforming the Internal Revenue 

Code, and I urge you to keep in mind the unique challenges that 

face small businesses. And I very much look forward to hearing 

your questions at the end of our presentations. Thank you. 

[The prepared statement of Mr. Martin follows:] 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
16 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.005

Testimony of Dewey W. Martin, CPA 

House Committee on Ways and Means 

March 7, 2012 

The Treatment of Closely-Held Businesses in the Context of 

Tax Reform 
17 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.006

Good mo.nlng. Ch~irm3n Camp, R~nking Member le\oin, and members of the Commin~. I am pleased 

10 be here on behalf of Ihe National Fede.ation of Independent BusIness {NFIB) as me Commitl~ 

conl(rlue, its ~, i .. , 01 hea,klgs an la, ,efo,m. The current 1 .. cod .. impact< ,mali and rla''''v·he'd 

bu'ines~5 in ~~efal imponanl w;,.r.,. S4 I apprKiate Iha! 1M Committee in~ ted me he.e lodaylo 

discuss these Importilnll"u~ I.om the pe rspectille 01 ,omeone wha is bolh 3 smali busines. cw"". and 

ala. praclillonerfor many close ly' held bUiinesses. 

The'NfIB I, Ihe nalion', leading small buslneSi advocacY o,gani~alion .ep.e~n ing over 3SO,OI);,)small 

bu ines. owners acro.. the countrv. I have bt!en a member of NFI8 si", .. 199O. and ha . .. alio ~rved on 

NFIB's iu ~v""rv fIc,;o,d .ince 1996. I have been a full·lime p.ofesS4' at Huso;on Unille.sity in Bango., 

Maine for 32 ye.a." In addition. I have had an accountlf\jj p.actlce forthesame 32 yea". which p.ollidfS 

seNke. to 12S-4mal! bu,ine" clie nts. TheV .ange1n size from $10,01);,) 10 $10,000,000 in s~ es and lram 

1·125 emplovee •. Prior to Ihis ~gmenl of mv Hfe, I was. la. manager il P!'icewalerhou.eCoopers in 

!!oslon. 

The typical NFIB m~mtJer ~m~l""s about 8!<> 10 emplave .. , wilh annua l g'os, receipts al aboUI 

SSOO.OOO. All 0INFI8', membRf!,lr.e Independentlv owned. which i. to sav that ncne are publldy 

Iraded co.poration •. While the.e rsofK1.one definition 0/ a smali bUSiness, the problem. our members 

confronl relatiVe to Ihe tu codear .. re resen ",e 01 moSI m~1I businesses. A few con,i,lenl (on(erns 

a.e rai,ed regardle •• of Ih .. Irade or indu.try \p.WhiCh Ihe ,mali bu,ine .. I, engaged. 

As pall of .epresenting small business owne.!, NflB f.eQuent ly conducts SUrvl"ll of both the NF!8 

membership and smail bu,ine ,e, a, a wl",lf, and taxes consist .. ntiv rank as one aflh .. " bigge.t 

COtlcernS. In the most .ecent publication of the NFIO Resea,ch Foundation's Small Business Problems ond 

prio<mes, 4 ollhe top 10 !mall business-concerns a.e tax ·re lll~.' In addition, the monthly Small 

Bu,iness Economic Trend. SUNt'V conslSlentIY . anb ~xes afarrong the mOSllmp<lrt~nl problems f<>tlng 

,mali busines,e.: 

Busi ne ss St.ucty.8 

One ol lhe fi.,t o.ganlt~llonal issue. encounle.ed when lo.mlng 11 busines,'» iu-le8al lorm. The legal 

fo rm ,ho,en has impHcation, 10. la. e" liability, ,tanup costs, rootinuit'/, compcr.itn5n of ownership, .nd 

mhern,atlers of concern for !.he bu.in .... owne •. Oilleal 10 Ihe busine"owne.l, Ill. clal rest to 

operate over Ihelife oltlle business, lndudinB !uccesslon 0 ' termination. Tl)eowne , c"el aPout the 

va.iety 011"" cost, (inrome, pav.oll .• etUrn filing. e lc.j that w;U be incurred a, we~.s Ihe CD5t.oi 

compliance wllh the ,elated laws. 1\ first meet n~ with a client would include 311 thost topiCS. 

I William I. O""n~5"""U susi ..... ProIJIt,... QM Priori/I ... , Nfl8 R",,.,.,,,,, fo~nda ion. W."'inglon. DC. ... ,ie. 

'lnl ~e l.te.l Sm.IIBU,I"" .. Economic Trend. \.urw>, Iaxe ••• nked Ihlrd ."""'1 Important preblems. SmoH 

B",IM<S CcoflOmic 7m>d" NflB ~He 'ch fo~ndatlor>. W.,/Il"iton, DC, feb,uary 20t2. 
18 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.007

The vnt m~Jorlty of 5tnall bUlln~5s.e s ~re t~.~d iI~ N SHhrough entities, with nearly 75 peru'nt choosing 

a pass·through bu.lne .. structtire.' This mean, that mo.t ,mall buslne,ses will OilY Ih~ir taxe. at the 

individual level ratherthan th ~ corporate level. From a ta. perspective. the pa,,·tl1,ough model mak~ 

,en ... fur the typlcal.mall buS!ne ... 

Sfl'~11 businesses iI<e.also overwhelmingly prlvately held arn:llndependent. Nearly 60 pe~e~t 01 small 

leJT1p IO'/Ing) bu,ine,." •• reowned bV one Indlvldu.al, and publlclvtraded .mali bu,iness.es amount 'a 

on/¥ ""e·!"nlh of 1 percent of .mali employer." MoreOller, small empiO'/ing businesses are also 

ovefW~mingly nol held bv another enlily-only 4 percenl are even panially owned by another 

business oIJ"On.profll.' 

While mo,1 'me!l bu,ines'", ,tan oH as ",,1e.proprieloBhlps or pa[!ne .. hips. Ihe !Iabili ~ protedion Ihal 

a corpo,atlO!1 olfer,1'l not lV.lIa~e fo, these bu.i~e.ss st,uctUres. lithe busIness i, liable lor a debt. Ihe 

bu,ine" owner', "",~. I ",s.elS are . 150 at risk. The h. RefD<m An of 1985 m~de sl'Vt'ral changes 10 

the u.alion of S·CorpO~tio'1s, reducing I~ ~ tilx i~bll ty for small busines.e', bul al.o providing the 

liability protection of a C-Corpo·" I1.J<>n. The passage of thol" changes has led 10 an e>plosion in the 

number of S·Corporatlons. In 1985. 22 pe~enl of all co,poration, were S-ec'poratlon,. tIV 1990 the 

figure has risen 10 43 percent, dndT"oday the majority of corporations Ire S·Corparatlons.· 

Busine,s.es ~hafl8e Iheir .trunure very in r~n ly and Ihe ~ W<I~ tonlrlbute. to thi,. I for example, 

there Can be tremendous costs when an S.(orporiltlon elects 10 conven to. (·Corpa/allon, paniculirly 

Ihe built_in gai", la" whk.h su bject. .sselS WhiCh e appreciated al the lime of con .... "ion 10 iI 

corporal\! leve l U> If sold within five yean (lO vean fleglnning In 1012). There are se«eralln'\allces 

where this lax would be due In the yea, 'ollowlng con"""io~ when there i. nol n"""ssarilV the ca,h on 

harn:llo pav II. 

Additlonallv, it ,""ould be.note d that, while Ihere are important Ij~bllity protecllon, offered 10 

Incorporated bUSinesses. [he re are al.o both startup and cmgoing COSI5 ~1HM:iated wilh [hal structure 

versu, non·corporate strunure,. FIling article, of incorporation, paying,iI reg;Slratlon fee with the state, 

drawing up corporMe bylaws, changing all slgnageand corporate corresponden,ce 10 Ind icate the new 

IVpe of entity, .e!tlng upa board of dlrecton;. a nd fi ling an a dditiona l laX ",tUrn """JuS!" few possible 

exampl\!sof administrative startup costs. In addition, while most 'la!e lilWS reqWre establishing a board 

I F1 ..... o' . ,1 .lle ""ponded ,h., lO.9"l1"tcenl orK,,,,,,ed •• soje proprieton, S.B·percent •• p.nnersl1ll>f.. l5.&-

percent I. t-Ct><P'. ~O.9-percen' •• !>-COIPS. Il,4·pe,,"n' os llCo •• nd 4.2·perceM ., otner/DN~. 8u.'~" 

SlrlJCh'~ - Nflll ,,,,. 11 Bu,ln"" 1'011, Nfrs R"'."ch FOUM. IiM, W .. nlnglOn, oc. Volu",. 4; r,,". 1; 201M .... 

· 'O,d. ' Ibid. 

' 501 BuIlMln.lntem.1 Revenue \.eM,e. U.s.oep.n",onl oIthe Tre •• ury. Selecte~ Histonc," .nd Oth ... 0.,,- I.ble ll. Winter 1999·2000. 

AI", ."", SOl To. Slats - 5 CQrpor3tk>n 51.ti51;'" Inle,n31 R • ....,ue S ...... i<e. u.S. De".rtment of the Tre.,ury, 

"v.lI.ble n : hup·llwww.I.leO.ll{toXlIJI¥bu.lij.stdW9rti<.eill!d~6:!OSOO.html 

I '" .n NFIS """ey, anI'\' 1 perc...,t of bu.;n ..... ' lu!d eIlange<! th"" 1e~. 1 rOlm wl\hln llu! pr...;ou. 3 V"". Of Ih. 

,mall busine,,,,, ,1\01 did cn, nle tnel' bu,'""" "",c,ure. 39 ""rce", ch.nged to .vold U. bilitv .• nd 17 percent 

cn.ng~d lor to. rea"", .. Bu.I".". SttII<1"~ - NflB Sm.1I Bu.I"""" Poll. NftB ~",earcn found."on, W.dling,on, 

DC, Volum. 4; r"!Ie 7; 2004 
19 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.008

of directors. more than two-thirds of small emplO'/ers. virtu.lly all of whom ire p'lv~tely held, $;IV th~1 

Ih~ r baard ex;'" primarilvto AIIIl'gal Qu:remen[S and nO! nece.sa ri ly .. an entily 10 govern the 

bu\ine$S_ ' In other word~. Incorporation makes ~nse for some bu"ne"e$ and would sel'Ve a. ""rf'er 

to ntry f,,. oth~" , 

Wnile Ihe variety of bu,l"e" S!ructure$ m,sht lead to ildditlonal fu les ,n the code. v.rl<lus models 

prcr.ide Ihe bus;ne" owner with more ~x lily ."d choice to orsani!e their business in iii wav thaI besl 

luin; \tie needs Oflh(> bu.ine ... EntiUes ,uch a. sol. pfOpri~to"hip' and s.-co rporalion. can ensure thaI 

a small bUlines, is nOI overburdened wilh eXlral;oyers of lil ~alion . In Olher cases. !\fuclureslike CCofporatic% S-CofPtlriitiOM, and lfrnited Uabllily Corporations (LLC.) can pro!",1 the buslne" oWner 

from perlOnilln.bilil\', In tilt: end, the structures promote the ma. 'mum amount.of nex ibility loallow 

thebusln .. " o" ..erto ma~e dedsions based on the fundamental, ollhel, business'. Il lhe bu,ine" 

grows or ,hangel. Ihe dillerent structures allow the business oWr\et to adapt in such .. w;ov thilt the 

busine" continues to opetate effectivelv, 

In add it ion, we recommend ma~i'1ll three change$to cUrrent law that could pro'o'lde additional flellibilily 

to small businesses. 

firsl, other Ihan certain non-profits. oo poration, are currenllv not 31lowed to own stock in S--

Corpo'~tion •. • Allowing .uch ownership would be h.,lpful to .mall busine .. own .... and would prevent 

the involuntaty termination 01 corporatio"-'I1' u~. which 1~ u,ually a surpr,se to the bUSiness owner. 

At h~ very least, " would dec,,~a 5e adminlstrati .... -cost~ if one S·CorpofaliOfl could OWn shares in 

another S·Corporallon. 

A second issue with business structure choices Ihat could makc;.owners· j;oes simpler Is in the area of 

Iringe benefi". If. b""in~ss owne r is ernpl~d by a C-CorporalilN). h., or.h~ c.n hav~ lringe benefot, 

like other mployees_ II the S-{orpo,alion or pannership forms a.e elected. the owne r can have no 

fringe benefits.!O Thi. would re$uit in complex planning to help tfie>@"own~' have similar co .... .,r.s.,. 

and the t •• results dlHer as we ll. This i. needlessly comple . We .hoUld require thallhe fringe benefits 

be non·discriminatory. but they should be allowed"" matte. what form ltie tIil~i e" entity;s. 

~inally, r.,ducing the holding period for the built·in gains la. would do much to promOte fiexibility lo r 

small bu,lnesses, The built·1n gains tax Iocks·1n capital assets il a C -{o'poration el«ts to change to SCorporation Slatus, and reduce$ economic efficiency. NFI8~pp<eclates Ihat the holdlnl per\o-c:i ha, be.,n 

red\ICed from 10 years to,S ~ears, and. it the .... ery IeIlSt, lhi, sl>ould be eKlended. 

GOiIls for Sma ll Busine" ~ Reform 

Ao th., Committee conside rs tax reform. I would encourage vou to keep these mosl impenanl goals in 

mind. AchieVing Ihese goals will greatly enhance the abilitv of smililand closetv·held businesses to 

thrive In the 21" century: II permanently keep [he tax rate.s low. 21 do not e.eate di,parity between Ille 

• Ibid • 

• 26 UK ~ U611blll )l!11 

'· 26USC~ un 
20 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.009

corpa"'te rate and In i~idu~1 r;o te, ~ reduce complexitv, and 41 do not sepirate the b~sln e •• owner 

from Ihe b~.ine.,. 

According 10 ~ Feb,ua,,/"2012 Small Bu.ine" Economic T,end'S survey, 18 perc!!nl 01 'm~1I bu,in",se, 

reported Ihall. '" wa . the single. most Import.nt problem facing them today." Small b~;lnesses need 

pe manenCjlln the tax code 10 make importanl buslnessdedsion5, .uch a. hiring wo,k!!" and ma king 

~pital'e.pend tu es. While .mall businesses miKh appreciat ed the work done in late 2010 to keep , rille,low"{o, .nmh ... two ye.", we .,,,again faced with Ihe lID',ibilltv thaI thaI ,.Ies willlnc'e.,e fo, 

Indi~idua11!lC0l11 e a~es, estate taxes, cap"allain5 el, and di~idend5 ta xes at the end of 2012. 

Without ~nowil;E I)'h.t their tax liab ility will be 31the end 01 this year, b<.JsinelS planning be<omes ve,,/ 

difficult for ou r nati<1h', numbe,one job e'e.to .... 

Ind ividual income tao rate. are paid bv pa,,·through bu.in""e., which are re,ponsible lor 54 pe rcent of 

ou, nation's priv.te secto. l"opto.ce. U One in ~ ,mall businesses e><pe.rience,a continuing ca.h fiow 

problem and one In 11'10 buslno!'S.s'" lace regula. cash now prablems, which I. exacerbated by higher 

uns. Higher individuil income l/1,11f,. ul away al the ability 01 small businesses owners to ~pend 

money on theicbl15ine ... One ofth"I1) • ..., sources al capilal lorexpanding a b~sine" i. earnings 

retalrled trom business profits (Le. 1M "moul't 01 money av.ilable aile. laxes h3~ been p.id~ . As 

busine"es are laced with the thre at th ;ot t"x", i\llligo up neXl year, they may suspend plans to hire and 

r 

Th!! 3nnll31 consr!!ssionalla. extende,s s ame, wh ich for seve,al yea.s has induded the /I,~ernatjW> 

Minimum Tax {AMTI. aute, even more uncertainty for lJ$l!,e~s planning. This IS e,peclal", true for tax 

prepar"" " nd makes lax planninillor a cl ient even more of ,,'challenge and Increase' the potentlallar 

error •. A mOle celta in talc cade will help to pramote prudent bIIsfness lannlng and decisions and 

improve compllatlCe. 

The unce,taintyof the esta te lax i, major pmblem for I.milv awned businllS'''', The planning ca'iLS 

.ssociated with this tax are not orlly a drain on busl""sl resou rces, but also ta k,mprley away from the 

day-to-day aperatlon, and inv"'tins1n Ihe busines •. Between 2002 and 2012, the exemplion a nd tax 

"'Ie hav" changed nine tim ... , which mak"s It"spedallv h •• d ta plan for family busi .... ,se5. Next year, 

tl\e,at eis set to Increase t055 percen t with onlv a Sl million exemption. 

While small businesses wo~ld na doubt welcome the opport unity to 'edoc" Indilliduallncome_Uu rale, 

Irom thef, cu rrerlt levels, at a minimum, N~18 m!!mbe" overwnelmingly sUpport perm.nently ~eQding 

the current 2001 and 1003 talc riltes. " In addition, NFtB member. strongly suppa" repeal of the /l,MT 

II S""'U au.,~ .. fc","oml< T"",d •• NFtS ~ ••• arcf"l FOlmdatior>. W .. ~I~aton. DC. F.b,uaryXlIl. 

~roll, ~"""n "dG ald P,."t~ . T~ Flow Th<ough Bu.j"~ .. SnfO, or>d T.,.. Rqalm: TIr ~ f rOt>Oml<Foolprlm oJ 

,~ Flow. /1r'Qugh Sntor ~rrd 'h ~ ""le~llollmpocl a,l"" ~Ja'm, Ap.illOI1. 

II tn a l010 MI!'mbe, 8allet, 8911<01 "IrlB Mem1>e ... u~""'ted e<tend",w oll the Indi.,d",,1 tII 'or .... "If/a Mem~' 

Balltll, vol. 559, No ... ",,~r20JO. 
21 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.010

and estate tal<, bvt il this is not immediately pmsible. providing • long term salmion 10 protect small 

bu,in"",e, would be very benelic.allo them. 

Address rOlf Reform Comprehensively ond Do Not Creole Disparity between the CO,PO'Olt Rote ond 

Individual Rate 

Pa..--th,ovgO bvsi"e.o.". and the many small buolnesoes Ihat choose a pa..--th rough structvre, mull be 

Inc luded In any reform oIthe tax code. The <u"""lla. fale, 10f p.O.-thfOugh bvsine •• e. are "milar 10 

a C~p'pfatlon· •. If the fal es were to go down forC<O<pofations bul remain unchanged lor passthrou~1i buoln"'SM, it would pvt pa"-throvgh bUsin""e, at. competitive dj,ad\lant.ge. A similar 

oUtCOme w""fld be reached If, as has been proposed in Ihe Pr",ident', budget lorlhe past 3 ~MO, the 

lap margin'll~ flIl es on individua" a,e allowed to .eWfn to p.e,2001Ievell. At the""ry lea", Ihe la ~ 

,ate paid by paso-through bu,in,ss.es should be the same rate that applies to (-(orOOfatlons. 

II a slgnlf1cant di.par~y between t •••• tes for C-Cc'po.atlon\ and pasS-lh.ough bv,'nesles was en,acted, 

Ihi, W<lvld he particularly har",fullo small bv.i"",se.and mishl lead them to c~ange the form of thei. 

business so~ y lor laX ruso';!>. ~ r:.hange in ash ovtfloW! reSUlting lrom a change In the form of 

bu'in .... <ould~ave one or more It?hs)n the bu.i"" .... If the cvrrent individvall •• r81", are allowed 10 

rise ''1 2013. Ih;'; will con an eIIl'n g'eat"! r umberol job~. I wovld eJ<pect a number of my d'enU to 

chanle their legal form solely for Ihat r.ear'1even If it (o«,lhem in the long rvn i t h~ time of sal, or 

dissolulion of their buslness. Sho.tterm didi'ions win whe~ il comes to cash flow. 

"~ally, il Conllres, pv"u", a ·corporate..,nly" relonp Ihat e liminate, deductions and cred,ts for a lower 

corporate rale, ma~v small businesses could end up payln, addil lo~a l tax", without a ny CO(fespondi~g 

benefit. A 201 1 studvfound thai. In lot.l. pa'HhroulIh bllsln .. " ... benefited from 23 I"'fCenl of the 

app.o. imllely S 1.16 bUlion ifIaMval oosln.esl ta~ expendilU..es_" - RepeJI 01 these provisionS could el)(all 

sub.tantial ta,increase:> lor pass-through bu.ine ..... l hat could /)l!lIalively impact employment Ind 

growth in the pass-through sector. Ttl .. !ludv found that elim;nalinll an businesr.es tax expenditvres 

would in{(e.s~ the inrome la.es paid bV ind ividval owne .. of Pa.HhrtlVllhbu. inesses. on averalle, by B 

percenl 0' $27 bil!!on annvilllv's t. ' 

~or illithese reasons, NFI8 .trongly recommend. th.t ta. relorm be pv"ued comprehen .. v"'v. 

addressing bolh indMduil and cerporale taxe •. 

Reduce CompleXIty In Iht To~ (ode 

The Iypica l sma ll buslnes, spernJs on'lUally belween l.7 billion and I.B billion hov .. on Ia. r:omeliaflce 

and Slg billion 10 $19 ~II!on on (OmpllanCf costs.'" The ' Mullis th3t88 percent of small business 

" Corroll. ~a~t1 ... nd Gerald Print •• rIM' flow TMolJgh 8JJf;n~" Steforond To~ lIefor"" r~r f<or><>mIrFOClprint af 

1M flow-l~ro","h Ste.a. and 1M PoI~nl;m ImpOr. Of 1<1.0" R~form, April 2011, 

" Ibid . 

.. Oonlld Del""o, s.con Sitma, • .i<>~n Gul'lon. WU·l.l"lllH, and jo~n O'I-Ia. o, !J9,.~ore (.limo!no a/5mol/ 

Bu.i~eS4 To.pOl'<" CompllofK~ B~rden, Pfoct'O!dlnso of tne 2007 IRS e.,<n ""'I nc •. 
22 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.011

Owne ... nOW hire a piid t3~ pre pare rto complete Iheir retllms." Small bU5;neS5 Ow nerS allO spend on 

ave.age $74.24 Jl!'r hour Of] the paJl!'rwo.k associated with tax e<>mpliance- Ihe high~1 papetwo.~ 

cost Imposed 011 sma ll bU5in~s bV the federal government," Unli~e ala rse r business. small business 

does not have a finance d"llartment or B "alf 01 accountalltsand lawyer. to Io<us on the nuallce. alld 

changes In Ihe t30 laws. Nor doeslhe typical smali buslneu have i full-time human .eSOurUS speciaiisl 

10 keep "P wllh the la. change. Tn,pactilll! heallh ca.e and re ti.ement plan •. III lacl. I function ve .... 

",uth like. part,tlme chIef financial officer for mv diMt!. 

There a)"l'.HIme areaS 01 Ihe lax I.wthat are sig~i kN'tfy mo.e ""mple. lhan neces<ary. For e .. mple. 

the healUt [nsuraoce credit .equlres .. S'pageworksheet in a ta. relllrn. and yeu do nel know if there is a 

credit avallable/ntil you havespent the limeon the worksheel. Va.ious credils for hiring employee. 

hi ve 10 great. PilP"["'Orx bu rden thaI clients rarel\" take advantage 01 ony of them, small busines>!!s 

hire employe ... beca"", they nee" them. not o..,auseol any credl!s theV ge! Irom hiring Ihem. And In 

general. moxt dkmfs are r(0ltven ~ware U1ey aregetling a numberof d~uctlons in tMe code a~d 

cert~lnlv are no! manag "lll~lr busint>Ssln a way!o gener~te deduction •. 

The complicated and. ,n many Ways unpredictable tax code. places a heavv burden on small busIness 

owners. In the end thisleadslo adilitlol1al costs and takes money away from the dav·to-d~y business 

operation. or Inve.tinQ in and upandif\S "'eir bu.ille ... The conlusinQtax code le ad, to more errors. 

which we o..neve is Ihe main cau ... of the.so..c;ol'ed Iax gap. amongst small business owners. 

While Ihe Inlernal Revenue Service (IRS) recently caku.laled Ihal the lax gao Brew o..tween from $345 

bUllon In 2001 to $450 bU llon in WOE>, 11 is verv Impona:lllO not e Ihal the compliance rate \layed 

.Irt~al!v unchanged. " No one dispute. lI'at we shoU,rf.IIS1iive 10 achieve the highest ~55lble level of 

lax compllance. buI Ihe recent re~al of two high-p rofile praiiioionsimended 10 reduce the tax KiP 

IlIuWate Ihedilficu ltles associated with dOing \.0. 

In 2010. a ~rov;'ion in Ihe PatientProtewon and Affordable Car" 1\1:1 would ha"" e~panded 1099 

reporting for bus,,,,,s>!!s Ihat purchased mo.e than S6001n gOOdS and serv\tl:s from 3 11 oth~ 

busin~ ... s.'" Before that. ill 2005. Ihe Tax Increase Pre-.lenlion and R~on(lliation Act created a neW 

requirement that l<1deral. state, and IOGI gOV<1rnm<1nlS withhold 3 pertenllrom p~¥.ments lor goods 

and service •. " Bolh 01 Ihese me~.ure. were strongly opp<><ed bV NFiB and other~. Slid lor good realOn. 

The burdens that the'" pro"".ion~ would have placed on sm~1I businesses were mucIJ;u,ner than the 

additional incom~ thaI Ih e IRS would hav@polentiaIlVcolieded. Fortunately 10revE'ryone. ttJe>e 

prOViSKlIIS were neve. allowed to go inlO effect and WerE repea led I" 1011.,1 Future ellorts to oose the 

'" 

" r"" Camp'''';ry ar>d rh~ IRS - "FI~ Smoll B",m~ .. Poll, NflS He .... «!> f oundalron. Wa.h i"i\cn, oc. Volume.6; 

I .. uo 6; 2006 

" r>opt:<WOfi< or>d RH:Ora (npi"9 - I¥FIB Smoll Bu./(Itu Poll. NflB ~e .. ~rch fO<lndailon. Was!oing'on. DC. ~oI<Jme 

3; !"ue 5; 200). 

0' rQ~ Gop for rQ~ r«Jr 1006, !n""nal Re.enue Servke. U.S. Oep.rt"",n' of the T, .......... J' n. 6, lOll 

"'Settion 906, P.l. lIH4~ 

~ior> 511. P.l. 1011·212 

" H.R. 674. whld> '"?taled Ill,,) percenl wllllOoidinl reQulre"""'l became P.l. 111·2S] on No .. mber 11. 2011. 

H.R. '. whOoh .""".,ed the 10119 reporMII~qol ... ment t>«.m. P.l. lll·IS on .lp~t 14, 2011. 
23 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.012

lax gap b'/ forcing sm~1 1 bUfinesses 10 be " informa tion collectors" for Ihe IRS, or by increasing federal 

Wilhholding. will aim be met wilh <liff resi.-ance. 

The tax g.ap is a symptom of a lax code thaI has grown far loocomple •. ~ortunalelv, by l3~ing conorele 

Sleps to 'implifVlhe code through tax reform. Congress Can increa'e compliance. whTle al<o redoong 

the burdens on smali bu,lness"s, 

eon~ess can al;o look to a few successlul reforms to continue to SImplify the code lor smali bu.ine.~s. 

Sectio~1.79 upensi"lll, j good e xample of simplification and provid inSlhe \ll1all busine ss wilh an 

immedlate\<>urce olnpila!. Since 2003, Congie" 1'1 .. steadily Increased the allowable expensing 

amount frot\l $25,000 to $500,000 for tu vear 2011. AdditionaliV. Congress upanded Section 119 

expen,ing to 1!1\::1'IY' real prop"rtY wfth Ihe pa .. ageol theSnwIlBu,inessJob, Aer. " WITh Ihes"~ftlrt', 

Congre ss has prOVid} d the majority of small business owners wiTh an immediate deduction 10' almost 

any investment thl!Y makein their businesse •. WMe increa,ln8 the Section 179 deduction over 

$500,000 might not benefit many \ll1311 bu!.lnenes, the $125,000 limit (plu,'ndexin,) that's in effect for 

2012 should hi! inc'ea!oe<l and sllould InClude real property. 

E~pensing ~Iso reduces the complellil'f of the t.l'I code. Instead 0/ following complicated depreciation 

\Chedules arid Keepin8 the paperwortla,sociated with e investment, the business Owner ca~ simply 

• claim the deduction In the year Ihe Item!<. purcha<e<l_ As Cong'e" conSider. ~ecifk i<sues in the code. 

making the hlsher Section 179 amounts perrriaoenl would 80 i long way to reducIng complexity and 

providIng an Important U~ benefit to small business owners. When conslderong Ihe >tress of my dients 

on Ihe lopicol ".pensi"ll the W'lt ollong·\i"",d a"$. ",,,king the law permanent and eliminating the 

rolier COaner 01 the mUlmum deduction would ease tbeirn)Jnds considerably. 

Another eumple olsimpllficatlon Is allowing the e.panded useo/ cash accounting. Under tMe current 

law, a taxpaye,with Ie .. than S~ million in eross receipts i. able to ea'h accountlns rathe r than 

accrual accounting. The cash atcountln8 method Is much easier lor.small business owners to fOllOW and 

mOle closelV matches the way that a .mall business owner will ~eep hts books. Allowing any buslne" 

entity with leve~u .le.s than $10 mlliion to use tash basls <I"ountln8, as Io..oB aslherost in~entoriel 

are not deducted until sold, would be a small b~t important change Ihal would ~~flt small businesses. 

00 NOI Separote !he Business Owne< from the Business 

A small business owner Is inuorab!y tied 10 his or her business; no matte, what busine" 'IrJICp re the 

small business owner chooses. I'OU ClInnotsepa,are the busineu owner from the business. White thiS is 

most apparent for bu.ine=s ,truclured as pass-through entiti ... , it is true even in the case of SITIiI\I 

businesses 018anlzed 35 C<orporatlons. Far many small business C·Corporatlons, t~e corporation pay5 

down iii annUill recelpu in busine,s e~p"nse$ ~ nd salat)', .uch that the corp<lratlon Itself ha, alm()';1 no 

ta,liabili",." 

" P_l- ll1·240 

" &i.ilN' .. Srfllcl"r tme S .... II eu . ....... Poll, NflB ~e_r<~ FOU"d~tlort ...... ngtort r DC. VOIY"", 4; I .. ~e 7; 

,~. 
24 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.013

Attempts to !~~ small business or p~SS-lhrQ~gh IllCOfl'Ie lind Iarv income ill Herenll~X riltes would 

('e !~ many new problem, for ~mall busin~ .. owne ... II i, ~tso (I)~nler to the goal of ,impllfying Ih ~ laK 

code. fhe required rt'cordlc eeping 10 delerfTline Qualifie-d ,,",ome and 10 allocale expen'es would 

increase the COSI and burder> 01 compliance for ,mall businesses and likely require professional 

"«I)unting service. 10 oversee and hilndle POlenti"I .. ~dil Inquiries bV the IllS .. nd/or state I~ X 

authorilies !for state, that conform 10 Ihe ledefa l tax code). 

C0!'Clusion 

Smallll!u.rnesses truly are the engine 01 ecoflOmiClfOwth. Thi. lsn't ~,t a ,logan.. a, smail tlUsinesse, 

creat ed twt".third. oflhe net neW jot>. overlhe last dec:ade. Small b~';ness owne ... re ri,ktakefS and 

ent.epfeneu They a re the ta<! b~siness", to layoff employees when bu.ine,.decllnes and .Iow to 

rehire WMn business pjc~ , up. The owr>er wo.k. additional hours ~ntilthey can taKe it no mare. When 

small business hira .. n emplovee. it is Iheir intent to k~p them on for the long fun. 

The current ta~ code has bec:o,,\ea ~onfu.ing and unpredictable challenge for I~ ast maJorily of .mall 

business owners. Our t .. , laws.should nOt dell!( Or hinder Ihe ability of small biJslness owne',10 creale 

or""pand their businesses. laxe"'~,e a major issue for all small bu.in""owne .... r .. law can dictate Ihe 

business decision Ihal at! owner will make, whether it is the typeo! wucture 10 <>dOpl or whether to 

make an Investment. 

Afte. decades 01 patchwork changes 10 Ihe talC~de, (ongress needs t<J make major ad ~stmenu to <Jur 

lax laws 10 reduce complexity and conf~,ion anitencou r,ilSe bu,lne .. glOwth. I appfedate that th~ 

Committee on Way. and Means is laking a 'ie,io~s 100II: at refofminM t~ tao code and mge vo~ to keep 

in mind the~n llu e challenges that face .mall busin.'se~ 
25 

f 

Chairman CAMP. Thank you, Mr. Martin. 

Mr. Tucker, you have five minutes, and your written statement 

is part of the record. 

STATEMENT OF STEFAN F. TUCKER, PARTNER, VENABLE LLC, 

WASHINGTON, D.C. 

Mr. TUCKER. Chairman Camp, Ranking Member Levin, and 

Members of the Committee, thank you very much for the opporVerDate Mar 15 2010 15:08 Oct 21, 2013 Jkt 078663 PO 00000 Frm 00029 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\78663.XXX 78663

wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.014
26 

tunity to appear before you today to testify in an area to which I 

have devoted my professional career for almost five decades—that 

is, the legal aches and pains that are facing closely-held business 

owners. 

I am the senior tax lawyer at the Venable law firm in Washington, D.C. My practice specializes in closely-held businesses, from 

the inception to the end of the business. I have a teaching career; 

I have been teaching at law schools for 42 years, since 1969. I am 

currently an adjunct at the Georgetown University Law Center and 

at the University of Michigan Law School, and I teach business 

planning at Michigan. 

By the way, Chairman Camp and Ranking Member Levin, I am 

a Michigan native. I was born in Detroit. (Mr. Levin: You may remember the Richton and Dexter intersection in Detroit; that is 

where I lived.) I grew up in Flint, Michigan. I am a graduate of 

Flint Community College, which is now Mott Community College, 

the University of Michigan Business School, and the University of 

Michigan Law School. 

I have absolutely no political agenda today. My purpose is to 

share with you the concerns that, in my experience over the decades, closely-held business owners face on a daily basis, and suggest Federal tax reform that you should consider to address these 

concerns. 

In my experience on an everyday basis, closely-held business 

owners are particularly concerned with four issues: first, growing 

their businesses, specifically capital access and capital formation; 

secondly, protecting their personal assets from business risk; thirdly, protecting the business and its personnel from adversity; and 

fourthly, business succession. And in fact, Federal tax policy impacts on all of these concerns. 

I would suggest that this committee consider four fundamental 

reforms of the tax system that would enable owners of closely-held 

businesses to concentrate on what they do best, which is actually 

running their businesses. And these are: a single-tax regime for all 

electing entities; secondly, an entity-level tax for non-electing entities, with dividends paid deduction; thirdly, simplify compensation 

rules; and fourthly, tax rate parity. And everything else is detail. 

Let me amplify. Okay? 

First, on the single-tax regime, I would make this elective integration. I would have it apply to any entity, whether a corporation, 

a limited liability company, or a partnership. And I would leave the 

choice of entity to be determined by the business owner based on 

non-tax considerations such as State law issues. Effectively, we 

would have a check-the-box. And this is because many of them are 

concerned about State law concerns, and should not be concerned 

about tax law concerns. 

The guidance for all of these pass-through entities would be the 

partnership rules under subchapter K. And in fact, I would eliminate subchapter S altogether and, therefore, eliminate all the traps 

under subchapter S of the Internal Revenue Code. 

I believe that anyone who works for the entity and is an owner 

of an interest in the entity, irrespective of the size of the ownership, should be subject to withholding, FICA and FUTA, and receive a W–2 and not a 1099. And of course there would need to be 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
27 

a transition period to move from that taxable corporation into the 

single-tax entity. 

Secondly, on the entity-level tax for non-electing entities with a 

dividends paid deduction, I would let every entity decide not to 

elect affirmatively to be a single-tax entity but to be a taxable entity. But I would give them a dividends paid deduction for dividends 

passed through to shareholders, which is effectively what REITs do 

today but with special rules governing REITs. 

It would apply only to dividends paid out of the current year’s 

income. To the extent income is retained, I believe the following 

should occur. If it is retained to acquire assets, tangible assets to 

be used in the trade or business within the United States, I believe 

that they should have a fast write-off on those assets, no more than 

five years or the current useful life, if shorter, thus giving them an 

inducement to grow their business within the U.S., not outside of 

the U.S. 

If the retained income is used to acquire tangible assets in the 

trade or business outside the U.S., let them use the longer current 

useful lives. And if it is later distributed, there would be no dividends paid deduction, and it would be taxed to the shareholders at 

their level. 

I think there should be simplified compensation rules. I think 

you should not have to worry about reasonable compensation because, in a pass-through entity, you would not have that issue. It 

would be a single-tax entity, and in big entity. And, in big double 

tax entities, golden parachutes and the like could be eliminated because that should be a shareholders concern, not a tax/IRS concern. 

Finally, there should be tax rate parity. The top rate for corporations that are taxed and for pass-through entity owners should be 

exactly the same. You should not have a gaming issue as to where 

you are and come up with deductions that you do not need. 

Thank you very much for your time, and I am glad to answer 

questions at any point. 

[The prepared statement of Mr. Tucker follows:] 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
28 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.015

HEARING ON THE TREATMENT 

Of' CLOSElY·HELD BUSINF.SSES 

IN THE CONTEXTOf'TAX REFORM 

MARCH 7, 2012 

- Submission by: 

STEFAN ~ TUCKER 

VENABLE LLP 

WASHINGTfiN, DC 
29 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.016

PltOPOSALS FOR TA.'I( RIU"QRM FOR I:N1'RF.rRENEUkl",LCLOSEL Y IIELI) (AN D 

OTm:R) 8 USIN[SSFS 

11m-e .... fo ... bme concepts .... , I bol;"". would _ the lnttmal Re""n .. Codo for 

oJIt:ql<CI'I<urial do.dr held (ond in fiott >II) ...,.;",,_ Ihc:rtby .....wu.g buoin ... ow ... " to 

""""""Irate 011 (i) occeH to ond occrctioo of •• pi"", (ii) ~ their person.1 ....... &om bu,'".''' risk •• (iii) prot<cring Ih. busi ..... ond po~1 ond (iv) p""'idina f(ll b .. inesoi 

M«o;,cs>ion. 1lnd "'" to <xp<r>d sigruflO4nl dollars IlDIIIIuman tapilill in doaJiog ,,-ilh the In,.mat 

R .......... C<>d<; 

A. Siogle Tax Regime fOl All r ... :Jl\",,,&h Erotitios 

I, Thio I'IOIlld appI~ 10 MY ~Ion. Ilmi,..! lilIbilily OOln"""y, i<r><rlll 

~p Of limilt~ ponnenblr00 Toil wwld ' .. "e IIIe <hoi<:<: of <nlily 10 b< doIemIiae<I II')' the 

CfIIft'pn: ....... b.&Kd "" .We It.)"' isI..,., 

(b) ,~ would be • "eh«k·the·bo.v elttuoo ~,";labIe fOf all 

, 2. Toi. would .lim ........ !rBpO wilhin <hcS col'JlOn,ion for the 1II1WU)' (lnd 

... on the wary) pnlOII' 

80s;" ODd adj."ed ba>i. 

R.o<o""m",;.,., of "",d. ood 0Ul;iil< hMi. 

,. "")"QN'wh"_f<I< '1>ocln;'y ..... ,..,_, lh- .~f"" 

po=nt of .. -=hip. """,IJ be""':!"" 10 wilhhold"",. FICA 111<1 n ITA. and """" YO~ W·2. "'" 

. 1099. 

•. 'n.. luid!!nc:e r", ... h jlUH"""-ogh en,it; .. """Iii b< .. bc:h.~I::. 

oliminoUn,""'.-I for ,ubcilopltr S. 

5. 'Tbere would IIe¢d 10 b< • ,ime period 10 move 10 ,110 .ingl. w< rqinlC 

win,,,,,, .t...., .... we eOll""'1""''''' (Th;" would be limn", to tho ond of 19&6 ",-ben C 

toJjIOBli<Ins ""uld .1"" to bc><;»me s corpomti""" wilboul ad.or.oe. w: _""",,a) 
30 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.017

n. n""ble (C) Corponuionl 

I, Theoo tntlties "",uW be taxabl~ at stmdonI corpo,,". I""""", 'ox "" .. .", 

lhel, IIIC<Jm<. depending.", \aXabJ. In<cm<.. 

2. Tho .. ,, <>Ul~ be. dividord! paid Jed1l<1,,,,, fur di,idofwl. p.wtd "'.r<>i.Iih «> \hei, ohat'<hokk"" TIIi. i ... "';1 .. 10 u.. =1 lO.oWioo ofREIT .. bU1 wilhoul ,It< ""Iuisil< 

~1Mi"" ""Iuiremen1S_ 

1. 1lIf div\dcndo paid <Ied""tion would oppl1 ",,1110 di,i.J<rd! pErl oul or 

"'" oun.1It "tat', ''''''' ..... To lbo .xLca' thou"y.uclI in«I .... I. """"'ed. lhe folk>willJ! lWIuld 

~~ 

(al If !be- moil>td ;"""",. i, IIS<d 10 acqu.ir< (onpbletiOtLSlIS<d in tho 

t!"ad<- '" Ousi ..... ~ilhin !be- U"lIed Stato$. <be oo<t bolo •• of ou.;h ~.ibl. UO<t! ..... uld be 

dtpnoc:labl. Ovel S y.;,n. Ih ... gi'i"ll ... ind""""""n/ '" ¥r''' .. tbc- bu>ineis .. ilhlo tho. Un;t<J 

SWes. 

(b) If\ho. ", .. 1nEd inoom< i. U$C<l1O acquire tang,ble ...... uS«! in tbc-. 

tn<le or bu.;n<" olllSido tbc- Uonod Sta~, dX\ ~ basis of...,h t3ni;ible .... 1< would be 

dtpm:i. bl. OVer Ihf "IIJTCII! .... blf.he<J li\la '-'!he Code. 

it) If !be maint<! (DOOm< I. !at .. disuibutN, there _uld be "" 

dividmdo poi<! ded..::ri"", &nd....,h I"""",,, ....oold be ""'00 to !he s/writold .... at thoi. Indi",dual 

-. 

C, Simplify lbo Compensation Rules 

I. n..r. wouI~ be no ~I. I;<Irnpon>alion """"'m:o fm any poMLhrougJr ..,{Ily, ..... mucll ~ &lllU,.1blt ir>como wollld pus Lhro.!'&'t lo!be ..,,;Iy ownm;, 

2_ Tbcrt wauid be II<> ~i"I<l<o pItI"OCbut"" ". <imiilr , ..... for •• ocu,i .. es of 

tlnble C """",ratiu"", leavinB ~ aboul ""ec:utive compenooliOn r" the ~ oflhr-

,d,an,bolckrs, wbt!e....,h «>n<:mtI mllhl be. 

D. TIle tJW:tnIl1t11 illdividualincOln< 1"" oM In. "",.imum OOrponlll: i ... -ome tu 

rol •• should be pili on • par, "" tlut Iht-ro. is no inclintLioo I\> gomeooo f""" or tbi>~. 
31 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.018

A Continuing Battle: 

FLPs and FLLCs vs. 

S CORPORA nONS 

Stefan F. Tucke.r, Esq. 

Venable LLP 

Washington, D.C. 

March 2012 
32 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.019

TABU: m' C01'o'TENTS 

, S CORPORA -nON/LlC CO).1PARISON .. _.1 

A. Struct ........ "."."" ..................... _ ........................ , ............. , ................ ,1 

B. Taxation .. __ .................... _ .. . _____________ .. _ .... 3 

C. F~ PI ..... iug ..... " .... , .... , .. , .... , ...... , ..... 8 

II. Bl1SINESS USE OF FLPI AND FLlC. ....... ...9 

A. R.,.u, Com",1 0"'" the B""ine$.o.,._._,._ , .... __ .. _ ... __ ._." ...... _" ... "... .. .. _ ... _.9 

B. PM'id. Contin"""" o...-......hip ofl'mperty wi thin tho Family Unit ___ ... ___ .. 9 

C. ~ theOwne .. from Liabili,y 0IId CredilOrsofthe Eatity, .... , .. " .... , ... " ... , ...... IO 

0_ ~_ the A~ofthe Emity from the Owners' Liability and Ctediton ....... _ .. .10 

E. UnBauQIlAvoidanoe .. , .... ".. "", .... " .. " .. , .... .. ... ,,, .. ... ,, .. ,, .. ,, ... , ................ , ...... 12 F. Probote A.'oi<bDc ... _ .. __ ..... ____ .. __________ .. __ _ ........................ , ... , .................. , ......... 11 

C. M_ru!.~Anou&lOiIllOSbyParcn\l; ..... , ................................... .1J II. Man. Flexible dlanJ'N5,.. .. ... __ ... __ . __ ... _." ... ___ ." ... _". ___ ". __ •. 1) 

_i_ 
33 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.020

I. S CORPORATrONlLl.C CO.\tPARrSON 

-" Sr;-I1IWP " UG' 

~ STIWcrURE 

Otsanizationa/ · A ""'flOr.Ition _y be: · A rimiled liability compm)' ,,'hicll hat 

. ~ treaocd IS on S <OlJIOI'IIio • more !han 0IIt membe. i. I Slat. law 

only lfil in omall busi ..... "'~1y lltal is taxed .. I pa",,,, .. bip 

<:QtponIIion unl= it ""'"' on . leotion ,,!be"'; .. 

· Tho IXIrponolion must be • · Any "',"",<>lion&! f'C<I"",me,,," domo!c;c oorpora.jOll 111M : would bc: ilTlp<»t<l Ullda lWa low. 

•• Is Mlinelij.ibl • or purpoSCII ..rlhit clIart, ;1 ;, ,. doei IlOl hll"e moK tIwt .. some.! I.Iw it ;'laXed ... 

looS1l, ........ J .• .<IO<ollOlha\~.."yS H 

ihlels D!ber Iha.o on 

=~::1'. 

• 

clwiW>lf o'ioniwiMS 

Joe.IIQ\ t.a. .. ony 51! 

\hal is a 1lOII'"~dtm 

alien; ond , .Joe. I>DI ho .... 1II<lf< !ban 

one- cl ... ohtock (can 

hal'. diff<= in ,'06 , M!If\II=' · M .... llemcnt i! ptriodioaUy · limited only by !be "w .. or's 

-= doct<d by tho " ......... imq,illllioll (.an bc: mIMj!"" by 

· StoIC law \ISIlIIIly p""";do, _i.ro .. ",""boB. '" bolh) II"1II1 tho _ or din:<:LMl i. 

· C"' ''' ~~'''_gem .... t 

I" ~o""m !lie Iffal .. of I io I m .... getlllanaged LtC "illt _"."00 decl"" _or,' 

· Mlnaa"'" <10 no! "" •• w stand r .. eleclioo 

· Monagcn ""'Y """""''''»0 111."",,1 

· 

...... } 

Monag., d<Jes IXI! hi""", bh 

III<mbo. 

· C.., 011<><.>1. dilT .... 1t1 furo:liot!o of1he- LLC '" dilfcrem m&nogcB 

· M oy UIISC lIIetnbc:r 10 """""'" 1Uhj<d 

",ooIf...", 'f\1mllitX 
34 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.021

L -'" · Function of SlalC tow . function of ow. ""'. bul m.on.oger'. 

nwnagerio.l .UIhority i. B .... I3II~ limj~ Ie! Ilw 

.ulhooity ... forth III tho OpomiDt ogreemer>l 

Fgrnlaliti .. 1 · New col'J'Of&lioll mU3I iii. S . Few regal ""luif">Il<flU -""'" olocti"" with IRS within 211. ..... uii'nnrnt< """,tho .tler Iho OlIrli.,.. of 

"'" following: (i) the 

corporation """ 

- stw.holdets. (ii) ""'Iuita 

....a. o, (iii) '"'Kill> doi"~ 

liii0 ....... 

· Slmt m,.law 

req.n:emen"' .. . C 

rorporation 

· MUSlMVO offi""", and dim:l",," 

· Amuw meri;Dj I)'pi<ally 

required (1Idd it' limo d •• iJtllllIN in \he by ln.~) _ 

this is wh= sJweholdC.} 

""" \0 bUe and lire din:<ton and III vow On 

fuodamtnlal chana" 

· SDarchoId<T VOIeo r<qoire 

unanimous wrincn C<lMCtU 

or . mee\il\g \hoI A1UO .. 

noli"". q""""", and voting - """'~ · orr", . .. on: s<ltcttd and 

......,.«1 by th. Di_1OB 

· !)i""""",o;tlon .... uimo 

unanimow ",;'''n """""m 

'~.c Of . _"S Iha< .. 1is6 .. 

~~ '1001Urn, and voti", 

""Iuin: .... n .. 

· Book .. =<>rds of IC«>U!lI. 

and minule:S from 

....... holdn modine:' mUSI 

be kept IS pan oflbt 

tJQmII./ """fSO ofb\lsj"".. 

· Ann.... nUJl!.requircd 

DO.>OJ,o '''' 
35 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.022

:::-.::;, """"M '

... " .......,... 

"== , , 

m; , 

--

I'a .. " 

t=, , , , Off ••• 

, , , .w .;; :::'" 

.. ...... ~ =- ~ I~ '-"'" .... '_ .. . ",,:;::: .. Mw'", 

I' ~ "'""""" ., .. , , "" .. , "'"'~, , 

-, -
36 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.023

• -= ... h:1bof inoomc from Iht · ...... o:lIi2nli:t<ror",,~ IUi:b;lOrn i • 

dill<harge of OIl S dercrmilltd II Jhc eN'ly Ie-.>c:I 

""rpom;OIl" dob! i. · Ho_ ..... the dole"",;""""" of """I ....... from. whether ,,,",,,,,,, from \he dilKharg" 01 slwrtholtler', iW" in<om< "" LLC', d<bt .. ""ch><led from ~ 

beca ... or , ..... I,tJ>C)' Of R><mbtr'. iroM i_ bocaOl$< of 

bankruptcy (under Soctlon DankrupIoY'" inWve"", (wuIo108) iJ 01", del"""i...J " s..ction 105) i.lktenninc:d II! !he Iht entity Itve/ m<mbtr level 

- · O..,. ... lty. ,1>0 .barehold .... 

