[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]



 
           REFORMING THE TAX CODE TO ASSIST SMALL BUSINESSES

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

                                HEARING

                               before the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                   WASHINGTON, DC, SEPTEMBER 21, 2005

                               __________

                           Serial No. 109-32

                               __________

         Printed for the use of the Committee on Small Business


 Available via the World Wide Web: http://www.access.gpo.gov/congress/
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                      COMMITTEE ON SMALL BUSINESS

                 DONALD A. MANZULLO, Illinois, Chairman

ROSCOE BARTLETT, Maryland, Vice      NYDIA VELAZQUEZ, New York
Chairman                             JUANITA MILLENDER-McDONALD,
SUE KELLY, New York                    California
STEVE CHABOT, Ohio                   TOM UDALL, New Mexico
SAM GRAVES, Missouri                 DANIEL LIPINSKI, Illinois
TODD AKIN, Missouri                  ENI FALEOMAVAEGA, American Samoa
BILL SHUSTER, Pennsylvania           DONNA CHRISTENSEN, Virgin Islands
MARILYN MUSGRAVE, Colorado           DANNY DAVIS, Illinois
JEB BRADLEY, New Hampshire           ED CASE, Hawaii
STEVE KING, Iowa                     MADELEINE BORDALLO, Guam
THADDEUS McCOTTER, Michigan          RAUL GRIJALVA, Arizona
RIC KELLER, Florida                  MICHAEL MICHAUD, Maine
TED POE, Texas                       LINDA SANCHEZ, California
MICHAEL SODREL, Indiana              JOHN BARROW, Georgia
JEFF FORTENBERRY, Nebraska           MELISSA BEAN, Illinois
MICHAEL FITZPATRICK, Pennsylvania    GWEN MOORE, Wisconsin
LYNN WESTMORELAND, Georgia
LOUIE GOHMERT, Texas

                  J. Matthew Szymanski, Chief of Staff

          Phil Eskeland, Deputy Chief of Staff/Policy Director

                  Michael Day, Minority Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                               Witnesses

                                                                   Page
Fortenberry, Hon. Jeff (NE-1), U.S. House of Representatives, 
  U.S. Congress..................................................     3
Sullivan, Hon. Thomas, Chief Counsel for the Office of Advocacy, 
  U.S. Small Business Administration.............................     7
Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue 
  Service........................................................     9
Rolnick, Ms. Thala, Price, Senior Tax Manager, Kong & Company, 
  CPA............................................................    11
Landis, Mr. Marilyn, Basic Business Concepts.....................    12
Darien, Ms. Kristie, Executive Director, Legislative Offices, 
  National Association for the Self-Employed.....................    14
Irons, Mr. John, Ph.D., Director, Tax and Budget Policy, Center 
  for American Progress..........................................    16

                                Appendix

Opening statements:
    Manzullo, Hon. Donald A......................................    25
Prepared statements:
    Fortenberry, Hon. Jeff (NE-1), U.S. House of Representatives, 
      U.S. Congress..............................................    29
    Sullivan, Hon. Thomas, Chief Counsel for the Office of 
      Advocacy, U.S. Small Business Administration...............    35
    Olson, Ms. Nina, National Taxpayer Advocate, Internal Revenue 
      Service....................................................    41
    Rolnick, Ms. Thala, Senior Tax Manager, Price, Kong & 
      Company, CPA...............................................    57
    Landis, Mr. Marilyn, Basic Business Concepts.................    65
    Darien, Ms. Kristie, Executive Director, Legislative Offices, 
      National Association for the Self-Employed.................    70
    Irons, Mr. John, Ph.D., Director, Tax and Budget Policy, 
      Center for American Progress...............................    75

                                 (iii)


           REFORMING THE TAX CODE TO ASSIST SMALL BUSINESSES

                              ----------                              


                     WEDNESDAY, SEPTEMBER 21, 2005

                   House of Representatives
                                Committee on Small Business
                                                     Washington, DC
    The Committee met, pursuant to call, at 2:18 p.m., inRoom 
2360, Rayburn House Office Building, Hon. Donald Manzullo 
[Chairman of the Committee] Presiding.
    Present: Representatives Manzullo, Bartlett, Kelly, 
Velazquez, Lipinski, Faleomavaega, and Bordallo.
    Mr. Bartlett. [presiding.] Our Committee will come to 
order. Chairman Manzullo is currently occupied on the floor of 
the House speaking on behalf of a manufacturing bill. He will 
join us as soon as he completes his speech on the floor. As 
acting chair, I welcome you to this hearing.
    Our first witness today will be Mr. Fortenberry from 
Nebraska.
    Before I yield to our ranking member for her statement I 
would like to note that from a personal perspective the best 
way we could help small business is to reform the Tax Code by 
abolishing it and putting in its place the fair tax. That would 
be very simple and would remove lots of pages of regulations.
    Ms. Velazquez.
    Ms. Velazquez. Thank you, Mr. Chairman. Given the fact that 
the world is not that simple, let me just make my statement.
    With the recent disaster in the Gulf region, our country is 
again reminded of the powerful role small businesses play in 
our economic recovery. Through our Nation's history it has been 
small firms that have been credited with acting as an economic 
stimulus, creating jobs and bolstering recovery during times of 
economic hardship. When it comes to providing assistance and 
assuring small firms have the tools they need to succeed, one 
thing has been clear: The Tax Code only continues to create 
barriers for a sector that does not need any more challenges.
    As we continue to rely heavily on our small businesses for 
economic revitalization, we need to ensure these small 
companies start seeing some tax relief. The truth is many 
entrepreneurs have not seen any real tax relief from the series 
of tax cuts that have been passed over the past 5 years. Only 1 
percent of all small business owners actually see any benefits 
from the top rate cut, rather, what they have gotten are 
increasing compliance costs, and little or no savings.
    There are several reasons for this. One is the increasing 
complexity of the Tax Code. While there have been a number of 
tax cuts over the last 4 years, the complexity of the Tax Code 
has increased significantly. Despite the fact that the Bush 
administration recognized the problem, the last two bills, tax 
bills, have actually increased the complexity of the Tax Code 
even further.
    The complexity has serious implications for small business 
owners. The IRS has noted that it takes the typical American 
family 8 hours more to do their taxes than it did a decade ago. 
Given that, small business owners' tax returns are much more 
complicated than the average American family's. They are now 
having to spend more and more resources on their tax returns.
    The Office of Advocacy released a study in 2001 that showed 
tax compliance costs for small firms, $1,200 per employee for a 
small firm versus 562 per employee for their larger 
counterparts. This is clearly an injustice to our Nation's 
small businesses. Instead of helping them cope with the Tax 
Code, small businesses are being overburdened with costs and 
time. What good is passing a tax cut which may give $500 to a 
small business when they only have to turn around and spend 
$1,000 on an accountant or an attorney so they are able to 
comply with the Tax Code.
    Small business owners do not have the resources to deal 
with this change. As a result of this, small firms are making 
fewer investments back into their businesses and more are 
hiring accountants and attorneys.
    To compound these problems, the IRS is now going after 
small firms in an attempt to close the tax gap. There are 
increasing audits on small businesses. Once again it is this 
Nation's entrepreneurs that are bearing the burden of a Tax 
Code that no one can figure out.
    Clearly the administration needs to step back and examine 
who, if anyone, is benefiting from the current Tax Code. What 
needs to happen now is that the administration start listening 
to the needs of small businesses who want to see provisions 
such as section 179 made permanent so they can successfully 
invest in capital expenditures and expand.
    Right now, as the Gulf Coast region and our Nation gears up 
to recover from Hurricane Katrina, we will be reminded of the 
critical role small firms play in making an economic recovery a 
reality. What Louisiana, Alabama and Mississippi need today is 
revitalization, and in order to do that there must be 
investment in small businesses. For an economic recovery with 
robust job creation, tax policies must be in place that makes 
small firms the centerpiece rather than an afterthought.
    It is time the administration recognizes that they have put 
small businesses at the back of the line. They need to start 
making changes to the Tax Code that would allow small 
businesses to flourish and expand so the Gulf region and our 
Nation's economy can finally move forward.
    Thank you, Mr. Chairman.
    Mr. Bartlett. Thank you very much.
    In a former life I was a small business owner. I am one of 
maybe 35 who came to the Congress as a member of NFIB. We 
always filled out our own taxes. Not only did we have a small 
business, we did land development and built homes. We also ran 
a farm. So we had to fill out those forms. And we filled out 
the itemized deductions and we did the taxes ourselves. So I am 
very familiar with the tax burden on both the individual 
taxpayer and on small businesses.
    We are very happy to have one of our own here today as our 
first witness. Mr. Fortenberry, the floor is yours.
    I am sorry. Different committees have different procedures 
for opening statements. I would like to ask now are there 
opening statements from other members? Okay, thank you.
    Mrs. Kelly. I didn't realize that you weren't going to call 
for opening statements, I am sorry. But since you have given me 
the floor, I want to thank our colleague and friend, Jeff 
Fortenberry, and I look forward to hearing about the work that 
he is doing.
    The small businesses in the Hudson Valley are constantly 
telling me that they want a simple and a fair Tax Code. The 
amount of time and money that we small business owners spend on 
complying with the Tax Code is just mind boggling and 
everything that we spend in terms of time affects our ability 
to do business. That is really a disservice to the American 
economy. And I just simply know that we saw benefits in the 
aftermath of September 11th and the resulting recession because 
small businesses, three-quarters of them--new jobs are created 
by small businesses and that worked for New York.
    We employ half of the private sector workforce, and we pay 
44 percent of the U.S. Tax private payroll. One of the 
interesting things to me is that women-owned small businesses 
in the United States of America employ more than all the 
Fortune 500 companies put together.
    With this emergency in Katrina, I think it is absolutely 
important that we knock down the barriers to success that are 
in the U.S. Tax Code. So I look forward to hearing what you 
have to say, Mr. Fortenberry, and I am delighted you are 
willing to come from the Committee today.
    Thank you, Mr. Chairman.
    Mr. Bartlett. Thank you. Without objection, the opening 
statements of all of our members, those who are here and not 
here, are made part of the Record.
    Ms. Bordallo.
    Ms. Bordallo. Thank you, Mr. Chairman. I really don't have 
an opening statement, but I do have some questions of the 
witnesses.
    Mr. Bartlett. Thank you very much.
    Are there other opening statements? Okay. Anyone who wishes 
to have an opening statement in the record we would ask 
unanimous consent for that to be done.
    Now, Mr. Fortenberry, the floor is yours.

