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




                               before the


                                 of the

                      COMMITTEE ON SMALL BUSINESS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION


                     WASHINGTON, DC, JUNE 27, 2006


                           Serial No. 109-57


         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

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

                  J. Matthew Szymanski, Chief of Staff

          Phil Eskeland, Deputy Chief of Staff/Policy Director

                  Michael Day, Minority Staff Director


W. TODD AKIN, Missouri Chairman      MADELEINE BORDALLO, Guam
MICHAEL SODREL, Indiana              ENI F. H. FALEOMAVAEGA, American 
LYNN WESTMORELAND, Georgia           Samoa
LOUIE GOHMERT, Texas                 DONNA CHRISTENSEN, Virgin Islands
SUE KELLY, New York                  ED CASE, Hawaii
STEVE KING, Iowa                     LINDA SANCHEZ, California
TED POE, Texas                       GWEN MOORE, Wisconsin

               Christopher Szymanski, Professional Staff


                            C O N T E N T S



Sullivan, The Honorable Thomas M., Chief Counsel for Advocacy, 
  U.S. Small Business Administration.............................     3
Alexander, The Honorable Donald C., Partner, Akin, Gump, Strauss, 
  Howard & Feld..................................................     5
Redpath, Mr. James, CPA, Partner, HLB Tautges Redpath, LTD.......     6
Porcaro, Mr. Gregory, CPA, American Institute of Certified Public 
  Accountants....................................................     8


Opening statements:
    Akin, Hon. W. Todd...........................................    21
    Bordallo, Hon. Madeleine.....................................    22
Prepared statements:
    Sullivan, The Honorable Thomas M., Chief Counsel for 
      Advocacy, U.S. Small Business Administration...............    23
    Alexander, The Honorable Donald C., Partner, Akin, Gump, 
      Strauss, Howard & Feld.....................................    30
    Redpath, Mr. James, CPA, Partner, HLB Tautges Redpath, LTD...    36
    Porcaro, Mr. Gregory, CPA, American Institute of Certified 
      Public Accountants.........................................    40
Additional material:
    Roderick, Mr. Richard M., Senior VP and CFO, Dead River 
      Company....................................................    53
    Employee-Owned S Corporations of America (ESCA)..............    57




                         TUESDAY, JUNE 27, 2006

                   House of Representatives
    Subcommittee on Regulatory Reform and Oversight
                                Committee on Small Business
                                                     Washington, DC
    The Subcommittee met, pursuant to call, at 10:00 a.m., in 
Room 2360 Rayburn House Office Building, Hon. W. Todd Akin 
[Chairman of the Subcommittee] presiding.
    Present: Representatives Akin, Kelly, Bordallo.
    Chairman Akin. The Committee will come to order.
    I'd like to open by saying good morning to everyone and 
welcome to the hearing entitled ``S Corporations--Their History 
and Challenges.'' And, obviously, providence is smiling on 
those of you who could make it through the rain clouds. I think 
we have one out of five witnesses that can't join us today 
because of the weather.
    This is about the history and challenges of these S 
Corporations, which was a bit of a new subject to me. So I 
think it may be of interest to others here as well.
    And I want to just thank you. I know that we have some 
really, really competent people that are going to be 
testifying. I want to thank you all for coming.
    We are here to take a look at this, the important business 
structure that has helped to foster an entrepreneurial 
environment since the late 1950's. Prior to the development of 
this corporate structure, entrepreneurs had two options in 
creating a business entity. They could form a partnership, 
which would allow for a single layer of tax on profits, but 
expose the entrepreneur to higher levels of risk. Or, they 
could form a C corporation, which would shield the entrepreneur 
from risk, but create a double layer of tax on profits.
    Neither business structure adequately addressed the needs 
of entrepreneurs and so in 1958 Congress and President 
Eisenhower acted to create the S corporation. The S corporation 
allows for limited liability and a single layer of taxation for 
small closely held businesses. The adoption of subchapter S was 
a huge step forward in encouraging small and family-owned 
businesses in America.
    Today, S corporations are the most popular corporate 
entity. The IRS estimates that there were 3.2 million S 
corporation owners in the United States in 2003, compared to 
approximately 2.1 million C corporations and 2.3 million LLCs 
and other partnerships.
    But while the S corporation community has grown and 
matured, the rules governing S corporations have remained 
largely the same. The number of shareholders is still limited, 
an S Corporation may have only a single class of stock, and the 
rules will still limit who or what may own shares in an S 
corporation. Today we will hear testimony expounding on:
    First, the history of S corporations and the role they have 
played in encouraging the rise of small and closely-held 
businesses and in the U.S. economy;
    Second, the unique challenges S corporations face with the 
rules governing subchapter S;
    Third, legislative proposals to modernize the S corporation 
structure; and
    Lastly, the IRS National Research Program study of S 
    I look forward to learning more about how S corporations 
benefit the American entrepreneur and what more can be done to 
aid this important component of the U.S. economy.
    I now yield to the gentlelady from Guam, Madame Bordallo 
and for her comments.
    [Chairman Akin's opening statement may be found in the 
    Ms. Bordallo. Thank you very much, Mr. Chairman. And I join 
you, too, in getting to know a little bit more about the S 
    I would like to welcome our witnesses this morning. In 
spite of the bad weather you are able to get here. We 
appreciate that.

