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[Congressional Record Volume 141, Number 82 (Wednesday, May 17, 1995)]
[Extensions of Remarks]
[Pages E1055-E1056]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

[[Page E1055]]

               SMALL BUSINESS TAX FLEXIBILITY ACT OF 1995

                                 ______

                         HON. E. CLAY SHAW, JR.

                               of florida

                    in the house of representatives

                         Wednesday, May 17, 1995
  Mr. SHAW. Mr. Speaker, today I am introducing a bill that will lead 
to fairer tax treatment of small businesses and will help relieve the 
compressed workload forced on CPA's by enactment of the Tax Reform Act 
of 1986 [TRA '86].
  Prior to passage of TRA '86, S corporations, partnerships, and 
personal service corporations, like today's C corporations, were 
allowed to pick any fiscal year they wished. Often these entities chose 
a year ending other than December 31 because their natural business 
year ended at some other time. For example, retailers could choose 
January 31 or July 31, after all the holiday or white sale figures were 
in; and suppliers of ski equipment could select May 31 after the ski 
season ended.
  Congress abruptly halted the fiscal-year election for these entities 
because it needed revenue to pay for an amendment to the low-income 
housing credit as part of TRA '86. That law accelerated income to the 
U.S. Treasury by requiring fiscal year S corporations, partnerships, 
and personal service corporations to adopt calendar years for tax 
purposes thus flowing through earnings to owners at an earlier date and 
speeding up tax payments to the IRS.
  The loss of the election for some small businesses that are formed as 
S corporations and partnerships has proven to be a major disruption to 
their business operations because the calendar year end can fall in the 
middle of their busiest seasons. Taking time out to comply with this 
arbitrary requirement hamstrings their ability to maximize production, 
generate revenues, and create jobs. In addition, because these 
businesses also adopted the calendar year for financial reporting, they 
had to close their books as of December 31; and their independent 
accountants were faced with the need to undertake year-end audits and 
credit compliance reviews for shareholders and creditors in the same 
few months as required for the preparation of tax returns. 
Consequently, these entities have found their accountants are least 
available at the time they are most needed.
  As a CPA, I can personally speak to the havoc TRA '86 has caused the 
accounting profession. The 1986 tax law has spawned a practice 
management problem of major proportions, with many CPA firms, 
especially small and medium-sized ones, finding 65 to 75 percent of 
their annual workload falling between January 1 and April 15.
  Furthermore, as Members of the U.S. House of Representatives this 
year, we learned firsthand the meaning of the phrase workload 
compression, as we raced to meet the 100-day deadline for voting on all 
10 items in the Contract With America. I don't think any of us would 
describe the working conditions at the beginning of this Congress as 
ideal or even desirable. But they were similar to the conditions the 
accounting profession has faced since 1986--every year.
  Congress attempted to provide some relief from the burdens of TRA '86 
in 1987 when it enacted section 444 of the Internal Revenue Code, which 
permits electing entities to have a fiscal year ending in September, 
October or November. The price exacted in return was that the electing 
entity pay a deposit to the U.S. Government which approximated the 
amount of tax to be deferred through election of the fiscal year. The 
calculation for the deposit--of what amounted to an interest-free loan 
to the Government--essentially required the amount of deferred entity 
income to be multiplied by the top statutory tax rate applicable to 
individuals, plus one percentage point. In 1988, therefore, when the 
top individual rate was 28 percent, the deposit would have been 
calculated at 29 percent.
  The current situation illustrates the limited value of section 444. 
The great majority of S corporations and partnerships on fiscal years 
in 1986, and those coming into existence thereafter, which would have 
elected fiscal years are now operating on a calendar year.
  Furthermore, the 1993 increase in individual tax rates exacerbated 
the situation. By the administration's own projections, approximately 
1.2 percent of individual taxpayers are expected to be in the 36 
percent bracket and only 0.3 percent in the 39.6 percent brackets. Yet, 
because of the mechanics of section 444, the deposit presently payable 
on deferred income is at a 40.6 percent rate, even though most owners 
of electing entities will themselves be in the 31 or 36 percent 
brackets. Simple financial self-interest dictates, then, that many 
affected entities terminated the fiscal year election.
  The stumbling block to greater relief in the past has always been 
revenue neutrality. The legislation I am introducing today overcomes 
that problem. It's designed to maintain the cash flow to the U.S. 
Treasury, but still be an affordable option for S corporations and 
partnerships. The bill also would return to S corporations and 
partnerships the right to elect any fiscal year and would ease the 
compressed workload facing the accounting profession.
  A description of the bill is included below, but briefly it would 
ensure a steady cash flow by requiring S corporations and partnerships 
electing a fiscal year to pay quarterly estimated taxes to the IRS on 
behalf of their owners. Certain statutory rates will be required to be 
paid on the business's quarterly income, instead of determining an 
individual owner's tax bracket. The statutory rates are determined by 
revenue needs, but this bill provides a de minimis rule for the 
smallest companies. Those businesses with a tax liability of less than 
$5,000 on the defined income of the business will not be required to 
make an estimated payment. Businesses with income defined above the de 
minimis level but less than $250,000 per owner will be required to pay 
estimated tax of 34 percent. For entities with incomes above that 
level, where the owners are themselves likely to be in the 39.6 percent 
bracket, the estimated tax rate will be 39.6 percent. Owners will take 
credit for the entity-paid estimated tax on their income tax returns, 
which will eliminate the non-interest-bearing loan
 approach of present law.

