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




 
   REPEAL OF THE INSTALLMENT METHOD OF ACCOUNTING FOR ACCRUAL BASIS 
                               TAXPAYERS

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

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 29, 2000

                               __________

                             Serial 106-51

                               __________

         Printed for the use of the Committee on Ways and Means

                     U.S. GOVERNMENT PRINTING OFFICE
66-735 CC                    WASHINGTON : 2000




                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma                LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington            MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma                JIM McDERMOTT, Washington
JERRY WELLER, Illinois               JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri              RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado


Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.


                            C O N T E N T S

                               __________

                                                                   Page

Advisory of February 16, 2000, announcing the hearing............     2

                               WITNESSES

U.S. Department of the Treasury, Joseph Mikrut, Tax Legislative 
  Counsel........................................................     8

                                 ______

American Bar Association, Section of Taxation, Pamela F. Olson...    30
National Federation of Independent Business, and Jeremiah's 
  Tavern, David Crosby...........................................    23
U.S. Chamber of Commerce, and Savoy Restaurant, Darryl A. Hill...    26

                       SUBMISSIONS FOR THE RECORD

American Institute of Certified Public Accountants, statement....    40
National Association of Manufacturers, statement.................    41
National Association of Professional Insurance Agents, 
  Alexandria, VA, statement and attachments......................    43
Printing Industries of America, Alexandria, VA, statement........    45


   REPEAL OF THE INSTALLMENT METHOD OF ACCOUNTING FOR ACCRUAL BASIS 
                               TAXPAYERS

                              ----------                              


                       TUESDAY, FEBRUARY 29, 2000

                  House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 1:04 p.m. in 
room 1100, Longworth House Office Building, Hon. Amo Houghton 
(Chairman of the Committee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                Contact: (202) 225-7601
FOR IMMEDIATE RELEASE

February 16, 2000

No. OV-15

  Houghton Announces Hearing to Review the Repeal of the Installment 
            Method of Accounting for Accrual Basis Taxpayers

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing to review last year's repeal of the 
installment method of accounting for accrual basis taxpayers. The 
hearing will take place on Tuesday, February 29, 2000, in the main 
Committee hearing room, 1100 Longworth House Office Building, beginning 
at 1:00 p.m.
      
    Oral testimony at this hearing will be from invited witnesses only. 
Invited witnesses include the U.S. Department of the Treasury, 
organizations representing small businesses, and tax experts. However, 
any individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    The accrual method of accounting generally requires that taxpayers 
recognize income in the year in which the right to receive the income 
occurs, regardless of whether the taxpayer actually receives the cash 
in that year. The installment method of accounting allows an accrual 
basis taxpayer to defer recognition of income until the taxpayer 
actually receives payment.
      
    Repeal of the installment method for accrual basis taxpayers was 
included in the Ticket to Work and Work Incentives Improvement Act of 
1999, which was signed into law on December 17, 1999 (Public Law 106-
170).
      
    Since the repeal of the installment method for accrual basis 
taxpayers, concerns have been raised regarding the unanticipated 
effects on small businesses. The repeal has caused hardships for the 
owners of small businesses when they try to sell the business by 
accelerating when taxes must be paid or by lowering the amount offered 
by potential buyers.
      
    In announcing the hearing, Chairman Houghton stated: ``It appears 
that last year's repeal of the installment method for accrual basis 
taxpayers has had unintended consequences for small businesses. We need 
to take another look at this and first see what the Administration can 
do to straighten it out, and then look to see what, if anything, 
Congress can do to help.''
      

FOCUS OF THE HEARING:

      
    The focus of the hearing is to review the effects of the repeal of 
the installment method of accounting on small business owners and to 
discuss possible regulatory and legislative solutions.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect or MS Word format, with their name, address, 
and hearing date noted on a label, by the close of business, Tuesday, 
March 14 , 2000, to A.L. Singleton, Chief of Staff, Committee on Ways 
and Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Subcommittee on Oversight office, room 1136 Longworth 
House Office Building, by close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1 
format, typed in single space and may not exceed a total of 10 pages 
including attachments. Witnesses are advised that the Committee will 
rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.
      

    Note: All Committee advisories and news releases are available on 
the World Wide Web at `http://www.house.gov.ways__means/'.
      

    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      

                                


    Chairman Houghton. Good afternoon. We are here to discuss 
the installment method of accounting for accrual basis 
taxpayers. We are here to discuss this particular issue. I know 
the topic may sound a little dry, but I assure you that I have 
heard from many small businesses that its repeal has created 
real hardships to small business owners around the country.
    The accrual method of accounting, as many of you know, 
generally requires that taxpayers recognize income in the year 
in which the right to receive income occurs, regardless of when 
the taxpayer actually receives cash. The installment method 
allows an accrual basis taxpayer to defer recognition of income 
in some cases until the taxpayer actually receives payment. The 
repeal of the installment method has caused hardships when 
owners try to sell their small businesses by speeding up when 
taxes must be paid or by lowering the amount offered by 
potential buyers.
    The repeal of the installment method was first proposed by 
the administration last February in the fiscal year 2000 
budget. The repeal was included in the tax bill the Committee 
passed last June. And it was finally included in the Ticket to 
Work and Incentives to Work Improvement Act that was signed 
into law in December. I don't believe the administration or 
Members of this Committee or small business trade groups 
realized last year how far reaching this proposal was.
    So today marks the first step to correct the unintended 
consequences. I want to thank Secretary Summers and his staff--
particularly Joe Mikrut--for working so quickly to draft 
guidance to resolve some of the problems that the repeal of 
this provision has caused. I am interested in hearing what they 
have come up with.
    I am also pleased that our colleagues, Wally Herger, John 
Sweeney, John Tanner, and Jerry Kleczka have joined us. They 
responded quickly by introducing legislation to repeal the 
repeal, and it is my hope that we can act soon to fix this 
problem that has caused so many businessowners--such as the two 
witnesses we have here today--so much concern.
    Chairman Houghton. Now I am pleased to yield to our 
distinguished ranking Democrat, Mr. William Coyne.
    Mr. Coyne. Thank you, Mr. Chairman, and thank you for 
holding this hearing.
    In recent months, the Ways and Means Oversight Subcommittee 
has received complaints from the small business community about 
the recent repeal of the installment method of accounting for 
accrual basis taxpayers. The new law appears to have had 
unexpected consequences for many small businesses throughout 
the country.
    This repeal provision was enacted into law as part of the 
Ticket to Work and Incentives Act of 1999. Currently the 
Department of the Treasury is finalizing regulations to 
implement the new rules.
    I applaud the Subcommittee chairman, Chairman Houghton, for 
scheduling today's hearing. Testimony form the Department of 
the Treasury, National Federation of Independent Businesses, 
U.S. Chamber of Commerce, and the American Bar Association will 
provide us with an analysis of what, if anything, needs to be 
done in providing regulatory guidance or statutory change.
    Also I would like to welcome to our hearing two former Ways 
and Means Oversight Subcommittee members, Congressman Jerry 
Kleczka of Wisconsin and Congressman John Tanner of Tennessee. 
They have both introduced legislation this year to repeal the 
installment method provisions of the 1999 act and return to 
prior law. I understand we will be hearing from them for an 
opening statement. Is that correct, Mr. Chairman?
    Chairman Houghton. Yes.
    Mr. Coyne. So Jerry and John will make their case for their 
legislation in their opening statement.
    Thank you.
    Chairman Houghton. Thank you very much.
    Mr. Herger, would you like to make a statement?
    Mr. Herger. Thank you, Mr. Chairman.
    I would like to begin by thanking you for scheduling this 
hearing to discuss an issue which has been of great concern to 
myself and literally hundreds of thousands of small business 
owners throughout the United States, a repeal of the use of 
installment sales for accrual method taxpayers.
    Just 3 weeks ago, Congressman Tanner, Congressman Sweeney, 
and I introduced legislation entitled The Installment Tax 
Correction Act. This legislation will correct the damage being 
done to small businesses across America by modifying the tax 
law to once again allow accrual method businesses to make use 
of the installment sales. It is a testament to the importance 
of this issue that our legislation has already garnered the 
support of a majority of the taxwriting Ways and Means 
Committee members.
    Our legislation does not break any new ground, it simply 
restores a type of business transaction which has been in use 
for more than 80 years. Since 1918, accrual businesses have 
been using the installment sales method because this method 
adjusts the payments of taxes to the demands of the 
marketplace. In contrast, a repeal of the installment sales is 
forcing small business owners who sell their businesses to pay 
taxes on income they have not yet received and may not receive 
for several years. In many cases, these sales are falling 
through or being put on hold.
    Is this good tax policy? I think we can all agree it is 
not.
    I was pleased by the Treasury Secretary's admission that 
installment sales repeal is having an effect more broad than 
what was originally intended. I look forward to hearing how 
Treasury intends to assist us in fixing this problem.
    Let us commit here today to correct this situation as 
quickly and completely as possible on behalf of America's small 
businessmen and businesswomen.
    Thank you.
    Chairman Houghton. Thank you very much, Mr. Herger.
    Mr. Kleczka.
    Mr. Kleczka. Thank you, Mr. Chairman.
    Mr. Chairman, I have a statement that I would ask unanimous 
consent to be made a part of the record.
    Chairman Houghton. Without objection, your prepared 
statement will appear in the record.
    Mr. Kleczka. Thus I won't have to repeat all that has been 
said by yourself and the other members.
    I want to join my colleagues in supporting legislation to 
reinstate the installment method of accounting. I don't believe 
Congress really understood the ramifications when we passed the 
repeal last year. When we were talking about the Ticket to Work 
and Work Incentives Improvement Act, we were looking at dollars 
to pay for the act and I think we moved in haste by repealing 
the installment method.
    I have also been contacted by many small business people 
and tax preparers who are relating some of the ramifications. I 
think through either passage of my bill, which is H.R. 3568, or 
the Herger Bill, I think Congress should reinstate the 
installment method. Clearly, it is having its effect. It was 
not the intent of this congressman to provide a hardship for 
small business people who are trying to sell or buy a business 
and having to pay the tax before the bulk of the receipts are 
received.
    Mr. Chairman, thank you for inviting me to participate in 
your Subcommittee's hearing today. I did serve on the Oversight 
Subcommittee for a couple of sessions. Had I known that you 
were going to be chairman, I would not have left.
    [The opening statement follows:]

Opening Statement of Hon. Jerry Kleczka, a Representative in Congress 
from the State of Wisconsin

    Mr. Chairman and members of the Subcommittee, it is with 
pleasure that I come before you to testify on behalf of 
legislation I introduced to reinstate the installment method of 
accounting for accrual basis taxpayers.
    As we all know, H.R. 1180, the Ticket to Work and Work 
Incentives Improvement Act was passed by Congress last year. 
Although H.R. 1180 contained many important provisions, it 
repealed the installment method of accounting for most accrual 
basis taxpayers. This change of law affected all transactions 
occurring after December 17, 1999.
    Prior to the passage of H.R. 1180, many business owners who 
sold their operations would pay taxes on the profits from the 
sale over the period in which they received payments. However, 
by repealing the installment method of accounting, business 
owners are now faced with the prospect of paying all the 
capital gains taxes owed from the sale immediately. In other 
words, taxpayers will be paying taxes on money they will not 
receive for many years in the future.
    The intention behind repealing the installment method of 
accounting was to crack down on large corporations deferring 
taxes for extended periods. Instead of addressing a tax 
avoidance scheme, H.R. 1180 eliminated a perfectly legitimate 
method of financing sales transactions for small business 
owners. Clearly, Congress did not consider the full 
ramifications of this change in law.
    Shortly after its enactment, I began hearing from my 
constituents and tax preparers expressing concern over the 
repeal of the installment method of accounting. To their 
surprise and dismay, many small business owners have found 
themselves facing an enormous tax bill if they decide to sell 
their business' assets.
    It is estimated that more than 250,000 small businesses 
will be adversely affected by the repeal of the installment 
method of accounting. Many sales that were not finalized by 
December 17, 1999 have fallen apart and countless others will 
never occur. According to the Wall Street Journal, ``While 
global merger megadeals done by pin-striped investment bankers 
get most of the publicity, in fact, most corporate marriages in 
the U.S. are tiny, involving deals valued between $500,000 and 
$2 million.''
    Furthermore, those who are looking to purchase additional 
assets in order to expand their operations will now find it 
more difficult to find a potential seller. As a result, the 
value of small businesses could be reduced by as much as 20 
percent.
    I understand the Department of Treasury is developing 
regulations to clarify the new law. While I welcome the 
Administration's participation in this important issue, I am 
concerned that the rule will not address the concerns raised by 
the small business community.
    Because of the consequences of repealing the installment 
sales method of accounting, I introduced H.R. 3568. My 
legislation would reinstate the installment sales method for 
all transactions occurring after December 17, 1999. This would 
have the effect of continuing the tax treatment of installment 
sales that existed prior to the enactment of the Work 
Incentives Improvement Act last year.
    Mr. Chairman, I believe the broad, bipartisan interest that 
this hearing has attracted underscores the importance of 
passing legislation to reinstate the installment method of 
sales. As the first member of the House of Representatives to 
introduce legislation on this issue, I look forward to working 
with my colleagues, the Administration, and all other 
interested parties to bring about a rapid enactment of this 
important legislation.
      

                                


    Chairman Houghton. You are very generous. Welcome back. 
Thank you very much.
    Mr. Tanner, do you have something equally as nice to say?
    [Laughter.]
    Mr. Tanner. I can think about something, yes, sir. I always 
brag on the chairman.
    [Laughter.]
    Mr. Tanner. I also have a statement, Mr. Chairman.
    Seriously, I do want to say thanks to both of you for 
bringing this timely hearing to pass. I used to be on the Armed 
Services Committee before I came to this one, and this seems to 
be the collateral damage from a tomahawk missile attack.
    [Laughter.]
    Mr. Tanner. There was a reason Treasury proposed and 
Congress accepted the proposal last year. In fact, we passed it 
twice in this Committee and in the House. But this is 
collateral damage from what was an abuse. I am glad Treasury 
has recognized this and we are going to work together to get it 
fixed.
    It is a pleasure to work with you, Mr. Chairman.
    Chairman Houghton. Thank you very much, Mr. Tanner.
    Mr. Sweeney.
    Mr. Sweeney. Thank you, Mr. Chairman.
    I, too, would like to commend you. And you know that I have 
often said privately and publicly great things about you 
because you are a real inspiration.
    I want to commend the Committee. As a members of the Small 
Business Committee and as someone who represents a district 
where 90 percent of the local economy derives from small 
businesses, this is obviously a great concern. There are real 
human elements to the problem that we are going to try to 
correct here.
    I will just give you one of them.
    I have constituents--George and Dorothy Long of Lake 
George--who have worked all their lives building their 
business, which is a resort in beautiful Lake George. 
Unfortunately, they have had to reconsider their plans to 
retire and sell their business off because they are faced with 
three options based on the problem that exists here.
    One is to take a loan out in order to pay for the capital 
gains tax. Two is to break the contract that they have signed 
already to conduct that sale and they would face a lawsuit. Or 
three is to suffer the consequences of nonpayment of taxes. So 
it put them in a very terrible position.
    I will submit for the record a formal statement and I want 
to thank Mr. Herger and Mr. Tanner for their work on this 
effort and I look forward to the hearing.
    [The opening statement follows:]

Opening Statement of Hon. John E. Sweeney, a Representative in Congress 
from the State of New York

    Thank you, Mr. Chairman.
    I commend you and your Subcommittee for your efforts to 
help small business and for holding a necessary and timely 
hearing.
    It is imperative that we review the installment method of 
accounting for accrual basis taxpayers.
    Thousands of small business sales have been inadvertently 
hurt by the inclusion of a provision in the tax extender bill, 
H.R. 1180, which prohibits the use of installment sales.
    I applaud this Subcommittee for focusing its attention on a 
problem facing small businesses across the United States.
    I appreciate the opportunity to participate in this 
Hearing.
    As a Member of the Committee on Small Business, and a 
Representative of a Congressional District where 90% of the 
local economy is generated by small business transactions, I am 
particularly concerned with this topic.
    I was shocked by the number of small business owners whose 
transactions were adversely impacted by the loss of installment 
sales.
    For so many families, their only equity is entrenched in 
their family business.
    Not only have I been contacted by many of my constituents, 
but my office has heard from small business owners throughout 
the United States, from Nova, Ohio to Lake George, New York to 
Clearwater, Florida.
    It is sad to say, but we hear this same story and the same 
pleas for help over and over again.