· Qenendly, !he """"bon are dl=1J~ 

..., JirMly w.cd OIl u.. wed On Iht inoo .... of on UC. 

i""""", of. «>tp<llalion. wll<tller diwibulOd 10 ....." .". maineJ ",".ther dlSlribut«l to \hem bylbe lLC. and .!i<lriblitiOlbloirC 

~bylht Kenerally nol1,, 0<1 <orporatlon, and 

Ji5UibUliono .... gener3lly 

II<>I, .. ed 

T<Wllioo of the · ~ ....... · '_through otpniUlion • Gtn.nlJy 1IOt'~.,.. 10 tax. · $iDgk _btl' - disroprdod rOf tax 

buun S ""'P. 1lUf""," a C ..,.. co:p. and IIu C """ • Ally OIht, LlC _ ... bjoct '" 

eamio&, flId profi" must partn<nltip ,""",i"" undet Subchoptet 

1"IY'",,"".~< ... i~ K UIII .... <lifT .... ", oI ... iflQ,lioo is 

and 

pus,ve 

no! ~ 

invesl"'''''' 

buill·;. 

iDt<lmc ,,- · LtC m ... ' ',I. 110 inform.,i"" ""un> - pi ... Wuablc income ktntt .. Uy <OOIpu""''' 

· Scorp. ".ustC,lc.., lboueb Ibe LLC I. OIl indl.idual, bul informal,,,,, mum _ llXabl. OIly ;lOm !lUll moy h.". dirr=m we i"""me 1I .... ralIY """'puled llQlm<J>t Id<diffem" .... m"'" m ... ' .. lbouih the s ""'1'. is"" be oepameij SIl'Icd 

individllil. but 6I\y it"", IN" moy ... ,. d,tlCren111l>: 

1n:alm<n. fur dil'lemll 

oharclr:>lderJ "" .. ' bI< 

stpOI'OIt"ly ... led 

Ab,li1y of OWIlers · l<>ti deductioo. oro Ilrni1c<i · Single membn - """"" "'"Y uoe "' .... Ioooet of '" th<: sIwe!loldeT"""",k I""",," 1<l Orr..:, O!hor inca""" .~«P'-

\be: nrgani>:a!;"" basiJ and k>Ions mode by W .. limiled by . Hi ... rul .. 1IId pM'l". sharcbolder 10 th<: l>Ctivi1y rut .. 

"0'1'0<111,,,,, · An)' oth<r LLC - member ""'Y usc 

· Los ....... deduct,bIe by th<: IMsos or th<: Lle 10 ol1'sel odroor 

.barohoIJ.~ in 000 iDc<Imc: .. llini1td b ......... riD: 

... 
37 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.024

$ t:DrprItdIiI 

III,b";rsbarnofo.........rup lUI ... and puol~ aetivity loss lUI .. 

• Shatoholder must sat;"fy .. · A""""balll_i._~ ... 

risk ""I .. and lW"i~ "Iimiltd partntJ" inltrnt for ~ 

OI:ljvi,y 10$0 ruin of .pplyil\llille pusi ..... lCri'·ily lou 

· S~bolilu ""'Y carry "'. fo~ di..:llow.d IOU<&, 

",hloh ore In.1i.o:l .. 

i ... "",ed by tho S 

corporlItion in tho DOXI 

1Uabl<: )'oar 

- · DisalI"",lMl k>oon ~ 

<l«Iualons ..... ~ 10 

lIr .h"rehoW., onJ canna, 

klmnsf.md 

AsoetJi \hal mOl' be • If:: corp. h .. c:amI .... · "" UC 1.0 ~-'<PI"5!Iy IUlhoriud III .""" and ~r. 1S from I prior holJ ... 01 or JII'l'>MlI p<Ilp<f1y 

y .... i~ ;;bich il was • C 

""'P" and~i . i!>COme 

in ""cess 01251"",,", 

receipu, Ihcn its .. <t«i ... 

r-i .... i""",me i. ~j«1 '" 

a35%penally 1alI, Ifll':"" roodirion exisa fur J ~ 

S corp. tlecti<>n I<lminal" II1Ih< be&innioa; oI'u.. 4-

= CompuIlU;O/I of · Ba:.i. i. initially u.. arno\II" · !milo .,·miliodly lhe 0/lIOIII1I of ...... 

bolo" of <osh c:ooIribu!cd aDd Ibo eoolributCd ..... !he bal.i. ofpropeny 

boosi50fprq><rty cootri~ 

"".!ribuled · Increased by """Iribuliono 

· locrcucd br oontribulio ... · In..nastd by rntmbo:r' •• b"" of Iho 10 ill< ""'P'=tion and I.".... LLC. debu 10 !be oorpontion, BUT no 

· No ",,"i. for w<IInl:i\ni"" of illCmISC in baoi. fo: dcbu prmni .... ry note ""til po)'ll\t'llo m .... uribe wrporolion 10 OIly "" ""'. (q""",,on .. 10 ... hclher'lhis i. <""'i<ol', even iflho """Ii<.>bl. f"" tit< toIlll1butloll <Ita 

llbiln:holtlor .. I .. blc on !he 

.klM (ho~"Cf, the peroonaJ promUsory nol0\ 

, hare""I"'" <an !.al. out • 

I""" and ,hen 1.,.., IOIhc 5 

~~ '" &<1 a wi. ,~-

Deal .. prnpttIy · An S eo<p. is beller suile<l · By """~ an LLC (Iik. " 

III inwlatc o~ f""" "'" , is oomeUmes tte&I<:<l u an 

... 
38 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.025

, , 

;:';;;"-," 

, ~~ ~~~ ;;:~':',~ ,. ,"n. 

- · The oak cfwilhd",wing ...... m', 

. M~'_ inlOreJl "ill <:IUt • • lOChnic.oI 

I • ',II II< lCfIIlinltion rlJl I"" LLC, if 50% or 

"""" "rille in!en:S1 '" Ibo lie is ooJ~ 

"';""";~ ;- ". within . 12_moo,b period. 

• lkgiMini in 2011. 1I"",,,.lly. a ).8" 

~.~ , .. , ;~ ", __ I taX";lI II< 

. "'Y~ i , DOl !be io:tunt:::' ~~ 

.;;.;;,;;; , ~_~.;;_~ "net p'n thaI would 

, if .. ~ , , , 

1 .......... ,i&lly .. J 

, 

. -'::,"""~ I ~ ~ throuBh IEId 

- tUtmbers. A """"ber'_ ba!is in it,; 

intefHt i. iD<reaoed by !hi> pin. '" 

" ... WIllie diWilntUon of oa!., PfOC«dJ 

no pi • ...."..d II< ",a1iml ;. _ ... 6) ... m.lI<CMd Ie\~l OrtllX. 

with reJp<Cll<l the m:<ipl · CltJHmIIly,)IliO f«lm!lle ~ i, 

of 1IIl. pooc<>tds by Ibo eligible for tift illsWlment mtlb>d 

I· ~:;~~. 0;:, . 

I· ~-;;';' . . . 

M'~ i ~ I .... , , .. ,,~ 

1-"= 

"""*"". 
39 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.026

Allocati_ 0 Allontions Dflncomc:, Joss. 0 llilocation. may be made in 1<1)' 

<ieJw:tion. OJ <:r<dit m"" be manner qm:d UjIOJI by tho "",mbeD, 

~ ... - .., I"", .. tho oIl~ ha'I. 

sharehold ... .ubotantlal economic .rr""t Dr Of<' 

0 'IlIo proHts >lAd I.,...., .... ocho",,;'" in ""~ with tho 

oIloc.",d 0 ... <triol pcr ........ beD' inl...,.,. in tho t.LC 

- do blsil 

Cllntri~af 0 A conuibution of propcl1y 0 Ge......Jly laX f=" unIe$o ~;,.J. 

~"'" if taOble 10 ,II<- abar.bokler saI."Of momber n:liovtdor_ ill 

..nI .... oolrQl .... 1$= m ... e:<ceuofbllisio - and I .. hiliti .. do IlQI ""~ 0 Rrteipl of "",,,,btrshlp interes! fos 

tho..Jj ... «I basi.loflllo ser.irn may be t.1Mbl._u .....,.fmed property rompct><atioo rnt oervi ... m><I<T«I. or 0 R<ecipl ohlOd, f<>t may be ueaLN IS • "pfOiito in!or<:$t" 

~1aX2b1' " or"promo", ; ... IUI" ullimalCly 

laUbl ... .~ , Comribut<d 0 U-.::ogn'P:" pi. or Ioos 0 Suih·in &lin Of Iooi! mIlO! bo .JlocalC<i 

proporty with . fmm oonlllbUlCd proporty i. to tho CQIlttibutinK memboet Iwho Iw 

built_,n JOin Of Ih=d by d.t obwI;IK>l""'" tho bookIIax diJpority) ". "" • pel' oiJy, pet ~ t.a.is 

Di>ttil>l11ios>o of 0 Musl be prupOrliooate 10' 0 N«<i 00\ be propostio .... to Lt.C ~, """'*uwnmbip oWl>Or.lhip. 

0 A dUttibl:lloo or 0 OenenIIly WI &t<:, ....! .... mombo:r io 

appr«i.1«I property .. ill n:litved of debt irI •• CdS of ba$i, in 

gonertily......., pin to be """",,rship i."teSt os_y ""'<i «I 

h:W,ni.zed It tlla c:orpon!l. by mrmllrr i> in = of odjl1S\<d 1.,.1 (a.in is =gni>..<d .. ba$i. of mtmber>ltip in .. "", 01" ;, . 

iflh< p!gpnty we, ... .,ld f<lf 

ito foir QW\I:OI , 01...- on !be 

"d;$lIui~" 

d3t. or <listtibutioo); ...ct. 

gain illIM=! mIl iIQ 

""""'B.~boldm 

0 The oorpontion 00.. "'" 

'~"" """,,,,i .. . ,y realiztdloa 

rOO" di.ltribut""', of I.". 

~, 

0 If an S rocpomtion Iw roo 

.wnlP and profilS (frum 

<l<1$\eJ><"ll$ ' C 0>'1'), 

am<Hlnil """i~od by 

&bartboldet5 in dlstrlb<nion;o 

.... tal< r...,. to tho .. ,tent of 

!h. "",,",holder'. b.:i. , 

~t .. , 
40 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.027

..... ~: 

~ ~ , ';~;'; , , ''."',::!" '""' .. , :' ,",'''''' , , , ... "', 

....... , ;;;'" , 

""!:lid< basi. ' 

, 

"~icc in' ....... 

It.?S4 el..,ci"" j, maJo, I.he wisor 

the lLC, OS$<'IIi will be adjasled "ill! 

~l o""'~""'mbor(or 

.. We oru;. <lee ...... mcmlxT) 

!ll=bYll'Oidini pinton tho 

dilT .. = 1:101......" the <>IdIa..oe.u.d 

!IIftnbeT', ba<if ..,d lhe 'leW n....,b;:r'. 

SI<ppOd up bo:<i.) on .... aal< or Iho ,ce_ , The OIMid< boLJi. fo< I.he...,. 

member/oow< ..... ~ be :II~'doWll 

iflho v.lue. of\he oue\ b .. IIIIltn 

below lIS basis; 1M 7S ~ .!«tiM ~d 

u.... ~"rnll.he """ momml_ from tlking • k>u .... Lbo ""I. of"'" 

I '.~'" 

.,~.~ 

, ~';':'i'::; ,,';',; ... ; , , -. , , , , 

'.' 1lCf'.IQl.O"., 
41 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.028

c..,... .... ,~, • Ilrorl'ies.lil:c LtC., p<QI«l tho =I 

... ... from <"'£10. cl&im.o thai "'" 

mad. qainBt anyortlle rnembon '" 

........ y other tnl .... ,. ""ned by 

• n>anber in a difT<IT<!<Il mtil 

~lyofl;re l . " <<KpC>r.I.'''''' MIl J>01JImlO.l . LLCt typically wiU III ... continuity or poriool of,dwmion duration .... te..lhnittd in lifo in Ih>. tho penonal <q>rnen'l<ivc lhrAmoleauf of \II< Iw """linlng ",..."bOrJ ""'Y , ;00 .k<:, u> CO<ttUn.. tho LtC 

II. BUSIl\'I'.s5 USE or I'Ll', AS[) FLu:. 

Real t>IItc ~ .... m~ties st&<:h .. Fwlly Umiltd partnenbj.,.("Fl..I'I"')ond r"",il~ 

Umhcd Liability CoatplUli .. ("FLLCo') fOf .. , .. r.JJ ~ llH: moat imp""'.:U of ... bleb ...... "'" 

!;ox "'1~t«I , n.... emilie< .110", Ill<- ""-"0" to ""nlin ... to 00""") ,ho rnanq,emenL of \he real 

.. Wo ODd "lIIb!;. & plan (Of chc lUOCdSion of Ihal "'""'"iemwt, "" "",II<. wbo the li .. ilCd 

porI%Irn or m"",ben ""'Y 1><. "Ilk!> i. impcratil't. sly ... "'" Ip«i.,j....:j ""'''''' of,..al .. l8lO manag ..... nt and dl:1'tk>pm",,~ ~. the entitie! proItcI the: r=l t:UaIC from rn:di!<!< 

,aim. lhaI .... made Ojjain.' ony orlho .",i!y'. o.....rn or lip;"', 811)' other real ...... " "'" 

individual."..... wIIkh prnutmbly .... held in..".... .. ""ilies, "',nally. thcac rntiti .. JW<Wid<-

lJUIIly 1l(JD" '" _. planning baJelil>, oucb- OS pmbat •• voidatI<;~ 

A. Retaia Centrol pm !he l\U!inm. 

l. Tbc: .... oh. FLJ> or FLLC oJ~ ohler family ft .. mben 10 tr3JUr ... thoi. 

pn>prt1y j",u .. 1S 10 )'CPIiDil'" fllDlily ",",,,ben ,,·hil. still _iIIing <""\ttI1 OWl" III<: tran>Knod 

_I>' by a<lin, ... (jl "'" Wencnol l"'rI"er {"(JP") of on FlP (plcforat>Jy throlr£lo o,""""",,p of. 

kpanle limited Iilbillry "lily). or (ii) tho M"""i'" of an n..Lc. 

... Somt-oldeTfornily """"ben lJIIIy 901 be~)' 10 band o .... """if,,1 

of"'" ,rarul"mN P"'P'n)' Lo YO",,!!,"" rllmHy """"be ... 

b.. Somt Y"""WOl family """"be.. ""'y OO! t.. rndr '" ... ...... 

"""",,1.,r1h< l/aInr~md p"'paly, ~itbot (i) bceo_lhoy"", no' old 0II0IIgh or(i!) be< ..... lh<y 

I"'k tbo bull""", knowINg< aOO >kill • .,..".osary fur RianIIVnI; "'" l!anSfemd prope<ty, 

2, 111< old ... r .... il)l ",.."bon will .1iI! be able 10 oontro.l Ihr ~ 0(11"; FLP 

or fllC ... tho GP Of ~1anai.r, ..... 0 .. ""'y <01\1,0"" Ie ....,.f« ""'i, inletCll1! 10 "'" FU' Of 

FLLC lhrough ltUlual gift Jiving. 

B, Pn,,"* Con!j0!!O!ll Owoojbjp cil'Npqty wjthin !be fMJjly UQI~ 

L Tho "'" of ... FI.P or flLC o.IlowJ tho olcler r .... ily m.mbcn to remC1 

Ihr younger faonily ""'mber\!' . "Iily Itr ~I or tran>f.,. hi. or her ial<feSU, 
42 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.029

2. Eulnpl .. oflhex .... rieti<r ... ote: 

I. Right> offm. "'fu>aI; 

b. Buy.o<U ptoVi.'m",: II>d 

e. l'rolIibili .... fill .. Ilin& Of ....... f<rring FLP '" FLLC iDloreslS in a 

I\lIIIIner l1li1 .. di<l'llplive to (\) the em"y '" (.iil the family. 

3, In oil ..... n! .. the emit)' ~,.houlJ pJOl'id. lhI1 !he O\bo, 0 ........ 

m<! 1M ... ~I)' oIIou,ld hi..., the fll1t rilll>l to pllrCb~ the inleRJl. if [, is to ~ sold. 

4 Older famity mem\>m "'"" oo,uin ... to 1IlIDl.iI< the _ .. bile !hey adopt 

• pllll1 for the "1u<OOS,iQQ or (i) ownnship. (ii) tlWl:>gtltl<lll ond {iii) contrnl of the ....u. f<'gaI'dle .. of wbo tb;:..limiw! J>IIl'I'"'" PI memben may be. 1"bil; it ...,...,ially impmturIl .. h<n 

dooJi"i willi the ."..,ialiud na'''''' of=! .. 1m- mat>llgemenl and de...,loprncm. 

C. I'm!oci tIJc Owrun from Liabjl"tv M!!!l CredilOlJ pi' Ib< Entjty 

, 0wneJ. of ELP and Ft..LC ;01."" .. will be ptQI<'«t"d f,oln tbe lilbllity Of 

credilO<J of the onlil)' unlon: 

• mult<J in 11>0 lilbilit)'; 

•• 

2. The uoe of !DO'" than """ "",il)' to bold c-nltip i" .. tHIS in telIl e:!UIte 

should tM: considem:l for th< MLowitli"""""" 

B. Cl';nu qaiostan <nli,y', IIf'lIIOfU' ( .... " ..... ...tronrnernal .~J 

will OJIly <<tend 10 the &JUtS .. Id it> W, entily. to the g ....... .a1 partner' ....... (if i,', • 

panncrUip). 01, if"'" (tIICta1 ~I)tt is • ~"" or "' ... , ... tily. to sucb <:Itri!,y'. "'lei!, 

b. A<rordLogly. if ~ "'" tw.~J in <lifT.""" emili<&, 1lit <Will> _ qaillSl <>lit entity "i\l1IOI .... im· the USd. in a """""Ie ... tily. 

e. A,. ",suit ofllle 11"11< .. 1 p.vtoo,', liabilily, CMSid.."TO.Iian lJIould 

~ ii .... 10 ";'Ii a _"'''' enli,y (IC!>m01 """"or fDr _II partn<rshlp. Ii""" tho ",ily i"n<ril 

partner', 1ntcrU! in tbe oth<r po>1\l1erShipo oou.ld ~ ,.ached becl! .... of the claims 14OOI"!iI """ part.nrnhip '.~, 

O. PM.,;! !he AmuQ(1ho F ..ruitvfrom lb" Owpm' W&biljty ooJ CmiiK>!J, 

- 10· 

UCNOI"'" 
43 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.030

I, FLP,_ ru.a. prooea tlot IrIlIIftmd PfCP<'I'l' from ctedixJr claims 1lIM 

............... .. y of Iho entiIy'. """ ..... '" "'""'" .. y ...,..., pn>p<ny \be ..... ~ """'" ~~iohoidin __ =ua. 2. fLI';u:w;l FLLC -'" ,enrrolly .-....I bo do=II) _ '" MIiJ)o the 

.,.,..,...1 debtI of \be partn<n '" mcmb<rl. Tbo ""' ....... ' credi,,,,, .... t)pi<;ally lell '" tlot 

foUo"";", II\fI:Io oplionI; 

"- "'1lin~ 0nIcr: " ~ ...... ; ... un,Ic, ;, the 00'0IlI-«dtI'«J mr...ty of . 

~ilbr If~ cmlil'" is unobI. '" fort •• par!MI" '" _t-!a 0I.$i", hi, or bot ittrefeft " 

cliarilna ..... i. IICiu.., In II$iI"""'fU nor ..... _~I. II iI • .....,., order ilia, dirf"..,. \be 

0lItIt)' 10 rnaI(~ AllY diJIri~ '" tho 0""""" crodilOri IIUI il 0I1Irrwi .. WOIIld ba>t modo: '" lbe 

!>WI"" thwItr"""1 iimil<d Jiobilit)' """PMY iWUkJ,' ohotgillj, order it !be lIIIIy ran<dy • 

... dilOr p<>IIOCUd:, 

~ _ ~ of ,.,.,....."p ... LtC ........ IU I tmliIor. TbIS """"" .. _.crodiIor ..... '" ro- .. __ "' ....... Ili."' ..... imft$ ... _CfItiIyIol\be 

atdio>r, The ttWiIor coW.! ~ ............ Of _bot (-. if I aco<nI portroor "*-' '" 

MONF ...... is .. ~ _I dot ~I IO'IIc:a "'" amt)'" ............ J"O'"icI<t oo.Iwtvou.. 

o. p.,...." '" ICIl iu!tnM· If. o::reditOr ... rob!i>I1lhaltlotclaim 1liiY 

IIO"m" be J'I'Il, • -.., IIUl)' ~ WI ...... !bn;iaj Ibc .... of tho dc:bI<><', """y in_. 

1Ol~ """b In onltt is ran: .~. sal. wooId ca\>IC . ....... 01 I<Iwnc <IiInq:I!ioD 10 tlot ... tit)' 

E,"CII if _h an unb is otou.ined, \be """m:ot will bo','e litll .. wl ... \0 In ""toiclc pony, qpodo.lly 

.. """ the pur"<!wc, "ill m=ly bco>mo ... &1OIS~. 

J. n., u>c of """" IhIn ~ enlity 16 bc!d c ... ll ...... ip inlefntl in mil nIIII~ 

..,.,OJbo~. 

I. CmoIial __ thM 01>< <nLi'1 ond ~ diilmnI~ 

Ibr _ b ..,lity "';U tuft illIIUdI """" dill' ..... ' "" !be pa! of. ucdi"" III ..-h 011 of tho ...... 

.. \bit tbt =ditor .... , dootlok III ICItaIfII '" ..,.,h III< iDInnIs iIIlbt entities """'"'" 10 !It.o 

c.cditO< ",10 -" to "'""'" only cmroin mill;'" ......... tho .... ~ 

b. A cmIi ... ",.y be- mono li.UI)I 10 ...u. with • d.bor ........ "" _ ofbio '" bot ...... 1ft 0<10 or lDIII~pIc FLI'I '" f'Ll.c..I~.- or IDUltiplc~_ 

Co . "',...,..,.,. Ilqe 1liiY be- .. ..mn. iDI:omc ... ....,..q....." of 

....... """" thM....e ..,.;ry;u:w;l hoIcIiAJ Iliff.....,. """"" in dilfcrml cm.ilia. 

,. ow-'. R;gIr! to !«<'Civ. "r lif V~~· _ Witb.lno.,.,.! '" o;,.,Iuti<!n, 

"- 1'lI>!"';lhlUn<,ti", "'" riahl of on IIWTItf '" """,iv. f'lir ....... """" Ilqw<lall.,.,.!he ombiauiryoFIhc Ittm "f~, ,"I .. " 111&)' well provido Pft>IO<;!ion "Pins. <""'ilOl'l. 

f or ORdilO< _ 1M IJIm'"",nl delermln .. "-M! ri&bU the CWIIC1'S"''''' 1<1 "i1bdra .. ond 

liqui<lot<: hil Of bor inln-ost. iIDd. 1iInhtr, Ibc ~1l1.OO ..... " 0 ........ "";0 .0' ('" hiJ Of ha intcral 

"""" wlthdto""" _ 

1>O\IQo,,,, 
44 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.031

b. The .. 1 .. 1"", or 10. inter',," 10 whith III 0 ........ i. omitted i. 

biNliQg on <:r<dito ..... well. At . mull. Iht _, ohould add.- '''''' &DIIl<: (i) rn.sI:J"I Iht 

<111>1)' inlOf<!I .. unal\lXtivo .. po>o>ible to • <mlilor b)' i",,,,,,iaB • ~ of ...JoWi Iht 

iru ....... 11101 will mloI, '10 the I<rua.o vrJ ... """,bit, lnd (ii) .. LObllJllillS. vol ... tbJl \be f"",~y 

CIIII af["nllll poy .,hell buyiog the """I<" "'" of the tDtil)', Gcuen!Uy. the basil OIl wlLith..tot 

can be do.." .. otd i. either "goil1:t ctItICCrn" nt .... 1II'I<kr .. 1Uoh Ihe enlil)' i. valued .. a ""soinK 

~ with no dj""ption.s. iDcludina tl>e- elemenl of jj<>Od'wilt. or "liquitlation" val .... wbid> it 

"'" val .. the .... 10 would bring if the ownm ...... 10 .. U 011 or \bc osset$ .. on< rime f", ,,:bljlt\ .... thoy could ()btoin, wilh<>ltl ""Y <:lemen, of iOOdwilL ()Ir;i<>u<ly. valui"i tho in"InU 

bY"';"8 tho liquidatkro vol"", mOlhod will mul';n I<>~ val"", FwIhtnnor.:, \be '~I 

will ";llIer ~~~C !be """""'. prtl ...ta percenl of til< .,,"il)' assN. as valL>«l dlh<f "" • ..,i", 

tono."mL or U~im ........ or OIl aJIl(}UIlI aft ... di'l<QW'lling the pro roll PO"'."! of ......... 10 for 

tho 0 .. .,..,', minority inl ..... 51 in Iho <IIlily, Again. tho I<ODfId Ilt.malive will ~I in n lowe, 

val ... for both ereditp. ~_hmet"~' {""""by li>n:ir>& tho crediIM to I""k .I_b= lOt 

'opIl)menl) on.! funil), rop=n- purpOoeo. 

.. The dioad"IIIlI.< of lbeoe. valuation oltcmalivcs i, 1Iw tlley canool 

be used only lOt creditor proIeI:lion ~ ;fthey .... to "ilhmndcoun scrutiny . .AI. =ull, 

there ""'Y be reasons WI • OWl>ei" wanlS to withdrlw IhaI how nluhiDl ., do with 6"""';1l 

i ...... , but tho enlily ",UII (in tho ~of .. w IlO!<IIi";ono) pay \be ""ne:r this lower Vll~ 

........ by filn:ioa \be o",n<,r to ..-am in \be ""tity .., IlLltI tit. Dr she "'"Y !UOLI\I hi, or her 

in,·Q\mca •. 

S. Con ....... ll.al PropenylO I'<non.ally. 

.. Ikintl obi, to <bani<' ~oi1llS of pm<OrI&I P"'f'C"~ <:all Il ... hove 

<I'\>:l.i.,.. lnd 1Q "".'an\l1l1ea, oItboulh it i. ~ th.I., lhono be: 00"'" ti .. 10 !he 

jurisditlion .. 1<'<O,oJ 00 th:n u,. <hole<> ofjurildic""" .. "!'l porui,'od as sOOppi.,. r ..... lhe ""'" 

fuorabl •• i,us fot credilor, probo~ or IIIX purposn. 

b. A. ",nul~ il i. poISlbIt!O <1w1J~ ljlO .. !US of ",01 propmy by 

pl..,in~ il into a ",,",~ip and mo_loa lhe "lUi ID • n.,.... b.,OflIW.'j'uiUdl<:tion f~I prob:u" (al 

, .... ID the .. , •• , of"",vi"" the ...... from the Iocotioo of""" e<lW< 1<1'1"" dt<:oIknI., domicile). 

""~ """"for "'" ODd <r<dil.or p""",*" 

E. yllpliQU Awj!lwe, 

l. Tho .... ofFLP.lnd FLLCa oUow ftLmiJicJ to nqoti ... with ...... )Itber 10 

_ delOMi,,.. a ,..,.... of rnanaainB tho J!NPOI\y "itbwl iU\la<fwnily U\lplion. If the fomily 

""""ben "'" beynad ~Iati"", !hrn n.. ""'ily ~t alloW! ,be p""'mJoldor getltt8\iOt:l. means of impo,;"i •• )'>t<'" of ~<:mtDI on ful"'" OWlrtn. 

1. The Pormonhip Agreement of an PLP or tho {)p<!uiD1l A"""",tDi of lID 

I'l.LC "illlypi<llly iIKIIIde . provilion R'quiMg """ :ubilr.>lion will be LMod 10 .. 1lle famlly 

<!i.puJ" .,.,.., 1be OIt ti IY· '~. 

·12· """"",,, .. 

Insert 78663A.032wwoods2 on DSK499XVN1PROD with WAYS & MEANS

i 

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f 

Chairman CAMP. Well, thank you, Mr. Tucker. And I think your 

personal background might even trump Dr. Kwall’s. 

Dr. Kwall, you are now recognized for five minutes. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.033
47 

STATEMENT OF JEFFREY L. KWALL, KATHLEEN AND BERNARD BEAZLEY PROFESSOR OF LAW, LOYOLA UNIVERSITY 

SCHOOL OF LAW, CHICAGO, ILLINOIS 

Mr. KWALL. Chairman Camp, Ranking Member Levin, and distinguished Members of the Committee, thank you for inviting me 

to testify at this hearing. I would like to make a couple of suggestions today, with a goal of trying to reduce the extent to which the 

tax law distorts business decisions, and to simplify the law. 

As you are aware, there are three principal closely-held business 

entities, corporations, partnerships, and limited liability companies. 

In addition, there are three alternative tax regimes that these enterprises can select from—two pass-through regimes, subchapter S, 

the S regime, and subchapter K, sometimes known as the partnership regime. I am going to call it the K regime. 

And pass-through entity treatment, of course, means that the 

business does not pay tax. Instead, the income of the business is 

allocated among the individual owners. Each owner reports his or 

her share and pays tax at his or her marginal rate. 

In addition to the two pass-through regimes, we also have a separate entity regime, the C corporation regime, that publicly traded 

companies are taxed under. But in addition, closely-held enterprises can also elect that regime, whereby there is a corporate-level 

tax, an entity-level tax on the business when it earns its income, 

and then a second tax on the owners of the business when profits 

are distributed. 

I want to focus on the two pass-through systems, the S regime 

and the K regime. They both impose a single owner-level tax, but 

accessibility and the operation of the two systems are very different. 

The S regime is a very restrictive regime. It only accommodates 

businesses where the owners agree to share economic profits consistently. In other words, each ownership interest has to have identical economic rights, meaning identical rights to distributions as 

well as liquidation proceeds. As a consequence, it is relatively easy 

to allocate the income of an S corporation among the owners. It is 

just a straight proportionate allocation. Everybody picks up their 

percentage share. 

By contrast, the K regime, the partnership regime, accommodates any economic arrangement regardless of what the owners 

agree to. The owners can agree to splice and dice profits and losses 

however they want to do it. As a consequence, the K regime imposes on the tax law the burden of unraveling the economic arrangement of the owners to figure out what the proper tax reporting should be. That is difficult, if not impossible, because the partnership does not distribute its profits each year. You have got to 

be guessing in terms of how those profits would get distributed 

based on difficult agreements. 

The tax rules attempting to ensure that the tax reporting 

matches the economic arrangement are complex and difficult to 

comply with. So by virtue of this situation, my proposal is that 

rather than having two pass-through systems, the tax law should 

have a single pass-through regime that applies to what I call simple enterprises, and a single entity-level tax, imposed on complex 

enterprises. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
48 

Now, ideally, all business income should be allocated among the 

owners and taxed at each owner’s individual marginal tax rate. 

That ideal can be accomplished for simple enterprises, meaning a 

business entity with one class of ownership interests, regardless of 

whether that entity is a partnership, a corporation, or a limited liability company. 

In the case of a simple enterprise, all you have to do is allocate 

the income and deductions proportionally among the owners unless 

the owners elect out; I would allow them to elect out of that system. And you would implement that system by simply refining the 

existing S corporation regime, which works reasonably well and 

has a long history. 

The ideal of taxing the income to the owners, though, cannot be 

accomplished for complex enterprises, meaning any business entity 

with more than one class of ownership interests, regardless, again, 

of whether the entity is a corporation, a partnership, or a limited 

liability company. 

In the case of a complex enterprise, my suggestion is that you 

tax the income to the entity when it is earned. If you tax the entity, then the tax law does not have to be concerned with how the 

owners are going to split up the profits and losses. And you can implement that by creating an entity-level tax and effectively eliminating the partnership regime. 

So in conclusion, I would suggest replacing the current system of 

three elective alternative regimes with a pass-through system for 

simple enterprises and an entity-level tax on complex enterprises 

because I believe that would both reduce the impact of the tax law 

on the choice of business form decision—it would make it purely a 

business decision—and simplify the law. 

Thank you for inviting me to participate in this hearing. I welcome your questions. 

[The prepared statement of Mr. Kwall follows:] 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
49 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.034

S'. , .... 6, nf Jon«)' L. KMOIl 

~IHB and Btn,.rd 'J ... ",y r ... f ...... of , .. ,,-

L~y.J. U.',-rolly c. ~o Sr ..., ' f I. ... 

lI. f.« , •• {lul,.d SI ... , 11 0 .... CommJll .. (>II WO) ' oad .\l.,. •• 

T"f !!donn ond Ci<>o<l)' 1l. l<l liuMnn. ~.II I< , 

Mar.k7,:OI1 

ChlI(m!>.o C~, RonI:ina Men'''''' l.c'l" ."" di";ntui:%<d "ootn~ <>flh~ Call1nlJU'', 

1h>nk)Vl' [Of imojli"8 m< """,!if)-" ,hi> """'ing. 

11\0 i,,<om.> lIii.""" of c!oocly.hold b..,nets etUiti .. i. <learly In "oed of o:efuo'm_ Tk 

jIIinolf'1ldo.cly-hold byiIi_ f"""" .... COOJl<O'OorI&, I'IIM .. """'" .. ~ ;,,~1ed ~""Uily 

""",,>IbCI.' lillClor c ........ Low, Lheoo oott'lJ>ri>u!lllly to< ,.....J "'~ "' .. "f"'_ .I'<mI,i,,, "'~ ) 

M~ do,dy.htld butlness of!'iti.,. ..... tued .. 'pa-Ihrooib" ""i"... .... _II. ,o. 

i""""", Of'M '"ltl)' i. "",eel "" .. , IIi=111 '" 1M OWII< .. \\llh oxh own., 1'tp\lI't;"~ hi. or tier 

""""0 "f,b< .",i'y", in<"""'- Ko further '" ... ~ .... U)"......-I IV"",,, 0 .. <"li'Y di;m~ .. ill 

"""f;", !'Oio$-Ihroogll rntl.y ''''~IJI!<''' i. ,,".ferml hy 1W0 . I' .... "'u'" fCj!in,es (-$u\o<I\>p!<' So. 

on!! "S.bchll;>tc' K") Tho SU\lcha.pler S ",gin" it P<'I".u.1Iy .""'bhk 10 .n hu;,r>na fM-n., 

proyid<>l '" . Iisibi,iiy ~IU"""""," "'" .. ,;,Lie>J, BY"9"II.OI, only ",,<nc<>rpt><3.led enlcrprim 

,>1, >C<e30 ,be Su!lcn..p'<r K "')!I= 

OI!Jer ' ...... Iy-ho'd b.mn=""Ii,i"".", "'" la.X«l .. pUl.-thr'9tl&h <n,iti .. R.th<r, ,_ 

e"'1;.i ...... Ibe>J like p"blid),-U'l>d«l <"",,,..ru .. IlrHlcr ,he "su"'hopI~+ ,..,g;"",. A. _h, 

""'iT iD<<Irne .... "*<'1 '0 00." or. ""'ily-"' .. I ,a, "bL .. il i, <..ned ~ "" 1'''= .... '·01 .... when 

pr~r. '" .,. diSiribUlro. Und..- <~rrefllla ... , ,\10 Subdup'" C!"egimt scomo,ry om"""" 

di.rproporlloru,dy 1Ii[<h II.>: """ _tid .. ,""'.""e1lOl11<>u«! by cl ... lJ-III'''' COIj,I'." A. 

e.pl';"'d took>w, ow.t<>ltho ~""""~-I.dd b .. Lr:o_""" .... Ih •• ~"''''''''''' ~ ~ in" 

0< """"VQnJr~ u. '''1'10'' ,IS ...... "rutl"lt 

Tho .~j,,,,rw;:c of tbru """"",Ii •• rest" .... _II ";lh di/T"""" '"" .IT«,., c.~"'" ~ 

0.'-""" 10 "" ""do.Jy inl1uct>CQ! by I'" <'-"";dc!o'i<HI1 \\'hm dccl,~n g how 10 "'B'"IIU .... 

oper4' • • bu;'n .... Thi,,,,"'I" In ""f.,,,,,,,,"- ,,,,,rr .. kncy,,,,,1 """'1'1.~i\y, I ha.~ "",,,o,,,ly 

... rill .... '''''l!'h "" how ,i><s<- "ffir'" ""gil' bo ameliorated' """ woold 11k '0 [{pc"' "" fuur 

,<comrno. ....... "' .. todO}' 

''''''-''I' .. - ............... ..... __ ... __ ''''',' .... · IrI'IfwL l ..... ..,. ...... ",i-. f .. ..-.. '". ___ ... ·"Tao ... ..-l2IIII...a), 
50 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.035

I. Tb. ""'0." Ip "'bl<b d"",l,·. bold bu,la ... ".IIlI ... r. Inotl ,hou ltl Ilopo~d on 

lb. «>mple.tlly 01 lb . .... !; . .... n.d~ ....... I, ... I , •• kpl foro" "rtb. bu<l . .... 

~. ,I. <.IM;1" ""'~,;,N..,,,t ~ • • buol" .... hnpoo.<"<l <I • • b~ ;.,~_ ~I • ..... pl. ~ <h .... y. 

h.kl h.'ln ...... und. , . p ...... t.rQu~h >1.1f ........... bll.~ <",,< •• I ... ··.-S ,.-.='"",." 

1. A sl ~I.,.n#IJ"",,,'.n """.Id br l.'I_ •• ••• lnoo'lI< of " ... ",pl'~ " d ••• I.I·, b •. 1t! bu,I ....... , .... Ut,-. 'he , .. , ... or Ih. bu,d •• of .II, ."., ~ In<" ..... r. 

~ •• "'pI .. " •• tlty .m""~ III ""ners. Tbl< flilty-le"rl,u would .. pb<. <or"., 

lu Krnr"",.~ 

~. CIo .. I,... •• liI " u,ln ......... 1,."ld .... " d"d«l r. olll <"rrenll. " '· .. doublt,lU He 

""Im..-

11"'''';0.11)'. m.porotl""-' and pa.ru><n<bipo "'m! ~ l""""plllbmI, in .. 'hioh b~ 

<II""' 'h"" ",1'1l"I"'l"Ii",,,,,blpo. "."'" <oool!.et,od. C<><j>W-W""" h.,. loo¥ t><.... I"'>ltd •• Iq>ll3I. 

1t~1 c1~i lo. LUlJ", 40'. \.ow and ao ~ •• "'\'I"'rI"& ".ulio$ ""de< IM<r.l.I 1 ... ·_ By ronlr3$t. 

l"'"'""r>II;"" " ... '" h"lIOriC.II)· ,.,.11. '.r""",1 "'l("ge,ne." ",pnIaI .. '''''''' .""""ifot,. ofth.i. 

0 ......... , . nd K<ontingly. ""' ...... hlp 111<0"'" w ", I>~od I*if'll<Uy ' o .... ~ Uti]., .n'e1lop 

(.",.cJ Ikt,,= Ill< 'YJ>O'O orb ... ,,.,..... I!'" '''lII',IU<l ... "<If)>IlnI' ....... p;ulnet1h~ ... ~Nn'. 

11.1. low .w.Jpoin~ howo ...... . utaj ... f:l<to}!" diIt,OI!l""""'" ~I"",' from I""'nom.ipo. ,,,. 

I'. h,"'y of ~ l<hatdltI~lcnI was hn"""'~' 1!Ieft- 'n,.~, in Ill. "".porollon. lIy C<>O\I!ut. 

pam-= ha<! unlimiled hobUit)' f<>< <I"h". agooi"", (lie parnlOMJp! 

-~ 

Il<lIlt i"lc anti """,I] _",'ion. w .. c ... 11;«1 !C 11>0 C ~8int..~SII tho 0"'( ltoJ' Of 

the .wcnli"'" =<Ur)'. 1loc C "'''_ loa!; . "" ... .1" "" .. b1);h1y ",",'n,,"..,..,Il.~ .. of ,to II<>Jbkl 

ta>:atioo IN'U!<c ("OfIUf\CfIl.""", h..-" Ioni col!cJ for 'ho CIIrJI"""< I .. , anJ ~ .. ~bol.kr (a>' '" 

be 'egr~",.j .., th'l d .. C ... "" .... imp<><es tho,:am, .. , 00""'''' .. "'" ""Hie iodi."J:aJ wt 

I"""""d "" pasr.-Ih"",!;lo '".it;...· I""grnion, 00"""", II .. Y'" '" lie adopted. """ i .... w.< .... 

tile C ~rne !n ;1, CIUICll' fMn will cononlle '" gil\'''''' 010_ . n pubhdy.lJ;>dod ~;ij .. l.. 

DIorio, lite 1950.. !he -"hsouib 01,.""11,,,," to ,be C rcllime odvJ.noxo<J draml,ic.loliY_ 

Pn ... ", 19~. V""""""'""JlI .tIIl pu!n<1'S had 1>0<" 1.,,«1 "oW I\!dlmenlatJ' rul ....... pan "rlit< 

1~S4 Ink .... ,1 R ..... ,,,n •• Co,k , doI. Bod p __ thrOllgl,,),l<m ~.tta<1<>J iii, I"'"'....-ohiplin!h. 

'1imIIH_~_"'_'*""" __ """""_""<:<:«"I'''''_''''_'''''_ '

-" -. .... ... ~..,;Iity """""cG> ... " ....... nC.W . ....... Jr.OdI . ... _'_"'''''" .. ,''''''''''' .. ..., __ 

'_'T ... ,_DU\Wl_"' __ '''''''''''''''''''''''"'''~ , 
51 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.036

rom. "ftho K ,"~imo. ~ 10 tho K 'OPnlO "" ... broadl~ _ranted pro"ido:d Iho ''''''''''''"'' had 

.,1 .... tWD """"'" """,..,.1lDI ilIoorj1<K;I,«I. lru;>ti<illy. i, "P!I<''''''<llhol unlin"IN l;'btlil) ror 

at kOlA '''''' Own<!r"'.., tho prit<: ~ I"pin """ ..... to IN: K regime.. Iky<mJ lhot.""" ...... ,. 

II!<> p""","hip ""!lime ",,,,,,,tmadl!<d .inu'llJI ... y """0'" m""~ n:jlWl ... Dr in 1<",1 

u( """,pl",;ry. for the IIU. fCI)QItins or pAfUlOrSlup inoomc: 1IDIl1""" to be "''l'"'''e.t,. 11 had 10'" 

<ooti'J"'" ,,',til ~,. """""mi. arr""l1"" ..... llI'the J>Of11lCf1L. Ik<:ai, .. ",.,. ~s.hip. uo."I'\'ru 

",1.~".ly ';mple ... nuM""''''''O'' lin. ,in"" u.. fl<",ibil;ly .,ftho "Y"''''' rliJ 001 """" major 

J' fr"'~ 

In 19S5. fb<,S ",gime ""'"""00'" r-,ht, •• ,_""" f.,. d<lO"'Y-!>eJ,l 

<tIIpO<Ol ion •. Un~k~ ,"" K ",Wme. 1 .... S regime ...... ",,,,,,,,.Iy Nltriell'" on~,".ny .• 

""'1>On1;OO "",hiM"" no nlOr< U"", 10 ..t ..... hCrlden '" be otiSlblc tor ,be S r<gimo, j i>I()I'IO 

" l¢ficoolly. \he S ",strut .... , Mly "<eMib~ to . <"'J'MIuon ilIlIl , .. oed. ""I,,,, ~"' .. of""", .. 

i,e., III , hud oh,ock ~ by the """"""Goo ....,... ""l!limj 10 ronf .. odtntic.al ",,,,,,,,,,it 

ngil" OIl the ""'net. Thi. ,?,",,00n rlr>m.hully oimrWi," III< """",G,,,, o(!he 5 reg>"'" by 

~l3rillg' straigluli:r ....... d ~rtiM.,. .U"".,joo ofoll ""'1"""'0. ifIcom< """ k>s> :uoo<IS 

,be- ..,>rchoIJ<n "ftho ontcrpri"', ~"'P""'!< ib...,boldtrs .,M "",,«I to Ilk muJiiple <I ...... of 

oIOCi:: w.", ",legale.! !<> the r\oolblo IIItMir>r> of 11>0 C "'1:"''''. 

Tho ~ oni",,, ,ook alOll "" m;. ~ ..... l}ruil lhe.la1lor part of"'" lfI' ,01>1111)'. 

UmT,e.J )lt1)IlOU"" W,,", i~ "" the bolU.an ... of1lreS .00 K "'pmes, Durirog 'his poriod, 

Il1o C 1'Oxi '''''. "'~ 'hot;mrlin~ ,\I< 4"'hl~ .... u"" . .... III< ",,,me "r <thoi«. Alibi, , ..... the 

CQI?')rOI~ W ........ IOliv.l y low ... , oJId t1tt mucll hl;hU sharcJtolJor W wao !lOI impoo«l "",il 

II" idend. "'0'" paid. Ito"" •. Ill< 0C<0<Id ond ""'"' ''''''Iy II. , omeIe. lhe C .. I!,I.I!I< ""!lid nn"" be 

ddem:d "..."""de.l, M. r<S\!tt, pmfl, .... 10 oiN<ly.""ld ,'I'itwn~ oonnaU~aspDN '" lbo C 

.. gun<. 1110, 1hc 5 "",m< .. u"Ill he.r';ly "tih""" " Ihi, timI:. 

Roginni"l' in tn. 19600:. llIX sh.ll .. "",i,;ly took otT iUId iii< j( rts1lft< " .... UI,ll1cd "' • 

'110<" 'j;If<m'" f.>bion, -no. n.,iblo """ .110<, ..", rul", of'be_ K ... 1;1'"", '"""" .. <pio.,<d by 

I*"'<" who 4l'J>TOP"f1ion ... ly . llor: .. <d ded,"-~ ;on' '" ;n,'o$''"'' d«irio8 '" "I'oll<T i""""", from 

,''''"" Allhough YVlwnioo ... """'I,b rqul:!tion, govemU'8 i."",,,,, and I"", .1Io<'.ri"", wor. 

pmml1lgale.J 10 tkI .. !hi< .""due'. it ... p'''' ..... '''''''''''Y d.llie" " 10 n..;.., . <yskp~ 

"""-1"IlPI" t", ,cponi"ll ,,'he. I'lru>aJ .n~, h"o '<>m(lk~ olloxatioo> .... u8<'".m~ 

r. ..... Y'"'' p ........ ,." .. i~"" bolh tho S IIDIl K ",,,,''''" ",boll. j" Ill< 1%.1<". lodl'iJual la,' ,."'" we", d~.".oI ly re<! .... J _ .... . ,,,,,,II r>f til"", int!iJlhl ... l ,at< r<du<1"" ... 

'''<1>'''''''' ,n ,,,,",, ...... ,"" ",divldt .. 1 r., .. IiJf lbe fin.l I ..... "'e<. Thi, .. I",,,,,/rip =«1 

"",dut p""""" '0 avoid .0.1 erIC""" fro", !he c: rogi"" Ck.oly·ItroW ."",,,,,,'i,,,,,, fh><:ke.!I" lbe 

S roIU"< MIlIb<: numl>et' of """'1'11"" ""''''''8 ,UI<kr 'lui "'11'''''' n., •• plodcd In I"" "",I 10\<' 
52 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.037

Je,;a.j.,.. In IIddiIiotl. the K ~ I!I:It ~"" bc<:n 5<I'\''''~ .. the but,,,,, oft .. Md,., ac"Vl'Y 

..... "OW \>OOiop by profi table """orpri«o b"l';n~ ttl """'~ tho ~;gh ... oorponoL" I ... CooK71'S> 

q.iddy prOO~'m puhlidy-tr.>dod <IItcrpri"" from ".ni'U\~ Ibe K regime' .." dJJ "",hinlll<> 

>lau,,,,h II .. oxodUS by profi.iUll<' cb<1)- hoW oolc<pri .... 

In I ...... "f""".;,y d"nn~ ,ho IaIo. 21/' C<f1.wy ...... l.tP 14I~ r,.",Od • myriod ~f 

b\l>inor:oo r""".II .. t r""~ Ii""",", h.b,li". ",, II """'eB"rthe 0111<:,,,,,..,. """" "",.bly 

IlIc Itini",,' h.bi!ityt""'~Y' Wi,,,, " ~ IhMlleriod <>fuon ... 11 filtyru.'<. ,,,".<te<I hmiu.-d 

1;'''Ii~' ~~y loghlalKln A.. ~ """'I~ b ... ;~"", ""n,'" ~ iOIIM<'r .-!od '" ~It ttl 

.... lIic:~ ~""ItD liabilily. Il ..... ~. 110< Ill,,", .... """' .... ,"'". 1><101'''''' 'ho C n~n'" _nil lirnitod 

Hobili'y ...... tlt'J)."'~imo """ unj,milod fiabi li'yblll dl~ ,....""1'1, regui.b<m$ ... .,.., 

promuJpt«! io. 1M 1",,, 1'1'>10', ID " IlQW oI;gib\< """",,,,,,,,,,,red onlolJ'ri_ 10 """ ... tho "C. and 

"S" "'tPm .. by<l~fillCb ~mu\t. ElTon. t~ permi, ;"'''')l"WN """'1'" ... 10 oJ0<1 ...... "" 

,,, I"""K" "'tim •. ~I.'<\ b ... bc:o:n """'fled 1<><1 ... .' 