 STATEMENT OF THE HON. JEFF FORTENBERRY (NE-1), U.S. HOUSE OF 
                 REPRESENTATIVES, U.S. CONGRESS

    Mr. Fortenberry. Thank you so much, Mr. Chairman. I really 
appreciate the opportunity to be with you. And Ranking Member 
Velazquez, thank you so much for the opportunity to speak.
    I want to speak about a particular issue regarding tax 
reform that I think could be extraordinarily helpful to small 
businesses. At the outset, though, I want to talk to you about 
a fascinating trend, and I recognize this trend myself 
intuitively but had it affirmed recently by more empirical 
data.
    Young adults, commonly known as Generation X, are 
interested in two ideals, family life and entrepreneurship, and 
I really believe that these ideals flow from the same desire, a 
desire for self-possession and a desire for self-donation. And 
if you think about it, in the family, a person enters through a 
commitment into a community of intimacy and builds a community 
of love and life. And this most solemn ideal is a great gift of 
the human experience and also a serious responsibility, and one 
that many young people are eager to embrace, even given the 
difficulties that they may have faced in their own upbringing.
    The second ideal of entrepreneurship embraces the freedom 
to use one's own gifts to produce a good for the community, to 
build something that is the very imprint of one's own self, to 
create, using one's own hands and mind, receiving in turn the 
full fruits of one's own labor. Again, this ideal is the 
essence of rewarding hard work and is a desire expressed 
readily by young people.
    Mr. Chairman, no more 40 years and a gold watch it appears. 
I think we may very well be entering the age of 
entrepreneurship.In recognizing this reality, I believe we must 
work to adjust our tax laws to assist those who want to create 
new opportunities for themselves and their families.
    I will soon introduce two bills promoting entrepreneurship 
and long-term economic security. First, I will proposal 
allowing individuals to roll over portions of their retirement 
accounts into health savings accounts. Second, I will propose 
to change the traditional IRA to allow small business investors 
to take loans from these retirement accounts similar to the 
existing loan provisions in 401(k) plans. These bills address 
two key areas of concern for small businesses, providing 
increased access to insurance coverage and gaining access to 
capital.
    Before I go into the details of these proposals I believe 
it is important to review why small businesses are so 
important--and Mrs. Kelly you pointed out many of the facts 
that we all already know. Small businesses are the most 
productive sector. It is where most people work, earn, try to 
get a little bit ahead in life.
    According to the SBA, small businesses account for 75 
percent of net new jobs added to the economy, and employ half 
of all private sector workers. They represent 99 percent of all 
employees and 97 percent of all U.S. Exporters. I believe we 
must develop policies to encourage this important sector of the 
economy.
    I have a keen interest in reducing barriers to entry into 
small businesses. I initially focused on access to capital 
issues, but quickly saw how the lack of available health 
insurance and rising healthcare costs decreases productivity 
and distorts social and economic decisions. For instance, it is 
not uncommon in my district among farm families for a spouse to 
drive very long distances simply to maintain a job for 
healthcare coverage. How can we count the loss of new ideas and 
new productivity because someone makes an undesired economic 
decision based solely on health insurance coverage reasons?
    As we have learned, the rising cost of providing health 
coverage for employees is a growing obstacle for small business 
owners, or those who wish to join the ranks. It is not 
surprising that only 63 percent of smaller companies can even 
afford to offer health insurance, and this is a primary reason 
why three out of five uninsured persons in our Nation are small 
business owners, their employees and their families.
    Recently the Small Business Committee held a field hearing 
in my district, and during this forum we examined the 
increasing cost of health insurance and possible solutions. The 
hearing emphasized the importance of an underutilized tool for 
small business, the health savings account, which were 
established as a part of the Medicare prescription drug law. 
These tax preferred accounts, coupled with high deductible 
health insurance, help alleviate the ever increasing cost of 
traditional health insurance premiums and empower families to 
better control their own healthcare costs as well.
    According to a survey conducted by the Kaiser Family 
Foundation and Health Research and Educational Institute, or 
Educational Trust, only 20 percent of employers who offer 
health insurance provide a high deductible policy option. The 
same survey found that only 2.4 million workers outside the 
Federal Government are enrolled in such plans.
    While the number of individuals utilizing health savings 
accounts is increasing, I believe we need to do more to give 
small business owners and entrepreneurs the ability to take 
advantage of this important new policy innovation. In fact, of 
the new policies, 37 percent were taken out by individuals who 
were previously uninsured and 27 percent were taken out by 
employers who did not previously offer their workers health 
insurance.
    As mentioned in my proposed legislation, individuals will 
be able to roll over portions of their retirement accounts into 
health savings accounts. This rollover will not subject the 
retirement account to the usual 10 percent penalty for an early 
distribution. Moreover, all individuals with retirement 
accounts would be eligible to take advantage of this 
opportunity. This will help meet the important policy 
objectives of increasing access to health insurance coverage 
and overcoming a major barrier entry into small business.
    An additional barrier that entrepreneurs often encounter is 
gaining access to capital, as we all know. Earlier this year 
the Committee considered and passed House Resolution 22, the 
Small Business Bill of Rights, which identified access to 
capital as a key concern for small businesses. According to the 
SBA again, the majority of small businesses use some form of 
external credit. Sadly, 46 percent of all these small business 
owners are using their own personal credit cards as a source of 
capital. The bill I propose will provide additional sources of 
capital by changing the traditional IRA to allow small business 
investors to take loans from these retirement accounts.
    The provisions of these IRA loans are similar to the 
existing loan provisions of the 401(k) plan in several ways. 
First, they permit individuals to borrow up to the greater of 
half of their IRA account balance or $10,000. In either case 
the loan would be capped at a maximum of $50,000.
    Second, the provisions will require the individual to use 
the money to finance small business capital expenditures. And 
third, individuals will have 5 years to repay the loan to 
ensure that the loan is not treated as a simple withdrawal from 
the IRA.
    Mr. Chairman, I believe these initiatives will encourage 
young people to jump-start and give them a jump-start into 
promising business opportunities, enable more advance workers 
to potentially have greater access to capital for the formation 
of small businesses, and potentially allow more senior workers 
who must often be risk averse potentially start new spin-off 
side ventures.
    These goals are consistent with the purpose of retirement 
savings in that they will allow more persons to be owners, 
possess the means of production, and provide long-term economic 
security for their families.
    Again, what a privilege it is to be on this side of the 
table today to have the opportunity to speak with you. This is 
a little bit different experience, but I really appreciate the 
opportunity to be before you.
    Thank you, Mr. Chairman.
    [Mr. Fortenberry's testimony may be found in the appendix.]
    Mr. Bartlett. Thank you very much.  As is my custom, I will 
reserve my comments and questions until the other members of 
the Committee have had a chance to make their comments and ask 
their questions.
    Ms. Velazquez.
    Ms. Velazquez. Thank you, Mr. Chairman. I have no 
questions.
    Mr. Bartlett. Ms. Kelly.
    Mrs. Kelly. Thank you, Mr. Chairman. I have no questions.
    Ms. Bordallo. Mr. Chairman, I don't have any questions.
    Mr. Faleomavaega. Mr. Chairman, I thank our colleague and 
good friend from Nebraska for his testimony. And as it is 
customary, also, most members, we don't have questions of your 
testimony, but we do thank you for your eloquent statement and 
look forward to working with you on your legislation, also. 
Thank you very much.
    Mr. Bartlett. Thank you very much. Just one quick comment. 
Fourteen years ago, when I was running for this House seat, Pat 
Rooney, President of Golden Rule Insurance Company, explained 
what I thought was a surprising new concept. He called them 
medical savings accounts. We now tend to call them health 
savings accounts.
    I like the idea of health savings accounts. I tell people 
we don't really have a healthcare system in our country, we 
have a really good sick care system, and I hope we can move 
from that to the true healthcare system, and the medical 
savings accounts, now called health savings accounts, help move 
us in that direction.
    Thank you for your initiative in making these more broadly 
available. Thank you very much for your testimony.
    Mr. Fortenberry. Thank you, Mr. Chairman.
    Mr. Bartlett. The second panel is taking the cue and they 
are taking their seats, I see. Thank you. Thank you very much. 
I would like to welcome the members of our second panel.
    Thomas Sullivan, Chief Counsel for the Office of Advocacy, 
U.S. Small Business Administration; Nina Olson, National 
Taxpayer Advocate; Thala Rolnick, Price, Kong & Company, CPA, 
Phoenix, Arizona; Marilyn Landis, Basic Business Concepts, 
Pittsburgh, Pennsylvania--I grew up near Pittsburgh--Kristie 
Darien, Executive Director of Legislative Offices, National 
Association for the Self-Employed; and John Irons, Director, 
Tax and Budget Policy, Center for American Progress.
    There is something about the Office of Chief Counsel for 
Advocacy. I noted in the prior Administration that the person 
who held that when he talked and said "we" he was talking about 
small business and when he said "them" he was talking about 
government bureaucrats, and I think that that is a 
characteristic of the people who serve in this very important 
office.
    Our first witness this afternoon is Tom Sullivan, the Chief 
Counsel of Advocacy at the Small Business Administration. Mr. 
Sullivan is no stranger to this Committee, having appeared 
before on several occasions in the past. He will discuss his 
recommendations for assisting small business through the Tax 
Code, as well as certain provisions in the Small Employer Tax 
Relief Act of 2005. Mr. Sullivan, the floor is yours.