    Small businesses drive our economy. And it is critical that 
our country's small businesses remain strong and vibrant. It is 
this Committee's responsibility to facilitate achieving that 
goal in any way that we can. Reviewing the benefits of and 
potential modifications to the S Corporation business model is 
important to our nation's small businesses, as many of them are 
indeed S corporations. Legal and regulatory structures must 
reflect the pressures of the modern business. And they must be 
written in a way that does not put small business at a 
disadvantage. Our country's small businesses must be allowed to 
remain competitive in today's fast-paced marketplace.
    The number of small businesses that have been organized as 
S corporations has tripled from around 1 million to 3.25 
million over the last 20 years.
    Among other things, the S corporation offers a number of 
appealing tax benefits and protections against personal 
liability. And I am sure we are going to learn a great deal 
more about that today.
    For instance, the S corporation classification allows 
entrepreneurs to avoid a ``double tax'' on their corporate and 
shareholder dividend earnings.
    The S corporation also provides a form of insulation for 
small businesses to be more confident in moving forward with 
their innovative ideas and their ventures.
    S corporation classification is a proven way for small 
businesses to achieve the benefits of corporate ownership. But 
there are still a number of barriers preventing S corporations 
from reaching their full potential for growth. And I look 
forward to hearing today's discussion on how we can work to 
ensure that the S corporations remain a strong and viable 
option and to learn about some of their concerns. I thank you 
very, Mr. Chairman.
    [Ranking Member Bordallo's opening statement may be found 
in the appendix.]
    Chairman Akin. Thank you.
    And I know that a few of you here, at least, Tom, you know 
the rules and what we try to do. I think this makes it easiest 
for our hearing to proceed in an orderly fashion if we take a 
statement from each of you. If you would like to submit a 
written testimony, that would be fine as well.
    And what we would like to do is to hold you to five minutes 
each. We will go straight across. And then that will allow us 
to get to asking some questions.
    I think we can wrap things up usually in close to an hour 
or so. So that would be a reasonable thing in terms of time 
    So our first witness is no stranger, the Honorable Tom 
Sullivan, Chief Counsel for Advocacy United States Small 
Business Administration, Washington, D.C. And a friend of the 
Committee and a friend of small business.
    Tom, please lead off