J\. 11 ....... ' or ~II __ ""'men,,,. hndl!"pod~ofta> olremali_fa< ........ y.~ 

em,,; .. now ""iii" (;""""'1"'-'11111. ...... <""""_to"" rilcif":",,tiy inO""""" u..: ,h(oio<' Q{ 

l:>l<slne .. rom' deo;i.1OII Tbi, I.""" '" ""!O! ........ ir><1'Ikim<y oud ollmpl .. ,,)· "' .. "OI~d .. 

r.litig,uod w,'" .. ~"" or ;11<"-",,,,,,,,1 ""Il" tha, or< diJ<<WOd ""low. 

I. Th ....... or I. k' _l),.~.ld b.'I . ... <II'III ... ro , ...... ~u"l d ,I.pnd lI. t" compl. ,itr of tb . b.'I ...... ra.K ...... ~ ... ' I~ I< • • I fo'm Of ,b. b •• 'n .... 

Hi!l""cony .•• "ri. to .... dirT",.." WI ,..Jl;imu dcpcrIo».l (HI the tepl IOmI Md,e 

"""in .... C~tioru nbli1ed tbo "C. """ .. S .. "'l;i'''''' .... 1 p .... II<'I>I>'p. ", ,\,-,,:d ,,,,,- "..:;" 

",pm.. Lomi'..! liabi~ty ""'" .... ooip.allullnwt< <>f "' .. ~''';"''tiop . WiU. tlJ<: "'\'ql' ....c.lh<> 

fimrttd li.bility c""'P"'\Y. an uru~1od "'"'1'n.., Ib>t 001""'" IEnmccll;"b,l"y "" . 11 of ito 

0WlI<f .. h "",kcs no ><:me '0 aU .... "'" 10.';01 fOrm oftloo bu<in<"'o i,,-,pao:t 11,. tal: "'$in>: 1111. 

~ Il10, burine$!. TIr. T",uury" doci,,,,,, '" al l"", ~tod b .... """ <lltiti .. __ 

to In"''C'' .. ul "SO ",gim<'!l r<:<OlPli>n ,hi. reality. }Ww<v..-, iJ>ro<pora''''' ""tqpri,.. 'mui" 

I.ghlaliv.ty blodo"'lli'om ""<CSOi~ .... - K" reglme. Tb.o, bklck '""""'" bojn<5(ood ... wi ,f"" OIot"' qllO i. ",ai ""i"",1. il """,Id.,. """';bio for C""v ... 'o aH"", clooely· ... ld ~". 

01«, ... 00:< ... '0 lb. "K" '<'JIime.' 

Tho d,{feml' legal femu i. ",Iudt ~ m.,,;1\UO ."gII' ... """"""ltd "" lo.nger 0,",," • rf"."J 

lOr " .. "~1c .. , n:&i'''''"' !l ""'·""lIel ... "'"IIi"" 1LII11k.I, Iho.t " ";"Ilk "'" Ngim< .,.,.,Id .. 

'ut.< 'rnMI'''''''''''''''''''' __ ........, '' ........ M ... 'o .... C'<rno). '1>OO,. ''' ~ ... JI,l:01''(_.I2000)I_' .. '"''..,''"''...-ty~''''_ ........ _.''' .... _ ·, ,,-... _foo, ......... ... -$-~·I __ ... ...,.;..,., · .. ~ ....... ,'I'_ ... I._ ... __ .... , ...1·_""").t>oI<o«l,_"'''''' ...... " ..... _'''"'''' ... I .. ....... 
53 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.038

~ .. ;~ ' 0 occomml>dlllc tho ondlc .. ,..nO\), of ~< .... ."gemoIU. tha, "" "" ...... oj' 

clooe\)'hoM ... tili .. migltt""" ,_ .. ~..,u ""IJ:<' froon. ""'iWur ........ rIi proporlll'''",O 

.... ,,"g of fH'I'ro" and \"'1ClI '" <OOIj'li .... li:<l ..,..,ial oLI.""..i"", of individual l.etru "fp,.fiu and 

k>so<o_ Rill ..... ,,," 1"" .. gune<.<honIi\ be .ppli<d '" ck, .. ,y-htid !»Iii ..... "'''iIi .. : """ prilnor)' 

regime lbol p'mIO the '~mpk" onti') .• nJ.., o.l(.:rruoti," ~or ... 11 "'~1lIC tholllQ""Tl'S "'" 

''<:\II1II'1",,- OTIlily.i 

1. ,... .lg~I •. o .. -." ... .I tax lbo.,d bt. lmfHMd "" .b. loco . .. of "simpl.-' ''''' .,' • 

• old btb ln .. _ •• dn • p • • Hbrn., b "m rc-s< mbU_, ""rTOnllow', "S " 1'1 ...... ~ 

An ,quil~bIf illO"lII<!aX irupo .... qo:ll b<onkno "" oimilulr . i".,,,,,,,, 1"w,idlWo. 110110<. 

"" "'I"il~"" i"""",l.1l!>. 5boukl <.I",," ,he income or ony bu,in .... ~ganl < ... " f 1<8>1 form, '0 bo 

UjCo<! di.=tl)" •• the' ;;;ili'id,,,,' ""''I>mI of~lo ........ ",lu, .""h ",,'no, "'\IOflin! hi:< III I><r ....... 

OIl Il-.e """",.'~ I"'rwnal.lU 1~"'11'I, Thi. 11._ W(rUld c.use ,lie income ourib.tab", to • ..,h 

own.,. '" to<- ..... ro '" 1m mdi .. d/lallll"!'II"1 "'" "'''' orll ... """,or. I. "."uld ttea(o • , ... , 

pl'ylng r.,I<I .. Ill minin"..., IIIb mn ..... e. of II>< ' '''' I .... <III .he <boi« "fill. form in ,,~ic~ 10 

... ..J"~I . bttoinen. 

Umo.t""",.,y. il ;1 "'" prot.".l "', .... :011 bwtDC« i"""",," to IIIe ""'lien of Ih< <nlotprioe; 

In !he < ... of publ"ly l.-..k\l ""'<fI"ioo> wh=.m ... )"~iff ..... " <I ...... or 4!"" ~ mi!;hl "" i .... o:d 

and "h<te """k ;. <baniing Ilo"d, C""l' ~ 'it """td "" vi" ..... ly i!llp<l«iblo '" 1111 .... 0 !be 

;""ODIC oft},c bu,,,,.. ,i"",,'iy 10 \I>< ""' ...... ,,(11.. "lIIrrprise, A, will be ",plainotl In gm;1., 

cIct.oil ""low. ""."'It i.~ ~ non-publicly tlOdod ..,tetprUe,_wbo .. tho "" ........ enl<r ".10 ... ~,,,,,,,,.r< 

~un>tD' ,1>., <_,,," """'.'"""P ",ltftOtI "'illl dilT.rttljl """""nO< righ .... ~'" """"" .. of 

IUoc:.riog II>< .... kfpri>c:., """""" """"'g lhe ""n .... i, .xtmn.!>,diflk\llt, 11""' ...... wllm ... 

""<rprioo ;..,.... &in~1c c1 ... of """''''''';1' inlerests and .x~ "'""'-..,.,f .... iJen,itol «>Onomi<: 

nglll., II>< pru<'" Qr aUo""linK 1110 I:I11"'l..; .. •• ;""""Ie am<mi l1l<I Q"nCts" re l.,i,-.Jy 

~lI'aigh,r""".,-d ." 

1;0lIl."'. 0 ""'\e"<O<'I .. , modified VOBIM ofllle S reg;mc .!hould """'0 "I\>< """".1 rcgi"", 

r ... n do.dy-IlcW ""., ....... I1lili ... b., ; .. "" • sinwk: d .... of"wnenlt-ip ;~I' . ~!!"rtllcoo nr "both« tbI'\ 0.,..;,..,.. ;. ""..Juettd by _ eOlpOClIic>n, p;mncn.llip '" lilDil"" li.bI61)" <,,"IPOOY." 

"''''~''' ... ~_od''''''''_''''' ''''''-," Goot ... ,,,,,,,,,,,,,,,,,,,,~ ........ '-.·._T .. _"'I'II'1'J~l....,.,..-...,.4'O ..... af"""'1<_ ... 'f"""-·_ .• '"'"'" w~_, $Woe .... ,,' .. •• _. r •• "_ 101911",). f<II. ,_ """~ ...... 01 ... <11<0 ....... , ... 

1l-.o .................. "' .... ~· __ , .. _.""" ..... """'u" ... "WNC"',.]{"'''l 

.. T ... ....,oI __ "" ............... , ... _<"t""_._pIoio"" .... L_,.;""' .... 'IO .... ~ 

,,,.,,. ", ... .-_ ~ ''''<, t "nI'Hl~ "O-"'" ....... _ ... ""' ..... ".._IO ..... ,."oIIk..........,S' ........... " ........ _'O " ............... , ..........., .. _".,._.0<ulI<d_. _-..., ......... ", ... w .... _ ....... '._oIIp''''''' ... ca<I'IOI ..... ''''''.,''-.'._. __ ... '''~ .... .... 

......... , .... "'_·,.,..,1 ... . , 
54 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.039

The S ",gilD<' """"Id b< ur.nded ~ ;,. <\lrT<1I1 1uruJ.1O u.. eJ<"",1 \hoI doing OIl 00.. ,~. 

Wl<!onnine Ihc r"nplkily '''Ill w~k~ lho regi,,,. Caol ... odmin;.kornl or )«JpOrdize la, 

coll«tioo." Tho S "'time is C~l:o..·lI1e1y P"f""1.,."..,d 1'I'0000s ""'II." I, .. dt.;rabl~ 10 build "" 

IJW IIU<<<., by ""pl)'.g a moJ,(,ro S "'I"'" 10 .11 cloooly·hdd CIlIC'l'""'" WIlli sin",l. 

,,"·.....-.kir '''''''11''" .... 10. 

J. A ,Ioel •• ' ."'l··lenl '0' l-bo_1d be ;"'po...:!'" Ib, i~' o .... of "«> mp ~.M ,k> .. . 

~')d b • • ;n ....... ~ r<llt-\·. ,b. ,,, law 01 Ib h'do. f.l loc. tI. ~ lb . I.,u ... of • 

.t,; ~~~ .. Uly . ",on8 1U b ..... ",. Tb ' ••• lIIy . ...... 1 In " '0 0'" "'pl •••• orr •• , 

I ... '. k: n ei_ .· 

lduUi, 

'-all c'Psely·hoIJ Iru&; ..... o"~~ .. "wid ... '~IItI ... ,lgkl """n ........ 1 tu, 

Won ..... '.ly, u..·I\iOlot)! of In. K "'xi''''' to... """'" IIw <1",,,,"8 a _)31= 10 ."sure Ill., 

incom. ;uwI La.... .... P"'OP"!"ly ,Uoc.1N on.,., """.,.., wOO utili." m"l~rl. "laue< o( 

","""",,"p in, ....... tI eJ<"ClllCli tlil"licuk, if"", il!lf<'Ulbk, Some ''''"mclIlllton: ..,Ii,", ' hoi the 

J;; .. !Ii""',,,,bo ... f~ 10 .J""'J'li'" 'hi'SOOI." ~,..,., if_b Uy>'om """IJ bo tkVlK<!.;, 

,.~.dd be ."=-<ly ,,,,npl •• IUId \III<I<l,oobt.dly <liffi,.11 III """liIu ........ 

..,., r"","J.~k nll"'" of Ill< probian ,undily _,ont CInrly, lho .,\\'n .... of on 

.. ".-rpri .. 5J><IuM tH: .11",,'011 '" '~A"b "hal<<<l>6<""ott"~~IrICI>,!h<-)' ~"",re, rcganll ... of 

_ rompl"" (It """""I,,'ed ""'~n tI1il!.h'''''. J.", ., oIOOfly, lM.n,,,,,,,,, or"",h on 

."torrn .. mU>, be IaJitd at !be "tII<: " ; • ...,,00 ju," lik ..... '''''''''''' .,f .... y ""'or on\etpriol'. 

ll.n~, if .. ""~-I.'·.l tax to 10 bo iru.,.,.oo. lIIC la, lo,,!:-ir Ionnl<n<d with 11>0, .... of ttru'O,'.Un3 

II .. """"""ic UfttOgcm<n' '0 dct..,..,; •• bow mw."h ofllle proDl <If IDs. iumibutabk: 10 c.och of 

IlIe ow ....... TI>o loll' t_ ",ai, un"lthe "",f,I"'" """",ny dWJihu,ed ar.I follow .... here they 

to bee • .,., lh<y frt<jUMlly ... ill no, .. distributed in (be 1_ wy _um<d, 

~ 

'!he laJt I.w ohoold "'" be burtlODtd wflb !he ..... of ..,.,,,,,'oIi '"' n~ tQt"llle, "''''''''"K 

... Eve" if ,\ """" ._pablo of doo'"., "'. II i. ""Iik<iy ,he , • ..,flilll _H'''''' .... ""]d Ill' 

:odmini>lnbh!. Th,. ..... be 1«"" (rom tho runmI "P'''''''''' <lr the "J;;" rej!in .. _Cautiou, 

'''PO)'t'rlt " tdtlpti"a "' """,p ly Of<' r",td wi,h ,mol<"'" burd., ... AUre<&l'" wpiy<"'" 

..wi,.., ,h. c(ltllpltlClly or,h ... ",I .. iOO "" "<:US< far """""""pll."" .. 

" ....... m"""" ~01"""." .. -._ .... ".,,_, ___ ..,. • ., ... ............ r, .... ...,...""""_"" ..... oo,""_" ...... U3 .. , .. ..,..WI"""", ........ ,_ttM U.l. ,,, .. ...-..,, ............ , ...... , ........ -.. ............. , ... -., .. _ 

" 102010.""...,. • • _.".., ..... ,<00<'''' • ..;.,' ... 5_.1.' __ .. ....-.... . , ..... , ..... _ ,...,., ......... _( .... __ ........ _.\, . ....... "'_ .... '"."'T.0I.11 

("" ... 1011), 

~n.._ ~'_~ ... '"'_'It< ......... ""'_, ... ~ .... I~ ....... -. """"'" ... """ __ '''' ~< ......... '_oI_ ... __ 

'._ ....... , ... !<I6oI 

1':<""" ""'''' ...... ,.".,.....,. ... v ........ "f"""'> __ -... ....... 'o-.".,"",.,.,.,_, I< •• ~- ..... - ....... g. 

, 
55 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.040

n.._"'''''''''''''IIIt~''''''oI~ ... It>~l''''lIIItl1o~w 

._I)"kIJ~it.~IO;~IJI'i'E~ .... .,.;.y.Ic\"I .... ""t""'._of"'" -.,...w If _ tlIo"""y-lnod ... ilPPllc:t. ""' ___ "-",,Id _ bellM>d dIr«:tI)' ... tbt 

; ........ Ie 01""''''''' ...... 1"" CIIIJ,y-le"'l nu: .. l!\Ild "" • rtobo.ivcly Pmp'" _, 01 ~ !hal .I! 

i.-.. orlll< 01\1"","'" ;, t>;ted ... ben it II cam<d, rhio .ystom olio(> .11_ !be.,..,.,.... oIthe 

~ '" UI< .. rompJio",cd on«.,.....". ~'''Ihry lih. 

N"' '''''''oingl' ..... nt.ilyolc.ella>~'" tlIoODt~ will rme"\' • .., .. ,or __ l>ONIl '-"" r", ..-.",,1<. III< ."tily-Ic ... 11a> _Id ",ohaloly be ~ at tho 

.... ~ ...... In<If.>doW II. III<. OIIt.n.ioc. tho '" 10..- _10.1 « .... ~ OIl Incnoti,,. for........,. 

•• i1' ..... linrple -..nk .....". ... _ to ........... lilt .... "1'.....,1 "', "'PD'<-1b<rrlt1 

.mod lIIo!llp iDJi"_ ........ .....-.t "" ......... -...... .. '_ by dot II>OdifiaI ><s" 

"'&*M. ~ .. MIlly ..... ' t&>..t a...;o-~ -.; .. 1_ ""1Iho be 1I<m" 

u~f';r to '''''---.no( o.~ ..... 1)' .. "ho _ "'" Itlijoc. '" tlIo ~ .... JI...! ....... . 

Ho ........ , ,"" Q'IIit1'le,el tu In~ly I dd~ub~"", it 4'l'1~ whnI tho u .. _. < ........ . 

""'"' r"""rl"" oconom" ~m." 1\.I_h. OIl)' oddItioruJ, .. bo,nIeto reouk,"i fiom on 

all 'y.I<~lln .. "",W rqm»<nl ~ ~I. tosll~ on !hi ... OWI><nI <>lI1"'1 '" ulill .. , 

"",url ... 0<'<>n<JmI<I ....... ~" 

" ''<ld b • • I . . ..... oII ... kl ltt «<:I. _ rr-. ... ~ ............... ...... bIe-, .. -c . ttI .... ·

w 

f~"l_J ... _...,..t.~ , ... Jl ... _"""'lytnU!t . 

....,....,. '" R_toUdol_ l. "lilllplol" ckooo/y.1>cld ..... li .. will be .. -....I by. modified""S'" 

.. ""to. ~ 10 Rrwmm<!lIbt"", ). "<""'fIla" clo«ly-hrld ontiu .. ""U be_III>'''''',,1 hy tlIo 

cl.fi.ull rcgl_ which nnp<>I<O • ';"411<. tnl;ly~e •• 1 ... on .1,. ;11<""1'; or <""",lei .",~n .... 

..... ..... 1 •• 00 dOfCI),,-beW hUll;" ... I"0Il1d be ¥","emI>J bY ' he C ,ojlmo, 

E".n ,(Reoommelld",,,,,," 2 ...J } .... not """..-. Ill< (" tqt .... IhDo,oIo! II<> ""'Fr be 

oIJeml II ............ "'..". d<IKI)'IIdolCll'lty M .... _ .......... WlII.......uo.I)".voId d", C 

fell"'" ... Iip, orlho rum:IM COIJ"I'"I'I • ....t ....aMd-.. 1 .......... 1Ift ..... lbr IK ...... """",oil< 

~ " .... ore ....... ed ... _ .. ~u-<l!IIorrorpor:tt.o iot-. tJlilt. • ..,1bo Q...pu:c 

c/f«h ... ,y loeb ;" • J.t" .. lJ')4.....,.....te Ib "" .... AI< or • ....,..t.OJ busincoo. iD ..w iqoI 

10. I'" _""" ... , p, ....... fly.~.,....lbt !<II<o{oJi/l\ilotly I'i._ ~ 

" !OrO, ta" ......... ..".. ..... 71'_ ... .., __ ... ... """, •• " ..... ""' .. " .... _"... ........... 

!'-

'''''' ...... .......

--- .......... ___ ... "" ...... ~ .. _I'IIIIIi' __ " .. , .. _ ~_Io' . 

w..-.....t"''"'_ ... _' ....... .,..,IU.J. ... ''''',. ... _tot_u.s_ ........ ....... ' ... 
56 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.041

e,,';IY ~Iy tC>U1" '" a .. ngle. " 'I\. .""i"'II\"In"""'. 111 .... new busln ... ow~n 

'lJlIi<:;p.Wo, ~'I ,,,,,,,e<£ ,,·,11 "'" """noll), elu><>oo It.! C ""ime. 

TIl<- d"",Jy-bold bu<i..",..,. lilal c"mndy "UU,.., !he C real .... foil j!T!IIUrily ;010 """ of 

I~'o COlogone,. Pi"". SOme oIQ.<I)·.held ~"""""O()\ eligible forS r.gime ""Iu, . 

. \\ ... ~""', lh;:y c .... "OI _<0» tho K n:aln", b.N...., .f,lIei, ....... "" ""'I"'flll""'" lftlt.y 

di&fuoolJ>O<"lNo Ih .. m".lUgb IU eMU """1~11& { .... .. . .. 10 .ftlt< bu,;.neso "ot>W o«ur; 

,,"mel}. •• 34% ... l""«>IPOfII'" 1>1>. . .,.d . I~ <barcl>ololcrl"". HeIIC«, 0..... busi:D<1«' "'" 

trapp<:d ill IN> C ... gim<"_ 

Otb<t c"",~""1J bu,I""",,.,,<o tbc C ~Sll'" to) "",ploil Ik 1"",« m;lIgiMlI'" ."os 

th>1 ""ply •• llre Iinf S1H)OIl<,f OOlPO"'I< inco" ... Sp«jr,,,,,II~. 1M r,rSI $SO.OOO of ""'1"""''' 

"""'no i. "",.<1 01 Q I '!~. 0Ad tile ",,,, S1$,OOO of""""",,,, """""" ;., .. «1 ... H% .. Ie. 

Fl y<OII~, "'-"in.". """""" ore,a,tId '" 'lIIIl"mum individ .... I .. '< orH,.. ;,,2012. Tit"" 

"" ,",,. .'p""'li1lj! 1m:;" ~ 10 .,..,....., . ,.,.,. I<>'rl of In<mnt nI'jOIl! .... iMI""'<l k. 

ir>:~ tit. bu.,,,... I. I'blIIf<: the '.""cdi .. , w. """"",,i .. · imp<>o«l "" lho' il",oo",,- Thi. 

1'1"""oe .,,,,,Id «>00 ,f c"","·lr·held """"l'O""" """" Jeuj<d """""'" I<> lhe C ,.~imt, I. 

1,1""in.lil\llllle C "'gim< ... 1\ ~ fOl"c!oklt-IIcki bu.<in<--,w<Klldbc!p .... .,1 ..... 

pl.yio¥ fidJ . "d tltoreby odv>n<~ faim<s$ ..,,,om,,,:n.y. II would .1110 ll,~¥ for "j!nin".,,' 

.. mplifk.,,,,,,," 

Th. imr"'" or~ tb= 01 ... "",6,.., t •• 'ewn>n IIW ~Pf!I.> 1rI do.d)_hold t...in ...... tilt~ 

"~ y Il>e ' ..... nof random hi"ori<allk>clop,U<,uu. .. A"',,<h. tIl<'~"""nl 'Y""'" on.., 

di<lort. blUiolM> J.d."",. iU>i.I "",oal .... tl«& ... """",1''''''1. 

QJite <Iud y • • raoo-tIlfWllh ",,,me 1Or.1I do<cly.hcld . ",eopn",'"",uld ~ tho id".\. 

In light of ..... nl """<Io!>mellt1 lbe Ii"", i. ripe fur .,.u.bijstll"ll thi_ ,<<IIlI .... ~. "'Fh •• )'11, .... 

COD b< <IR-<ti,-"Iy odminlO\erW.. Sp«:i6c.Jly. \h. rllt<I!rIC or ""y ''''''''Y·"-:'cI ""'t'IllriK. 

"'prdl ... ofi .. hm, ohooklbo 1OlI~ dirtt~y 10 Uto 0"""" of,ll<: tJlotrp<1'" "h..-.!lie--

...,...",,;< ",\.:l.tiomhipumi>ll~ tboo" ... 'lO."" ....".",,-.laI .. Ihi ........ II . Ao '''''", . n '"!!J'>I'''' .... 

""~ cntCtpri_ ..-b"", >11 ",,·nm:Ioip itll<","", coofcr id"flIj<.a1 «x>n<>mio rip' ... .obould "" 

1OlIt'\J under ~ p ..... lnroup .,....,m. A~ "'''I<,·I,,·.II3-X ... oo.IcI b< ~ "SOltua n,. I 

!nrom~.t!he Ume i. i. oarI\CII, """ each 0" ....... '. "re ",-",Id b< la>.ed .1 hil or h<f OWl! 

m'l!lln.I .. , •. 

• "' ... "''''''_Id .... boU._ ... __ ... _., . ............ A ............ 1O. __ .. 1 .

• "' •• .,. .. ",,,,01<>«(«_,, (1" ..... ,,.. '''' _~ ",n , .... N<jltl IltHIOll) ·' ..... m."'.H_ .. htOd",,~'~~ __ .,.,_ ,"'"C."' , .. _ ..... ,_."""" ..... _ bl_._'.~.c."nM)1.!A'·,.., ..... , .. .-_, ..... <OI>IdbeOm .. ""' _I ~,C.UOl 
57 

f 

Chairman CAMP. Well, thank you very much. Appreciate your 

testimony. 

Mr. Nichols, you are recognized for five minutes. 

STATEMENT OF THOMAS J. NICHOLS, MEISSNER TIERNEY 

FISHER & NICHOLS S.C., MILWAUKEE, WISCONSIN 

Mr. NICHOLS. Thank you. Chairman Camp, Ranking Member 

Levin, Members of the Committee, thank you very much for the opVerDate Mar 15 2010 15:08 Oct 21, 2013 Jkt 078663 PO 00000 Frm 00061 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\78663.XXX 78663

wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.042
58 

portunity to testify today on the important topic of the treatment 

of closely-held businesses in the context of tax reform. My testimony today reflects the views that I have developed over 30 years 

as a tax professional, working with closely-held business entities, 

as well as my role as an advisor to the S Corporation Association. 

When I first started practicing law in 1979, the top individual 

tax rate was 70 percent and the top income tax rates for C corporations was only 46 percent. This rate differential provided a tremendous incentive for successful business owners to elect C corporation 

status. The devil’s bargain was that those lower taxed earnings 

were supposed to be taxed again when distributed out to the shareholders, resulting in an aggregate cumulative tax burden of 84 percent. 

This tax dynamic set up a cat-and-mouse game between the IRS 

and taxpayers, whereby shareholders sought to pull money out of 

their corporations in transactions that avoided the ordinary income 

tax rates, or to accumulate wealth inside corporations and indefinitely delay the second layer of tax. This is described in more detail 

in my written comments. The only winner in this struggle was the 

tax lawyers. 

The bipartisan Tax Reform Act of 1986 changed all this. It altered the relative C corporation and individual rates so that businesses were no longer forced into C corporation double-tax status. 

This allowed most closely-held business owners to migrate into 

the more rational single-tax pass-through system, which eliminated 

the need for all of that gaming that I described. This system has 

worked well for businesses and the country in the intervening 

years, and retaining these benefits will be critical to the success of 

any future tax reform efforts. 

Unfortunately, this favorable relative rate structure is now at 

risk. Right now, the top rate for C corporation and S corporation 

retained earnings is 35 percent. However, unless there is a change 

in the law, as shown in chart 4 in my materials, the top rate for 

pass-throughs will rise to nearly 45 percent next year for partnerships and S corporations in certain circumstances, while the top 

rate on C corporations will remain the same. There are also proposals for a C corporation-only tax rate reduction, which would 

make the wedge between C corporations and pass-through businesses even larger. 

Instead, I believe that Congress should build on the reforms 

started in 1986, including continuing to move businesses toward a 

single-tax system, keeping the top rates for corporate, pass-through 

and individual income the same, and implementing tax reform on 

a basis that is comprehensive and not piecemeal. 

Focusing merely on the headline C corporation marginal rate and 

broadening the tax base for all businesses unavoidably increases 

the tax burden for closely-held pass-through entities. Since passthrough business owners employ over half the workforce in this 

country, lowering the marginal rate for all businesses should be the 

goal of comprehensive tax reform. 

In light of that, it would be appropriate to facilitate the continued transition away from the C corporation double-tax system for 

as many entities as possible, including maintaining the holding period for the built-in gains tax at five years, as proposed in H.R. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
59 

1478, introduced by Representatives Reichert and Kind, and several other proposals that are described in my written testimony. 

Adopting any or all of these changes would continue the trend 

begun with the Tax Reform Act of 1986 toward a more transparent, 

less artificial single-tax system for closely-held business. 

A couple of other observations. Probably the most important reform for closely-held businesses would be the possibility of extending and/or expanding the option of expensing investments in capital equipment. 

Most closely-held business owners intuitively evaluate their business on the basis of cash flow rather than financial statement net 

income; that is a matter of survival for them. For companies without access to capital markets, expensing is important. 

Others have suggested forcing the double tax on large pass- through entities, say, entities with gross receipts over $50 million. 

My written testimony outlines a whole host of problems with trying 

to implement such an arbitrary rule. Here I would just observe 

that if the goal of reform is to make American businesses more 

competitive, why would you force more employers into the punitive 

double-tax regime? 

One last tax reform proposal is the possibility of forcing all passthrough entities into a single, uniform structure. If I were designing a system from scratch, I would consider doing this. 

However, we already have roughly 4 million S corporations and 

3 million partnerships. Any such proposal would unavoidably impose substantial additional tax and compliance costs on a substantial number of ongoing businesses, either the partnerships or the 

S corporations. I do not see any benefits that would necessarily justify such substantial a cost. 

That concludes my oral comments. Once again, I would like to 

thank the committee, and answer any questions you may have. 

[The prepared statement of Mr. Nichols follows:] 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
60 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.043

TESTIMONY DEFORE TH.I': 

COMM ITTEE ON WAYS & MEANS 

UNITED STATES HOUSE OF REPRESENTATIVES 

Thomas J. Nichols, J.D., CPA' 

Mllrch 7, 2012 

Chilinn'Mi Camp. Ranking Member Lc ~in and Members ofthc (·ol11mluee. than); )'0" tor the 

opponunit)'to kStif~ today o n the important topic of tile trClltmcnt ofclosdy-hcld bU!;incs~5 in 

Lhe context ofL:l~ rdonn. My tC.ltimony today rel1ccts Vlc"s that I ha,'e dcvdoped Mer more 

Lhon tl1n:e decades as, tax protession~1 \'ool1;.;"g with clm<ly-hdd business entitics_ as well !IS 

my role M on advis!'lr to the S Corpomtioll AS5OCI~lion. 

The bip;lrtisun To~ I<\ct&m Act of t 9M6 C'TRA -86--) was a I~ndmark piece [)f,ax 

legisla'ion. It allowed manyclo;;.elYl'cld busin~~ o"nen; 10 n,igrd'~ into 3 more rIIli!)",,1 single 

I~X pIi.,-tnrough 5yS'~m. and;n the~ rctlueed their incentive \0 fngage in upens;ve and 

$ophistic.1k..J ral~l!if'S;n ord ..... to mitig:de.,the onerous eff.",IS oflh" C t<>rporation double !aX 

rules. The system engendered by the TRk'S6 has worlo.ed "ell for busincs>cs Dnd the cQuntry in 

the inLervening y .... df':l. and retdining ,hese I)i,nd;LS will be ri li~"lIllo ,he >ucc~s5 ofB"y future tax 

refonll dforu. In this regard. I n.'Spcctfully bmi~l~ following gener~1 cQn~idcrtlli"m; 

n.·~ruin& tax rdonn: 

First. as much aSl'Ossiblc. the business t.1X sysK1n in the. Unilctl Statl'S shQuld mo~c 

toward 11 singk tax S!n'Clnre. and away Irom tile punilive dOuble t8X C c<If"jlOrntion systcm. 

Espccially f(.lf closcly·llcld bvsinl"SSl'S_ a .inllie la, syslem snbstanli~lly mltocl"li cl'mpicxily a!\d 

eliminatefi the opponunity ~,\d incc"fItivc for non-productive tax plannin~ and s!llncgiljng. 

M(.Ifrovc', il has Ih~ heueGIS ofsimplicity lind \r.ln~I"tre"cy , 

Second, broadenin" the Ill" b:l ~e and lowerilJS and flaueujng the ,ax ra'e.' wuuld ~...-~ all 

""&lncnL> ofrocict)'. Closely_held and uthe r bu.ine<s "'\l1e", rC~l'Ond \0 incentive$, The low~r 

th~ rntc on a g;ycn amount of marginal iocomc. the more likely ,t i. thnt a businclsowner i. 

gQing IQ cxpend the cfToo and take ,he risks in urderlQ eam th8t income_ and thc Ic,;~ df()r1 he or 

sht will expend If)'in!; 10 Jcfer orotherwj,c rnil;lla,c the ,aX ctm""'lucn.,.:s h~v,"S <Ion&50. 

llusincss uwnC,," w;\I a~",ssi\ely grow their businesses only flhe~ have co"r;denc~ th31 lpey 

can mah' rnon~y owr Ih" upcoming years lind nOI be subject 10 punitive l.1J< rale,;. They 

intlliliYcly ~now th~1 Ihe country can nut gcncrnLc ~l\oul!h I'CWnue lu solve all of its problems 

(mul:h less 1!l0s.: oflhc resl ofthc world) mcrel), by t!l!ling ··'he rich.'- Ho,,'e,·er. they' arc ufrJid 

Lhat lhey may be the r;"'t casualties in an ill-faled llLtCmpt to do sn. This f<:ar is ocpressing 

~{)nomic ~ctivily now. 
61 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.044

Third. it i, important thai whatever ta~ " fQm1 is ImpkmentM Ix comprt'hensi\'e. 

Focusing m/.'Rly (If1 th<- tOp C cl»p(>l' .. lion mar!;;n~1 row. and broadenin!; lh~ tax base rorall 

busines~ lIl;(pay~ in ord~r to pay for il. unavoidably inrreasl'S tbe W~ burd..,., for el{)!;ely-bdd 

bus;nt"ss owners. bl'{".,IIISt", ~s J will e.~plu;n. the large majorily oftloscly-h~ld bu,ine.ws are 

opt.'r1ucd tbrou!;h single tax pas~Hhrougil e1lliti"" and not us C cNpor:lIi0!15. Since p~ss-tlm)llgh 

busin~ils owneN; ~mplo)' 0','" half of the wOOfo""c in the country. IOIl'ering the tax role for all 

laxpa,Yl'rs (rolher thanju,t the-headline rate iN C cllrpol1ltilln~~ should Ix" the goal of 

comp~hensi"e tax reform. 

III light of the 1I1l111'e. it would Ix" oppropri~te tbrCongress 10 eo",ide. proposals III 

facilltalC tltc,Jransilion from double tux C Corponllilln Statu~ Ii! S corpormion Stalu!; for 8, many 

entities ~s possible. I understand thai Ih"re hal' ~Iways I>«n a reluctance to allow C corporations 

to CO!1HTI on n 1Il~-ljce ha,i~ In [lllTlnership StalUs Nher thllJ1 IhNlugil a fully ta~able transactinn. 

Ilowel'cr. Con~h~s allnwed. in fnet cncoIIT1lg~'tI. C c,>rpomtiolls to OOnl'CTlIO S .tatus ol'er 

the yeaTSl 

AIMng the "cps thatt.ltlld be Ulk~n to facilimtc such convcn;ion ~re the following: 

I. The ShilTler. live-year il9)ding period for the built-in g~ins lax shnuld be. at the 

least. ~x\ended as proposed in !I.R. 1418. introduccd by Representatives Rei chm (R· W Al alld 

Kind (O-WI ) and C05[lOnsored by scW1'3I,of)\lUr colieaguCl'. The built·in gains tax wa~ 

nriginally intended to prel'cm C eorpomlion!"from Dvoiding the double tax on Ihe ,ale oi 

hllsine".: Ilowc"".. as I will explain in more detail later in my teslimony. IheC oorpomtion 

income IJ.' r.Jtes hal'c n011lce1l signific~mly more favornble than the indi"idual mtesduring the 

appr,,~lmalcly 25 years ,inee thc TRA ·S6. and all newlY' formed business havc been ~hle tn 

choose P;lss-through treatmcnt 31 ineeptiun and al'oid doubl~ t:l.~ C corporalion Lrealment 

altogether during th~t period. Imposing a jX'n.1II)' 0<1 cotN~lol1s nOW seeking tn eonven to S 

~orpomlion sla tnsln thesc circumstanc~~ <ioc:s nOI St:em lI'armn!cd, MC)re.wer. during times of 

economic stress slICh as \I'C are experiencing now when access- to capillli is impnired. forcing 

businesses to sit on under-utilizM tapi1nl for D lI«:ade is COUl1lcrprodt.c1ivc. 10 l;gIll nf Ihe 

above. at this point, il clearly seems appropri~tc tn allow C rorpomtliill~ 10 e,)nven to S status 

wilh[luL th~ imposilion orthc aIlditiunal fOl\:cd double lax fI.'llimc or the ouill-in i>3ins ta ~ as the 

pricc ofllml election. At th~ least. reducing that jl<.'fioo t;) five }'ears. as h3!< rcecntly been done 

by Con~<!SS on a tempomry basis. clcarl~ is "arrantM. 

2. The res\rictionson eligible shardlOlders ors corporatill11S should be rcllIKX'<i Or 

eliminOlcd in ~Ium tOrsllbj~...,tinlllh~ income anrihllt~ble \0 soch sh3rch<lld~rs to tax. perhaps 

evCn at the hlp TalC. The ori8inal prohibitiomi a!'ain.\ fOT\!ill" anll t:lx-!!.~tmpt slmrehold€nrwere 

lk:sign • .'tI \t) pr':'''IIent income from a,,)ldinllla~ at th~ c.)rporalc level Bnd thl.'1'l b.:ing non-llI,:i'ali!e 

31 the shoreholder k.'cl also. Cong~ .. s hIlS nlready t:Xpandcd the S corpomLion Shareholder 

eligihllity mles 10 inchlde elccting; .mall busine~s 1ru.~\S Bnll mMlta,,·;.'Scmpl entities. while at 

the same time subje.:linll the incomc attributable In ~uch ImSlS and enlities 101m; at Ih~ 3S 

pt."ITcm rate. 11 apjX'3T1l Ihal this princIple eOlll1l he expanded til all otherwisc ineligible 

shan:holdcrs. includin!> 111m-resident alien,. partnerships. etc . 

• !iN. "g. H.R. coor. I< Krp. NQ. </9.~~ t " 198-911. 

, 
62 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.045

3. This is also an appropriate time 10 l·o.nsid.!r increasing Ihl! S ~OlfKlrJlion num~rical 

sh1r~hQlder linlil~lion to 3 nUlre pIllicy-lxlsed le>d, rnthc'rlhan Ihe unavoid~hJ)' artJiu".uy I()()· 

shareholder cUloff. As will be: noted l~tCJ" in my testimony. pannerships are n.'quired H) apply the 

duuble tax C corpornlion regime unly ..... hen they arc publicly tradl-d. It seCMlS appropriate that 

rorpormions be allowN to mainlain Iheir status as a pII£.S·through entity in the same I:lshiull. i.c .. 

ut1Je, ~ and unt;lthcy chO<J5C to wlt advantage ofth;s cuuntl)"s robust public I1Wrlicts. 

dQPlin~ any ..... all oflhc""W changc"S to> increase the availal)ility ofS l"{)'l'QrJu<>rr Stdll~' 

"Quld c OIllinue the Irend I>cgun wilh TRA '~6 1'1 a more Irnn;;parcnL Ie .. artificia l singl~ 1.1>:. 

~YS em rnr clQs<:ly-hdd business. 

Whrn 11'1li! ~tart'" pmc1icing law in 197\1. the lop tndiVidUIII i!"'omc ta~ Me WItS 7U 

percent.' whereas Ihe tQP rnCQme lax raIl.' for oorporallon. ta ~ed allhe cntity level ("'C 

cOrpQratiotu;') was <mly 46 pCl"Ccnt."' Thi~ rate dif!crcntial nbviously pr(lvidcd a Irernendous 

intt'rl1ive for s"cc~ssful Iru~ir ... si owner!; to ha, ~ a~ much o f tll<'ir i~come $~ p(Jssible tasw, al 

Il!:lst inilially. 3t lit£, (" cOrpor.lifon ta.~ mte,. r:Jther th~n at the indi> idu~llnX flue .•. whiCh were 

more Ih1n 51) p<."TC~nt higher. 

The problem. hl)wcvcr, with this apptuach Undl"T Ihe old rCJ!,ime W!lS that Ihoseaftcr-ta.\ 

cllmings at the cQrporJtc lcv~l wcr~ supp(Js.icno' bc taxNi again at ordinary inCOlm· tax nlle:S 

"h.·n ullimmcly distributl-o tQ the illdividual h,tfChQldcrs. resulting in un aggrcY8tc cumulative 

{3~ burden of83.11 percent,' and (his i~ even ber6rt B~i"g stale ;!loorne tues inl!) account. Thcre 

wele sollie limiwd nc~pliol1s to this c:<.tremely high !].l3l"ltinallJX mil.' system. such as Ihe stepup in t)asis U~11 death' and th(· sale o f assct.s in cQnnection with the complete liquidati<>rt oftlte 

corporation. Howevcr. these a ltl"fttat;vC'S ge[\crally iuvl)lvcd tho complete liquidatio11 of U\lltcr 

lIte L"f'rpor~\ion lJr"\he ,,,di"id,,"1 taxpayer, which. for obvious ~as<Jl'S. was IIOt always lh~ 

pn:fcrrcd altC"'3t i.-c . 

This tax d~namie sel up a cat and mow;!: gamc belwecn Conk,"'cl,,- Ih~ Dc-panmcnt ofthc 

Tr<!aSury and the Inlernal ev~nlle Sl"".'ic~ (the "Se"';c~Hl on the On~ h,;lci and tupaycrl< and 

Iheir uUvlso ... nn the mher, ,,'hereby C~orpora inn sharehlliders SOUghl 10 Pull money 001 ofthcir 

oorpornliort5 in trnusaclions that "m,ld subj<'Ctt hcMl 10 Ihe mllrc favoroblc capltol gains rates tlrat 

were prev~lt1l1 during this pcrirxt or to acurrmrlale wealth insidc the c<)lporatiOll~ Ollgrcs.~ 

reacled by cn~ct tlg numerous fln}\"i~iQns Iltm werc int~mkd to lon:e C rorporalion sHnrehQlders 

10 pay the full d!)uhle tu~. cITons Il,a! " '(Te Qnly panially sl"ccssful. Thc-sc provisions lndurled 

InlL'mu l Revenue ("(>de (Ihc "CndcH) S«tlollS 302 (trcating tenoin J"(Xlemptions o(rorponlle 

StQt],,: as "di\"idelld~n and 304 (trt'lllirrg the pu ... :hase ofstQt]( in related l"('lpOr::l1ion . as ··dividend.··), 3S well a.~ Code SC'Clions 53 1 (imposing ~ tax on e:trnings ret~in«l inside the 

J t.II.C. ; tl\97QI, 

: ~,,~:. f7:~~!~~l~1 ·1.f1.C.~IOt4. 

, 1.1I..c. f )17119861 

3 
63 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.046

tQrpOnlti!)l1 othl'!" Ih:1fJ ,ofor Ihe reaS()nable ~c<,ds of III.' business") snd 541 (impOSing a las on th~ 

undi~lributcd intQm"Qf~persun"1 holding.; cQmpani~s" d~riving most Qflhcir J!fOSo; in<'<Jme fTtlm 

inl'estmcnlSl. 

Sinc~ the laxc'S al 51alno could be suboltanlial, the la ~ opponUllili.'S and pilfalls inherent in 

Ihissystcm pru"idc<ila~ ad,iso", wilh 8 sigl,ilieanl SQUfl't'-OnlUSitll"lls. For c~amplc, Sc<:lion 

1.~7-1 (b)(l) Oflllc Trcasury Rcgula ion~ provjd~ Ihal "the corporalion mU51 have speciiic, 

fj.Ujle , and fcasibi~ pians for Ihe <.I.e of such accumulalion" iu urd<-'1' rOf :;uch plalls 10 be taken 

inlu"'\tc-.:ount for purpoliC~ ofjuslifying such accumulaliun and 3VI;1iding the accumulated elll11ings 

ta" TII(.<k'tl manycluscly-hcld busines~ uwners 10 hirc attorneys tu h"ld mc~in8-' andlor drnll 

<--orpomle minules when Ihey ,,!)IIld (llhern'isc nOi have incurred the lime and expense ur 

d(o,:umenling ~u.:h plans,;o fonnally. 

C. ~ I~ef"rm Art o f 1986 

TI,is syslem ~lan'NIt(1 change wilh the Econnmic Rccnvcry TB\ A'I <)f IQ)l1 ("ERTA " I, 

,,!lich 10w<'O'd the lOp individual intome lax rale d0Wl110 50 Il'-'ttent, i.e .. Imly four fl"It'enl~ge 

poinlS hi~h<T Ihan lhe 46 Il<'r~ltop COrpQrtlle intonli' ta~ rille. The prior las d)1lamit was e\'ell 

mo", pcnllan~nlly all ........ 1 "ilh Ih.:1fRA '86, which IQwuc<i lhe lOp individua l income 13 ~ rale 

down IQ 18 p<T~elll, Ihe l'lW~1 il h{d been in 57 years. TRA '86 ~Iso low~l"1.'d the lOp corpol1ll~ 

Me, bill (Only I" 34 ll'-'1'ccnt h"s.lb~ rel~li,"e iop tax l"3lc pref~rence for incomo .'am~'tl inside 

and outside ofe cOrpOMiollS was actually rtv<-rs.:d. That silualion did n01 last long, and tod.1Y 

Ihe top incollle la ~ rdtC fOf bo1l1 C COrporaliQflS"and individuals is Ille samc. namely 35 percent. 

, . 

• 

Chi rt I: S Corpg'i lions'ilS",.l'<lrunlige of i ll 

Co<por tl"n s_ 1980 10 2008 

...... -..,. 

The,," TRA '86 changes brtlughl aooul a dramatic shill in the la~ ,truCIU", for dllsclyheld businl"Sli owners throughuu t America. As shown in Chan I, the numb\:r ufCOrpl)ralions 

, 
64 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.047

electing to have corpOrate inromt paslied throngh to the shan.."'oldc,," and ta~~d m the individual 

level ("S corponllitlns~) grew fmm a lillie t)Vcr 20 percell! in 1986!() alnlMI 70 pcrcem in 2008 

Ithe-Iast year for which such stali~l ic s are currently avai abl~), In addition, with the- enactment of 

limiled li~bili y comp;lny stmutfi throull~lIUttlte ~tHICS durin!! the 1990's and promulgatiun of 

thl

o "ehcek·thc-bo,- Treasury Regulations in 11)97, busincs.s owners W(r;: provided with Ihc 

additional l1e~ibilily 10 h~\'e a eurp0r3tc-likc businl'Ss emity under stale law trcatl:'d as a 

"p;tnnership" undL'" Ihe Code. which alw im'oh'ed '·pasS·lhruu~~ taxation at the ind vidu~I, 

miller Ih:m at tile entity, 1",·,,1. 

I 

hu~, closely-held bYsinl'SsoWn~"I'S had Iwo ah01113ti,e ·jllI.~' -t hrough·' laxation slruetun..'S 

lu choo1e li'bm: S cOrp<lflllions/thc la ~ niles f.)r which WCrC mOr<l n:slricliw. but much simplct) 

and partncr'i;hips, Chart 2 sho"s Ihat substantial nllTnbcrs ofcloscly·hCld business (Owners have 

chosen each Of.llwse alternative ta~ stl\l~tures, rt'Suhing in appro~imatcl)' 4 million S 

rorporlllir'l1s a~d P'!l~im;ltcly 3 million partnerships as of the end of calendar year 2008. II 

should be nmed thm lite partnership categury cowrs a ~nricly ornun-corporalc business cll1itics, 

im:Juding limile<iliability ro.m[XIn;es. gencr1Il partncr~hip>, limite<i partncrships, limited linbilu), 

pa"n~rships and even limiLd! liability limiled partnerships, nnd also includes non-corporate 

~nti ics formed hy publicly held compnnies. The bonn!\} line is that, althnugh S corporation 

slatus ~pf>l'ar:; 10 be lIIore popul81"f-8 \'l"l')' substantial numlx ... of p:lss·throuSIt emilie> ha~e 

chQ!lcn 10 "'" t3~cd as partnerships. 

-• 

,"-##.,~,.f'-,#."n'I"#"#""./',~~"~"';"~'~~'" 

Th= are a !lumt>crofpolicy reasons why S <;{''1'Qf:Itions are all c~,encnl ~thida rvr Jhc 

oonduct of do~ly-hcld businesses_ Firs1, 31 cum:nl regubr rlItcs, the double ta~ C corpora\;Q1I 

regime would iUlfXI'" ~ lop marginal f~'<lcrnJ income \all r~ c of 51,8 percent.' even before theconsideration ofstntt income laxes, That is a punishing la~ rale for closdy-held busin~.,;s 

nwn~"I'S who correctly pcrcefw their business cnJitlt'!l as th~ extension of their i1"" personJI 

businCl;s etrons. 

, 
65 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.048

Second. imp!l~inlllh~ lax .1 the individual levfl ha' lh~ nenefil$ ofcomp et~ tr.lnip;.!rency 

in l~nns of who is actually paying lhe taK. as 'l'ell as ",inforcing I'.h3t~wr proy..'Ssivity Congress 

decid'-'S M ret~in in lhe lax sysl",m. As Eric Tt.>der Ilflhe Ta~ ['oliey CC"Ilter tllid the Sen:n~ 

Fimmcc Commitl(c IUSI sllmm~.,.: 

1,,,,,,,ld ... '/(JIII/hl.I/I,t id,'''! "'(1), /() lUX IJIIslne.'.f i"("I m~ is lire " 'ilY ...... ,lIX S 

c(lrp(mlli(lllJ. W ... ''''''lid like '0 "nrl/JIII ... ,h/! ;"('u",v 11> ,he ""·,,us IIIl(lliw '111('-~'I$(J11 

"'(J ""'''' U C(lrIH)rtliC lax ~for 1"'"It,, """}i"I!fIIJ(!""r Irud"d C(III'I1<mil'J- '-'1)' hwd Ir. ,1(. 

11(11 ultd id"nrifj II~ UI,."n" whu ,,"ould P"Y Ih<! /iII . . W ... here .1''''' ,"011 do Ihlll. wc sh,,"ld 

ik> 11"'1. um! Ihnl i, Ih~ rigitllrmllfll!m.· 

While alloCalin l!.la~able i~m<' amllng lite wlddy-dishu,""cd "",nefS-hip of publ iely-held 

compllnies mo)' bellflworlmblc. lhDI is nOI the case" illl cillsl'l),-held busincssenlilid. 

