Reforming Treatment of Business Start-up Expenditures

Today, once a business starts carrying on business (when it is no longer getting ready, but is instead ready to serve customers), it can start amortizing its start-up expenditures as defined under IRC Section 195 over 15 years. If the total is $55,000 or less, up to $5,000 can be expensed immediately and this amount phases down as the aggregate expenditures range from $50,001 to $55,000.

S. 5204, Tax Relief for New Businesses Act, would increase the expensing amount from $5,000 to $50,000 and the phaseout point to $150,000. The bill sponsors note that the average small business spends about $40,000 to get their businesses from getting ready to carrying on.

Those with over these amounts today or per S. 5204, are amortizing expenses over 15 years. Meanwhile, we allow use of the cash method of accounting by most businesses, and have Section 179 expensing of over $1 million. Why not just allow the small business to expense up to the Section 179 amount along with other eligible section 179 property? This sounds like simpler and would truly help small businesses. That is why amortize something over 15 years when Section 179 expensing is over $1 million?

This proposal is in a list of proposals from several years back from the AICPA Tax Division on modernizing the tax law for small businesses. I hope that upcoming tax reform will not just extend expiring or expired TCJA items but also take a look at reforms that would help businesses and make sense given other provisions in the law.

I've offered additional tax reforms to help small businesses in this blog. One of my favorites (beyond what is in the AICPA paper which I'm pleased to say I was able to assemble with other volunteers and staff when I was chairing the AICPA Tax Executive Committee), is allowing co-owners of a new business to elect to be a Qualified Joint Venture something which today is only available to spouses (where both file identical Schedule Cs). This would be very helpful for a start-up run by two or more people because while they are getting started, they don't have to deal with setting up an LLC or filing a partnership return - which is a lot of work when unfortunately, they might not survive. After a few years, they would be required to shift to a partnership or C or S corporation.

I'm sure many people have ideas to truly help simplify tax rules for small businesses. 

What do you think?

Ryan Foresees Tax Reform Legislation This Year

Today, House Speaker Paul Ryan released a joint statement on tax reform  (from the six folks working behind the scenes on tax reform - Ryan, Brady, McConnell, Hatch, Mnuchin and Cohn). Here is the key portion about tax changes:

"We have always been in agreement that tax relief for American families should be at the heart of our plan. We also believe there should be a lower tax rate for small businesses so they can compete with larger ones, and lower rates for all American businesses so they can compete with foreign ones. The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas. And we are now confident that, without transitioning to a new domestic consumption-based tax system, there is a viable approach for ensuring a level playing field between American and foreign companies and workers, while protecting American jobs and the U.S. tax base. While we have debated the pro-growth benefits of border adjustability, we appreciate that there are many unknowns associated with it and have decided to set this policy aside in order to advance tax reform."

It appears that the plan will:

• Not be a consumption tax as proposed last June by the House Republicans. Thus, the plan won't deny a deduction for imports or exempt export revenue. And there is no need to deny a deduction for interest expense of businesses. Also, expensing of business assets is not a given, but there may be non-consumption tax reasons for allowing such expensing.  Also, with asset expensing, it's likely not all business interest expense will be deductible (assuming asset expensing is in the final plan).
• Include a rate cut for both businesses and individuals. How much of a tax reduction that translates to for taxpayers depends on what changes are made to deductions and credits, the AMT, and for higher income individuals, what happens to capital gain rates and the net investment income tax. 
• Include a shift to a territorial system. Senator Hatch noted recently that this has bipartisan support and was part of both the House plan and President Trump's 1-page plan.

So, the most significant part of the statement today is the last sentence in the excerpt above - they are not pursuing a border adjustable consumption tax.  The import tax of that was a significant revenue raiser so it also means they need new revenue raisers to support either the 20% corporate rate House Republicans want or the 15% rate President Trump seeks.

But, still lots of questions including what revenue neutral reform means in terms of how much base broadening will be needed and how the effect of changes are measured. The President's budget proposal (page 115) "assumes deficit neutral tax reform." What is the best change approach for economic growth? Will the drafters wait for Senate Finance Committee to review the ideas they received in July?

#trih - tax reform is hard

But with continued hearings, discussion, and work likely already underway on drafting legislative language, perhaps we will see a proposal this year.  And, rate reduction, base broadening and a shift from worldwide to territorial all mean major changes and rethinking for tax compliance and planning. And we'll also need to see what the states do in response to any federal changes.

What do you think?

Small business tax reform

On July 17, 2013, the Senate Committee on Small Business and Entrepreneurship held a roundtable on "Small Business Tax Reform:  Making the Tax Code Work for Entrepreneurs and Startups."  I was pleased to have been invited to participate along with ten others.  Senators present for the roundtable included Landrieu (Chair), Risch (Ranking Member), Shaheen, and Enzi; several staff members were also present.

