[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]



 
        SETRA: FAIR AND SIMPLE TAX RELIEF FOR SMALL BUSINESS

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                               __________

                      WASHINGTON, DC, JUNE 9, 1999

                               __________

                           Serial No. 106-18

                               __________

         Printed for the use of the Committee on Small Business


                               


                     U.S. GOVERNMENT PRINTING OFFICE
61-230                       WASHINGTON: 2000



                      COMMITTEE ON SMALL BUSINESS

                  JAMES M. TALENT, Missouri, Chairman
LARRY COMBEST, Texas                 NYDIA M. VELAZQUEZ, New York
JOEL HEFLEY, Colorado                JUANITA MILLENDER-McDONALD, 
DONALD A. MANZULLO, Illinois             California
ROSCOE G. BARTLETT, Maryland         DANNY K. DAVIS, Illinois
FRANK A. LoBIONDO, New Jersey        CAROLYN McCARTHY, New York
SUE W. KELLY, New York               BILL PASCRELL, New Jersey
STEVEN J. CHABOT, Ohio               RUBEN HINOJOSA, Texas
PHIL ENGLISH, Pennsylvania           DONNA MC CHRISTENSEN, Virgin 
DAVID M. McINTOSH, Indiana               Islands
RICK HILL, Montana                   ROBERT A. BRADY, Pennsylvania
JOSEPH R. PITTS, Pennsylvania        TOM UDALL, New Mexico
MICHAEL P. FORBES, New York          DENNIS MOORE, Kansas
JOHN E. SWEENEY, New York            STEPHANIE TUBBS JONES, Ohio
PATRICK J. TOOMEY, Pennsylvania      CHARLES A. GONZALEZ, Texas
JIM DeMINT, South Carolina           DAVID D. PHELPS, Illinois
EDWARD PEASE, Indiana                GRACE F. NAPOLITANO, California
JOHN THUNE, South Dakota             BRIAN BAIRD, Washington
MARY BONO, California                MARK UDALL, Colorado
                                     SHELLEY BERKLEY, Nevada
                     Harry Katrichis, Chief Counsel
                  Michael Day, Minority Staff Director



                            C O N T E N T S

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

                               WITNESSES

Wordsworth, James, Owner, J.R.'s Steakhouse of Virginia..........     4
Joseph, Frank, Owner, Key Communications Group, Inc..............     6
Wallace, Eric, CPA, Carbis Walker and Associates.................     8
Neese, Terry, Chief Executive Officer, Terry Neese Personnel 
  Services.......................................................    20
Reardon, Brian, Manager, Federal Public Policy, National 
  Federation of Independent Business.............................    22
Sinclaire, William, Senior Tax Counsel and Director of Tax 
  Policy, Economic Policy Division, Chamber of Commerce of the 
  United States..................................................    23
Coleman, Dorothy, Director of Tax Policy for the National 
  Association of Manufacturers...................................    25

                                APPENDIX

Opening statements:
    Talent, Hon. James M.........................................    32
    McCarthy, Hon. Carolyn.......................................    34
    Sweeney, Hon. John...........................................    35
Prepared statements:
    Wordsworth, James............................................    37
    Joseph, Frank................................................    40
    Wallace, Eric................................................    45
    Neese, Terry.................................................    48
    Reardon, Brian...............................................    53
    Sinclaire, William...........................................    58
    Coleman, Dorothy.............................................    63
Additional material:
    NFIB Business Capital Expenditures...........................    68
    Letter to Hon. Velazquez from Dorothy Coleman................    69
    Written Statement of the National Alliance of Sales 
      Representatives Association................................    70
    Written Statement of Roger Harris, President, Padgett 
      Business Services..........................................    73
    Written Statement of David Goodreau, Quatum Manufacturing....    77
    Written Statement of National Society of Accountants.........    82
    Written Statement of the American Farm Bureau Federation.....    86



    HEARING ON SETRA: FAIR AND SIMPLE TAX RELIEF FOR SMALL BUSINESS

                              ----------                              


                        WEDNESDAY, JUNE 9, 1999

                          House of Representatives,
                               Committee on Small Business,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10 a.m., in room 
2360, Rayburn House Office Building, Hon. James Talent 
(Chairman of the Committee) presiding.
    Chairman Talent [presiding]. Good morning. I want to 
apologize to the Committee for being late. When I was in 
school, we used to give the professors about 15 minutes, and 
you gave me 10. I imagine I was at the end of the rope there.
    Over the last few years, largely through the determined and 
united efforts of the members of this Committee, we have 
succeeded in convincing the rest of the Congress to give some 
modest tax relief to America's small businesses and family 
farmers, including restoring the home-office deduction, 
increasing the deductibility of health insurance premiums, and 
modest estate tax relief.
    Clearly, more is needed. Small entrepreneurs are the 
backbone of our economy. They run local, national, and 
international businesses. They provide the bulk of the services 
we need. They raise our children. They care for the elderly, 
and they grow our communities. They unambiguously need fair and 
simple tax relief from today's complicated tax code.
    I am introducing a bill today, the Small Employer Tax 
Relief Act of 1999, called SETRA, on which we're going to have 
a hearing today, and I want to recommend it to my colleagues. 
It squarely faces the realities that small businesses confront 
under today's tax code. SETRA calls for deducting 100 percent 
of small employer's health insurance costs, restoring the meal 
deduction, increasing expensing, lowering taxes, including 
payroll taxes, and simplifying complex tax accounting IRS 
rules.
    The bill tackles these important changes to complement, not 
compete with, leading proposals by other Members of Congress to 
eliminate the death tax and to reduce taxes across the board 
for all Americans.
    In particular, I think that repealing the death tax, or 
eliminating it gradually, as proposed by Representatives Dunn 
and Tanner in H.R. 8, is essential. We should protect small 
farmers, family-owned businesses, and women business owners 
from having their life's work confiscated by the Internal 
Revenue Service after their demise.
    In addition, there is no reasonable justification, in my 
mind, for denying small businesses healthcare, business meal, 
and other business expenses to run their business, so they can 
keep more of their hard-earned money, create more jobs, and 
grow the economy.
    High taxes, a complex tax code, and IRS tax traps, now 
penalize unnecessarily an otherwise vibrant small business 
economy. Small business Americans should be able to afford to 
save and invest in their children, in their communities, and in 
their future. I hope that SETRA, or legislation like it, will 
simplify and lower small business taxes and help small 
businesses continue to excel.
    I want to now yield to my friend and distinguished 
colleague, the ranking member, for any statement she may wish 
to make.
    [Mr. Talent's statement may be found in the appendix.]
    Ms. Velazquez. Thank you, Mr. Chairman. Before we begin, I 
would like to take this opportunity to introduce our new member 
of this Committee, Ms. Shelley Berkley, from Nevada. She has a 
law degree and has worked extensively in the private sector. As 
such, she is bringing with her a strong background in business 
issues and a knowledge of trade groups. Representative Berkley 
also comes from one of the fastest-growing cities in the 
Nation, and I look forward to having her insights on what small 
businesses on the front line need to succeed.
    Over the past few years, America has experienced an 
unprecedented economic boom, and no one can deny the importance 
of small businesses in helping create this growth and 
strengthening our communities. Our Nation's entrepreneurs 
provide jobs, represent a major tax base for our schools and 
roads, and embody the spirit of entrepreneurship that has made 
this country great.
    However, too often, small businesses lack the capital they 
need to grow. They do not have enough money at the end of the 
day to make being their own boss a reward. One of the reasons 
for this is that our tax system often creates disincentives for 
our Nation's small businesses.
    An easy way to ensure that small businesses continue to 
grow and are able to compete with large corporations is to 
provide them with some sort of tax relief. The additional 
revenue, although small by the standards of Wall Street, can 
often be the difference between a successful, growing firm and 
one that fails.
    I would like to take this opportunity to commend Mr. Talent 
on his continued efforts to relieve the tax burden on the small 
business community. He has been a strong advocate of tax relief 
for small business and I am glad that I have been able to join 
him in this fight.
    One of the most important roles of this Committee is to 
educate the rest of Congress about tax relief for small 
business. Today we will be looking at the Small Employer Tax 
Relief Act of 1999, introduced by the chairman. I am a strong 
supporter of many of the provisions contained in this 
legislation, and I would like to thank Mr. Talent for providing 
us with the opportunity to examine some of the other tax relief 
proposals which haven't been as thoroughly examined.
    Both last year and again this year, I have joined Mr. 
Talent as an original co-sponsor of legislation that calls for 
an immediate, 100 percent deduction for small businesses of 
their healthcare expenses. This is crucial, not only for our 
small businesses, but for millions of Americans who are 
currently without health insurance. Since large corporations 
can already deduct 100 percent of their healthcare insurance, 
small firms are suffering from an unfair tax burden, and this 
must stop.
    Small businesses also do not have the million dollar 
advertising budgets that larger corporations do. Much of their 
advertising is done face to face over lunch or dinner. The 
value of this type of marketing should not be underestimated 
and it is a legitimate business expense. To help small 
businesses offset this portion of their marketing, I am a 
strong supporter and co-sponsor of legislation to increase the 
meal expense deduction from 50 percent to 80 percent.
    Increasing this deduction is a common-sense proposal that 
should be made a priority by Congress. It is a win-win 
situation for everyone involved. Our small businesses win 
because they will be able to compete with the million dollar 
advertising budgets of large firms, and our restaurants, most 
of which are small businesses run by families, will also 
benefit. This is a practical thing that we can do, and it is 
also a smart, common-sense initiative that will helpstrengthen 
our small businesses.
    I would like to thank the chairman for providing the 
Committee with an opportunity to examine other aspects of the 
tax relief to small businesses. One of the proposals that we 
are examining today would repeal the temporary Federal surtax 
added in 1976 to repay loans from the government to the 
unemployment trust fund. Even though this loan was repaid in 
1987, the surtax is still in effect. Today we will be able to 
examine why this still exists and determine whether it is fair 
to small businesses.
    Additionally, we will hear about possible changes to small 
business accounting rules to make it simpler and more cost 
effective for small firms to comply with current tax laws. 
Today the Committee will have the opportunity to examine these 
simplified accounting rules. I believe that we should take a 
serious look at any proposal which simplifies the accounting 
procedures for small business.
    Finally, the legislation before us today would lower the 
maximum individual income tax rate from 39.4 percent to 34 
percent on productive income of small and family-owned 
businesses and the self-employed. The net result of this change 
will be to reduce the highest tax bracket for a small business 
to that of larger corporations. I believe that we must provide 
a level playing field between small firms and large 
corporations, and this may be one of the ways of doing just 
that.
    Once again, I would like to thank the chairman for holding 
today's hearing. Creating a fair and equitable tax structure 
for our Nation's small businesses is crucial to their long-term 
success. At the same time, we must work to ensure that by 
solving one problem, we do not create a more serious problem 
elsewhere. I look forward to hearing the testimony of today's 
witnesses, and I thank the chairman again for his hard work on 
this issue.
    Chairman Talent. I thank the gentlelady for her comments, 
and we'll go right to the first panel. We have two panels 
today, and the first witness in the first panel is Mr. James M. 
Wordsworth, who is the owner of J.R.'s Steakhouse of Virginia, 
in Fairfax, Virginia, who is testifying on behalf of the 
National Restaurant Association. Mr. Wordsworth.