STATEMENT OF THE HONORABLE THOMAS SULLIVAN, OFFICE OF ADVOCACY, 
               U.S. SMALL BUSINESS ADMINISTRATION

    Mr. Sullivan. Thank you, Congressman Bartlett, 
Congresswoman Velazquez, members of the Committee. Thank you 
for giving me the opportunity to appear this afternoon.
    As you know, my office is an independent office within the 
SBA, so therefore the comments expressed in this statement 
don't necessarily reflect the position of the administration or 
the SBA.
    This testimony was not shared in draft form for comment 
with OMB; however, I distributed copies of the testimony to 
colleagues at OMB and at the Department of Treasury as a 
courtesy.
    I am honored to join these panelists to help the 
Committee's deliberations, and I believe that recent research 
already cited by the previous witness done by the Office of 
Advocacy will add weight to the support for tax reforms 
beneficial to small business.
    These studies are cited in detail in my written statement, 
and with the Chair's permission I would like to summarize key 
points. Without objection, I will summarize.
    Lower marginal rates. First of all, the research conducted 
by Donald Bruce and Tami Gurley published this past March 
entitled, Taxes and Entrepreneurial Activity: An Empirical 
Investigation Using Longitudinal Tax Return Data reveals that 
decreasing marginal tax rates across the board will spur 
entrepreneurship by increasing the rate of new firm formation 
and slowing the rate of firm closing.
    Decreasing the complexity of the Tax Code. A study released 
2 days ago by my office updates the study that Congresswoman 
Velazquez cited in her opening statement. This is a study that 
is published about every 4 years, and it shows the regulatory 
burden on small business. The study released 2 days ago 
continues to show the disproportionate impact of Federal 
regulations on small business. The study shows that on average 
it costs small businesses 45 percent more to comply with 
Federal rules than their larger business counterparts. The cost 
disparity and compliance costs between small and large business 
is most severe when it examines small manufacturers and how 
much they have to spend to comply with the Tax Code.
    The study by Dr. Mark Crain shows that tax compliance costs 
are $2,582 per employee for very small manufacturers compared 
to $767 per employee for their larger business counterparts. 
Very small firms in the sector pay three times more per 
employee to figure out the Tax Code versus the large firms.
    Lower marginal tax rates. The concepts of lower marginal 
rates and less complexity, two of the key parts of my 
testimony, echo throughout the Small Employer Tax Relief Act of 
2005 that was introduced in the House of Representatives this 
morning. The act makes permanent the expensing provisions of 
section 179, allows health insurance premiums to be deducted 
against self-employed payroll taxes and eliminates the AMT. 
These are key to achieving the tax reforms necessary for small 
business.
    Expanded expensing provisions. The Office of Advocacy and 
the small business community have consistently applauded the 
benefits of the expanded section 179 provision, specifically 
within the 2003 Jobs and Growth law. The expanded limits will 
sunset on December 31, 2007. Small businesses have asked that 
the increased limits be made permanent. The President's 2006 
budget request also proposes that the expensing provisions of 
section 179 be made permanent. The Small Employer Tax Relief 
Act would grant permanence to the increased provisions of 
section 179, certainly a benefit to small business.
    Tax deduction on self-employment taxes for health 
insurance. We have already heard about healthcare even before 
the witnesses started testifying, but there is really no 
greater crisis issue than healthcare if you ask any small 
business man or woman anywhere in the country. I applaud this 
Committee's action that has already taken place, 
Congresswoman's Velazquez's leadership, Chairman Manzullo's 
leadership in passing association health plans. Obviously there 
is more to do.
    The Small Employer Tax Relief Act of 2005 helps make 
healthcare more accessible. Under the bill, self-employed 
taxpayers would be permitted to deduct their health insurance 
premiums when calculating their payroll tax.
    Repealing the individual Alternative Minimum Tax. I think 
it is unfortunate that when I say AMT, more and more people 
realize what the acronym stands for. The small business 
community has consistently supported repeal or reform of the 
AMT. Repeal of the AMT will lower marginal rates on small 
business, simplify compliance by eliminating a notoriously 
complex calculation, and it will increase predictability of the 
Tax Code and as a result small firms will gain more time and 
capital to grow their business.
    In conclusion, my office believes that the Small Employer 
Tax Relief Act will be helpful for small business, and for that 
reason you can count on my support.
    Thank you.
    [The Honorable Sullivan's testimony may be found in the 
appendix.]
    Mr. Bartlett. Thank you very much.
    Our second witness this afternoon is Nina Olson, the 
National Taxpayer Advocate at the IRS. As a National Taxpayer 
Advocate, Ms. Olson serves as an advocate for tax payers to the 
IRS and Congress. She included a number of proposals in her 
most recent report to Congress that impacts small businesses in 
the Small Employer Tax Relief Act of 2005, and we look forward 
to your testimony. Thank you very much.