11'ird. lhe pas.<Hllrough S corponolioll regime eliminales lhe dmlllulic diffrrencc in la~ 

c"ns~qU\!nci.'!i for income earned at lh<· C".."oml~. n, "ppo ... "<l to lhe individlll\llc, ~1. thert!hy 

ob~i31;ng lhe ueed for mor;lcpmpJical~-d ~lrutillres and lrilllsacli(ms designed III miligill~ the 

h~a~y burdl'n oftbe dlluble Ia.\al;oo C CllrpOrJl;1I11 .y'lem. 

This ba~ i)o,Cfl bom~ OUI in my·praclice. PrillT 10 lhe TRA '86. su<'\:<'Ssful bu,iness IIwners 

were rtgul~rly cngagL'd in tbe tax pl;utning proccss in ord<'!" to miuimize the substanti~1 burdens 

under lhe doubk taxation r~g;me. S;ncC"lh~\ lime. and wilh the millf"~lion of clOS(:I~ hcld 

business aeli "il), 10 Pa5S'lhrough \l1xal;on ·!rc-:llmcnl. business owners arc no longer elLga.llW in an 

onl!o;ng srrugSIc 10 na"iJ;ale lhe h~a"y il1lpo.1Iill'" urlhe double lax syslc'n. Theyare kss 

locuscd on lax rl~nnin!! lhan ther wen: IJI,f!)re lIN-1M ·8/>. ami 01<}I"C focused!)n running lhdr 

business. They are k<'\:nly awar.: oflhe margilLal r:ues 11I.1.,t will apply \0 additional incollle. and 

tiley reserv .. for thaI. However, once they have paid t1';oI. ad~onal ta~ (unCll at Ihe lOp MC). 

thcy arc comrortable b,owin!; Ihal tbcy can 110"' pulllhc rCIJl~ n;ng alkr-13~ earnings Oll! to 

engage ill anOlher bU$il.'e~~ or Ihr ItJeir 0"" perrooaJ welfare. or .rctain the money inside lhe 

oorporation 'IS working ~apil31. \0 im'CSl in new equipment 3mf mher-itcm.>. or simply as 3 buffer 

againsl fulur~ ,,",igenci<os. wilhoul h~vins 10 \\orry aboul any ''''c''1! n:lble ooml"''''IlItion'' 

!imilations"" onc hamJ !)~··unrcaSO!.18b!c 3"eumulalion,' on (h~ other. 

I). Tod ~y'~ Tn StruClul'£ 

As nmed t'lIrlier. lhe la~ rale Sln'ClUf"e in 2012 is Slill quile ~onsislenl wilh lhe fl'fom's 

implemented in rhe TRA ·~6. The top individual and cOIpllr:lle income lax nlle~ "re.fdenticlli. QI 

35 !lfrC1'nl. llowever. II!)"" the double la~atilln burden for C e<lI"porlltion shareholders !>lis been 

I'mller Intlig~led by 11 rcdu~lion In lhe top indi,.idual inoome 1O~ rate ror qualified d,vidmil, to 

IS perrenl. Th~ nel clT";:l oflhe currenl r"dle Slruttur~ i; 10 impo,... l"Qughly C\lmp'Jrnble la.~ 

burdens on in,'Qmc eam<'lI ~nd rt.'13ined inside lhe busineSj for bolh C eOl"pOrJtioll and p~~~­

thraul'h cnlerpri5t'~. However. the 15 p<'rcent double lax on C corporal;on dividends adtLs ~n 

ap~oximalcly 10 pt."'~<"I\1 nel addilion311KX burden on C". rnings distribulL-d. Whe'll cllmpllrt.-d 10 S 

L'OI"J'Of1Ilions. Also. the sclf-cmploymclll lax. which :Ipplies \0 nlW\ pannerships :md wit 

• u~.ri"g """t!cod II" ", lJo C""'f'I"'/IY. l.ho." rl~l" '· ",,J Oil"" f' .. ·"", /"'1""'/ 11.,.1"1''''' m T", I",....""",' 

R""I"""'< ", . qurslfo<l bot"'" ~S<,,'eC"""n""'" on F,~. M.",h JO.10! I. 

, 
66 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.049

propri~lorshipS (bul nOI S C<!fp()mtillnS). adds an additional18x ofnearly 3 percent On enterprise, 

~ated as partnershipS for t3!< P"rpOS<.·s. Th."., nct ",~rginal taX nne~ for income e:lmcd in the 

top raw brackets are shown in Chart 3 . 

• 

~ .. - , ....... 

___ - ...... -.. at 

"-_'"" .... -___ t __ 

...... -

, ___ flo 

--. ......."......". ......... ,-

....... , 

,~, 

,-

'_,[t_1I "-I ~.""'" 

'~""Il''-_ 

-

• -,,,., 

• . ,--

• 

.-

.-

''''' 

-, - .. 

, -- - , -,., ".-' -

"'. I'£-./' 

• - - , - - -

Finally. another filetor 11I"orinll pass-through l:lX slatus for mnny closely-held businesses 

is the impact oflhe C corporJlirm double lax regime upon-salc oflhe business. Mosl 

enlrepreneurs s<:ckinl! 10 sdllhcir business hope 10 do so al ~ price in ~C(:s~ oflhe nel book 

¥aluc and la ~ adjusle.:l basis ofils assets. As a conse<jucncc. buyers In such sales mosl 

commonly s<:ek 10 achic,'c "asset s.al~" lreanncm for such trans.aCtIQIU, '!I'hc!""by they will be 

~ntitled to amonize and depre<:iate the entire purchase ,ricc paid. r:l1h ... tlJnn m<'l>'ly ded ucllhe 

nomeininJ:l 111,'1 .. djuSlcd basi$ in.ide Ihe ""llor'~ "ntity.' ow"~cr. "u!;<:( l'ill~" lnonlmml i, 

p3.rticul~rly onerous in Ihe C corporation conlex! for two rea>l)ns. Firsl. Ihen: i~ no e~pi al g.a.ins 

t:u preference at Ihe C <'orp<)<":ltion kvel. l 11i5 mcans thai any gain On tltl: SllI~Qr !hc· i)usinL'Ss is 

IirStla.tcd ~I Ihc lOp (or close 10 th ... toP) C corpomtion lax nne. Sl'Contl. tJt~1"Il is ~Iill ooOlltcr tax. 

albeil at a lo,,"er marl!in31 r~IC. when Ihose proceeds arc tlislribuletl OUI to lite sl13rclKild~'f5 upon 

liquidation.

11 

.. TII'_. ",n II<- .. ~i","td. of""", ... by.n "",,,,,I .","" .<:<1< •• ,hn-.:by ,hi: CU)<" 1",n;\);l!l<S , II "flO. .... " of lIIo: 

""'nib.> dj""'lly rt(J'" lhe bui'''''' <nIiI~ . Co,nparobl< ''''",nltm c ... "" .. II)" l>< ... 'l1.","" <",'m ifll'" ao4~lsilion is """""",& .. Iho 11<1".,..... "r.,,,,,k or other , ..... """ i<t In. ."'it' " .. ,rln"IIe, Ih.n of,,,, .IS<I.). tore <'''''''''''~'''''' 

Ihe-co" ", .. II) be accompli."," by ",.kin.s'" d«"M uoo.t ~.;.",.uS "rlh<<':<>de. fnr S,"'1""""';""'" ,h', .... 

..... Ii)·"" .,,,,,<t'pli,",,,, t>y ,,,.~;,,g .n .~""" .. ~kr~I~'" 3.I8\hXIO)uf"", C.>de. F,,. ".rtn, .. ",hip •• IhlOC." 

..... ltybe •• :"ompli',..,. "Y In.~ing.n """""" onder Seo;,iOll 7s-1 or!/>c>Cod< '" ~y~ln ... of II .. ck<mC>l I>QUid.l ioI, 

"r,1Ie 1"'I1",,,,hip "",W, a<40i,i,ion, 

" C ..... SKI"", 1202 do« 1"'" ,d. f<ll" ~ SO fl<"I""<"l1 •• <I",ioo (l)(11""""'" for ,-m;a,n ''''P'' ... '"m1<ft1 "" .... nli'i .. ) of 

ll"in ollb< . ho,.loc>lder "".1 in a limi'<d nU'''Oer of .m,.",,,,.,,,,,,,. 11o"".>,,,. Ih .... ,.h .. iQQ do.><> OOlhi1lll '" mi,iSO'" 

1 
67 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.050

Nonethek,s, as ! hown in Chan I, th~", art" still :\O m~ ... "t;lil'5 lhal ~O"I; f\U~ 10 4perate as 

C cOrp!lmliollSl Although n(l doubllh~r~ ar~ a multitudl: Ofrell!ons why p;.'C;fi~ ntiti ... s mighl 

n.'1ain C cO<pQr3lion Slalus inSlead of cl)llvcr\ing to SIlme fomtofpass·thruugh l"'~tmc~ll. I havI: 

l'ounJ that lhcrc ure !iOmc n.'Curring itu'l;ull~ where l'Ol'pQl':IliollS mighl d,·tioo 1lI dl!l:lor relllin 

C cO<pQrnlion status. Th~ first is publitly held tOTJXlmlion. Ihal ubv io usly haw m(Jre than 100 

sh?l{'huldcrs. and as a "on~cqul-nce are simply nut eligible I'or S corpurJlion slalus. l l Moreover. 

partnl'rships engagw in active tradl'S or businl'SSCS are l(C1terally requin.'tI 10 be treat,x] as C 

l'U~iuns if their uWltcrsbip inkn.'!IS an.' publiclr traded. I

' 

A!lultlU group ufbusiness ePtil;es thaI ",,!ail! C cu<pQr.ttion status wu uld be those that. 

for one reasqn or another. are e;ther nul eligible fur such Slaws andlorwuuld be sul>j<'C1 10 

sigrU fielUlt Ia. ... al ,lhe C<J!1lO'llle level. d<:spil<.' S status. E,\ampk-s uf tbe funner wuuld be 

c'Urp!I"uions Ihat h.y ... a significant mlm~r uf inelillible sharenolders." o r have multiple classes 

ofsluck.'· thai am not able lu be oo~l!.ht out or ulherw;1>" climinatt.-d. An ~~a",plc oflhelauer 

would bc an emity thallJ or o nc reai>Qn ')r anulher, wuuld bto llbj~'CH x]t() cilhcran umcc~ptab!e 

amounl ()fbuilt-in ga ins I""''\J~ Con\'L'r5;on J~ or w()uld be slIbjt:<:1 lu th e lax ()n pru;si,'e 

inVC$lmCm income and the Icnm,mliun ufS ()rp!lr:ltion S131ns as n n:<;uli uf exCL'S5 ne l plIssi\'e 

income allhi!>corp!lrllle le,el. " 

Finally. Ihere a", many sma ller l"tlrpoT'd1ions when! Ih ~ diffcnmce he1,,'ecn Iho dOuble 1nx 

C eO<pQ"uion reg ime' and plIss-lhrOl,gh,¥ trcalmenl is not alilhal $igniJica n1. For mpl~. n 

medical. lega l, accounting or ot her sc!"\'kc torp"il"Jtion mal' regu larly pay all or all11asl all oi"its 

l'lrofits Oul in la~able eomJXl\~lion. leavi"llfitllc.()r no incol11e to be duuble la~ctI inside Ih~ 

COrp<lflllion and upo-n distribulion, and mal' ~0 1l01 Mlicipate ~Iling out at a ;;ignirkanl profil at 

3n~ poi nl in Ih~ forcsce9ble future. :S hareholders mai r in and be bou~1 001 al relati"el y 

modes1 sums ,,\'/.'r Ihe years. bc<:aus.: thl.'Je is no anticipatlo" thai an a~qu;r(.,. will come in and 

pay a Il~lllnti al premium in onkr 10 purdmse !h~ entire bt,3iness. In such a euse. Ihe rcl~til'ely 

few la ree liingc benefilsl" Ihnl " 'ould OIhc", ise nOI be 8".1tabie 10 par\ll~rs and S e<l<pQT8tion 

sharcholdcrs with un ownership intcr.:st In ",cess o f 2 pen:cnll'l' ean be sufficient 10 justify 

n:toininll.C eorporaliol1 Sl.1IUS. cven IhnuJ!lllhut do.:s rtoquin: IIl~t all t'oM,pcl1sJtion paid be 

subj ect to full FICA I~X, 

the """.p,dc'femi.t .. ~ " tb< ~I'f'OI" . ""el, . "" i. lIIlI . pplic:d>1o 10 S """",n""'" ""d ulh«,......~ en"ti.,. AH ""R>diklt""., j, i> of ' '''Y linle utilil) ,n ,iI< ".,,, ,najuri'Y of <In,d)' held """",,-.-.. Toornl; J. Nj<h<>I<. 

C",",,,,, <if En"ry C""",.,. • ON"'.I«. 1](1] SIOC/r. Foal', Coo/oJ '" ";, ... ~ fi.r ,\/"" 7",1"':'">'" J""",,,1 ot I'~ ~ .. hfl)ul'h 

En!!!in (Ju )'.A "~ ...... 201(1). 

" I.R.C'. j 1 J61 (bW I ltA). 

" S .. e I.R.C', & 77llol. 

" Onl)' <"i, ..... rtiiJenc 01;""$ .•• "1<'> ond ,c".in "" ... ond . ,.mpt "'PH""""n, om' ~Ii~ibk ., .han.'hoid ..... "r!;n 

S <""",,1'01-;"", So¥ ute. ~ 1l61(b.I.II).(.), 

., A~ S ""'f'OI'lO';on n' ) Jk}I !ro"e on",. ,llano .. da .. of5lO.:k, Sn Ute. ~ 13nl,M(I)(OI. " S .... I,R,C.J IJR 

s.-~ 1.)t.C. t 117~. 

"t'"" cu,upl •. btno!,, ~ ""d.,~,"' fi«lI> .. I'h ",imll'm<" ... ' >.""","u.'" . tr",.d.:d ,",-Irei' Ir .. ,menltbr C 

iXlrp.m;tw" •. S<'<' ' ,II..C'. f I();. I h"',~'~'. beotlh I" ...... ,,,,,,, "",mill"'>"'" ",-" .... "tiIIN t~ ,,,onpMIbk Ia., t ... .,m.nt 

rOf I>o<h C """""'"t""" . "d p",-'lIr<>Iogh ,,,\I,,,", .~ I,R.C. §t62t1). 

"Sd IJl..C_Il Il12-

8 
68 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.051

r.. rUfUrC 1'lnu nlnG 

Ifno CQngressiQnal action is t8kL~I, the tL~ bndsc3p" .... ill ~hangt dram!tically ~s of 

Jonumy t, 2011. The m"~t signifi~~m dl3ngL"S, frum a businc,> lax nue f)(.'1sf)(.'CIiv~ ..... ill be th~ 

e~pil1ltion ofdw tl1.~ cuts u>h~red in .... ith th~ Economic Growth and Tax Relief Rec(lntili~li<ln 

AS' ,,1'2001 (~EGTRRA") ~nd the im(l<lsi1i<ln ofa ncw tax on th~ nel inV(Slmenl inc..,ml,lQ of 

hig/l,incol11c laxpayers under lhe Pa i~'111 I'rQIL-<:IiQn and Affordable Cure Act and lhe Ikahh Car~ 

and.£l/ucmiQI1 ACI Qf 2010 (colil'ctiwly. lh~ "Ikahh Care ACls'·). Tile EGTRRA ~pirJliul1 

"ould uusc Ihe IUP 'ndividuallllarginul inCQfllC lax rate 10 incrcllSo: 10 3'1.6 f)(.'fI:CU1. h would 

alsQ rei!llpo:;c the ro-cal1ed (>ellS<' redUClion, which fcdllL-es itcmi;(Cd dlxfuctiuus Illhe M~ of J 

l'I""<.:ent for aU i"come in excess of certain te"els of adjusted gross inCOllle. The net ef1~-<:1 oflhis 

la\1er pr~vi>ion i§ ~ incrca5e the lOp r~'1!;ina.l rllie 10 i'fPro~imalely 40.8 [Jer<:C\11 for n\em S 

mrl'or31\on and ot pasS. lhrou~ hus)n~ss \IIcome_ • 

'The new net in ~~Iment com~ tn unde, the Ilcalth Care Act~ is imposed On Ihc le~seT 

ofnci invCSlm~nt cOm~ Qrlhe "xcess <If modificxf adjuslL>tI gross- income ovcrccmm 

Ihre§holds. The Ihresholds 3r<" $250.000 fo t11aITil..J «Juples filing ajoint r~ um (S I25.000 for 

married indlvid"91~ filing separately) and S200,llOO fuf all miter , elurns.:J This net in\'~St",cn l 

income 111..1 is ilcncrall), imposed on intCr<lSl. divi(knds. annuities. royalli es. r\'IIlS nnd gaiM. with 

one \cry import~nt eXceplion. Con~lC\:oJllliL~d Ihal this new impOsition shOUld nOIBwl), to 

incollle derived hyo"ncrli dir<"ctl~ In\o ~cdjn oclive businesses. Thcr.:fore. Con~s ~"chlded 

from the la .• basc all income derived Irom ~ trndc r>r busine'ss unless !h~ income was rcpnn~d by 

a p.:rson wllo did not "malerially plInicipatc" under the passive aClivilf, rules or the trade or 

bu~iness consistM nftmdins in l'nancial mstnun~'Il!$ m cumlllndilics:'J rllen: lire suI! qtlilC 11 

f~w open iSSUe'S regardin.l1 the upplicalion ofthi~ 13.\'in l:lJrious cOl11l11onplal"t' cireulIIsl3nCfi. 

5uch as the treatment ofciccling small business trusts. 'which.are spl"Cia l tJ\lSIS al!o ... ed under the 

Code 10 be S corpol1llion sh,treholdc~. Th~re ar~ nl~ significant unanswered qUi:Stion~ 

r<:g:.rrling Ihe impacl o rillis a~ on tile sale o f stoc k or int~rt!Sts in_an S corporulioll or Illll('r pa.~s· 

through enliIY.:' 

,. AI'''''u~h \hi> ... " to.' 00 ~ i","""'"",nl i"" .. "", i>«II". ir>«! in ... ,,·O"'fII'" !A ~f ,!lrJ-'\':d< <n",kll "Uno,f1K'd 

Intom< Modica", C""",bUllon." my W>dorst,ndi"l! '" tNlt \he prO<<<& .nlll< Ill< w1ll .." r.., lt~od I~ til< 

M<4i<u1" rru>t fund, 001 "'ill ; .. ,N<! br i""lu.k.! ill JCfI<f\'I ,."·m.,,,,", ""on ..... TI,.rdOl'. i9 c.d." 10 .void '01) 

mi, • .-""".",''''''', I 00 IlOl n:Rr to h ... til< fit", M<dirar< nx ......... ""'nn' .. "'." ... 00. 

" Thi. ~b •• ,.u", ... t< """'mo I., orld O!h<:r .J<du< ion~ ...... iI)'l""n.""""....,...,mll~ wilh i""""., .• l nd 10 

1aXP".\' ..... n."-,,' run 0"' of d.:ductjon< kI "" ruhJt:cd. t' 

",,,.,... Ih.-".hold! Ore "'" ,"noli<m-4Jjll>l<d. 

" 'f"II< Ilt.t\h Carc "",,..1,,,, ",isrd IhI: !'ICN .. lf ... mpl.t ........ nl IU ""<0" "'lIO's."" ,, f~m<>l-""'-'" i",,,,,,, • • bow tit< S.:!S(l.OOWSI2~.()I)Il.$l00.000 lhrc,ItoJl<I> nl<nli",tc<l <",I"" b~ .~ I'< "t'"' Si""" ,,,,,h ,,-.(!" > """ ..-1(.: 

<mp""""'.' '.,,, ..... "'''''' . l,.,dy !IIIbj«1 '" fICN"'r,,,"'pltJ)',ntnl '" at t~. III" "f2 ~ pt""'"'. Ih< ..... ,T"", ~r 

\h1«1to"l!<' " .... 1() i,"'",,,, ,h. \If<'S$ "",.MIL, ~n Io""h "'<in.'''' '''''''' .... ,oJ,S 1'<11'<11'. ,ho.: $On", "" tho ... " la, 

on .... , in''':;.I,,,n,, i, ... un ... lI"w.", ... the ... ,<[f«li .. nno ,)r,~" ... ' ~1(: """,lr .. ",pl"y,,)Cf)' \a~ ,"')"I~ " .... II) ~ 

",,,,,,whi! k>w •• thou ,ho l.g 1"''''''"' "'-~ on ",~ In"e->'m<n, i",-,<,<ne. lli"''' lite do<jO<l,bi li,) fo.1UreS M\ht: nCAI..,lf· 

=IlK>}·n ..... , "'~ ')"olem. " .\:.>~ l'h(>m.u J. Nkl>ot. It Joshua I.. t" ... oon. 1'!<f'U"1 if Ih~ N~. ' H,,~," C ..... Hill,,,~ (/iurlJ' h,1I) /lu"""", . t!£l!: 

Y'>rl. Unj,'rn;"lyM"' ln"iM< '"I from! r."lioo en.2 (lOll). U¢.It<ol \<r>i<on ... flhi •• rtkl< ,.I1<'Cl'!\l 

"""""Ofnld<".IOf'Jne"t.< ond .... Iy<i, .", ••• ibbl< r,'om M.",,,,,,Ti,,",,,) Fio .. .,.&. Nicholl S.C'_ 

, 
69 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.052

As sh(",n in Chan 4, tbe nel dTe<:1 urIbe.., ~banges would be 10 drastically incr~ase Ihl" 

tup marginal raIl! un nn additional 5IQ(J,()(Xf ofeaminj,\S and tu create a significantly mure 

~omplicatcd syst~m. The marginal ralc'S would increase from a rnng~ of 35 pcrcentlO 44.8 

pcm:~mt in ('al('nd~r year 2011 up to 3 mnge of4Q.8 ".,n,cnt all the way up to ncarly 64 pt.'n,~nt in 

20\3. From pa~t experience, J can assure you lhal any such draslie increase in ratcs will result in 

substanlial inwme tax planning regarding the liming of both income ami dedul1ions It the end uf 

this year. nle only thing prel'cntinllthe del'otion of substnntial resourct:"S toward this ~nQn now 

is businl"SSCS' confidence that Congress will du sotncthinglO miligate lhis sudden and dl1l5tic 

incltasc in rah.'S for neXI ycar. 

F!"IIIn a choice oren!ity standpoint. this ncw ta~ Oil net invesllllcnl incollIe will 

signiticamlyj Qcrcasc Ihe double ta~ on shareholders ore corpollltions.. because Ihc. law I'!-'CIllS 

deBr Ihat the tradl'-or business of the C cUfJlOrnlion will nut be 311ribuIl-d 10 its ~hareholdcrs and 

SO no exemption will be .vail~ble . 

.... __ ... 

., , 

.$ 

Im,,,,,,,, ~_ 

L uS 

-

'" .oo._.FH~oD1O ·'~~n·~ 

0 . f.A'tl I~ l._ 

- '-

This new tax also add. a I~,'d orcoSt and complexity ror S corporations and uther pas.>t 

through cntities. For amplc, if WI S corpomlion h3~ a mix oractivc and p",~ivc shardlOlders, 

right now the top tax rateS applying 10 both grllUjlS are th~ samc - 35 percent. St3rting next year, 
70 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.053

how~ cr. the tax rate 00 aCl ive ~hn'hold<'rS w@ld fN, 40.11 percent. while pa;sive shar~holder5 

would f~~" a top rate of almost 45 perc~nt (after laking into account th~ 3.8 p" Te~"f1t tu on n~t 

inve.tment ineome). Not only doc"S this higher r"dte rdlcetl higher 3..~ bunkn on the bu~incs;. it 

~Iso has Ihe d fcct of drJininK resourct"S from the bu;;nl'S§. S e!)rporalions I~pically II)' to 

di5tribUic l~lOUgh earnings f!)r thciT Shareholders to pay the ta~ On the income pas~d through 

from the busin~"SS. With the si"Sic class!)( stod reseriction. th~"SC distributions mUSI bo: 

p~nional. which mc,,,,s thai, sUlnill1l ill 20D, many S corporali!)IIS will need to disrribute 45 

~l~lt '1fthcir cnrningsjll.~t rv pny rhe businc.",· ta.,cs, L"OIUI,,,red tv 35 perc~nt rod"y. 

Probably the m .... 1 detrimental a;;pct.1 ufthi, new lax "!roCtu"," ,s the fact that it would 

diminnle lhe relative parity ill t()P marginallllX tllt~s fOf both individuals and C cillp<J"'lion~. 

Thl:. 45 pert'enllop indi"idunllDx rate win once again ~ ~ubstantia ly highl'r th:m the 3S pcr~lll 

/orcI·c" ll'wcr) 19f1-tax r:ll~ Insid~ C corpor~tions. Ifnothing iii done. lhis 10 pcr.:entallc point or 

b'1"cat~rdiffcretlce wikr,id re v~ Ihe e.wemcl)' important rc-fonll first Introduced in TRA '86, and 

Ihe resulling ,,...,,0.1 toward !It~ single IU n:gime thul is both mon: 'nl1l~p:lrcnl and tess subjCC\1O 

manipulnlion. 

F. Tn rop"s s 

In addition 10 addressing tt.~ ;S')I.JI' of las "'1<.'$. I understand that Ihere arc. a num~r of 

ptopq;;al~ «"Iat;ng to the tax trrotmhm ofl:loscly-hcld businl'Ss that arc being L"On,;idered. 

Pr<Jbably Ihe most imponam oftheS(" propo~ls IQf mOSI closely-held businessl"!; would 

bi! Ihe possibility!)f ~~tending andlor expanding Ihe.optil'll of ~x~nsin~ nwstm~nts in capital 

L"Iuipml'm undl"f_ ~!llong oIhl"f pm,"isiuns. SI"1:tions I Nand l68{k) I'fthe Cooc. Most closd~­

held btl5im.'ss o"lIers imuitil·cI), CI"~lllate tllcir busi!ICSS nn Ih ~ basis nr cash nn"'_ rather thall 

ftn3!1cial Slalement nel incollle. nlis is c5pt."1:iaUy ilnpona1l1 for i/io::m fN,causc Ihc)' oficII do nOI 

have access IU 5ubstalltial cash reserve", or crt:dit csreci,llly in limes of stress where cash nIJ'" is 

Ihreatcnc"<l. 

> Ilearn • .J this te"'!)n mi y in my carecr. A cli~n' , wh" had in,;t eamid his fo,., million 

doUars_ h~d Ihen Spt."Il1 the munty un equipment and olhef capital e.~p<!ndi~ thai Were """ely 

nc~ded in hili rapidly-grtlwing bugine~. ~ ~"UUcd me alkr the cnd ofth~ ~·~ar ¥' di"cIIss Ih~ 

'-problcm~ ruis..'tl by his aC1.'Uuntant thaI he nowo,,·OO income tall. Trained 8S r "as in :J.~ law 