    Many small business owners signed sales contracts prior to 
the enactment of this provision and are now suffering the 
consequences of having to postpone their retirement plans.
    These comments only scratch the surface of this growing 
problem.
    Several months ago, Dorothy and George Long arranged for 
the sale of their resort in Lake George, New York, part of my 
district.
    Unfortunately, they may have to reconsider their plans.
    Mr. and Mrs. Long were relying on this sale to finance 
their retirement and are now faced with three options:
    1.) take a loan out in order to pay for the capital gains 
tax, or
    2.) break their contract and face a law suit, or
    3.) suffer the consequences of non-payment of taxes.
    It is terrible that small business, the engine of the local 
economy and the source of innovation throughout the country, is 
being hurt this way.
    For example, this has happened to Richard Lohnes and his 
brother of Schaticoke, New York.
    These gentlemen currently own an insurance agency in 
upstate New York, and after a lifetime of working, over
    fifty years, they planned to finance their retirement by 
selling their business.
    Sadly, they learned the tax bill for their sale exceeds the 
first year payment -a bill they cannot afford to pay.
    Due to the loss of installment sales, these men and their 
families must consider temporarily postponing their 
retirements.
    It is ironic that after more than fifty successful years in 
the insurance business, they cannot afford to recover their 
hard-earned equity.
    We all know and agree this provision was unintentional, so 
we must work together to ensure small business sales are no 
longer depressed.
    Thank you, for addressing this detrimental problem to small 
business across the United States.
    I look forward to hearing this important testimony and 
working with this committee to restore the use of installment 
sales.
    Thank you, Mr. Chairman.
      

                                


    Chairman Houghton. Thank you very much, Mr. Sweeney.
    I would now like to welcome and call on Mr. Joseph M. 
Mikrut, Tax Legislative Counsel, United States Department of 
the Treasury.
    Mr. Mikrut.

   STATEMENT OF JOSEPH MIKRUT, TAX LEGISLATIVE COUNSEL, U.S. 
                   DEPARTMENT OF THE TREASURY

    Mr. Mikrut. Thank you, Mr. Chairman.
    Mr. Chairman, Mr. Coyne, Members of the Subcommittee, 
members of the Full Committee, we appreciate the opportunity to 
come before today to discuss the repeal of the installment 
method of accounting. We especially appreciate your leadership, 
Mr. Chairman, in addressing this issue so soon after the 
Secretary made his statement before the Full Committee.
    This afternoon I would like to quickly discuss where we 
are, potentially how we got here, what we see as the effect of 
the repeal of the installment method, and potentially where we 
should go from here, both administratively and legislatively.
    As you mentioned in your opening statement, Mr. Chairman, 
there are essentially two types of taxpayers: Cash method 
taxpayers and accrual method taxpayers. The cash method 
taxpayer generally takes an item into account in income or as a 
deduction when he receives or pays the cash with respect to 
that item. In contrast, accrual method taxpayers generally take 
amounts into account when the event occurs that gives rise to 
the income or deduction.
    The installment method of accounting is a different type of 
method altogether. The installment method provides an exception 
to these overall methods of accounting by allowing the taxpayer 
to defer the recognition of income from the disposition of 
certain property until payment is received. Under the 
installment method, a taxpayer recognizes gain resulting from 
the disposition of property proportionately as payments are 
received on the installment note. In this regard, the 
installment method more closely resembles the cash method of 
accounting.
    Primarily for this reason, the Treasury Department and the 
administration last year proposed to repeal the installment 
method of accounting for accrual method taxpayers. In addition, 
the budget proposal also contained several rules dealing with 
the treatment of certain pledges and other items which are 
essentially cash equivalents and are not allowed under the use 
of the installment method of accounting.
    Soon after the 1999 Act was passed by Congress, the small 
business community began to express concerns that the repeal of 
the installment method of accounting for accrual method 
taxpayers negatively impacted the sales of small businesses. In 
particular, small business groups have asserted that the use of 
the installment method to report the gain on the sale of 
business enabled the seller to get a higher price for its 
business and for a buyer to purchase a business for which bank 
financing may not be readily available.
    As a result of the enactment of the installment sales 
provision, several small business groups have estimated that 
the reduction in the value of small businesses has exceeded 8 
percent or more.
    I would like to clarify two things with respect to the 
installment sales provision that was proposed by the 
administration and passed by Congress just this last year.
    First of all, the installment sales provision is applicable 
to all accrual method taxpayers and is not limited to only 
small businesses. In addition, I believe certain press reports 
may have overstated the effect of the repeal of the installment 
method. Again, the installment method is still available for 
cash method taxpayers.
    As indicated by the legislative history to the provision, 
the sale of stock of an accrual method business by a cash 
method taxpayer will continue to qualify for the installment 
method. Similarly the sale of an interest in an accrual method 
partnership by a cash method taxpayer will also continue to be 
eligible for the installment reporting. On the other hand, the 
effect of the legislation is that sales of assets of an accrual 
method corporation or partnership will no longer qualify for 
installment reporting.
    These different tax treatments add to the tension that 
already exists between buyers and sellers with respect to the 
decision to sell assets or stock. Buyers generally want to 
purchase assets in order to avoid contingent liabilities 
associated with the stock and to obtain an asset basis step-up 
to fair market value.
    On the other hand, sellers typically want to sell stock in 
order to avoid two levels of tax, To obtain favorable capital 
gain treatment, and to transfer contingent liabilities 
associated with the stock.
    Treasury's Office of Tax Policy has met several times with 
interested industry groups, including the NFIB, NAM, AICPA, the 
Small Business Legislative Council, and the U.S. Chamber of 
Commerce and listened to the concerns on the effects of the 
repeal of the installment sale on small businesses. These 
groups have requested clarification of the effect of the 
installment sales provision on particular transactions.
    As indicated by Secretary Summers, we intend to issue such 
guidance in the near future that will address the availability 
of the installment method for the most common business 
disposition transactions. In addition, in analyzing the 
situation further, we will issue broader guidance that should 
alleviate the effect of the legislation on small businesses 
regardless of the entity's form, as well as provide additional 
tax accounting relief.
    As the installment sales legislation as enacted by Congress 
only applies to accrual method taxpayers, the threshold issue 
is: Which taxpayers must use the accrual method and which 
taxpayers are allowed to use the cash method? As indicated in 
our most recent Treasury and IRS priority guidance plan, we 
intend to issue guidance addressing the requirements to account 
for inventories, and as a result, to use the accrual method. 
Part of this guidance generally will allow a qualified taxpayer 
with average annual gross receipts of $1 million or less to use 
the cash method and thus the installment method of accounting.
    Let me point out and be clear that this is a significant 
change that will change not only the availability of the 
installment method, but the use of the cash method as well for 
all small taxpayers meeting the requirements. The details for 
qualifying for this exception and the procedures to 
automatically change to the cash method of accounting will be 
provided in guidance that should be published in the near 
future.
    We believe that it is important to provide this guidance 
quickly. However, we understand that the guidance may not 
provide redress for all taxpayers. Consequently, providing 
relief for additional transactions may require legislation.
    Overall, we believe the policy of repealing the installment 
method of accounting for accrual method taxpayers was sound, 
that the accrual method and the installment method are somewhat 
inconsistent. However, as exhibited by the comments we have 
received, we now understand that the legislation has imposed 
financial burdens on small businesses that override this basic 
tax policy concern. As such, we are eager to work with the 
Congress to develop a legislative solution to alleviate this 
unforeseen impact on small businesses.
    We believe that any legislative response should be targeted 
to address the legitimate concerns of affected taxpayers. To 
address the liquidity problems often brought up by sellers of 
small businesses--traditionally businesses with less than $5 
million in gross receipts--use of the installment method should 
be allowed, perhaps with an interest charge as provided under 
present law, regardless of the seller's method of accounting. 
If there are other concerns regarding different treatments for 
different types of entities--for example, partnerships or 
subchapter S corporations--legislation can address these 
concerns as well.
    Mr. Chairman, this concludes my prepared remarks. We look 
forward to working with you, Mr. Chairman, Mr. Coyne, and 
Members of the Subcommittee and Full Committee in addressing 
these concerns and we will keep you informed of our proposed 
administrative actions.
    [The prepared statement follows:]

Statement of Joseph Mikrut, Tax Legislative Counsel, U.S. Department of 
the Treasury

    Mr. Chairman, Ranking Member Coyne, and distinguished 
Members of the Subcommittee:
    I appreciate the opportunity today to discuss with you the 
repeal of the installment method of accounting for accrual 
method taxpayers, which was originally proposed in the 
Administration's Fiscal Year 2000 budget and was enacted by 
section 536 of the Ticket to Work and Work Incentives 
Improvement Act of 1999, effective for sales or other 
dispositions occurring on or after December 17, 1999.

                               Background

    Items of income and loss generally are taken into account 
by a taxpayer in a taxable year based on the taxpayer's method 
of accounting. The cash receipts and disbursements method of 
accounting (cash method) generally requires an item to be 
included in income when actually or constructively received. In 
contrast, an accrual method of accounting items generally 
requires an item to be included in income when all events have 
occurred that fix the right to its receipt and its amount can 
be determined with reasonable accuracy. Accrual methods of 
accounting, when compared to the cash method, generally are 
acknowledged to better reflect economic income and comport to 
generally accepted accounting principles. Present law places 
several restrictions on the use of the cash method for income 
tax purposes.
    The installment method of accounting provides an exception 
to these general recognition principles by allowing a taxpayer 
to defer recognition of income from the disposition of certain 
property until payment is received. Under the installment 
method, a taxpayer recognizes the gain resulting from the 
disposition of property proportionately as payments are 
received on the installment note. Payments taken into account 
for this purpose generally include cash, marketable securities, 
and evidences of indebtedness that are payable upon demand or 
are readily tradable.
    The use of installment reporting was originally permitted 
by Treasury regulations in 1918 for dealers and subsequently 
sanctioned by Congress in 1926 for dealers and nondealers, 
subject to certain conditions. As explained by the Supreme 
Court in South Texas Lumber Co, 333 U.S. 496 (1948), the 
installment method of reporting was enacted to relieve 
taxpayers who adopted it from having to pay income tax in the 
year of sale based on the full amount of anticipated profits 
when in fact they had received in cash only a small portion of 
the sales price. However, beginning with the Tax Reform Act of 
1986 (1986 Act), the availability of the installment method has 
been restricted and the benefits derived from its use have been 
substantially reduced. For example, use of the installment 
method was denied for revolving credit sales and sales of 
certain publicly traded property by the 1986 Act and for dealer 
dispositions of real or personal property, with exceptions for 
farming property, timeshares and residential lots, by the 
Revenue Act of 1987 (1987 Act). In addition, the 1987 Act 
significantly limited the benefits of using the installment 
method by imposing interest charges on the deferred tax 
liability attributable to certain installment obligations and 
by treating pledges of certain installment obligations as 
payment, thereby triggering the recognition of income.

          Administration's Proposal and Subsequent Legislation

    The Administration's Fiscal Year 2000 budget proposed to 
prohibit the use of the installment method to report income 
from an installment sale that would otherwise be reported on an 
accrual method of accounting (installment sales provision). The 
proposal did not change the use of the installment method by 
cash method taxpayers or the present-law exceptions regarding 
the availability of the installment method for sales of farming 
property, timeshares or residential lots. The Administration 
also proposed to eliminate certain inadequacies in the pledging 
rules by clarifying that put rights or other similar 
arrangements will receive the same treatment as pledges. The 
installment sales provision was proposed to be effective for 
sales or other dispositions occurring on or after the date of 
enactment.
    As indicated in the General Explanations of the 
Administration's Fiscal Year 2000 Revenue Proposals, the 
installment sales provision was proposed because the use of the 
installment method is inconsistent with an accrual method of 
accounting and effectively allows an accrual method taxpayer to 
recognize income from the sale of certain property using the 
cash method. Consequently, the installment method fails to 
reflect the economic results of a taxpayer's business during 
the taxable year.
    The policy reason underlying the installment method of 
accounting is to impose tax when the taxpayer has the 
wherewithal to pay the tax (i.e., when the taxpayer has 
received the cash). It was difficult to reconcile this policy 
reason, however, with an accrual method, which requires the 
payment of tax on trade or business receivables prior to the 
receipt of the related cash. Moreover, as a result of the 
repeal of the installment method for revolving credit sales, 
certain publicly traded property and dealer dispositions, the 
law already required taxpayers to include in income amounts 
that had not been collected. Allowing an exception for accrual 
method taxpayers for the disposition of certain property, but 
not for other property, created additional inconsistencies in 
the application of accounting methods.
    The installment sales provision and the pledge rule 
clarification were enacted as part of the Ticket to Work and 
Work Incentives Improvement Act of 1999 (1999 Act), effective 
for sales or other dispositions occurring on or after December 
17, 1999.

                    Effect of the Legislative Change

    After the 1999 Act was passed by Congress, small businesses 
began to express concerns that the repeal of the installment 
method for accrual method taxpayers negatively impacted the 
sales of small businesses. In particular, small business groups 
have asserted that the use of the installment method to report 
the gain on the sale of the business enabled a seller to get a 
higher price for its business and a buyer to purchase a 
business for which bank financing was not readily available. As 
a result of the enactment of the installment sales provision, 
these small business groups have estimated that the sales price 
of some closely held businesses may be reduced by 8 percent or 
more.
    The installment sales provision was made applicable to all 
accrual method taxpayers, not just to small businesses. The 
ability for an accrual method taxpayer to defer a realized gain 
until the related cash was received is inconsistent with an 
accrual method, regardless of the size of the taxpayer's 
business. The provision applies to both casual sales of 
property and sales of businesses that would otherwise be 
reported on an accrual method. However, the extent of the 
impact of the provision on the sales of small businesses 
apparently was unforeseen by policymakers and potentially 
affected taxpayers and their advisors during the legislative 
process.
    The repeal of the installment method for accrual method 
taxpayers decreases the flexibility of structuring certain 
business dispositions, but does not totally eliminate the use 
of the installment method in such transactions. As indicated in 
the legislative history to the provision, the sale of stock of 
an accrual method business by a cash method taxpayer will 
continue to qualify for the installment method. Similarly, the 
sale of an interest in an accrual method partnership by a cash 
method taxpayer generally should continue to be eligible for 
installment reporting. On the other hand, sales of assets of an 
accrual method corporation or partnership will no longer 
qualify for installment reporting. These different tax results 
add to the tension that already exists between buyers and 
sellers with respect to the decision to sell assets or stock. 
Buyers generally want to purchase assets in order to avoid 
contingent liabilities associated with the stock and to obtain 
an asset basis ``step-up'' to fair market value. On the other 
hand, sellers typically want to sell stock in order to avoid 
two levels of tax, to obtain favorable capital gain treatment, 
and to transfer contingent liabilities associated with the 
stock.

                          Treasury's Response

    Treasury's Office of Tax Policy has met several times with 
interested industry groups, including the National Federation 
of Independent Businesses, National Association of 
Manufacturers, American Institute of Certified Public 
Accountants, Small Business Legislative Council, and U.S. 
Chamber of Commerce, and listened to their concerns about the 
effect of this recent legislation on sales of small businesses. 
These groups also requested clarification of the effect of the 
installment sales provision on particular transactions. For 
example, they requested that we address the sale by a cash 
method individual of an accrual method business conducted as a 
sole proprietorship; the continued viability of section 453(h), 
which allows a shareholder of a liquidating corporation to use 
the installment method to report the gain on the exchange of 
its stock for an installment obligation of the purchaser of the 
corporation's assets; and the effect of a section 338 election, 
under which a stock sale is deemed an asset sale for tax 
purposes, on a stock sale of an accrual method corporation by a 
cash method seller.
    We intend to issue guidance in the near future that will 
address the availability of the installment method for most 
common disposition transactions. In addition, we will issue 
broader guidance that should alleviate the effect of the 
legislation on small businesses, regardless of the entity's 
form, as well as provide additional tax accounting relief. As 
the installment sales legislation applies to accrual method 
taxpayers, a threshold issue arises as to which taxpayers are 
required to use an accrual method, an issue that we have been 
aggressively studying in other contexts. As indicated on the 
most recent Treasury and IRS Priority Guidance Plan, we intend 
to issue guidance addressing the requirements to account for 
inventories and, as a result, to use an accrual method. Part of 
this planned guidance generally will allow a qualified taxpayer 
with average annual gross receipts of $1 million or less to use 
the cash method and, thus, the installment method. The details 
for qualifying for this exception and the procedures to 
automatically change to the cash method will be provided in 
guidance that should be published in the near future.
    While we believe it is important to provide clear and 
timely guidance to clarify the effect of the installment sales 
provision on particular transactions and certain small 
businesses, we believe the law is clear that where an accrual 
method entity sells assets, or is deemed to sell assets, the 
installment method will no longer be available because the 
method of accounting of the entity controls the transaction. 
Consequently, providing relief for such transactions will 
require legislation.
    Overall, we believe the policy underlying the legislation 
is appropriate. The installment method is inconsistent with an 
accrual method of accounting, which generally requires a 
taxpayer to pay tax on a realized gain, regardless of whether 
the taxpayer has received the related cash. However, we now 
understand that the legislation has imposed financial burdens 
on small businesses that override this basic tax policy 
concern. As such, we are eager to work with Congress to provide 
a legislative solution to alleviate this unforeseen impact of 
the installment sales provision.
    Any legislative response should be targeted to address the 
legitimate concerns of affected taxpayers. To address the 
liquidity problems facing sellers of small businesses (e.g., 
businesses with less than $5 million in gross receipts), use of 
the installment method could be allowed (perhaps with an 
interest charge), regardless of the seller's method of 
accounting. If there is concern that different types of flow-
through entities are treated differently (because sales of 
partnerships may be structured to allow the buyer to obtain a 
stepped-up basis and the seller to use the installment method 
while sales of S corporations allow either the buyer to obtain 
a stepped-up basis or the seller to use the installment 
method), special rules could be provided to level the playing 
field. In addition, legislation also could clarify the 
treatment of sole proprietorships and address other issues 
related to the use of deferred payments. Finally, any 
legislative solution should promote simplification and 
administrability.
    This concludes my prepared remarks. We look forward to 
working with you, Mr. Chairman, Mr. Coyne, and members of the 
Subcommittee and full Committee in developing any legislative 
proposals deemed appropriate, and we will keep you informed of 
our proposed administrative actions. I would be pleased to 
respond to your questions.
      