       STATEMENT OF NINA OLSON, INTERNAL REVENUE SERVICE

    Ms. Olson. Thank you, Congressman Bartlett, Congresswoman 
Velazquez and distinguished members of the Committee. Thank you 
for inviting me to testify today about the tax burdens facing 
small businesses and proposals to reduce these burdens through 
changes to the Internal Revenue Code. I commend Chairman 
Manzullo for introducing the Small Employer Tax Relief Act of 
2005, which contains a number of proposals that I have long 
advocated and believe would benefit small businesses 
considerably.
    For many small business owners tax issues are the single 
most significant set of regulatory burdens. Now it seems to me 
that Congress and the executive branch should try to identify 
the behavior they want to promote, and then make it as easy as 
possible for taxpayers to comply with these expectations. 
However, sometimes tax law provisions have unintended 
consequences despite our best intentions. Thus Congress should 
periodically review the tax rules applicable to small 
businesses to ensure that they are narrowly tailored to 
accomplish their objectives and do not require small business 
owners to jump through unnecessary hoops.
    The tax treatment of married couples who are business co-
owners is an example of this law of unintended results. An 
unincorporated business jointly owned by a married couple is 
classified as a partnership for Federal income tax purposes. As 
such, the business is subject to complex record keeping 
requirements and must file a partnership income tax return. In 
practice, most couples merely report their business income on 
one spouse's sole proprietorship return. As a result, that 
spouse alone receives credit for purposes of Social Security 
and Medicare. The spouse for whom no earned income is reported, 
the ineligible spouse, does not receive credit for paying 
Social Security or Medicare tax. In the event of disability, 
this ineligible spouse would not qualify for Social Security, 
disability or Medicare benefits. In the event of the death of 
the ineligible spouse, the surviving spouse and children would 
not qualify for Social Security benefits.
    To make matters worse, the Internal Revenue code imposes a 
penalty on taxpayers who fail to file a required partnership 
return. The IRS, however, has issued guidance that in the case 
of partnerships with 10 or fewer partners it won't impose the 
penalty because these partnerships have reasonable cause for 
not filing because of their size.
    So here we have government passing a law that requires 
certain taxpayers to behave in a way that is counterintuitive 
to their practice, then we impose a penalty on these taxpayers 
for failure to comply with that requirement, and then finally 
we issue guidance that says we won't impose that penalty after 
all. All of this instead of just simply enacting the 
appropriate law that drives the appropriate behavior.
    I am pleased that Chairman Manzullo has adopted my 
recommendation to amend the Code to address the problems 
experienced by married co-ownersof unincorporated businesses.
    In my written testimony, I describe several other 
legislative proposals and administrative initiatives that will 
ease the tax and compliance burden for small 
businesses,including changing the due date for electing 
statuses of small business corporations under subchapter S of 
the Code.
    On consistency and equity grounds I, too, have recommended 
that self-employed individuals be allowed to deduct the cost of 
health insurance in computing net earnings of a sole proprietor 
from self-employment. This approach places the tax treatment of 
health insurance for self-employed taxpayers on a par with the 
tax advantages enjoyed by wage earners.
    And of course one of the most complex provisions in the 
Code, which I identified as the most serious problem for 
taxpayers in 2003, is the individual Alternative Minimum Tax. 
For business owners the AMT recaptures section 179 expensing 
and can postpone the benefits of business tax credits. Quite 
simply, Congress must repeal the AMT or revamp it substantially 
to achieve its original objectives.
    I would like to draw your attention to one proposal not in 
the bill because I think it really provides relief to small 
businesses that are trying to comply with the labyrinth of tax 
laws and regulations, and because it illustrates the common 
sense approach to tax administration that I believe we should 
strive for.
    The first time penalty waiver, which I also call the one-
time-stupid-act proposal, authorizes the Secretary to grant a 
one-time abatement of the failure to file and failure to pay 
penalties for taxpayers who have a history of compliance. Given 
the complexity of the tax law and the tax administration 
system, it is easy to see how taxpayers can make mistakes, even 
stupid ones. Traffic cops are permitted to give warnings rather 
than tickets for first time or minor infractions, why can't the 
IRS?
    In closing, there are many common sense proposals that can 
help eliminate burdens on small business. I appreciate the 
opportunity to testify before you today about a few of them, 
and I commend the continuing efforts of this Committee and look 
forward to answering any questions.
    Thank you.
    [Ms. Olson's testimony may be found in the appendix.]
    Chairman Manzullo. [presiding.] Our third witness this 
afternoon is Thala Rolnick. Ms. Rolnick is a senior tax manager 
of Price, Kong & Company in Phoenix, Arizona, where she 
specializes in providing tax services to small businesses. In 
addition, she is Co-Tax Chair for Region IX of the White House 
Conference on Small Business, and also serves on the Council on 
Small Business in the U.S. Chamber of Commerce.
    She appears before us today on behalf of the U.S. Chamber 
of Commerce, which I am proud to say has endorsed the Small 
Employer Tax Act of 2005. We look forward to your testimony.
    [Chairman Manzullo's opening statement may be found in the 
appendix.]

     STATEMENT OF THALA ROLNICK, PRICE, KONG & COMPANY, CPA

    Ms. Rolnick. Thank you, Mr. Chairman, and Ranking Member 
Velazquez. Thank you very much for inviting me to speak here 
today.
    As has been said, my name is Thala Rolnick and I am a CPA 
from Phoenix, Arizona. And as you know, I am here also 
supporting the U.S. Chamber, who applauds you and supports your 
leadership on introducing the Small Employment Tax Relief Act 
of 2005.
    The Chamber has spelled out its small business priorities 
in detail in the written testimony. I would like to address 
IRS's current audit programs of small business, which has 
become a growing concern.
    We all know that the IRS has announced plans to carry out 
the National Research Program to audit 5,000 randomly selected 
S corporations. The Commissioner said that this is necessary to 
make sure that corporations and high income individuals are 
paying their fair share.
    Right after this announcement ETAAC released its findings 
of IRS's audits that it made during 2001 through 2004 of small 
businesses and S corporations with assets of under $10 million. 
Over this period, the IRS audited over 27,000 S corporation 
returns. This average is about the same average as they hope to 
cover in the NRP audits. Of those returns, 42 percent, or over 
11,500 returns, resulted in a no change. Only about 1,300 of 
those returns resulted in a change of tax liability to the 
individual shareholder. The report stated that IRS is doing a 
very poor job of selecting returns to audit. That is why they 
say they need this program. I counter with, why can't they 
obtain the statistics they need from the audits they have 
already completed?
    This is the announced program, but there are two 
unannounced programs that are truly affecting my small business 
clients. The first is an audit program for first and second 
year S corporations. The second is an audit of individual 
returns where there are W-2 wages and Schedule C losses. I 
asked the agent why, and she said that the IRS wants to make 
sure new businesses are doing it right from the beginning. I 
believe the taxpayer education and communications are the first 
people from the IRS that should be visiting my small clients, 
not the IRS audit agent.
    I am currently working on an S corp audit. The taxpayer 
actually had wages, a small profit and minimal distributions. 
That means that she did everything right. We feel that if the 
auditor were to make an adjustment of $20,000, which we really 
don't believe will happen, this will result in an additional 
$3,000 of taxes and we expect our fees to run about $5,000. I 
don't see where this benefits the small business or the IRS.
    I have just completed one of the schedule C audits. The 
client I represented was a start-up dentist. She had wages and 
a small Schedule C loss in the year of the audit. The following 
year she had no wages and a small profit. And in the current 
year she expects her income to be that of what she would have 
expected in her fifth year of practice. If the auditor had been 
allowed to lay these 3 years side by side, he would have seen 
the progression of a start-up business. And if he would have 
been able to limit his audit scope to, say, her working capital 
loan, then maybe we could have reduced the time of the audit 
from 4 days to 1 day.
    What complicated this audit even further was that the agent 
requested information the taxpayer was prohibited from 
providing based on HIBR rules. He wanted to see every patient's 
charge sheet and every lab's expense. The client's patient 
sheet filled a four-inch binder. We finally got him to agree to 
1 month. All these documents had to be sanitized before we 
could present them, and it took her time away from her 
practice. As I said, we are expecting a no change audit, and 
this audit cost her from our fees some place between $2,000 and 
$3,000. Again, I see no benefit.
    When I discussed these audits with a friend of mine, his 
response was, as a taxpayer I am a shareholder in the IRS, and 
this does not sound like a good return on my investment.
    I started by stating, sharing with you the Commissioner's 
reasons for these audits. I don't see how these audits 
accomplish that goal of making sure corporations and the highly 
wealthy pay their fair share.
    Thank you for allowing my time to share my experiences.
    [Ms. Rolnick's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you very much.
    Our next witness is Marilyn Landis, President of Basic 
Business Concepts, Incorporated, which provides consulting 
services to small businesses located in Pennsylvania. In 
addition, she is Chair of the National Small Business 
Association's Legislative Action Committee. She appears before 
us today on behalf of the National Small Business Association, 
which I am proud to say has also endorsed the Small Employer 
Tax Relief Act of 2005. We look forward to your testimony.