The roundtable format seemed to lend itself to more interaction among the Senators and participants compared to a formal hearing. Some of the ideas suggested included:

• The need to simplify so that small business owners can better understand the rules and not spend as much time and dollars complying as they do today.
• Expensing of assets allows for simplification and a possible boost to the economy.
• A representative of the Angel Capital Association would like to see the current (temporary) 100% exclusion of capital gains of qualified small business stock (Section 1202) made permanent and the holding period of the stock reduced from five to two years. 
• A representative of the Cato Institute thought the rate on all capital gains should be reduced.
• A representative of the ESOP Association wanted to be sure incentives for employee ownership were continued.
• A few of us, including Senator Landrieu, noted the need to modernize some of the rules.

A video of the roundtable is available. I think written comments of the participants will also be posted. I have included mine below (or pdf) and I plan to submit a longer explanation of these items that includes suggestions for modernizing the tax law (moving it into the 21st century). One example I noted was the need to expand Section 179 expensing to include intangible assets, such as acquisition of software or a domain name. It doesn't make any sense today to have this simplification and investment incentive only apply to tangible property.

One purpose of the hearing was to get ideas for the Senate Finance Committee's "blank slate" project where all Senators have been asked to tell the Committee what special tax deductions, exclusions, credits and rates should remain in a reformed Tax Code. Their comments are due by July 26, 2013. My suggestions are my #9 below.

Committee press release summarizing the roundtable (7/18/13).

What do you think?

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Small Businesses Tax Reform Roundtable

U.S. Senate Committee on Small Business and Entrepreneurship

Introductory Comments of

Professor Annette Nellen
San José State University
http://www.21stcenturytaxation.com/[1]
annette.nellen@sjsu.edu

July 17, 2013

Thank you for discussing tax reform and small business and the invitation to participate in today’s roundtable. I’ll offer a few points briefly at the start. I’d be glad to elaborate further today and submit detailed written testimony on these items as well as others raised today.

1. What is a “small” business? Too many parameters and bases are currently used to define this term. Use the easy ones, such as gross receipts rather than full-time equivalent employees and consider that many small businesses have no employees.
2. Consider trends to help modernize our tax system. These include growth in numbers of self-employed entrepreneurs, working out of your home, greater focus on intangible assets, and the reality that today, any size business is likely involved in international and multistate operations.
3. Consider appropriate use of technology to ease compliance. Why can’t filing of a return, W-2s and 1099s be as easy for a small business as ordering something from Amazon?
4. Improve equity among rules such as allowing self-employed to deduct health insurance in computing self-employment tax, and enabling similar funding access among entity types, such as through Sections 1202 and 1244. Be sure the research credit includes R&D on cloud computing solutions and helps start-ups with a partially refundable credit.
5. Improve certainty for inherently complex rules, such as worker classification, by allowing use of a safe harbor Q&A checksheet.
6. Include measures to reduce the tax gap to help reach revenue-neutral reform and improve fairness among taxpayers.
7. Encourage and help states to join in tax reform to ensure small businesses don’t continue to face complexity at the state level.
8. Simplify!  If you cannot describe in a few simple sentences how a rule works or it requires alternative calculations, the rule is not simple and either needs to be revised or repealed.
1. Recognize that for small businesses, simplification may trump accuracy. For example, a standard deduction for home office expenses, may be warranted to simplify compliance. Or, tax forms may need to be consolidated, such as is allowed for employers of household employees.
2. Avoid temporary provisions and numerous changes that complicate the tax law and increase compliance costs.
3. Simplify depreciation by expanding Section 179 to a permanent, inflation-adjusted large dollar amount that also covers all intangible assets, such as acquisition of a domain name.
4. Avoid new complexities disguised as small business benefits, such as a deduction for domestic business income of qualified small businesses. Lower tax rates and simplicity are the best tax benefits.
5. Find ways to consolidate duplicative provisions, such as multiple retirement plan options.
6. Require administrative alternatives to compliance with regulations found to exceed a minimum complexity tolerance level for small businesses.
9. For the Senate Finance Committee’s “blank slate” approach to tax reform, let them know that key tax expenditures for small businesses include use of the cash method,[2] Section 179 expensing, retirement plan provisions, and the self-employed medical insurance deduction. Improvements should be made to these areas though.
10. Once you have draft legislation, get input from small businesses and tax practitioners.
11. Pursue multistate tax reforms that will help small businesses such as ones to simplify and clarify payroll requirements for virtual and mobile employees, as well as income and sales tax nexus rules.
12. Evaluate all proposals for change against the principles of good tax policy.[3]

Thank you. I look forward to the discussion.