and lIcNunting. I calmly~xplajned 10 him thJt Ih~ reason he owed ta ~ was Ihat th~'SC ~api\al 

~~~ndjtur.!5 sliU had ,·aluc at the end oflhc )'~~r and would be dcpn."1:inted lor lax purpo~~ only 

11:< Iltey WCTe consumed in Ihe bu,ines> nver Ihe nc.xt sel·crnl years. Less (811T11~. he >aid to me 

"Tom, you IIon'l understand. I h:',"e no ~"lt.'h." 

Over the yean;, I han come 10 mure fullyllppri."1: iatc the wi>dom of his Slat""'''lll. Must 

clos~ly·hcld husinus owner,,; cnrreclly think of money sP'"nt on equipment and othcrcnpital 

c~~!ld; ures as slill :II-risk in the busin(!S~. ~nd a. nm ·~:Irn d· ' until it COIT1~'S back tu th~ 

busines~ in the- fonn ofcolkt:linns upon sait'S. From a till( p!)lic), ~rspccliw. allowing 

businesses 10 deduct their ctluipment ~nd othl"f capital expenditures mah-s ml'rc in tuitive scnr.c 

" 
71 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.054

"hc~' yon cOl1sidL'r the f~c. Ih:!t the seller oflhe equipment or other item will be requin.'tl to t~~c 

.he ... nire sales proCt, .. 'tls into incQm~. Thi~ i~ ton~istcnt wi.h the Jl"l'!ipective ofm3ny clo;l<'lyheld bIIsiness owners. i,c .• that it i~ 1m, seller that experiences th ... income in this Lr.ln~lion. 

Tlw S:I111(' principle appli.-s to inventory. for 'hose busincssL'S that an: n:quiri.'tl.o 

maintain 8" inventol)' for ta.~ pllrpose.s. lIowcwr, this disadvantage issigtlili"antly mitigated by 

.he provisions rcia,in!;'O last_in. lirst out I"LlfO~) in\"L~l1ury accOllIl1;n!!! u!ldc-rCudc- Section 472 

~ndJoliowin!;. At kas. u~tkr UFO, the b~incs.' owner i~ 1.~ltjtled to exl""lSC his..,.. her ltK)St 

re~nt imentor), expenditures. fD.hcr .han whaL 11) him or her, is 3 more artificial numocr based 

on~n 00 much oldL.,. historical costs. 

!. Cad , Ibsi. 

Although 111m sure there are odditkonal examples of where c.1.11 basis nee"umin!; rnr tU 

pUl"pOIic;; wnuld belter m~tch closely-held bu~irw;s owners' realistic jX1\":cption ofthcir aC!UJI 

;!)fOmc. my gllC$ is tlla.1 ellui pl11!'111 und ;Menlory purcha!>Cs tOllStitulc the two pnnwy 

eS[l<"nditUre!; ClIu~inl: pTllbleTl)$ fOT buSini:'!lSfi n:qui..,.j to US<' accrual ijtt\)uming fOT tal( 

pUrp<lSes. Ac~oun~ r<'ceiva1)l~ <'1m Ilea pr()bl~m in that. in somcca>cs. a bu>in~ •• ntU!it w~il 

y~a,.., to aClually CQII<'Ct rt'(:,,;vab:I~, that art' n:Quired 10 bt- taken into income immt:di~tcly. 'ro 3 

c"rta;n e;dcn t. tllis 3C<'dcr31ion is (I~I by the fael th~1 accrual trJsi~ taxpay~rs can alSo d,-duct 

accounts pay;,nlc for ~pcI1SCS Ih"l ba c not yttlx'C" paid by lile clld ut"thc year, buttht Code 

OOl11a;IIS "«oIlOlIl;e pcrt"om,aIlCC" and OIheCfCljuireTIlcnts lu P1"\.'\"ot siglli!icunt time gups 

belW,'e1l dcduction and payment. aud well·run busiuL"'SSt's ol;oviously pay their liabilities on a 

rdatively prompt basis in any event. 

Also, nUl all closely-held busin~sscs af~ r~q ir~d by the Code!O ,~...., aceruw accounting. 

In general, pa'~-through cntit;~.,; and :wle propnd!)rship:< "",nOl ~"qlli ed to oc t,u(,d On th ... 

accrual bllsis. unil'S. Ihey maintuin i",cntoncs~! orcon.tiwle IWI" shcl.<:rS .~ nlUS, mOSl dos~ly· 

held entltics Ihm ar¢on Ihe aceruJI ba~is h,we volul1lanly (c.;.cd:~uch treatment. 

Man), do elect ~uch trcnu11elll.impiy becausc they art' ~lre4d m;tuired, for bank lending 

or O1h~r purpo>cs. 10 pTqW"e and m~intain fmandal Stntcll1cm, on Illl<,hn&is of l,\ff1ffitUy accepted 

ac~U!l"ting prindpjc~ (~OAAI'''), ",hi.h 31>0 "'<lui ..... accrual at<'Ountiog,'lInt1 It is ~askr f(>T th'lI1 

to d" 3ccrual acc01Jnting for bo.h bool: and lax pUfTl"lSI:!;. In Slimnlary, !"nisin!; th~ limi. on lhe 

x~n'plion for n.·quin.-d atl"nml b.1sis accounting from $5 million \I) $10 millil>l1 untkr Cod., 

S<'CtiOI1 448 is nUl likdy to bt-l1efit th~ va,. majority orclll'lcly-h~ld blls;n.-sst"S_ ,!hi, is in ~tark 

contra,t 10 thc "'IlIipml'mfc~pital c.~pI.'ld;tur" (xpensing nIles. which would impact P6th'qu;/t and 

accrualt~xpayrrs , 

I al~ untlcrslllnd lha. there are pmpo!ials \" broaden the busin~~s t"~ base in ord~r tll 

lower the C cllrpol1lt;un inco",,", ta~ r,Uc un a rt'venue nwtral hnsis. While Iuwcriug thaI 3S 

percent rat ... twhich puIS the Uni.ed Stales at the '(Tj top lIfth~ induslnaliLL..J ~lI" ntriL"S in \ern" 

"s.-.. 1""",, Keg. t. 71 I . 

.. S"" I.R.C. § ol48 , 

" 
72 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.055

Ilfmnrginal rnll~) ili an ~xtremely luud:lbk gila!. it is impOrtam 10 n-cognize that. if this i$ done 

in the coolexlof only lo ..... erillg lhe C corp!Ir~ti()n income lax rale. the n~t eITel'loflh;s ~«'IQnn" 

..... ould be a substantial IlwralJ tax incn'asc for Ihc vasl majority of clo,;ely-hdd busines .... • •. This 

is becal,se. as indicaled c<I.lier in my K'sliniony. thc larg~ mujority of clO<!cly-held busincsiies arc 

Opi'Ming as pa!;S-lhrough enlilies ...... hich 11lCllnS thc~ ..... ould be un~lTcetcd by any reduction in 

the C \;(-"l,.,,,mion income ta~ rnt<.'S.17 

An Em.<;1 & Young sludy comjllclc..J un bchalf uflhe S Corporalion As,;ocialion earlier 

laSl,yea.r n13<.l~ cI~ar the chatlcngc corporntc-only la" reform presents 10 p:IS,;.through businc'Sscs. 

ACi:onlln@.lolh,,-study. a bro~d roli.:::y of eliminating bu~incss Ib cXpi'ndilures whiletuuing 

only cot'por:ne raWs would raise the lax burden On pass·lhrough businesses by appr.)xim81el y S27 

billion pi'r ye~r.!Ij nis is imrortant bt..'Cau~c plss-thmllgh husinc,s<'S employ o~cr 54 pcre~m of 

lhc privalc se<:HlT 'l:orkiorcc. and. a~ my eJrlicr lestim.my indicates. anything lhat affecl~ the 

<ush now ofci""e1y-hcld bu>;ne~~cs ~nd w.~cs certnillly do) will unavoidably hJv~ a ciepf<"!iSllnl 

~ITecl Ufl'Oll their eonfribulion 10 1he e1:Qnomy. 

:l. Fnrecd C C"fllOr'1IlIon Trc~lm nl 

There b,\Vcalso ~e" propvsals \0 foree double \a~ C l'Ofjllll1lt;ol1trc"tmcnl 0\1 large passt]'rou!ll' entities.!NIY (hose h"vin~ gOP" rcttip15 OVCf S5Q million. In addili"" (0 imposing" 

substantial additional compliance and 1lI:O: burdc" on the most l)foductiv~ ",eotocrs of the p"'stl"OI,gh sector of our ~'Conomy. such a p"i'l,)i~ion would "'quire a detailed:ll.ld complieat~d 

'ystcm nfimcl'-fci.le-d ruld. I'or exurnpl~, hllw,,"ould an enllty be lrcl\~d thaI hmcrs both 

ab<m.' nnd below the S50 million tri&!;er poinr7 Woujd thc built·in gains tax apply when Ihc 

cnlil), re-eleets S SWllts after ha";og been tim:.:d inlo C c()rporJtion Slalns M ~ (<!SuI! o rho ving 

cSlr.lordinarily g.ood INeipts during Ihc lesting pi'rlod} Wouh.l on entity be trnppcd in C 

corpor .. lion ,tUIUS ewn lhnuj;h il no longer had S50 million of gross rc~ciplS. because of higher 

rc«iplsduring Ih~ t<'Sting pi'riO<l? Ifnm. would ~Io>el)'-hcl !l bUiiness owner.; not b<: in Q 

posilil)fl lO know whether tlwy will be ~ubje"lIO a C corportlliO'l .... S .OrpQration t~ , "'gime 

unlil3fl~r the' eqd "rlhe year in question? 

Alw. I am 'ls5uming thaI the", would h't\·c 10 bc some type Or~llj,ngatioo rules so th31 

dosdy-hi.'ld busi'ICSS ownc'l'S c"uld not simply splilthcir business inlo t .. ,ro or "'ore entilies and 

avoid the C corporation regimc in lhal fashion, A~ you can un~Gine. 5uch a&i;rcgalio" rules",c 

cxtrcmdy difficuh to administer. Fur CHn)pie. ir "arinus bU8incss emities wem-fo con'li\Ule " 

""ri<'S of ovcrbl'ping "&!;rcg>lled commlgruups or afTolialed ~rvi""~,,up •• h",,' would thaI be 

handled'/ Ir onC ortllc group" was bclow the threshold and another of the gmuJ1:S \\"~~' above the 

Ih~shold, wonld the own"r~()flhi: lifO"P thaI "'lI;; bcl"w Ihe \h",sh,)ld be force..] in\(> do<lhle Ill>; 

C corponlilon 5Ialus.l ... ·en lhough sOme "rthem owned (lnly an interest in u ",h,ti"ely mall 

business? 

"' """,,,mer •• ,,,,,,01<--.1 W1~ .. li<!. '''''') <1"...1 1 1 .. M C ""'I"~ .. ;,., .. <k> ""',,,,"in' ,u",,,",i;ot ."_n' or;"",...,.. ., tho ""'J" ""~ I~"'\. '00 .. ·on r.,,·.,,- or'''''m ,..,.;. ''''''"''' , ubj.." '0 Il>< '''P """ginol norr<. 

" ~,*,"M C.""tI . "d C .. ,.W p,."t<. n,. I,,~' rm.."'l!h /Jo." .... .,. ."'-""'" .. ",Id r..,. Rrfo....,. Ynl>! & yll\II'" (Avril 

20 II ~ A"il.obk 0" lIIluJI" 'Ill K"!l"') ''' ~ 1II9iILJllinl;<-!¢,"""gr..-,!!!d, ... noJ.-OOI .... 

" 
73 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.056

£v~n in thc ubsen~~ Qfmul1ipl~ o\'~lapping groups, how w~,ld you handle the nUml'r1)U.'i 

compleKili"'; Ihat are in\'olwd "h~n muhipl~ cnlilics nre I"'~led a. a Jingle unil? The 

~Q"SQlidaH~d relurn ~I"ulalion~ ~p<ln owl" 440 p!lg.,,; in Ihc standard .-dilion oflhe CCH Im:omc 

Tax Rt'gulalions. dealing wilh iSSUL"!> su.:h as inl~H:ompany II"JnSil~tions, ~Iock investn"~111 

accounts, calculation or cn.-dil!;. alloc~lion of income tax liabilities and "um,'fOUS olhl'f mailers. 

n)~C l"{)mple~iljcs are difficult clIough for groups orbusiucss t:1Uili,:s Illal voluntarily choose 10 

'!"CauhcOIsdvcs as a single aflilimcd group. bUI Ihis level of cO"'I'Ic..oly would be 'nu\tiplioo 

matly lioll"!> by IOrcing al:grc~<· lrealm~m for aUla., JIU'lJOSl:!; on an amalgamation or 

rorpbfll }O~~.l'artnerships. limil.-d liabilily COnlp'mics and mhe. entilies thai happen 10 be linked 

by cunnnQM oWllL"f1;hip 3c ivitiL"S. 

This fllrced ~m~lgam~llon mighl ~I~o hay':' the oninten~ed ~on",quenL-'; ofopening up 

opponunilies for 3&/Zfessiv~ lax plAnninil RnJ tax shelters. For exampl~. ifdiviJen<l!; arc tr~ul~-d 

as coming frum the bUrc,!lnh!Carnin/lli and prolits of the anmlgnm~ted entity, wuld Ihi: C 

rorpornlif>n O\\'ncrs of on" flh~ amalganl~ ed entilles drain olTnll of the earnings and prolilS on 

a lax·prcfC1TCd basis, wh;Ie.~lJo\l'ing the remaining individual owncn;,(> achicve Ihe cqui'"lIlent 

ofS corporalion lreatlnenl as ~ *~uh ofnon·dividcnd distributions·! 11"00t. would the individual 

owners nfnne orlhe separale entilies ,,·itlt :lCparatel)" lrelltcd earning, and prolils be able to 

achieve S COrp<lrlltion.I),pt:' trealment by cMlfuity mannging th~ o)l<'fll1ions ohhnl emily? 

In addition 1<llho:s~ wor~abilitY1<p!lrcms. making an arbilrary nod involunlary ~Ul0ITf()l 

p.1ss-throug)1 tax tn'alnlcnt is imply 110t g'/)Qd tax policy. for the !"l'asuns indieatcd atth~ QUI...,t 

uflhis testimony. lhc douhle 13~ C ,·orporJtiun 'i}'s1<:m is nl)l prcfcm"<i lax policy. MU!"l"tw<"f, the 

$50 milliolllriggcr (ur whatc,·tr numbo:r is ehoo;eu as the Irig);er) ,,·ould cle;,rly discourage 

growth in eomp;,nics th~t are appruaching thal lcvel, ;[.n~ slIch cumpanies would be inccntjvizl-d 

10 eo&"gc ;'1 a great deal ofsoplt sticat~d 3nJ expensive'tuK p\aJl!l;ng 10 avuiJ Ix·;ng im·olullt,,,i\y 

subje<;tcd 10 thc double la~ system. Sueh nlanC\lVcrs migl~ nJncthel.,..s bejusl;ficd ifsuch a 

pmposal WL ..... cnacled. h\:call~c one addilirmal Jolla~ of I:f<'S-S rcc~iplS could lilerally tri~c~ 

millions of dollars of fcMraJ la~ C011~equencl"$. Such clifT_like 1ri ~ are otwi"ously nOI favored 

fo~ policy purposc.;. 

Finally. just bcc~use 3n enlity h"~ S50 million ofJ,;ross receipt;; does nOI mean that il is 

prOfilable. There Drc many ';ueh entit,.'S lor amalg.1n1alions ofs"ch enlilik') Ihat actually h~"e 

losses. "Mich. under CllfTent 10"'. Dr~ approprialely tUken into oce,llmt (and fri~ary cMricd 

O\ICf) 01 Ihe indivi<lllallc\"cl, forcing Individua! owners attoat level ofactivil)" 16 fon:lID Ihe 

abilityto deduct these los;;cs would una"oidably impact thei~ willingnes;; 10 co,l1inuc 1{) run~ 

Ihe~c cnmprises, with the concomil~nt imp.lct OIl the jobs and linaneial securily oflhci. 

employ.:es. E'·cn profiloble ~nlilics would not secm 10 ",crit such drac'JI1ian treatment. For 

e~Ul11plc. a low-mRrgin I p<'"cnt-of·ii3Ie-s bu~incs> eQuid cosily havi'" S50 million !lfgfO!;~ 

ret<'ipts, but have only S5(1).000 ofaclualla.ublc incomc. Triggl:ring C corp<;>rotion Slams in 

thc~ci"umstal1cL'S S<'<.'ms enlirely ''"W3rrnnICd. 
74 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.057

s. Il rr " Rul e 

Aumhcr propo,allhm should he considered in Ihis conlC~1 is the so-calkd ~Burlell 

Rule." While IIIC AdminislI'llioll hm; nO! fully ~niculalcd ill; Buffell Rule proposal. legislalion 

ha, oc.:,n inlrodm:cd in bolh the Ilous(' ~nd Ihe SenalC \ II.R. 3'XJJ and S. 2059) 10 imP'lISC U 

\'crsioollflhc Rule. Ai imroduccd. Ibis prOl'isilln wOlild !;CllcralJy il11po5C an tfleetil'c lax role 

of 30 p<'l"<:e'1I on Qdju~tcd gross income without laking any itcmiud dcduction> (olhe. than 

th[\J"h~blc contribulions) i"lo Ql:i:OUn! for i"dil'iduals earning ol'er $2 million. including ~ phasein fO I~payers making oct .... ·ccn S! million nnd $2 mil1i')I1. 

III "fleel, Ihis legislation ..... ould impo;;e a Ihird U~ Oil high illcomc la~pa) crs - forsl the 

individuol inl:Qlnc ta ~. n~'X1 the Altcmnl'l'c Minimum Tas. 811d then finally the O"tfen Rule laXIII1d would mi r\\lmcrou5 iaimcss and adminislralilc oomplulTY is,ue>. For (!"~ill11pl~. the 

murglnul fl1lo::S incnm:d by individual~ caming bclw(.~n S I million lind 52 million tould. in somc 

eircumsl3J1ccs. be as liiSbIl5 60 percenl. Th~ Ilutli:tl Rul~ ,,"ould also eMcerbate the C 

oorporlllion double lax pfIlplcm I oullinc'{\ carll~r b~ jmpO'>in~ a minim,jm till Il\te of 

approximately 55 pef"l.'enP' ~ uistribulcd C corpofl1lion earnings, an increase of appro xi mal ely 

10 percentage poin15 from Ihii )'tar's raiC. 

As for S corporatiOns. c",li& i tli=s.:tll~~ challcn~e ofapproprbld), diSl ibutin~ 

Sllflick.,,1 camin£,> for S corpnralio~ro/lOldcN to P.ly 13~~'" On Ihe b"sinc;,~ ' income. The 

Uuffdl Rule Ilouid cX3C"'OOI~ Ihis cha)l~nke by forcing:m S corporatio" 10 calculat<l and 

di5tribulc additional eamings, ",en if onlyOnr"llfilS ~Imrcho dcrs ~as (u. l11ighl hav .. ) incilm" 

subjecl 10 the UuffetL Rul~. The result would be to drdin addiliolUll capital and rc'SOUfCeo; from S 

corpor~liO\l ~ seeking 10 bmld up Ihcir L'<juily and .... 9I'king "apilat 

Finally, pemaps the mosT <irnnJalic and unfair ~5eqUL'11CC Oflhc BulTett Rul .. fm 

closely. held bllSincss QII"n(>f1l would occur in the COniC"1 of a :;ale of 'he b\iSin","-~. The current 

federal lax nne for:;ale lransocli<..nS is 15 !,<,,"ccnt and il$ schcdulea 10 incre~ 10 20 percent 

~Ianinl.! n<'Xt year (before takinG imo accounllhc 3J~ pcn;cni addilionallD" on nel itlVC"SlmCni 

income under the llcahll Care Acts). The Iluneu Rule would inC","D5Clhis (D)('rnIC fnr la~payC"r.i 

makiul.! more tll'ln 51 miilion. e\'Cfl iflha! hiGher income was IriGl:eri:d liy a ",'''ce in a lifetime'" 

transaction involvio!l5oilte ora bllSinc'Ss buill up owr d,-.:adcs.. 

6, un:~d ~l ~ r ".\-T hruuch Tn mcnt 

One lasl lax refonn proposal thai I Undc"lbland hm; bt~l con~idef"l.'d is thc Ilili"lbiiiJ,y of 

foreinJ! all pJss·lhrough cmil;cs illlo Cillll'" S corporJliOlI or partnership !a~ In:,U!11en!. 1ft was 

designing a system from scratch. 1 wuultl collsider doiog this. HO\<cvc .... lIS shown in Cha~ 1 ~arlicr. we noll' have uver 7 million pass-through businesses operating in the counTry. 

apPll)ximatcly 4 million oflO.hich :lre taxed under lhe S cOl"flOl'lltion n'Gimc antlthe remaining 

approxirnulcly 3 milliun oflO.hich are tre:'tl"tl as panlll>f1lhips. TIIUS. any forced channeling of all 

pJss·\hrough activity through dther ont oflh~c vchicles would ""avoidably impose ~"b.;la'l1ial 

additional ta.~ e{)mplian~ ... eo ts and ulher cons':quenees on a ubSlantial number of 011 going 

15 
75 

f 

Chairman CAMP. Thank you, Mr. Nichols. 

Mr. Sullivan, you are recognized for five minutes. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.058
76 

STATEMENT OF MARTIN A. SULLIVAN, PH.D., CONTRIBUTING 

EDITOR, TAX ANALYSTS, ALEXANDRIA, VIRGINIA 

Mr. SULLIVAN. Mr. Chairman, Ranking Member Levin, Members of the Committee, thank you for this opportunity to testify. It 

is a great honor for me to be here today. 

Mr. Chairman, over the last three decades, we have seen a fundamental transformation in how America does business. Passthrough businesses have grown rapidly in number and in size. This 

growth is almost entirely due to an exploration in the use of limited liability companies and subchapter S corporations. Here are 

the facts. 

In 1992, LLCs were virtually nonexistent. By 2008, there are 1.9 

million of them. Between 1980 and 2008, partnership revenue grew 

from 4 to 14 percent of all business revenue, and over the same period, the share of total business revenue claimed by S corporations 

grew six-fold, from 3 to 18 percent. 

The United States has an unusually large non-corporate sector 

compared to other countries. A recent study found that the United 

States ranks second only to Mexico in the size of its non-corporate 

sector. 

On April 1st, when Japan cuts its corporate tax rate, the United 

States will have the highest statutory corporate rate in the world. 

There is widespread agreement that we should lower our rate; the 

issue is how to pay for it. 

One approach would be to eliminate some or all business tax expenditures. This approach, however, would hurt pass-through businesses that would lose their tax breaks and not receive any benefit 

from the rate cut. 

Pass-throughs depend most on two tax expenditures: accelerated 

depreciation, worth about 8 billion a year, and the Section 199 

manufacturing deduction, worth about 41⁄2 billion. Eliminating 

these tax benefits would be particularly harmful to smaller passthroughs for which cash flow is critically important. 

Many pass-through businesses are large businesses. Here are the 

facts. In 2009, there were 14,000 S corporations with more than 50 

million in sales. They accounted for 29 percent of all S corporation 

profit. There were 18,000 partnerships with more than 100 million 

in assets. They accounted for 64 percent of all partnership profit. 

Clearly, we can no longer equate pass-through businesses with 

small businesses. 

As the search continues for revenue to pay for lower corporate 

rates, we should consider extending corporate taxation to large 

pass-throughs. It is really no different than any other base-broadening option. It would level the playing field and raise revenue that 

we could use to lower the corporate rate. 

Now, some tax experts worry about the effect on small business 

job creation if current rates are not extended for the top two brackets at the end of 2012. I believe, however, that the question of extending high-end rate cuts should not pivot on the effect they will 

have on small business owners, but on larger issues such as the 

need for deficit reduction, the effect on tax fairness, and their effect 

on the overall economy. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
77 

If I could call your attention to the screen. Well, I am sorry, we 

are having technical difficulties. But the chart I am referring to is 

on page—oh, thank you. Thank you very much. Sorry about that. 

The figure on the screen shows a box. The box represents all the 

income affected by a rate change on the top two brackets. Only 30 

percent is pass-through income. Only 21 percent is related to passthrough employers. And only 8 percent is related to small business 

employers. 

If we want to promote small business job creation, providing tax 

relief to all income in that big box is a very inefficient way to do 

it. By targeting tax relief to pass-through employers, we can promote small business job creation at a lower cost. 

Now, to this end, Majority Leader Cantor is proposing a 20 percent cut for pass-through businesses with fewer than 500 employees. Unfortunately, this proposal has some serious technical shortcomings, as I explain in my written testimony. A better way to 

spur small business job creation would be to provide a permanent 

tax credit equal to a percentage of wages with a cap on the number 

of employees who can qualify. That would create more small business jobs than a rate cut for high bracket taxpayers at a fraction 

of the cost. 

Finally, a recent IRS study confirms what most of us already 

know: Small businesses are subject to a massively disproportionate 

compliance burden. I think all of us on this panel agree that Congress should aggressively modify provisions of the code that impose 

a large compliance burden on small business. That would provide 

significant tax relief, with little impact on the budget deficit. And 

I believe the proposals by Professors Kwall and Tucker on my 

right, about choice of entity, would be an excellent place to start. 

Thank you, Mr. Chairman and Members of the Committee, for 

allowing me this opportunity. 

[The prepared statement of Mr. Sullivan follows:] 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
78 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.059

T~Minll"'Y o r Marlin A. Sulliva n. "11.1>. 

Cliid Econ<l ",hl 

T n nal)" IS' 

"~,,,, I:" Bnal ·) s.~"'n Bnd ""w .... tn .emn 

<l ~ lhe otntnillc ~ <I n W.l" ~ Dnd C1l t' ) 

U.S. 11 ., ~t <If H. pus~ nl lh f!i 

~lDr ll 7. 2012 

lhr<l h gosin"" . 1I nu. ln .. ~. and Tu R. r.,rm 

Good ",<mung Ctfainl'Bn Camp. Rankin g MC1n\K"r L~\"in, and n'~"'!)ers ... fthe Cmnmluee. Thank 

}"illI r ... r Ih,. opporlunil), Q.,~ h~rc !II)' vic"s on lhe imporlanl W'p,c () pa~Slhrough business UtKDlioo. 

I. Til" Imporl am'c Ufl'35sthrblll:h BUJlness In th e mcrk~ n &ollom), 

Owrlhe luSI Ihre<: dt.'Cad~s. a mptd~ incr~a sing number f>r AmeriCII's businesses h:h'c organi/cd 

Iheir nlTa irs- Kl lhnt Ihe)" arc enlirely rr ~ Orille cnrpnml~ in~ome la ~. The~ arc lhree majOl!lO-

~nrpnrDte tas alternatiwI': S Lwpor.ttiM~. ~:nln ers hi (l5. or $Ole proprietorships. Collectivel), th~.,;e 

,11"-,,, 181< clsssilicotion. are Nfc,.,..,d to a. 'h ro"llb" ~"';ti"" booa"Be. unllk" C C<>rp<>",.';ons 

wll"", prolits tan be bollied upumU Ule)" are di,lrlbUiro. the profits of these bu~j"c,".s a", passed 

IlIn'ugh immcdi~t ) t6 ll"llCnr wh ... 0)".1 report Ihis income on lheir individual ta.' ret"rns. 

As shown in Table I. p;l.\~UlJ"ough huS"I~~"-'S ilCcoufte-d (0,.113 pc1l"Cnlllfall bu,ioc$I; retums in 

19S0. By 20(18, that Ilgure h~d incre,lscd III 94 pereeTil. rjt\:ir ~areor tulal r''<:cipts. unly 13 pctl:cnt 

in 1980. gr,"", 10 34 pere""1 by 2008. Their share of profits gf"llw froQ' 20 to 4 7 percenl. 

l1ec~ui>C lhe corporate ta~ is being "hollowed" out frum be low. the cOI"JPO!lI'e las mlm' !h~n cwr is 

now a ta~ un big busine'5.111i~ deve\opml'll' is the f"CSult Ofl w" pr.tnoln,,"~: Ih" dromalie in crea~ 

in Ih" siu ~'Id nu,nt>cr ofSut>chaptcr S corporarions and Ihe 5\1I"\;C. ml»'tly i]l the 199Os, ill Ihe 

number urli",ilOO li.bilily cOfpOf"dliuns I LLCj;~ . whkh arC laxed as p"nn~\j". 

Subd,aprerS Corp<lTar;<Jns. l"h"drnmatic rise ;n Ihe p<!pularity ofSulx:hap1t'r S .latus is ~how" in 

Fi re I. TI"ore ,,'ere haifa milliun S curpurnliun rerums filed in \\)80. ThaI number ~ to 1.6 

million in 1'NO,1.\! milliuo in 1000, and 4.0 m;niu" in 200~. S curpu ..... tions J;f"w in siz.:ol!1j "dl as 

number. As shown in Tobie I. pn)fil5 ofS"behaptcr S COrporalions in 1980 werej .. st I p.'I\:cnI 311 

bu si nes~ pT()fla. In ZOOS thot figure had ris..'11 15 I'erctnl.' 

'TIle,,.,... <,........,..1> ........ "'r~ ... n om! "'" r ..... orrn tlo.ly .... f,omdod ,n 197Q ... """II"Iti,urpnI1~'''''': 

To An. ~<L' i •• le>'l,n& f""O'·,d.,. of .. , M>\. at>.! aJI.llpi< R>r ,h. ,,_1 «l'n """"'~ tly """''''11 r ..... tho '''''<!W<'''"Y 

of ... , N ...... f,""'n ~ ,,.,.,....,.. d .. IoB"" bott,,· ..... luJoi "",I>00,,,,:rod ''''iIQ)''''. antl pru~"in~ forum. (Of odue",;"" 

""" <kbo'<. T., 1"",1)',,, .... , .. ~ .. "'. "'""'"'" ~rt"' 11 ... .,.. ",., ~I"< f., ....... '''opl ........ d "'''''' «·"""",:..Ibd lk'"". 

, Subc.....,... S oorp.""ion • .". ...... ".lIy , .. cd lik.d 1""0"''""'11>. Sub<hOl>ltr;<; or"", l.ltr!\IIlll.""",,,,, Ct>d< .. n 

..... "",«1 ,OlIO 10 .. in 1958. '\' ,be ,,,,,. Ir • .-", ..... ~ ........ "'~ "",.eo..,." ,110, ~i , """"",,i,...,. ~ on: "'''''''''''' "", "'"ni .. ", in Ih~ ... ",,,icon .... -onli<ll). Til< ,nl.." orS"h<~"I'I<'" ~~.s \I""'~I!-oon "'"",ica', .. " , II and r ..... u)-<>'",,"<I ...,~,.,-"" 
79 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.060

,,-

R,,,, i .. 

1'1"1"""",, 

R"""u 

R,,,,i 

1'/«1 

,,-

R .... ,; . N<lI""""" 

,,-

R""i 

><<<1, ........ ~ 

-, 

sc ......... " , II';, 

All P .. """", 'Bu~.n ... , . .. . robo". ill" ~ 

," ,J\" 

.!>\o 'J ~, "<. -- ""', l SI. 

.~ 

IJ".. II~ '>"\ "'" 

R<<<; , ~ m. " .. 6$\' 

><<<,,_ 111'1. S~, ~) ,. $1 ' . 

S-.. s.. '; ~i<><>I" O" .llt$"h_.I<Ioi",,, A~;' A "'M' M;. A. SulI" .. , ('~ r", ~"'" 

1~"",PMr", .. ,h.!!· ('........". ,, ~l _ 

''':> 

Utfljlt'</ Uubililj' CfI,pfI,ulim .. · um/ O,lrer Pa?,,,en',ip.,, The &ile and numller of partnerships has 

al$!! grown rapidly ov~r lhe IUllhrelldecade,_ Tlible I shows Ihm Ih~ir $h:tre of lOla I bu~iness 

profils has riso."II from 3 (l':rc~nl in 1<)80 lu U reroc~1 in 2008.) At \h~ same ljm~. their share uf 

lotal r'1.1um~ fel l by nne percent Thi, inc~~ i~ alrJKll;) enlirely Ilue tu Ihe ~ky-nxkCling groWlh of 

• new form nrbusiness '".ganization. th~ Ijmit~d liabiOty,e')'I']l<II'dtion. 

In Ihe '-drly 19805 LL(", Ilarely eJ(i.!<'d. r.l"w tMY are avail~ bJe ~~r the J3WS of311 SO stales ulid 

Ihe OisuicI ufColumbia. Fi.\\u,,, 2 shows IRS data ml busi"e.s (ilin~ lax relun .. as LLCs ~ well.1I 

other partnership>. The 4i>lher pa.nnershi~~ C3!egory i"cludes p!ainJllll J:i~nern l partnership" with 

""limitM liability, And it also includes limit~d p~nncrW>ips (d llf~rent tom IInllled liability 

pllT1ncrshipsl "here som" paMI:fS have limited liability and some (gl-n"erar"..t\ners) have unlimited 

liabilily. Th~ firsl year the IRS coU""led dat3 on LLC. d~ in 1'.193. Aooul,lO.1/oo exisled ~l lh e 

S"",,~'ro'"' S .~'ic"'" """td .... ~ IlIt loW of ""'~ ... "Id. ' ,~. ",!\Ill pri,';k:to> "r. ""'l''''''''''',:..o.1'''''''''' Ii.'hill,y. 

rrt. ".l .. ';'",bll" ~f-.ll""'" H.,;.,j"..t III<-"i_ f"'yj~",,) ."..,..,...« La'. From 1/W'p<"'I"'d.J'. "rJ,l;l,. "'''. 

SllI><hap''"' S <t>rpor.olion .. rt "" d,IT=IM lha~ O\b<f <_"""",'ion.-. "S • ..,hop1<r SO' " .• ..., fLIi"ll '''1"', "" • ~'C 

L~I"'Qflq:.I .. ,;ly. Und<"h< 0<11;"" ",.,"'t, ir. ".".,.,.,..", Ud t, '" r<" .. ", rtII~I<I<". on.! """" <krlo 

... ~ ;ndj"dll. ls."d U,S. , •• tIltr>O,.1/W' prot;" orllK:.,..".",.".,., \\'""klno, be: wb.«<, 1"""'1""""" "". T~ ll<i. lLI>l" 

"""i","," """,ton of~ o.V'l'I"'l'I"" <ho.,,~cMm ,,',", 'n<,< ... ~ I<I)~ in I'lli:. k\ ~,~ 1~~"n4 t(> I"'lito J(lfl1_f"T' 

m<r6\ S ''''1''''''''''''' ,I>< 'lUll'''' ~r>lw<l>olokr> lim,'"'''' """,." i . ..... ,.1OOl!S «>f!>O'IL"" ... wl," 1 ,. (bo,,,, 

",.rthold ... """"''''"" n". 9S """",., <or 5 '"<I''''''''''''' ft'''"'"' 

, Unli"" S"lw:horl"" S NrJ>;lm'''''''' O~ ""'" or """",nil.". ""'1 .""Iud< ~"",,", In !{)(I7 ,tt..- T ""'""!"J" Dqxo1,""" ..,..,.,od (I"" ",''''' .\!) P"'<"' ~f ''''.ll'''" .... ,h,r ;""""'< S"'" '" """"""'" PO"" '" "ilk.,. u""..,,,n >fI1i, ... ,,, ..., C """ S ""1' ... '~"iTrl.-""""<l" llep,,,,,",..,, . • "'p"""",1k> ,,, 1",1'<''''. ol<eC'''''",,''''<l1CSI> uflllc t),S. 11 .. ; ...... T .. 

S~ .. ""'" R>r <he ] 1>1 C.,II"')"· tk<>. JOO1;. In I" 1010 ""udy. tho r",;i<k.)'. """"""'" Roemor)' "'d.l",,) 1Joord, 

od""'J b~ Ill<: 'f ...... U1)' \lqJlrIm.nt. rtl"'f\<d ",", l'<1,,/)l"JI IS &rld ]Q I"-'f«'" of I"'l\ne,,~lp ino.~ "'" ~rJ . , ,he 

"""",,"";'" ,",'C'l "''''''0''''' tc","""", 1(,«",,,,) i\d, 0I0t) ll<,..,d. ' The Ikr<'" "" To> Rot,,,,,, Qr!;,,.,.; 

Si"'plffit.'iM. C","nl.'III<:o .• rId CO'l'''''''.1'J",,,,". ~ .... ~ ~Ot 0, 

, 
80 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.061

time compared to lAS million other pannership •. Subs':quenlly. "'hik OIhcr panJlcfships sl",,'ly 

d~clin~<L LLCs r~pidly Wew in numb.:,.,. - no,OIIo in 10m I" 1.9 millioo in 1008. 

SO/l!propri/:lIJr#.ipl>. When ill"{lmes III sh~~r numben>. )'Ull can'l beal ,;ole Ojlri~lorships. There 

were 1~.6 millinn Ul 200$ Aprroxim~lcly unCOIII ur every si~ iTldividull1 ~'lX relums f,kd includcs 

sol~ pmpri~lon;hip income. Figure 3 shows Ihal inslead ofb..'OOming obsolescent tile !lUmbcruf 

!;Oit propri~!orshlps has grnwn .llcadily in ewry year from I'I~U In 2007. The growlh from <} In 23 

million sule prupril'lorships ha5 occulT\!d dl'Spile the simllll~ncOUS increasc in Ihe uSC urSutx:h~pler 

S crnporalions with nnly OllC owner. In 2008 there wc~ 2.4 minion SUDchapl~r S corp<ll""dtions with 

" si ngk\iharcholder. 

"li~ c Sbl'>l:hap1cr S corporations and p.1r\l1<.nioips which (III average have grown in si1c. Ihe site or 

Ih" a\C!1Ige sole prtlpriel"",hip (adjn'led for innali",,! hws been cui in halfbe1wcen I<}~I) and 200~ . 

Thai is proOObly.dlJ,; In an in~n:a>e in SC'lf-cmployed cnn~ullamj;, a~ incmI>e i~ Ih" number of 

worker.;; formally clo~ifi"d fonn~d "-'i ··;"dependcm CunlnIClurs.~ and all iucn:a", ill acc,',s 10 high· 

.peed intcmcl wll;cl",lIow8 .Imost anybody to beCl}m~ au cntreprcucurovcm;ghl. 

D«line I>fll' ~ Cl>rfXJrU/~ Tu:r. While lite pa.;~lhrlluPt :>e<1(>r a~ gmw~. bolh Ihe aOwlute numb« 

ofla ,abl~ corpora1ion. and Ihl!i~re of lotalbusinl'SS incom( h~ve shruh~. In 1994. Iher.: Wl'Te 2.3 

milliM Subch~plcrC corpomlion!rdll;>jecl lu Ihe tOf]Xlrnle t3JI. Uy 200~. II,e numb.:r had declined 10 

1.8 milHon. Ik-cal~ lllOSI sm~lIcr b4( ~sses are S"ilching fll1m Sutx:haptcr C tnpasslhroug.h ~t~1U~ 

larg<' C{}'poIlliiotls >ceoun! for 3n incr<.oasing sh ~ofcQTpOr"l( ta ~ ,..,VC'tlue. In 19'J4. Ih" tor or 

Fig u re I. GroWlh ill S CotllOrations, 111110-20011 

(I~ mllllo<\{) 

'-' ,------------,----------c 4.11 , . 

" 

" 

'" 0.5 

.. '-------------------------' 

,4' 

.' , 

J 
81 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.062

Fil:ur ~ 2. The Ibl'id Rise or I.I. ~. 1993-2008 

(!n mill.., • • ) 

>.> ,---------=-==--------------, 

, .. , 5 

. Othor r onno.ship • 

• !..l.r, 

I , 

,. 

•.• ""''--'''- ,~ __ ---'<-____ '''''11,-__ ---'<-____ '--'''-__ ---''<-____ -' 

'" 

15 

IU 

5 

, .. , ,m ,,,," ,... ,.., ,... ~-'.... : .. , : "'1 11103 l .... ltM I... ltI1 1I11III 

R.' 

Figure J. Sole I'roprielllrships. 1980-2008 

(!n milll"",1 

'-

r 17.9 

" .. ~R __ ---------

• 

23. 1 

n 
82 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.063

1.500 corporaliQlIS p~jd 70 percenl oreNpor"l~ I"-~ rcvcn~e. In 21)08 il 0111)' Ion>: .he lOp 600 

torponllions II> a,:c:ounl f>Jr?O perceot ofrorporlltc rC'-""I1111:. 

IIrtnllu!ioltu/ ,'omf'U,i"m'i. As 'Kllctl by the T","sury [kpanmenl ito 2007. nOl'-torporalc 

busmesst:s play an ,,,n,su'lily imponao! rolf ,,' 111,,- U.S. <'\:0110"'). SU"lIy rlM~ cpl le.:led by Ih" 

OECO .shows th~1 Km""g IS OECD co"mrie~ for which d,na a",available, th. l1n iu-tl SllIil'S (al 82 

pcrc~1l11 had Ihe sccOl,d higlJl'S' p"ITenla!!" of unincorpornlM busi,,"'Sses in 2004. 13 pCrcc"llI\:c 

points abo,'~ th. OECD a'·erage. M<In' 'mllOna"t fOf Ibeir innllCllC( on general t<;onomic a(ljvily '5 

th,(su.:, of U.S. non-torporate bus,ne5SCS: Ihey are m,,« h~~~ily rcprt'Sl>flll'<i among )a ~ 

busitl;J~< than in OIher cUllmries reponing to lhe OECD. for businc..,.,s rcponillil proiits ofal least 

S I milli't;,). th~ Un,ted Slates (al 6(i percent) h~d the highest Marc of un[IlCorp<)I"Jlcd btJ.'[!\Cs~ 

~'"o,,!: rePQf'l'ng OECD wtul1rits.' 

II. l'Olcnli.1 rlt lll ~ ofCoq )oral e T n Rcforn) for B~~ th ou h Hu in .s~es 

A quartcr«nlury fIgO.'ihc Uniled St3tc~ had One oflhc lowesl CO<JlO<llIC lax rtlles in the world. bUI ;1 

has not reduco.'tl it> "'IU mte . ;nce 19Sb. On April I ofl hi ~ y~ar. whM> Japan win reduct'S 

its corponlle "'te. ~II of our \119]0£ c'~np"litl)fS w,lI h",c r~ducL>d their OOfll'U'"Jtc ta, rale. Ica v'n~ Ihe 

Un"ed Slat~willl n eombln.o,d federal·slatc III~ rale of 39 .• percenl- wlth Ihe hij!,he~1 SIDlulory 

corporate Ia.~ rale;n lhe wor!d. "" ("~ .... 

~ 

In l!,~nCTaI. l"\:o"om;;;ts a!!,"'" thai ~;g~li o..n t rale reduclion will incre~sc jO\ ~01ent in the Uoited 

STates. r..'tIucc till: usc ofco ll)' ta~ pla,minv; ~nd convolultd tax shd(~rs. reduce the incentive 10 

shill pro111s Iu roreign lax ",wns. and .. ,'tI0Ct0 tl,e.inccnl;"" 10 increaserlcbt./Jul whi le it is easy to.-

IU t<;onom;sl~ 10 agree allo1ltlhe desirabilily ora Io\\'~rcorporatc r;ll~. Ihe hard pan is paying for It. 

Undl'" C1II1\:"1 bud:;~. eo",lrainlS la< rdorm at"t!»1 c,"'p,,,lywili nMS 10 be 1\1 !ca;;1 rcw"u~· 

neUI",1. The additional revenue from incre~ lunll-nUl c,,,¥,omic aClivily (11;,1 would follO"' a 

corporate lax cui will not oc nearly cnouJ;h 10 Offs.:llh~ r..>{·cnue loss. t~ reduction fOr Sul>ch~pt"r 

CCOrpQr:llion$ mu,t be !"lid ror wilh IIffsetting IU im:=sc •. 

There 'Ii a "id~ "'ng:e of (lo'1SSib!e re"~"ne ~",~cs 10 pay fur a COI1."""""5 role c"t. A com,uooly 

SU!:scsltd 3ppr<)a~h iJ diruinat;ng: SQm~. <11 \' ~n all. bwine!oS tax eXPe!1d ~res. Accurdmg III 

Trea.ury [)epanment "",(mates. eli,,,inaJinjt all oome5tic~!y ta., e_,plr )d"ur~. "<)1)1<1 allo" a 

"" 'en",-,,-ncut11l1 ralel"duct'on 10 18 percenl. P.I'm,".ting ~II bu,ine.s lax e~~itu~il1d"dil1g 

Ihe rc"SCar~h credit- would be ~tn.~"t1y di/Ticult. Mon:o""T. if this "ppro:tcb ,s adoptro. it ",ould 

"rl<'c.,;ely ""I"'Ct passlhruugi1 b<,sinc~S<.'S Ihul would only lose .kdl'c~ions and ~illi and nM get 

any benefit rrom Ih~ lo"er corporate Me, 

By fur the Iwo m.,,;1 importantlu cApcnrlitun.'S for pa>Slhruugh business.... arc accelc .. lcd 

depreciation (;nduding 'lel:tion 179 expellsing) and the 'lel:tion 199 dctluclion for domeslic 

ma"uf~clurin:.\. Accordi"J;'o 'he iutC'!llax o:xrendilurc budge' fron' lire Joinl Co",,,,ince..,., 

Ta'2Iion. S8.3 billio" o~I0f1 llla l ofS23.7 billii)u (3S 'fo) Oflhc projcttcd 3~crngc ~,,,,ual b<:neflt of 

:tCl"Cler:lted depreciation goes til ~thrl/llgh b1Jsines~. Wi,h respecl 1<1 the deduction fllr domesl;,' 

'~. U_~.l ,<a>Ur) u..,.onm •• ,. T"",-"")' ~",rn'. ""'~"'Y C""t""""""" S",i""" T~ .. ,"", ,n.! (it<>l»1 

1::""'1'<'0;'....,.,., 1I .. ,~g"""'d P.q>:f." Jul) !~. !OO7; P,'I,~ II.. "knil~ -rtw,. ("'P'''' ~ To, (""...,-,drum.- T,,-< "'IN.,.., Oct'*""~. !OO?: and o.po"a,;"" r(~ E<<><H><"1c """ "nd 0.",.<1"""",,,,. 'Su""r "" ,k< ro.,",,,,, ~rs ... II.nd 

M .. r,,,, • .si,,,<! 1i""'<I1'"~: [)ron It.""n u" 1t.,I'''' ..... w, ,r.. 0<"".'""'''': ""',,,-<l :~ J.ly 20117. loN. I, 
83 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.064

manufacturing. $4.b billion OUI of lOla I of$14.4 billion 02%) orlh~ projl:\:ted average annUl,1 

benefilll""" 10 1",,'Slhmuil.h busin~s<.~ Manufacturers an' Ihe m,jo.-hoendiciaries \>fthcsc 

provisions. SI) eliminating IheS(' lID; benefi1s would be p3nicularly harmful I!> mam,fac1un'T5 

or£;lllized as pa,Slllrough busin~~"'5. 

Ae<:O<din,g 10 badq~row)d documents pro\'ided by Ihi~ commine-., Cllairman Camp's dra1i prOf>l>ssl 

for inl~mali!>nal tall relMm i~ inlended lu be re, cn"~·nculrnl.· Gi,'cn !>ur~"Grmous budgel d<!ticil~. 

~n 1Q.e l>\enfT05ily {If eum", U.S. inl....-natiOtlDI la~ roles, Ihal i$ a n'asonableDPPIl18eh. How"" .... , Wi 

lax rclflrm progA:S>t..,;. Ihere will De In:mendous pressure from mullinaliot)al businesses for 

imc"",,~""1 reform IQ indude a" oVC'1"lI11 Ulx cui on f"""i!;n'li<)ill\;c income. JU$I 3. a cmpmlll" role 

cnl pr<Nl~no benefil 10 (XI~slhruugh businesses. Ia.< elLIS on foreign pro1;ls pmvide IIIi1e or nO 

b<nefit 10 n)C~ f1~~Ihrough bu.ine:;s. And. 10 Ihe e.<!enl foreign liS benef,t.' ",duce ~,.enue. Ih~r~ 

will be incTt'tlsed·pr-rssure tU mi;,: lax~'S On p.mthrouj;h hend;I~. 

h IS Imponnnt 10 k~p In milld thaI D taX hike). mOr~ ~lIlfill for a small busmess than a larg~ 

bu~inO':ls - c,p"'j~lI y-si n~" th~ fil1"ncial ~risis. C~sh Ilow is intpo:mBm \0 all busillesse;;'. ilul it is. 

u~ually much mQrecrilic.a1 1.11 11 501311 bllSi~~>s·- whidt may nOi ~~en be ~bk 10 obtain a bank 

10""'- than it iJ to" In'l:c 1i1Jii~"'$S __ which can borrow din.-..:tly in bond and WUlII)c",i.1 pa",'I" 

mark~t" at low inle,est mles. 

There i.also ~nolh~r reaSO<l fr>r lawmj'k,-n nOl to lak" their rue ""Iy frum I~rl;e publicly Irad,'\! 

cO'l""'liolls when uS<'ssing 1he enCi:t.o~~mc Ul1< changes. Wilh respect to aceek'1"llloo 

depn,cia litmjand c"nain olherla;>. henl.'r.r.-I~~I arisc from liminH differences). lh~ lax benetit d<><.~ 

OOIlr~nslule inlo a lower f<'I"trlc"f/cll"ecli"e I~ Me and hij;her proHIJ 1V1">rIed10 ~an:lluldcn;. 

CfO;: Can obs<:,;,; about their repOned effective lax ":lIe. and CEOs Can rx>Y Hn ;lIl)rdin:lleamoulIl of 

nttt·."iOl) «,I rel'Oned profi~ . (I,-..:ause less ac~cle .... OO dcP'""cialion doa tIN alTeel tlJQSC ,ucasun's, 

publicly traded corpor31ions and other businesses u~ing (iA!,P accounlinH may be far Ie>s res;Slllnl 

IQ such a ehungc lhan a ;;mall husin= I'sin£: cmoll !lCCQUMlilig. 

, 

In lhe past. When II\cr( wen: nOI so many ,elf·employcd cOnSUllllnl""1IlId ~QI ~ mony !)Wple 

"'orkingas in dc""nd~nl Contr~ctors, before the !0Q5eninl>\ of$ub,:,hnpler.s <C>:iu"t'rn~nl$. before the 

in\"clllion of I..LC~ ir Wl1:i nOl so l~"';blc 10 uS<' Ihe dara 11" passthrough buSin~SJC$ as a mrasllfC of 

nil sm311 oo"inesscs. \Jul looa)" s p3.",\hrm'gll enlilie. Me an cxtrc'mel), hetcrogeneQus lol As 

tc'Chnology. wor~ rdallil-nship.'<. and bus!r.c~ organlu,ljon Ila,·c noll·cd dramalically. we tan 11(1 

loncer Ihink ofth~I mas.s Qfincomc la~ tilinl>\~ go! prt>vidinj; us "ilh 8 pictu", ofsm'all busine$S, 

, I'.'!ony ilulle businesses arc Subchapkr S ~orpor"tif}"s 3nd limited liahility c(""p<rnies. A'<"sn.,.wn in 

T~ble 2. Ih~n: wen: 14.000 S corporal ion. willt mon: lhan liSO million in r..'CciIlIS '" 2()Ol(. Th.'Y 

l>Ccounl(d for 19 prrc~'Ilt of all S torporntion profit. Theiraverage levd ",' profit wa~ $6.4 m1UiQn. 

' l",", C"",m~I«>OO T .. ,alfoo, -r",;rna,<> o(~<J..r..1 I. , hporn<lltu"" ;or h><>1 y ..... II.l 5,~ lJll1toary 17. l012 . 

• -S."''''lry Qf 1I''')'' .... d M ... n< 1),,,,,,,-,,,," Droll: 1'.rt;dl"',l"" E,"n'p'ion (1<,""",.1) S)SI<m·· (kr<)bn 14. lOIO. 

n", dQ.·u"' .... ' ''''<S: ""T1"t< ~~"'" droll" 'n' ........ ,to .... "" '<nO" "010",1 HI ond " fllKtr"ll<O\ "",.;d.:m.lu ",n vf 

""lop""","' ;' ..... "'(OInt l.jjlu>'lK>O. 1 "" {""",m,,"'" d""" "'" bel",,'. 'hOI olom...,.i< "'" ... I>ruiuknif\t '1I! .. ld "" u"," '" 

fill>"'" in'''''.'i .... 1 .~ ... Ii<~ atkl • i« ,'rna. W 

, 
84 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.065

Otller !RS data (not shown in Ihe labl,,) indic~h' thai more than 8 pert:ent I'll' SubchJplef S 

corllO ... tion profils w~fC earned by bllSin~.""" with ,weT $250 millio" in 8s<elS. 

, , , " , ,', , , , 

'om' 1" I: :~ ' ~~·,i " ,: ~~· , 

' ,~ " , 

~ 3lE: ,. 

" , 

, , , ~ ~ , 

, , , , , , , 

" , 

, , , ~ " , 

" " != , 

" , 

~ 

Tabk J looh at large (liInn~r,;hiP!i. It present!; 200H dJla on lh~ I ~.OOO T~lUm~ Qi"lno,;" p~rtnl""r.lhiP!i 

thai had assets 0($100 million or ml'lre. Even Ihoul1h Ihcse ra" IL'f'>hip~ "cre Utlly 0.6 rcrcClIt ort~( 

3.1 lIIillio" "'tal partnCl""Ships. Ihey accoun!cd f",. 64 percen! Qflhq!,"oJil ~ ofalil"'rtnenhips. For 

Ihi~ group. Ihe a"cragc number nfpartner.; a~ 300 and Ihe a¥ernl;e pmfn w~s SI6.~ milllOlI.1 

To ~u"'m~rjlo:. because oflrcmcnooUi growth in ihe uSC of l.,LOi and Sube ~l' er S corporal ions. il 

;s a ""riou. m;'lake 11'1 cnnnak Ih~ lcnns ·· "'S.<lh",ug.h~ and ",mal l businc",:' 

AS Ihe dc!~nninoo efforl com;nucs for reVenue 11'1 pay for low .... cQrpOrnle lax rilles. Ih~n; is growing 

;nl,"",SI in 13UnJj large P3¥lhrough busin~5 as W'l'()Uli\)ns_ Ifl>a$c-·broad<:ning is fhe ni.,lS [}f 

pny;ng fllT luweI r~les. il is only Ifll!ic3110 indude.;jll an opliml. subjecting large l'as,throQ!~ 

bus;n~s~ IQ the WHIe a.~ as Ihcir Su~h~I' ICr C cQ p<:~ilor>. 

hk a liI', all busi" """,",, should ~ subje<;t 10 only on~ I.yeroftax_ BUi ",I""I?- (1S IheN! is Q 

CUf"IHmJlion I,U. the 1110>1 ecimol1lic.liy ellic;cnl wa)' Ib col lect it is b,-cr ~ bruad bas.. and O"~'f thl! 

broadl'SI QU"'~r Qfbus;ne~~ with 11> low R rale K, po.'lSsibk. 'faxin.>; jatge pa5."lthrough bu~ines~e> 

removes their f8;r compelitive Idvmll g~ ov~r ta~able corpomtions. and the n"vt'1me m;sed can 

7 
85 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.066

m.luce thC-COrporJI~ ro te. JU~1 k~ olher b3se-brood~ninl! Ill~asures unde, considcnlion n pan of 

lax ,dom •. this propmal will help promot~ eConomic Ilmw!!!." 

!> ~ .1. r . " n. ,."bi , .. ilh 5 100 Mllli ~n '" Mo« In A~\< w, OOS 

% nf To'"',oII 

~.or 1 01. ' r ' Qnl ",t-r ",111 ,1"1 r. "n<._ .,"" .. Port .... Ibilllon.1 -, '"11110.' ) .. , I'.oro, 

." n U~O .' 00 S 9~.J S 16.1 % 

- Pd. . IT ••• o: 

'" ,.~ " sn9 54,0 I,', ""'. IU~I ,~ S U.6_4 S2.1.6 M, 

B,-II •• od I ndu _ .. ,' Cion' 

Fi ... ,~.., '.'" : 22 S 146,3 51M .~ 

R<3 i ~>I"< 4,.,OJ ". 5U StU ZO% 0". UqJ , '" S 1'~2 S ]1.(, '" 

IV. Aooul Indil'idUIII Tn 6 ~nu ,,", allllu in 6~ 

'-

Withoul congressional a<:lioo. indiv;du"j int'(jTllC n~ roles wil l rise I !lIe bc-g.in"ing of2U13. 

Althoogh Ihen, i~ !:l1lcral consenSus thallhl.' !IP-CIIlku Bu>h IIX elliS should be tXt.'ndl'd for luw-

""d middk_'!lcome '''-'P'I}"CrS. IIlere is disagreem('", atlQ\n wheth .... !he two top ra le.ssl",uld be 

uiJ(I,,'cd 10 conlinue ~l their 33 and 35 pcrtf:nt Ic' Of rc,'Cr! l'll helr j1I\'-2001 le"els of 36 nnd 3\1.h 

pcn:en\. Proplmenlsoflhe lower-rale opliun ar~U<' M misip@.lheloptwoTIltes "ould impi,de job 

~n.'3lion by pas~ tltr!>ugh bu>ill~s. 

L. 

Although onl), K small fraclion (aooul J ""r(cm) of p:wthmllgh busin.:sses would be affecled b)' 

!hi ~ indi, idli~1 ["rome la~ rale hi~e. the po"i,)11 nfP'lsstbmugh b",inc!;S pm1its afTectcd " o,uJd be 

much lar,,~r. There are man y i.~ucs with interpreling data un P'l SSlhro\;g~pu incsses. and thl'1'\.· is 

nu un. CllmCI w~y 10 pres."t IhL1n. lIowcvtT. a nCW lechn,icul paper fr.;m 1.\It' Trea~"1)' Dcpa"lIIenl 

hllS greatl)' in ...... a ... ..:1 Oil' Ilnderslanding orpa.>thmu&l! businc.i-'f's and lit" tai silualion orth~ir 

I,lwners.' D<IS<"d nn dRta dl~do>ed in Ihi ~ study. '10-'-: C<ln estimate Ihat 4-l fl<'I'.;;'iill)f incl)m,· gemml1cd 

by 511)311 business uwners would be> 30~tled by a chanH.~ in th~ top IWU mtes.

w look at Ihe 

income gCIlcrdted y~JI- (lUljUS\ small-- business O'loIlC'" 6\ perce,,1 uflhal in"::'t>mc wQuld 00 

afTbCtcd by thl' rale ehBn-lOc . 

• ~blth"w """ •• 1. SUIan Nol",", J .. "", Ikl\oc~ ... J~~" KJ""n. J ..... I'<",co. ond Mi</tonl l'''$",'''''''. """""'I"!\)I 

to Ido:!1"r~ S","II &""",,.. , 00 Tho:If 0.,.-",,,,,. o m .. QJ'T,~ AnaIJ';". f«hn1Cll1 P'P« ~. A"-S. :~ II. Fi>< m"", 

di""_,,"'''flh .. iIa .... "". M."",, II. Sulli,'.'" "S", .. id Wolt,;,. r",<>~" 11" '.1(\,) r."'rl")'<1'lIr" Tar"",..,'. s.".. ll. 

lOI i >n<I "1M M)ll'I ofM"", lnd I'<>p Uu""""'" roil' "'''''', S<I", 12, :!OI l 

" rho: l' r""~f) >ludy den", .. . "",11 ~!Iu-ooj;h> '" ,,.,.. ,,;111 I" .. tho. $111 m;ll;"" or ¥""" ~P'" Tho: ,,, "'um 

""II TI'UWIY-.o d. ..... ~ ,,,,,I""lhc "Urn .... ,,('mrloy<<> III """","",,,gil., 1I,,· ... ~;"l! 10 C." .... llw .. uda .. lilt 

2007. ,"n"~ ",til ho:''''"", S7.:! .,iIl"", t ntJSHlmillio<I<,l'pokl =t,1'I' had on ' ''''''t« fS2 ompt~rn"-- Thi. 

",<m, ","_N<:. ISc. 'htll< 1. 1\,'«il" Si« of Cmrlii)<r F""". ~7. ""~" '' '''' -''''''' ''.J!~' /I:o:'" "".Il .... " h'ml, I 

" 
86 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.067

o...,s il foll"w thai because rnle i""reases would arfecl a significam pon ioo ofpassthrougl' ""sin~-;;. 

in<omc IhHI Ihe Bush lax cul~ ,hm,ld be exH,,,,kd 10 ~II uppe, income la~ra)'crs? 1 would ~trongly 

argW!' lhal il d(WS 1101. l~ me ~gin by ealling )lour a!l~nlio~ 10 Figure 4. h shQWS Ihilt of all I he 

high-brnckct incut\"lC sul>jC<:1 to rc~ulur ta~ rnlC:S (Ihal i~, excluding ca jliml gains and <[uali lied 

dividend,) aooul 30 pen:~nl i, rdated Iu pa.>sthro ,,~,. Only about J I I"'",~ m ofurdinary highl>rnde1 incilme is from paSSlbrOllllh cmplo)·cJ'l<. And !"Inl)' Boout 8 percent of ordinary high·bracket 

illOOjl'c is gcner3IW by small business employers. Th~ h!:mon, line,s Inat mOSI income f1etled by 

tht""ratc chang( h~s nothing 10 do wilh ~mall bosinc"lS employment lflh j;oal is In promote 

cmplurPK"Il1 al =all busine ...... -s. pruvidinyta>. r~licrlO 1111 inmme in high br .... el" i. an cXircmeir 

incmd~u \)'IY of achi~ving Illal objective . 

• 

Other Ordinary Income 

O! HlglHncome Tu pay,,", ,,. 

'" 

L. rge . nd Mid l lze Employer 

Income, 13'10 

, 

Ue<:aus." a~ discus,ed belr",·). Ihere arc "11~ma!ive mC1hods of p ... ",it!i/1¥-lax r~lier In sOIali business 

elllplo) ~r>. Ihl"R"'~ I\C> rtaSOn fbr the olcbllte on c~lensiOn nfthe !lush la~ SUloljot hip.h-Incomc 

househOlds to pivol on ils impacI on snlall busine .. employment. Th~ meril! ore~ti."Ildi!lg hi!:lt-cnd 

rale CUIS should Ot- judged W;llt relm;on 10 la",~r ;ss .... ~. such lIS: lh~ n«d (or d(Gt;1 reducI;on, Ih"";r 

i.up"c! un faln'~~5" and Iheir it(!paCI on tlJe o,",,,,/f econumy. 'i,I 

The best way 10 pmvilk 18X rclief f<lf small hUSln<'liS is "ot1hrough bro8d·bru,h polick't Ill>': 

changes in hillh·cnd !'lICS, bUllhruullh a~ rclicfl~'l!ct~-.J IUWJrd sIIIal1 bl,sim:ss. Along i~ line'S. 

House Majority Leader Eric ("anlor is proposing" deduction equal to 20 percent of p.as.'liomuJoli 

income f<)t b"sinl"S~ ... ith less IhM 500 emplnyc...'S.' I AlIho"f!h Ihis pr<lpos:ll;s a far mote c>N· 

~fI~l;ve lll",hQd of providing hsiSlnnce to s11Iull bt~i".-ss thnl1 ~ r.i!~ tut. it sufTers rroo, IWU major 

problems. 

, 
87 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.068

Firsl. i( w()uld rt.'qu;rt c()lTlplex anli·abuse rules 10 prevt!nl hil;h·brnckc( (axpayers frum shifting 

nUl1 ·husi"",. income into) Ihese n~w lax advanlag~-d w hicle'S. Willl"ul lOOse rul",. 113»;lhmugh 

busfncsS<.'5 would become Ill:< 1>hcllcrs fur (h" weallhy. Sec"6nd. Ihe proposal is nOli wclltargelc-d for 

C"1lcOUJ3g;ngjob creation. For c.~amplc. B sl11DII I.w firm wilh $IU million of pro III Dnd only 10 

~mploy .... "S would 1:'"1 half(lIe tU bene l;( r«dved b~ a small !lleNi"c finn with SS million in profit 

nnd 100 emplo)e.:. •. Moreover. lite "cw deduction would provide no m~q;j 31 inc~nli~l' 10 incr ... "" 

':mplo),,,cnl. Jfc;(hc't oflhe linns in (his exampl~ hin:d more emplo)'e<.'S. il Would nol ,~'Cei,c any 

addjJ.ionmltRS benefn. " 

If,,'e,.';:.tiJl to usc (h" I:u. code 10 p,,,,no(e small busincssjub cr~3Iion. Ihe be'l appnmch would"" t" 

pmvidC:wnrnncn( deductions orc,cdils equal 10 I fI<!,ccntn!l-c ofcuclr empl<"lye~'5 pa)'Tuli wilh a 

limil on 1M "lunber ofcmployl'e~ Ihal Can qu:tlify. This would PrQv;dc a simple and ~asy·I';>­

undersland inc~'pl\w to ;n.wase and r~l"in cmploy",:s, Und~r Ihis prupos;tl. addinlljobs would 

reduce laWS. 1l",,!~Si."S wilh few employees and large prof.1!; \\'ould n01 receive large windfalls. 

V. Co nclusion: 11 0'" ((j Rutty Ildp Small Hu ln ess 

Ac"Curdin~ 10 the laic.! eS(;f;:8fes"..small bu,inc"",,< s!",n! aboul 1.75 billion h"u"" "nd S15,5 l>illion 

on income fax cumpliance.U Mosl of the time bnrden is for record ke.:pinl\. And mos( nflbe 

fin3nei~1 burden i5 in pay;nl\ for PT\"!fe~sional hdl'. What Bbonuldifferrnce~ in COSt by finn size? 

ESlim~les slrtown in the Figure 5 "onfir.;l "hal common S<.'l1SC would h3~C u' assume: l1l~1I 

bminesSCll f8ce~ign;fic3nl fixed compli:u.ce costs, "nd co", fl"r emploYL.., d""rea""s with finn sileo 

.... ( 

The figures d~m"'''slrnte the ne'ed for s1ll~1I bu.<ints.< laS .implirl("8tion. l 1.e ,nordinately I.rge 

,,~ 

~'.' " -'r;-T •• 

•• ,,- . ~ l 

, - >1_,.,..,. '" -J:: i - , -"- i 

! - :,: - ". 

• -- .... ,- ---- .. " i' 

" •• • " 

• " a ••• ... " " .... ,. .. " " ..... ' . . _ ...... " ........ " ......... -. ......... _ .... ,, ___ .""'.r_' 

Il to , • • Iso ",,,,,,bl<- ,,.., p .... hrnu&O ","pi,,}''''' _""'lII"~ ,nc SOO-c",,,I"~,,'" ,",,-.I1old " 'ould II< di",wr.g«1 r""" 

:f':U "'t\. "'pl<!) m<n~;in<l 'N' (,rn, •• _c til<' lhrc>""ld m(gh' ...... lIy<u' ".'plll>""".' IOqu. I' 1) ftlr!he ... ", 

"""",,,ion. 

" D<on.I~ IJcL ..... Jolul Go,,,,,. Wu·b'ld L«>.J<"'o 0'1 I.rt. 'oo So..u S'''.'''f. 'Ellu.." .... <>fU,S, rode .. 1 I.""". Ta, 

CQ,nph."'" II",*" fM Sn.1I1 0">10"'''',," III.S R"< .. ,,,~ /).11.'1110.1001 

'" 
88 

f 

Chairman CAMP. Thank you very much. And again, thank you 

all for being here and for your testimony. 

With most active business income and most of the private sector 

jobs coming from pass-through entities, it seems clear to me—and 

some of you articulated this—that for reasons of competitiveness 

and fairness, that tax reform should connect the corporate rate 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.069
89 

with the individual rate, that reduction. And I think somebody 

used the words ‘‘tax parity.’’ 

We did that in the House-passed budget last year, and I know 

that the President’s tax reform framework that he released recently, when connected with his budget, would raise marginal rates 

on pass-through entities to 40 percent while cutting the rate on 

corporations to 28 percent, as I said in my opening statement, 

which is a spread of 12 points. 

I would ask each of you to respond. Do you think it is good economics to try to keep the top corporate rate and the top individual 

rate as close together as possible? And what are the risks of having 

a spread between those two? And I will start with you, Mr. 

Smetana. 

Mr. SMETANA. Thank you. I think that we need to recognize, 

in the pass-through regime, you have got two sources of income on 

the tax report. You have the earned income, wages, and then you 

have the business income. And I think the big distinction in terms 

of pass-throughs is that that earned income is different. 

It is taken out. It is used. The business-sourced income is kept 

in the business, typically. And, as I mentioned in my comments, it 

is the primary source of capital to sustain the business and to grow 

the business along with traditional financing. 

So I think it is vitally important that whatever policy that we 

adopt in terms of marginal rates, we try to retain as much of the 

capital in the businesses to sustain and grow as we possibly can. 

So therefore, any rate regime which causes an increase in the 

amount of taxation paid on that business source income will retard 

growth, and it will retard the ability for those pass-through entities 

to be competitive in an international and even a national scene. So 

therefore, I believe that one of the things we should try to make 

a distinction on is not where the income shows up on a tax return, 

but what the source of that income is. And I think that is very important. 

Chairman CAMP. Mr. Martin. 

Mr. MARTIN. Well, I think it would increase my fees a lot of 

they did that. I would make a lot of money because I would be involved in the very difficult tax planning arena of helping my clients 

pay the least amount of taxes. And it would really harm the form 

of business that they wanted to operate in. 

By the way, I played golf at Oakland Hills and the country club 

at Detroit and couple other courses, but that is the best I can do 

on this. 

[Laughter.] 

Mr. MARTIN. I think it would be very harmful to force small 

businesses to operate in a form that saves them the most tax liability when it is not the form they really should be operating in. So 

I think that would be a huge mistake. 

Chairman CAMP. Okay. Mr. Tucker. 

Mr. TUCKER. I think one of the things we need to be aware of 

is that small business pays an enormous amount of fees to accountants and lawyers to deal with the complexities that they have to 

deal with—the discrepancies in the law, deductions versus capitalization, and the like. 


wwoods2 on DSK499XVN1PROD with WAYS & MEANS
90 

I think a tax parity—and I am the one that used the words tax 

parity—would help immensely. I think the top rate for corporations 

that are not pass-through entities and for individuals should be the 

same top rate. 

Chairman CAMP. Mr. Kwall. 

Mr. KWALL. Chairman Camp, clearly, under existing law, I 

would agree that it is very important that there be a balance between the maximum individual rate and the maximum corporate 

tax rate or else, we have seen in the past, when corporate rates 

were much lower than individual rates, there is pressure to use a 

corporation as a tax shelter. 

However, under my proposal, I would not allow closely-held businesses access to the C corporation regime. I do not think they belong in that regime. And if they are outside of that regime, then 

there are two independent regimes and it would not be a problem. 