      STATEMENT OF MARILYN LANDIS, BASIC BUSINESS CONCEPTS

    Ms. Landis. Thank you.
    Chairman Manzullo, Ranking Member Velazquez, members of the 
Committee, thank you for inviting me to provide testimony on an 
important topic, the intersection of small business and the Tax 
Code.
    As introduced, I am Marilyn Landis. I am the President of 
Basic Business Concepts, a company that I founded, a multi-
faceted service that provides financial consulting to small 
businesses in Pennsylvania and throughout the Northeast.
    I also have a background prior to starting my own business 
of working for three of the largest SBA lenders in the country, 
marketing and originating SBA loans. I had a career in a 
variety of finance related fields that touched small business, 
from consumer loans to mortgage development, delinquent 
collection and a coordination of the operations of a multibank 
merger. And outside the business world, I dedicate my time to 
serving on several nonprofit boards that oversee social and 
economic development.
    So I am here today first as a business owner, which I am, 
second as the Chair of the National Small Business 
Organization's Legislative Action Committee.
    As you know, SBA is the Nation's oldest nonpartisan small 
business advocacy group, and we represent 150,000 small 
business owners, and my role as the Chair of that Committee is 
to oversee the formation of the policy issues for those small 
business owners.
    Both my personal experience, as I have outlined it, my role 
in NSBA, have allowed me to see small business owners wrestle 
with a complicated tax system. In fact, in the 108th Congress 
two of my fellow NSBA members have testified on the 
difficulties a small business faces with the Tax Code.
    Many excellent studies have been conducted.They estimate a 
cost of complying with the Tax Code when calculated. It is 
important to remember that this cost is not the money paid to 
the Treasury, but as we have talked about here, the time, 
opportunity lost, the changing practices, maintaining records, 
paying professionals go into the cost of complying.
    The National Small Business Office of Advocacy, as we have 
talked about, have done numerous studies. Chief Counsel for 
Advocacy, Tom Sullivan, has detailed those, the results are the 
same. Because of their size, because of the availability of 
resources, small business owners pay a disproportionate amount 
of time and money to comply with the Tax Code.
    Compounding compliance costs to the costs faced by 
employers and employees at small firms who are prohibited from 
participating in tax advantage benefits that are available to 
companies of larger sizes, being financially excluded from 
pension plans, pretax health savings and fringe benefit plans 
have a real economic impact on entrepreneurs.
    The issues facing small business owners of the Tax Code are 
so vast we that we at NSBA commissioned a study to root through 
the Code and return the most egregious examples of inequities. 
Members of NSBA have testified before this and other committees 
on the findings of the studies. We are very pleased that some 
of our top priorities are included in Chairman Manzullo's 
recently introduced legislation, the Small Business Tax Relief 
Act.
    One recommendation from the NSBA tax equity report that has 
been addressed by Chairman Manzullo and Representative 
Velazquez in past legislation--and National Taxpayer Advocate 
in recent reports--is the repeal of the self-employment tax on 
healthcare. As the law stands now, self-employed individuals 
still pay for their healthcare with money that has been 
subjected to the self-employment tax. All employed individuals 
pay the FICA tax on their wage income, 6.2 percent is allocated 
to Social Security, 1.4 percent for Medicare. Employers are 
required to match that with 7.6 percent. Self-Employed 
individuals are required therefore to pay both sides of this 
tax, resulting in 15.3 percent tax on income, commonly referred 
to as the self-employment tax.
    Contrary to rules for C corporations, a provision of the 
Internal Revenue Code requires self-employed individuals to pay 
the 15.3 percent self-employment tax on the cost of their 
healthcare premiums. No other worker is required to pay FICA 
taxes on any portion of their employer-sponsored healthcare 
benefits. With healthcare costs already sky high, our members 
find it unbelievable that the Federal Government would slap an 
extra tax on those who have the hardest time securing coverage 
in the first place. NSBA is encouraged to see that Chairman 
Manzullo included this important issue in the Small Business 
Tax Relief Act.
    Another issue from the tax equity report--and I am going to 
skip over that for time. We have created in the 104th Congress 
a SIMPLE plan allowance which is designed to be a simple tax 
plan. Unfortunately this legislation, even though it allowed 
for the fact that it cost more for small businesses to provide 
services only allows them to save up to $8,000, where the rest 
of the 401 traditional plans would allow for a savings of 
$12,000 a year.
    The Small Business Tax Relief Act of 2005 would also fix 
this inequity in the amount of pension funds that small 
business owners are able to put aside.
    The Small Business Tax Relief Act of 2005 includes many 
additional tax reforms that are important. I again thank the 
Committee for the opportunity to share my thoughts on how the 
Tax Code might be reformed to assist small business.
    As a final thought, we would appreciate the Tax Code being 
eliminated. As you know, NSBA supports the fair tax, but we 
commend the changes that are being made.
    Thank you.
    [Ms. Landis' testimony may be found in the appendix.]
    Chairman Manzullo. Thank you for your testimony.
    The next witness is Kristie Darien, Executive Director of 
the National Association of the Self-Employed. Ms. Darien 
operates out of NASE's Washington office. NASE is a strong 
advocate on behalf of small businesses. I am delighted to have 
Ms. Darien here today before the Committee. I would also like 
to add that NASE has also endorsed the Small Business Tax 
Relief Act of 2005.
    Ms. Darien, we look forward to your testimony.