  I urge my colleagues to cosponsor this bill. We have a rare 
opportunity to support legislation under which everyone wins.
  The detailed description of the bill follows:
                           General Provision

       Under current law, a partnership or S corporation, except 
     where an election is made under present Internal Revenue Code 
     section 444, must use a tax year which ends December 31st. As 
     a result of making an election under new Code section 444, an 
     entity would be able to use any fiscal year it desired. 
     (Present section 444, which permits the use of a September, 
     October or November tax year, would be renumbered as section 
     445.)
       The election would be made by the 15th day of the third 
     month of the first 12-month year using the new fiscal year 
     end. For example, a 1995 calendar year entity wishing to 
     change to a June 30 year in 1996 would file its election by 
     September 15, 1996.

                            effect on entity

       Because of the nature of fiscal year passthrough entities, 
     a deferral of tax is created on the tax returns of the 
     owners. To alleviate the negative revenue impact of this 
     deferral, the entity would make quarterly payments of 
     estimated tax timed with the earning of income, the first of 
     which would be due by the due date of the election. The 
     entity income used in making the calculations is the amount 
     currently reported on 1994 Schedule K, line 23(a) of the 
     partnership return or 1994 Schedule K, line 23 of the S 
     Corporation return. This amount is the aggregate of entity 
     income less deductions without accounting for the character 
     of each separately stated item on Schedule K.
       Anti-abuse measures are included to prevent post-December 
     31 payments to partners or S Corporation shareholders to 
     reduce the entity level tax (for example, an S corporation 
     electing a May 31 year end, and ``zeroing out'' its line 23 
     income by salary payments in May).
       In order to provide revenue neutrality, a 2-rate estimated 
     tax system will be required. Most entities will pay estimated 
     taxes for their owners at a flat 34% rate. However, those 
     whose owners will, themselves, likely pay individual tax at 
     the 39.6% top statutory rate will have to make entity-level 
     estimated tax payments at 39.6%. These ``high average income 
     entities'' are those where the prior year average entity 
     income of owners with at least a 2-percent interest in the 
     entity is $250,000 or more. They also include partnerships 
     whose prior year income is at least $10,000,000.
       The entity may use one of three methods to calculate the 
     quarterly estimated tax payments. The first method is similar 
     to that for high-income individuals, and bases the tax 
     payments on 110% of the
      prior year income. That income is multiplied by the 
     statutory estimated tax rate, then multiplied by 
     [[Page E1056]] 110%, then divided by 4 to obtain a 
     quarterly estimated payment amount.
       The second method allows the entity to calculate estimated 
     tax based on the current year income. Estimated current year 
     income is multiplied by the same 34% or 39.6% statutory tax 
     rate and divided into four quarterly estimated payments.
       The third method uses similar calculations to calculate its 
     payments based upon annualized current year quarterly income, 
     similar to the rules presently applicable to individuals or C 
     corporations.
       The payments of tax are due on the 15th day of the 3rd, 
     5th, 8th, and 12th months of the taxable year of the entity.
       In addition, the entity makes a one-time payment with its 
     fiscal year election that applies to the short period created 
     (if any) by moving from a calendar year to a fiscal year. 
     This payment is at the same statutory rate and is based on 
     short period income.
       The election terminates if the owners of more than half the 