Chairman CAMP. Okay. Mr. Nichols. 

Mr. NICHOLS. I would certainly endorse the whole tax parity 

approach that I think everybody is advocating soon here. I do not 

think there is any question that if you change the rates to be significantly different for C corporations and for pass-through entities, 

you are going to go back to the game-playing that I did experience 

at the beginning of my career between the lower C corporation tax 

rate, and the devil’s bargain of trying to get that money out in 

some form or another without paying the nasty double tax. 

Any system that enhances the gaming is—at the end of the day 

it is going to start a dynamic between the IRS and taxpayers that, 

frankly, just benefits the people sitting at this table but does not 

benefit the country. 

Chairman CAMP. All right. Mr. Sullivan. 

Mr. SULLIVAN. As Professor Kwall pointed out, the gaming is 

mainly a result of the ability of small businesses to use C corporation status. And that should be eliminated. I look at it from a different perspective. 

In the rest of the world, the clear trend is to reduce corporate 

tax rates to improve competitiveness; and then because there are 

tight budget deficits everywhere in the world, they have to make 

up the revenues somewhere else. And where they are making up 

the revenue is increasing rates on individuals. 

S I think we have to look at this more broadly. We have budget 

deficit problems. We have competitiveness problems. And the rest 

of the world, when they have had this problem, what they have 

done is lowered their corporate rate and increased their individual 

rates. And I believe those problems can be—the borderline can be 

policed with effective anti-abuse rules, and very simple rules. 

Chairman CAMP. Okay. I just have one other question. We have 

had suggested by some, and I think it is in the President’s tax 

framework, that certain large, closely-held entities should be subject to a corporate tax rate or the double tax that comes with that. 

And they use the threshold, I believe, of gross receipts. 

My question is for Mr. Martin and for Mr. Nichols. Is it not better to have fewer business entities subject to double taxation than 

more? And if we cannot eliminate the corporate income tax, would 

it not be better to determine who can get pass-through treatment 

by using a business distinction, I think such as Dr. Kwall deVerDate Mar 15 2010 15:08 Oct 21, 2013 Jkt 078663 PO 00000 Frm 00094 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\78663.XXX 78663

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scribed, whether the entity is complex or whether it is publicly 

traded. And I would like to get your thoughts on that. 

Mr. MARTIN. Well, to me, the elimination of double taxation 

would be an answer to all kinds of simplification problems. If we 

allowed corporations to liquidate with one level of taxation and 

made dividends deductible, as has been mentioned here, many, 

many S corporations would go away because that is why they were 

created to begin with. 

And certainly I do not think that we should be using the Internal 

Revenue Code to decide, based on a level of revenues, who should 

be a C corp and who should not be. As long as the tax rates have 

parity, I do not see any reason to have a forceful choice of an entity 

for anybody. 

Chairman CAMP. All right. Mr. Nichols. 

Mr. NICHOLS. I would have a couple of comments on that, and 

my written testimony deals with that in more detail. The $50 million test, for example, is extremely arbitrary. Theoretically, you 

could have one dollar of additional gross receipts that could trigger 

literally millions of dollars of additional tax because you are in the 

C corporation system rather than the S corporation system. 

And as I go into more detail in my written testimony, you are 

going to have to have numerous rules to deal with simultaneous 

where there are multiple entities. We have something like 440 

pages of regulations of consolidated return rules to deal with corporations that voluntarily group together to treat themselves as 

one entity. 

But you would effectively have to come up with—if there were, 

let’s say, two dozen affiliated entities in this structure you would 

have to come up with rules that were at least as complicated and 

probably many times more complicated in order to deal with that 

situation. That’s on top of the fact that double-tax C corporation 

treatment is not the preferred alternative, I think, on the part of 

anybody here. 

So I think it would turn out to be much more unworkable than 

it may appear on its face. And I would be happy to follow up with 

more detail on that. 

Chairman CAMP. All right. Thank you very much. 

Mr. Levin may inquire. 

Mr. LEVIN. Again, welcome. And Mr. Tucker, we will not do it 

here, but let’s compare notes; where we grew up, it was pretty 

close, including some of the markets we went to. 

Mr. Kwall, congratulations. Your five minutes was very succinct, 

really, very much so. In fact, all of you have been. And I think as 

we proceed with tax reform, which we must, I think it is useful to 

have a discussion like we are having here. 

I went back and looked at some of the Joint Tax materials that 

we received earlier, and it was really interesting. Some of it was 

a bit surprising. For example, on the distribution of these various 

entities by asset size, for C corporations, 97 percent of assets are 

held by those with over 100 million. So we are dealing mostly with 

C corporations that are rather large. 

And it was interesting, that was more mixed as to S corporations, quite a bit more mixed. But as to partnerships, 75 percent 


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of assets are held by those with over 100 million in assets. So I 

think we need to look at facts like that. 

In terms of business shares, it was also interesting that now 

pass-throughs, this is, I think, given to us by Joint Tax, have 49 

percent of the net income and C corporations 51 percent. And of 

that, the partnerships have the larger part, though not a vastly 

larger part, of the business shares. 

Also, there was a recent article in the New York Times, based 

on figures from the Bureau of Labor Statistics that I think all of 

us should look at that. In terms of job growth, between April 1990 

through March 2011, it said that over that period, employment at 

larger companies rose 29 percent while employment at smaller 

companies rose by less than half as much. 

But also, and the data will become, I think, clearer, they said, 

later this year, that small companies seem to be more nimble when 

it comes to various economic impacts. So I think as we go forth and 

talk about tax reform, that all of us should look at the materials 

from Joint Tax and the Bureau of Labor Statistics. 

Let me just ask you, Mr. Martin, in terms of the position of 

NFIB, whose members overwhelmingly support permanently extending the current 2001 and 2003 tax rates, has the organization 

spelled out how it would pay for that extension? 

Mr. MARTIN. If they have, they have not told me. 

Mr. LEVIN. We are talking about trillions. 

Mr. MARTIN. I understand that. 

Mr. LEVIN. When they tell you, let us know. No, seriously, it is 

a major, major issue, and I think everybody has the responsibility 

of indicating how they would pay for these items in view of our deficit challenge. So maybe you could ask them to be in touch. 

Mr. MARTIN. I will ask them to get in touch with you. 

Mr. LEVIN. Thank you. 

Mr. Sullivan, just quickly, I just want you to emphasize this. On 

page 9, and your chart shows this, you say, ‘‘Only about 8 percent 

of ordinary, high-bracket income is generated by small business 

employers. The bottom line is that most income affected by the rate 

change has nothing to do with small business employment. If the 

goal is to promote employment at small businesses, providing tax 

relief to all income in high brackets is an extremely inefficient way 

of achieving that objective.’’ 

Could you elaborate? 

Mr. SULLIVAN. Yes. This data is actually—as people who work 

through pass-through data know, it is very hard to work with. It 

is very hard to interpret. There has been a new study that came 

out in August of last summer, a technical study from the Treasury 

Department, that made this type of linkage between small businesses and small business owners possible. And so we really 

weren’t able to—this is new data. You have not seen anything like 

this before. 

And one thing that comes out of it is wealthy, high-income 

households, most of their income has nothing to do with—it is 

wages. It is interest income. Most of it has nothing to do with small 

business. And that is what comes out clearly in this data. 

Mr. LEVIN. Thank you. 

Chairman CAMP. Thank you. Mr. Herger is recognized. 


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Mr. HERGER. Thank you, Mr. Chairman. 

Mr. Martin and Mr. Nichols, both of you mentioned in your written testimony the importance of Section 179 expensing rules for 

small businesses. Coming from a small business background, I 

have long supported the expansion of Section 179 so small business 

owners can write off their investment in the current tax year rather than depreciating them over an extended period of time. 

Could you comment further on why this policy is important and 

how small businesses would be affected if the expensing allowance 

were reduced to 25,000, as is currently scheduled to occur next 

year? 

Mr. MARTIN. Well, I can address it from the perspective of my 

client base. I think 500,000 is high enough. I don’t think it needs 

to be raised, even though I think NFIB would support, I think, 

would support an increase in that expensing election. 500,000 is 

high enough in my tax base. 

It is not just the complexity issue. The complexity of keeping depreciation records is not a big deal. I don’t have one client that 

knows how to calculate depreciation; I do it for every one of them. 

So putting it into software, it is not really a complexity issue for 

me, although that is argued by a lot of people. 

It is the availability of capital. If you can get a deduction for 

equipment that you are buying, you are much more apt to buy it, 

for one thing. You are more apt to be more efficient in your business, generate more profits, put investment in the capital equipment industries. There are just a tremendous number of benefits 

to increasing that expensing election. I would be very much in 

favor of maintaining it at $500,000. 

Mr. HERGER. Thank you. 

Mr. Nichols. 

Mr. NICHOLS. I think that is a critical provision. Frankly, it 

was brought home to me early in my practice. A client called me 

up. He had just made his first million bucks, and he had quickly 

invested that million bucks buying capital equipment and all sorts 

of other things he needed in his business. He called me up and 

said, ‘‘We have got a problem. My accountant tells me I owe taxes.’’ 

And I started to explain to him all of the depreciation rules and 

that he does not get an immediate deduction for all of that. 

Well, he did not let me finish. He said, ‘‘Tom, you do not understand. I have no cash,’’ and that, frankly, is for a lot of closely held 

business how they look at things. That is a matter of survival for 

them. That is what they look at. That is how they analyze their 

business. That is how they analyze the success of their business. 

So obviously, having the expensing rules available at the current 

levels or maybe even increased is very important, I think, for closely held business. 

Mr. HERGER. Thank you. 

That is certainly my experience, and as I talk to small businesses 

I do not think that these points can be emphasized enough. 

In looking at the data on privately held companies, one thing I 

found somewhat surprising is the number of very small companies 

that are organized as C corporations and subject to the entity level 

tax despite the apparent advantages of pass-through status. According to the Joint Committee on Taxation, about one in four C 


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corporations had less than 25,000 in total receipts in 2009. My 

sense is that many of these companies may be trapped in C corporation status by overly restrictive tax rules for companies who 

want to convert to S corporations. 

I would like to get your thoughts on why so many small businesses are organized as C corporations. As part of tax reform, 

should we look for ways to make it easier for closely held C corporations to transition into a pass-through regime? And starting 

with you, Mr. Smetana. 

Mr. SMETANA. My opinion is that the fundamental reason you 

see so many of them is that they are not getting good tax advice. 

Really for an entity, especially a small receipts entity, the double 

level taxation and the marginal rates of approximately 60 percent 

really are inappropriate for reinvestment. 

The other cause that we typically see is just longstanding small 

companies that were originally formed as Cs before they had options typically do not switch. Built in gains considerations are certainly a factor if they are on the LIFO method of accounting. They 

have a catch-up tax payment due. So there are economic reasons 

as well that I believe prevent them from converting to a more appropriate tax regime for their business. 

Mr. HERGER. Mr. Martin. 

Mr. MARTIN. Since the Tax Reform Act of 1986, I think I have 

only had two clients come to me where I advised them to be C corporations, and that was because of fringe benefit reasons. There 

are some fringe benefits only available to C corporate level employees, not to S corporate level employees, and that was going to be 

a significant benefit to them. 

Other than that, they have all elected to be S corporations. There 

was a forgiveness year when the Reform Act of 1986 was passed, 

which allowed people to convert without built-in gains. The builtin gains burden is significant. My policy is to ask my client are you 

going to retire within ten years. If they expect to retire within ten 

years, we try to elect S corporation and get out of it. 

There are some cases, like a cash basis business, you really cannot elect to be an S corporation from being a C corporation because 

you have to pay tax on all of the receivables in the next year. You 

really cannot do it. So they are locked into that position. 

Chairman CAMP. All right. Thank you. The time has expired. 

Mr. Johnson is recognized. 

Mr. JOHNSON. Thank you, Mr. Chairman. 

Mr. Martin, you testified that an important simplification measure for small business would be to increase the threshold for cash 

accounting from five million to ten million in revenue. Can you explain how doing so would ease the administrative burden for small 

business? 

Mr. MARTIN. Accrued income and accrued payables could just 

be completely ignored. Calculation of the wages that are due for vacation pay payable or sick pay payable, it takes me an hour at least 

at the end of the year to do that for a client if they are on full accrual method. If they are on cash method, we just ignore it, do not 

have to deal with it at all. 

So simplicity-wise it is a great benefit. The IRS has been pretty, 

I guess, accepting of small businesses because they passed revenue 


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procedures for one million dollar levels for all businesses and $10 

million levels for some businesses. I would like to make that $10 

million for all businesses. It would save my clients a lot of cash 

flow. 

Mr. JOHNSON. Yes. Would it require some other changes to the 

code or just that? 

Mr. MARTIN. No, all you would have to do is just that. The 

phase-in last year, the last time they did it, they were very accepting in terms of how the phase-in was done. It was very easy to do, 

and if they did the same thing again, it would be a huge benefit 

to small business. 

Mr. JOHNSON. Thank you. 

Now, Mr. Nichols, you testified the proposal in the President’s 

corporate tax reform framework to increase the threshold for small 

business to use cash rather than accrual accounting from five million to ten million in revenue would not benefit the vast majority 

of closely held businesses. Can you elaborate on why you think that 

is the case? 

Mr. NICHOLS. I must admit that I am not as familiar with the 

President’s proposal. 

Mr. JOHNSON. Neither am I. Do not worry about it. 

Mr. NICHOLS. But just to be honest, I think there are a lot of 

closely held businesses that for banking and other reasons, end up 

using generally accepted accounting principles anyway, and they 

get used to using the generally accepted accounting principles in 

terms of analyzing their business and their profits and losses. 

I would not want to say that it would not help anybody, because 

there are no doubt situations where it would. On the other hand, 

there are many businesses for whom I do not think it would make 

a great deal of difference, and there are some that will actually affirmatively elect accrual basis treatment simply because it is easier 

to keep both their tax accounting and their regular books on the 

same basis. 

So in terms of the list of things that would be useful and helpful 

for closely held business, I cannot say that this would have no 

value, but I do not think it would be at the top of my list. 

Mr. JOHNSON. Thank you, sir. 

Thank you, Mr. Chairman. I yield back. 

Chairman CAMP. Thank you. 

Mr. Neal is recognized. 

Mr. NEAL. Thank you, Mr. Chairman. 

Since 1986, the number of corporations has dropped 28 percent 

while the number of pass-throughs has grown by 102 percent. The 

1986 pass-throughs earned 40 percent of all business income. 

Today they account for nearly 60 percent of the income earned by 

all businesses. 

Some have suggested that this change is in large part due to tax 

considerations, as Mr. Herger noted, and others have taken a different position, indicating that multiple reasons exist for this shift, 

including the growth of the service sector, ease of administration, 

and the fact that you can get limited liability and still get passthrough treatment. 


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To the witnesses here, what are your views on the reasons behind this shift? Mr. Sullivan, you touched upon this. And what do 

you think about the trend and whether or not it is a problem? 

What implications does the increasing proportion of business income that is being taxed as individual income have for an issue 

that is close to all of us, and that is the issue of tax reform? 

We will perhaps start with you, Mr. Sullivan. 

Mr. SULLIVAN. The invention of the limited liability company 

was in the mid-1990s or the early 1990s, and that after the 1986 

Act just made it open season for larger businesses to have the advantages of limited liability and the exemption from the corporate 

income tax. The problem that this causes, it is a benefit for these 

companies, but there is a disparity. Some large businesses pay corporate tax. Some do not, and that is an arbitrary distinction with 

no economic basis. 

Mr. NEAL. The other members of the panel? Yes, please, Mr. 

Nichols. 

Mr. NICHOLS. I think the treatment of closely held businesses 

is a matter of critical importance, but if we start to focus on having 

different systems for the two, that is problematic. 

And I would want to respond to something that was said earlier. 

If we start to focus and we essentially allow publicly held and larger corporations to essentially retain earnings at a lower rate, which 

is what I think has been suggested, and we do not allow passthrough entities to retain their earnings at that same lower rate, 

that to me is an arbitrary advantage that you are giving to the 

larger corporations, and I see no reason to do that. 

Another thing is the pass-through system itself: it is the most 

logical one I have seen. I have seen business owners convert especially around the Tax Reform Act of 1986 convert from a double tax 

system to a single tax system, and they literally stopped spending 

as much time worrying about taxes because they paid taxes once. 

They pay them right away. They reserve for them, and then they 

are done. And then they think in terms of their business. 

So from the standpoint of moving forward on tax reform, pushing 

toward a single tax system is very beneficial and at the end of the 

day constructive in my opinion. 

Mr. NEAL. Mr. Kwall. 

Mr. KWALL. In terms of the shift, I think a large part of it was 

attributable to the 1986 tax reform and two changes that occurred 

at that time. One was the parity between individual and corporate 

tax rates that was created because prior to 1986, corporate tax 

rates were much lower. It was aspirational to use the C corporation 

regime to get the advantage of those lower corporate tax rates. 

Secondly, after 1986, you could no longer sell a C corporation 

business without the imposition of a heavy corporate tax on the 

gain. It used to be just one shareholder level tax on the gain when 

you sold a C corporation business, but now there is a big tax at the 

corporate level. It is a capital gain, but there is no reduced capital 

gains rate for corporations. So it is a prohibitive cost on any business that thinks it is going to be successful. 

Mr. NEAL. Mr. Tucker. 

Mr. TUCKER. I think you are seeing two things. Number one, 

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pany would be taxable as a partnership, not a corporation. It started in Wyoming in 1977, but it wasn’t until the late 1980s that the 

Revenue Service allowed it. That enabled your client to have a 

shield from liability as a limited liability company, even if they 

were managers, even if they were the business people running the 

business. 

Corporations have enormous risk of complexity, equity versus 

debt, reasonable compensation, audits on a continuing basis, and 

you need simplicity, lack of complexity and the ability to run the 

business, not to be afraid of taxes at all times. 

Mr. NEAL. Mr. Smetana, you had your hand up and then we will 

come back to Mr. Martin. Just a few seconds. 

Mr. SMETANA. Quickly, again, it goes back to the fundamental 

economic principle of business. Privately held companies, closely 

held companies elect this form and it is increasingly so because 

they get to retain more cash in the business. That is a fundamental 

economic driver of growth and maintenance and jobs and economic 

activity at these corporations. 

I would also make a comment that whether you are in a passthrough regime or a corporation, the entity is still covering the tax. 

So I think it is an important distinction to make that that cash 

does still come out of the business regardless of which regime you 

are taxed on. 

Chairman CAMP. All right. Thank you. The time has expired. 

Mr. Brady is recognized. 

Mr. BRADY. Thank you. 

I would like to follow up with Chairman Camp’s questioning in 

favor of taxing income of closely held businesses only once. The 

White House often speaks of the pass-through business form as if 

it is some type of loophole that is used to avoid the double taxation 

business income that applies to C corporations. 

In fact, in the corporate tax reform framework, the President recently proposes to double tax the income of certain unspecified 

large pass-throughs. So my question: in this struggling economy, as 

we look for companies to invest and create jobs, what would the 

President’s proposal do by proposing double taxing some of our 

pass-throughs? 

Mr. Smetana, and we will run down the row. 

Mr. SMETANA. Sure. We actually did an analysis of the President’s proposal. First of all, the increase in the marginal tax rates 

would cause our company to only retain approximately 40 cents of 

every dollar of profit we earned versus 60. That would certainly decrease our opportunities in terms of reinvestment and growth. 

Secondly, the provisions related to lengthening out the depreciation schedules also moving us to the corporate regime and the 

elimination of the last in, first out accounting method for companies that hold inventory would create an additional five to $6 million a year in taxes to our corporation, again, reducing our ability 

to fund the business and invest in the business. 

And certainly the LIFO impact on us, on a business that holds 

inventories in an inflationary environment over the last three decades would cause roughly an $18 million tax burden on our company that we would have to pay over some amount of time, again, 

money that we would have to find either out of future earnings or 


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borrow against, which again would limit our ability to grow and 

maintain the company. 

Mr. BRADY. The President or at least the White House views 

LIFO as some type of accounting gimmick, some type of subsidy 

loophole that businesses apply to. It is a traditional form of accounting, and that change would, in my understanding, hit companies with inventories in a major way. 

Your thoughts? Is that a loophole? 

Mr. SMETANA. I believe that is a sound economic principle if 

our objective is for companies to maintain a sustained inventory investment, and simply put, the LIFO method of accounting allows 

a company to reinvest every dollar of profit on the increase in that 

inventory cost back into inventories. 

Otherwise companies would have to find either 40 or 60 cents, 

depending on which tax regime they are, in our case 40 cents of 

every dollar of profit. We would have to either borrow or take out 

of other economic activity just to maintain the same amount of inventory investment. 

Mr. BRADY. Thank you. 

Mr. Martin, on the original issue of taxing pass-throughs in a 

double sense. 

Mr. MARTIN. I have already expressed that I am very much opposed to double taxation. I like to think of the word ‘‘fairness,’’ and 

when I stand up in front of my classroom and I am teaching 30 

students about the tax law, I am very quick to tell them that certain things in the law are fair. Some of them have no equity at all 

and it does not make any sense, but are there maybe for social reasons or whatever. There have been allusions today to generally accepted accounting principles. Generally accepted accounting principles recognize what is known as the matching principle. LIFO 

very much adopts the matching principle which says that we match 

current cost with current revenues. The non-LIFO methods of accounting do not, and they are very expensive for companies to 

adopt. LIFO has not been a big deal because inflation has not been 

rampant over the last ten years or so, but there are some heavy 

industrial companies that have been using LIFO for a long time. 

If LIFO were disallowed, they would pay a heavy penalty. 

Mr. BRADY. That is what I understand. Thank you. 

Mr. Tucker. 

Mr. TUCKER. I think one thing that people forget is in a passthrough entity, the owners are taxed irrespective of whether they 

receive distributions and, therefore, very often they are being taxed 

without receiving the cash, as somebody noted before, but the cash 

is being used for the business. They have elected to do that. They 

are willing to do that. 

To penalize them either because they are bigger or to penalize 

them because of some other reason would result in double taxation, 

and they are already paying the taxes on the income. But taxing 

the companies that grow these businesses because the growth has 

been in pass-through entities is wrong. It is just erroneous. 

Mr. BRADY. At the end of the day the economy suffers. 

Mr. TUCKER. Everybody suffers, the economy and workers. 

Mr. BRADY. Thank you. 

Mr. Kwall. 


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Mr. KWALL. You really need a rationale for double taxation, and 

under current law, the rationale seems to be public trading. If you 

are publicly traded, you are subject to double taxation. 

So if the line is to be moved, there should be a rationale for the 

movement, and you also want a line that is going to work well and 

work as a good division. 

I think public trading historically has worked reasonably well. So 

if you are going to substitute some other standard, you need to 

make sure that it is going to do the job and actually—— 

Mr. BRADY. Rationale is not necessarily a prerequisite to policy 

changes as you know in Washington. 

Thank you all very much, Mr. Chairman. 

Chairman CAMP. Thank you. 

Mr. Tiberi is recognized. 

Mr. TIBERI. Thank you, Mr. Chairman. 

Just two questions if the panelists could answer them quickly, 

and some of you talk about them in your testimony, the two questions. The Chairman has been quite clear that he believes that we 

should provide comprehensive tax reform or go in that direction. 

Some in this town believe that we could just do corporate only and 

that would be fine. 

If we could start from the left and go to my right, what would 

your opinion on that be? 

Mr. SMETANA. We need to have comprehensive reform, period. 

Mr. TIBERI. Mr. Martin. 

Mr. MARTIN. I agree we need comprehensive reform as well. We 

cannot have divergence of tax systems. You just add tremendous 

burden on small business. 

Mr. TUCKER. I like being in the center. I am neither on the left 

nor the right. On the other hand, I truly believe we need comprehensive tax reform. It is time for it. It is really time. 

Mr. TIBERI. Thanks. 

Mr. KWALL. I would agree with my colleagues. We are definitely 

in need of comprehensive reform. 

Mr. TIBERI. Mr. Nichols. 

Mr. NICHOLS. My guess is we are going to have unanimity on 

this one. I do not think there is any question that comprehensive 

tax reform makes sense. Comprehensive tax reform makes sense, 

and anything other than that essentially risks us going back to the 

game playing that we had before the Tax Reform Act of 1986. 

There is no need to go backwards. 

Mr. TIBERI. Mr. Sullivan. 

Mr. SULLIVAN. Let me put it even a little more strongly than 

the panel has put it. I believe you should start with small businesses and then move to the larger businesses because I have been 

around a few years. There is a tendency to forget small businesses 

once the big issues come up. To prevent that bias from occurring, 

start with the small and the large will take care of itself. 

Mr. TIBERI. Thank you. 

I met with a group of farmers from Ohio yesterday. In your testimony, Mr. Smetana, you mention about privately held companies 

and their need for planning, long-term planning, and these farmers 

were talking about that. In fact, as you probably know, farmers 

sometimes plan not only decades but generations, and one farmer 


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in particular was distressed over the Tax Code and how complicated it had become to him and his family. 

Can you talk about the differences in comprehensive tax reform—we can start again from my life—and how we should apply 

the differences between closely held family enterprises versus publicly held companies and the differences between long-term planning versus short-term planning? 

Mr. SMETANA. Sure. I think it is a very important distinction 

because, as I said in my testimony, most privately held or closely 

held companies have time frames that are years or even generations, and so, therefore, there are several considerations. 

One is certainly the sustainability of the business, and that is 

largely based on the amount of cash flow that the company can 

generate on an annual basis and over a period of time and retain 

in the business to sustain itself. 

On the longer term basis, the shift in generation to generation 

is extremely important, and you need closely held companies, particularly family owned ones. Because of the onerous level of taxation at the time of death of an owner, we have created a situation 

in this country where the mere form of organization creates a distortion between a company that is one owned by a closely held family versus one that is owned in a different form of structure to the 

point where the family owned business, in effect, has to have 

enough liquidity or try to plan if they possibly can for enough liquidity to pay the tax at the time of death of one of the owners. 

What typically results is that, as some of my colleagues in FEI 

have said, we end up doing unnatural acts to try to prevent a catastrophe at the time of death and the loss of jobs and economic 

activity, and that typically results in diverting economic activity 

away from the business to try to preserve that. 

It just do not seem to make sense to me that at a time when we 

are trying to preserve jobs and trying to preserve economic activity 

that the death of an owner should cause some interruption in that 

activity, especially on a going concern. 

Mr. TIBERI. Thank you. 

Mr. Martin. 

Mr. MARTIN. I think most of you received a copy of a study by 

Mr. Carroll who basically identified the agricultural industry as the 

hardest hit industry in this country if we had different tax rates 

for businesses whether they are owned as C corporations or are 

owned as pass-through entities, so a very, very unfair result I 

think. 

My clients operate from the checkbook. Small businesses want to 

know if they have enough money to pay the payroll every week. 

They are only thinking about succession if I force them to or if they 

get to the age where they really have to or if they have children 

who are kind of pushing the issue on them to deal with it. They 

do not want to talk about it. They do not want to deal with it. It 

is a closely held situation with families. 

Small businesses are on a short-run decision making process. 

They fire people last. They hold onto them because they believe in 

them. They trust them. When they hire them, they have longevity. 

If you work for a small business, even though there is very rarely 


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a union, you have longevity with that business. They support you 

in that position. 

Chairman CAMP. All right. Thank you. 

Mr. Davis is recognized. 

Mr. DAVIS. Thank you, Mr. Chairman. 

I would like to follow along a little on that line of questioning, 

just having worked in the manufacturing world and its various 

tiers before coming to the Congress. I think that the underlying 

premise in this discussion is we want to address the rate issue, 

which is very real, but there is another other tier of issues underlying that. I have an example I want to put out and seek some 

comment on how we harmonize this, knowing that our premise for 

discussion is a revenue neutral reform. 

And it is very exciting to be part of the dialogue to try to change 

the underlying process to stimulate the creation of job, especially 

encouraging small business owners. 

Let’s look at the automotive industry as an example. The OEM 

or their Tier 1 suppliers invariably are international businesses. 

They will be located in multiple sites, integrated information and 

financial systems, supply chains that transcend the borders. Rates 

become a big issue. Those companies are operating on an accrual 

basis by and large. They are dealing with capital investment in a 

different way than, say, the Tier 2 or Tier 3 suppliers might be addressing the issues, to Mr. Martin’s point, functioning from the 

checkbook. 

I have worked with a lot of suppliers that, in fact, did that, very 

successful businesses, but they were much more cash oriented. 

They were often cash basis accounting. They did not like the idea 

of rates, but for the most part, they were pass-through entities for 

all practical purposes because you typically had a family or a collection of families that had started this business and grew it, where 

LIFO is a huge issue. 

Capital investment for machine tools, I watched a number of 

businesses, two in particular, that walked away from, say, purchasing five axis vertical mill technology because they were uncertain about what their depreciation schedules were going to be, you 

know, dealing with that aspect. 

England has tried some interesting approaches in harmonizing 

these issues at some various reforms. There is a lot of talk around 

the world about different schedules, you know, and how to deal 

with these issues. I am going to premise my question as someone 

who wants to see us go got a territorial system, have the ability 

of this rate issue to be addressed, but what I would like you to 

comment on in terms of reducing complexity, especially for small 

business: how do we address this issue of maybe giving the smaller 

businesses some options to address the issues like LIFO, to address 

the issues like depreciation, to encourage capital investment when 

they are functioning on the checkbook or cash basis and still hit 

revenue neutrality? 

Maybe start with Mr. Smetana first and then open it up to the 

panel. 

Mr. SMETANA. Sure. A couple of quick comments. First of all, 

I think there are a lot of allusions to the size of the corporation, 

and I will just say I think in the case of deciding policy, in this case 


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size does not matter. It is really the form of organization and what 

we are trying to do with the economic activity within that business. 

You know, me and my colleagues compete with companies of different sizes. So I think the level playing field is to create all businesses, regardless of their form or size to be able to have the same 

advantage. 

With respect to simplicity though, I do think that we can recognize that smaller formed companies do have some more complexities than larger ones in terms of maintaining current Tax Code 

and compliance, and I do think that it would be appropriate to look 

at levels and limits that are appropriate and typically used by 

smaller entities to have access to quicker deductions than perhaps 

larger companies with respect to recognizing that fact without 

changing the fundamental text related to the form of the organization. 

Mr. DAVIS. Thank you. 

Mr. Martin. 

Mr. MARTIN. I would say that I do not know how to make it 

revenue neutral, but for a small business to have—— 

Mr. DAVIS. Let’s imagine CBO actually has formularies that reflect the way you actually do business for a moment. 

Mr. MARTIN. Okay. When I was a representative to the White 

House Conference on Small Business in 1986, the number one 

issue voted by the representatives there was to have no changes in 

the tax laws for two years. Small businesses would love to have no 

changes in the tax law for two years or more in terms of managing 

their business. That just gets it out of their mind completely. They 

do not have to worry about it. They do not have to call me once 

a month to ask me what the issues are. 

I would say adopt the changes you are going to adopt, and then 

somehow put limitations on some future Congress. I know that is 

not something that is done, but small business would love to have 

that fixed right. 

Mr. DAVIS. Mr. Tucker. 

Mr. TUCKER. I would like to concur with what was just said. 

One of the worst things that we face every single day is not knowing what the law is going to be next year or the year after, and 

therefore, are you embarrassed because you made an investment 

this year and only got to write off 25,000, but if you had just waited until next year, it would have been 100,000 or 500,000? 

You need to bring stability into the Internal Revenue Code for 

all business. 

Chairman CAMP. All right. Thank you. 

We do have the prospect that we are facing of all tax policy expiring at the end of this year. So we really do not have the option 

of not doing anything. 

Mr. Reichert is recognized. 

Mr. REICHERT. Thank you, Mr. Chairman. 

So-called flow-through entities or those businesses that pay taxes 

through individual codes play a huge role in our economy, as you 

all know. Fifty-six percent of the jobs in Washington State where 

I am from are sustained and created by these businesses, and they 

account for 69 million people across the United States, and they 


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cannot be neglected in the tax reform effort that we are involved 

in here. 

So, Mr. Nichols, first I want to thank you for your comments supporting the extension of the five-year built in gains holding period. 

This shorter, more reasonable holding period unfortunately expired 

along with other tax extenders at the end of last year, and as you 

mentioned, I have introduced bipartisan legislation, H.R. 1478, 

with Mr. Kind from Wisconsin, to improve many of the rules governing S corporations, including making permanent an extension of 

the five-year built in gains holding period. 

And, Mr. Martin, you mentioned this is one of the issues that you 

pointed out would be very important for us to address going forward also. 

The IRS statistics suggest that thousands of U.S. businesses 

should be sitting on appreciated assets that could be put to better 

use. In an economy short of capital, it just makes sense to allow 

these businesses increased access to their own capital. 

Mr. Nichols, can you explain the purpose of the built in gains tax 

and why the five-year holding period is more reasonable than the 

ten-year holding period? 

Mr. NICHOLS. Well, the built-in gains tax was originally adopted primarily to prevent people in C corporation status to convert 

and avoid essentially the double tax on the sale of the business, 

and I have never been convinced that paying only one tax is a tax 

loophole and paying two taxes is appropriate policy, but that was 

the policy, it seems, behind the built-in gains tax. 

In terms of how the built-in gains tax works to free up capital, 

essentially I have got a situation. Fortunately it is a client who has 

already been an S corporation for a while, but they have got a piece 

of property, and they want to buy a new, bigger piece of property, 

expand their business, hire more employees. If they were subject 

to the built-in gains tax, what they would have to do is sell their 

old property, pay double tax on that property, and then essentially 

turn around and invest those proceeds in the new property. 

Now, they cannot qualify for Section 1031, the like-kind exchange rules, because they have got to operate their old facility for 

a period of time before they can move into the new facility. And 

so as a consequence, if they were seriously considering doing exactly that, but if they were in a position where they would have 

to pay double tax, which is what the built in gains tax regime is, 

they would essentially be trapped into that for five years or ten 

years. 

Obviously, five years is a heck of a lot better than ten years in 

terms of waiting to utilize this capital. 

Mr. REICHERT. Thank you. 

Mr. Martin, would you like to comment? 

Mr. MARTIN. I had a client that I asked when he was going to 

plan to retire at age 50 and he said age 60, and then at age 55, 

he decided that he had had enough. He had converted on my advice 

at age 50 to be an S corporation, and I said to him at the time, 

‘‘You know, when you convert, you cannot sell your principal piece 

of real estate here which is fully depreciated and worth a lot of 

money for ten years.’’ 


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And that is what happened. He sold the rest of his business. He 

did not sell the real estate until the ten-year time frame was up. 

That was not good for him. That was not good for the economy. It 

was not good for the buyer who bought the piece of property, but 

here was the tax law dictating what would happen in his operation 

of his business. It was kind of crazy. 

You know, five years is a whole lot better than ten years. Five 

years kind of takes into account unusual things that happen unbeknownst to all of us. 

Mr. REICHERT. Well, thank you, gentlemen, for your answers, 

and I yield back. 

Chairman CAMP. Thank you. 

Mr. Roskam is recognized. 

Mr. ROSKAM. Thank you, Mr. Chairman. 

And, again, Mr. Smetana, thank you for coming at our invitation 

to give a perspective. 

In our district in suburban Chicago, we have got a tremendous 

amount of pass-through entities who are job creators and employers and just a tremendous amount. I was at a company not long 

ago touring the plant floor, and the owner said to me, ‘‘Congressman, the smart move is for me to put three-quarters of a million 

dollars into this production line, but I am not going to do it, and 

one of the reasons, not the only reason, but one of the reasons,’’ he 

said, ‘‘was Washington tells me I am rich, and I am not going to 

do it.’’ 

You mentioned sort of the long-term planning in terms of the 

pass-throughs. You mentioned the generational aspect. Could you 

reflect on that, just be a little bit more expansive on it? 

What is the impact when Washington tells Eby-Brown you are 

rich? 

You know, Congressional Research Service a couple of weeks ago 

reported that nearly 60 percent of all business income is reported 

through the individual income tax system, and 62 percent of that 

amount is reported by those that the President calls wealthy. 

Can you give us the lay of the land on how that has an impact 

at your end of the rainbow? 

Mr. SMETANA. Sure. As I said, you know, we were a family 

owned company for, you know, decades, and we were not big at one 

time, but we became big, and the reason we became big is because 

the family was able to reinvest its after-tax cash flows back into 

the business, with a little help from the banks from time to time 

to finance the business to grow. 

So you know, the fact that we are big and the fact that the family has been able to commit to the business and grow its employee 

base, grow its asset base, grow economic activity, you know, is really the fundamental point about it. The fact that we are large 

should not really dictate whether the family can keep 40 cents or 

60 cents of its profits. In fact, I would clearly tell you that if the 

family only got to keep 40 cents of its profits, we would be a smaller business than we are today with less employees, less assets, less 

economic activity. 

I also think that fundamentally, as Mr. Kwall talked about, there 

is an important distinction between the double taxation regime 

over corporations which is mostly public formed corporation. An inVerDate Mar 15 2010 15:08 Oct 21, 2013 Jkt 078663 PO 00000 Frm 00108 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\78663.XXX 78663

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vestor in a public corporation is really a trader of securities, and 

if the government wants to tax that trading activity as a separate 

economic activity, I suppose it can decide to do so. 

But to try to equate that with the income derived out of a closely 

held business which is left in the business; closely held owners do 

not actively trade the business as a holder of a C corporation stock 

does, a publicly held C stock; so, therefore, I think you have to 

make that distinction in tax policy, and I think that distinction 

helps those privately and closely held investors make decisions to 

reinvest in their business. 

Clearly, from our perspective as we look at our business planning, the most important things to us are the ability to retain as 

much cash as we can in the business on an after-tax basis and the 

certainty which we have when looking out forward when we make 

decisions. And our investment decisions in business are not typically a quarter at a time or a year at a time, but multi-year in nature. 

It has been very difficult over the last several years to make 

those decisions, and I would submit to you that many investment 

decisions are not being made because the fear of the marginal rate 

increase, which has been delayed from time to time, but only at the 

last minute, which has really put a crimp in making good economic 

decisions for the long term. 

Mr. ROSKAM. This Committee and this Congress in the coming 

months are going to have decisions to make as it relates to the extension of the 2001 and the 2003 tax cuts and those rates. What 

is the impact on your business if those individual rates go up? 

Mr. SMETANA. As I mentioned before, Mr. Roskam, we are facing an increase in our marginal rates of four or five percent. Certainly under the President’s proposal, if we lose AMT preferences, 

it could go higher, especially with sourced income from higher 

taxed States. 

We have been able to take advantage of the faster depreciation 

rules over the last few years, and our owners have invested tens 

of millions of dollars back in the business because the after-tax 

cash flows of those investment decisions have been aided. 

So from our perspective it would reduce our after-tax cash flows, 

and it would certainly make an impact on the kinds of investment 

decisions that we make going forward. 

Mr. ROSKAM. And the employee opportunities, I would assume? 

Mr. SMETANA. Absolutely. We have been fortunate that we 

have been able to grow our business. We are in a relatively stable 

industry, and our business has been successful. We have been able 

to add jobs over the last several years and increase that economic 

activity accordingly. 

Mr. ROSKAM. Thank you for waving the Sixth District flag. I 

yield back. 

Chairman CAMP. All right. Mr. Gerlach is recognized. 

Mr. GERLACH. Thank you, Mr. Chairman. 

My question really is sort of a follow-up to what Mr. Roskam just 

asked. If I heard correctly from the panel a number of minutes ago, 

there seemed to be some general consensus that in our tax reform 

efforts we ought to sort of try to align the maximum marginal rate 

for corporations and individuals and make that as consistent and 


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comparable as possible so that you do not have an inappropriate 

shift of entities. 

If that is the case, there seems to be a developing consensus in 

Congress and within the Administration that perhaps the maximum tax rate for corporations ought to be around 25 percent. 

The House passed a budget last spring calling for a maximum 

rate of 25 percent. I think just looking out ahead, perhaps we will 

do the same again this spring. The President just put forward a 

corporate reform proposal which I think is a maximum rate of 28 

percent with maybe on manufacturers of 25 percent, so clearly 

within the same ballpark of discussion. 

So based upon that, if we can have all the panelists answer the 

question, would you agree then that the maximum individual rate 

of taxation under any tax reform proposal ought to be 25 percent? 

And just start maybe with Mr. Sullivan. You are the closest, and 

then just work up the panel. 

Mr. SULLIVAN. Well, I think I am going to be the contrarian 

here. I think this line-up of the rates, which my attorney and CPA 

friends obsess on, is the tail wagging the dog. We have larger considerations: deficit reduction and competitiveness. We need to lower 

our corporate rate. When we do that, we have to find revenue elsewhere. 

One place that you may have to look is at raising taxes on individuals to make up that difference. We do not want to do it, but 

there are not many options. 

Mr. NICHOLS. I would go in the other direction. It is absolutely 

critical on a marginal basis that we have a low marginal rate, and 

I think we proved up until the Tax Reform Act of 1986 that if you 

have varying rates for varying types of income, that it is going to 

essentially cause tax lawyers and tax accountants to intermediate 

between those two rates to prevent the government from essentially getting the full benefits of the various differing rates that it 

wants to achieve. 

The simpler the tax system you have the better. I would make 