STATEMENT OF KRISTIE DARIEN, NATIONAL ASSOCIATION FOR THE SELF-
                            EMPLOYED

    Ms. Darien. Thank you very much. Thank you very much, 
Chairman Manzullo and Nydia Velazquez and members of the 
Committee, for having me here today to talk about important 
issues facing small business.
    As the Executive Director of the National Association for 
the Self-Employed, I am here to speak on behalf of our 250,000-
member micro-businesses, all of which have 10 or fewer 
employees.
    The importance of micro-businesses to our economy cannot be 
overstated, and more than ever our Nation needs these 
businesses to marshal their resources and continue to advance 
the American economy by doing what they do best, create, 
innovate, produce, build and grow.
    The complexities and inequities within the Tax Code have 
long placed a significant burden on the self-employed and 
micro-business owners. Small business specific tax reform would 
assist in creating a favorable environment for the growth and 
success of small firms. The NASE strongly supports this Small 
Employer Tax Relief Act of 2005, and we feel that the 
provisions included in the bill would greatly assist the micro-
business community.
    In particular, I would like to highlight two key provisions 
and their importance to the self-employed, the SETA tax 
deduction on health insurance premiums and the annual standard 
home owner deduction of $2,500.
    As many of you are aware, the state of healthcare among our 
Nation's micro-businesses is critical. The number of uninsured 
Americans continue to rise, and many of these individuals are 
owners or workers in small businesses. We believe in removing 
current inequities within the Tax Code would make purchasing 
health coverage more affordable and also remove a disincentive 
for the self-employed to insure.
    NASE member Scott Falnes is an owner of a carpentry and 
construction company located in Lake in the Hills, Illinois, in 
Chairman Manzullo's district. He pays about $336 annually in 
self-employment tax and health insurance premiums. Scott calls 
this extra tax on sole proprietors unfair. He states, 
"Obviously the tax is not fair across the board. The general 
population is not affected. I have to fight to keep my prices 
competitive, pay the bills, and hopefully have enough to let my 
business grow. I don't mind paying my 'fair' share so long as 
it's fair."
    Mr. Falnes is of course referring to the fact that he and 
16 million other sole proprietors and partnerships with earned 
income have to pay the equivalent of payroll taxes amounting to 
15.3 percent on their health insurance premiums.
    On a national scale, according a recent Kaiser Family 
Foundation Study, the self-employed pay on average $10,880 for 
family health coverage. Because they cannot deduct these 
premiums as a business expense, they are required to pay 
approximately $1,655 in additional taxes that no other business 
entity must pay. This is money that our members tell us they 
would use to reinvest in their business, hire part-time 
assistance, or utilize to offset the rising premium costs they 
face each year and hold on to their health coverage a little 
longer.
    NASE member David Caffrey, an electrical contractor in New 
Mexico, pays an additional $715 annually in self-employment tax 
on his health insurance premiums. He says that this extra cost 
adds to the high burden for small businesses and increases his 
healthcare burden. If David didn't have to pay this extra cost, 
he would use it to help pay his increase in gasoline costs.
    The issue is about fairness. Again, let me restate, the 
self-employed are the only segment of the business population 
that do not receive a full deduction for health insurance 
premiums. This inequity needs to be corrected, and we are 
pleased to see this issue addressed in the Small Employment Tax 
Relief Act of 2005.
    In addition to inequity within the Code, the self-employed 
struggle with the complexity of tax regulations. Increasingly, 
entrepreneurs are utilizing their home as a primary place of 
business. Over 50 percent of NASE's membership are home-based 
businesses. According to SBA Office of Advocacy, home-based 
businesses represent 52 percent of all firms and provide 10 
percent of total revenue to the economy, yet many home-based 
business owners do not make use of the home office deduction 
due to the complexity of the deduction and the stringent 
criteria that they must meet. The form for the home office 
deduction is very complicated. The taxpayer must differentiate 
between direct and indirect expenses, as well as other 
complicated calculations. The words "see instructions" appear 
on this one-page form 16 different times.
    The option of a standard deduction of $2,500 for use of a 
home office is an excellent step towards tax simplification and 
would allow the myriad of home-based businesses in our Nation 
to utilize this important deduction.
    Overall, an overwhelming hardship faced by the self-
employed and micro-businesses continues to be complexity, 
vagueness and at times unfairness of tax regulations. 
Understanding and then complying with the Tax Code is extremely 
difficult and time consuming for a self-employed business 
owner. The inequities within the Code are unfair and greatly 
hinder their ability to contribute to our economy.
    The introduction and hopefully eventual passage of the 
Small Employer Tax Relief Act would greatly assist in removing 
roadblocks to success and strengthening the competitiveness of 
our Nation's micro-businesses. Again, the National Association 
For the Self-employed is pleased to support this important 
legislation, and we applaud the Committee's leadership on these 
crucial issues faced by the self-employed.
    Thank you.
    [Ms. Darien's testimony may be found in the appendix.]
    Chairman Manzullo. Thank you.
    Our final witness is Dr. John Irons, who is Director of Tax 
and Budget Policy at the Center For American Progress.
    Dr. Irons, we look forward to your testimony.