                                


    Chairman Houghton. Thank you very much, Mr. Mikrut.
    I usually pass the questioning off to my associate here, 
but I would like to ask a general question.
    As you probably know, I have been pretty interested in the 
tax simplification issue and the ramifications on people and 
all business, particularly small business. But it just seems to 
me that the repeal last year of this particular provision 
really sort of flipped on its side 80 years of tax policy, and 
also makes it much more difficult for small business to exist, 
particularly because it is a lot easier for legal action to be 
taken against these small businesses.
    How do you feel about that?
    Mr. Mikrut. I think over the years, Mr. Chairman, Congress 
has slowly itself cut back on the use of the installment method 
with respect to accrual method taxpayers. For instance, it was 
no longer available to the sellers of goods, which had 
traditionally been accrual method taxpayers. Likewise, the 
installment method is not applicable when what you receive is 
publicly traded property primarily for liquidity concerns.
    We take to heart, though, your call for simplification. And 
we do recognize that the repeal of the installment method for 
accrual taxpayers, including small businesses, will create 
complications in trying to structure transactions. I will point 
out, though, that in present law, use of the installment method 
with its concomitant interest charges is itself a bit of 
complexity. I am not here to suggest that we are saving 
taxpayers from that complexity by requiring them to pay their 
tax up front, but I will point out that any solution here ought 
to be both administrable by the IRS and readily applicable by 
taxpayers.
    Chairman Houghton. And it makes you wonder whether an 
almost complete repeal of the repeal isn't the only way to go.
    Mr. Mikrut. Again, Mr. Chairman, we believe from a policy 
standpoint that the use of the installment method is 
inconsistent with the use of the accrual method. In general, 
most taxpayers that use the accrual method are larger taxpayers 
who can probably more readily adapt to such complications. That 
is why we have suggested in our testimony that a more targeted 
direct carve-out for small businesses would be most 
appropriate.
    Chairman Houghton. Mr. Coyne, would you like to ask some 
questions?
    Mr. Coyne. Thank you, Mr. Chairman.
    Mr. Mikrut, you had testified that those in the million-
dollar category or less that would be covered by your proposal 
would be about 30 million businesses. Is that correct?
    Mr. Mikrut. I can give you some better statistics than 
that, Mr. Coyne.
    In looking at 1997 return data, of the 2.2 million 
subchapter C corporations, which generally are the larger 
corporations--some 78 percent of those would qualify for the 
million-dollar exception. With respect to the 2.4 million S 
corporations, 85 percent have gross receipts of under $1 
million.
    With respect to the 28 million partnerships and sole 
proprietorships, in excess of 95 percent of those entities have 
gross receipts under $1 million. So we think providing the 
million-dollar exception, as we outlined for use of the cash 
method, will alleviate much of the concern small business has 
raised.
    Mr. Coyne. Is it accurate to say that there are 33 million 
business taxpayers? Is that the figure?
    Mr. Mikrut. That is correct.
    Mr. Coyne. Total?
    Mr. Mikrut. That is correct, according to 1997 return data.
    Mr. Coyne. What types of small businesses in that 33 
million figure and sales transactions would not be covered by 
the Treasury's guidance?
    Mr. Mikrut. I think it is approximately three million of 
those taxpayers, and those are primarily subchapter C 
corporations, which are in general the larger, more 
sophisticated taxpayers who generally use the accrual method 
for book treatment as well.
    Mr. Coyne. Is there any additional legislation that you 
would suggest now? I know you are going to work with the 
Committee and the Committee is going to work with you in trying 
to come up with additional legislation, but is there anything 
you can touch on now? And could you let us know the major 
features of such legislation?
    Mr. Mikrut. Again, Mr. Coyne, the purpose of this hearing 
is to hear the direct concerns of small businesses and other 
affected taxpayers. We think any legislation should be crafted 
toward those concerns.
    Traditionally, Congress has defined a small business as one 
that had less than $5 million of gross receipts. So in that 
regard, perhaps the use of the installment method for those 
taxpayers--those with less than $5 million in gross receipts--
might be appropriate. To the extent that Congress would want to 
backstop that, there is under present law a requirement for 
some taxpayers to use an interest charge. Perhaps the interest 
charge could be applied to those taxpayers to make the 
government whole for any deferral of tax.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mr. Herger?
    Mr. Herger. Thank you, Mr. Chairman.
    Mr. Mikrut, I want to begin by thanking you and the 
Treasury and expressing my appreciation for the effort you have 
been making to help us correct this very major problem. We have 
been hearing from literally thousands of small businesses 
throughout the United States. I have heard from many hundreds 
just from my own district. Having said that, we have just today 
seen your proposal. I am really waiting to hear more from the 
small business community as they begin looking at it to see if 
indeed it is able to address the full concerns that we have.
    I do have one question. I think about a million--in this 
day and age we are talking about gross sales. Is that correct?
    Mr. Mikrut. Yes, Mr. Herger. Traditionally, Congress has 
used a gross receipts test to try to define a small business.
    Mr. Herger. My concern is that with small business, 
particularly today, you can get up to $1 million--particularly 
if you have a couple of McDonald's restaurants, for example. 
Maybe each business may not get over $1 million, but maybe 
several together may. If someone, say, had two or three 
McDonald's around town that he had built up, and he was selling 
one of these for his retirement or whatever, would it be the 
aggregate of his several businesses, or just that one that he 
was selling?
    Mr. Mikrut. Mr. Herger, we haven't put together all the 
details of the proposal, but if you look at current section 
448, which provides the $5 million rule for required use of the 
accrual method, those rules use an aggregate concept and we 
would most likely try to apply those types of rules as well.
    Mr. Herger. So in other words, you would take the several 
businesses--you would add it all, not just the one he was 
selling? So that very well could put this individual in over 
the $1 million range.
    Mr. Mikrut. As Congress addressed this in 1986, you would 
not want to have a well-advised taxpayer start dividing his 
business into very small parts so that each one qualified for 
the $1 million or $5 million exception.
    Mr. Herger. And I can certainly understand that. But also 
just the nature--this is not uncommon at all. You have a small 
business man who may have a Burger King, and he may have two in 
the same small community. I represent a very large rural area 
and there are small towns. You could have one in each of the 
small towns. He hasn't divided this on purpose to get out of 
paying his taxes, that is just the nature of his small 
business.
    Mr. Mikrut. I understand, Mr. Herger. It is just very 
difficult to distinguish a tax-motivated transaction from a 
pure business-type transaction.
    Mr. Herger. The concern that has been expressed by several 
of the members--as well as Secretary Summers, I believe, in so 
many words--and I don't want to put words in his mouth--when he 
was before our Committee a few weeks ago he indicated that they 
were not aware of the incredible ramifications of what this was 
going to do. Certainly those of us as Members of Congress--as 
was mentioned by Congressman Kleczka a little earlier--were not 
aware of the ramifications this was going to have.
    As we move forward with this, I would hope--and it would 
appear that maybe it doesn't take care of all these 
ramifications--I would certainly hope that perhaps the Treasury 
and the administration could support our legislation that would 
basically put it back like it was for 80 years and do away with 
it completely.
    Do you have a comment on that?
    Mr. Mikrut. I also don't want to put words in the 
Secretary's mouth, but I think it is clear that what we are 
trying to address both administratively and with proposed 
legislation are the direct concerns of small businesses. At 
this point we don't believe that a complete repeal of the 
repeal is necessary to do that. Clearly, it would cover 
everything, but we think that a more limited approach using 
traditional means by which Congress has tried to define small 
business might be appropriate here. Of course, we are looking 
forward to the testimony from the other witnesses to see if 
that might be appropriate.
    Mr. Herger. Thank you.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you.
    Mr. Kleczka.
    Mr. Kleczka. Thank you, Mr. Chairman.
    I am still unclear as to Treasury's position on the 
legislation introduced by Mr. Herger and myself which would 
reinstate the repeal of the installment method.
    Your proposal is to provide for continuing the cash method 
for businesses with gross receipts of $1 million or less. 
Current law is $5 million or less. Is it not?
    Mr. Mikrut. No, Mr. Kleczka. Present law is that if you are 
a subchapter C corporation or if you are a partnership that has 
a subchapter C corporation as a partner, and you have gross 
receipts in excess of $5 million, you must use the accrual 
method of accounting.
    Mr. Kleczka. So if you have $5 million or less you can use 
cash accounting?
    Mr. Mikrut. You can use cash accounting--and I think the 
legislative history to the 1986 act makes it clear--you can use 
cash accounting if you were otherwise eligible to use cash 
accounting. Regulations also dating back approximately 80 years 
have made it clear that where merchandise is a significant 
income-producing factor in a business, there is a requirement 
to keep inventories. And if there is a requirement to keep 
inventories, then there is a requirement to use an accrual 
method of accounting regardless of the amount of the gross 
receipts.
    So traditionally dealers in goods, sellers of goods had to 
use an accrual method of accounting no matter what their gross 
receipts.
    Mr. Kleczka. But the statute at one point does talk about a 
$5 million gross for a small business. What would be wrong with 
Treasury using that same $5 million figure instead of the $1 
million that you are proposing? What is the problem there?
    Mr. Mikrut. Again, it would be overturning approximately 80 
years of regulations that have been in existence. We also 
believe that it would result in the improper measurement of 
income, that for sellers of goods or larger businesses it is 
more appropriate to use an accrual method of accounting. This 
is the method of accounting that is often required to be used 
for book purposes, to provide financial statements, to apply 
for bank loans. It provides a clearer reflection of income. It 
eliminates any timing ability for taxpayers to take in receipts 
or to make prepayments and receive deductions.
    We think many of these concerns are not there when the 
level of gross receipts is small, $1 million. But once you 
reach the $5 million plateau, general tax policy and other 
considerations require the use of the accrual method of 
accounting.
    Mr. Kleczka. I guess we just disagree what that level 
should be.
    We do have two pieces of legislation to introduce. What is 
Treasury's specific objection to the bills that are before the 
Committee, and how would you recommend they be changed to get 
Treasury's support?
    Mr. Mikrut. I believe the bills are important in that they 
try to address concerns that have been raised. But I think they 
address more than those concerns because I think they also 
address the use of the installment method of accounting by a 
Fortune 500--
    Mr. Kleczka. The bills repeal the repeal, so whatever was 
previously current law--
    Mr. Mikrut. That's right.
    Mr. Kleczka. How do you suggest we change the legislation 
to comply with the thinking of the Treasury Department?
    Mr. Mikrut. I think perhaps the most appropriate method 
would be to provide a small business exception. If you believe 
a small business should be $5 million in gross receipts as 
opposed to $1 million in gross receipts, that would be an 
appropriate cutoff. I think that is what Congress has 
traditionally tried to define a small business as.
    Mr. Kleczka. So the bills would be more acceptable with a 
level or definition of what type of business shall be 
applicable to the cash accounting, and that would be either $1 
million or $5 million, but not higher than $5 million?
    Mr. Mikrut. That is correct.
    Mr. Kleczka. Thank you, Mr. Chairman.
    Chairman Houghton. Now I would just like to ask a 
question--sort of a peripheral question--but in terms of the 
installment method, which was established 80 years ago, it 
wasn't $1 million and it wasn't $5 million. What was it in 
1920?
    Mr. Mikrut. There was no dollar threshold, Mr. Chairman.
    Chairman Houghton. When did the dollar figure come into 
effect?
    Mr. Mikrut. In 1986, Congress again provided that a 
subchapter C corporation with gross receipts over $5 million--
except for certain professions--
    Chairman Houghton. So it was keyed in 1986 for the first 
time?
    Mr. Mikrut. Yes, and again in 1986 and 1987 Congress 
repealed the use of the installment method for dealers in 
goods, which were essentially accrual method taxpayers, but 
continued to allow the installment method for casual sales of 
property, for instance, land used in the business, maybe a 
division or subsidiary, something like that, but imposed an 
interest charge to the extent that the installment obligations 
exceeded $5 million. And that's where we were until last year.
    Chairman Houghton. Thank you very much.
    Mr. Sweeney.
    Mr. Sweeney. Thank you, Mr. Chairman, and thank you, Mr. 
Mikrut, for all of your work and for issuing the guidance 
today.
    It seems that, as the prior questioners honed in, that the 
difficulty we are going to have--as is usually the case when 
you are trying to define delineations that will provide 
benefits to some and not to others--the standard for defining 
what a small business is. That is really the crux of the 
disagreement. So I am going to try to hone in a little just to 
clarify in my mind how we can begin to develop those 
definitions.
    Is it correct that the guidance that you have issued today 
will not help closely held businesses operating as 
corporations?
    Mr. Mikrut. I believe it would, Mr. Sweeney. We haven't 
issued the guidance yet. But again, as we began to examine this 
issue, the small business community pointed out several 
different type of transactions that the legislation affected 
and requested guidance with respect to those limited types of 
transactions. But the more we looked at it, we thought a more 
global solution was necessary and that is why we came up with a 
$1 million threshold that would apply to all businesses.
    And more importantly, this $1 million threshold for the use 
of the cash method is applicable not only for the installment 
sales but also for purposes of reporting day-to-day operations. 
That is why we think it is a significant development.
    Mr. Sweeney. So the type of business structure doesn't 
really matter?
    Mr. Mikrut. No, it does not.
    Mr. Sweeney. Would the $1 million exception apply 
regardless of inventories?
    Mr. Mikrut. That is correct.
    Mr. Sweeney. That seems to be a new approach. What is that 
based on? What precedent?
    Mr. Mikrut. Again, we think the cash method of accounting 
Congress reserved for less sophisticated taxpayers. One measure 
of determining sophistication is the level of gross receipts. 
Also in the law is a concept that as long as the accrual and 
the cash method give you substantially the same results, the 
cash method would otherwise be allowable. We think with respect 
to gross receipts of less than $1 million the results will not 
vary by that much between cash and accrual.
    And finally, part of this is a very practical concern, Mr. 
Sweeney. As you know, there has been a lot of litigation or 
potential litigation in the area between cash and accrual 
methods of accounting. It is probably not an adequate use of 
IRS resources to look at businesses where gross receipts are 
relatively insignificant, less than $1 million.
    Mr. Sweeney. I think if there is going to be disagreement, 
it will be based on the sense that many of us have that--and it 
is true that when you are setting an arbitrary number to define 
something clearly you are going to have these difficulties--but 
I am concerned that the $1 million figure would limit the 
applicability and it may not cover all kinds of circumstances.
    I noticed in your statement you recognized that we need to 
take approaches that would respond to those issues and concerns 
of the small business community.
    I look forward to working with you.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you very much.
    You cut off the cash method for a business at $5 million 
and kick into the accrual method, and yet the United States 
government which has a budget of $1.9 trillion is still on a 
cash basis.
    Can you explain the difference?
    Mr. Mikrut. The rule that requires a taxpayer with $5 
million of gross receipts to cut off from the cash to the 
accrual method is something that Congress enacted in 1986. I 
believe the rationale there was that the accrual method is 
generally the method that corporations use for book purposes. 
There was an attempt to conform book and tax treatment with 
respect to those types of entities.
    I do not know why the Federal Government necessarily--nor 
am I a budget expert able to explain to you why--it uses the 
cash method for accounting.
    Chairman Houghton. I didn't really expect you to have that 
answer. [Laughter.]
    Mr. Tanner.
    Mr. Tanner. Thank you very much, Mr. Chairman.
    I think this has been an interesting discussion. I think 
there is room for agreement here with everyone. I think we are 
talking about two different things. I don't know who would 
change their day-to-day accounting. We are talking about the 
sale of a business, which is a one-time event in the lifetime 
of a small business, not a year-to-year situation.
    Number two, you stated that you were concerned that our 
bill addressed more than the problem. I am a little concerned 
that your solution is more narrow than the problem. So I think 
we have some work to do to see where we can work together to 
make the end result we all want come to fruition.
    Thank you for your time, Mr. Chairman. I am going to have 
to go to another meeting, but I sincerely appreciate the 
invitation and the opportunity to speak. We will work with you 
and Treasury to see what we can come up with.
    Chairman Houghton. Thank you very much, John, for being 
with us.
    Mr. Weller.
    Mr. Weller. Thank you, Mr. Chairman.
    I missed the opening statements, but I do have an opening 
statement I would like to submit into the record.
    Chairman Houghton. Without objection, your prepared 
statement will appear in the record.
    [The opening statement follows:]

Opening Statement of Hon. Jerry Weller, a Representative from the State 
of Illinois

    We are here today to hear testimony about the inadvertent 
effect that a provision included in ``The Tax Relief Extension 
Act of 1999'' is having on small businesses. Section 536 of 
that Act modified the installment method of accounting and 
generally prohibited the use of the installment method of 
accounting for sales of property by taxpayers that use the 
accrual method of accounting. It appears that the impact of 
this Installment Sales provision goes well beyond anything 
hinted at in the President's Budget for 1999 which first 
introduced this repeal provision. While the provision appeared 
to target larger, accrual method businesses when they sold a 
particular asset or assets, its real effect will be to reduce 
the value of closely held businesses when they are sold in 
their entirety. These small business run the gamut -from dry 
cleaners and mom and pop convenience stores to insurance 
agencies and other small service providers.
    I have already heard from many independent insurance 
agencies located in and around Joliet in my home district that 
this provision is crippling the value of their agencies that 
they have worked lifetimes to create. I believe that it is 
essential that we take corrective action immediately to ensure 
that small business owners like the independent insurance 
agents in my district do not suffer from such needless 
punishment. I hope that the hearing we are holding today will 
be the first step toward that goal.
      