  STATEMENT OF JAMES WORDSWORTH, OWNER, J.R.'S STEAKHOUSE OF 
                            VIRGINIA

    Mr. Wordsworth. Yes, good morning. Mr. Chairman, members of 
the Committee, thank you for the opportunity to testify before 
this Small Business Committee on legislation that would help 
thousands of restaurateurs across the country, the Small 
Employer Tax Relief Act.
    I am pleased to see that the Committee is addressing such 
an extensive package of tax issues that have long been a burden 
on small business. My name is Jim Wordsworth. I have been a 
small business employer in this area for a quarter of a 
century.
    In 1974, I was a marketing manager for a large, high-tech 
corporation, and decided to open my own restaurant. So I did 
that, in Fairfax, Virginia, and we called it J.R.'s Steakhouse. 
With a lot of hard work and probably miracle upon miracle, we 
were successful. That enabled me to open another restaurant and 
catering businesses shortly thereafter. Today, we employ 250 
people, both part-time and full-time.
    Privately, I am proud of the success of our business, and 
throughout the years I have learned many, many lessons, too 
numerous to mention. One of the lessons is that you do 
everything in your power to treat your employees well, to serve 
quality meals to your customers, and to give back to the 
community. That is within your building. Yet, you will never 
have total control over whether or not you succeed, and that is 
outside your building.
    There are barriers that hurt your business and keep you 
from breaking even. These barriers can make or break your 
business, regardless of your own efforts. One of the barriers, 
one of the largest barriers, is the heavy hand of the Federal 
Government. To those of you in the business world, and to us in 
the business world, the Internal Revenue Code is probably the 
thing we fear most.
    It is not just the rules that can't be deciphered without 
the aid of lawyers and accountants, it is the tax burden 
itself. It is substantial, and it is constantly changing. 
Looking at the Small Employer Tax Relief Act, it is clear that 
Chairman Talent understands the barriers that are caused by the 
tax code. In fact, almost every provision will have a direct 
impact on my business.
    However, it will not surprise any of you to hear that what 
I'd like to focus on in my comments is the provision to 
increase the business meal deduction to 80 percent for small 
businesses and the self-employed.
    As most of you remember, in 1986, Congress lowered the 
business meal deduction from 100 percent to 80 percent. In 
1993, it was lowered again to 50 percent. As far as I can tell, 
the reason it was lowered, aside from bringing a large amount 
of revenue to the Federal Government, was that Congress really 
considered it some sort of fat-cat tax loophole that people 
used so that they could have three martini lunches. I would 
like to assure you that Congress could not have been further 
from the truth.
    When I walk around my restaurant at noon on a day like 
today, here is what I see. At one table I see a salesman up 
here from North Carolina trying to sell his outdoor signage to 
a guy who is down the street who has a shop in a strip mall 
that is down the street from our restaurant.
    At another, I see a female who is new in business and is 
venturing into her own human resources consulting business 
talking to a guy from a start-up high-tech firm in Tysons 
Corner about how they can work together.
    At still another is a friend of mine, Monty Coleman, a 
former Redskin, who is with an emerging high-tech company, 
meeting with the president of United Cerebral Palsy to arrange 
a sponsorship and a golf tournament. That is not really a 
direct business to business, but it is an effective thing that 
is happening.
    But, in short, the business men and women who are having 
lunch in my restaurant are the same people that you see 
testifying here today. They are traveling sales representatives 
that they pull off the Beltway, the start-up business working 
on new clients, or the self-employed. Each one of them 
considers my restaurant his or her conference room. For many of 
these small business people, this is the best--and sometimes 
the only--way they can do business. There is no less legitimate 
business expense than any other form of marketing, but right 
now the tax code is telling them that it is just 50 percent 
legitimate.
    When Congress first reduced the business meal deduction, I, 
like restaurateurs throughout the country, saw an immediate 
impact on my business. And while that is very important to us 
in the restaurant business, what is even more important is to 
look at the impact of Congress' decision on the business meal 
user.
    Since Congress first dropped the allowable business expense 
in 1986, our association's research shows that the number of 
business meal users has declined by more than 2 million. A 
great majority of these were small businesses.
    Let me take a minute to talk about who really uses the 
business meal, because it is important not to generalize or 
stereotype based on any misconceptions, and I think you'll be 
surprised. Onthe chart over here, if I can direct your 
attention, two-thirds of the business meal users make less than $60,000 
a year, with almost 40 percent making less than $40,000. One-fifth of 
the business meal users are self-employed. One-half of all business 
meal spending occurs in small towns and in rural areas. The average 
cost of a business meal per person is $11.60.
    For people in the business world, a business meal is just 
that; it is business. They are not trying to scam the system 
for a tax break. They are not out to waste a hard-earned 
marketing budget on something that won't help them grow their 
business, and they are not out to eat a meal for their own 
personal enjoyment, and to heck with the business. They are 
business people simply trying to drum up business.
    Clearly, it was the small business that was hardest hit by 
the cut in the deduction. I think it was part of TEFRA-86. That 
is why, on behalf of the National Restaurant Association, I 
applaud the inclusion of the business meal provision to 
increase deductibility from 80 percent for small businesses and 
self-employed. This mirrors the stand-alone bill introduced by 
Congressman McCrery and Congressman Tanner, H.R. 1195, which 
has received strong bipartisan support.
    Ideally, we would like to see the deduction go back up to 
100 percent for everybody, because we believe that conducting 
business over a meal is a 100 percent legitimate cost of doing 
business. However, we also realize that the revenue impact of 
such an increase would be very difficult to enact in one bite, 
and that is a pun.
    Again, Mr. Chairman, I would like to thank you and all of 
the members of the Committee for the opportunity to tell you my 
story and hopefully provide some insight on this tax issue. The 
thing I would like to end with, and I think is so appropriate, 
is the Department of Commerce has declared this year, 1999, 
this is the second time now, as the year of the restaurant. It 
is an acknowledgement of what restaurants have been in our 
business community. I think it would be appropriate, since we 
are the industry of the first experience for so many Americans, 
this is the year of the restaurant, that if the sweeping 
changes that this bill would have on all of us were passed in 
this year, I think that would be extremely appropriate, and I 
thank you.
    [Mr. Wordsworth's statement may be found in the appendix.]
    Chairman Talent. Thank you, Mr. Wordsworth, for your 
testimony.
    Our next witness is Mr. Frank S. Joseph, who is the owner 
of Key Communications Group of Chevy Chase, Maryland. He has 
testified before this Committee before, and we welcome him 
back. I urge the members to take a look at the resume of each 
of these witnesses. Mr. Joseph's resume is quite impressive, 
both as a businessperson, and, before that, as a reporter, and 
we're happy to have him here.

  STATEMENT OF FRANK JOSEPH, OWNER, KEY COMMUNICATIONS GROUP, 
                              INC.

    Mr. Joseph. Thank you. Thank you, Mr. Chairman. Chairman 
Talent, members of the Committee, good morning. I am Frank 
Joseph. I am a publisher and publishing consultant in Chevy 
Chase, Maryland, six miles from here.
    My wife and I have been the self-employed owners of Key 
Communications Group Incorporated for 17 years. We publish the 
Federal Personnel Guide. You may be familiar with it.
    Key has been a home-based business for the last eight of 
those years. I am very happy to endorse your bill, the Small 
Employer Tax Relief Act of 1999, speaking both personally and 
on behalf of the National Association for the Self-Employed.
    There are many good ideas in the bill. But, above all, I 
commend this bill for keeping up the effort to immediately 
raise the health insurance deduction for the self-employed to 
100 percent. For millions of self-employed Americans, this 
deduction represents the difference between having no health 
insurance, being under-insured, and having real health 
insurance. Almost six million self-employed people and their 
dependents are uninsured. That includes nearly two million 
children. This is a very real national problem. Thank you for 
fighting to get those people insured.
    It is also a fundamental issue of tax fairness. When I 
worked for a larger company, my employer provided my health 
insurance. I had a policy that covered my family. A small 
premium was deducted each month from my gross pay, and I barely 
noticed the cost. My employer excluded his entire cost for that 
health insurance from his taxable income, 100 percent.
    Now I am self-employed. My wife and I operate Key as an S 
corporation under the tax law. I can only deduct a fraction of 
my health insurance cost. It is same thing for other self-
employed people, like sole proprietors and partners. Sometimes 
it seems like the smaller your company, the less the government 
wants you to have health insurance. A mile or two away from me 
is Phillips Publishing International. Like me, Phillips 
publishes newsletters. Tom Phillips is an acquaintance of mine, 
friend of mine. He has done very well. Last year they recorded 
gross revenues of about $600 million. That is orders of 
magnitude larger than my publishing business, which is in my 
basement.
    Yet, when it comes to health insurance, Congress has 
legislated an advantage for Phillips over me, lower taxes. But, 
thanks to your past efforts, Congressman Talent, as well as 
those of a few other Members of Congress, like Senator Bond, we 
self-employed are finally on a schedule to deduct 100 percent 
of our health insurance costs by the year 2003.
    Still, as the SETRA bill acknowledges, people without 
health insurance should not be asked to wait four years to get 
sick, and the many people who struggle to get by with 60 
percent deduction now should not have to wait four years to get 
a tax advantage that General Motors has enjoyed for half a 
century.
    I would like to add one other personal note. When I came 
before you in this Committee two years ago, I said that if 
Congress increased the health insurance deduction for the self-
employed, I could use the money to hire more part-time help for 
my company. Well, you did, and I did. Today I use more part-
time help than I did then, thanks, in part, to the higher 
health insurance deduction. I also have one full-time person 
working for us, and, because I try to be a good employer, I 
provide her with 100 percent of her health insurance.
    But think about this: Since she is an employee of my 
business, the insurance that I offer her is fully excludable 
from my business' taxable income. That is a better deal than I 
can get for my own family. The insurance that I purchase for my 
own family, same policy, same providers, same everything, 
because my wife and I are self-employed, still is only 60 
percent deductible. Luckily, I can afford to buy health 
insurance for my family, but I'm sure that there are many self-
employed people who cannot.
    The statistics show that somewhere between one-fifth and 
one-fourth of us don't have health insurance, and cost is, by 
far, the most important reason. The current tax law undoubtedly 
is creating situations where self-employed people with 
employees can afford to buy health insurance only for their 
employees, but not for themselves and for their own families. 
Certainly some people will be selfless in such a situation. 
They will buy the health insurance for theemployee and not for 
themselves, but other people will think, ``How can I possibly explain 
it to my family that I'm buying health insurance for someone else, and 
not even for us?'' Therefore, they might not offer the health insurance 
to their employees.
    Increasing the self-employed health insurance deduction to 
100 percent could help more than the self-employed. It may well 
result in more employees of small business getting employer-
provided health insurance, and in a time when an estimated 40 
million Americans don't have health insurance, anything that 
could help a few more Americans get health insurance would 
certainly be in the social interest of the country.
    Thank you again for all of your work to get this deduction 
up to 60 percent. I hope we can finish this job this year. 
Thank you for allowing me to testify.
    [Mr. Joseph's statement may be found in the appendix.]
    Chairman Talent. Thank you, Mr. Joseph.
    Our next witness is Mr. Eric Wallace, a CPA with Carbis 
Walker and Associates, of Pittsburgh, Pennsylvania, who is 
testifying on behalf of the Associated Builders and 
Contractors, Inc. Mr. Wallace.

