H.R. 9, small businesses and complexity

On April 12, 2012, the National Small Business Association released results of a survey on taxation. Per NSBA's press release, "when asked to rate the most significant challenge posed by the federal tax code to their business, the majority (56 percent) picked administrative burdens while 44 percent said financial burdens."

This is not really news.  Tax law complexity affects everyone with the worst impact on small businesses and low-income taxpayers who face high compliance costs in relation to taxes owed.

Despite this longstanding concern and a growing deficit and debt, the House has passed legislation to add a new, temporary complex tax cut for small businesses, as very broadly defined.

H.R. 9 (112th Congress), the Small Business Tax Cut Act, passed in the House Ways and Means Committee on March 28, 2012 and in the full House on April 19, 2012 (235 - 173). H.Con.Res. 112 (the budget passed in the House in March 2012) also includes a 20% small business deduction but it is not clear if temporary or permanent.

H.R. 9 would add Code Section 200 to allow all small businesses, regardless of entity form, a special deduction only for the first tax year beginning after 2011. A small business is one with fewer than 500 full-time equivalent employees in either calendar year 2010 or 2011. Per House Report 112-425 accompanying H.R. 9, the purpose is to "help free up additional resources allowing small businesses to create more jobs" (page 5).

H.R. 9 increases complexity for many businesses. The dissenting views included in House Report 112-425 note that the special deduction applies to 99.6% of all businesses (page 38). H.R. 9 includes, though, a deduction limit tied to W-2 wages paid. Thus, the 99.6% applicability rate seems high as sole proprietors without employees appear to be ineligible for the Section 200 deduction.The dissenters note that the break is "available to partnerships of highly paid professionals, including lawyers and lobbyists. It is available to hedge fund and private equity fund managers. ... [And] many professional sports teams would get the tax break."

Section 200, which operates in similar manner to the Section 199 manufacturing deduction, is 2,000 words long and includes interaction with several other Code sections most notably those that define "modified AGI." Any gross receipts considered in computing the Section 200 deduction may not be considered for Section 199 purposes. Thus, many small businesses will have multiple calculations to determine which is more advantageous – Section 199 or Section 200.

The 20% small business deduction also raises the complexity issue of the many ways that "small" is defined in the tax law. The dissenters to H.R. 9 note that using measures of revenues or assets, many of the covered businesses would not be labeled as small. 

Why doesn't tax reform include eliminating multiple definitions for the same term? (See Nellen, "The Many Sizes of Small," Corporate Taxation Insider, 10/28/10.)

H.R. 9 not only violates the simplicity principle of good tax policy, it also violates the transparency principle in that the deduction does not represent any expenditure, but instead is intended to lower tax liability. It is a disguised rate reduction that will make it difficult for businesses to know their marginal tax rate for planning purposes.

If there is a desire or need to provide a lower than 25% rate for small businesses, why not provide for it via the rate structure for individuals and corporations?

Congressman McClintock (R-CA) offers some budgetary concerns with H.R. 9 (April 19 Cong Rec H2015):

Also see http://mcclintock.house.gov/2012/04/the-tax-cut-illusion.shtml.

What do you think?