                                


    Mr. Weller. Mr. Chairman, first I want to thank you for 
conducting this hearing. This is an issue I have heard about 
from back home--folks who run dry cleaners, mom and pop 
convenience stores, and particularly some insurance agents. The 
other day they were looking for someone's head because they 
took a look at the impact of this provision in last year's law 
in the budget and have come to the conclusion that it really 
has a big impact on the value of their agency. These are 
middle-class guys and gals that have worked very hard to build 
something they would like to pass on to their kids and they are 
already threatened by the estate tax, which can have an impact 
on passing that on to their children.
    They now see that because of this change the value of this 
asset they would like to pass on to their kids has diminished 
as well.
    It is my understanding that this idea came out of the 
Treasury Department last year.
    I would ask Mr. Mikrut, was this Treasury's idea?
    Mr. Mikrut. I think this is an idea that has been around. 
In the deliberations for the 1986 Act, Congress considered 
this. The theory then was that the accrual method and the 
installment method are somewhat inconsistent methods of 
accounting and therefore the installment method should be 
reserved for the cash method taxpayers.
    Mr. Weller. As I stated, it is having a negative impact on 
middle-class people who are trying to build up an asset they 
want to pass on to the next generation.
    I really want to commend my friend, Mr. Herger, for taking 
the lead on working to repeal this provision which is hurting a 
lot of people.
    I am trying to get a great understanding of it. Who was the 
villain you were trying to slay when you proposed this last 
year?
    Mr. Mikrut. There was no particular transaction or 
particular abuse, Mr. Weller, we were trying to direct it 
toward. Again, we were trying to reconcile the different 
methods of accounting and we thought that accrual method and 
the installment method just did not line up as well as the 
installment method and the cash method. That is where we drew 
the line.
    Mr. Weller. Wouldn't you agree that for these insurance 
agents and these small business people it was working at that 
time? Shouldn't we admit now that it was a mistake and make 
this change?
    Mr. Mikrut. I think the price effect was unforeseen. I 
think the inability for certain small businesses to get bank 
financing and therefore have to extend seller financing was 
unforeseen. And I think, again, any legislative response should 
be to try to address those types of concerns.
    I will point out, Mr. Weller, that the concern you had of 
your insurance agent who passes on his agency to his heirs--
they should not be impacted by the provision. Again, the 
installment sale provision only applies to gains. When you pass 
on your business to your heirs, they get a step-up--
    Mr. Weller. How about if they decide, for retirement 
purposes, they want to sell their agency? They have been 
building up the value of this agency and decide it is time to 
retire, and that is their retirement income? And you have 
reduced the value of that asset.
    Mr. Mikrut. It would have an effect in that case, yes.
    Mr. Weller. You have indicated here that you have a 
proposal which is very narrow. I have always wondered about 
your Administration's definition of targeted relief, because it 
usually means that very few people get very little. In this 
case you are proposing a very targeted relief, which is only $1 
million. A lot of small businesses today have over $1 million 
in gross sales. They may not make any money, but they have $1 
million in gross receipts. You have indicated in comments to 
other Members of this Subcommittee that you might be willing to 
raise that threshold to $5 million.
    Why do we even need a threshold? Doesn't an income 
threshold just complicate the Code? I think one of the goals we 
all have is to simplify things for people. Before we adopted 
the change you recommended last year, things were a lot 
simpler. Now we are making it more complicated. And then the 
solution that you are offering complicates it all the more.
    Mr. Mikrut. I will agree, Mr. Weller, that a threshold 
generally creates some level of complication. I will point out, 
though, that the $1 million threshold--looking at 1997 tax 
return data, amounts reported on those returns, not the average 
of the 3 years, which would normally be lower--would exempt 78 
percent of C corporations, 85 percent of S corporations, and 95 
percent of partnerships and sole proprietorships would be under 
the $1 million threshold. If you were to go up to $5 million, 
those percentages become much greater.
    We think the $1 million threshold we have proposed, subject 
to the aggregation rules Mr. Herger was discussing, would 
exempt a great number of taxpayers.
    Mr. Weller. How does your proposal impact closely held 
small businesses that operate as corporations? Are they given 
relief under your proposal?
    Mr. Mikrut. Yes, Mr. Weller, we would apply this across the 
board to all forms of business entities.
    Mr. Weller. I see I have run out of time.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you very much.
    Mr. McInnis.
    Mr. McInnis. Thank you, Mr. Chairman.
    Sir, this was effective December 17, 1999. Is that correct?
    Mr. Mikrut. Yes.
    Mr. McInnis. In your opening remarks you said you intend to 
issue guidance in the near future that will address the 
availability of the installment method for the most common 
disposition transactions.
    Is it your intent to make that retroactive to December 
1999?
    Mr. Mikrut. Yes, Mr. McInnis. Again, methods of 
accounting--most of the businesses this would apply to we are 
simply clarifying that they continue on the cash method and 
therefore would not trip into the installment method provision. 
We fully intend to clarify that small gap period of essentially 
one to 2 weeks where the installment method would be available 
to those businesses as well.
    Mr. McInnis. So in essence, based on your guidance, there 
will be no gap?
    Mr. Mikrut. We would hope not. That is right, sir.
    Mr. McInnis. When is your guidance going to come out?
    Mr. Mikrut. As soon as we can address the details we were 
discussing with Mr. Herger, and in addition looking at other 
ways we could be helpful in providing additional guidance as to 
the use of the cash versus the accrual method.
    Mr. McInnis. Your threshold is $1 million?
    Mr. Mikrut. Yes, $1 million of average annual gross 
receipts, which is usually a 3-year rolling average.
    Mr. McInnis. And in the past we did not have a threshold 
over what was repealed. There was no threshold, was there?
    Mr. Mikrut. There was a threshold for a different form of 
the installment method that required the use of an interest 
charge if you received over $5 million annually of installment 
obligations.
    Mr. McInnis. The problem we have today was really the 
result of--it kind of slipped through. We didn't envision the 
difficulties--neither Treasury nor the Congress. Now you are 
suggesting a partial repeal, not to go back to where we were, 
but does Treasury see an opportunity to grab some territory 
through the confusion? Is that you don't support a full repeal?
    Mr. Mikrut. No, Mr. McInnis. We believe in the policy of 
the use of the installment method being restricted to cash 
method taxpayers. We now understand that that had a significant 
and unforeseen effect upon certain small businesses. We are 
trying to address those situations where the business or the 
non-tax policy considerations override this policy concern.
    Mr. McInnis. Thank you.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you, Mr. McInnis.
    Any other questions?
    [No response.]
    Chairman Houghton. If not, thank you very much, Mr. Mikrut. 
We appreciate your testimony.
    Chairman Houghton. I now call upon the next panel, which is 
David E. Crosby, Co-Owner, Jeremiah's Tavern, Rochester, New 
York--the garden spot of the country--on behalf of the National 
Federation of Independent Business; Darryl A. Hill, Owner-
Operator, Savoy Restaurant, on behalf of the United States 
Chamber of Commerce; and Pamela F. Olson, Chair-Elect, section 
of Taxation, American Bar Association.
    Please take your seats.
    Mr. Crosby, we will begin with your testimony.

    STATEMENT OF DAVID CROSBY, CO-OWNER, JEREMIAH'S TAVERN, 
 ROCHESTER, NEW YORK, ON BEHALF OF THE NATIONAL FEDERATION OF 
                      INDEPENDENT BUSINESS

    Mr. Crosby. Thank you.
    Good afternoon. My name is David Crosby. I am the co-owner 
of Jeremiah's Tavern in Rochester, New York. Jeremiah's is a 
90-seat neighborhood restaurant located in the Upper Monroe 
area of Rochester. On behalf of the 600,000 members of the 
National Federation of Independent Business, I appreciate the 
opportunity to present the views of small business owners on 
the subject of repealing the installment sales provision.
    I would ask that my written testimony be submitted for the 
record and I will summarize my remarks here.
    As you have already heard, the installment sales provision 
is literally blocking the sale of small businesses across the 
country. Others have described the technical reasons why this 
is the case, let me state the bottom line reason: The 
installment sales provision greatly increases the downpayment 
necessary to purchase a business or commercial property.
    Let me explain using my own experience.
    We started Jeremiah's Tavern by purchasing its current 
location in 1978. In 1982 we started buying houses around the 
original property so that we could use the backyards to expand 
parking. Except for two small mortgages, all those properties 
were purchased using seller financing. If this tax provision 
had been in effect at the time, I am confident that Jeremiah's 
would not exist today. I seriously doubt our original $15,000 
downpayment would have covered all the taxes and closing costs 
owed by the previous owner when we bought this building. If he 
had been forced to pay all those taxes up front, he could not 
have afforded to sell his building to three under-financed 
entrepreneurs.
    Now we are facing the other end of the issue. From the 
beginning, we planned to grow our business until we could 
afford to retire. Now that plan is in jeopardy. The banking 
community is not receptive to financing restaurants and rental 
properties, which means we must carry the note.
    Under the old rule, we could spread whatever capital gains 
we realized over the life of the note. As an accrual method C 
corporation, we now have to pay tax in that first year. That 
means it would likely cost us money to sell our business. Gene 
has two children in college and my daughter starts next fall. 
We can't afford to go an entire year with negative income. So 
unless we can find someone who can pay cash or get a loan, we 
can't sell our business.
    And my situation is not unique. When I first became aware 
of the provision, I called my accountant to determine if it 
would affect us. After he gave me the details, he told me that 
he was in the middle of a sale that was in danger of falling 
apart. The seller cannot afford to pay the capital gains tax 
due if the sale is structured as an asset sale, and the buyer 
is unwilling to purchase the stock of the business rather than 
just the assets.
    Buyers rarely are willing to purchase stock in a closely 
held business. In this case, the buyer offered $2 million less 
for the company if he had to buy the stock.
    Another concern I have is, What happens if the buyer fails 
to make all the promised payments? A friend of mine sold his 
restaurant to a buyer who went bankrupt 2 years later. My 
friend was forced to take back the business and spend the next 
2 years rebuilding it so he could sell it again. If this had 
happened under the new law, he would have two problems: First, 
rescuing a badly damaged business, and second, recovering taxes 
he had paid on income he never received.
    Finally, what happens if I die unexpectedly? Under the buy-
sell agreement I have with my partner, my family will receive 
the proceeds of a life insurance policy as partial payment for 
my share of the business. The remaining payments will be 
handled through an installment sale. Under the new law, my 
family would not only deal with the loss of their father and 
husband, but also face a huge tax bill as well.
    For these reasons, I strongly encourage this Committee to 
support the Herger-Tanner Bill to repeal the installment sales 
provision. This new law destroys plans that have been formed 
over years and decades, creates new insurmountable obstacles 
for young entrepreneurs trying to get started, and it 
unnecessarily complicates transactions that are already full of 
complications.
    What really concerns me is that the IRS will get the same 
amount of taxes whether we use the installment method or not. 
This prohibition does not increase taxes collected by the IRS, 
it just speeds them up. All this harm is caused by a provision 
that doesn't really raise any new revenues.
    I thank the Committee for the opportunity to speak today. I 
also thank the chairman and the other Members of the Committee 
for taking the lead to reverse this provision. I would be happy 
to answer any questions.
    Thank you.
    [The prepared statement follows:]

Statement of David Crosby, Co-Owner, Jeremiah's Tavern, Rochester, New 
York on behalf of the National Federation of Independent Business

    Good morning. On behalf of the 600,000 members of the 
National Federation of Independent Business (NFIB), I 
appreciate the opportunity to present the views of small 
business owners on the subject of repealing the installment 
sales provision.
    My name is David Crosby. I am the co-owner of Jeremiah's 
Tavern in Rochester, New York. Jeremiah's is a 90 seat 
neighborhood restaurant located in the Upper Monroe area of 
Rochester. We opened our doors on August 25, 1978 with one 
building, three partners and no employees. Today, we have grown 
to four buildings, eighteen apartments, four store fronts, and 
34 employees. Our first year we had about $250,000 in sales. 
This year we should top $1.3 million.
    Jeremiah's has also grown as a presence in the community. 
We have held fundraisers for the local YMCA, the Hillside 
Children's Center, and we contribute thousands of dollars in 
gift certificates every year to various charities. We hold 
charity golf tournaments. We donate food to our neighborhood 
association. We even donate chicken wings to two area high 
schools for their senior class parties.
    In addition to being an NFIB member, I am also the incoming 
president of the local Restaurant Association chapter.
    As you have already heard, the installment sales provision 
is literally blocking the sale of numerous closely-held 
businesses. Others have described the technical reasons why 
this is the case. Let me state the bottom line reason--the 
installment sales provision greatly increases the down payment 
necessary to purchase a business or commercial property. Let me 
explain why using my own experience.
    When we started Jeremiah's Tavern, we financed the purchase 
of the building with seller financing. In 1982 we started 
buying houses around the original property so we could use the 
back yards to expand parking. Except for two small mortgages, 
all the financing was private because the banks wanted no part 
of the restaurant or non-owner occupied rental property.
    If this tax provision had been in effect at the time, none 
of this would have taken place! I seriously doubt our original 
$15,000 down payment would have covered all the taxes and 
closing costs owed by the previous owner when we bought his 
building. If he had been forced to pay all those taxes up 
front, rather than over the life of the note, I doubt he could 
have afforded to sell his building to three under-financed 
entrepreneurs.
    Now we are facing the other end of the issue. From the 
beginning, Gene and I planned to grow our business until we 
could afford to retire. We have IRA's, but the bulk of our 
retirement income will come from the sale of the tavern and the 
surrounding properties. Before this provision took effect, I 
planned to continue to work for four or five more years and 
then sell.
    Now that plan is in jeopardy. We have always assumed we 
would finance the sale of the business ourselves. The banking 
community is still not receptive to financing restaurants and 
rental properties. While we have developed an excellent credit 
record over the past twenty years, it's not our credit that 
counts. Banks won't even look at a young potential restaurant 
buyer.
    Which means we must carry the note. Under the old rule, we 
could spread whatever capital gains we realize over the life of 
the note. As an accrual method C-Corp, we now have to pay that 
tax in year one. I do not know of anybody capable of paying 
enough cash up front to cover the tax we would owe, let alone 
the other costs involved. That means it would cost us money to 
sell our business. Gene has two children in college. My 
daughter starts next fall. We can't afford to go an entire year 
with negative income.
    So, unless we can find someone who can pay cash or can get 
a loan, we can't sell our business. My future plans are 
dictated not by our hard work and the economy in Upstate New 
York, but rather by a tax provision proposed by the Clinton 
Administration. My retirement plans have been in the making for 
twenty-five years. I took me years to save the $10,000 I used 
to start this restaurant and twenty-two years to build the 
business to the point it could be sold. Now, we're starting all 
over again.
    My situation is not unique. When I first became aware of 
the new provision, I called my accountant to determine whether 
it would affect us. After he gave me the details, he told me 
that he was in the middle of a sale that was in danger of 
falling apart. The seller cannot afford to pay the capital 
gains tax due if the sale is structured as an asset sale, and 
the buyer is unwilling to purchase the stock of the business 
rather than just the assets. In an asset sale, the buyer gets 
increased depreciation. In a stock sale, the buyer assumes any 
liabilities -known or unknown -in a stock purchase. Therefore, 
the value of the company is significantly less to the buyer. In 
this case, the buyer offered $2 million less for the company if 
he had to buy the stock.
    Another concern I have is what happens if the buyer fails 
to make all the promised payments? A few years ago, a friend of 
mine sold his restaurant to a buyer who went bankrupt two years 
later, defaulting on his promised payments. My friend was 
forced to take back the business and spent the next two years 
rebuilding it so he could sell it again! If this had happened 
under the new law, he would two problems -first rescuing a 
badly damaged business and, second, recovering taxes he paid on 
income he never received.
    Finally, what happens if I die unexpectedly? Under the buy/
sell agreement I have with my partner, my family will receive 
the proceeds of a life insurance policy as partial payment for 
my share of the business. The remaining payments will be 
handled through an installment sale. Under the new law, then, 
my family will not only deal with the loss of their father and 
husband, but also face a huge tax bill as well!
    For these reasons, I strongly encourage this Committee to 
support the Herger/Tanner bill to repeal the installment sales 
provision. For small business owners like myself, the impact 
goes far beyond the immediate effect of paying the capital 
gains tax upfront. It destroys plans that have been formed over 
years and decades. It also creates new obstacles for young 
entrepreneurs trying to get started and unnecessarily 
complicates transactions that are already full of 
complications.
    What really annoys me about this provision is that the IRS 
will get the same amount of taxes whether we can use the 
installment method or not. This prohibition does not increase 
taxes collected by the IRS--it just speeds them up. All this 
harm caused by a provision that doesn't really raise any new 
revenues.
    I thank the Committee for the opportunity to speak today. I 
also thank the Chairman and the other members of this Committee 
for taking the lead to reverse this provision, and I would be 
happy to answer any questions.
      