     STATEMENT OF JOHN IRONS, CENTER FOR AMERICAN PROGRESS

    Mr. Irons. Thank you, Mr. Chairman. I would like to thank 
you and Ranking Member Velazquez for inviting me to testify 
before this Committee.
    As you mentioned, my name is John Irons. I am a Ph.D. 
Economist by training, and I am currently the Director of Tax 
and Budget Policy at the Center for American Progress, which is 
a nonprofit think-tank here in Washington, D.C.
    As an economist, I am continually amazed by the resiliency 
of the American economy and the creativity of our Nation's 
small business owners. While the title of this hearing is 
Reforming the Tax Code to Assist Small Businesses, I feel it is 
important to note at the outset that the small business 
community does quite well on its own, and the goal of tax 
policy in many ways should be to get out of the way of private 
activity while still raising adequate revenue for vital 
domestic and international priorities.
    Analysts often think about the following three basic 
principles in setting tax policy: Simplicity, fairness and 
economic growth. The Center For American Progress has developed 
a broad reform package based upon these principles. A copy of 
that proposal is included this my written testimony.
    The principles that guide overall tax reform should also be 
followed when looking at taxation of small businesses. I think 
it is important to keep in mind that most small businesses are, 
indeed, small. The medium number of employees is fewer than 
four, and 89 percent of firms employ less than 20 people. 
Recent estimates of IRS data from the Tax Policy Center, for 
example, show that in 2004 only 1.3 percent of those that 
reported small business income on their tax returns were in the 
top marginal income tax bracket, and nearly half of those of 
small business incomes are in the 10 and 15 percent tax 
brackets.
    Now let me return to the three principles of simplicity, 
fairness and growth.
    First, the Tax Code needs to be simple and predictable. I 
think we all know the Tax Code needs to be simplified, yet the 
Tax Code has been more complicated and less predictable over 
the last several years. In order for small businesses to make 
sound investment decisions, tax policy must also be stable so 
businesses can be confident in their business projections. To 
take one implication, the use of reconciliation in the budget 
process to enact tax policy should be avoided.
    Some would argue that making the President's tax change 
permanent would solve some of this uncertainty, but doing so 
would simply lock in complicated policy and permanent deficits. 
I would argue that reform of the Tax Code is indeed necessary, 
but it should be reformed in a very different direction than 
current policy.
    Second, most small businesses are not at the top end of the 
income scale, thus any restructuring that cuts revenue from the 
top will either shift the Tax Code to the middle and low income 
small business owners or will increase the deficit, which can 
then harm small businesses through higher interest rates. Small 
business efficiency requires a fair, progressive rate 
structure, not a flat structure.
    Third, to be efficient and to have solid growth, incentives 
for investment in physical capital must also be balanced with 
incentives for investment in human capital. A tax cut that 
already favors wealth and investment in capital goods ignores 
the fact that it is human capital that is often the most 
important component of modern businesses. Also, Federal 
expenditures in other areas are vital for small businesses, and 
raising adequate revenue to fund our national priorities is 
essential.
    We need to resist the temptation to claim that the small 
business community needs a tax cut each year to survive. 
Massive budget deficits, which can increase the long-term 
interest rates, do far more damage to small businesses and 
investments than a few tax breaks here and there.
    Overall, the goal of small business policy should be to 
create the right environment for growth. The American small 
business community is vibrant, resilient and helps to make our 
country economically strong. The goal of tax reform should be 
to simplify the Tax Code, while keeping a progressive rate 
structure and preserving the incentive to add value to the 
economy.
    Thank you.
    [Mr. Irons' testimony may be found in the appendix.]
    Chairman Manzullo. Thank you, Dr. Irons.
    Mrs. Kelly.
    Mrs. Kelly. Thank you for calling on me.
    I would like to ask Mr. Sullivan about what he thinks we 
can do in terms of these IRS audit programs and problems that 
have been presented here today with regard to the audits and 
small firms. If you have got any answers or any ideas about 
that, I would like to hear them.
    Mr. Sullivan. I think the most simple answer, Congresswoman 
Kelly, to what can the Committee do about the NRP and other 
audit programs is to continue to hold vigorous oversight of the 
programs.
    I think in the last hearing that this Committee held in 
that regard, you got some very good commitments from 
Commissioner Everson that possible inaccuracies of draft data 
be corrected in between the draft and final stages. I think 
that we are expecting that the final data from the NRP be 
available in the fall, and I am optimistic that the 
Commissioner corrects some of the inaccuracies in that data.
    I think one of those inaccuracies was a problem that this 
Committee looked at, and that was the potential for 
oversampling the small business sector. I think that the 
message from this Committee was loud and clear. I think the 
commitment by the Commissioner to try to address those 
inaccuracies is something that deserves this Committee's 
continued attention.
    So I think that that is primarily a good focus for this 
Committee, and you are making a difference as far as that 
oversight goes because the IRS heard the message that this 
Committee is looking over their auditors' shoulders.
    I think one other emphasis by the Committee that other 
witnesses, in particular Thala Rolnick, emphasized was to 
encourage the IRS to look at existing data sets for the 
information that they are professing to need these audit 
programs for, and I think that that bears further investigation 
by this Committee. Are they conducting audits to get 
information that already exists within the master file and 
within the return file?
    Mrs. Kelly. So you are suggesting that perhaps a check with 
them on redundancies within their systems would be good, 
overlap redundancies, things like that?
    Mr. Sullivan. Yes, Congresswoman.
    Mrs. Kelly. Thank you.
    Mr. Irons, you talked about a progressive structure. Given 
the problem that we have had with Hurricane Katrina and 
possibly with another one following close on its heels today, 
if you were to put in place a progressive structure, what would 
it look like?
    Mr. Irons. Well, I think for the overall tax cut, I think 
the first thing to keep in mind is the right frame that you 
raise, which is Katrina. We have a $300 billion deficit. With 
Katrina, it is going even higher than that, exactly how much 
about that, you know more about that than I do. But that is the 
context and we have to realize that we are going to need for 
revenue and in the tax plan which has been included in the 
testimony, we have a progressive rate structure which has three 
tax brackets which is down from the current 5 or 6 brackets and 
we set the rates at 15 percent, 25 and 39.6 percent which 
initially sounds high. But we also balance that out by 
eliminating the employee's side of the payroll tax.
    So actually, in the plan that we submit, we reduce taxes on 
70 percent of the population so essentially make the entire tax 
system more progressive and make people or ask people at the 
high end of the income scale to pay a bit more.
    Actually what we do is we reverse some of the tax cuts at 
the high end for people who have benefited the most.
    Ms. King. Thank you, Mr. Chairman, for letting me go.
    Chairman Manzullo. Thank you.
    Mrs. Velazquez.
    Ms. Velazquez. Thank you, Mr. Chairman. Mr. Irons, Congress 
has passed nearly $2 trillion in tax cuts in the past 4 years. 
But the lack of relief for small businesses is outstanding. In 
2001, we passed a $1.35 trillion tax cut, a $42 billion tax cut 
in 2002, and $350 billion tax bill in 2003, and $137 billion 
tax cut in 2004.
    Yet despite all of this cutting, small businesses have 
never seen a more complex Tax Code and the amount of relief has 
been minimal.
    Mr. Irons, you talk about how small firms are reluctant to 
invest because of the use of the sunsets in these tax bills. 
Why do you think that some of the targeted provisions aimed at 
small businesses have been sunset when we have nearly $2.2 
trillion in budgetary cuts to work with?
    Mr. Irons. I am reminded of the statement, I believe the 
statement was cast in terms of millions, but I will talk about 
billions. A few billion here and a few billion there and you 
are talking about real money pretty soon.
    We have spent quite a bit on tax cuts, $2 trillion. Last 
year if you look at the percentage of revenue as share of the 
economy, it was down to 16.3 percent, which is the lowest level 
in 50 years. So we are realizing very, very low levels of 
revenue. When you look at what could have been done with that 
money, immense strides could have been made simplifying the Tax 
Code. You have less revenue, and I think what is needed is a 
simplification as much as providing relief to targeted people.
    I don't think small businesses, I don't think the American 
public was well served by having a Tax Code that I believe is 
moving in the wrong direction. So some reversal of what we have 
already done coupled with some simplification, I believe, is 
the way to go.
    Ms. Velazquez. Thank you. Mr. Sullivan, in your testimony, 
you also talk about the importance of predictability and 
certainty for small businesses. Would you agree that providing 
permanent relief for some of these targeted small business 
measures should be a priority as opposed to extending 
provisions such as the diffident tax cut?
    Mr. Sullivan. I actually consider extending and making 
permanent very similar for the predictability in the use of 
small business planning with regards to the tax cut.
    Ms. Velazquez. Ms. Olson, I know your organization works 
with the IRS assisting small businesses to properly file their 
taxes. I would like for you to expand on your comments on some 
of the restructuring efforts at the IRS. Do you believe that 
the reduction in staff at the IRS Small Business Self-Employed 
Division will lead to small businesses spending more on tax 
professionals?
    And I am also concerned about the impact on the self-
employed. Do you believe that the IRS and the changes that they 
have will lead these micro entrepreneurs to hire accountants 
and lawyers that they would not otherwise?
    Ms. Olson. I am concerned about whether the IRS is 
achieving the right balance between, as the commissioner is 
want to say, service and enforcement. The recent changes with 
the outreach in education functions in the small business 
component concerns me.
    I think that my colleague to my left is right when we say 
that we should have an education contact perhaps before an 
audit contact, particularly for start-up businesses. And I am 
concerned that the IRS is walking away from a physical 
presence, a face-to-face presence with business owners and 
relying on more passive interaction like Internet, which may be 
cheaper for the IRS but more expensive for all taxpayers in the 
long run because people make mistakes.
    My office is very much watching that and we are finding 
more and more that my local taxpayer advocates around the 
country are the first point of contact that small business 
owners and their practitioners and preparers make.
    Ms. Velazquez. Thank you. Ms. Rolnick, Congress has tried 
to pass some measures such as bonus depreciation and increased 
expensing to spur investment through reduced tax liability for 
entrepreneurs. However for these measures to work, we need for 
small businesses not to worry about taking advantage of these 
changes.
    Do you think some small businesses will be reluctant to use 
these tax breaks out of concern that they might be red flagged 
by the IRS and subject to an audit?
    Ms. Rolnick. I have never had that experience. Of course, 
they are working with me, not working on their own, so they 
come to me for my expertise. And when I say to them we can take 
this and that is fine, I have never had one say no, I am afraid 
that is going to raise a flag. I have had clients say I really 
have some more expenses, but that is going to put in a loss 
situation, so I am not going to give them to you.