 STATEMENT OF ERIC WALLACE, CPA, CARBIS WALKER AND ASSOCIATES, 
                              LLP.

    Mr. Wallace. Thank you. I know how loved attorneys are in 
Washington, and apparently CPA's are getting in the same light, 
so thank you.
    My name is Eric Wallace, CPA, and I speak on behalf of the 
Association of Builders and Contractors. ABC is a national 
trade organization representing more than 20,000 firms in the 
construction industry. ABC's diverse membership is bound by a 
shared commitment to the philosophy of rewarding work based on 
merit. With 80 percent of the construction today performed by 
open shop contractors, ABC is proud to be their voice.
    I am a practicing CPA with over 20 years of experience 
serving construction contractors and service providers from 
across the country in the fields of taxation, accounting, and 
consulting. I recently researched, published, and authored an 
article titled, ``The IRS and Cash Basis Contractors,'' that 
appeared in the Construction Financial Management Association, 
as well as the ABC publication. My extensive experience dealing 
with this issue enables me to provide to you specific expertise 
and insight regarding the proposal in SETRA to clarify that 
small business taxpayers are allowed to use the cash method of 
accounting without limitation.
    Ms. Velazquez referred to the accounting rules, and I am 
trying to bring some reality to what we are talking about here 
when we talk about accounting. A lot of people seem to go into 
a gray matter when we talk about accounting. I am trying to 
bring some perspective as to how this really affects a lot of 
contractors from across the country and how serious this is 
from them.
    The IRS is targeting just about all contractors and service 
providers who report their taxable income on the cash method of 
accounting. One of the most onerous audit adjustments a 
contractor or service provider can face is an IRS initiated 
change in its accounting method from the cash to the accrual 
method. The IRS proposed audit changes typically subject the 
taxpayer to six figure assessment, with the majority of this 
based on accrued interest and penalties, not necessarily a tax 
increase.
    The difference between the cash method and the accrual 
method is not that the accrual method necessarily results in a 
greater taxable income, and, therefore, greater revenue. It is 
a matter of timing. Under the cash method, we report all of our 
income as we collect it, and our deductions as we pay them. For 
example, if we collect our income earlier and don't pay our 
payables, we actually report our income sooner.
    But, now more than ever, the IRS is pushing their cash 
audit position change on a national level. They are basing this 
on a publication in late 1997, titled the Construction Audit 
Technique Guide, or ATG, as part of its national market segment 
specialization program.
    In their ATG, it states to the IRS examiners, that they 
should generally conclude that a contractor or service provider 
should be changed from the cash basis of accounting when their 
material costs as a percentage of their receipts is 15 percent 
or more, and, depending on the facts and circumstances, they 
can make this assessment when the ratio is less than 15 
percent.
    This position is not based on any code section, but is a 
result of several court cases successfully litigated by the 
Service. This push is based upon an IRS certain logic flow. 
Their foundation flow is summarized as follows: materials are 
merchandise. If the cost of merchandise is over 15 percent of 
the gross receipts, it is a significant income-producing 
factor. If material is a significant income-producing factor, 
the contractor or service provider must use inventories. If the 
taxpayer is required to use inventories, it is required to use 
an accrual method of accounting.
    The result of this arbitrary national push by the Service 
would leave few, if any, contractors or service providers 
remaining on the cash method of accounting. One of the IRS 
authors of the Audit Technique Guide stated to me that the only 
type of cash basis contractor that the Service is permitting to 
stay on the cash basis is an asphalt contractor who does not 
produce asphalt in their own plant.
    Think about that for a second. Of all of the potential 
contractors and type of contractors there are, the IRS is 
saying there is only one type left to be able to be on the cash 
method.
    Chairman Talent. Mr. Wallace, let me interrupt for just a 
second, because we're going to have a vote and I don't know if 
everyone will come back, and I want them to understand this 
issue, because they are probably being contacted by the 
contractors, so I am going to take the unusual step of 
interrupting. A few of us up here are not accountants. So, when 
you talk accrual method, that means that if a guy or gal is a 
painting contractor and they paint your house and finish the 
painting, the IRS says you have to report the income from that 
job the day you finish the painting and are entitled to be 
paid, even if the homeowner doesn't pay you for 60 days. Is 
that correct?
    Mr. Wallace. That is almost correct. When you are invoiced 
is where you recognize the revenue, even if it might take them 
six months to pay you. So you are paying taxes prior to your 
collection.
    Chairman Talent. So they want you to pay taxes on income 
that you have, admittedly, not received at that point?
    Mr. Wallace. That is correct.
    Chairman Talent. Okay. Go ahead.
    Mr. Wallace. Thank you. Thank you for your question. The 
IRS denies that there is a national coordinated effort to focus 
on construction contractors and service providers, and that 
they are merely enforcing the laws as they interpret it. I do 
believe, however, that there is a national effort based upon 
the calls that I have received from across the country from 
contractors, service providers, and other practicing CPA's 
saying, ``here is the situation I face, what are my 
alternatives in this situation?''
    For example, a carpet installer from Michigan called me. He 
was being audited by the IRS,doing $1.2 million in revenue. He 
had materials and supplies equaling 12 percent of his revenue, not very 
significant at all. Again, this is less than that 15 percent. The IRS 
only audit change was to change him from the cash to the accrual 
method. The cost to him was over $100,000. The IRS auditor had told him 
that, ``I am basing this upon the new audit technique guide.''
    I advised an underground utility pipeline contractor to 
voluntarily change before the IRS came after him. It would cost 
him $100,000. It would put him out of business.
    A window installer from Texas called me. He had 20 percent 
of revenues in material cost of revenue. He was fearful of the 
IRS coming in, and, if they do, based on mandatory assessed 
interest and penalties, would literally put the guy out of 
business.
    The Service believes that, based upon a series of court 
decisions, their position to change all contractors and service 
providers from the cash method to the accrual method is 
justified. That is in past conflict with the congressional 
intent. I have a quotation in my testimony related to the Tax 
Reform Act of 1986 where Congress said, ``The Committee 
recognizes the cash method is generally a simpler method of 
accounting, and that simplicity justified its continued use by 
certain types of taxpayers and for certain types of activities. 
Small businesses should be allowed to continue to use the cash 
method of accounting in order to avoid the higher cost of 
compliance which will result if they are forced to switch from 
the cash method.''
    A head IRS construction industry specialist stated to me 
that based upon the current IRS approach and court cases, cash 
basis contractors and most service providers will not be able 
to maintain the cash basis position or have it supported in 
court. ``Their only solution is a congressional change.''
    Section 7 of the SETRA would provide such a needed 
congressional solution. The IRS makes a statement in their 
audit technique guide that the use of an inventory accounting 
method is required in every case where the sale of merchandise 
is an income producing factor. It doesn't matter that inventory 
accounting methods may result in inventory balances that are 
zero or minimal. They are not maintaining inventories. It is 
clear that the Service position is inappropriate. The SETRA 
would stop the Service's universal push against the cash basis 
contractors and service providers, and enable these small 
business to utilize the simpler cash method without fear of IRS 
reprisal.
    I want to thank you. I want to thank Chairman Talent and 
Representative Phil English for leading the effort to end IRS 
abuse of the cash basis contractors, and for introducing this 
straightforward legislation to solve this problem. Thank you 
for letting me present ABC's views on this important issue, and 
I welcome any questions you may have.
    [Mr. Wallace's statement may be found in the appendix.]
    Chairman Talent. I'm going to ask a couple of questions and 
then I will recess the hearing. I certainly understand if 
members want to get over there and vote and get back. I will 
hurry.
    I want to follow up on this subject a little bit, Mr. 
Wallace. What they're basically doing is taking a method of 
accounting that is appropriate when a business has a lot of 
inventory and applying it to contractors who don't keep any 
inventory, who only buy paint or asphalt per job. And they call 
that inventory?
    Mr. Wallace. That is correct. That is a good observation. 
If I've got a contractor who builds a building, say, for 
example, they put up one of these pre-manufactured buildings, 
and the only thing he does is put up the pre-manufactured 
building, he doesn't have to buy the material; maybe the owner 
supplies the material; the IRS is coming in and saying, ``I 
don't care, you bought it for this job. You still have to----
    Chairman Talent. That is, in effect, your inventory. The 
accrual method, which means that you take your deductions and 
you report your income, at that time where you have a legal 
obligation to pay or a legal right to be paid, makes some sense 
when a business carries a lot of inventory because you're 
getting your inventory. You are not necessarily paying the cash 
for that right away, but you get to take the deduction right 
away?
    Mr. Wallace. That is right.
    Chairman Talent. So, if you are not getting paid for the 
sale right away, but you're having to report when you have a 
legal right to pay, at least there is a balance there. You're 
getting your deductions earlier and you're reporting the income 
earlier. That is the logic behind it?
    Mr. Wallace. That is the logic. If I am buying inventory, I 
should not be able to write off the cost of my inventory, 
because I am not selling it yet. If you are a contractor, that 
is not what they face. They are not doing inventory; they are 
doing job costing.
    Chairman Talent. Right. It doesn't make any sense at all 
when a business doesn't have a lot of inventory, because then 
they don't have the accounts payable that they would not be 
paying for 30 days or 60 days, but taking a deduction on early.
    Mr. Wallace. That is correct.
    Chairman Talent. So there is an imbalance there. That is 
the reason the people have done it on a cash basis all of these 
years.
    Mr. Wallace. That is right. A contractor faces a lot of 
obligations. People want to be paid, and they want to be paid 
quickly. The cash basis really is a good reflection of what 
their income is.
    Chairman Talent. Would you, as an accountant, apart from 
the tax consequences, recommend to these people a cash method 
for these purposes just as the best way of keeping the books?
    Mr. Wallace. Yes, that is how they manage their business. 
It is really difficult for me to sit down with an owner, 
contractor, or service provider and say, ``You manage your 
business on the cash method, but the IRS is going to ask you to 
pay taxes a lot earlier based upon the accrual method.'' They 
look at me and they get very frustrated.
    Chairman Talent. I took the member's time to go into that 
before we go voting in case people didn't come back. That is 
the aspect of this that I think may be the most difficult to 
understand, if you are not familiar with it. But, certainly, 
these other issues are important.
    And I will recognize the gentlelady from New York as soon 
as we come back. We'll recess the hearing to be able to go and 
vote.
    [Recess.]
    Chairman Talent. We'll reconvene the hearing.