     entity's equity consent to such revocation, or when the 
     entity itself terminates. (``Inadvertent terminations'' of an 
     S corporation however, will not terminate the election.) 
     Subsequent re-elections may not be made by that same entity 
     for 5 tax years unless the entity obtains consent from the 
     Internal Revenue Service. Rules will also be provided under 
     regulations for successor entities.
       A penalty for underpayment will be due from the entity if 
     it does not make the required level of estimated tax 
     payments. The penalty is based on the amount of underpayment 
     and continues until appropriate payment is made or until the 
     April 15th that the owners report their share of entity 
     income. At that point, the owners become liable for the tax 
     and any existing underpayment penalties that may be imposed. 
     An exception to the entity level penalty is provided which 
     parallels the analogous exception for individual taxpayers 
     (casualty, unusual circumstances, etc.)

                            effect on owner

       The quarterly estimated payments made by the entity are 
     ``passed through'' to the owners of the entity as a credit on 
     their individual tax returns. Since the entity is making 
     these payments on behalf of the owners, they may reduce their 
     quarterly estimated payments for their shares of the entity 
     level payment. When they receive an annual information report 
     from the entity (Schedule K-1), it will list their share of 
     fiscal year income as well as their annual share of the 
     credit. The amount of the credit allocated to each owner is 
     based upon his or her share of the entity income (no special 
     allocations of the credit are allowed). The credit is 
     reported on an owner's individual income tax return as if it 
     were estimated taxes paid by the owner.
       In making their own quarterly estimated payments, the 
     owners may rely on amounts reported by the entity as paid, 
     even if errors occur or payments are not made, so that 
     penalties accrue only at the
      entity level. If payments are overpaid or underpaid compared 
     with those reported to the owners, such amounts are 
     treated as any other tax due or overpaid under Subtitle A 
     of the Internal Revenue Code.

                           tiered structures

       No election may be made by an entity that is part of a 
     tiered structure under this proposal. Additionally, if an 
     entity becomes part of a tiered structure the election is 
     terminated. The tiered structure rules do not apply, however, 
     if all of the owners are partnerships and S corporations that 
     elect the same fiscal year.

                         alternative tax years

       Nothing in this provision will affect an entity's right to 
     a fiscal year that exists under current law; for example, 
     under the natural business year tests. The provision also 
     allows for retention of fiscal years by any entities that 
     currently use a fiscal year under Rev. Proc. 87-32.

                            old section 444

       The new provision would preclude any new elections under 
     the old section 444. However, existing 444 elections would be 
     allowed to continue if the entity so desired. Alternatively, 
     an entity with an existing section 444 election, may elect 
     instead under this new provision thereby entitling it to a 
     refund of its current 444 required payments, or a credit of 
     such required payments toward its new estimated tax payment 
     requirements.

               de minimis and reasonable cause exception

       The provision provides for an exception to payment of any 
     entity level tax if such tax would be below $5,000. The 
     provision also provides for the relief of section 7519 
     penalties if reasonable cause can be shown.
     

                          ____________________
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