                                


    Chairman Houghton. Thank you very much, Mr. Crosby.
    Mr. Hill.

STATEMENT OF DARRYL A. HILL, OWNER, SAVOY RESTAURANT, ON BEHALF 
                OF THE U.S. CHAMBER OF COMMERCE

    Mr. Hill. Good afternoon, Mr. Chairman.
    My name is Darryl Hill and I am the owner of the Savoy 
Restaurant, a small business headquartered here in Washington, 
D.C.
    I would like to give special commendation to Congressmen 
Herger, Sweeney, and Tanner for proposing this much needed 
legislation.
    I assure you, considering the nature of the business of the 
previous witness, restaurants aren't the only small businesses. 
It is just a coincidence that we are in the same line of 
business.
    Our enterprise employs 65 individuals dedicated to 
providing excellent top quality food in a warm, friendly 
atmosphere. I am also a member of the U.S. Chamber of Commerce, 
the world's largest business federation. I appreciate this 
opportunity to relate my story on the repeal of the installment 
method of accounting for accrual basis taxpayers, and its bad 
effects on the small business community.
    When you enter a small business, all small businessmen 
generally think about one thing: An exit strategy. Most exit 
strategies have two solutions: You sell your business, or you 
die. The second exit strategy is not one I want to opt for, so 
I am concerned with the first exit strategy.
    Over the last 25 years I have started, owned, operated, and 
sold many successful small businesses. Every enterprise has 
created jobs and investment for the community. When the time 
came for me to sell, I provided a great opportunity for the 
next owner to succeed and be a productive member of society. In 
every case I was able to reinvest the proceeds of the sale into 
my next small business.
    Also, because bank financing is generally not available, in 
virtually every sale I have had to finance the purchase by 
taking back the note. A situation which my accountant tells me 
would be financially prohibitive under the recent change in the 
law.
    It also takes a bastion of creative financing to make these 
small business sale works. I have been on both sides. I have 
been a buyer and I have been a seller. If this law were 
previously enacted, most if not all of my arrangements to buy 
and sell would have been financially impossible. It just 
wouldn't have happened.
    Buyers only have so much money to put down, they are 
generally not bank-financeable, generally small businesses are 
not attractive to venture capitalists at the outset, and 
brokers want their money at the time of settlement. And God 
forbid, as a previous witness stated, if you offer credit and 
someone goes bankrupt, then you have a double problem.
    In my previous life, I was a director of an organization 
called the Greater Washington Business Center, which had as its 
mission the development of minority and small and disadvantaged 
businesses. In almost every case in these type of businesses, 
these purchases are done on an installment purchase basis. 
Women and minorities and disadvantaged businesses will be 
severely affected by this act because they won't have the 
entre. This would put quite an imposition on them.
    Ladies and gentlemen, it is grossly unfair for the 
government to require me to come up with cash in order to sell 
my business and to pay taxes on money I have not received. I 
have labored many years reinvested a lot of tax dollars in 
order to build equity in my enterprises. Current law would have 
a chilling effect on the transfer of small business ownership, 
denying many people like myself from enjoying the fruits of 
small business ownership.
    I do understand that the consequences of this legislation 
were unintended. Now that the lawmakers realize the effect on 
small business, I strongly urge the Congress and the 
administration to act quickly to pass the Installment Tax 
Correction Act.
    I just have an analogy and a couple of comments on the 
testimony given by Joe Mikrut from the Treasury Department.
    He cited that 85 percent of small businesses have gross 
receipts of $1 million or less. That is quite true, but those 
businesses of $1 million or less generally have nothing to 
sell. They are just not affected by this. Most of those are 
individuals, sole proprietorships who hang out their shingles, 
consultants and so forth. The businesses above $1 million are 
the ones affected by this act.
    Second, the act itself--if you took the statistics another 
way and instead of measuring it in numbers of small businesses 
if you measured it in gross receipts, you would find that the 
statistics were reversed and 85 percent of the gross receipts 
come from businesses of $1 million or more. So I think you have 
to look at who is getting hit here, and it is the guys in the 
$1 million and up bracket who are affected by this.
    I thank you for allowing me to testify here today and 
strongly urge you to pass this legislation.
    [The prepared statement follows:]

Statement of Darryl A. Hill, Owner, Savoy Restaurant, on behalf of the 
U.S. Chamber of Commerce

    Mr. Chairman and members of the Committee, my name is 
Darryl Hill and I am an owner of the Savoy Restaurant, a small 
business headquartered in the District of Columbia. Our 
enterprise employs 65 individuals dedicated to providing 
excellent top quality food in a warm friendly atmosphere. I am 
also a member of the U.S. Chamber of Commerce--the world's 
largest business federation, representing more than three 
million businesses and organizations of every size, sector, and 
region. I appreciate this opportunity to relate my story, and 
to express the views of the U.S. Chamber on the repeal of the 
installment method of accounting for accrual basis taxpayers 
and its effects on the small business community.
    I hereby ask that my entire oral and written statement be 
incorporated into the record.

                               Background

    The provision denying installment sale treatment for 
accrual basis taxpayers was originally in the Administration's 
FY 2000 budget proposal. The Chamber provided live testimony 
against the provision before the Ways and Means Committee on 
March 10, 1999. Also, the Chamber's opposition to the provision 
was included in written testimony for the Ways and Means 
Committee's, March 10 hearing on revenue provisions in the 
Administration's FY 2000 budget. Written testimony was 
submitted in opposition for the Finance Committee's April 27 
hearing on revenue provisions in the Administration's FY 2000 
budget.
    Repeal of the installment sale method then resurfaced in 
the waning days of the first session of the 106th Congress 
during the Administration's attempt to negotiate an offset with 
Congress on the cost of the ``extenders package,'' HR 1180. The 
repeal of the installment sale treatment for accrual basis 
taxpayers was passed and signed into law on December 17, 1999, 
as a provision in the Ticket to Work and Work Incentives 
Improvement Act of 1999 (PL 106-107).
    As a result of its enactment, it appears that many small 
business owners attempting to structure the sale of their 
accrual method businesses by means of an asset sale with them 
providing ``seller-financing,'' may be required to report their 
total gain in the year of sale, i.e., recognize the profit, 
irrespective of when payment is actually received. However, 
prior to the law change, the installment sale method could have 
been elected irrespective of the accounting method of the 
business sold and gain would not have been recognized until the 
tax year in which payments were actually received by the 
seller.

                Asset Sale Method of Selling a Business

    The traditional method by which small business owners sell 
closely owned enterprises is by the asset sale method. In most 
of these cases, the seller will self-finance the purchase with 
an installment sale note secured by the assets of the sold 
business. The seller's corporation transfers ownership of all 
assets and goodwill to the purchaser's newly formed taxpaying 
entity, usually a C-corporation or an S-corporation. The seller 
then has the flexibility of retaining the shell corporation for 
a variety of reasons. The purchaser operates the business free 
from any potential hidden liabilities that may have been 
imbedded in the seller's corporation. To the average patron, 
the transition is seamless and the business shows no visible 
signs of change except the new ownership team.
    The new law is having, and will continue to have, a 
dramatic negative impact on small business owners attempting to 
structure an exit strategy for the sale of their business or 
for the partial sale of assets from an ongoing business. For 
most small business purchases, traditional bank financing is 
not available to fund the sale of a business, thus requiring 
the selling owner to hold any balance due over and above the 
down payment. The purchaser would then remit installment 
payments over time on the remaining balance to the seller.
    Before the change in the law, the seller could defer the 
tax by reporting the gain as the installments were received. 
The gain on the sale by the seller would then be reported and 
the tax liability would accrue at the time the installment 
payment was received by the taxpayer. With the new provision, 
the total gain would be required to be immediately recognized 
and reported, subjecting the taxpayer to the full tax liability 
on the sale regardless of how much actual cash is received. The 
tax liability could exceed the cash generated for the sale by 
several times in the first year, severely distressing the 
business and its owners. In addition, the business broker 
usually requires his fees at the time of settlement 
exacerbating the demand for cash at the time of sale.

                Adverse Consequences for Small Business

    In the short time since it became law, this provision--
which denies the installment sale treatment for accrual basis 
taxpayers--has had an unintended and significant negative 
financial impact on many small business owners attempting to 
sell their enterprises.
    Small business owners who would have previously been 
allowed to elect the use of the installment sale option in the 
sale of a closely held business are experiencing dramatic 
reductions in sales price in order to execute a contract. It is 
estimated that a devaluation of 8.2 percent in the equity of a 
business is the average.\1\ If this figure were applied to only 
a fraction of the estimated six million small businesses, the 
hundreds of billions of dollars the owners would loose in 
equity would dwarf the $2 billion the government hopes to 
collect from this onerous tax law change over the next 10 
years. This is inequitable and unfair to those small business 
owners that labor and sacrifice their whole lives in order to 
achieve a small sense of financial security. This also amounts 
to a hidden tax on those who, on average, make less than 
$50,000 a year and, in many cases, depend on the sale of their 
business for their retirement.
---------------------------------------------------------------------------
    \1\ Mike Adhikari, Illinois Corporate Investments Inc., ``Analysis 
of Installment Sale Repeal (ISR), 175 Olde Half Day Rd., Lincolnshire, 
IL 60047.
---------------------------------------------------------------------------
    The recently enacted provision sets an artificial barrier 
to the traditional methods for small business ownership changes 
and has had a chilling effect on the ability of an owner of a 
small business to sell. An important ingredient in structuring 
an exit strategy is flexibility. Bank financing is generally 
not available to the purchaser. The new law dramatically 
reduces the ability for a purchaser to tender enough money to 
cover the sellers closing costs and taxes. Sellers are 
reluctant or incapable of entering into a transaction that 
requires out of pocket expenditures.
    Small business ownership has been the vehicle by which many 
people, including women and minorities, have achieved financial 
empowerment. In many cases, this has been accomplished by the 
purchase of existing businesses on the installment method. 
Restricting or complicating the process of transferring 
ownership inhibits the means by which all people can access the 
doors of economic prosperity by being your own boss.
    Many small business owners use the sale of their businesses 
as the primary means of funding their retirement. For some, the 
worth of their business reflects the majority of their life 
savings. Denying the use of the installment sale treatment for 
accrual basis taxpayers has frustrated many business owners in 
developing an exit strategy for retirement. To look forward to 
living the first years of retirement strapped for cash due to 
the tax requirements necessary to orchestrate a sale and the 
subsequent years at a reduced rate due to the devalued equity 
in the business is unfair and bad policy.

  My Personal Experience with the Installment Sale Method For Accrual 
                            Basis Taxpayers

    Over the last 25 years, I have sarted, owned, operated and 
sold many successful small businesses. In every enterprise, I 
have created jobs and investment in the community. When the 
time came for me to sell, I provided a great opportunity for 
the next owner to succeed and be a productive member of 
society. In every case I was able to reinvest the proceeds of 
the sale into my next small business. Also, in virtually every 
sale, I have had to finance the purchase by taking back a note, 
a situation my accountant tells me would be financially 
prohibitive under the recent change in the law. If this law 
were previously enacted, most if not all of my arrangements to 
sell would have been financially impossible. Buyers only have 
so much money to put down on a purchase. Brokers want their 
money at the time of settlement and I need a certain amount of 
cash to live on and reinvest in my next venture.
    Ladies and Gentlemen, it is grossly unfair for the 
government to require me to come up with cash in order to sell 
my business to pay taxes on money I have not yet received. I 
have labored many years and reinvested a lot of taxed dollars 
in order to build equity in my enterprises. The current law 
will have a chilling effect on the transfer of small business 
ownership denying many people like myself from enjoying the 
fruits of small business ownership.
    I do understand that the consequences of this legislation 
were unintended. Now that lawmakers realize its effects on 
small business, I strongly encourage the Congress and the 
Administration to act quickly to pass H.R. 3594, The 
Installment Tax Correction Act.

                               Conclusion

    Bank financing for the sale of small businesses is 
generally not available. For those selling a closely held 
business, flexibility is an important ingredient in structuring 
an exit strategy. The recently enacted provision sets an 
artificial barrier to the traditional methods for small 
business ownership changes and has had a dramatic negative 
impact on the process. Restricting or complicating the ability 
of small business owners to ``cash out'' of their businesses 
after laboring to achieve a level of success is destructive and 
bad policy. The U.S. Chamber of Commerce believes the provision 
denying accrual basis taxpayers should be fully and quickly 
repealed.
    I want to thank you for allowing me the opportunity to 
testify here today.
      

                                


    Chairman Houghton. Thank you very much, Mr. Hill. I 
appreciate your testimony.
    Ms. Olson.