    I want to ask one more question, very briefly, and then I 
will recognize the ranking member. I have a press conference at 
11:30, so I just want to make sure I have a chance to explore 
this a little bit.
    Mr. Wordsworth, the provisions in the bill relating to the 
meal deduction apply to smaller businesses. I, personally, 
would like to expand it and apply it to everybody, but there is 
a reason for that. You talked about it a little bit in your 
testimony how small business people, I don't mean the size of 
the person; I mean the size of the business. [Laughter.]
    People who run smaller businesses or participate in small 
business use restaurants like yours to develop business in a 
way that larger companies might use a corporate conference room 
or thegolf course, or something like that. Go into how 
restaurants are used, maybe especially by the smaller-type businesses.
    Mr. Wordsworth. My colleague here, for example, has his 
business in his basement. You couldn't go out and meet with a 
large company and invite them over to your basement through the 
back lawn. I believe what you would do is pick a lunchtime, and 
you would make a reservation for 4:00 to 6:00 or 8:00, and it 
gives you a window of time. If you work intently at this--and 
as a small business person, everything you do has to be intent, 
because you can't fool around--you will set the meeting for two 
hours, and it is four to six people, and you can do that over 
lunch--in somebody else's real estate, and in an office that 
you don't have to maintain that has public accommodations, that 
is geographically located, so you have the largest number of 
people. So, it is the ideal way to conduct a business.
    If I can just take a moment to contrast it, put a box 
around it--to run an ad in The Washington Post, a small ad, for 
one day, let's say it is $424.60, one time. That is a shotgun 
approach to meeting with people. If you take a rifle approach, 
because as a small business you can't just throw out shotgun 
approaches, a luncheon at my restaurant in Tysons Corner, which 
is a fine dining, tablecloth restaurant, at lunch averages 
$11.85. So, it is far more effective for you to have an eye-to-
eye contact with the principal at $11.85 capped cost, and that 
includes everything--desserts, beverages, whatever you have--
versus this shotgun approach. So, people have done that for 
years that can't maintain meeting facilities. You just can't do 
it for an occasional meeting--if that is a good example.
    Chairman Talent. That is exactly what I am getting at. It 
is a fitting point to recognize the young lady from New York 
because of her excellent work on all of these subjects. In 
particular, I think, I know she has a very powerful interest in 
the meal deduction, and I am very pleased to recognize her for 
such questions that she may wish to ask.
    Ms. Velazquez. Thank you, Mr. Chairman.
    Mr. Joseph, I just would like to say that, based on the 
kind of support that we have seen here in this Committee, where 
it is pretty even Republicans and Democrats supporting 100 
percent deductibility, it is important that we understand that 
the only way we could enact this legislation is by getting 
bipartisan support, and we are going in that sense to make sure 
that we pass such legislation.
    I would like to ask you, do you have an idea of how many of 
these 6 million people would be covered by health insurance if 
we had 100 percent deductibility?
    Mr. Joseph. I don't have any idea. There is no doubt that 
it would be more people.
    Ms. Velazquez. I'm sorry. I'm sorry. I wasn't listening, 
please.
    Mr. Joseph. I said I don't have any numbers or estimates, 
but it stands to reason that more people would be covered.
    Ms. Velazquez. Have there been any surveys or other 
attempts to quantify the likely impact of this change?
    Mr. Joseph. I am not aware of any, but I will ask the 
people at NASE to inquire about that and get back to you.
    [The information may be found in the appendix.]
    Ms. Velazquez. Well, I guess that you answered that 
question. I would like to ask some questions to Mr. Wallace.
    First of all, Mr. Chairman, I would like to point out the 
fact that I wish that we had an IRS representative here, and I 
hope that in the next occasion that we have such an opportunity 
that we have a witness such as Mr. Wallace, that we bring in a 
person from the IRS to be able to react to your testimony, and 
in some way your accusations.
    Chairman Talent. If the gentlelady will yield for just a 
second, I agree totally. When he was saying what he was saying, 
which personally I agree with, we should have had the IRS to 
respond and to allow the Committee to inquire into how they've 
conducted things. If we have a hearing on this subject again, 
we definitely will have somebody from the IRS here.
    Ms. Velazquez. Thank you, Mr. Chairman.
    Mr. Wallace, I used to be a college professor, and I have 
to tell you that, if I had a student who reached the 
conclusions in the way you did, I would have failed him. Having 
said that, I would like to ask you, your testimony seems to 
indicate that the IRS is guilty of unreasonably forcing small 
businesses to use the accrual method of accounting, as opposed 
to the cash method. My question to you is, if the IRS has won 
most of the court tests involving the accrual versus cash basis 
question, fair to accuse or imply that the IRS of being on some 
sort of vendetta in this area? It seems to demonstrate to me 
that the IRS is simply carrying out the law as Congress 
intended.
    Mr. Wallace. I appreciate the opportunity to respond to 
that. I have watched the IRS for 20 years go after construction 
contractors and service providers. They first tried it from an 
inventory approach and were consistently knocked down in court 
cases. There was a specific court case that was decided. It was 
a court case that came out and said, ``If your merchandise is 
15 percent or more of your revenue, it is a significant income-
producing factor and you should be on the accrual method.'' 
That court case was a casket case in a funeral parlor. The IRS 
has taken that case and has applied it to various industries, 
and because of their success, they have tried it in the 
construction and service-related industries, and they have been 
successful.
    Ms. Velazquez. That is one court case compared to the many 
court cases that IRS won?
    Mr. Wallace. That is the foundation in their logic flow.
    Ms. Velazquez. Mr. Wallace, I take it that you think the 
accrual method costs more to maintain, putting aside the tax 
consequences? Do you have an estimate of the relative costs of 
each method?
    Mr. Wallace. I appreciate that type of comment, and as a 
CPA, I should probably be here supporting the IRS. I should 
probably be here supporting their actions, because I make more 
money. I make more money when the IRS comes in and says, ``You 
have to be on the accrual method, and because of that, you have 
to hire an experienced CPA who understands that.''
    But, coming down to what is common sense and how the 
industry can better function, I have to side with the 
contractor to say that, when we start in our business, we want 
to start and give our costs, whether they are attorney costs, 
CPA costs, insurance costs, whatever those obligations are, for 
the starting contractor or service provider to keep their costs 
as low as possible. The cash method can best make that happen.
    Ms. Velazquez. Can you tell me how much it would cost a 
business with $4 million in gross receipts to use the cash 
method, and how much more to use the accrual method?
    Mr. Wallace. From a tax and reporting--because we now have 
to hire personnel inside and outside to take care of that. If I 
was a guessing individual, based upon my experience, I would 
say $20,000 more a year.
    Ms. Velazquez. What about the tax implications of changing 
from the accrual method to the cash method? Does one method 
produce more tax savings than the other? Is one method 
potentially more easily abused than the other?
    Mr. Wallace. That is a good question. There are four basic 
methods a contractor canapply. There are two of them that we 
have talked about today; the cash and the accrual. The other one is the 
completed contract and the percentage of completion.
    Depending on the type of contractor, depending on when they 
invoice, depending on when their jobs are completed, any of 
those four methods can--I don't want to say manipulate, but can 
change your income reporting. It is clearly only a matter of 
time--if we start the year and end the year with all of our 
monies collected and billed, every method produces the same 
result. It is only a matter of timing. So, from an IRS 
perspective, they will get their money. They do get their 
money. It might not be this year. It might be the year 
following. Where the IRS is coming in and going after the cash 
method, they are getting their money on that timing, and 
because of the mandatory law requiring interest and penalties, 
that is where they're looking for their funds.
    Ms. Velazquez. Thank you, Mr. Wallace.
    Mr. Wordsworth, I would like to ask you, in terms of the 
meal deductibility. Do you know what percentage of the typical 
small firm's marketing budget will be devoted to meals and 
expenses? How does this compare to large firms?
    Mr. Wordsworth. I'm not sure I can answer your question in 
exactly that way. But, as I said before, and I want to comment, 
I enjoyed your comments so much in the beginning. I think you 
really have a handle on things.
    If you are a small business, your contracts and your 
contacts are made one-on-one. If you're one-on-one, you must 
meet somewhere. You must have a contract. You must have a 
presentation. So, I would say, not necessarily in numbers of 
occasions, but in the importance of the occasion, that you be 
able to sit down somewhere. You couldn't do it in the 
drycleaners. You couldn't do it in the metro. So, that is why 
restaurants are chosen as the chosen venue.
    Ms. Velazquez. Have you done any analysis of what an 
increasing meal deductibility might mean for those it benefits?
    Mr. Wordsworth. I haven't done an analysis myself, but I am 
aware of one that I sincerely agree with. In my State of 
Virginia, tourism is a great cash-flow item for us, which I 
have chaired for several years. I know that the Bureau of 
Economic Analysis, I believe, using their formula, the National 
Restaurant Association has determined that in my State the 
impact for the life of this increase would be about $145 
million. Now, tourism annually in Virginia does about $11 
billion. So it is a significant increase, and it is mostly 
vested in smaller businesses.
    Ms. Velazquez. Thank you.
    Mr. Manzullo [presiding]. Mr. Hill.
    Mr. Hill. Thank you, Mr. Chairman.
    Mr. Wallace, I particularly enjoyed your testimony, having 
worked with construction people most of my life. I want to 
visit with you a little bit about the issue with regard to the 
cash basis accounting.
    First of all, accrual accounting methods are far more 
complex. The reason that it is a good thing for small 
businesses to be able to do cash basis is that they can 
basically keep their records out of a checking account, or a 
very simple accounting system. In accrual accounting, you have 
to put receivables and payables and all that sort of thing. 
But, there are two kinds of accrual accounting systems that you 
made reference to. One is completed contract, and the other is 
percentage of completion.
    The IRS forces contractors--I think it is $5 million or 
more now have to go to percentage of completion method. The 
percentage of completion method is really complicated, isn't 
it?
    Mr. Wallace. Absolutely.
    Mr. Hill. Would you just comment about the added 
complexities that come from the percentage completion accrual 
method of accounting?
    Mr. Wallace. The thresholds are $5 million and $10 million. 
There are a couple of different thresholds, if you'll permit me 
to make that statement. Like I'm saying, there is the cash, the 
accrual, the completed contract, and the percentage of 
completion. The percentage of completion and the completed 
contract are accrual methods, in that you first have to have an 
accrual method to recognize your basic accounting methods. The 
completed contract and percentage of completion deal with the 
accounting related to the contracts. So, in addition to the 
accrual method, we now have to track accounting for each 
individual contract.
    Mr. Hill. It is like having a profit-and-loss statement for 
every job.
    Mr. Wallace. Correct. That is a good observation.