one other important point, and this is virtually universal for the 

taxpayers that I represent. Their biggest fear is that there is going 

to be an attempt to essentially solve all of our fiscal problems and, 

frankly, many of the world’s problems, by essentially, quote, taxing 

the rich and they today worry about how much their marginal income tax rates are going to go up. 

What you need to have is a system whereby everybody is paying 

taxes. Everybody is paying taxes maybe not at the same rate, but 

at similar rates, and everybody is benefitting from government so 

that essentially there is buy-in both as far as revenue and also as 

far as expenses so that people are similarly motivated. 

Mr. KWALL. I do not really have a view as to what the rate 

should be, but if current law continues, it is clearly destabilizing 

to have a corporate rate that is significantly lower than the individual tax rate. We have been there before, and what happens is 

it puts a heavy burden on the government to preclude taxpayers 

from trying to shift income to corporations and to resurrect penalty 

taxes that require the business to justify its needs for its earnings. 

The Government has to find these cases and try to pursue them to 

avoid the tax avoidance. 


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Again, in my view the better solution is to keep closely held businesses out of the C corporation form. If you do that, then you have 

really got two separate systems, but if you are not going to do that, 

then I would agree that you want to maintain that parity. 

Mr. TUCKER. I am an advocate of parity. I would also like to 

remind everyone that we also have an estate and gift tax. Whatever these people have earned and have left after taxes is going to 

be subject to an estate or gift tax, and you go back, unless the law 

is changed rather quickly for next year, to about a million dollar 

exemption and a 55 percent estate tax rate, and I think you need 

to take that into account as well for small businesses and small 

business owners. 

They are not rich at that kind of level. They are simply not. 

Mr. MARTIN. Well, we have expressed several times that parity 

is important. I do not know what the rate should be either, but as 

close as it can possibly be I think is better for business planning, 

and let’s have some permanency, like the extenders that we deal 

with every year or every two years. Let’s do some things on a permanent basis so small businesses can plan. 

Mr. SMETANA. I think you are in an unenviable position of having to try to correct a fiscal situation with only working at one side 

of the equation. As financial professionals, we can hardly ever turn 

around our companies and improve them if we are only dealing 

with revenue and not dealing with spending. 

But to your point, I think the policy and goal of our Government 

should be to take the least amount of taxes from its people to sustain the Government for the spending that it feels it is required to 

do. So whether that is 25, 28, 15 percent, I think you have got to 

look at it on balance with the total expenditures of this Government and what we should be providing to our citizens. 

Mr. GERLACH. Thank you very much. 

Thank you, Mr. Chairman. 

Chairman CAMP. Mr. Buchanan is recognized. 

Mr. BUCHANAN. Thank you, Mr. Chairman. 

I want to thank our witnesses today. 

As a guy that has been in business 35 years and started in 1976, 

I remember my first entity was a C corporation, and then they 

came to me, the tax professionals, in the 1980s with an S corporation because it gave you the liability protection, and then they 

came to me and all of our entities lately have been LLCs because 

it gives you flexibility and distributions and all of the other things. 

But I want to make one point that Mr. Smetana mentioned. Let’s 

just take a bank or a lot of times you have got a lot of people who 

are franchisors or they are dealers, and the factories or the banks 

require even if you made 500 and even if you want to take it out, 

you cannot take it out. 

Now, many people believe that in the end they might make 500, 

and they have got 100 employees. That is a lot of exposure and 

risk, but they might take 100 out and leave 400 in, but many times 

my experience has been that people require you to keep the capital 

in. So it is almost like a C corporation. 

Now, all of that being said, I hear up here that, you know, all 

we talk about, even the White House and the Administration talk 

about lowering the corporate income tax to 27 percent or, our 


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thoughts here in terms of the corporate to be more competitive in 

the world 25, but again, I want to get back to the point. I do not 

know how you can lower the taxes for corporate entities without 

dealing with Sub S and LLCs because of their growth. Because people will go back and the tax professionals will come back in and 

tell you to be a C corporation. 

So we have got all of this discussion about raising taxes, but all 

of these pass-through entities are going to be tied to the tax rate. 

So you have got them going down to 25, and you have got the guy 

who is running the company going up to 39, many times in the 

same entities. 

So I guess, Mr. Martin, I will start with you. Dealing with a lot 

of businesses, do you see under any circumstances where you could 

lower C corporations without really lowering it for small businesses 

and medium size businesses that are pass-through entities? 

Mr. MARTIN. Well, I think the lowest C corporation rate, a huge 

company, multinational level, probably brings more taxable income 

back to this country because right now big companies do their planning to ship business overseas where tax rates are lower. So hopefully that increased revenue would somehow offset that. 

What we need to keep in mind is the point that was made earlier. The typical pass-through entity takes out their salary at a reasonable level; takes out of that pass-through entity the amount of 

money they need to pay their taxes; and leaves the rest of it in 

there. Sometimes that is because creditors require it. Most of the 

time it is because that is the only way that growth is going to come 

about. 

If you think about an accrual basis entity, you are required to 

use the accrual method. You cannot grow if you do not have cash 

because you have got to invest in receivables and inventory. One 

of the biggest problems small businesses have is growing too fast. 

If you grow too fast, you cannot find the increased receivables in 

inventory and you can go out of business. 

Mr. BUCHANAN. I have one thing to add to that. In today’s environment, in the last three or four years a lot of banks—I am from 

Florida—especially in Florida, but in other parts of the country, are 

not lending. So they have to leave the money in there. 

Mr. Tucker, anything you want to add to that? 

Mr. TUCKER. Two things. One is my clients are all small business people. They all leave money in the entity even though they 

are taxed on the money. 

The second thing is a lot of them have debt that is being paid 

down, and when you pay down debt, because my clients do not like 

to be in debt, you get no deduction. So you are doing it with aftertax dollars. To keep taxes for entrepreneurs up here and to have 

C corporations’ taxes down here without parity is truly inequitable. 

Mr. BUCHANAN. I want to add a second question. I know a lot 

of these guys that are in the top tax brackets. Most of them I know, 

most of them I have known for 30-some years. They are usually the 

job providers in the community. So really what are we doing if we 

want to grow? 

The talk up here is three things: jobs, jobs, and jobs. Well, who 

provides those jobs? Most of the folks that, you know, have 25 to 

200 employees are these pass-through entities. So if we are going 


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to have them pay more in taxes, all we are going to do, in my opinion, is hurt more jobs. 

Mr. Kwall, do you have any thought on that? Yes, go ahead. 

Mr. KWALL. In evaluating the consequences of creating a system 

where the corporate rate is lower than the individual rate, you 

really have to take account of in terms of estimating revenue, the 

potential fleeing from pass-through entities in that situation. In 

1986 what ended up happening is everybody fled from the corporate tax when individual rates came down and heavier burdens 

were put on the corporate tax. So that has just got to be done. 

Mr. BUCHANAN. Mr. Nichols, anything? 

Mr. NICHOLS. Just a quick point, and that is there is a temptation, of course, to not essentially tax everybody all at the same 

rate. If you are going to raise rates, raise rates on some and not 

necessarily on others, but frankly, that is what got us into the 

hodge-podge that we have got in the Tax Code now. I think it is 

much better to take the courageous approach and essentially face 

the revenue needs we have and get a system that works over the 

long term. 

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

Chairman CAMP. Mr. McDermott is recognized. 

Mr. MCDERMOTT. Thank you, Mr. Chairman. 

I could not help it. I was watching this down in my office, and 

I came up because I wanted to ask a question. I felt like Russell 

Long had come out. I was looking around for his picture, but I 

think he is over in the Senate. His theory of taxation, as you know, 

was do not tax you; do not tax me; tax that guy behind the tree. 

And I have a feeling that we are sitting here talking about where 

the guy behind the tree is. Then I thought about the fact that 

former Ways and Means member, who must have learned something on this Committee; I mean, I cannot assume that he sat here 

and did not learn a thing, Mr. Cantor, presented an interesting tax 

proposal that he hopes to jumpstart the economy. He says the provision would provide a 20 percent reduction on small business income. 

But then I read what is going on in the press, and the Small 

Business Association and the independent business people, they 

are not throwing their arms around this proposal and saying it is 

a good idea. 

So tell me about Mr. Cantor’s proposal. Why is the small business community not just in here beating down our doors to have 

that happen? 

Anybody can answer that. 

Mr. SULLIVAN. Well, I do not have any idea why because it 

seems like a proposal which would be highly beneficial to them. 

Mr. MCDERMOTT. Does anybody else have anything? Why are 

the small business organizations not endorsing this? 

Mr. MARTIN. I think primarily because of—nobody has told me 

this—but added complexity in the tax law and how you define what 

that number is going to be that they get to deduct. I just do not 

know how that number is calculated. I have not even seen the proposed legislation. So I do not know what he is putting through. 

Mr. MCDERMOTT. You took the words out of the mouth of Chris 

Waters. He said, ‘‘Just for our members, the top two important 


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issues are keeping the marginal rates low and reducing the complexity.’’ That is NFIB, right? 

And what you are saying is the Majority Leader of the House has 

introduced a bill that is making people more anxious because it introduces more complexity. That is his solution to this problem it 

sounds to me like. 

I mean, I was here under Clinton when we set the Clinton rates. 

Okay? I was here in 1993 when we did that vote, 1994, and the 

country was booming, and so now everybody says we have got to 

reduce the rate somehow because that is the only way we can get 

the country going again, and what I hear also is from Mr. 

Buchanan and others, the banks are not lending. 

I mean, let’s talk about what the real problem here is. Small 

business people’s problem is the banks will not lend to them unless 

they have got—I just tried to get my loan refinanced on my house 

because I thought a 3.9 percent interest rate was pretty interesting. They wanted to have my pay stubs for the last three 

months, and they wanted to have proof that I had—you know, I 

can see why a small businessman would go crazy dealing with this, 

and I do not understand why the Minority Leader would put one 

out to make it more complex. 

I mean, what would be the purpose of that? Has anybody got an 

answer? 

[No response.] 

Mr. MCDERMOTT. I yield back the balance of my time. 

Chairman CAMP. All right. Mr. Smith is recognized for five minutes. 

Mr. SMITH. Thank you, Mr. Chairman. 

Certainly I can appreciate this discussion about the complexity 

of the Tax Code and adding new preferences in the Tax Code. The 

last I checked, there has been more than one bill introduced or suggestions for our Tax Code that would add more complexity, which 

certainly does concern me. 

But in a broad sense, I mean, we talk about confusion and frustration and instability of the Tax Code, but for the CPAs here on 

the panel, how often do you encounter someone, aside from the instability and the short-term nature of a lot of these tax policies; 

how often do you encounter a client who would say, ‘‘Gosh, in going 

back I wish I could go back and redo some planning perhaps’’? But 

how many of them think retroactively and then would apply that 

moving forward? 

Mr. TUCKER. I am not a CPA, but I can tell you that in my 

practice my clients both look back and look forward. The problem 

with looking forward is you cannot assure the client of any stability 

looking forward. It is not just complexity. It is stability, and they 

do not understand what is going to happen next year, for example, 

extenders, non-extenders, tax rates, and everything else. 

So they look back and they say, ‘‘If I had done this at that time, 

I could have saved taxes. I could have done something different. I 

could have paid less taxes in the long run.’’ 

It is a balancing act, and very often my clients, being entrepreneurs, are, frankly, upset with planning we did before because 

the law changed, and they did not know it was going to change and 

we did not know it was going to change. So I think stability has 


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to be part of focusing on complexity. You need to provide stability 

for the people in this country and the entities in this country. 

Mr. SMITH. Okay. Anyone else? Mr. Martin. 

Mr. MARTIN. I would say that my client base does not look 

back. It is not profitable to look back. You cannot change things 

that have already happened. If they ask me about some advice that 

I gave them before, it is always on the basis of what we knew at 

the time. 

It is a struggle enough to get my clients to look forward far 

enough to make huge business decisions that will affect them in 

the long run. They are operating today. Do not look back. It is 

fruitless to look back. 

Mr. SMITH. Mr. Smetana. 

Mr. SMETANA. I would concur. We are forward looking. You 

need to be in your business. I would say that over the last several 

years we have tried to make behavior by the tax policies we have 

instituted particularly around depreciable lives and fast expensing, 

and I think what we run the risk of is similar to a shopper in a 

retail store. They keep looking for the sale. So they defer their purchases until that sale occurs, and I have a feeling that we continue 

down this path of just short-term policy fixes and short-term incentives to try to change behavior and what we are really deferring 

are the kind of long-term investments that are necessary for business to thrive and survive and grow. 

Mr. SMITH. Okay. Mr. Nichols. 

Mr. NICHOLS. And I would certainly concur in everything that 

was said on the subject before. I would add one other thing, and 

that is clients, good clients that are running successful business, do 

not want to do tax planning. They would be very comfortable and 

would be delighted to have a stable system and, frankly, they want 

to work on that next sale. They want to get sales to go up. They 

want to figure out that new technique that is going to reduce cost. 

That is what they want to focus on, and they resist the idea of, 

frankly, paying people like us and others because of the complexity 

or the uncertainty of where things are going to be. 

They want to do their business, and if we could just let them do 

that, we would all benefit. 

Mr. SMITH. Now, I guess in light of this topic though, you know, 

we know that the Tax Code has so many tax preferences, hundreds, many of which are temporary in nature, and there are more 

proposed as we have heard several times this season. Obviously, 

the beauty of a tax preference is always going to be in the eyes of 

the beholder, aside from the rate, but perhaps a rate can impact 

that a little bit. 

How high of a priority should reducing preferences in the Tax 

Code be as we tackle tax reform? Mr. Sullivan. 

Mr. SULLIVAN. Thank you. 

Well, it should be an extremely high priority. It simplifies the 

Tax Code, and it will allow much lower rates, make the system 

fairer and promote economic growth. As you say, the benefit is in 

the eyes of the beholder. The hard part is the politics. The economics are very simple. 

Mr. SMITH. Mr. Kwall. 


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Mr. KWALL. The most stable tax would be a low rate, broad 

based tax. So to the extent that preferences can be reduced and 

rates can be brought down, that approach is the ideal. 

Mr. SMITH. Perhaps we should resist adding further preferences 

in our Tax Code. 

Mr. KWALL. Definitely. 

Mr. SMITH. Okay, and Mr.—— 

Chairman CAMP. I think we are out of time. 

Mr. SMITH. Thank you. 

Chairman CAMP. Ms. Jenkins is recognized. 

Ms. JENKINS. Thank you, Mr. Chairman, and thank the panel 

for being here today. This has been very interesting. 

Mr. Kwall, your testimony calls for requiring all complex businesses, those with one or more class of stock to be taxed at the entity level potentially, stating this would eliminate their ability to 

pass losses through to their shareholders. This would limit the ability of start-up businesses to raise capital. 

I am concerned with this rule that only the simplest of businesses be allowed to pass their income and losses through to their 

owners would make it harder for start-up businesses to raise capital since they can only pass the losses they incur in the early 

years through to their investors if they have the simplest of capital 

structures. 

So, Mr. Kwall, I guess for you might be: Do you share this concern and could your proposal be modified to allow real economic 

losses to be used currently by those start-ups that are in a loss position in their early years? 

And then I would be interested if anyone else would like to comment. 

Mr. KWALL. Thank you, Congresswoman Jenkins. 

That is actually a very good question. When I talk about simple 

enterprises my assumption is that system really govern the majority of closely held enterprises. In other words, a simple enterprise 

basically would mean that they are not going to have preferences 

with respect to distributions or economic preferences with respect 

to issuing different types of stock or membership interests so that 

some interests would be preferred and others would not be. 

So first of all, hopefully the bulk of new enterprises would fit 

under that simple regime and losses would pass through. 

Ms. JENKINS. Okay. 

Mr. KWALL. To the extent that a more complicated ownership 

structure was used under my system, it is true the losses would not 

pass through, but that is a default regime. I guess that is a cost 

of choosing a more complicated economic arrangement. 

So the real question would be how necessary a more complex arrangement would be to a business that thought it was in that situation. 

But it is clearly something that needs to be thought through. I 

agree with you completely. 

Ms. JENKINS. Okay. Thank you. 

Mr. Tucker. 

Mr. TUCKER. I really disagree. I think the concept of two classes of ownership creating a complex business rather than a simple 

business is not focusing on the entrepreneur. Most of my entrepreVerDate Mar 15 2010 15:08 Oct 21, 2013 Jkt 078663 PO 00000 Frm 00116 Fmt 6633 Sfmt 6602 I:\WAYS\OUT\78663.XXX 78663

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neurial clients are very concerned about capital formation and capital access, about protecting their personal assets from the business 

risk, and business succession. 

All of that goes to two classes of something. I would rather bring 

in equity than debt because I will have somebody who will have a 

share of the ownership, but will not have an obligation on my part 

to pay them. With business succession, I may have family members 

who are going to run the business, and they would have a voting 

class of stock, and I might have people who are going to be in the 

business and have a non-voting class. I think the great bulk of my 

entrepreneurial clients would be caught under the definition of 

‘‘complexity,’’ not ‘‘simplicity,’’ and I think we need to move away 

from that. We need to have pass-through entities. 

Ms. JENKINS. Okay. Sure. 

Mr. KWALL. One point of clarification. A simple enterprise could 

have voting and non-voting stock. It cannot have different kinds of 

economic interests, but you could have stock that was voting and 

stock that was non-voting. 

Ms. JENKINS. Okay. That helps. 

Mr. Nichols. 

Mr. NICHOLS. I would second Mr. Tucker’s comments, but I 

guess I would have a more fundamental comment, and that is I 

think we are clearly in a situation where we need to have rate parity. I think everybody agrees on that, and so as a consequence, that 

is something that we should not avoid by doing this and we should 

not try to avoid it by doing this. 

The other principle I would apply here is ‘‘if it is not broke, don’t 

fix it.’’ At the end of the day I am not quite sure there is something 

that would be so bad policy-wise or even at all bad policy-wise, 

frankly, that would cause us to disrupt what people are doing 

today in order to get to something that might theoretically be better on the basis of theory; I am not sure how much policy consideration is behind it. 

Ms. JENKINS. Okay. Mr. Sullivan, I know you made note of this 

in a recent Tax Notes article. Do you have any thoughts on this? 

Mr. SULLIVAN. Well, I think the details need to be worked out, 

but the theme keeps coming up over and over again. If you are 

starting up a business, all you want to do is your business. These 

entity choices are way too complex, and Professor Kwall is offering 

an easy alternative for a start-up business that does not want to 

be concerned about taxes. 

Ms. JENKINS. Okay. Thank you. 

Thank you, Mr. Chairman. I yield back. 

Chairman CAMP. Thank you. 

Mr. Paulsen is recognized. 

Mr. PAULSEN. Thank you, Mr. Chairman. 

I just want to raise a couple of points because it seems like there 

is pretty much unanimous agreement that parity is important in 

terms of comprehensive approach to tax reform for both large and 

small businesses. You know, we are not going to pass one bill that 

is going to address one side of it and then you can count on us 

passing another bill that is going to catch up with it, right? That 

is just not going to happen. 


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We talked a little bit about family ownership, but we have not 

talked much about employee ownership, and I just think it is important, too, that we make sure that employee ownership is also remembered as a key component of existing tax law, and I think it 

is important that we keep employee ownership actually in mind as 

we move forward through larger comprehensive tax reform because 

there are huge benefits to employee owned companies. 

And I know that there are some of my colleagues that go back 

to 1994 when the rates were raised. You know, this is 18, 20 years 

ago. The world has changed. It is a lot more competitive. It is a 

lot flatter. Small businesses, in particular, have to compete on a 

global scale that they have never had to compete on before as well. 

But let me ask you this question. I will start with Mr. Nichols. 

Can you highlight some of the restrictions on S corporations? And 

could we consider updating some of those restrictions? 

It was mentioned, I think, a little bit earlier about the importance of a five-year built in gains period, for instance, but are there 

any other proposals that could be considered outside of the context 

of larger comprehensive tax reform, such as the limits on the types 

of shareholders allowed for an S corporation to help open up opportunities for any businesses that are, for instance, trapped in that 

C corporation area? 

Mr. NICHOLS. There are a number of things that could be done, 

and I think they could be done without dramatic, perhaps not even 

significant, losses of revenue. A lot of the restrictions on S corporation status, such as on the nature of shareholders and actually 

even the types of entities that can elect S corporation status and 

various other things, have been in the code for some time, but they 

do not really need to be policy-based and do not need to be retained. 

Let me give you an example. Nonresident aliens were excluded 

because, when it was originally enacted, people were worried that 

the nonresident aliens would not pay tax. So were partnerships 

and corporations and various other ineligible entities. 

What we have done or what Congress has done for several of 

those is it has essentially said, okay, we are going to let a certain 

type of trust, an electing small business trust, or we are going to 

let certain tax exempt organizations, we are going to let you be a 

shareholder, but in return for that what we are going to do is we 

are going to tax you effectively at the top rate. 

So is the same is done for these other restrictions, the Government gets its revenue, but essentially the corporation is enabled to 

have a partnership as a shareholder or a nonresident alien as a 

shareholder. I am not quite sure there is any loser in that transaction. It just essentially gives more flexibility to closely held business, and I do not think it would lose a lot of revenue. 

Mr. PAULSEN. Okay. Mr. Tucker. 

Mr. TUCKER. What I teach my students is that there are five 

things you could do to reconcile S corporations with partnerships 

within the S corporation regime. Number one, you could take out 

any limit on the number of shareholders. 

Number two, you could let anybody be a shareholder, including 

not just the nonresident alien, but a partnership or a C corporation 

or an S corporation could be a shareholder. 


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Number three is you could reconcile inside basis and outside 

basis. Right now in a partnership, partners share inside basis for 

debt, but in an S corporation you only get basis if you put money 

in or lend money to the S corporation. 

Number four, we have something in the partnership regime 

which says if you die and get a step up in basis on your partnership interest, there is an election to reconcile inside basis with outside basis, and we could do that for the S corporation as well. 

And finally, we could allow any kind of stockholder, preferred, 

non-preferred or anything, without having an issue if you wanted 

to do it. My proposal would be, fine, let’s eliminate S corporations 

and let them use the partnership regime, which would be the simpler way of doing it. 

Mr. PAULSEN. Mr. Martin, let me just ask this before time runs 

out. You represent a large stakeholder group from a small business 

perspective. How much time do your members spend navigating 

the Tax Code? 

I mean, you know, what is the best story, the best anecdote that 

really just paints the best picture of why this is so critical to address? 

Mr. MARTIN. They do not spend a lot of time because they call 

me on the phone. 

[Laughter.] 

Mr. MARTIN. And, yes, I bill them for it, but what is stressful 

to them is the changing tax laws. I get numerous calls in November every year about Section 179. What is it this year? Is it likely 

to change before December 31, because they are thinking about 

capital investments now for things that they need to operate their 

business? Should they do them now or do them in the next six 

months? That is a huge issue for them, is just the stability. 

My clients wrestle with payroll taxes like crazy because it is an 

abomination of the Small Business Administration. It is a huge 

cost to administering payroll taxes, but not the income tax law. 

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

Mr. HERGER [presiding]. Mrs. Black is recognized. 

Mrs. BLACK. Thank you, Mr. Chairman. 

There I think has been a really great discussion here and a lot 

of good questions that were asked. When you come down to the end 

of us last members all of the questions have just about been asked, 

but I want to follow up on what my colleague was just saying about 

how much time this takes, and, Mr. Martin, you said the timing 

is not really the biggest issue with the employer. It is more just 

the stress. 

Obviously, we have talked a lot about complexity and the fairness and the uncertainty, but I do want to go to what is the actual 

cost. Can you determine the actual cost of this kind of complexity 

and what these businesses need to go through with the complication of the Tax Code? 

Can you give me an idea of what this actually costs the business, 

a percentage of what it might cost them? 

Is there a way to be able to evaluate that? 

We can just go right down the line, whoever would like to answer 

that question. 


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Mr. SMETANA. I can just speak for our situation. So we are 

family owned. We have two shareholders, brothers, that own the 

company. We operate in seven states. We are U.S. domestic only. 

So we are not as complex as most larger businesses, but we spend 

hundreds of thousands of dollars a year on federal and State tax 

compliance. We do it both with internal staff people and as well as 

hiring experts from tax accounting firms to help us deal with all 

of the complexities. 

In addition, there is a cost to compliance and recordkeeping by 

deploying sophisticated accounting systems, particularly those that 

have to track three or four different types of depreciation, records 

given the various regimes that are out there. 

So in our case it is a big dollar, and that is money coming out 

of the business in reinvestment. My colleagues at FEI have similar 

experiences. 

Mrs. BLACK. And let me just follow up on that for just a second. 

Then I do want to hear from the rest of you, but just to draw to 

that conclusion, I think, down the line, would you be able to hire 

more people and expand your business? 

Then ultimately I think at the end of the day what we have to 

consider on all of this is that the cost to the consumer of the product on the other end, and as we talk about this, I think so many 

times that is forgotten, that the cost of whatever the service of that 

product is is increased, and it is really harder for those at the lower 

income because the end result really impacts those at the very lowest income in purchasing that good or that service. 

So would you say if you did not have this kind of complexity you 

could make things a little easier and you could use those dollars 

to grow your business and, therefore, grow jobs? 

Mr. SMETANA. Absolutely. As we said, the key to business economic growth is after-tax cash flows, and whether you spend it on 

income taxes directly or on the cost of preparing those taxes, it reduces the amount of money you have to sustain the business. 

Mrs. BLACK. Others? Mr. Martin. 

Mr. MARTIN. It is difficult for me to estimate what it would 

cost, but there are a couple of provisions. One I mentioned, the 

health care credit. It is crazy for me to have to spend the time that 

I do because the law is so complex I cannot figure out whether I 

need a benefit without spending the time. 

The domestic production activity deduction is another one that 

the guidelines that we follow are extremely loose. Again, I feel like 

it is malpractice if I do not get my client the $300 deduction they 

should be entitled to. So I have to go through the calculations for 

it, incredibly complex, all of the job credits that are out there. I do 

not have any small business clients that hire people because they 

are going to get a job credit. They hire someone because they need 

someone to help run the business. 

Mrs. BLACK. Thank you. Thank you. 

Others? Mr. Tucker. 

Mr. TUCKER. I think there are two costs. One is the cost of 

planning, which takes both financial resources and human capital, 

which is often not measured, but two is for the clients who do not 

come in advance on planning. The cost of some foot fault is even 


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much more expensive, and I think they do not realize that a lot of 

times until the foot fault occurs. And we need simplicity. 

Mrs. BLACK. Mr. Nichols. 

Mr. NICHOLS. I had really only two points. I know there is limited time, but, number one, in terms of complexity, there is no 

question on several of the things that have been raised. The items 

that actually on an ongoing basis affect how closely held business 

calculate their taxes and things like that, there is no question that 

that complexity could be improved upon, and in particular, it would 

be best in terms of tax reform to resist the temptation to micromanage and to have more global rules that are essentially applicable and rely on the economy to weed things out rather than to 

micromanage. 

The only other thing that I would say with respect to complexity 

is we have talked about choice of entity and forcing people, let’s 

say, to a single pass-through regime. I am not as worried about 

complexity there because essentially once a business has elected a 

particular pass-through regime, that is its entity. It has got its entity, and you are actually adding to their complexity if you force 

them into a new entity. 

There is complexity, but it is complexity for the law students. It 

is complexity for the tax advisors, but you are not helping closely 

held business if you force a disruption on their tax planning. 

Mrs. BLACK. Thank you. 

And I think I am out of time, and I yield back. Thank you. 

Mr. HERGER. Mr. Berg is recognized. 

Mr. BERG. Thank you, Mr. Chairman. 

I really appreciate the panel being here. I started a small business from the ground up, and we worked our way through a lot of 

these things. The comments that we have heard today are really 

right on. 

You have a small start-up business. I mean, you do not have an 

accountant full time. You do not have an attorney that is looking 

at the regulations, looking at the rules, and quite frankly, a lot of 

the decisions on what type of organization you are going to be as 

a tax entity kind of are made at the last minute with some advice. 

And talking about those people who went through a C corporation and for tax reasons cannot get out of it and have struggled and 

every year the tax liability gets more and more severe, you know, 

as I approach tax policy for business, my goal is to say that people 

will make business decisions based on business principles. And 

very secondarily or third they would say, ‘‘What are the tax implications?’’ 

Instead I think we have reversed that where people are saying, 

‘‘Before we make this business decision, what are the tax implications?’’ So it is almost backwards in terms of if you want to build 

a better mousetrap, beat the competition to do these things. There 

are all kinds of barriers within the Tax Code. 

The least amount or I should not say the least, but one of the 

biggest is the uncertainty in the Tax Code. I mean, who knows 

what is going to be our tax come January 1 of 2013? You know, 

no one. 

So I do not know where we are going or where I am going with 

my questioning, but there is a lot of frustration I have. I think 


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probably the first thing would be to, you know, really look at the 

President’s budget and what kind of an impact that is going to 

have on business. Probably specifically is where we have a corporate rate that is lowered and a personal rate that is increased. 

I would just like the panel to respond to how do you see that impacting the small business that we are talking about. 

Mr. SMETANA. Sure. As I mentioned earlier in my statements, 

we analyzed the President’s and the Treasury’s proposal, and the 

impact of not bifurcating, you know, business source income out of 

closely held from the individual regime would cost our company literally millions of dollars both in terms of the loss of certain of the 

current tax preferences around capital and inventory investment as 

well as the material increase in the marginal rates that our businesses would pay in taxes in the pass-through regime. 

So it would certainly have a dampening effect with respect to the 

economic activity that we could plan going forward by having less 

capital with which to work. 

Mr. MARTIN. We are talking about less job creation. We cannot 

afford it. 

Mr. TUCKER. We are talking about more complex here. We are 

going to go back to the personal holding company, accumulated 

earnings tax, and all the other things that are done to offset this, 

and it is just the wrong direction to go, sir. 

Mr. KWALL. I would start with an ideal income tax that would 

tax income to the owners at the owner’s marginal rate. So whenever you are trying to duplicate like that, it is just really inconsistent with the ideal. 

Mr. NICHOLS. To a great extent I am going to reiterate. When 

you stray from rate parity and the single-tax rate, corporate owners will respond to the incentives. They may not like them, but 

they will respond to the incentives, and at the end of the day if the 

next change incentivizes it, either as a result of complexity or otherwise, they will move to C corporation or other status just on a 

temporary basis. Then there is a lot of lawyer work to get them 

out, and if the tax rates are too high or they are different for other 

people, they will respond. They will adjust, and the people that will 

be hurt, I think, are the new entrants into the labor market or the 

newly unemployed, who are the last people that at the end of the 

day businesses would be hiring if things went well. 

Mr. SULLIVAN. Well, I am going to be the contrarian again. 

Again, that is the tail wagging the dog. We need a competitive tax 

system. We need to raise revenue. We have to lower our corporate 

taxes because those larger corporations are internationally competitive. 

If there is not enough revenue, you may have to consider raising 

taxes on individuals. These rules are anti-abuse rules. If businesses 

are not pushing the envelope, they do not have to deal with these 

anti-abuse rules. There is no reason for a new business to seek C 

corporation status. So I have no sympathy for a corporation that 

goes in that direction. 

Mr. BERG. Clearly, in my mind if there is a 40 percent tax rate 

and a 28 percent tax rate, people are going to go to the 28 percent 

tax rate, which from my perspective, the way I started this is exactly opposite to what we want people to be doing. 


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I mean, I think if we want to raise revenue, we have got to grow 

jobs, period. And that is my concern with the President’s proposal 

on taxes. It creates more uncertainty, and it is not growing jobs. 

I have got one more question. 

Chairman CAMP [presiding]. Well, your time has expired, and 

we have got one more person. 

I would just say that lowering rates is not the same as lowering 

taxes. There is a difference there, and so you do not necessarily 

have to go somewhere else in the economy to raise taxes. 

Mr. Reed is recognized for five minutes. 

Mr. REED. Thank you, Mr. Chairman, and I am the last one. So 

that always brings a smile to the panel’s face whenever I get to ask 

the questions. 

[Laughter.] 

Mr. REED. Going last here, I will say I echo the sentiments of 

my colleagues, and also being one of the colleagues that started a 

small business like myself, and we talked a lot about the time pressures, obligations of starting a business and then having to deal 

with these issues. I can vividly remember in the beginning when 

my CPA called me and asked me to get a document, and it took 

me two days to find the document. I was so frustrated, and he actually did not need the document at the end of the time. So I was 

almost firing him on the spot, but you know, the bottom line is I 

have been there, and small business owners across America are 

frustrated with this Tax Code, and I am so glad to be part of an 

effort to try to reform it, and we will do our part on that. 

What I am hearing is a general theme from each and every one 

of you that we should be focusing on the certainty and the stability 

in the code, looking at the rates to make them competitive, and 

combining the individual and corporate rate. 

One thing that I do not know if we spent enough time on and 

I am interested in exploring and going down further is does anyone 

feel that the underlying business activity of the taxpayer, is that 

something that should be taken into consideration when we are 

setting tax policy. 

And the reason I bring that up is as a new member down here 

in Washington, D.C., I hear a lot of politicians talk about bad guys, 

oil and gas industry, and there are provisions in the code that treat 

folks differently just because of the business activity upon which 

they are engaged when it comes to their tax burden. 

Can anyone tell me is that something that is good policy to advance as we go through comprehensive tax reform, or is my gut 

telling me the right thing and that we should avoid looking at business activity as a reason why tax policy should be set? 

Mr. Tucker, please. 

Mr. TUCKER. Are we not really trying to look at the ability to 

create jobs? Do service businesses noted create jobs just as manufacturing businesses create jobs, just as real estate creates jobs? 

If that is what we are looking at, I think the type of activity is 

totally irrelevant. Our objective should be to create jobs, be able to 

collect tax from the people who are earning money and go forward. 

Mr. REED. I appreciate that. Anyone else? Mr. Nichols. 

Mr. NICHOLS. Well, I would say, and corresponding to and following up on that and certainly not disagreeing with it, and that 


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is the trick, you need to be careful, but the trick is to treat all businesses, I think, comparably. Obviously they differ, but at the end 

of the day, there are certain fundamental principles. 

If you follow the cash, people are making money. Then that is 

a good time and an appropriate measure of whether or not taxation 

is appropriate. Now, I realize that is an oversimplification, but in 

general, you should not favor, you know, insurance company taxation versus oil and gas taxation versus manufacturing. 

I represent some of those. I do not represent all of them. Essentially the goal should be not favoring one industry over another, 

not picking winners and losers, and not micromanaging. The more 

simple, straightforward, then the economy, the capitalistic system, 

will figure out who is going to invest in what industry based on actual profits rather than tax considerations. 

Mr. REED. I appreciate it. 

Mr. Sullivan. 

Mr. SULLIVAN. Well, I know you have been lobbied, and when 

I was on staff, I was lobbied, and every lobbyist comes in and tells 

you, ‘‘How can you raise my taxes when I am creating jobs?’’ And 

everybody says that. It is jobs, jobs, jobs. 

We have to have the discipline to understand that when we help 

one person, we are taking something away from another, and that 

is just the balance sheet. It is just the math, and what we want 

to do is not provide anybody with special privileges because in the 

long run what you do not see is most job creation will be created 

by not giving that lobbyist the special tax break. 

Mr. REED. I appreciate that. 

With that I will yield back, Mr. Chairman. I have got a couple 

of seconds left and I will let you enjoy them. 

Thank you. 

Chairman CAMP. All right. Well, thank you. 

And I want to thank all of our witnesses. This was an excellent 

hearing. 

I appreciate your time and your testimony today. 

And with that, this hearing is now adjourned. 

[Whereupon, at 12:26 p.m., the committee was adjourned.] 

[Public Submissions for the Record follows:] 


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U.S. 1I0USE Of REPRESENTATIVES 

COMl\lrrrEE Q,"<l WA \'5 AND MEANS 

UF.AR ING ON TH E TREATMENT OF CI"0 5 EI.Y·II F.U} BUS1NF:SSES IN TlIF: 

CONTEXT OF TAX RHORI\I 

MARC H 1. lOll 

Mr. ('haimmJ1, Ranklllg Member Lc~in and dislillguished Members orlhc Commincc: 

Cafrix. Inc. ("Carrix") is plcm;cd 10 submit wrilV:n commellls for the record in conne<;;lion 

with Ihe Mnreh 7.1012 hearing ofth~ Comminee on Ways and Means ("th~ Comillinee" ) 

on the cr; ic~lIy impol1~nttopic uf treatment of clo;ely·IH:ld businesses in Ihc context of 

lax rdoml. 

Rudr.glYJ/llld (m Ca/,I'£t: 

Corrix is a closel" heir! U.s.·based port tcmlinal op.:mting comp.lny thol,manages more 

cargo l('mlil'laI5 than any otll('l" cOlllpan)' in Ih(' world. Carrix provides- a full sp"~lrulll of 

transportation servicl'i, from tcrtllinal managclIlcnllo stevedoring, in a number of U.S. 

and loreigu portS. 

As a d051.'ly·hcld company built on intcn13tional trnde. Carrix fully apprecim.;>s [he lopic 

oflhc h~aring: how Ihe [ax eod~ impo~s a ~ari~ty ofburd~ns on closely·held cnmpani s, 

\\hich public compMics do nOI fnee. Cnrrix. 11kI' many olher U.S.·based companies in all 

sectors of the economy, faccs fierce competitive pressuI'C trom foreign·based companies. 

Unlike [llost other U.S.-bllscd cOlflpan;es, nlany of our for"igJI·ba~d competitors are 

large foreign mu\linulinnpls, some (If which nrt' closely aligned wilh foreign 

governmems. and operate under more favorable home country lax n:gimes. 

We would likc to bring 10 the Commillee'S allelltion it lax iS5U.;>lh,l\ directly :lnd 

negatively impacts our ability 10 grow Ollf U.S. operalions: till'. potential application of 

the pL'rsonal hQlding company (PHC) lax to earnings we wQuld seek 10 repatrbtc in the. 

fonn of dividend. from our fon:ign subsidiaries. As will be discussed further, the PIIC 

tal{ is an ouuooded relic in the Ta.' Code Ihm olTers lilll.:. ifany, compclling.policy 

rationale for its continued exislence. As the Comminel' considers fundamcntaltllX 

refonn. we belie".;> Ihe regime Shflllid either be repealed or subslllntially rcvis~d. 
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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.071

BlIcligfOllnd on fhe PenOllall1oldillg Complln)' Tilt 

The PIIC ta.x was enacted in Iq)4 and. at th~ tim~, reprcselHed:111 approprime response 10 

prevent individuals from shel tering invc,tment income from individual income HL~ by 

using Iheir closely hcld US corpomlions 10 Ilold inveslments, ref~m:d 10 as Ihe 

incorporalcd checkbook. Atlhe limc Ihe maximum individual income tax ralC was 

subSTantially higher than the maximum corporate ta .~ rate l and corporations C<JuJd be 

liquidated on II tax-fret: basis.l Neither possibility exists today bt'i!aus~ of changes 10 the 

tax laws. yet thc PHC provisions were never updated 10 rdlcet more modern 

circumstances. particularly closely hdd consolidall-d groups with foreign llililiatt'$. 

The P~IC ndes impose 1\ c,?rpor:lte level pcm,lty ta~ of 15% (the mtl.' will become )9.0% 

in 201) if the Bush tax cut, expire as schcduli:d al the end o(2012) on Ihe undistributed 

PHC Income ofn PHC. A corporation eonsliluteS a PI Ie ifW% o f its adjuslL"<i ordinary 

gross; income is PHC income and if50% of its stock is owned by li v~ or fewer individunl 

sharl'hold~rs at any lime during Ih~ laSI half of til(' taxable year. PHC income generally is 

defined as interesl. di.'i<iends, roy:lI(iCS. rents. ~nd c<,rtain oth<,r lypeS of passive 

investment income. Thc PIIC pcoalty ta ... ClIO be avoided by an entity by distribuling 

I'HC incomc to its shareholder(s), resulting in the shllreholder(s) paying the appropriate 

tax on the distribution. 

In the ca~e ora group uf US corporations filing a consolidated relurn, Ihe I'HC 

calculati,ms (11\' gt'llernlly cOllducted un ~ constllidat~d b(lsis. HowevCf. in certain 

circumstnnccs the PHC leSI and lax compUTation muS! bc madc on a scparalc company 

basis. SecTion .'i42(b)(2) provides Ihe PHC I<'st mUSI be applied on II sepamTe company 

basis ifmon: than to per~enl of any cOrpQrnt~ member's adjUSted ordinary gross income 

is recei~ed fron1 a SiJultc out~idc the aniliak-d group (sucb as foreiJ!)l subsidiaries) and 

mor~ than 80 percent of such adjUSTed ordinary gros~ income is PHC Income. PHC 

income would include dividends flX>m foreign subsidiaries. 

for l'llch 1a,\:3ble y~r, if any separate corporalI' enlily includl'd in thl' afliliated group 

1hils the teSt under Section 542(b)(2), the entire corpor.uc structure is tainted and each 

;cp~rdle corporale entity is pokntiully subjC<:l to Ihe Pile tme. Thus. Whl'll the test is 

conducted o n 1I separote company hasis, II US group of corporations filing II consolidat~d 

retum can cosily find thm it hilS a personal holding company lax liability even though a 

majority of ils cOnsoli,lated re",,"ue may be 9cljve trade or hus ss income and it ","ould 

not othcn .... ise be s ubjecI 10 tbe Pile tax except For the rules req uiring sepJrate compllny 

testing. 

, tn 1934. '~e ni~h~SI indi,·,clual "'~ OlIO WU, 6)~ ~"d (n~ hi.gh~,t ~"'l'<'I11 ~ 111.' roUe ~~. ! 3.5%. "",,,Iii,>!! in 

a 49.S% n>'< din~"'nliul. 

2 Gellrm/ ,ilj/'-~, .t O!'<'r..,mli Cum{l<my ". /lei>""'''I!. 296 U.S. !OO tI9JS). The Ge,,",,1 UrUII,,,, 

<locuine lib ,"""ate'\! by Co'IJII~"" in 1~86. 

2 
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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.072

Tho: policy ralionaks th~t led 10 Iho: 1'1 Ie tax regime ale nO longer operali\'~. Firsl, the 

lOp marg inal laX mle for bolh individuals and corporations is 35%.J Second. with the 

Il.'pi.'al nfthe Gi?n"m! Ulililics dOClrine in 1986, ~orpor: e liquiduting dislribulions of 

appri:clalM assets srI.' laxed al the corporalI.' leve l. Simply pul: TudoJ"s IIU: I" ... ~ do "01 

p" ... i<lI'"" illcelllb'l' 10 illcOrpfJral/' pl/rlll/lio ;III'I'SlmelllI IfJ l'.\·cape IIII' illdi,';d",,1 

im"Ome /IL(. 

A",,/rCaliOIl oINle I,n 10 CO"'ix 

An exampl e will he lp 10 Iariry the lack ofa CQmpelling policy justiiieation for the 

appli cation of the PHC TUX. The rcq uircmem 10 COndlJClthe PHC lesT~ on a separate 

company basis ollen unrairly penalizes eorporale groups Ihal are :tetivcly eobaged in 

business. A common fatt p~lt elllt hal givel> rise 10 this unwarrunted jmposition o flhe 

Pile Ittx is where P member nf"lhe group reeeive~ di vidends fron' for~ign suDsidiaries. 

{" 11Ii., CU ~I.'. 1/11.' ';i'pUrllti' cllm/,ully PHC IILI: campiliuliull $1'''''",£ a." a d"ll'rrl'lIt 1/, III ... 

repalrioliall Ulld reim'!'!lm",,1 uffr""ig" "utnillg~' ill IIIi' Unill'd Slaln.fur/l1", 

exucerhalillg till' srI-C"alled 'Ior/mllt' l'ffl'cf. 

In other wOrds, Carrix would be hit by' lite PHC ta;< 10 the e~(elll II Icp.llrialed dividcuds 

from il~ overseas affilinl.::s simply bttousc it is 0 closely held company. fCllrri.~ were 

organi ~ed as a public company, the PIIC IX'nahy ta).: would n01 apply. Simply b<.ocausc 