---

[1] This URL is to a website maintained by Annette Nellen for the purposes of promoting modernization of tax systems and consideration of the principles of good tax policy, with opportunity for readers to post comments. Views represented at this website are Professor Nellen's views only and may not represent those of her employer or professional organizations of which she is a member.

[2] Note that the Joint Committee on Taxation treats use of the cash method as a tax expenditure, but OMB treats it as part of the normal income tax structure.

[3] See http://www.cob.sjsu.edu/facstaff/nellen_a/TaxReform/PolicyApproachToAnalyzingTaxSystems.pdf.

Picture of the roundtable (I'm in the burgundy jacket).

Reforms desired by businesses

Recently, the Kogod Tax Center at American University and Bloomberg BNA released the results of a survey where advisers of both small businesses (less than $10 million of gross receipts) and medium-large businesses were asked how they would rate 15 tax reform proposals. The result was that 7 had similar support from both groups. Per the Kogod website: "The findings provide strong evidence that any tax reform bill would have to contain these measures to win the support of businesses."

The seven reforms:

1. 100% expensing of assets
2. a lower tax rate for corporate and passthrough entities
3. reduced payroll taxes for employees
4. elimination of the estate tax
5. clarification of rules on worker classification
6. replace the income tax with a national sales tax or other consumption tax
7. a single, flat rate income tax

Looking at more details of the survey, the top reforms desired by small businesses are not listed above - repeal of the AMT which was tied with lower payroll taxes for employers. The top reform for medium-large businesses was 100% expensing of assets.

I encourage you to read the article on the survey, written by Dave Kautter, managing director of the Kogod Tax Center (and formerly a partner in the Ernst & Young National Tax Practice, and my boss a long time ago.)

Some observations I'd like to make:

• One possible way that has been suggested to pay for a lower corporate tax rate is to change from MACRS depreciation to Alternative Depreciation System (ADS) with longer lives and slower methods. I think this flies in the face of trying to make U.S. firms more competitive internationally (see my article on challenges of reaching a lower corporate tax rate - here). The Kogod/BNA survey indicates that businesses want to move in the other direction - immediate expensing of assets! How will this affect efforts to lower the corporate tax rate in a revenue neutral manner?
• Reform discussions and the realities of finding revenue offsets to extend the 2001/2003 tax cuts for everyone and lower the corporate tax rate likely means that while we might see a lower corporate tax rate in the near future, we will see higher taxes on high income individuals including on qualified dividends. This all makes it difficult to know the tax rate any business is truly taxed at. Why not move to a system where all businesses are taxed the same with elimination of double taxation in the process?
• Why do businesses want lower payroll taxes for employees?  What about future shortfalls in the Social Security Trust Fund and the increase in the number of retirees to workers?
• Replacing the income tax with a consumption tax would be a risky experiment. It also is contrary to international competitiveness in that other countries have a VAT and an income tax.

What do you think?

Expensing of Business Assets - New Treasury Report

Economic stimulus provisions of the past few years have included bonus depreciation and higher expensing amounts under IRC Section 179.

President Obama has suggested that broader expensing can provide additional stimulus by reducing the cost of capital for all businesses. In September 2010, President Obama released a proposal to "jump start private investment and job creation" by allowing full expensing of qualified investments through the end of 2011. He also noted that this would be the "largest temporary investment incentive in American history." (White House Blog, 9/8/10)

On October 29, 2010, the Treasury Department released an 18-page report, The Case for Temporary 100 Percent Expensing: Encouraging Business to Expand Now By Lowering the Cost of Investment, to further explain and justify the President's proposal. The report states that full expensing will "lower the effective tax rate on income derived from business investments, and thereby encourage additional demand for capital goods."

The report also notes the added benefit of a temporary rather than a permanent provision, namely the incentive to accelerate investment. Expensing also equalizes the effective tax rates on different types of eligible assets regardless of useful life or the MACRS recovery period.
Treasury also notes advantages of expensing of qualified assets outside of the IRC Section 179 expensing regime. That is, the expensing proposal has no limit based on the dollar amount of assets placed in service during the year and no limit based on current year income.

Whether broad-based, temporary expensing will take the place of the temporary 50% bonus depreciation depends on finding revenue offsets, whether Congress also finds that additional stimulus legislation is needed, and how the proposal ranks among other congressional tax priorities.

Over the years, both full and partial asset expensing have been suggested as part of major tax reform as well as an approach for reducing the effective corporate tax rate. So, I think the report may open the door to continued discussions not only on economic recovery approaches, but also on fundamental tax reform.

What do you think?