    Mr. Hill. One of the things that I discovered working with 
construction companies, or small business in general, is that 
cash is key. Most small businesses struggle for cash. Many 
small businesses show profits but don't show cash. In fact, one 
of the most troubling things I've ever experienced is watching 
people borrow money to pay their taxes, rather than borrowing 
money to build their business. I think one of the reasons 
Congress supports the cash method of accounting is for that 
reason; that is wants small business to succeed.
    Under the cash system--and you made this point in your 
testimony--it is a matter of timing. You don't avoid the tax. 
In fact, if you don't manage it well, you could wind up with a 
big tax problem. It could work the other way; you actually pay 
more in taxes. So, this isn't a tax avoidance; it is a tax 
timing. What it does is allow the business to pay the tax when 
it has the cash to do it.
    Mr. Wallace. That is correct. That is a good observation. 
So, if you look at the revenue, it is a neutral part of the 
provision when we talk about what it is going to cost the 
taxpayer to enact this. It is revenue-neutral.
    Mr. Hill. I would agree with that.
    Mr. Wordsworth, I happen to agree with you with regard to 
the deductibility of meals. I had a business where I had 
salesmen, and I decided when the IRS made this change that I 
was going to continue to pay those meal expenses, and that 
really made my accounting system complex, because then I had to 
do two profit and losses, one for the IRS and one for the bank, 
because of what was a deductible expense and what was not a 
deductible expense.
    I just ask you this: Is another potential to get to the 100 
percent to maybe put some limit on what is a deductible meal? 
Is that something that would make some sense as well?
    Mr. Wordsworth. As a matter of fact, that is what I have 
thought many times as an approach that should be used. I think 
the inception of the original act itself was to stop abuse. I 
think abuse would occur more in higher numbers. If you had a 
$50 lunch, I don't think that is middle America. I don't think 
that is small business. I think that is something else. But we, 
small business, and a reasonable lunch and a reasonable dinner 
got taken in the wake of pursuing the $50 lunch, and I don't 
recall in my 25 years that lunch occurring in my business.
    Mr. Hill. Your prices aren't that high? I can remember when 
I started my business, we had a two-room office. We had four 
people in those two rooms. When we had a customer come in, we 
took them to the coffee shop or we took them to the restaurant. 
As you said, that is where we did our business. The last thing 
you want to do, if you're prospecting, is let them pay the 
bill. So, the idea that we've taken that away, I mean, it is a 
legitimate business expense and it is important, particularly 
to small businesses, I think. So, I certainly will do whatever 
I can.
    Mr. Manzullo. Mrs. Christian-Christensen.
    Ms. Christian-Christensen. Thank you, Mr. Chairman. I 
really don't have any questions. I want to thank the witnesses 
for coming, and let me just say, as a member of the travel and 
tourism caucus, we supported the increase in the meal deduction 
last year, and we are pleased to support it again this year. As 
a physician, it really just makes good sense to allow the self-
employed to deduct their full insurance. The other issue is 
very, very complex, but I think what we're reaching for is 
simplicity and lifting burdens from small business. Thank you, 
Mr. Chairman, and thank you for your testimony.
    Mr. Manzullo. Mr. Pitts.
    Mr. Pitts. I yield back to Mr. Hill. I was enjoying his 
questions. [Laughter.]
    Mr. Hill. I apologize. I really don't have any more 
specific questions, other than--and any of you might want to 
address this--that Congress has been explicit in the past with 
regard to its intention for small businesses, and the IRS has 
consistently, in its interpretation, tried to shift that away 
from the intent of Congress. Do you believe that the language 
that is in this bill is sufficient to make adequate clarity to 
the IRS to deal with the concerns and issues that you have 
raised here? I would like to ask each of you to respond to 
that, and then I will yield back my time to the chairman. Thank 
you.
    Mr. Manzullo. Okay. Mr. Moore. Where are we? Oh, I'm sorry.
    Mr. Wallace. I believe there is adequate clarity, and if I 
have reading this from a CPA perspective, certainly the 
provisions for business meals, there is nothing left to doubt. 
The deduction for health insurance, there is nothing left for 
doubt there. I am sure that this cash-versus-accrual issue for 
the small service providers and contractors will, no doubt, 
continue to be--I know that there are some feelings that I have 
been overly aggressive in my comments, but I am more than able 
or willing to sit in front of an IRS representative, including 
the top dogs, because I have sat with them on many panels and 
had these same discussions, and I am adamant about my 
conversations related to this. I think this is absolutely 
needed,
    Mr. Joseph. I've been brought here to talk about health 
insurance, but I have to tell you, listening to my colleagues 
here talking about these other things, these are issues for us, 
too. We're on the accrual basis. I would much rather be on the 
cash basis. I used to be on the cash basis when we weren't a 
subchapter S corporation. It was better. It was easier. It was 
less complicated. A big part of my business is consulting, and 
I was talking during the break to my colleague here. Consulting 
clients think nothing of waiting four to six months or so to 
pay you. You bust your brains out for them, and six months 
later maybe the check comes. By that time, it is the new year 
and you've paid the taxes in the old year.
    Restaurants? I was in a restaurant yesterday in a business 
meeting. I'll be meeting a client in a restaurant tomorrow for 
probably four hours or so for a business meeting. It couldn't 
be more true. I used to have a larger business. I sold most of 
the business eight years ago and moved the business into the 
house for a lot of reasons; personal reasons were large among 
them. We have to use my dining room as a conference room. 
Luckily, we have a very nice dining room and it works pretty 
well. But, most of the time, if I am having a meeting, I will 
go to Clyde's in Chevy Chase, or something like that, and we 
will meet there. It is not an extravagance. I am not trying to 
beat the system or anything; it just works better.
    As far as health insurance goes, we aren't publishing in 
healthcare now. We used to publish in healthcare more, so I 
know a fair amount about uninsured Americans and stuff like 
that, and I think anything that will bring some more people 
into the tent will be good. I saw trends operating 10 years ago 
that I thought were going to bring more Americans under health 
coverage, and instead, it is going in the opposite direction. 
There are 5 or 10 million more Americans today than there were 
10 years ago, when it was viewed as more of a crisis, it 
seemed.
    So, I just want to associate myself with the other 
witnesses here and say that these are all important issues, not 
just for small business, but for America.
    Mr. Wordsworth. I certainly hope there is clarity. I 
remember the Family and Medical Leave Act. Coming out of 
Congress, I think the bill was 47 pages. The legislation and 
the code ended up being something like 900 pages, and it was 
interpretation upon interpretation versus the spirit versus the 
letter. So, I hope there is great clarity in this. The reason 
that I do hope there is great clarity is because these items 
affect so many people. It is such good that can be done. I hope 
that in the implementation, that the regulators, the people who 
write the code, carry out the intent of your act.
    Mr. Manzullo. Mr. Moore.
    Mr. Moore. Thank you, Mr. Chairman.
    Mr. Wordsworth, you and some of the other witnesses have 
made the point that, for small businesses, a lot of times a 
restaurant or other dining facility is the office, and I guess 
my question to you is that you also made the point that 
Congress, several years ago, addressed the issue of abuses by 
placing limitations on lunches or dinners.
    My question to you, then, is: If a cap is appropriate, what 
would you suggest would be an appropriate cap? I guess I'm 
agreeing with you that for somebody to go out and have a three-
martini lunch and spend $50 or $75 is probably abusive. But, 
what would be an appropriate cap? Twenty-five or $30? Do you 
have an idea?
    Mr. Wordsworth. Well, if you try to think about that 
comprehensively, geography has a lot to do with it. In North 
Carolina, a $25 lunch is extravagant. In New York, it might 
just buy you a hot ham and cheese. [Laughter.]
    Mr. Moore. What's wrong with hot ham and cheese?
    Mr. Wordsworth. Without mayonnaise. Hold the roll. But, I 
think a $50 lunch almost anywhere is pretty extravagant. I 
think $125 dinner is pretty extravagant, I would think. I would 
go so far as to say, I don't want to alienate my colleagues who 
may have those kinds of lunches, but small business, that 
people who qualified, and were covered under this act, if you 
were willing to spend $50 for that lunch or $125 for that 
dinner, it would have to be for a magnificent reason. This is 
the ultimate contract signing that will give you two years of 
revenue. So, in that case, that might be an appropriate reason. 
In that case, I would be willing to lose the deduction if it 
were that magnificent. But what is impaired by this is the 
ordinary, everyday, fact-of-life, pedestrian kind of marketing 
activity, is what got caught in the wake of the ship.
    Mr. Moore. Well, I understand that, but if the fact brought 
up here is correct and the average lunch is $11.60, the 
question is, if we are going to allow people to take 80 percent 
of $125 meal deduction without any limitation, and asking the 
United States taxpayers to subsidize that----
    Mr. Wordsworth. Well, in that case, as I said, in that 
case, if you had a $50 lunch, I would say you don't get to 
deduct it at all, because it would be such a small occasion and 
be worth it. I wouldn't even cover it.
    Mr. Moore. I want to apologize to the other Committee 
members. I am the new kid on the block here, a relatively new 
Member of Congress, I guess five months now, but I don't 
knowwhat discussion there has been regarding limitations placed on 
this, but I would think that might be an appropriate consideration. 
Thank you.
    Mr. Manzullo. Okay. We want to thank the first panel. But 
before we do, Jim, do you remember when I first got elected, I 
went to your restaurant when I think your dad was there with 
the finest barbecue ribs in the world. Do you remember that? 
[Laughter.]
    Mr. Wordsworth. I think I have your picture in our lobby. I 
do remember that very well, and I appreciate that.
    Mr. Manzullo. It wasn't a $92 lunch. It was very 
reasonable. We want to thank you for coming here. Is your 
father still involved in the restaurant?
    Mr. Wordsworth. Yes, he is. He is 79 years old.
    Mr. Manzullo. Is he down in North Carolina with your 
brothers?
    Mr. Wordsworth. Down in North Carolina with my brothers, 
who started a distribution company as a small business, and now 
they are the fourth largest in the U.S.
    Mr. Manzullo. That is great. That is a great example of a 
small business that was started by your grandfather. Is that 
right?
    Mr. Wordsworth. Actually, by my father, J.R. We call him 
``Big Foot.''
    Mr. Manzullo. That is great. We appreciate you taking your 
time to be here. Thank you for the courtesy of coming to 
testify before us.
    If we could have the next panel, please? We have our next 
panel, and what I would like to do is to introduce each of you 
and then put on the five-minute light. Please try to abide by 
that light, because I'm going to try to keep the members up 
here to the five-minute light, also.
    The first panelist is Terry Neese, who is the CEO at Terry 
Neese Personnel Service in Oklahoma City, Oklahoma, a corporate 
and public policy advisor for the National Association of Women 
Business Owners in Washington, D.C. She will be followed by 
Brian Reardon, who is Manager of Federal Public Policy for the 
NFIB, here in Washington. Then Bill Sinclaire, Senior Tax 
Counsel and Director of Tax policy, Economic Policy Division, 
at the U.S. Chamber of Commerce will testify, and then Dorothy 
Coleman, Director of Tax Policy for the National Association of 
Manufacturers in Washington, D.C.
    Ms. Neese.