Carrix is closely held. Ihe tH.l ratc on fordgn earnings repatrioted hack 10 lit e United 

States would be. mther lhon the nonnal35% rate. II 50% mx mte. Such II Inel Of13X 

makes i1 more l'C011011lical lorCarrix 10 k.:: ~p foreign earnings olTshore for pUrpQSl'S of 

fUr1her developing iOlemaliooaJ Q""rations, rather thall repatriating camings from 

Ovt'ISe<l$ operntions 10 fund prQductive inlle'.illne nlS in the United States. In ClI.rr i~ ·5 case. 

for ~umple , we would plan In use ft portion of the repatrillted cash to fund tile 

construction of a major pan Icnninal facility in Washington Statc. 

Addiliol1ul Policy COl1J"idel"fllilmS 

Ca rr i.~ bdiel'cs that nddiTional policy considerations argue in fO llor of repealing, or 

subs l~nli ll y modifying, the PHC IIlX n.'gime. The lax wa.~ enacted In prevent umucnt 

individltals from esc"ping the reach orlhe individual income tax. Given the changes 

described above in our naliun's ta.x laws, the I'HC tns regime docs less to deter the 

fonn:nion of SI>-ca lk'd ··incorporuted pocketbuo),:.s'· than (0 inhibit certain doscly-held 

active busine$Scs from I)ursuing logical busini3s transactions that other companil'S are 

able to do because They may givc rise 10 PHC tas eonscquene~s. 

While- some companie~ afe able tu 1.'V1Idc the reach orthe PHC tax through sophisticated 

tax counsel. OTher compani es are not so lucky and arc either unaWare orthe PHC ta.x or 

cunnot avoid the tax unk-ss thcy ch~nge their owncr.!hip stl1lcturc. In addition. lhe PHe 

I Th. top indi'·ld"ai'ax .... i •• I.,eJ und.rcuncn, law!O ,is<" In 39.6%!)11 J.flU"')' t. 2013 """II,n ~ in 

I"". ,h.n a ~ d;fT .. ~n,j"\ bnwecn '"" 1011 ""'l"""uc and ;Mi,·jall.1 ""rs. 

3 
124 

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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.073

lax ndlls signilicant complwdty 10 tho: Inlernal R~venll~ Code. whik rnisinl! a rclati~ely 

nominol amount oftll.~ n:venue: nppro ~imaldy 538 million per ye~r.4 

M05! importantly. from our pcr.;pccli\·c. Ihe PHC tax lInnl'l:essarily and unfairly taxes 

rt'\"t~nues which would olh<'rwise be- 3~3ilable for im·eSlmenl in much needed 

jl\fr~structun: projt"<:ls or l!lher important corporate us<:s which would promule ecoomoic 

developmenT in lhe. Unilt.'d Sml<'s. 

COlic/liS/Oil 

Thank you for tht: opportunity to submit thesc wril1en commelllS ror the record. Carri ~ 

looks forward to working .... ·i1h )'Oll 3nd your stuff to ensure 1113tlhc U.S. lax code is 

reformetl in a way Ihnl makes sense, \r..'ats similarly situatcd taxpayers equally_ :lIId 

doesn't pen~lizc certain closely·hcld l:I ~paycrs due to certain antiquated pmvisiolls of the 

Intemal Revenue Codc . 

• ~O/J~ IRS SOl d3!~ 

, 
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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.074

Comtnl'nlS for Ihl' Rl'cord 

U.S. Hlluse ~)f RCI l'~e nlali\'l' s 

Comminee lin \Vays and I\1 cn ns 

Hea ring on IIII.' Trea tmenl of Cl05ely-Hcld Bus- jnl'SScsin Ihe untc~t of Tax Rerorm 

W~dnesday. March 7.10 12. 10:00 AM 

By Michad G.[I'ndncr 

Center for Fiscal Equi~y 

Chainnan Camp and Rnn~hll!: Member LC"in, ~hnnk you for ~he oppo"unj~y ~o ~ullmi! thes~ 

commcnt5 for tile ~cord to the liou>\: Way~ and MeM~ C(llHmlt1ec. Our ~'(lmment~ ~re an 

c~~III~;on ()nU~1 month's conunell1$lInd are. a s uJwars. in the COIlICM orour ta ~ refonn plan. 

which h~s the following four ~Iemcms: 

• A Value Added Ta~ (VAT) 10 fuud dQ"1<Zlic military ~flC,wJi g and dome.lic 

disc,,"lirnmry spcndin~ wilh 3 rsl~ betw~"n IO"A. and 130/., "hich mah.,. .~ ure very 

American p"ys """'~'I.hmg. 

• Pcrson"1 income su"~xI.'!; on join! ~nd wido,, ~d fliers wilh net an nual income!; of 

SI()/),OOO lind ,;ingle fil~r;; camins $50.000 per y~nr 10 fund net inlcrest p3ymcllls. delll 

retirement and ovet1\ca, Rnd Sl11ltcgie milimry 5p<:nding lind other international 5f1cnding. 

"ith I!J1Id!~11Cd rnlC ~ bel'l\X1I S% lind '25% ill th~r 5% or 1()"10 incrcmem~. Il ei .. would 

olr.o puy la~,'"S lin di~lributilln~ [!\lm eslul<'S, bUI I10t lhe a~~ct> thc"Illsch'cs, 

EJ "plo)'~:e con!Tibutioru.; to Old Ag<' and Sur\"i\'o"l Inwrance (OAS I) with a lower income 

cap. which allows forlow .. 'f jlayme\lt Ie, cis lu wealthier relirL"'~ without making ~nd 

points mO,-., p"'llf"ssive. 

A VAT li~c N ... Business Rt"(C~iplS T3~ (NBRT). which i, cs...;emially a ,;ubtractiOlt VAT 

with 3dditional taX cXiA'ndilu~~ fOT family suppUrl. per!iOnal retiT~m<'n1 aCC(junlS, health 

caT~ and the private delil'ery <If gOI'('l1Hnental ;;ervic(.'lj, to fund cnlillemcm spending and 

r~pl""" in~n",~ I~~ mine fnr ",,,<I l'I""ple (indudine 1"'01'1"- " 'h,, lil ~ w;lh""1 p"yin£), (h" 

~orporale incom~ tax. bnsillC!iS la.x filing lhroustt indi\"idu.,1 incume taxC!i and th,' 

employer cunlribution 10 OASI. all payroll taxt"S for hospilal nsur~nce. di!lllbility 

in.umn,'e. unemploym~m insumnc~ and survivors uncl,'!" age 60. 

We h~\ e nu proposals regarding environmental taxes. CUSloms dUlies. ex~ise I:n~s and Olhcr 

offsclling ~p<:nses, ahhoul!J1 increasinG these la~cs "'wid resu]t;1I a lower VAT. Small and 

clOiiCly held busin~ already pay IheiiC laxes and will continue to in reroml. 
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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.075

Small busi"~~>~. will pay VAT. ahhough they moy n()l Ix a VAT tilIIL"ClOr. depending upOn 

whelher bu5il"'~~ siu e.\emp'ions are included in any VAT legislation. Their il1lp~~tl\'O<lld be 

merely 10 repOrt the VAT they pay on the receipt so thaI tU~lomer.; may' beaware ofla~Mion 

whill' thO!ie who us~ Lhe product in lheir supply chain C'JII use Lhi~ infllml~Lion for cr~di15 a¥Kinst 

Ihei. VAT collection. Ulrger bnsincs:leS which ute closely ht'ld will pay VAT in the .\.lme WDy 

public COllllfaniL'S do. 

Small bu.inL'Sscs may lik",,·;$(.' not ha\'e 10 (XIy the NBRT. Ind~Lod. for con~ultllnts who work 

primarily for Olle clienl Qr sell from olle supplier. NBRT rult;; ,hould mandaw that ;m~1I fiml 

cmploy~cs Ill· t,\,alcd like employee'S Oflhc larger finn fur PUrp!)SL": of health care coverage and 

the Child Tax Credit, ~hould h~ consultant or distributOr not meeL the ;ncum .. lh ........ holds 

illcludl'ti fm filing. Large bu~inCSII which are closely held will pay lhe NBRT in the .\.1m<: way 

public rOnlp;lni .... do. 

Accounting for Employee-paid Old Agee and SUrl'i\ors InslIranL'c will be no mure eomplieuti."d 

titan eurrl1111~w, while a.:l:ounting for lh~ ineomc suna.\ will be ~"'1I1Iy simphlil'ti. Indi~iduJls 

who p!"Cviously paid tlteir businl"Ss 11l ~C"S as])art of income la ~alion will (lltly file the inc<Jme 

su"~\ if they de"r 550.000 after lXlyilll! stafftSI OO_OOO for joinL fi lers Jnd qLllIlifi('d 

widoYo(cr)s). The only c()mplesily wil! be ~ccounling for sal~s In a Ijualifit>d ESOP. whi~h may 

~olltinll" to be taX e:ti~mpL - although ifpc.'rsQna! aCCQUnlS are cnJc!e'<l under CASI il may be 

wisetQ rel"'alth~ £SOl' deducti()" so t11~\ thl' WD,C of ESOP cQnversions Ihal will result will 

al1ow-a substanLial pay down to the national debt. which will more qui~kly allow the !UIlSeL of 

Ihe in(~)mc surtax. 

Establishmenl ufpe'f"Sonal 3("<;OUnl. :I~ an uffset for Old A~" and SUf"ivtm: InsurJnc<' will reljuire 

compl~\ accounling. ru les. bUl only for firms which pay the NBRT. Again. con~lIhants and 

disLribulOB who do nOl hould bc 'ItTordL-d Ih .. opportunity 10 accumulate (X'1"!;<»1ul 3L"CounlS 

through lite I~rger fi nn /hl'y deal with. buying the'ir company sH)C:k as iflltey weru full·timc 

emilloyrcs. For e.\amplc. worh'f"S al car' dealerships WQuid have Lh~ opportunity tu invrst in 

jX:rsoltal accounll! oflhal rnnIHtfac1\m ..... _ "V<:Tl llt~ lk:dm;hip is large e'llough 10 pay the NBRJ . 

Largcrclosdy hdd fiml$ I1my alSQ wi~h 10 rethink their fonn of ownt:rship to take 3d ... ~nlage of 

the opponunil)' pcrsonal reti",mtm\ ~ecounts afford (or both capital accumulalion (for both linns 

:md individuals) and for suece'SSion planning. 

n~ yOIl for lhe oppoorl uniry '0 dd ss (he tilll1l11illCC. We a1\'. of l"{)UI"S\:. availa ble for dircc' 

Ic~ti y Of to an,wer qucstion,s by 'TICtn\lc!"!' ~"d sta ll: 
127 

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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.076

u.mact Sheet 

Michael Bindncr 

C~mler for Fi~~l equilY 

4 Canterbury Square. Suite 302 

AI~ ,aTlo.lria, Virginia .22304 

j71-}J.I·~771 

fi,,'lIIc:!!um (,':\,cn~"n !lei 

Co m",i ltt~ on \\ 11)'5 Ulld I\1C II S 

Huring rln Ih~ Trealmenl lo ~~ -IMd BusinessC!i in Ihe Conln l ofTu Reform 

Wednesdll)". Mueh 7. 2012. 10:011 AM 

All submissions muS! include a list of~11 diems. pcrsonsandlor organizalions on whose ix:1t.alf" 

Ih~ witness ~P]l<':lrs: 

This lesllmony Iii nOl submlued on bch~lrof~ny clienl. person or orl,'anitallon oth~r lhan lh<· 

Center il,;c:lf, wbJch is ijQ far unfunded by any o.lonalion:j. 
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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.077

March 7, 2012 

T'~ 'l<)f'''_ .. , .... 

I1U M "....,NW 

"~~~, 

W ...... iI''''" OC UIfI). 

~'''''' M! 'l' .. ~i_""'''!l ,;.. .... "" """ , .. "" e'Qr " __ ""J 

HOllsc Ways and M(,lII1S Commincc 

1102 t ongll'onh IlouseOtlic(' Building 

Wa~hington DC 2051 5 

Following is:I SUl1 cm.:nt from The ESOP Association for the Ways und Means 

COllunince's March 7, 20 12 hearing: H.:ari'lg Oil the Tr('mm.:nt ofClosely-H.:ld 

Businesses in the Conl"-\"1 fTa.~ Refonn. 

The Slnll.'menl is being submi!1ed by 

The ESOP Associalion 

1726 .... 4 Slreel, NW 

Suile 501 

Washi'lglOIl. DC 20036 

2021293-2791 

www.e.j!ID:tSSoci:l1ion .ru:g 

The author oftne SI:ttemenl is 1. Michael Keeling, president of The ESOP Associatioll. 

He ('au be rl!llchl.'d at the address and phonl.' lIumber provided above nr by email at 

Mich~el liicSQl!as5OCialion <lrg. 

The ESOP Assoc:ialion ;; the Ilationaltmde association for compan;l.'s with employee 

stock ownl."rship plans (ESDI's). The Assoc iati on'~ primary memocrs are U.S. 

corporations Iha1 spollsur ESDI's. The mission of The ESOP Associmiou is simple: To 

advocmc for, aud cducale 3bQUt, I."lIlployce OWJwrship through the ESOP model. 
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wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.078

t' ment oll ow~: 

Mr. Ch~irmnn ClImp, R~nking Membo:r levin. and di;tinguished membo:rs of the 

House Commiuee on Ways and Means. Ihe 20 10 Geneml Social Suryey (GSS) evidences 

thaI during the Crem Recession oompnnies that had brond-based employee stock 

ownership pmgr.lms, such as an ESOP, laid orr empl'lyet's at II rtltC nf les ~ than 3%, 

"hcrcas conventionally owncd companies Inid ofT employclos at a mle gK~Jtcr than 12%! 

Why would;l spokespt:l");on for The ESOP Association, a llatioll~J 501 (c)(6) trade 

association wllose primJry membo:rs ~re U.S. corporations sponsoring ESOP$. begin hiS 

statemenT to the Commillec on pass-through enlities for lax purposes on the results of the 

most preSTigious survcy t)f Americ1H1S' work and living p;mcm~ ! 

B~c~nsc, oflhe AnociOlion's nearly 1.500 corpomtC' mcmbo:rs Ihnt arc all, or 

panially Clltploycc-(tWIlCd. appro.xil11~teJy 70%:lcc S corpomtions, lind of this group of 

O\'er 1,000 U.S. corporntions. appra~imately t" o-thirds. 31\' owned I O()% by tile ESOI' 

on bo:half of the employees. 

Thus, whtn t~'"' Committe<:, "'h<"n tilt CouilJes:\, and whtn the current 

Administnl1ion, s it set fonh in '"The I'resident's Fromework for Business TB ~ Reronn," 

address the tax tremmenl of S corpor:lTion~, il is 3 lidocial)' duty oflhis Assoc:iJlion to 

prol'ide Ihis Commi u~ 's history in 3uth ori~ing legislation for S corporations 10 sponsor 

ESOl's. 

One myth abo~t ESOl's is that aUI;SOI' laws were developed by the U.S_ Senate 

due to the leadership of former ~n~tor Rus.wll B. long in his rolla, ChJir or r:mking 

member of the Sl"Uatc Commitll'c on Financc. Granlcd. as the origin~1 advocmc for more 

ownership in America using th~ ESOP model. Senator Long is 3 revered ligur<, among 

those who bel ieve that we would have amort! competi iv , more fair. eeono'nic SitUalion 

if there were more owner.; in our capitalistic society. 

But, in 1997, len y~an; :Iller Sen.1tof L()(lgrctircd. the Wnys and Means 

Commiltct: JdOplCd. ~ ith no disselll, an Hmendmcntpt""nnilting S corper-nions for the f'l"'>t 

time. commencing in 1998, 10 have brond-based employee' stock ownership through the 

ESOP model. 

TItuS, while no one claims that past action by the Ways and Means Committee 

dictates whallhc Committee decides lall'r with regard to S corporntions 3nd ESOPs, we 

do emphl!l;izc that S eorpemtions and ESOl's arc not something th~ljustthe SeI131~ 

should think about in Ih.: move to reform our Fedcral taX code. 

We would also like tQclariry a myth thatth" nK-dia often says, and it seems law 

smdcnts and lawyer.; like to repent In I~ w school jonrnals. that S corporation ESOI' 

compilnies IIrc [3X exempt. What Congres~ did in 1997 was permit a deferral of!a,x3tion 

o r s corporation shareholdeTl> who were paid. via a distribution. from th", ESOP on th", 

va lue ofS assets --- in other words. [h~ ESOP p;lnicipant pays tuXes on hcr or his account 
130 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.079

when it i1 distributed in cash to the employee owncr who retires, leavcs tbc compMy 

vested. or is sadly disabled, or dies while ~n employee. 

Thus, Ihe COSIIO the Treasury oflhe ESOP S regime is HOllhc bulk Mlhe socoiled tax expendiwres lha\ encournge 0 policy lhat has tons. and yes. I s~y Ions. of 

evidencc frum very reputable !IOCial and l'Conomic researchers thaI show employccoWl1ed companid. in the vastl11ajofily ofinst311ti.'5, ~rc more productive, ruore pro1itable, 

and provide ,ustoinable jobs thai are locally·controlled here in the U.S. 

Th1.' ESDI' community respects Ihe call by this CommiUee. by the lead1.'rship of 

both political parties. and (he Administrnlion for policies Ihol will "creme" jobs: weunderstand Ihat dilTl:rcnc.:s arisc Ol'erthc precise policil"> 1hal should be imp1cml'nll:d 10 

"create" jobs as w"n. 

WI'. howel'l'r, with all due reS"'"'!:t to our n31iunal k'aders. including those who sit 

on Ihis Commin~e. nOle Ihat unemployment rises to unDc~ptabk kvels when people lose 

their jobs. when they are laid alT. Thus. il would seem Ihol encournsinll, a policy (hot 

resuit$ in fcwcr lay oft's, in sustaining employees in th~ jobs Ihey have, is pcrh~ps Ih~ beSI 

approach~s 10 making sure those who wsnl 10 w\lrk hav(:. jobs. 

In lhat regard. WI: take notc thal IS members uflhis Commillcc havc introduced 

and co·sponsored H.R. 1244. the PromOTion and Expansion OfPriV3Tc Employee 

Ownership Act 01'2011. We. of course. express our strong suppo" for ihis legislalion. 

which is primarily focused on incrcasinll, cmployee slock owncrship among S 

corporations by expanding the alttaC\i, ~ncss of the ESOP 10 men and women whO have 

rc:lchcd ~ point in lif~ when they haw to 'exil' lheirownership of an S corpor<llion. The 

precise mechanism is a provision applied tirsl in 1984 10 C corpof"Jlions Ihm arc not 

publicly trndcd by deferring the capitnl gaills tax on Ihe sale of privately held slock to an 

ESDI' iflhe ESOP hold. more than 30% oflhe sponsoring corporJtion's slock. and if the 

sellcr reinvnts herlhis proceeds in Ihe securities of olher U.S. corporntions [IRe 1042). 

In particular we lip OUT hms to Consr ... ssmen Reichcrt, Kind. 13Qustany. Blumenauer, 

Paul,en. and Pa,erell. who introduced this Icgi,lalion nn March 19, 201 I. NOI (lnly ha~e 

flinl: colleagucs oflhis Commillce joincd them. so haw 49 Olhcr members ofthc House. 

Similar legislalion. with Sllpport from both sides of the chamber. 'is pend illS in the U.S. 

Sen;.tc·- S. 1512. 

We respectfully request that as th1.' Comminee works on refonnin~ the Federal tax 

code. it wt)rks as il did io 1985, COllgn'ss needs to take SI<:ps HI <:n<'\!umg~ gwalcr 

ownership of produetil'e assels in our nalion by remaining liml in its suppon of employ!.'\: 

siock ownership through lhe r::SDP mood. 

Aud with Ih<ll we do~ witb asalulc 10 the leadership M lhe Committee, in 

particular Chair Comp, who h~s made it clear that pieeemrol re toml of the lax code. by 

addrcsiiing only those provisions that impa~1 bu~iueSSCii orgal1;l~tl as C corporations, and 

Ihe rales on which their laxes an.' calculated. is not in the bt:st interests of Arncric~n 

businesses. nor indil'idunl taxpayers. Inlhis regard, D 10lal. holistic 3pprOllch 10 making 
131 

f 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.080

our tal( cooc supporlJobs, our free cmerprisc systcm. with fairness. is the pathway ttJis 

Commincc is following. History proves thm ~uch nn npprQ3ch is the correct appro~th. 

WI! apprec iaw your hearing (111 thl! potentia! impact oft3" relhfm 011 P.1 SS through 

enl,ties. Jnd thc openness with ..... hi<:h you are conducti"!! our review, 
132 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.081

AMERICAN UNIVERS ITY 

Mr, D3vid J i(aulte. 

Managing DirKtor 

4'>4542" Street, Suite IDS 

Wasnlngton 0(, 20016 

(202) 885 · 6506 

March 22, lOll 

II \ <, II I \ I , I " \ , I i , 

CommUte" on Wav~ and Means 

U.S Hou.,., of ~epre.ent3t ~. 

1(0000 TAX CENTER 

Heir'ng on Treatment of dose IV - Held Businesses In Ihe Context of Ta~ Reform 

Good Atternoon: 

I am submitting a testimony in ,up~rt of vour efforts to reform the la.code for closely he'd 

bu"nesse •. To more elflciently administer the tax law and reduce the overill burden and COS! 

of complying willi Ihe law, I propose" sImplification oltll e cash method of accounti ng already 

gene.a lly used by mo" ,mali bus;n ... «" •. The simplifkation calls for me recognition of Incorn"-

and deductions onlv whe" cash Is recelwd or e)(penses.are am,ally paid. I believe the 

SImplification will not reduce e~enue to theIlOVllfnm@ntandwill incr@ase the le~ 1l1 of 

(ompll.nce from ~m all businesses i lld entrepreneurs. 

Your cons,der3tiol'l of my testimony is II aW-app,e(l at . 

Sincerely, 

David j , ~autl er 

Entlosure: TellimonV 

KOGOO SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-804. 202-885·6505 

FAX: 202·885·1390 

kogod.ame,;can.edu 
133 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.082

AMERICAN UNIVERSITY 

II \ <, II I \ I , I " \ . II , 

1(0000 TAX CENTER 

Statement for the recold of 

Mr. David J. Kautter 

Managing Director of Kogod Tall Center 

American University Kogod x hool of Business 

Washington, District of Columbia 

Committee on Ways and Means 

U.S. House of Representatives 

Hearing on 

Treatment of Closely-Held Businesses in t he Contellt of Tillt Reform 

March 13, 2012 

Chairman ( i mp, flanking Member le~ ln ilnd Members 01 the Com",i!!ee, tllaf\k voulor 

the opp<lrlunity tosubmitwrllten comments on tax reform pI!"alnlna to Ihe treatment of Im311 

bu~rn~r.se s. 

I ha~e been 5 tax pro/essional to, over 35 yean. For most 01 that time, I advised clients 

OI1la~ malters as a partner wTth a BIg, f OOl iI~counl ng firm. I also s.erved il5 tax counsel 10 

former Sena'", Fina",,!' Committee member john Danforth, and I have ,emalnl'd closelv 

Involved In the taK policy p'oces~ over heen lrecoor~e of mv c;ueer. 

I ~m writing to vou today to ~upport your e1l0m to ,eform the la, code for closelV held 

bUSine5ses In Ihe hopes of growing nd c' eating job!. Reduclns the comple.1ty of the COffent 

KOGOO SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 2001 0.. 202~85..f1505 

FAX: 202·885·1390 

kogod.american.edu 
134 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.083

AMERICAN UN IVERSITY II \ ;. II I \ {, "I' 0) \. I) I 

KOGOO TAX CENTER 

la.law pertaining to ,mall bu,ines,e, would allow .mall businen owners 10 spend mo,e lime 

creating jobs and less tfm~ filling out forms, As the United States continues to strugSIe. with a 

p"",stentlv high unemplovment , al e. the need for ,mall bu,;ne"", to create new Job, Is selfevident. 

According to the Small Bu,jn~Adminj.t ra ion, D~e r half of . 11 employed Amellc"", 

Wl)rk for Imali businesses wllieh .ccounl for 98 percent of. 1I U.S. employer •. Additionally, 

smali bu,ine"es account for nearlv 45 pe rcent of Ihe lolal private .ector p<lyrolL In 2010 .• mali 

business" • • <counted for 7S percent of all new jobs cre ated In Ameriu,' S"mall busin~" ... a re. 

(ritk~1 source 01 economic growth and new job. whlen is why U.s. laX policies mUlt encourjge 

the~e bUIlnessel to re lnyest their profits in a manne r th.t Wi ll foster Job ~rowth , 

On~ may u~stion whe ther ta ~ refo,lII can cre~ "Job., but 1t cannot be denied th~t the 

time ~nd reworees consumed by 3~ compliance foster neither eco nomic growth in the small 

businen community nor efficient t~ . administration, In fact, the Taxpayer Adyocate hif labeled 

the complexity of the Internal eYenu Code the 'most serious problem' la.paVers, including 

small bus1nesses, enCOUIIle,. Oespite continual calls for simplification, there "ave been no 

fewer than 4.428 am","dmenu 10 Ihe Code we. lhe laSI 10 years. The Taxp~ e. AdllOCa te 

e,llmates that e ach vearsmail businesses spend appro~imatelv 2,5 billion hours complyio8 with 

tax folioS requiremeou, the equivalent of 1,150,000 full·llme jobs, In addition, over 10 percellt 

'~ ... II u ........ 0\<1'" .. _ ... "'III< k ... ~._11 " "' ..... '. ,_", li<'!.k_OI""'U_ S ..... r""', .... '.Mol' 

tho ~ ..... w .... o lho! 1'«""..' MIn. .. ~ 

KOGOD SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-804. 202-885·6505 

FAX: 202·885·1390 

kogo d.ame.lcan.edu 
135 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.084

n 

AMERICAN UN IVERSITY II \ ;. II I \ {, "I' 0) \. U I 

KOGOO TAX CENTER 

of all unin<:orpOrated busin..sse. u<;e paid L1x prepa,~f" and .pend ""~, $16 billion lor 

professiona l ad~ke -and compnanc! assistance from 3ttOfneys and accountants.' While thl' 

compl",,11y has spawned full employment for lax profl',,;on"I •. oure<:on<>my cannot pro'pe, 

when bu,;n .. """ ''''I'",;a lly-,m.U bw;ines,e., a,e d ivt'rting valuable time and fl!5.0UfCO" 10 

unproductive behavior Ihat is an inevitable drag on the economy, 

Any refo rm that reduces the UrnI' alld cost of complyIng with tax filioS' will enallie sma ll 

bu. ln"" ... ' 10 use their '""'Ufe,,. In more prod uctiw way •• In addition, ma king lax compllante 

more undern.nd.ble will J;<>fVe to change the public', perception that the Code i, u~laj, and 

replete with "looph"lert only understood by ~phisllcilfed tax profeSSiona ls. In sllort. we 

believe tll~t.impliNins the tilx code wllllrn:rea,e ta.Pilv"r compliance. "a5f' the burden of til. 

admlnlstratlon. raise sovt!rT)menl revenue and ultimatelv reduce th e ta. gap. 

Our view Is th~t one of tile moSt eHecUve ways to reduce the current ta~compllance 

burden on small bu,iness is to drilmatiCilllv ,implit-,o the m~nner in whlth they compute their 

incClme subject tel tax. Tile rules governing tt.ecomputation 01 taxable income are not only 

unduly complex, they arE' unnecessarily burden§On1e. PUI ,imply. wepropore. 3n alternalrve 

method for small busine-;se. 10 maintain Iheir lax books and records ,md com pUle their tauble 

inoome: Tile Simplified Casll Method of Accounting (· SCM"I. The SCM would abl~ small 

buslneues 10 fCIC\J' their efforts on srowllI ralhe' tllan fWlnS out tax forms. It would also 

KOGOD SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-804. 202-885·6505 

FAX: 202·885·1390 

kogo d.amerlcan.edu 
136 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.085

~ AMERICAN UNIVERSITY 

II \ <, II I \ " I ,I \. I) I 

KOGOO TAX CENTER 

reduce lime cOnlum,ng and pens"",- dmini~lratl~e burdens upon tho>. IRS 3nd fo.ter an 

overall eco~omic climate that would unleash resource! ~31 can be devoted \0 mOre 

productive, Job [,ealln~ activitie •. 

Under the "simplified <'5h method" of accounting ("SCM") computation of lanble 

Income would be reduced 10 the followinll formula: 

cash Receipts 

less: Cash Expense.! Induti lnl' 

In~entory 

Prepayments 

Materials/Supplies 

Dep!edable P'O/I!'rty 

fa~ab e Income 

In 5hor'(, derivation 01 taxable Income would be based solely on amounts actually 

received or paid during the!a~ year by means of e.",nlnlng Ihe Ia.payer', checkbook for wilen 

checks we, ~ written and depo,its mad .. , 

With respect to gro"lnoome, under SCM gros, inmme would consj.t only 01 c~"', 

propeny Of 5efvke~ (Kejved d"'nOB the ta~ab e year Wil~OU( regard to lll'putl'd nco"1 u~de( 

the construu,ve r""e'pt, casM equ' .. ale.n<:e or economk m.nefit doctrines AltMougM determining 

and ~a uinR the receipt of in·klnd goods and services will coniinue \0 be an issue, small 

KOGOD SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-80.. 202-885·6505 

FAX: 202·885·1390 

kogod.american.edu 
137 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.086

n 

AMERICAN UN IVERSITY II \ .. II I \ { , T 0) \ . U I 

KOGOO TAX CENTER 

busine ss"" will otherw;~ D@ab letocalculateincomebvaddingupllle;. bank dr.poslt, lortl\ ... 

year. My!iming ad~anuge afforded to ta~p~vers from not being subject to the Judiciil 

doclrine, mentioned above will be monimal ,iven th al .5mall b .. ,ine"escannot. as a prlIelical 

malter, d~fer recognition of "".h by more than 8 few month. without creating ,evere c}Jsh flow 

problems with regard 10 the payment of their own bilt •• The complexity of the judicial doctrines 

mentioned abmle doe. not warrant their application to small bu.in .. " .... 

With respect to tax upense., there a'", four . ,us Ihal creau most of the comple~jty 

for small bu,ine'!''' ': Inventory. prepayments, maleri~l/ upplj ..... ; .nd depreciable prOPl'rty. We 

would proprn;e,hat alle.penditu,e, /orin ventorv. prepayment>, materi~I 'hupplie. and 

depreci .. ble property be deductible when paid. All cu,rent upenditures, including Ihose lor Ihe 

a<qui.ilfon and/or construction of inventorv, wou ld De deduCied when paid. Whlle ~ technical 

violat!on olthe m31Chine principle 01 iCCOU~llng, allowins fOf Ihe Immedlale deduction ol lhe. 

COl! 01 in""ntorv ,impilliel " 'mall bu"nes' recordkeeping al rel alively lillie COSI to tke 

government. For a .mall bu~ine .. to stay in business inventory pa id for and deducted in one 

vea' will likely be sold no later than the ne.~1 year to ensure sufficient cash lIow for the business 

to continue in operation. The "lm" holds true lor prep~vment'. The va,t majority 01 small 

bu,lnesse. do not have the financial wherewithal 10 prepay e~pense5 at al~ let alone make 

,ubstamial prepayments. 

Perml" 'ng the Immediate expensing of dep reciable. property ,imply continues 100'II\ 

bonu! dep reclat!cn for property acquired In 2011 and e~pand5 upon the §179 upen,e 

allowance currentlv available for small businesses. 11 may be appropriate to put some so.t 01 

KOGOD SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE. NW WASHINGTON DC 20016-.804. 202-.885·6505 

FAX: 202·885·1390 

ko go d.ame rica n.ed u 
138 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.087

U 

AMERICAN UNIVERSITY 

II \ <, II I \ " I " \ . I) I 

KOGOO TAX CENTER 

limitation on th~ .bilitv of small bu,ln~ssM to Imm~dialely deduct otherwj,edep,ec]able 

I!,operty, such 3. certain very lOllS lived property. Bul. -as a general principle. we would 

advocate ~lIowjn! .mall bu,;"""", 10 immediatelv deduct amount!; they -,pend for otherwise 

deprec+abl" property. Finallv. eoempting ,mall bu.'ne.. ..... nom thee~lensive proposed rule. 

relaling to whether an e~pen,e ,hould be ClIpltallted or deducted naturally follow. if 'mall 

bu.lne .. e. ar e allowed to immediately ... pen ..... depreciable property. A. diKU .. ed bo.low, 

threlholds 0< I,mltation,should be established talimltSCM to onr,- sma ll businesses 'im;!.' to 

those currently de'IC'ibed In §448 or §179. 

Threshold, or limitations should be established \0 limit SCM \0 only small businesses 

similar to Ih05e currently de!;<;ribed in ~48 Dr §179. Under currenll~w, onlv 5011' 

proprietorships,S corporations, qualified personal s<!1~jce corporilUons, C corpor.lUolIS With 

gross receipts of not more than 5S million and partnerships with no partner being a ( 

cOfporation 'wilh gross rece ipts over $5 million may currently ur.e the Colsh method. We WOIJld 

propor.e applying these same limitations tor the SCM. If tMie limitations were ur.ed, 

approJlimatelv 99 percent 01 ~II businesstaxpaver, ~ccounting for over 12 percentol all 

business gloss receipts will qualify for the proposed SCM accounting method. Alternatfvelv, If 

the gross receipt dollar limits for SCM', adoption were set"' S5,OOO,OOO or $10,000,000 for all 

taxpayers "Imonthe Same 99 percenl le~ el of qualification would be reached, The small 

decrease (,4 !Ii) would be orimarilv attributable 10 5011' proprlelorshlps, S corporations and 

qualified personalserv;ce corporations wholoe gross ""ceipts e.c~ed the $5,000,000 or 

$10,000,000 threshold. Resaldless of whelller a $5,000,000 Of $10,000,000 gloss f~celpt 

KOGOD SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-80.4 202-885·6505 

FAX: 202·885·1390 

kogod.amerlcan.edu 
139 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.088

AMERICAN UN IVERSITY 

II \ <, II I \ " I ,I \ . I) I 

KOGOO TAX CENTER 

doll ar limitation h utill,ed, th~ percentage,,! business 8ro~ receipts subj~cl to SCM wOUld 

IlI(fease to a,ound 16 pe,cenl, 

aecause most bus/neue. will qua lity lor SCM and its ,educed la~ compliance burdens, 

la.pay ..... will be mo,e able to marnlaln tl!eirown accounting records ilnd pr."are Ihe ir own 

returns ,eduCing the need for costly la~ pro/esslonals who currently prepare over 70 percent of 

all busin .. " return •. Such a reduction in Ihe 'I'llan,,, on lax ""Qunmnts ilnd lawyers will !,,<lel 

iI bener ppredil lion by ave raSe Ameri(iI~s that Ill .. 11I~ law i. not benefitting onlv special 

interesn bul is. In fact. attempting to measure UtI! ta.Oilver',true «onomie income. In short. 

SCM will offer better compliance a t lowe reos! to 0011> toI.Pilver~ and the gov~rnment with 

mlnim31, jf 3ny, Ion of 3~ revenul!. 

Background on the Kogod Ta. Center 

The Kogod ~ Center i. ~ t~. rese~rch institute loc~led 31 Am ,ic~n UniversitY-s Kagod 

School 01 Businen. The Center promotes IJalan~d , fIOTlparttS3n reseilrch on ta~ law, thl! 

challenge. of13X compliaTlce and planning, and the implication. Ofl~~ relorm, 

Our efforts foeus principally on tax issues affectlTlR 5mall businesseS', IiOntrepreneUt •• ind 

middle-income taxpayers. We develop and a nalyze pOtential solut[ons to selected IJ~-related 

KOGOD SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-80.. 202-885·6505 

FAX: 202-885-1390 

kogod.amerlcan.edu 
140 

f 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.089

AMERICAN UNIVERS ITY 

II \ <, II I \ I , I " \ . " I 

1(0000 TAX CENTER 

problems laced b~ these three le ctOr! 01 th~ ~c<momV promo' ,,- public d1aloS~'" to Inform 

taKpayefl, pollC'/make'5, academics, lhi' press, and 13~ practitioner. about crillcal ux Issues. 

We.ltppreciate yourtakl nK Our conCerns o n behalf of sma ll si ,,~,", into ~ctount . 

Please do not hesitate to contact me ;f'lou have anI" ~ueslion5, 

KOGOO SCHOOL OF BUSINESS 

4400 MASSACHUSETTS AVENUE, NW WASHINGTON DC 20016-804. 202-l185·6505 

FAX: 202·885-1390 

kogod.american.edu 
141 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.090

Statement on behalf of the National A5$ociation 01 Home Builders 

Committee on Ways and Means 

Hearing on 

The Treatment of Closely-Held Businesses In the Contut of Tax Reform 

March 7, 2012 

Th" National A'iWCiati"n of flomc Build~r$(NA mJ pp",d3tc~ Ol~ oPIl<lrtunity to submit this 

SW"In~nl ollthe 'Treatment orOoscty-lIckl [lu,;inl'SS<.'S in the Cunt':J(t orTa~ Refurm," 

Founded ill 1942. NAIlIl is a l'cdcr:uion of ",o...., than !IOO amli",~d wue and local building 

indu,try aswciat;uns. It is ~ 'o i~<' orthc hom:;ng imJuslry in lhe Unit.'" StUl<'S. NAHB 

represents mon: Ihun 14 .11I~) bulkier nnd assodale m~mbC'rs Ihmuj!hom lhe COIInII)'. indudin!!: 

individuals and r,rms t1"t <lmstrocr and ~upply single_t;,mil), hom..,., as well a.~ apanlllcnl, 

condominium. l1lUJtitnmily. cml11llCreial and industrial buildc~ Inud developen; aod rcn.JUdcl .. ,.rs_ 

The rnidC1ltial construclion S~'Clor. which includes single-I'lloily and mull ifamily hom(' builders. 

l'I."fl1o,jclers d UlhL'I' bu!;in~~ conn~ctL'd to OIC hU!lsing sector. is dornin~tcd by small 

bu~i"f'Ssf'S. The median NAil l! hom~ builder member h3 " empluy~""~, constn~ s 3 hom<'f per 

YCllr, atld repons lC'Ss th~n S! million in gro.>s rec:eipt". ApproJ(lfllntel~ ~()% of NAIIB's 

membcrsllip con.iSls un"L,incssesorgaoizcd as non C-Cor;>orntion entities lsole propriclon;hips. 

panncrships. LLCII ~tld S Cor;>oral on~). Of the 20% of mcrnbC'rs organized as C Cor;>omllons. 

\'ery few an: publicly-traded corpor~t;ons. 

BL'\:m'~ Mou~ing plays such:1 cenlrJl role in the economy. UL~ chang(O> thut impact pa.<s_thl'\J 

entities could have a bri)ad impacl----both po5ilil't ~nd ncg:nive---<m the&1>nom~ liS a I>holc. 

HOllslnli conlributes 10 gross domestic product (GDP) in two basic ways: through priy~tt 

l"<'sidcmial iO\-cstlllcn' and t;uns umption ~I"'nding 0" huus;,,!! scrvic;,s. Ili~toric"lly. ,,",sidcmial 

inl'e51mCnl has 3Vel1lgl'tl roughly 5pcrcent ufGDP while housing scrYic~ hu~ e I,'cm"ed 

bcIW<'<:,' 12 ~nd 13 jX'rccnl. for B c{>lllbincd !7 10 18 [l('n:cnL or G DP. TIlL~ shores tend 10 YUI)' 

("'cr the busincs~ cycle. Resitl~nli~ 1 inocsnnL'fIt indud~s constructiu\) ofn~w in~lc family 3nd 

mulLifamily Slntcturd, residential n:rnotkling, IlrOductiorr u( lllanul;lChtred homL..., .• nd brokers' 

f<'CS. Consumpli<m spending IIll hQusing ~n'ite~ inc!vde~ gTO!i5 !"llIS (which in~lude utili i~s) 

paid ~ renLers. and owners' impuLc'(\ renl (an cs imDI~ ofholl' much II would cost to renl U",nCroccupi<-d units). and utility paymen's. 
142 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.091

Currently. bl:caus~ of the impllc\!; .,ftlle Great Ro:c"ssiilll. housing's towl C\}ntributi(1l1 to GI)P 

stand" al t-l.9 pcrc~nl. HOI,sing SI~"S arC down by more thM 75% sin~.:: th~ir peak ntlll~ 

beginnillg 01'2006. with mure than IA5 lllilJiorl jobs 1051 in 11\" [1:sidcntial wnslructioll sector. 

ome pric~s are down approxim~t~l)' one-Illird fmm 10QC, kvcls. wiping OUI trillions ofrlollars 

ofwenllh oflhe notion's 75 mililoo homeowners. 

Tile ,)nJ;oinll depression In the rcsidenlial constnlCtion industry also translates Into I,N'Cf federal 

tax revenue ~ builder,; and Ih~ housing ~r\'ic~ 5eCI(>f strUIlIlIc. R~'Sidcntial cOllslruction 

pro"id('!; a sizeable ren-nue s()Urc<' for 10CIl1. Slale and fedcrIIl go"tn\ln~nls. NAHI1 ~troogl)' 

believes there is,gfcat polential for increllsed ,eWnuc ift,.., refomlS;U~ impbncnrcxl that both 

I'rQnH/lC \."ConOfl'ic &To ... ,h and r<'<:lliP"1.C the ionponallce ofhOllsing 10 thc econom)'. 

NAIIO estimales tht f<,lIo"';ng economic imp.1cts from home buildin!; utili remolk:ling.' 

('(mSlroclion ofan lIver~ge l1g!c r~",;I~· hum~ l.'I'eale~ 3.05 jub/; and gen<'r.1t('S 589,2 III ill 

1~r:lI, S131e. and loc31t;o; reVenUe. Constru~tioll of an 3, ~c multifamily unil createS 1.16 

jobs and gcneroles $33,494 in fcde(;ll, stat~ and local ta;( C\ CnU~. Expo:lIt1iturc.s (lf$IOO.OOO of 

"'mod<'ling imp"wemc-nl!i c"'ale J .11 job:l ~m! gen~rIIlO'j; 530,217 ill federal. StJIC and hnlt:u 

revenue. 

Untillhe Mtion's housing man-CIS Il.,<:o\·cr, Ihere can be no robust e~onomic r\."Covery for the 

econom)' al largt. I lousing is linked In household wealth, con.umer conlidClH:c. 3 healthy labor 

market (by enubling people to Il)(:llW from cit)' to city). ~nd the d;rt'Ctjob~ imp3ct cOnllL'<.'tcd to 

the hnus'ng Industry. 

sjll\$.~ Tn~ l'ulL~d /lon~lJ"ildi!Jg 

Given Ihal m{l!;\ hOl11e buildcr~ 1111<1 n:nll ... lekr.l nn: nrgullIlcd 3S jlII.SHhru cmill<:!1 flIT ta~ 

purposes, the individual income tll.~ nlte "Ys!em lim~tinns 8~ rhe d~ facIO husm(!i;s h\1\ ,die. Fn.-

this reasun. Ihe nalion's home buildCf$ sllppun ItXltllding the 2001/2003 individ",,1 jnL..,m~ tJX 

nnc redUl·,lions. 

runhcmlorc, 3. >mall finllS. Ih~re nrc cerUlin t~~ niles Ihal help ... duce the ~d'ninislra\ive burden 

th~t oompll~al"d laJ( mleS can impose On bu;;;ncs""" thai do n,)1 I"i"~ in·hou;;e tax c~pl""iS<!. 

Good ~aml'lcs of the simplifying ru les include the section J 79 small busi'lCSS c~pcnsing 

pmvi~ion~ nnd Ihe c~sh la~ accountins rules. flQth ofthe;;e pnwisiuns signili~~ntl)' reduc~ the 

clllnpliall~'" costs of!h.., ui.ting tll>i cnd~. MorcOl'eT. cash ae~ounling i,·erilica! for smull finn. 

because il help~ pf\'\'<'nl a timing mismatch reIW""," taX<!$ paid and aclual .... ·,·cnuc recciwd. 

Under ~n accrual ixIsis, it is possible for smull fjrm~ In O"'~ I.1Xe!; before revenue j~ in h~nd, 

Il''''rcby c,,,,"ting cash 110'" c11HII~nIlL'S. Su~h 18.'ation would constitute tal< o1'''p),antom inmme," 

as il requires pIIying taxes On money no\ yet r,'<:civC\l by the businCSll. 

'Tho o;,.ct lmp.ct o! Home 6ulldin,~"" ~.mod.t ni on t~o U.S. E<onom1. NAt<6 E<O<\Omia GfO~p. 

(~ , t» J/ ...... " .~ I~b, o.rlll iO'Mrir .• ,p,I •• ctl",,1 D"1J4"~~ .... 'kC """mIO_ 10l S4l& <~"nn.[I DC' 3) I ) 
143 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.092

Another impOrlom rule for home buiJlkrs that help .. Jln'vcm t3~ati(>11 on phamom income i~ th~ 

section .:j6O(e) home.eOrlStru.:t;On COntraCI c.~ception to thl: \Mg·tcnn ta.x aeeounllng ntlcs. In 

gcn~,."I. the tax code ""luire~ l>usin~-s:s.cs III""raling under ~Ol)[rncts Ihat ...-quire more than onc la.x 

yC'~r m comp\em (long-term rontt""~CtSllO p~y t~XC$ lin the l.'.x)J!.'Ctcd ",venu.· (3 fQftJ1 uf phantom 

income) pmponionally for ench )'c~r of the cnnlrllct. This i~ in cnntrast to the eompklcd contmel 

method. 

The;,,:· rul es were estilblished by the Tali Ildt>nn A~t or 1'186 \0 ensure lorge bu'incsSl!s opi:rilting 

ondt--r contracts lasting many years did 111)1 ddcr tax liability for lon"periods oftim~. This woold 

ocrur ,n absl'l1tt ofth( long'(<"fIl\ contmet rulCli beI.'HISC ~uch tupa~1"!I could dcf~-r incom~ tU 

paym~nt until the COlllract "'os completed. 

Section 461l(e) pmvidC"s an i"'roMnt e~ception h> Ihelie lonll-Ierm contracts lor ccrtain home 

buildin.;! co\U,,'c .... "hi~ cbange wa~ made after th~ 1'll!6 ",fonn efTOIl b..-cau,,, It wa~ "'mgni,cd 

il131 hQm<.· building "'115 ~11 example ofa mall busint'<$S IIndt'r whicb C<Jn~truL1jol1 could take 

~lightly more th~n a yc~r (or pan tWI! tax y~'ars). llte home COl1strucli(>n contracl exception 

a!tow. hOlll e buillkrs to usc the l"<lmplet~d comr.l~t method dux account in.;!, thereby pr~~enting 

home bu;Jd~rs frum having to linance half oflhe eXpi:ctoo income ~ paymCTlt associal~d "'ilh 

Ihe cOll~lruc ion and sale ofu h!)lI1e. iii would be re{juired under Ih~ long-term a~ "anunling 

rules. Under the la., ~odc. a qllulilied hMle cOIl;lruclion I:01ltl1l<:t is a oon,truclion (Onlmet f<>r 

which ,n ICIl$I 80 )J!.'f1;CIlI Qflhe ~'StilllaK-d IQ\al costs are rca50nabl y cJ<ptlCted 10 bcsuril>ulablc to 

C!)nslruCli!)n or development !)flhc dwelling unils c(>nlaincd in building,; with 4 or fewer units 

and improvement, to r.:al )lfOpcny located on the silc of such units. 

FinJlly, <lue 10 the GreJt Re;;:cssioll and ils c<:ol1omk impacts, another form nfphnn\om income 

m.w,; is taking" loll on many home builders across the n]li"". s"C1;on IU~ ofth" ta.x code 

T<"Iuires caneelll-d dcbt1U be Irl"dled as taxabl~ income. As pan <lfth,- eunsi.~u,'nct'!; ortb~ 

hOIl;;ing nlitrkcl cri.;s. many bllillk..,-.,; o"n lnnd Ihat wa~ pun:hmied with acqui~ilioo. del'cill)lll1cnt 

and con~tmc1ion (All&Cj loons from bolh national and ~ommunity b""ks. AS lnnd prices f<-lt 

some of!hcse loans bc>;ame dislressed. EfforlS WCTC and continue to be l11ad~ to mitigate trutlblcd 

loans. Some<lfthcse marhl-bascd I'ITorU invo!.',: limit...d princip.1! rt'(Iucti!)n, inten'St r:ll~ 

d.;:cr.:aM's., teml c~lcnsiolYS, or olher aClions Ih~1 would conslilulc clUlcellation ofdcht. 

Unfonunnlcly. stich act inns also gi,'c ri>e 10 incomc tax li~billlY jilr 5111all nrms r.:~dy fnclng 

the wo",t markct env;ronment since tbe Great DCpreiiSion. As B result the only option ror mDny 

of these finns is dedIT;'- bankruptcy or becomc ;nsulvtnt. Unlike large finns. bankruptcy tor 

many. sma ll family--(}"'n~d lim1S can I11c~n the end uf generations· old family entcrpriSt.'S. 

AS pan oflhe American R.-.;u~ery and Re;nl'estmenl ACILlf2()O'), Congr;.-" pruvidcd an 01) tU 

lo-ycar la~ defemll for sucb incom~ la ~ liability for debt i>rgi~cn In 21)()9 ,1nd 2010. However. 

for builders opcrnli"g in stales "'~crt: debt issues became a f~ctor in 20 11. this deferT'JI oncrt:d 

no b<.~l~lil. And tbe deferrul itself was "flimitcd bcnc.iit fur small busincs,..'S withoul the access 
144 

f 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.093

10 I~nding and ~~pilallhal larg!! businesses pl>s.st' •• lind withoul whic h it i~ dirlicult 10 maintain 

opcrulions. 

For this re~'Ofl. NAIUl suppons l,mYiding 3 tn.' e~clusion for busill('!;~ debl fOrglveness for debl 

m,tWali"n elTons In 2011 and for a number "fy"ar:s thereafter. until the business economic 

etwimnmem b:;l~nljally impro,·cs. Such a la~ JlOlicy change would cnable ~",a ll. family owned 

firms 1<la oid hankruptcy !IIltt COlllribute to the econemy recowry as indi viduall!)('"aL mnrl.:L'IS 

imprm"c. 

J.P. Delmore 

A"istant Vicll'. President, Gove:mme:nt Affairs 

National Ass"'iation of Home Builders 

(202) 266·8412 

jd~rr,,-ol..e@nahh.ors 

• 
145 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.094

~B 

WIA 

Amortco'. Beer 

Olatrlbutors 

Statement Submitted 

By 

National Beer Wholesalers Association 

Committee on Ways and Means 

Hearing on the Treatment of Closely-Held Businesses in 

the Context of Tax Refonn 

March 7, 2012 
146 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.095

Chainnan Camp. Knnking Member Levin. Ml>m~ " flh Woy~ und MUlls Commilll"', Ih" 

NaliUllallk<'t Wholualers ASS(JCialion (NBWA) 3ppri,dalCS IheopponunilY 10 COmnK'I11 on Ih., 

In'alment ofdu><'ly_hdd bu ill<." ~st"S in tax ",foml. TheNBW A is a Imde a,:;oc'aliOn t/ull 

ropr.-Sl:ni~ Ihe ;mereslS urlh ... 3.300 lil>cIH;.:d. independcnt l'T dislribulors - wilh " p.:r.lLion;; 

~a l(:(l in c,-ery I3U~ and congre~sio"al di, lricl armss Ihe Unitcd S131es. NBWA member; 

dirc1:lly employ approximalely 98.000 hardworking AmeriL~dns who eam ~0<Id wages and 

receive employer-pmvidcd benefits. 

NB\VA member ~omJX!n;t'S arC closdy-held bll~inesscs. For lhem. la~ reform represcnts a 

pClK111iaJ upportunily 10 impro, ~ Ihc lax laws by reducing unnLx'essarily high I<IX rJI~S " 'hilc 

implif ng lhe rules by liminnling 113ITOW. spL..:ial b(:ncfiIS Ihal"llpply 10 a limiled number of 

laxp:.ycrs. Howcv~r, like olher c1ose ly-hcld oosinesscs. NBWA m ... mbc~ are anxious about tax 

reform. [lased un some oflhe incomplete 18 ~ rdonn l}f()pO$a ls Ihal ha,'e been diseIlSSL'tIIO date. 

diSlribulO~ arc worried thai tax refom could result in ~j~njfic~nlly high"r taxe$ on their business 

in~ m~ . 

A~ is commU'1 for d ose ly-hcld businesses. N"BWA member cump3n;es -arc gcrn:l'lllly organized 

ao; partn,·rships. lint;t<'d liabilit ~ c<)ntpanic •. or S corpomtions. Along " 'ilh ,:ole propn~ 01>hips. 

lh ~ bu~iIlL"'S 1~P<'S arc I""dled as '- now-lhrough enlitic>~ undL't the. a.~ law - Ilie business 

own~n p:.y llIX d;r~'C tl y un the in,'onte oflhe business. As 11 Tl'C<'nt Entst & Youn~ sl ll<l ~ 

r~, ·e nlcd . businlO;;,;c, org3n ~cd in '-flow_lhrough" f'lffil BtCount f<)1' n!Ql'I! than !!;!If Qf~l]job> in 

lhc United Slalcs. An), tax rdurm Ihal resulls in ~ hIgher In burd~n fur Ihi'lOC fluwthruul!h bu~in cs~~s would hDrlll thclr a bility to ~u nti nuc lu SfT\·t MS Ihc mDin IIroduccr$ of 

jobs ill the U.S. econnm),. 

As the ~ys and ,,1caJl.! Commill"" conlinues 10 consider tax ",fonll. we be liew il should k~ep 

in mirnl a few ha,ic principles 10 lI\'oid an advcrM" imp:.cl on d osdy-hdd businesSC!;, 

First, lax rdonu should be ,omprern:n,ive. cncomp1issing both businCiSl.-s nnd individuals. Til.>: 

refomlll!nl is limiled to reducing torpol'llle la ~ rnl~s aud l is paid for by eliminating busin<1s 

ta~ deducli,,,,, and credits ncro.<05·lhc-bonrd c"uld l'('5ult in signiliealltl y high~r IItxes UII th~ 

inoonl"or lh ~ 95% of U.S. busi""ss etllilies rg.lni ~cd in Oow_Ihmug)l foml. 

A cOr(ollary is Ih31 t~x refonll 11111.\1 Set the l3X I'llt-S "rcorp(lr.:lliun;; nnd individual, Plthe same. 

If)wer nlte~. The IUp m~ Tllle~ on l'Iow·lhrnugh bu~i "ess income are ITI!ad y ~e tlo in~rea>e fmm 

35% in 2012 10 nearly 45% ill 2013. And some in Congress have llgg~"led intr~asing lh~ top 

individlUlltu nltc~ p;lid on flow-Ihrough busill;:!;~ in"'lm~ e"en hi gher. The lOX rnte~ un dllSl:lyheld business in C'Q m~ 5hould be "'duced. nOI ;IlCTl"llS<"<!, 

Congress should also cUlltinue 10 k ck ways to eliminate Ihe t'ConQlllic di!lortiQl1ji caused by Ihe 

duuble taxalion ofcorporole income. The Admin;stration hilS propo>cd \0 nearly tripk Ihe 101' 

individualla ~ rJle· on divid<'llds. As Chai nn3n Camp pOi nled Olll during a hearing lasl monlh. 

-'because dividend, are p:.id {lUI uf illcumc Ih~1 h, ~In:ady J,ecll l,,~~d ~Ilh~ c(lrl'ural~ k,'cI and 

Ih!:'!1 are la~<"d gai n ;n thc shareholdl't's hall ds. this pn)pOsal wQlJld push Ih~ lolal fe<J~ml tax 

ral~ on di vide nd,; 10 64'1.," I'low-\hr\lugll hllsiness enlities ~re nut subj ecl to Ih i. pllnilive 
147 

f 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.096

do"ble-tn~ation. bUI Ibis ~-oI)1~ at D ~il:tnifiC!ln t pric.::; in order 10 main their now-lhrough smlus. 

lh"y are dl.'Oi~d ac('t$~ lO public e"pilal m~r\.:~'t>. 

A~ Cha inn~n Cam", noted in th~ announl~menl for Ihis hc'ar;ng, some have su~\!St<xI th ... i.ka uf 

subjecling ~~i~lin!l flow -through entities IQ double lualiun as C corporJtiOII$. ObvioU!;ly such 

an idt'J would hnn ai)l<cR'tl clu~ly-hdd businl'S~"'i and would Co>;l them in their ability I" 

invcsl and provide jobs. Th.· dQubl~l~xmjon of ~orporalc in£om~ is ahnust universally 

Tt.'Cugni~cd I" be undl'5il1lble. S<)subjcetinll thuusands IJT millions "f3ddilional businl'Sscs tu a 

double-t:t.x regime cannOI be vi ... ,,·cd as 1I ",...,form,·· EJtp.1nd~d double-tax~lioli tcnainly would 

nOI Tt.'Suit in Ih ~ lypeof pro-growlh la~ syslem Ihat sbuuJd be lheCommincc's I!U~1. 

Wilh r"!,Iard 10 IheaeCOUl11Qlg conect"ns 111"1 uro: "Iso a subjC<:l Oflhis hcarlng, NRWA "ould U1l:C 

\be Comm;J((c to avuid in a~ I\:form accoullting changes Ihal ha"e I"1:lrospj.'Cliw impact ur Ihal 

will resul( Ul an accckrJtioo ufla~es paid by closcly-hc)d busines,. ... s. ,\n c·~:J)npk of such an 

aecuuoliol! dwof:c is Ihe Ad01in;~lnujun proposal 10 I"1:peul liIe last-"l-fm;!-OUI (LIFO) method of 

in,"cutory acc"untin\:, Repeal of UF'O would have all ill\m~"<.I;ate advcl"St' impact 01' Ihe \'ash 

lio,," ofNIlWA membe rs ~nd others InJintainint< 1.11'0 ill,"enlOrics_ As a re5ull ofl,..lFO repeal. 

IDese bu~ioeSSl.o;; would QWC $ignificamly more in currcn 1a~C5 ,,'iIDI)UI l)Uvin~ '1H}' additional 

busill<.'SS receipts OUI of which I" p..y Ihose tal<~s . Any ~uch impaCl Oil buginess cash nows 

wt,luld jffipardi7c lhe ability "faffccted bus;ne~scs to mminue 10 pro"ide job.<. 

Il~r di;.tribulor$ conl;nue 10 priwid~ tremendous employment oppnnunilie< ((, hard-w'lrk.ing 

men and women across the nalion. We look forward ({) the oppomlHily ({) "",I; with you and 

your Committee during Ihc·!aJI ref.lrm pruccs~ and will do all thaI ,," can to cnsur~ lh~1 

America 's small b""inesscs will n,,1 be n\,giui\·dy impacted by I;u; rdorm. 

Thank YOIl for your c"nsidcrntioll ofNHWA 's '·;l'WS. 

Craig A. Purser 

NIlWA Presidenl and CEO 
148 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.097

M.rt~ 6, 2012 

'h~ Hano bl ~ D.~ C;wnp 

C/1afrman 

flo", (ommilt"" Oil W'v> "nd Mean, 

UMed S,"le. flour,e of ~ep,e,enunlve, 

1102 1""8worth H"" .. Offi", Bullalng 

W.,~ing!"", DC 20515 

The Hooonbl. ~ndv l-eYln 

an""'l Member 

House u,"I"'i"t:<! on wtryI and M~aM 

United Stale. flo" ... 0 1 Rep'e.entMi ...... 

1102 loo"""" h 1'40010 af/ke s"ijdlni 

Wa.hlnlton, DC 20515 

T"e Honor3b~ Mo, Ba"'"' Chairman 

Sena!. (<>mmiue, on F,naoce 

Unl!rC 5lale. 5I!n.'e 

219 DI'~n Se"'l~ Dlfoce Building 

W •• hlngron, DC lOSIO 

The f/onof4bleO'tIn Ha,ch 

""'''icing Membe, 

SeMt. CommlnO'e on ~In n,e 

Unitrd 5tale. SeMle 

219 Di,~.en ""naIf Office 8ullOi"", 

W •• hingtOl1, DC 20510 

Ttlere i. In o ..... ""'loelmloll COI1>eNu' ''''''''g Ia>,.av<:'>. CoII/I'.'" ",Ide""" a"g ne."" all 

othe, 't ~e!IoOle" 110M '~efede •• 1 U. ,,,,,om mun II> .elonned . .... :slmplifiedlt> e.d., fe, 

U.s. busl",,<se!o \0 co",pet~ gtobally, pr<>mOI" I!<"(>n(Imk i"'Wlh and <f • • '" u.s. jobs. 

we ~liev. the rorn.,,!one of r.fo,m mu51 be • ,i, nifianl ,edu<llOn in Ihe currem 35" 

!I.tutoryc",!>" .. 1. 1 • • ~t., which Iswhvwe loa"" cern. logetn~r a, I~ IlATE Ce I~Jon 

(R~ ormlnl Amenta', ' .. eo [q"Ub!v), The !VoTE Coalitlo" io rMIIt u~ of ~'. mlnd'd 

bu.ineslO. a nd .ssociatlcn. witt. tile pu'_ of advcullng fo, ,ound a"g oqu~.ble ,.IOfm, 10 

tl>e fed ... 1 t» cod. t~ t would reduce the corpor.t. ta~ .... ~ in o<d~ , to ImprOY< tn. 

competitive"",. of Ame,icon bu51ne ... Important!v. ", our <u"em deficJI envi",,,m,,,,', we 

"ndef1,.nd that b.,.... b'oade"~" may be requlre<l lo ""hie ... I "","n'"8'''' cotP013' . ,.,. 

,.ovctlon. 

Co.lition member <Om~n"" employ million. of /IIm'fi",n •• nd provide bener.u fo' retiree. 

, iln! her. In In. u.S,; ..... t hlgner 10. f4le, o"g . cempllcated I .. cod e pul OUf compo"I • • at a 

d"llnC! cr)<"~liI i .... o""dvantoge compoffa to OUf for"", competiIO". l/Idglobal economy 

",ne'. capital i. nlgl1!y mobile.II',";mply norder Ie compete from "m~flCL Re ..... 'ch loa. founa 

w""" B U W 'jt!ge ,.,... 

irl!o8W!<<>a ~jon.rom 11166-332 ... 611 I P.O, IIo< ,HaI7, W""""'O<IIX, l oon 
149 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.098

1hIt """,,, o.,~ c.m. 11>0 ~on, Sandy Lovin 

'-' 

T~_."'"B.1"""'· The H<N>. 0...;., Hat<h 

tMa, tj,e. CQr~ra' t I~«>"'" taX r •• e C~" h."", • larBe fmPict on ,,*,~r ~ <omp.1n1e. d>O<>S<i' I" 

plate p!"oduCI>onfacilitll"s and Ott Ihe ,~. 0' Investments. We n""d to ~'u .. Ihal ........ rla il; 

I~ e plite to In ... " now and in tn! fuhlft. 

1\ h., ~"" U V"'" line! 1M '.11 comp .. hen"." tax ,efo.m "'a' ;occ:o<l'o~,".d. 5i"C~ lIIfon, 

other <o<mute.' t." .... "em. have d>anged dramatully. ind not to our i>enefil. O<Jr 

competlto,. In tM OECO haY. lowered tlle~ statutory I .. rate, ",hlle the US. ,ale "", 

'ematn..d r.lalively constant, Thli ha. re .... ~.-d In I n unwmp.eljl j ... I •• ernnronmlm' that 

dl'>COlJrageo l"""",,,e"1 and job ClUI!un h"r~ al home. 

A lo",e' U.S. <o.pam. la •• ate otte,. crilkal boone/il' 10 I~ e u.s. ec.o~omV and 10 all 

Aml'f'<.in •. MO" impOrlantlv, llower<o,por.'~ ,.Ie will boo" in"".lm. ", In the U,S,. brinr'nl 

mo,. "'me,kon /011>. inno,alion and g.OWlh. 

Weur&<,you to """,eforwa,d nOW 10 ena<1 • lowe, <o.pora,. I"" ,;>Ie _ ,.11" .. Am •• I .... '. 

«>m~I' ;.t edet. 

Michael f,S'yminC"lylo: 

Chahmin " nd 

Chief u.e<lltJv. Office, 

AII~~ G'oup, Inc. 

~andaI151~p"enWn 

(hal,m.n and 

Chief he<utive Office, 

AT&T loc. 

Lo'IY J. Merlo 

p.eoidtnl and 

Chief E .. CUIIVe Dltkt' 

CV5 c.'em"~ 

Alan Rog~r Mu lAlly 

P.e.idenl and 

Chi~r E.ecutlV. Off",er 

ford MOlo, Coo'oanv 

~ob.n J. St."en. 

Qalrmao and 

Chief h ecuti.e Office, 

lCltkh..,a MonTo (o,ao,"ion 

Ed"'i.d~. Hamberl~r 

Pre.ldeol and 

o.Tef E.ewti .... officer 

A5~ tJon af AmMcan all.oad~ 

11m M<tl~.n~v 

dI.irm.n, P,esidenl ina 

(~iel f'wewli .... Dlroc., 

TMc BoeIng Companv 

f"'deti<~ W. Smith 

(h.irmM glthe Ilodn:l ood 

Chief E~<'C\ItNe OIficer 

f«lE~ Corpo'ation 

G,ef1)lV B. MaHei 

Pfesid",,' '~d 

Q .. f [)etc"li .... Olroce, 

lib,,", Media 

Terry I. umdB.en 

Ch io' E~.rutNe Olfice'. Chai,man 01 th e 

Soil.d, Pn •• ident •• n~ Oi.ector 

MK'/'-. Inc. 
150 

Æ 


wwoods2 on DSK499XVN1PROD with WAYS & MEANSInsert 78663A.099