    Chairman Manzullo. We are going to have a series of votes. 
I would like to give everyone a chance to ask a question. Ms. 
Bordallo, please give us your best one or two questions.
    Ms. Bordallo. Thank you, Mr. Chairman. I guess the one that 
is most pressing is the one for Attorney Sullivan. What are the 
tax relief provisions available to small businesses following 
disaster situations as in the aftermath of Hurricane Katrina? I 
ask this because Guam is located in what is commonly known as 
"typhoon alley." typhoons can have devastating effects and 
small businesses have limited resources to respond to the 
catastrophe. Tax relief at time of crisis is essential--
    Chairman Manzullo. I need your question, otherwise I cannot 
get everybody else time before the next votes.
    Ms. Bordallo. Okay. What, in your opinion, should we do to 
cover all future national disasters and should this be in the 
tax relief package?
    Mr. Sullivan. Actually, I don't know. I know that Congress 
is focused on that type of stimulus.
    Ms. Bordallo. Talking about the future.
    Mr. Sullivan. I don't know.
    Ms. Bordallo. Can anybody answer? Should it be in that 
package?
    Ms. Olson. I think both Houses of Congress are looking at 
provisions that include things like re-employing people who are 
victims in a disaster area, making them eligible for the work 
opportunity credit for employers. Looking at even more 
stimulation for rebuilding in the area, education incentives 
for retraining when people have to move around. Incentives for 
employers to rehire people when they have to be retrained and 
moved around. Those sorts of things.
    Chairman Manzullo. Mr. Faleomavaega, we will keep going 
with questions until the bells ring.
    Mr. Faleomavaega. A question, I gather, from some of the 
recommendations that members of panel have made have all been 
incorporated in the chairman's proposed bill for 2005? Some of 
them? So it is not enough yet. How do you tell an independent 
agency like the IRS not to conduct these audits? Does this 
require a presidential mandate?
    Mr. Sullivan. Very carefully.
    Ms. Olson. When I heard the audit stories, my first thought 
was my colleague should have come to the taxpayer advocate 
service. I think that the IRS is trying to conduct audits and 
do a balanced approach to making sure everybody pays the fair 
taxes.
    I think that right now, we have to be careful about the 
messages that we are sending to the front line IRS employees, 
and sometimes I think the IRS employees get a little bit too 
vigorous in their requests. And your continuing oversight will 
help. If you hear from your constituents, I would like to hear 
about it as well because we will look at each individual case.
    Ms. Rolnick. And I do believe that IRS should have audit 
functions that is important but there need to be better choice 
of who they audit.
    Chairman Manzullo. Mr. Lipinski, do you have a question for 
the witnesses?
    Mr. Lipinski. I have a more specific question. I was just 
in Chicago on Monday with the chairman and we were speaking 
with manufacturers. Manufacturers, Chamber of Commerce people, 
local leaders, officials, speaking specifically about problems 
with American manufacturers. One of the ideas that was thrown 
out there is we have an industry, manufacturing, that is facing 
some really significant immediate problems right now. And one 
of the ideas that they gave to us was giving them a temporary 
tax break to allow them to deal with what they are facing in 
terms of foreign competition.
    Is this something that--does anyone have any comments on 
that? It is something we have seen done in the past to good 
ends? Or do you think that this is not something that would be 
useful or good?
    Mr. Sullivan. Actually, I would like to take a stab at it. 
First of all, any complexity in the Tax Code disproportionately 
impacts small manufacturers more than any other sector of the 
economy. That was really the stark findings from the research 
issued by my office 2 days ago. We are talking about three 
times the compliance cost for small manufacturers versus their 
larger business counterparts. So when you look at any part of 
the Code and simplify it, you have three times the benefit to 
small manufacturers than any other part of the sector.
    I think the one part of this bill that you get the twofer 
on, lowering rates and simplicity and gaining more attention 
and purchasing from the manufacturing perspective in section 
179 expensing. The idea of encouraging folks to take 179 
expensing and actually purchase products from their neighbors 
their friends and other manufacturers. Not only do you get 
greater predictability that you make a provision, you remove a 
sunset provision so you get greater predictability. It is a 
simplicity dream for small businesses to have 179. And you are 
encouraging folks to purchase other products throughout the 
United States. So you really--that provision stands out as a 
win, win, win, provision within this legislation.
    Ms. Olson. If I might make a point about the depreciation, 
which I made in my testimony. Every time someone takes a large 
deduction for section 179, there is the possibility that is--it 
is added back in in one's alternative minimum taxable income 
and it may pull you into the AMT. So you give them the 
deduction on the one hand and then you tax them again on the 
AMT under the other. You have to really watch out for that.
    Chairman Manzullo. Mr. Bordallo, second question.
    Ms. Bordallo. Thank you, Mr. Chairman. To Director John 
Irons, tax reform can be used to guide--
    Chairman Manzullo. I believe Mr. Irons' title is "Doctor."
    Ms. Bordallo. It says "director."
    Chairman Manzullo. Sorry about that. Please proceed.
    Mr. Irons. I wish I was the director of the organization. I 
am only the director of tax and budget policy inform.
    Ms. Bordallo. All right. In your opinion, how effective 
have recent tax cuts been for providing incentives for small 
businesses to grow and also in your opinion what is the most 
pressing important reform that is needed currently to assist 
small business?
    Mr. Irons. On the growth front, I think if you look at 
growth of the overall economy over the past several years, you 
have seen reasonably robust growth or the past 2 or 3 years, 
but you really saw very slow poor recovery to the 2001 
recession. And so I think when you look at small businesses, 
you see the same general pattern. You see relatively reasonable 
growth, nothing spectacular over the past several years.
    I think the economy should be doing stronger than it is, 
which leads to second part of your question about what we can 
do.
    And there, I think let me come back to my testimony, it is 
important to realize that most small businesses are small and 
when your talking about spurring small business growth, you are 
talking about really helping out people lower in the middle of 
the income distribution, not people at the high end. So the tax 
plan that we have put forward as I put in my testimony actually 
lower tax burden on people at the lower and middle end of the 
income distribution and that should be good for growth, good 
for small businesses to preserve the incentives, and it should 
really help out the economy by looking at where the bulk of 
small businesses are.
    The second component of that is it is important to realize 
that it is really the human capital, it is education, training, 
skills, that drive most of the economy. So that is true of 
small businesses as well. So I think incentives, not just for 
capital equipment, but also incentives for school and 
incentives for training. I believe that is a really important 
part of how we should think about the Tax Code. And to not just 
focus solely on wealth and capital as the end all and be all of 
tax policy, but there is this whole other component that is 
really what the modern economy relies on.
    Chairman Manzullo. Mr. Faleomavaega, second question? Mr. 
Lipinski, second question? If we have no additional questions, 
I will ask a question. We have been concerned that the IRS is 
too energetic in going after small business people in audits. I 
have talked to Commissioner Everson about it, and Tom Sullivan 
has mentioned the flawed NRP study. But this is a new 
situation, where, I think, Ms. Olson, you testified that the 
IRS is going to start auditing S corporations during their 
first and second years. Were you the one that testified to 
that? Or was it Ms. Rolnick?
    Ms. Rolnick. I was the one.
    Chairman Manzullo. Where did you learn that information?
    Ms. Rolnick. My first audit. I had a client audited. It was 
her first year as a corporation, and the auditor came in and 
said why are you auditing this client? Why do you audit first 
year businesses? They never make a profit? And she said this is 
a program and we want to make sure they do it right at the 
beginning. I am still in the process of that audit. I think we 
started the audit about 2 months ago.
    Chairman Manzullo. Would you send me a letter on your 
letterhead? I will send that letter to Mark Everson and ask him 
if this is another program that the IRS has started. I think 
that is terrible. It is something that we did not know about 
the last time that we had a hearing on this.
    All right. Does anybody else have any more questions or 
comments? Ms. Velazquez? Please proceed.
    Ms. Velazquez. Thank you, Mr. Chairman. Mr. Irons, going 
back to a possible Katrina tax bill, I would like to hear your 
thoughts on some of the proposals that are out there. There has 
been talk about allowing small businesses to deduct more of 
their income through a higher section 179 expensing level. 
Given that many of these small firms would have little or no 
profit, this would be more attractive to offer a refundable tax 
credit aimed at the small firms?
    Mr. Irons. Obviously, a deduction that you do not get to 
take is not worth anything. So for a lot of small businesses 
having something that is refundable putting money in your 
pocket is probably a very good idea.
    Ms. Velazquez. Thank you. Thank you, Mr. Chairman.
    Mr. Faleomavaega. If the chairman would yield. I would like 
to offer a humble recommendation if there were other 
recommendations offered by members of the panel that we would 
seriously look at it and make it a part of our proposed bill 
and not be lost in the cracks, so to speak, and maybe the 
majority and minority staffs would seriously consider those 
recommendations, Mr. Chairman.
    Chairman Manzullo. Okay. We have completed all of the 
questioning. Thank you for your patience in this sort of a 
roulette way of asking questions. I want to thank each of you 
for coming here and spending time with us and sharing your 
thoughts.
    Ms. Landis, please take 30 seconds. You had raised your 
hand, and I caught you in the corner of my eye after I 
recognized another Member. Do you remember what you wanted to 
say?
    Ms. Landis. I do. Just in general, when you were talking 
about ways to benefit small business. The point you had made is 
that a tax deduction is a benefit if you have a profit to 
deduct it against. When small businesses are struggling whether 
it is Katrina or the economy or whatever it is, simplifying the 
Tax Code so that their energy can be spent on growing the 
business instead of hours with professionals on how to deal 
with their taxes. And any savings, because most business owners 
that I know and I work with hundreds of them, any dollar saved 
they invest in their business and employees and benefits to 
their employees.
    So any way that you can enable the business owner to keep 
more money on the table for his company he will invest--he or 
she--in their business. I appreciate deductions they are 
wonderful when I have a profit to take them against. But 
anything that can be done to simplify the Tax Code or enable me 
to save tax dollars I can pass on to my employees, like the 
things in your plan with the self-employment tax or the pension 
benefits are important.
    Chairman Manzullo. Thank you. Ms. Rolnick?
    Ms. Rolnick. You commented that there was something else 
that was left out of the bill that I thought might be a good 
aid to small business. What I see on a regular basis is when we 
have somebody buying into a new business, somebody is retiring 
and the new person is buying in. We have covenants to not 
compete, and they are paid over 5 years and they are amortized 
over 15 years. That means the taxpayer has to pay out the money 
in 2 to 5 years and does not get the benefit except for over 
15.
    Chairman Manzullo. Thank you. Again, thank you for coming. 
This hearing is adjourned.
    [Whereupon, at 3:37 p.m., the committee was adjourned.]

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