STATEMENT OF TERRY NEESE, CHIEF EXECUTIVE OFFICER, TERRY NEESE 
                       PERSONNEL SERVICES

    Ms. Neese. Good morning, Mr. Chairman and Congresswoman 
Velazquez, and members of the Committee. I am Terry Neese. I 
own a business in Oklahoma City, and am past national president 
of the National Association of Women Business Owners, and 
currently serve as a consultant to NAWBO on corporate and 
public policy issues.
    NAWBO represents this country's 9 million women business 
owners. We are employing about 27 million workers today, and 
generating $3.2 trillion in annual revenues.
    I want to discuss today the simple tax relief proposals for 
small business, what they mean, and why they're important, 
especially for women-owned businesses and minorities.
    First, I want to talk about the increased small business 
expensing. Small businesses continue to invest in property and 
equipment in order to maintain growth and efficiency in the 
market place. Typically, small business owners will choose to 
pay for these assets in advance rather than finance the 
acquisition over time. This decision is based on the difficulty 
of obtaining term loans for small equipment acquisitions from 
lending institutions, as well as the business owners' desire to 
re-invest the profits back into the business for long-term 
growth, development, and stability.
    The current expensing limit of $19,000 is not allowing 
small business to keep up with the increasing costs of 
equipment and technology. An increase to $35,000 would enable 
the small business owner to maintain their equipment 
acquisition needs by reinvesting profits. They would also not 
incur a tax burden on the difference between cash expended and 
tax deduction allowed. This provision will assist in 
maintaining the wherewithal-to-pay concept, whereby taxable 
income is essentially equal to cash flow.
    Providing tax accounting relief to small business. Under 
current law, small businesses are required to use the accrual 
method of accounting for income tax reporting if they are 
involved in merchandise sales and maintain an inventory. 
Although this provision provides for a clear reflection of 
income earned, it does not necessarily result in a matching of 
taxable income to cash flow. Typically, the small business 
owner must maintain a material amount of inventory, as well as 
float a large amount of accounts receivable.
    On the other side, the small business owner will acquire 
the inventory with COD or 30-day payment terms. This timing 
difference creates a need for flexible financing from lending 
institutions who are not particularly interested in writing up 
small business credit lines to finance inventory and accounts 
receivable.
    In addition, funds must be borrowed in order to pay the 
respective income taxes on merchandise sold and included in 
taxable income, even though the proceeds from the sale have not 
been collected. This provision under the Small Employer Tax 
Relief Act will again assist in maintaining the important 
wherewithal to pay concept for small business.
    Repealing the Federal Unemployment Payroll Surtax. The 0.2 
percent surtax was intended to be a temporary increase to repay 
government loans from the Federal Unemployment Trust Funds. 
These loans were paid 11 years later, in 1986; yet, the surtax 
has continued to be assessed and collected.
    The fact that this surtax has continued 12 years past its 
original intended and represented purpose is truly an inequity 
that unfairly burdens the small business community. The Federal 
Unemployment Tax is assessed on the first $7,000 of wages per 
employee per year. Thus, the turnover of employees and the 
hiring of temporary employees or seasonal employment further 
escalates the employment tax burden on the small business 
owner. This 0.2 percent surtax should be repealed now.
    The 80 percent tax deduction for entertainment and meal 
expenses. Small minority and women-owned businesses typically 
rely on close personal relationships and customer service to 
compete for sales, rather than on expensive advertising 
campaigns. Expenditures for meals and entertainment are often 
an important part of this effort. Relationship marketing is key 
to women-owned businesses. Being able to sit down across the 
table from a client or prospective client is the best form of 
sales and marketing techniques available.
    The prior changes in the tax laws that disallowed 50 
percent down to 30 percent of these expenditures for tax 
purposes have disproportionately increased the selling costs 
for many small and women-owned businesses. Ten years ago, 
business and travel meals were 100 percent tax deductible, as 
ordinary and necessary expenses. Looking for revenue, Congress 
lowered the tax deduction to 80 percent in 1987, and 50 percent 
in 1994. This results in an unfair and disproportionate tax 
increase on the restaurant and entertainment industries and the 
businesscustomers they serve.
    This cutback has been particularly punitive for the small 
business community, and this is evidenced by the fact that the 
White House Caucus on Small Business cited its restoration as 
one of its top two priorities. So, reinstating the 80 percent, 
and ultimately 100 percent, tax deduction for meals and 
entertainment expenses is the right thing to do for this 
Congress, and the fair thing to do for women-owned business.
    One hundred percent deductibility of health insurance for 
the self-employed. This is a no-brainer. The fact that the 
self-employed can not deduct 100 percent of healthcare premiums 
is a glaring inequity between large corporations and the self-
employed. The 100 percent deductibility of health insurance for 
the self-employed is favored by large majorities of both 
parties in both houses of the Congress, spanning every region 
of the country and every political philosophy, including the 
White House. Now, we need a strong political will to find the 
formula that can make the change happen. Over 16 million 
Americans could benefit from this tax relief.
    I would be remiss if I didn't also mention the onerous 
death tax issue in this testimony. Relief from the current 
death tax enables children to keep what they rightfully 
inherit, such as the farm that has been in their family for 
generations, or the small business that has helped them live 
the American dream. Now, many have to sell their family legacy 
just to pay the taxes. This is an issue near and dear to my 
heart. My daughter recently joined my firm. I want her to carry 
on my legacy. She, in turn, may want her daughter, my 
granddaughter, to carry on my legacy. Will we be able to do 
that without selling the company to pay the death taxes? Only 
this Congress can answer that question, and that is a huge 
burden that you can eliminate this year. Thank you very much 
for allowing me the opportunity to present this testimony.
    [Ms. Neese's statement may be found in the appendix.]
    Mr. Manzullo. Thank you very much.
    Mr. Reardon, if you could please follow the lights on 
there. I want to get the testimony in before we get a huge 
series of votes on the defense bill.

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

    Mr. Reardon. Okay, I will go very quickly. Good morning, my 
name is Brian Reardon. I am the Manager of Federal Public 
Policy at the National Federal of Independent Businesses. We 
represent 600,000 independent businesses nationwide, and I 
appreciate the opportunity to represent or present the views of 
small business owners on the legislation outlined by Chairman 
Talent today.
    NFIB supports all of the provisions contained in this 
legislation, including the reduction in small business tax 
rates, 100 percent deductibility for the self-employed on their 
insurance costs, and increasing the business meal deduction.
    Right now, though, I would just like to focus on two 
provisions within the bill. That is the repeal of the FUTA 
surtax, and increasing small business expensing.
    NFIB supports comprehensive reform of the Federal 
unemployment system. Right now, the Federal Government collects 
payroll taxes to fund the administrative and extended benefits 
of the Nation's unemployment system, and the States collect 
payroll taxes to fund the regular benefits. There are four good 
reasons why this system should be reformed.
    First, payroll taxes at the Federal level have never been 
cut. Since their enactment in 1937, they have only gone up, and 
while Congress, when it has a tax bill before it, tends to 
focus on the income tax side of the burden, for most small 
employers, for most workers, the payroll tax burden is 
significantly higher than income taxes.
    The second reason is, Federal taxes collected by the 
Federal tax, the FUTA tax, are about twice as much as is 
necessary to finance the system. In 1997, FUTA collected $6.1 
billion from FUTA, but Congress only spent $3.5 billion. FUTA 
taxes should be cut to reflect the costs of the system.
    Third, the system is simply too complex. Right now, 
employers pay both a Federal unemployment tax and a State 
unemployment tax. That is twice the collection points, twice 
the complexity, twice the paperwork burden, and twice the 
opportunity for errors in fines from the IRS. There should only 
be one point of collection.
    Finally, there is the FUTA surtax. As Terry mentioned, this 
temporary tax was enacted in 1976 to repay the borrowings from 
the unemployment trust funds. It was fully repaid back in 1987, 
and Congress has extended this surtax five times. Chairman 
Talent's bill would repeal this surtax, and we certainly 
support that. This temporary tax has survived the Carter 
Administration, the Cold War in the Soviet Union, and NIFB's 
hope is that it won't survive the millennium.
    Expensing. Chairman Talent's bill would also raise the cap 
on small business expensing from $19,000 to $35,000. The 
purpose of small business expensing is two-fold. First, 
simplification, and second, cash flow.
    Regarding cash flow, small business expensing encourages 
small businesses to invest by reducing tax liability and 
increasing their cash flow. Almost 70 percent of our members 
report having made a capital expenditure in the last three 
months. Expensing allows those members to recoup some of the 
cost in the first year that they make the expenditure.
    For those members who report having a capital expenditure 
in the last three months, almost half of them report having a 
capital expenditure that exceeds the current cap of $19,000 for 
small business expensing. By raising the cap, Chairman Talent's 
bill helps reduce the cost of investment for many of those 
small businesses.
    The second reason is simplification. Deducting investments 
immediately is simply simpler than depreciating them over a 
number of years. For relatively small capital purchases, 
maintaining records and calculating depreciation schedules is 
perhaps the most complicated exercise a small business has to 
go through. They have to determine appropriate categories and 
schedules; they have to keep extensive records. By raising the 
cap on small business expensing, Congressman Talent's bill 
would allow our members to sidestep much of the unnecessary 
complexity, allowing them to focus more on their businesses.
    In conclusion, taken as a whole, the Talent bill goes a 
long way towards creating a simpler, fair tax code for small 
business, and NFIB applauds the efforts of this Committee to 
move this forward.
    If I can make just one final point, and that is today is 
June 9, and that is the 46th anniversary of what is perhaps the 
most onerous small business or small employer tax, which is 
employee tax withholding. Forty-six years ago, Congress enacted 
withholding in order to accelerate tax receipts to pay for 
World War II. We still have withholding with us, and I think 
that it is appropriate on this day that Chairman Talent and 
other members of this Committee are introducing this bill and 
attempting to simplify tax complexity for small employers. 
Thank you very much.
    [Mr. Reardon's statement may be found in the appendix.]
    Mr. Manzullo. Thank you, Mr. Reardon.
    Mr. Sinclaire.