STATEMENT OF PAMELA F. OLSON, CHAIR-ELECT, SECTION OF TAXATION, 
                    AMERICAN BAR ASSOCIATION

    Ms. Olson. Good afternoon, Mr. Chairman, Congressman Coyne, 
and members of the Oversight Committee. My name is Pam Olson 
and I am the chair-elect of the ABA section of Taxation and 
testifying this afternoon on behalf of the section of Taxation.
    With me today is Fred Witt, the immediate past chair of our 
Real Estate Committee and a principal drafter of our testimony.
    We appreciate the opportunity to appear before the 
Committee today. We believe the repeal of installment sales 
treatment for accrual method taxpayers is a topic deserving of 
prompt action. In short, we believe the repeal was a mistake. 
It adversely affects small and closely held businesses 
attempting to sell business assets, it creates traps for the 
unwary, and it eliminates the certainty and consistency the 
installment sales rules brought to sales of assets for 
contingent payments. And that latter point is not just a small 
business point.
    First, some background on installment sales treatment. This 
is ground that has already been trod this afternoon, but I 
think it is worth treading it again because we reach a very 
different conclusion from the conclusion reached by the 
Treasury Department.
    Generally, an accrual method taxpayer is required to 
recognize income when all events have occurred that fix the 
right to receipt and the amount can be determined with 
reasonable accuracy. The installment method is an exception 
that permits a taxpayer to report the recognition of gain from 
the sale of capital assets in the year payment is actually 
received.
    First set forth in Treasury regulations in 1918, codified 
by Congress in 1926, the law has permitted accrual method 
taxpayers and cash method alike to sell business assets for 
installment payments and report the gain in the year cash is 
actually received. The policies underlying the installment 
method were best summarized by the Supreme Court in 
Commissioner v. South Texas Lumber Co. as follows: The 
installment basis of reporting was enacted, as shown by its 
history, to relieve taxpayers who adopted it from having to pay 
an income tax in the year of sale based on the full amount of 
anticipated profits when in fact they had received in cash only 
a small portion of the sales price. Another reason was the 
difficult and time-consuming effort of appraising the uncertain 
market value of installment obligations.
    In the Installment Sales Revision Act of 1980, just 20 
years ago, Congress streamlined the rules, made them easier for 
taxpayers to apply, and applied them to sales for contingent 
payments. Since 1980, Congress has enacted a number of 
limitations on the use and benefits of installment reporting 
while maintaining its simplicity and fairness.
    In our view, the limitations that have been placed on the 
use and benefit of installment reporting adequately address any 
potential problems with it.
    As against the strong policy reasons supporting installment 
sales treatment, we understand there was essentially one 
reason, and that reason was reiterated earlier this afternoon 
in support of repealing the installment method: that the 
installment method is inconsistent with the accrual method 
because by allowing deferral of recognition the annual economic 
results of an accrual method taxpayer's business are not 
properly reflected.
    We believe this quest for theoretical purity is an 
insufficient basis for overturning 80 years of consistently 
applied tax policy. We also believe it fails to withstand 
careful scrutiny.
    The accrual method of accounting requires the recognition 
of income from business operations in the year the income is 
earned and the right to receive the amount is fixed, without 
regard to the time payment is received. While a taxpayer may be 
expected to pay taxes on ordinary profits earned from business 
operations, the non-recurring sale of a capital asset falls 
into an entirely different category. The imposition of 
immediate taxation on the anticipated gain from the disposition 
of a business or substantial capital asset, such as real 
estate, places a burden on the business seller that is unfair, 
unexpected, and cannot be justified by the rationale underlying 
the accrual method of accounting.
    The installment sales method adjusts the payment of taxes 
to the demands of the marketplace. In our experience 
representing business taxpayers, arms-length buyers and sellers 
have opposing views of the market and objectives in negotiating 
a business asset sale transaction. Buyers want the lowest 
possible price and nothing down, and sellers want the highest 
price with cash paid in full at closing. It is against these 
market forces that an installment sale is finally negotiated. 
The ability of the seller to take back an installment note for 
the balance of the sales price without being subject to an 
immediate tax liability maybe the most critical issue in the 
transaction.
    In the case of contingent payment sales, the tax 
consequences could be even worse. Not only will tax be due 
immediately on the fixed component of the sales price, but the 
IRS would likely assert that the contingent amount must be 
valued and reported as taxable income in the year of sale. The 
result? An installment seller would be taxed on amounts that 
are only estimated and might never be received.
    We have a number of examples of the adverse effects of the 
repeal contained in our written statement, which has been 
submitted for the record.
    In conclusion, let me just say that the repeal of 
installment sales reporting reverses 80 years of sound tax 
policy without any compelling reason or abuse cited. This 
change adversely affects the price and liquidity of small and 
closely held business assets, and will substantially increase 
complexity for taxpayers and the IRS alike.
    I would be pleased to answer any questions the Committee 
might have.
    [The prepared statement follows:]

Statement of Pamela F. Olson, Chair-Elect Section of Taxation, American 
Bar Association

    My name is Pamela F. Olson. I appear before you today in my 
capacity as Chair-Elect of the American Bar Association Section 
of Taxation. This testimony is presented on behalf of the 
Section of Taxation. It has not been approved by the House of 
Delegates or the Board of Governors of the American Bar 
Association and, accordingly, should not be construed as 
representing the policy of the Association.
    The Section of Taxation appreciates the opportunity to 
appear before the Committee today. We believe the repeal of the 
installment method of accounting for accrual method taxpayers 
is a serious topic deserving prompt action.
    As you are aware, following a proposal set forth in 
President Clinton's Fiscal Year 2000 Budget Proposal, Congress 
repealed the installment method of tax accounting for accrual 
method taxpayers in the Tax Relief Act of 1999 (Title V, 
Subtitle C, Section 536), enacted as part of the ``Ticket to 
Work and Work Incentives Improvement Act of 1999'' (H.R. 1180). 
The repeal of installment sales treatment for accrual method 
taxpayers will adversely impact small and closely held 
businesses attempting to sell business assets, because they 
will be taxed immediately even if payments are received years 
later. Immediate taxation of business sellers, and its chilling 
effect on the marketplace, simply does not represent sound tax 
policy. For these and other reasons outlined below, we 
respectfully request that Congress reenact prior law which, for 
over 80 years, has permitted accrual method taxpayers to sell 
business assets for installment payments and defer the gain 
until the year cash is actually received.

         Background: The 80-Year History of Installment Sales.

    A brief review of the history of installment sales provides 
an important framework for discussion. Generally, an accrual 
method taxpayer is required to recognize income when all events 
have occurred that fix the right to receipt and the amount can 
be determined with reasonable accuracy. The installment method 
is an exception that permits a taxpayer to defer the 
recognition of gain from the sale of capital assets until the 
year payment is actually received. The treatment given 
installment sales was recognized almost from the inception of 
the income tax laws. Although first set forth in Treasury 
regulations promulgated in 1918, Congress codified the 
installment method of tax reporting in Section 212(d) of the 
1926 Revenue Act. The policies underlying the installment 
method were best summarized by the Supreme Court in 
Commissioner v. South Texas Lumber Co., 333 U.S. 496, 503 
(1948):

        The installment basis of reporting was enacted, as shown by its 
        history, to relieve taxpayers who adopted it from having to pay 
        an income tax in the year of sale based on the full amount of 
        anticipated profits when in fact they had received in cash only 
        a small portion of the sales price. Another reason was the 
        difficult and time-consuming effort of appraising the uncertain 
        market value of installment obligations.

    In the Installment Sales Revision Act of 1980, P.L. 96-471, 
96th Cong., 2d Sess. (1980), Congress streamlined the rules and 
made them easier for taxpayers to apply. Since 1980, Congress 
has enacted a number of limitations on the use and benefit of 
installment reporting. Installment treatment is not available 
for dealer dispositions, it does not apply to the sales of 
publicly traded property, and gain is recognized if the seller 
monetizes the installment note through a pledge transaction. To 
further limit the benefit, there is an interest charge for the 
tax deferral to the extent a taxpayer holds installment notes 
in excess of $5 million.

                           Reason For Repeal

    We understand there was essentially one reason cited in support of 
repealing the installment method for accrual method taxpayers--the 
installment method is inconsistent with the accrual method because, by 
allowing deferral of recognition, the annual economic results of an 
accrual method taxpayer's business are not properly reflected.
    This reason fails to withstand careful analysis and is insufficient 
to overturn 80 years of consistently applied tax policy. The accrual 
method of tax accounting reflects a business's economic performance by 
requiring the recognition of income in the year in which the income is 
earned and the right to receive the amount is fixed, without regard to 
the time payment is received. Coupled with the economic performance 
requirement for deductions, the accrual method matches income and 
deductions from operations in a manner that measures a business's 
economic results each year. However, the installment exception 
essentially applies only to nonrecurring dispositions of business 
assets. While a taxpayer should be expected to pay taxes on ordinary 
profits earned from business operations, the nonrecurring sale of a 
capital asset falls into an entirely different category. The imposition 
of immediate taxation on the anticipated gain from the disposition of a 
business or substantial capital asset, such as real estate, places an 
unexpected and unfair burden on the business seller.

 Market Effect of Repeal on Business Sales--Liquidity, Price and Deals 
                         That Will Not Be Done

    Since 1918, the installment sales method has been an 
important rule in our Federal income tax system, because it 
adjusted the payment of taxes to the demands of the 
marketplace. In our experience representing business taxpayers, 
arms-length buyers and sellers have opposing views of the 
market and objectives in negotiating a business assets sale 
transaction. Buyers want the lowest price and nothing down and 
Sellers want the highest price with cash paid in full at 
closing. It is against these market forces that an installment 
sale is finally negotiated. Often the buyer only has 10 to 20% 
of the purchase price in cash, but the seller is convinced the 
cash flow generated by the asset will enable the buyer to pay 
the balance over a period of years. The ability of the seller 
to take back an installment note for the balance of the sales 
price without being subject to an immediate tax liability may 
be the most critical issue in the transaction. In today's 
marketplace, it is difficult to find a bank willing to lend to 
a small business buyer. Small business buyers cannot access the 
capital markets or draw down on their bank line of credit. 
Simply put, in today's tax and economic environment, sellers 
take back an installment note because there are no other viable 
financing options available.
    In addition to adversely affecting the liquidity of 
sellers, repeal of installment treatment will tend to depress 
the price paid by small business purchasers. A small business 
buyer is often limited in the amount it can pay for business 
assets. In order to increase the sales price, a business seller 
may increase the term of years or agree to a fixed price with 
an additional contingent or ``earnout'' based on future 
performance of the assets sold. After repeal of installment 
reporting for accrual taxpayers, the tax consequences of 
structuring such an arrangement may be devastating. As the 
payments are spread over an increasing number of years, so will 
the burden of immediate taxation in the year of sale be 
increased. For example, assume an accrual method taxpayer sells 
a building (with adjusted basis $100) for $1,100 payable $100 
cash and $100 a year for 10 years. In the year of sale the 
taxpayer will report the full $1,000 gain and, assuming a 35% 
tax rate, will have an immediate tax due of $350. Since the 
taxpayer only received $100 cash down, the asset sale will have 
produced negative cash flow of $250--meaning the taxpayer will 
need to find additional cash of $250 just to pay taxes.
    In the case of a contingent payment sale the tax 
consequences could even be worse. Not only will tax be due 
immediately on the fixed component of the sales price, but 
under the original issue discount and installment reporting 
regulations the IRS might assert that the contingent amount 
must be valued and reported as taxable income in the year of 
sale. If this interpretation of the regulations were upheld, an 
installment seller would be taxed on amounts that are unknown 
and might never be received. Taxpayers will resist this 
treatment and argue that the ``open transaction'' doctrine 
applies to defer taxation on the contingent piece until actual 
payments are received. So, in addition to the adverse effect on 
price and liquidity, repeal of the installment method for this 
group of taxpayers raises the possibility of unnecessary 
complexity and increased controversy between taxpayers and the 
IRS.

         Examples of Transactions Adversely Affected By Repeal

    Passthrough entities exist, in great part, to serve the 
needs of the small or closely held business owner. With the 
numerous restrictions placed on the use of the cash method of 
accounting, and based on our experience with business clients, 
we expect that the vast majority of S corporations, business 
partnerships and limited liability companies taxed as 
partnerships use the accrual method of accounting. Accordingly, 
we believe many common transactions will be adversely affected 
by this change in law.

Employee Buyouts.

    It is common for a retiring owner or family group to sell 
to key employees. The employees typically lack the cash to 
complete the purchase, hence the owner must act as the lender 
and take back an installment note. This is a ``win-win'' 
transaction; the retiring owner is selling an illiquid asset 
and receiving a stream of cash (with interest) paid over a 
period of years, and the employees are realizing a life long 
dream of becoming the owners of the business. With bank 
financing difficult or impossible to obtain, the ability to 
seller-finance, without an immediate tax burden, is essential. 
We are aware of a number of these types of transactions that 
have been canceled since December 1999 due to the change in the 
law.

S Corporation Selling Assets.

    We understand that most S corporations use the accrual 
method of tax accounting and thus, under the change in law made 
last year, cannot use the installment method to sell business 
assets or the entire business. The entire gain is taxable in 
the year of sale even though the installment obligations, 
payable years later, are immediately passed through to the 
cash-basis shareholders. Although the individual cash method 
shareholders could sell their stock on the installment method, 
as pointed out in the 1999 legislative history, buyers 
generally want to purchase assets and will refuse to assume, 
directly or indirectly, the contingent liabilities inherent in 
the acquired S corporation entity. As a result both the price 
and liquidity of S corporation businesses have been adversely 
affected.

S Corporation Selling Assets to Family Under Succession Plan.

    For the reasons stated above, repeal of the installment 
method will negatively impact family succession planning. 
Unless all of the family members involved are willing to 
transfer stock in the family S corporation, it will no longer 
be possible to sell corporate assets to younger family members 
using the business profits to pay the senior family members and 
fund their tax liability over a period of years.

S Corporation Selling Assets and Liquidating.

    A common plan when the owners of an S corporation wish to 
sell their business is the adoption of a plan of complete 
liquidation for the S corporation, followed by distributions of 
the cash and notes received from the sale to the shareholders 
as liquidating distributions. Under prior law, the distribution 
of an installment note to the shareholders in complete 
liquidation was not a taxable disposition and the shareholders, 
in effect, took the place of the S corporation for purposes of 
installment reporting. After the 1999 repeal of the installment 
method for accrual method taxpayers, whether the S corporation 
sells assets and liquidates or the buyer buys stock and makes a 
Section 338(h)(10) election, the shareholders will be required 
to pay tax on the sale immediately.

Accrual Method Partnerships.

    For partnerships, we believe the change produces 
unneccessary complexity and creates a trap for the unwary.
    If an accrual method partnership sells its assets for an 
installment note, the full gain must be recognized and passed 
through to its partners. On the other hand, if the cash method 
partners sell their partnership interests, the installment 
rules apply and there is no gain recognition until payments are 
received. This rule applies even if one buyer acquires all of 
the interests in the partnership. This means that if the buyer 
desires to purchase less than all of the partnership's assets, 
full gain must be recognized on the installment notes received. 
Moreover, often one of the partners wants to withdraw from the 
partnership and receive a liquidating distribution at the time 
of the sale. However, it is not clear that the gain realized on 
the sale can be specially allocated to the departing partner 
who actually receives the distribution, and thus taxation of 
the transaction will unnecessarily complicate matters for all 
of the partners.
    We appreciate your interest in this matter. The Section 
would be pleased to work with the Committee and its staff on 
this important issue.
      

                                