STATEMENT OF WILLIAM SINCLAIRE, SENIOR TAX COUNSEL AND DIRECTOR 
OF TAX POLICY, ECONOMIC POLICY DIVISION, CHAMBER OF COMMERCE OF 
                       THE UNITED STATES

    Mr. Sinclaire. Good morning. I am Bill Sinclaire, and I am 
with the U.S. Chamber of Commerce. The U.S. Chamber appreciates 
this opportunity to express its views on the Small Employer Tax 
Relief Act of 1999, and we would like to thank Chairman Talent 
for introducing this legislation, and the co-sponsors for their 
endorsement.
    The U.S. Chamber is the world's largest business 
federation, representing more than 3 million businesses and 
organizations of every size, sector, and region. More than 96 
percent of the Chamber's members are small businesses with 100 
or fewer employees, 71 percent of which have 10 or fewer 
employees. Accordingly, we are particularly cognizant of the 
problems of smaller businesses, as well as issues facing the 
business community overall.
    Simply stated, taxes should be levied in ways that minimize 
their negative impact on taxpayers, economic growth, and the 
international competitiveness of American business. The tax 
bias against work, savings, and investment should be minimized. 
The tax system should be made as simple and easy to comply with 
as is consistent with equitable administration of the tax laws. 
Particular emphasis should be placed on monitoring and reducing 
the administrative and paperwork burdens on small businesses.
    Small business is the backbone of America's economy. They 
contribute almost one-half of all sales in this country and 50 
percent of private gross domestic product. Small businesses 
also provide more than half of all employment and about two-
thirds of all new jobs. In recent years, the number of new 
businesses has been at record levels, and the interest in 
starting and owning a small business has been dramatic. 
Nonetheless, parity with large businesses does not exist for 
small businesses under the tax law. It is time to remove 
inequities between small and large businesses and to provide 
small businesses with incentives to grow and create jobs.
    The Small Employer Tax Relief Act of 1999 brings together 
several small business tax provisions and would provide 
substantial tax relief for America's small businesses. The bill 
would remove inequities between small businesses and large 
businesses, foster savings and investment, and bolster job 
growth. Specifically, this legislation would modify six areas 
of the Federal tax code. Namely, it would increase the 
deduction for health insurance costs for the self-employed. It 
would increase the expense deduction for meal and entertainment 
expenses. It would increase the expensing allowance for small 
businesses, the Section 179 expensing amount to $35,000. It 
would repeal the FUTA surtax. It would create parity on the 
maximum tax rate at 34 percent between small businesses and 
corporations, and it would provide accounting relief to small 
businesses by allowing them to use the cash method of 
accounting without limitation.
    Our long-term economic growth depends upon sound economic 
and tax policies. Today, we are critically shortchanging 
ourselves and, more importantly, our children, as we commit too 
many of our scarce resources into consumption and away from 
prudent investment. Our tax system encourages waste, retards 
savings, and punishes capital formation, all to the detriment 
of long-term economic growth. As we prepare for the economic 
challenges of the next century, we must orient our current 
fiscal policies in a way that encourages more savings, more 
investments, more productivity growth, and, ultimately, more 
economic growth.
    The Chamber believes the tax reforms for small businesses 
specified in the Small Employer Tax Relief Act of 1999 would 
reduce the tax burden, create jobs, and increase the savings, 
investment, and productivity growth. The Chamber therefore 
wholeheartedly supports this legislation.
    Mr. Chairman, members of the Committee, thank you for 
allowing me to testify today, and I would ask that my written 
comments by incorporated into the record. Thank you.
    [Mr. Sinclaire's statement may be found in the appendix.]
    Mr. Manzullo. We will incorporate all of the written 
comments from all of the witnesses unless there is any 
objection to it. Thank you, Mr. Sinclaire.
    Ms. Coleman.

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

    Ms. Coleman. Thank you. My name is Dorothy Coleman. I am 
the Director of Tax Policy at the National Association of 
Manufacturers. Mr. Chairman, members of the Committee, thank 
you for the opportunity to come before you today to talk about 
tax rate relief for S corporations.
    The NAM is the largest broad-based industry trade group in 
the United States. Our 14,000 members include over 10,000 small 
and medium manufacturers. About 41 percent of our small and 
medium manufacturers are organized as S corporations.
    Mr. Manzullo. If I could interject?
    Ms. Coleman. Sure.
    Mr. Manzullo. The new president of the NAM is a small 
business person in suburban Chicago, is that correct?
    Ms. Coleman. You're right. Tink Campbell.
    Mr. Manzullo. Tik.
    Ms. Coleman. Tink.
    Mr. Manzullo. He does have under 50 employees at his 
manufacturing facility?
    Ms. Coleman. Yes.
    Mr. Manzullo. Thank you.
    Ms. Coleman. You are welcome.
    The NAM's 1999 agenda includes a number of pro-growth tax 
incentives, including a reduction in S corp tax rates. For our 
small and medium manufacturers, S corporation tax rate relief 
is one of the top tax issues that would have the most positive 
impact on their company's ability to grow.
    We applaud you for including S corp tax rate relief in the 
Small Employer Tax Relief Act of 1999. This morning I would 
like to briefly outline the history of S corps, discuss some 
recent tax law changes, and, finally, describe why S corp rate 
relief is so important to our members.
    Congress created subchapter S corps more than 40 years ago 
to give owners of small and medium companies more flexibility 
in setting up and operating their businesses. This hybrid mix 
of a partnership and corporation was specifically designed to 
encourage the growth and stability of small and medium 
businesses by allowing owners to maintain control of their 
companies while benefiting from the liability protections 
afforded corporate shareholders.
    For more than four decades, American business owners, 
particularly small and mediumcompanies, have recognized the 
value of this unique corporate structure. Presently, there are more 
than 2 million businesses in the United States operating as S corps.
    Over the years, lawmakers have passed additional laws to 
encourage the creation of S corps. Legislation enacted in 1982, 
1996, and 1997, simplified and eased many of the S corp rules, 
making it easier for companies to form S corps, and also more 
difficult for companies to inadvertently terminate their S corp 
status.
    S corps received a real boost in 1986 when legislators 
lowered tax rates, and the individual rate ended up below the C 
corp rate. The rate differential provided an additional 
incentive for businesses to organize as S corps, since S corp 
income, which flows through to shareholders, was taxed at the 
lower individual rate.
    By 1993, nearly half of all U.S. corporations were S corps. 
However, legislation enacted that same year dealt a major blow 
to S corporations. The 1993 Omnibus Budget Reconciliation Act 
raised the highest marginal tax rate for individuals from 31 
percent to 39.6 percent, almost six percentage points higher 
than the comparable C corp rate, which remained at 34 percent.
    Consequently, S corporations, as pass-through entities, now 
pay a higher tax rate than C corps on income that is reinvested 
in their businesses. The tax rate changes enacted in 1993 
represent a stark departure from Congress' strong support for S 
corps, since they actually discourage small business owners 
from reinvesting earnings back to their corporations.
    To put it simply, S corp owners now pay a higher tax than C 
corporations on money used to develop new products, enter new 
markets, and hire additional employees. The higher tax rate is 
particularly harmful to S corp manufacturers who have to make 
large capital investments to grow their business and improve 
their competitive position. These companies typically do not 
have access to capital markets that C corporations have, and 
have to finance capital investment from their cash flow. 
Increased investment translates into additional jobs. It is 
estimated that, for every $100,000 that is reinvested, a small 
manufacturer can create three to four new jobs.
    Recent surveys conducted by the NAM support these 
conclusions. In particular, the surveys show a dramatic decline 
in investment, R&D, and employee hiring among small 
manufacturer S corporations after enactment of the 1993 tax 
law. For many companies, changing from S corp to C corp status 
is not an option, in part because of administrative costs and 
planning problems.
    There are ways to address the problem. One proposal 
advocated by the NAM would level the playing field for S corps 
by applying a maximum tax rate of 34 percent to the first $5 
million of S corp income that is reinvested in the business or 
used to pay taxes. Providing rate relief for S corps is an 
opportunity for Congress to continue the mission it began in 
1958 when lawmakers first established S corporations. In fact, 
given the critical role of small and medium business in the 
United States economy, it is imperative that Congress correct 
the economic injustice of the 1993 tax increases. Now is the 
time to level the playing field for S corporations and 
encourage entrepreneurs who are trying to grow their business.
    Thank you for your time.
    [Ms. Coleman's statement may be found in the appendix.]
    Mr. Manzullo. Thank you very much. I have just a couple of 
questions.
    Ms. Neese, you mention that by increasing the deductibility 
of health insurance to 100 percent, there could be up to 16 
million people added to the rolls of the insured. Was that in 
your statement?
    Ms. Neese. Actually, those figures came from a research 
firm in California. For me, personally, I have 12 employees and 
I pay 80 percent of their health insurance premiums today. If I 
had 100 percent deductibility of those insurance premiums, I 
would cover it 100 percent and I would also cover their spouses 
and their children. I don't cover spouses and children today.
    Mr. Manzullo. You can deduct the full cost of health 
insurance policy. If they were self-employed, they could only 
deduct a certain percentage of it. Isn't that correct? Did I 
get that right?
    Ms. Neese. I'm----
    Mr. Manzullo. For yourself? For your own policy?
    Ms. Neese. Right.
    Mr. Manzullo. Brian.
    Mr. Reardon. If I could jump in, I think there are about 16 
million self-employed individuals in the United States.
    Mr. Manzullo. That don't have insurance?
    Mr. Reardon. No, just 16 million. There are about 3 million 
that do not have insurance. So, out of the 16 million people 
who would benefit from increasing the deduction for self-
employed insurance costs, 3 million right now don't have any 
insurance at all. So, this provision would represent about a 10 
or 15 percent health insurance cut for them, which is 
significant.
    Mr. Manzullo. Plus members of their family?
    Mr. Reardon. Very much so.
    Mr. Manzullo. So, this figure could be--what?--10 million? 
Five to 10 million? Somewhere in there?
    Ms. Neese. And their children and spouses. If you look at 
the 16 million self-employed--and they're not all covered 100 
percent--plus their spouses and children, you are looking at a 
huge number that we could take off of the uninsured rolls.
    Mr. Manzullo. I think it is very difficult to come up with 
the actual figure of self-employed people who don't have 
insurance. There is no reporting form from the government, at 
least on that one yet. The best figures I saw are based on some 
pretty rough estimates. Obviously, the more people who become 
insured, the lower the premiums become.
    I have a question with regard to expensing of equipment. 
Obviously, those businesses that have a lot of equipment, such 
as restaurants, are in different positions. But those who don't 
have such a heavy investment, can anyone estimate the average 
costs of annual equipment purchases for the typical small 
business owner? Any real rough guesses out there? The purpose 
of the question, obviously, is with regard to increasing the 
amount that is expensed as opposed to amortized. Anybody want 
to take a stab at that?
    Mr. Reardon. The best numbers I have are the survey I 
mentioned in my testimony. We have the whole range here, but, 
essentially, 48 percent of our members who had capital 
expenditures in the last three months, and that was 7 out of 10 
of our members had capital expenditures exceeding $20,000. So, 
I can provide these numbers.
    [The information may be found in the appendix.]
    Mr. Manzullo. Exceeding by how much? Do you have an idea?
    Mr. Reardon. Twenty-two percent were between $20,000 and 
$50,000. Twelve percent were between $50,000 and $100,000. 
Eleven percent between $100,000 and $500,000, and then 3 
percent were above that.
    Mr. Manzullo. Thank you.
    Ms. Neese, did you want to comment on that?
    Ms. Neese. In my business specifically, you look at the 
$19,000 and you look at the Y2Kproblem, and replacing the 
computers and trying to get Y2k compliance, $19,000 is minuscule. I 
just brought my company up to speed on the Y2K problem, and hopefully, 
I am Y2K okay at this point, but I am a small business and I spent 
close to $40,000.
    Mr. Manzullo. The service industry is particularly being 
hit with the extreme cross of computers and computer 
technology. Mr. Sinclaire, did you want to comment on the 
question?
    Mr. Sinclaire. We do not have any specific numbers; 
however, on the issue, there are other aspects. Many of the 
small business people that I speak with, their largest asset--
as was mentioned earlier, they don't have offices; they meet in 
restaurants; they are also very mobile--so, their biggest 
investment is in their motor vehicle, and under section 179, 
motor vehicles are excluded, and that is something that should 
be thought about being added for the small business person. 
That can be their largest investment.
    Also, the Section 179 amount phases out at $200,000. That 
$200,000 cap has been there for a number of years, and we would 
submit that there should be some thought about changing that 
cap or indexing it, and they both would be helpful to small 
businesses.
    Mr. Manzullo. Mrs. Coleman.
    Ms. Coleman. Since manufacturing is such a capital-
intensive industry, the vast majority of our members, can't 
take advantage of the current expensing provisions, 
specifically, for what Mr. Sinclaire mentioned, because it 
phases out after you invest $200,000 a year.
    Mr. Manzullo. Okay. Ms. Velazquez.
    Ms. Velazquez. Thank you.
    Mr. Reardon, the bottom line in regards to assisting 
business through tax breaks is to enable them to expand. 
Increasing the expensing allowance will certainly allow a 
business to expand. Are you aware of any analysis that shows 
what type of job creation we can expect through the enactment 
of the increased expensing to $35,000?
    Mr. Reardon. I'm not, but I will search the records and see 
if I can come up with something.
    [The information may be found in the appendix.]
    Ms. Velazquez. Have any of you done any analysis? Do you 
have any numbers? Thank you.
    Ms. Coleman, one of the bill's provisions would reduce the 
top individual income tax rate from 39.4 to 34 percent for 
productive income derived from small businesses. This means 
that individuals with the same income, but derived from 
different sources, will be taxed at different rates. My 
question is, isn't a proposal which would tax similarly-
situated taxpayers at different rates potentially both 
confusing and unfair?
    Ms. Coleman. Well, we are looking at it more from the 
business, the S corporation being taxed at the same rate that 
the C corporation is. Right now, if you are an S corporation 
and you are trying to buy a piece of equipment, and a C 
corporation is trying to buy the same piece of equipment, you 
are actually paying more, simply because the money that you are 
using to buy that equipment to make that investment is taxed at 
a much higher rate than the C corporation.
    Ms. Velazquez. Isn't this proposal unduly complex in an era 
when many are seeking greater simplicity in the tax code? Could 
this go too far in the opposite direction?
    Ms. Coleman. I don't think that I'm prepared to answer that 
right now.
    Ms. Velazquez. When you are prepared, can you send it?
    Ms. Coleman. I certainly will.
    [The information may be found in the appendix.]
    Ms. Velazquez. Does this change potentially give rise for 
conversion from C corporations to S status, or some other form 
of ownership, which will qualify for the next tax treatment?
    Ms. Coleman. Pardon me?
    Ms. Velazquez. Does this change potentially give rise to 
conversion from C corporation to S status or some other form of 
ownership, which would qualify for the next tax treatment?
    Ms. Coleman. I don't know that that is necessarily true. I 
think businesses decide whether to become an S corp or a C corp 
for non-tax reasons. There are also State law ramifications. 
There are restrictions on S corps, restrictions on the number 
of shareholders, and who can be shareholders. So it is not a 
form of business that works for every company.
    Ms. Velazquez. What specifically are the administrative 
costs and planning problems that make conversion from S to C 
status so difficult? Is this the real problem, or is it that 
profits that are through-in are taxed at both the corporate and 
individual levels?
    Ms. Coleman. Well, as I mentioned in my testimony, Congress 
set up S corporations specifically for small businesses to give 
them the flexibility and the control of ownership, and also the 
limited liability protections. The C corporation can be 
publicly traded. There are less restrictions on shareholders. 
The tradeoff for becoming an S corp, there is a tradeoff in 
that you are limited on the number of shareholders, and there 
are also, again, some State law limitations on a state-by-state 
basis. I don't think you can really compare. It is not easy to 
move from one to the other. There are a lot of factors that go 
into that decision.
    Ms. Velazquez. Your proposal to limit a rate reduction only 
to reinvested profits is interesting. This is quite a bit more 
targeted than the provision in the SETRA bill, isn't it?
    Ms. Coleman. Yes, it is.
    Ms. Velazquez. It also seems to me to be less complex and 
probably less costly.
    Ms. Coleman. I believe so. Most of our members are S 
corporations. In fact, that is why I'm testifying specifically 
on their problem. Certainly, Mr. Talent's bill would address 
our concerns and provide the relief, but as far as the other 
types of entities, I can't comment on that.
    Ms. Velazquez. Ms. Neese, other witnesses have suggested 
that the problem with regard to the cash-versus-accrual 
accounting method is a narrow issue centering on alleged 
stretching of the definition of inventory by the IRS. Yet, your 
testimony seems to say that small firms of all types, including 
those that do carry meaningful inventories, suffer from having 
to use the accrual method. Do this mean that the issue is a 
larger one than what people are saying here?
    Ms. Neese. I think it is a larger issue. Let me refer to my 
tax accountant here for a second because I want to be succinct 
to your question, so that I can get it right.
    Ms. Velazquez. Ms. Neese? If you want, she could provide 
the explanation.
    Ms. Neese. We'll get you some information in writing.
    Ms. Velazquez. Thank you.
    [The information may be found in the appendix.]
    Ms. Neese. But if I could go back to the S corporation 
question just a moment that you were talking about, an S 
corporation is first a C corporation. So you can go back to it 
by giving up the election to be taxed as a C. It is 
complicated. We can also send you some things back in writing 
on that. I just wanted to put that in for the record.
    [The information may be found in the appendix.]
    Ms. Velazquez. I'm finished with my questions, Mr. 
Chairman.
    Mr. Manzullo. Well, that is pretty good timing. I pushed 
you along and then the bells went off for what I think will be 
a series of votes. We want to thank you for coming before us. 6
    I do have a very short question. On this issue of the 
inventories, the actual amount of tax that is paid is really 
not any more, if you use the accrual versus the cash basis. It 
is just that there is more of an accounting function and more 
papers that have to be filed. Is that a correct statement?
    Mr. Sinclaire. It is a timing question. If you boil the 
Federal Income Tax Code down to its basics, there are two 
parts: What is income, and when is it income? Going from cash 
to accrual, you determine when it is income. Generally, you 
would pay the same amount of tax, but it is spread over a 
different period of time or different tax years. In that sense, 
there is no difference. Now, you have the time value of money. 
You are giving your money to the government earlier and you 
don't have your money available, so it is a cash-flow problem 
also.
    Ms. Neese. The other issue is--and my inventory are people. 
I am in the human resource business.
    Mr. Manzullo. So you're on the cash basis?
    Ms. Neese. Yes. But, many times you have to pay taxes 
before you ever receive your money, based on what you think 
might come in.
    Mr. Manzullo. Based upon billing?
    Ms. Neese. Yes, and that is pretty tough.
    Mr. Manzullo. Mr. Reardon.
    Mr. Reardon. I also think that, under the accrual method, 
there is the opportunity to overpay your taxes one year and 
then you have to go back and get a refund. You have to file a 
form, and it takes a long time to get your money back, which is 
what Bill referred to.
    Ms. Neese. If I could comment on that for just a second?
    Mr. Manzullo. Sure.
    Ms. Neese. I cannot tell you how many thousands of dollars 
that I have overpaid, and it takes sometimes two years to get 
the money back. It takes forever. And when you are talking 
thousands and thousands of dollars, you are talking thousands 
of dollars that I could have been using for advertising or 
other things in my business to continue to build my business 
when it is sitting at the IRS.
    Mr. Manzullo. Okay. Again, we want to thank you. I want to 
leave the record open for a week. Let's see, who is giving 
additional information? Are you, Ms. Neese? In a couple of 
weeks? Can you get that to us within a week? We will make that 
part of our permanent record. Again, thank you for coming. We 
appreciate it very much.
    Ms. Neese. Sure.
    Ms. Coleman. Sure.
    [Whereupon, at 12:10 p.m., the Committee was adjourned.]


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