    Chairman Houghton. Thank you very much, Ms. Olson.
    We will go to the questioning now.
    Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman.
    Mr. Kleczka is the main sponsor of H.R. 3568, which would 
return the situation to prior law. Inasmuch as the panel will 
support that provision, I would like to yield to Mr. Kleczka 
for questioning.
    Mr. Kleczka. Thank you, Mr. Coyne.
    Mr. Chairman, I don't really have any questions of the 
panel except to thank them all for appearing today.
    Mr. Hill, in your testimony, you adequately pointed out the 
problem with the Treasury proposal of $1 million. We all think 
$1 million is a lot of money--and in fact it is--but in a 
business, having gross receipts--underscoring ``gross''--of $1 
million covers a lot of small businesses today. I have to agree 
with the panel that the $1 million Treasury figure is arbitrary 
and something that this panel and this Congress is going to 
have to talk about.
    After listening to not only Treasury but to this panel as 
well, I would think that $5 million would not be out of line, 
bout we can talk about that later.
    Ms. Olson, you also pointed out that we are talking about 
non-recurring transactions. That also must be underscored. 
These are not normal everyday business transactions. This is 
something that just happens on occasion. It doesn't happen 
every year. If we are looking for abuses in the Tax Code, we 
should look at those, find those, and get rid of them.
    But clearly this was not one of those abuses, so I would 
hope that--in fact, I know you do support legislation I 
introduced to return back to the old method. If in fact we need 
a cap of a dollar amount, clearly I don't think it should be 
any less than $5 million. Possibly the panel can respond to 
that, the $1 million Treasury proposal versus the higher 
amount.
    Mr. Hill.
    Mr. Hill. Defining small business is a complicated and 
intricate procedure. What may constitute a small steel mill, 
for example, may be very much different than a small 
restaurant. I don't think it is as simple to just put a number 
on it. I think the Treasury and this body and this panel should 
work--I think you should repeal the act and then start all over 
again.
    Mr. Kleczka. Restore the old act?
    Mr. Hill. Yes, restore the old act and then start again. I 
think Treasury can better define what it wants to get at and 
then you can go from there.
    Mr. Kleczka. I think a better way to put it would be like 
the chairman stated, repeal the repeal.
    Ms. Olson.
    Ms. Olson. I would like to say that I agree. We ought to 
start by repealing what was done last year and then start over. 
The ABA has previously testified before this Committee that we 
would support, as a simplification measure, the use of the cash 
method of accounting for small businesses, which we defined by 
reference to section 448 and section 263 as $5 million or more. 
We think the $1 million is too low to be particularly useful 
and that small businesses up to $5 million should be able to 
use the cash method.
    I would also say that we don't think that just allowing 
small businesses to use the cash method and therefore to still 
be eligible to use the installment method of reporting 
addresses all of the problems that have been created by the 
repeal.
    Mr. Kleczka. Thank you very much.
    Chairman Houghton. Thank you very much.
    Mr. Herger.
    Mr. Herger. Thank you, Mr. Chairman.
    I want to thank you, Mr. Hill, for bringing out a very 
important point, and that is that $1 million can vary an awful 
lot. If someone is being paid for their services, perhaps $1 
million is much more than it would be as it is in your 
restaurant business where you are going through your gross--
your margin of profit may be very, very narrow of that $1 
million, whereas someone who is receiving payment for services 
may be much more. Therefore that is a major inequity. I 
appreciate you for bringing that out, as several have.
    We have just received today the Treasury's recommendation 
of how they would correct it. Ms. Olson, I don't know how much 
you have been able to look at it or really analyze it, but what 
is your general analysis of their recommendation?
    Ms. Olson. With respect to their recommendation that they 
issue guidance allowing taxpayers with gross receipts under $1 
million to use the cash method of accounting, we would support 
that. It is a proposal that the Tax section has supported in 
the past, but we would go with a higher number. We would go 
with something more on the order of $5 million.
    With respect to the remainder of it, I am wearing a big 
orange button that says ``simplify''. The Tax section has 
joined with AICPA and TEI in an effort to work together to find 
ways to simplify the tax law. My biggest concern about what 
Treasury has suggested today is that it is another layer of 
complexity upon complexity and it seems to us that a far 
preferable way to go is just go back to the drawing board and 
start over. We don't think there are abuses out there that need 
to be addressed with a repeal of the installment method of 
accounting, so we would like to see old law returned.
    Mr. Herger. Thank you. That is very helpful.
    As I visit with my constituents, particularly our small 
business people, one thing we continually here is that the tax 
system needs to be simplified. It is just so complicated now. 
Even the smallest of businesses are required to go out and pay 
large sums of money for a CPA to figure out the system. It 
would be so much easier to just go back as it was. We are 
human, the Treasury is human, we as Members of Congress voted 
on this and certainly contributed to it as well. It would make 
much better sense to just go and repeal what we did and start 
over again on how we can make it more simple.
    Mr. Crosby, do you have any further comments?
    Mr. Crosby. Yes.
    The NFIB continues to push for the repeal of the provision. 
In my particular instance, our business will gross over the $1 
million cap this year, so the Treasury issue would not apply to 
us. I believe that when you start looking at thresholds you 
create a situation where anyone who is either just below or 
just above the threshold--those who are below the threshold are 
in a position where they may find it necessary to put the 
brakes on the growth of their business because they don't want 
to cross that threshold. Those who are just above the threshold 
are in a position where they may be tempted to tamper with 
their business to put themselves back under the threshold.
    So I think the position of the NFIB is sound and we should 
repeal it and not have thresholds.
    Mr. Herger. Another very good point. If anything, we do not 
need the government throwing monkey wrenches into our system to 
be slowing down business growth and slowing down the hiring of 
new people.
    I thank you very much and I yield back my time, Mr. 
Chairman.
    Chairman Houghton. Thank you very much, Mr. Herger.
    Mr. Sweeney.
    Mr. Sweeney. Thank you, Mr. Chairman.
    I want to thank the panelists as well. Mr. Crosby is a 
fellow New Yorker. Welcome and thank you very much. Mr. Hill, 
it is good to see you again. I thank both of you for putting a 
real human face on what the implications are here.
    Ms. Olson, you have given us some very sound technical 
analysis, and I thank you for that.
    I have really two areas I would like to question.
    The first relates to discussing the cash method versus the 
accrual method.
    I am a member of the Small Business Committee, as I 
mentioned before. I am concerned that in part this may be an 
effort by the IRS to broaden its efforts to impose accrual 
accounting on more small businesses. With that background, I am 
concerned that the IRS may be using the installment issue to 
issue broader guidance on whether a business uses cash or 
accrual methods.
    As we have mentioned, Congress has set the cash accrual 
threshold at $5 million. I am very concerned here that the IRS 
may be attempting by regulation to impose the $1 million and 
set some precedents that may cause some real harm.
    I would like to hear comments from any of you regarding 
that, which have not been said, and whether you share in my 
concern regarding the IRS' attempt to impose accrual accounting 
on small businesses.
    Ms. Olson. I am not sure whether I think this is an effort 
on the part of the IRS to impose the accrual method more than 
it has been used, but I would note that anytime you introduce 
additional rules, the additional rules create additional 
complexity. When there is additional complexity, there are 
people who won't understand what the rules are, and some of 
those people include IRS agents who are trying to do their jobs 
and understand the law, but can't always get it right.
    So it is certainly possible that the effect of the rules 
would be to take service businesses, for example, who don't 
maintain inventories who would not be required to use the 
accrual method of accounting currently and end up with an audit 
where it would be suggested that they should be on the accrual 
rather than the cash method of accounting. That could certainly 
happen in the future.
    Mr. Sweeney. In conjunction with that, I want to get a 
sense from the panel on how you would feel about using an asset 
threshold as we try to look at the arbitrariness of what is 
happening here.
    The Tax Code in section 1202 that defines C corporation is 
at $50 million in assets, I believe. Considering that many gas 
stations have more than $50 million in sales and insurance 
agencies must include policy revenue in their receipts, $1 
million or $5 million wouldn't come close for such businesses.
    Can you discuss further how we would begin to define small 
businesses and give us a sense of establishing thresholds?
    What would your recommendation be?
    Mr. Hill. I tend to agree with Mr. Crosby. I think 
thresholds may not be the answer here. I think there are other 
ways of defining small business, if it is necessary to define 
at all. It is a complex issue. But it is not so simple to put a 
dollar amount on it because $5 million means different things 
to different classes of business--severely different. It would 
be a boon to some and a hardship to others.
    Ms. Olson. I agree with that statement. I would also say 
that we don't think that just fixing this for small business is 
the right thing to do. The repeal of the installment method for 
accrual taxpayers doesn't just affect small business. In the 
area of contingent payment, it affects large C corporations as 
well with the result that there is likely to be an increased 
amount of controversy as taxpayers try to move to a different 
method of reporting their income altogether.
    Right now you have an interest charge already if the 
taxpayer receives an installment obligation in excess of $5 
million. That seems to me to be enough of a tightener on the 
use of the installment method of reporting. I wouldn't do 
anything more. I wouldn't put in a rule that limited it to 
small businesses.
    Mr. Sweeney. I would take it then that you would disagree 
with Mr. Mikrut's testimony or his perception that the guidance 
that is going to be offered by Treasury does take care of 
closely held corporations? In a real tangible way, it does not.
    Ms. Olson. No, I don't think it will. I think there is more 
work to do.
    Mr. Sweeney. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you, Mr. Sweeney.
    I just have one question to Mr. Crosby.
    If you repeal the installment method, what effect does that 
have on your life? What effect does that have on your 
retirement plans?
    Mr. Crosby. If it is repealed and it returns to the way 
that it was prior to December, it puts me back in a position 
where I feel like I have some control over the next several 
years of my life. My partner and I have spent roughly 25 years 
buying, building, and growing a business all along with the 
intention that we would use the proceeds from the sale of that 
business when we chose to retire. Whether that is 3 or 4 years 
from now or beyond, I can't say with certainty.
    But the issue that I see with the new provision is that in 
the first year after we sell the business we can be saddled 
with an enormous tax burden that we can potentially--as we 
hopefully begin retirement years--we could be faced with a 
situation where we would literally have to go to a bank to get 
financing to borrow money to pay our obligations to the 
government. To me, that seems like a particularly unfair way 
for a person who has worked very hard growing a business over a 
lot of years to start out retirement.
    Chairman Houghton. Thank you very much. That helps.
    Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman.
    I just had a question for Mr. Hill.
    You are representing the Chamber. Is your testimony applied 
just to small businesses, or are you talking for all small and 
large businesses?
    Mr. Hill. We are talking about businesses in general, small 
and large.
    Mr. Coyne. So it is not limited to the--
    Mr. Hill. But our focus is on the small businesses because 
we think this bill is onerous on that level.
    Mr. Coyne. So the focus is on small businesses, but really 
all businesses?
    Mr. Hill. Ultimately.
    Mr. Coyne. Thank you.
    Chairman Houghton. We have been joined by Mr. Neal of 
Massachusetts.
    Mr. Neal, would you like to ask questions?
    Mr. Neal. Thank you, Mr. Chairman.
    This question came up last week when I addressed the Boston 
Bar Association and their Tax section.
    Ms. Olson, can we patch the current law? Or should we start 
over?
    Ms. Olson. It is my view that you should start over. You 
should repeal the repeal and go back. If there are changes that 
need to be made, you should make those changes directly. But in 
our view, there is no abuse that has been identified, no 
problem that has been identified, that justifies the repeal of 
the installment method to begin with. We think you should start 
by going back to where you were.
    Mr. Neal. Thank you.
    Thank you, Mr. Chairman.
    Chairman Houghton. Anybody else have any other questions?
    [No response.]
    Chairman Houghton. If not, thank you very much for being 
with us.
    There being no further business before the Subcommittee, 
the hearing is adjourned.
    [Whereupon, at 2:25 p.m., the hearing was adjourned.]
    [Submissions for the record follows:]

Statement of American Institute of Certified Public Accountants, Tax 
Division

    Mr. Chairman and Members of this Distinguished 
Subcommittee:
    The American Institute of Certified Public Accountants 
(AICPA) is the national, professional organization of certified 
public accountants comprised of more than 330,000 members. Our 
members advise clients on federal, state and international tax 
matters and prepare income and other tax returns for millions 
of Americans. They provide services to individuals, not-for-
profit organizations, small and medium-size businesses, as well 
as America's major businesses, including multi-national 
corporations. Many serve businesses as employees. It is from 
this broad base of experience that we offer our comments.
    The AICPA appreciates the opportunity to provide written 
testimony on the subject of Section 536 of the Ticket to Work 
and Work Incentives Improvement Act of 1999 (P.L. 106-170) 
(Act). This section of the Act added section 453(a)(2) to the 
Internal Revenue Code of 1986 (IRC), effectively repealing the 
use of the installment method of accounting for most accrual 
method taxpayers. The AICPA, as do numerous small business 
trade and membership associations, believes that Congress 
should reinstate the ability of accrual basis businesses to 
utilize the installment method of accounting on the sale of 
assets and of the business. The issue is one of equitable 
treatment for closely held or small businesses, and reinstating 
that ability would reverse the adverse economic impact on small 
business created by enactment of Public Law 106-170 last year. 
Further, there is no historical basis for limiting the 
installment method to cash basis taxpayers. The installment 
method of tax accounting was promulgated, enacted and upheld 
for the purpose of relieving the tax burden on small businesses 
without regard to conformity with book accounting principles.
    While this provision also affects larger, accrual method 
businesses when they sell a particular asset or assets, its 
real effect has been to harm small and closely held businesses. 
When such businesses are sold, the new owner may wish to 
acquire assets rather than the stock of the business 
corporation (to avoid taking on the business liabilities, for 
example), and common practice is for payment to be made over a 
number of years in installments. Most such businesses use an 
accrual accounting method (tax law requires them, for example, 
to use an accrual method of accounting with respect to 
inventories). However, under the Act, they will now be forced 
to report the full gain from the sale of the business in the 
year of sale, even though payment for the assets will be made 
years into the future, and the first year payment may well not 
even cover the tax due on the sale.
    This provision is already having a significant effect on 
the sales of small businesses. We have heard directly from 
numerous CPAs whose clients have had and are having trouble 
selling their businesses; many negotiated transactions for the 
sale of all or part of a taxpayer's business have recently 
fallen apart. As a result of the change in tax law, either the 
purchaser finds it uneconomic to pay the full purchase price up 
front, or the seller finds that he or she will have to produce 
funds from sources outside the business to pay part of the now 
immediately due, full tax on the sale. Alternatively, sellers 
are forced to take a substantial cut in sales price to persuade 
a buyer to accelerate the payments in the year of sale or they 
abort the transaction completely.
    A sale of stock by a cash method shareholder is sometimes 
an option to transfer a business. More often than not, however, 
the buyer is not interested in purchasing the stock because 
doing so transfers the corporate liabilities to the new 
stockholder. In the case of an S corporation, because of unique 
shareholder restrictions, a stock purchase is often not even an 
option. Further, it is still not clear whether a deemed asset 
sale by an S corporation under section 338(h)(10) could be 
treated as a stock sale for this purpose. Again, from a 
practical standpoint, the inflexibility of requiring a stock 
purchase compounds the problem of market illiquidity because it 
further reduces the pool of willing buyers.
    The use of the installment method of accounting for tax 
purposes is widespread. It is used by all types of taxpayers, 
small and large, both C and S corporations, sole 
proprietorships, partnerships and individuals. It is used by 
businesses that are selling assets piecemeal but it is also 
used for the sale of an entire business. Regardless of whether 
a business is winding up or just selling assets, it may finance 
the sale by taking back a note. This is especially true for 
small businesses where financing may not be readily available 
to the purchaser and the seller becomes the financier of last 
resort. Before the change in the law, the business could defer 
tax by reporting the gain in installments, recognizing gain as 
the note was collected. This resulted in a deferral of the 
income tax and was consistent with the cash collected from the 
sale. With the new provision, the gain is immediately 
recognized. Tax liability could exceed cash generated from the 
sale by several times in the first year, severely distressing 
the business and its owners.
    We believe the broad nature of the Act's language leaves 
Treasury relatively little room in solving this problem through 
regulation because there is no room in the statute for 
exceptions, particularly for the sale of small businesses. 
There are some highly complex fixes and exceptions that may be 
available to a few taxpayers, but regulatory responses, 
overall, would simply be small bandages on a large wound, even 
if the administrative response were generous.
    To provide the measure of relief which approaches the level 
of hardship currently being suffered by small business owners 
contemplating a sale of their business, we strongly believe a 
legislative solution is necessary. Congress should make it 
simple and fair for all business owners to pay the often 
substantial tax due from the successful sale of their business 
when the sales price is received in installments over many 
years.
    We welcome the opportunity to discuss this matter with you 
further.
      

                                


Statement of National Association of Manufacturers

    The National Association of Manufacturers (NAM) appreciates 
the opportunity offered by Subcommittee Chairman Houghton to 
comment on the recent repeal of the installment method of 
accounting for accrual basis taxpayers. The NAM--``18 million 
people who make things in America''--is the nation's largest 
and oldest multi-industry trade association. The NAM represents 
14,000 members (including 10,000 small and mid-sized companies) 
and 350 member associations serving manufacturers and employees 
in every industrial sector and all 50 states. Headquartered in 
Washington, D.C., the NAM has 10 additional offices across the 
country.
    Repeal of the installment sales provision, which was 
originally proposed by the Administration in its fiscal 2000 
budget proposal, was included in P.L. 106-170, the Ticket to 
Work and Work Incentives Improvement Act of 1999, enacted on 
December 17. Unlike many other negative tax law changes, the 
provision became effective on enactment and did not include any 
binding contract language or transitional rules. This tax law 
change is having and will continue to have a significant 
negative impact on sales of small enterprises. We urge Congress 
to act quickly to restore the ability of accrual method 
taxpayers to use the installment method of accounting for asset 
sales.

                      Impact of the Tax Law Change

    The impact of the installment sales provision goes well 
beyond anything hinted at in the explanation of the revenue 
proposals in the President's Fiscal 2000 Budget or the 
legislative history of P.L. 106-170. While the provision 
appeared to target larger, accrual method businesses when they 
sold a particular asset or assets, its real effect is to reduce 
the value of closely held businesses when they are sold in 
their entirety.
    In the past, many small and medium manufacturers used the 
installment method in business sales for a variety of reasons, 
including the ability to spread the capital gains tax payment 
over the life of the sale. The installment method also has 
benefits beyond those related to taxes. It enables sellers to 
be more flexible in structuring the sale and to get a higher 
price for the business and it allows buyers to purchase a 
business for which bank financing is unavailable. The 
installment method also ensures that the seller will continue 
to have a financial interest in the ongoing success of the 
business.
    The conference report on the Ticket to Work and Work 
Incentives Improvement Act states that when a cash method 
taxpayer sells stock in an accrual method business-either an'S 
or C Corporation-the seller could use the installment sales 
method. However, in sales of closely held businesses, the stock 
sale is not always possible or most efficient. Even when stock 
exists, many sales of small businesses are structured as asset 
sales, for a variety of non-tax reasons. One of the most common 
reasons is that the buyer is interested in the assets of a 
business but not the imbedded liabilities that come with buying 
the stock. In fact, potential buyers sometimes refuse to buy 
the stock of a closely held company.
    Depending on the structure of the sale, the loss of the 
installment sales provision will reduce the sale price of a 
closely held business, in some cases by as much as 20 percent. 
For instance, a seller may be forced to sell the stock, rather 
than the assets of his business so that he can use the 
installment method. Because of the potential liabilities that 
go along with the stock, an owner is likely to get a lower 
price for his business.
    In other cases, the loss of the installment sales rule will 
prevent a sale from going forward. Many sales of small 
businesses are seller financed, in part because small business 
buyers have a difficult time obtaining commercial financing. 
Without the installment sales provision, a seller offering 
seller financing now has to pay the tax on his capital gain at 
the time of the sale rather than spreading the payments over 
the term of the installment note.
    Under the deprecation recapture rules, a small business 
owner using the installment method already is required to 
recognize any recapture income in the year of the sale. 
Requiring the owner to also recognize capital gain at the time 
of the sale places yet another financial burden on the seller. 
In many cases, the seller may not have enough cash to pay his 
total tax bill, making it difficult or impossible to go through 
with the deal.
    The loss of the installment sales rule also can exacerbate 
the problems faced by families when a business owner dies. In 
the United States today, two-thirds of family-owned businesses 
do not survive into the next generation, often because of the 
burden of estate taxes. Families are forced to sell the 
business to pay the estate tax liability. As noted above, 
repeal of the installment treatment could make it more 
difficult for a family to sell a business and/or reduce the 
price they are able to get for the business.

                       Proposed Treasury Guidance

    After the changes in the installment sales rules were 
enacted last December, we were hopeful that regulatory guidance 
could ameliorate the impact of this change on our small and 
medium manufacturers. However, this is not the case. The 
proposed guidance outlined by Treasury on February 29, while 
helpful to some small businesses, will not address the 
situation faced by our small and medium members.
    For instance, one of the Treasury proposals would allow 
business taxpayers with average annual gross receipts of $1 
million or less to use the cash method and, thus, the 
installment sales method. While this will provide relief to 
some taxpayers, it could force some taxpayers to choose a 
method of accounting for tax purposes, rather than business 
purposes.
    Moreover, even if our members decided to use the cash 
method, very few, if any, would fit into this category. Based 
on a 1999 survey of our small and medium members, only 17% of 
our members have annual sales of less than $3 million and its 
estimated that a much lower number have annual sales of $1 
million or less.

                            Legislative Fix

    In previewing the guidance at the Oversight Subcommittee 
hearing on February 29, Joseph Mikrut, Treasury's tax 
legislative counsel, acknowledged that a legislative fix is 
needed to ``alleviate this unforeseen impact of the installment 
sales provision.'' In particular, he suggested that sellers of 
small businesses with less than $5 million in gross receipts be 
allowed to use the installment method.
    Unfortunately, the possible legislative fix outlined by Mr. 
Mikrut does not go far enough. The carve-out for businesses 
with less than $5 million in gross receipts would benefit, at 
most, one-third of our small and medium manufacturers. It would 
create winners and losers within our industry, with about two-
thirds of our small and medium members unable to use the 
installment method.

                               Conclusion

    In comments before the House Ways and Means Committee on 
February 8, Treasury Secretary Larry Summers acknowledged that 
the provision has had a broader impact than initially 
anticipated. We believe that total repeal of the provision 
enacted in December is the fairest, simplest and most effective 
way to address the problem faced by small business owners who 
are selling their businesses. On behalf of the National 
Association of Manufacturers (NAM) and our 14,000 member 
companies, I urge you to support immediate legislation to undo 
the damage inflicted on small businesses by changes in the 
installment sales rules enacted last year.
      

                                


Statement of the National Association of Professional Insurance Agents, 
Alexandria, VA

    The National Association of Professional Insurance Agents 
(PIA National) applauds Chairman Houghton and the Ways and 
Means Subcommittee on Oversight for holding today's hearing to 
discuss last year's repeal of the installment method of 
accounting for accrual basis taxpayers. PIA National represents 
180,000 insurance professionals nationwide, many of whom are 
small business owners. The topic of today's hearing is of vital 
importance to our members. We appreciate this opportunity to 
present our views and real life testimonials from a number of 
our members who have already begun to experience the 
devastating affects of this unexpected change in tax law.
    In short, insurance agencies are more difficult to sell and 
acquire, and could lose as much as 15% of their value as a 
result of tax provisions included in the Ticket to Work and 
Work Incentives Improvement Act of 1999. These provisions force 
agents to pay taxes on the sale of their agency all at once 
even if the proceeds of the sale are received in installments 
over several years. In some instances, tax liability exceeds 
the agent's first year revenue, making the sale impossible or 
forcing the agent to borrow money to pay taxes. The new law 
equally disadvantages buyers. Unable to spread the purchase 
price over a number of years, buyers are forced to secure 
financing or deplete savings to acquire an agency.
    As you can see, the provisions prohibiting the use of the 
installment sales method by accrual basis taxpayers are already 
having a negative impact on the sale of small enterprises such 
as many insurance agencies. The net impact is that many 
insurance agencies are now worth considerably less money. This 
potentially devastating problem is compounded by the fact that 
many agents use the proceeds from the sale of their agency to 
finance their retirement.
    The installment sales method is used by small businesses 
for a variety of reasons. It enables sellers to be more 
flexible in structuring the sale and can lead to a higher 
purchase price. Buyers unable to secure financing often prefer 
the installment method. It also ensures the seller will have an 
interest in the ongoing success of the business, which is 
important for buyers when a large portion of the purchase price 
is attributable to good will, as is the case with an insurance 
agent's book of business. We see no good public policy reason 
why small business owners who happen to be accrual basis 
taxpayers should be prevented from using the installment sales 
method.
    While the onerous tax provision is not new--it was also 
included in the President's FY 2000 budget proposal and the tax 
relief bill ultimately vetoed last year--its consequence for 
small business owners is just recently surfacing. The provision 
was originally designed to target larger accrual method 
businesses when they sold particular assets or a portion of 
their ongoing concern. Unfortunately, as we now know, it also 
ensnares closely held businesses such as insurance agencies 
when they are sold in their entirety. This is an unintended 
consequence and it should be fixed.
    Fortunately, legislation has been introduced in the House 
and Senate to repeal the new tax law prohibiting use of the 
installment sales method by accrual basis taxpayers. PIA 
supports these efforts and implores the Ways and Means 
Committee to move quickly on H.R. 3594 introduced by 
Congressman Wally Herger (R-CA). This bill already has well 
over 100 co-sponsors and is universally supported by the small 
business community. We appreciate this opportunity to present 
our views and look forward to working with the Committee and 
Congress as a whole to see H.R. 3594 enacted into law.
    Attachments A-D are letters from PIA members explaining in 
their own words the chilling effect this new law has had on 
their livelihood.
                                Shenandoah Insurance Agency
                                    Stuarts Draft, VA 24477
                                                   February 8, 2000

Honorable Robert W. Goodlatte
United States House of Representatives
Washington, DC 20515

Dear Congressman Goodlatte:

    I am writing to ask you to join Congressman Walter Herger (R-CA) in 
his plan to introduce legislation to repeal the Ticket to Work and Work 
Incentives Improvement Act of 1999. This is my story:
    During the year of 1999 I placed my insurance agency on the market 
and in the fall of 1999 I concluded the sale. In fact the buyer and I 
signed a buy and sell agreement in December 1999 about the time 
President Clinton signed the Act which went into effect the day the 
President signed. The buy and sell agreement went into effect January 
1, 2000. Soon after January 1, 2000 I met with my CPA who informed me 
because of this Act I would probably owe taxes on the sale of $30,000 
plus which because of the Act would be a one time payment. I was not 
aware that such an Act was even being considered by the Congress and I 
now find out that this was something that Congress did on the last day 
of your session last fall. I like hundreds of small businesses use the 
sale of our business as retirement income and we planned to pay income 
tax on the interest that we receive from the sale but now we are being 
hit with another tax.
    I do not understand why you, the other members of Congress and 
President Clinton tell us in the press that you want to cut our taxes 
and at the same time pass the above mentioned Act.
    I sincerely hope that you will join Congressman Herger in his 
effort to strike this unfair provision from the tax code as it will 
kill the sale of every small business in the country.
    Thanking you for the help that you can give me on this matter.

            Sincerely yours,
                                         William S. Swecker

                                        Bohmer Agency, Inc.
                                   Brooten, Minnesota 56316
                                                   February 8, 2000

Honorable Collin C. Peterson
United States House of Representatives
Washington, DC 20515

Dear Congressman Peterson: RE: Wally Herger's Upcoming Tax Bill
    I am writing to ask that you co-sponsor legislation that will soon 
be offered by Rep. Wally Herger (R-Ca). The Professional Insurance 
Agents (PIA) organization informs me that a correction in the tax 
provisions contained in the ``Ticket to Work and Work Incentives 
Improvement Act of 1999'' is needed. It seems that we small, 
incorporated businesses are being caught up in a tax correction aimed 
at larger businesses.
    I have a small insurance agency in Brooten, Minnesota and am forced 
to use the accrual basis of accounting since I am dealing with 
insurance companies. With the current law I would have difficulty 
selling all, or a portion, of my stock to one of my employees: I would 
be unable to finance them with an installment contract if I have to pay 
all the taxes ``up front.'' In addition, if I chose to sell the agency 
outright only large existing agencies will be able to afford to 
purchase my agency. I don't think this is what was intended by the 
existing law.
    I haven't been able to thank you in person for the help you gave 
our community in organizing a cooperative frozen food plant several 
years ago. THANK YOU. I have reminded local people of your assistance 
and am still your strong supporter.
    Please feel free to call me at (320) 346-2234 or write me if you 
have any questions of me. I appreciate your assistance in this matter.

            Thank you.
                                              Respectfully,
                                            David W. Bohmer

                                   Balland-Zimmerman Agency
                             Baltimore, Maryland 21202-3311
                                                  February 28, 2000

Representative Ben Gardin
Unites States House of Representatives
Washington, DC 20515

Dear Representative Gardin:

    As a small businessperson and professional insurance agent in your 
district, I am writing to ask that you co-sponsor legislation soon to 
be offered by Rep. Wally Herger (R-CA) which repeals onerous new tax 
provisions contained in the Ticket to Work and Work Incentives 
Improvement Act of 1999. The new law effectively prohibits the use of 
the installment sales method by accrual basis taxpayers and will have a 
tremendous negative impact on all small business owners wishing to sell 
their business.
    I have been in the insurance business for 54 years, and have been 
taxed on an accrual basis. This year was to be my final one, and I had 
planned to sell the agency to another agent, and on an installment 
basis. The new law would force me to pay all taxes up front, reducing 
the value of the agency to me as well as to the buyer. As I understand 
it, the new law was intended to target large businesses that were 
selling off one or more assets, but it's impact would fall hardest on 
the transfer or sale of small businesses like independent agencies. 
This was an unintended consequence and should be fixed.
    The installment method of selling an insurance agency is one of 
long standing. It allows more flexibility in structuring the sale of 
their business and buyers often prefer the installment method as it 
ensures that the seller has an interest in the business' on going 
success. This is important to the buyer when a large portion of the 
purchase price is attributable to good will.
    I am counting on you to remedy this terrible situation faced by all 
small business owners and to co-sponsor repeal measures. I look forward 
to hearing back from you on this topic.

            Respectfully yours,
                                           William S. Stack

                 Frederickson-Brown Insurance Service, Inc.
                                 Canon City, Colorado 81212
                                                  February 28, 2000

PIA
Attn: Allison Lewis
Re: Ticket to Work Act of 1999

Dear Allison:
    Please stress to those involved what a tremendous hardship this 
bill places on small businesses in general.
    I have worked for 26 years at Frederickson-Brown Insurance and plan 
to retire the end of this year. If I am required to pay all of the tax 
on the sale of my agency in the first year, it would be impossible 
since the income will be spread over a period of 20 years. This law 
will prevent the use of installment sales and could cripple small 
business owners selling their businesses or passing them along to other 
stockholders or family members. Thanks for all of the hard work being 
done by PIA.

            Sincerely,
                                                Brad Knotek
      

                                


Statement of the Printing Industries of America, Alexandria, VA

    Mr. Chairman and members of the committee, thank you for 
providing an opportunity for the Printing Industries of America 
to provide comments on the installment method of reporting 
income from an installment sale that would otherwise be 
reported on an accrual method of accounting. PIA is the 
nation's largest graphic arts trade association with more than 
14,000 members nationwide.
    Although little was said about this provision before it was 
included as an offset to the tax extenders included in the 
Ticket to Work and Work Incentives Improvement Act of 1999, the 
unanticipated consequences have caused uproar in the small 
business community. Since repeal of the installment method of 
reporting sales for accrual basis taxpayers was signed into law 
on December 17,1999 (Public Law 106-170), I have received 
numerous calls from our members concerned about the effect the 
disallowance could have on their current and future business 
plans. Countless businesses will be adversely affected if this 
repeal is allowed to stand unheeded.
    Until this year, sellers have been able to set up sales of 
the assets of their businesses by financing a note using the 
installment method. Owners were able to defer capital gains 
taxes until the year payments were actually received. This was 
particularly important since many small business sales must be 
financed by the seller, because traditional bank financing is 
often not available to the average buyer.
    As the committee is aware, the December change in law will 
now force business owners to pay taxes on sales in the first 
year, rather than when payments are actually made. Because many 
small business owners simply do not have the cash on hand to 
pay the taxes now required in the year of the sale, sellers are 
faced with limited options such as lowering the sale price or 
borrowing the money from a bank.
    Either of these scenarios would place new burdens on a 
small business owner as they often use the sale of their 
business to finance their retirement. An unexpected reduction 
in expected income could very well require continued work 
rather than selling to retire. Another unfortunate circumstance 
that could result from this requirement is the position a 
seller would be put in if the buyer were to go bankrupt a 
couple of years down the road. In this instance with the 
current law, an individual would already have paid taxes on 
money he now will never receive.
    A difficult situation arose for a New England member 
recently, as a result of the disallowance of the installment 
sales method of accounting. This particular member happens to 
be the proud ten-year owner of a direct mail printing company 
employing approximately 45 employees. This printer was in the 
process of purchasing a mailing house company, which employs 
approximately 195 employees, in an attempt to add to the 
current growth of his direct mail printing company. He had 
arranged a loan with the sellers of a mailing house company, 
which would come from the proceeds of the sale of the company 
to our member. This money was crucial to our member in order to 
obtain approval from the bank for the loan to buy the mailing 
house company.
    At the time when the repeal was signed into law in December 
of 1999, our member and the sellers of the mailing house 
company were nearing the end of their negotiations and were 
almost ready to close. However, the tax implications of the 
newly enacted law almost caused the sellers to balk on the deal 
as the realization of the additional tax responsibility dawned 
on the sellers. It was only their desire to sell to a fellow 
small business owner that kept them from pulling out of the 
deal altogether. In order to close the deal, our member had to 
agree to a repayment schedule at a higher interest rate and on 
an accelerated basis. He also agreed to give the amount of 
money equal to the taxes due in the coming year or pay a 
significant penalty in addition to the amount borrowed from the 
sellers. Our member continues to hope for a ``repeal of the 
repeal'' in order to relieve this incredible burden placed on 
him as a result of the disallowance of the installment method 
of reporting this sale. If repeal is not enacted by the time 
the taxes are due on this sale, our member will be forced to 
borrow this sum of money and go further into debt in order to 
satisfy the terms of the agreement.
    Further, our member has expressed his concern as to the 
continuation of the business plans of the people involved in 
the sale. Should this provision remain intact, many business 
owners, including our member, may have to consider selling to a 
consolidator, instead of to their current management or perhaps 
a family member, in order to get the price needed to sustain 
future plans and retirement.
    Our member has said that for years it has been his plan to 
finance the sale of his business when he is ready to retire. 
However, with the current law, this option would probably not 
be considered due to the tax responsibilities of the current 
law. This will certainly curtail the employee advantage in this 
scenario and limit the future of small businesses while at the 
same time encouraging sales to larger companies.
    Is this really what Congress would want? Do we want to make 
selling a small business company so difficult as to endanger 
the future of small businesses overall in our community; those 
same small businesses that have been a staple for providing 
jobs and economic growth in our communities for years on end? 
For the reasons provided in this statement, the Printing 
Industries of America urges your support for a complete 
``repeal of the repeal,'' as this is the only way to keep the 
playing field level for the small business community. On behalf 
of printers across the nation, PIA encourages you to support 
H.R. 3594, sponsored by Representative Wally Herger, for a 
complete repeal of the disallowance of the installment method 
of sales. Thank you for the opportunity to submit this 
statement into the record.

                                   - 