    Mr. Sullivan. Thank you, Mr. Chairman, Congresswoman 
    It is truly an honor to appear, not only before this 
Committee, but also as part of this distinguished panel.
    My name is Tom Sullivan, and I am the Chief Counsel for 
Advocacy at the U.S. Small Business Administration.
    I would like to submit my complete written statement. And 
as the Chair referenced, just briefly summarize in five 
    Chairman Akin. Without objection.
    Mr. Sullivan. The Office of Advocacy, is an independent 
office with the Small Business Administration. Therefore, the 
comments expressed here don't necessarily reflect the position 
of the Administration or the SBA.
    Small businesses are a driving force in the United States 
economy. They compromise 99.7 percent of all employer firms, 
employ half of all the private sector workers and have 
generated 60 to 80 percent of the net new jobs annually over 
the last decade.
    Small firms pay 45 percent of the total U.S. private 
payroll, and create about half of the non-farm private gross 
domestic product.
     Small businesses also tend to innovate at a higher rate 
than medium or large businesses, producing up to 14 times the 
patents per employee than their larger business counterparts.
    And finally, during economic downturns small businesses 
fair better than their larger counterparts. Increases in small 
business employment and self-employment often help steer the 
economy out of recessions.
    Just as small businesses are the cornerstone of the U.S. 
economy, S-corporations are the cornerstone of the small 
business economy. According to IRS Statistics of Income for tax 
year 2002 there were approximately 3.1 million S-corporation 
returns filed, making up 59.6 percent of all corporate returns. 
Those same S-corporations generated $3.9 trillion in annual 
    The written testimony discusses the history of S-corps, the 
complexity by which S corps can be started and operate and the 
need to update laws for S corps to continue to grow as a viable 
business structure.
    My office is supportive of legislative efforts that will 
enhance the growth of S corps. We are concerned, however, as 
the small business community is concerned, with what some view 
as unfair scrutiny of S corps by the IRS.
    The National Research Program has been described by IRS as 
a program that will fill data gaps needed to ensure efficient 
tax enforcement and prioritization. That is far different from 
what small businesses say is an audit initiative focused on S 
corps. I'm all for IRS proceeding with better information, but 
I share the concerns of small businesses with how IRS appears 
to be focusing its in depth, and I might add painful, audits on 
S corps.
    Research sponsored by my office continues to show that the 
cost of tax compliance costs $1304 per employee per year for 
firms with under 20 employees. That's 67 percent higher than 
large firms.
    Facing an audit, obviously, increases the costs of tax 
compliance by requiring business owners to incur the expense of 
representation and it takes time away from their business to 
answer IRS inquiries.
    Small businesses take their responsibility to pay their 
fair share of taxes seriously. No one wants to defend those 
that deliberately cheat the system. However, IRS's approach may 
punish those that voluntarily comply with the law based on the 
failures of those who do not.
    In summary, small businesses have a long history of 
contributing greatly to the American economy. S-corporations 
play a critical role in keeping the economy strong. To ensure 
their continued success, government has to be wary of taking 
steps that may stifle the entrepreneurial growth of S-
corporations. Legislation introduced to reform S-corporation 
provisions should be based on tax policy that enhances 
entrepreneurial competitiveness H.R. 4421 accomplishes this. As 
the IRS strengthens tax compliance efforts, attention should be 
given to why taxpayers become noncompliant so that 
recommendations are tailored to meet those challenges.
    Thank you for allowing me to present these views. And I am 
happy to answer questions.
    [The Honorable Thomas Sullivan's testimony may be found in 
the appendix.]
    Chairman Akin. Tom, you are starting off pretty well. You 
redeemed 30 seconds there. Good job, and what you said raises a 
lot of interesting questions. I appreciate your coming out and 
chatting with us on the subject.
    Our next witness is the Honorable Don Alexander. And Don is 
a partner at Akin, Gump, Strauss, Howard & Feld and former IRS 
Commissioner from Washington, D.C. And as he has told me 
earlier this morning, he's probably forgotten a lot of what he 
once knew but I suspect still knows a lot more than a lot of 
other people.
    Don, we are just delighted to have you here. Please share 
what your thoughts are on the subject.

                     STRAUSS, HOWARD & FELD

    Mr. Alexander. Delighted to be here.
    I have a long statement to make, it's historical. And I 
request that it be inserted in the record. I don't intend to 
read any of it.
    Chairman Akin. No objection.
    Mr. Alexander. 1958 was the year which sub S appeared as 
legislation adopted by the House and Senate and signed by the 
    1958 happened to be one of my better years.
    Chairman Akin. If you could slide that mike just a little 
    Mr. Alexander. I will.
    Chairman Akin. Thank you very much.
    Mr. Alexander. Two mikes. Wow. Well, that takes me back to 
1958. I didn't have two mikes in 1958. But we had sub S in 1958 
because the Eisenhower Administration thought that there ought 
to be a way for small business to have a vehicle, a way of 
conducting their business that would give them the corporate 
limited liability, which you really have to have these days. 
Even then you had to have. And at the same time not have a 
double tax. Once when the vehicle itself paid a tax and then 
when it distributed some of its profits to its owners, and low 
and behind there was another tax.
    Well, we still have that today. We do not have the same 
rates that we had then. We had a rate on individual income that 
went to 91 percent. Very few people paid it, willingly anyway, 
or unwillingly for that matter. Because IRS didn't do very much 
about it.
    Then in the Reagan Administration we got the rate down to 
70 percent, 70 percent that is on unearned income and got to 50 
percent finally on earned income. We treated earned income 
better than unearned income then, far different than what we do 
    Anyway, sub S was enacted to try to help small businesses 
carry out their role as essential to the U.S economy as Mr. 
Sullivan as just pointed out and as you pointed out in your 
opening statements, in a simple form. Well, the idea was a 
simple structure for simple people. The problem is that Sub S 
through the years and in my statement I mentioned the changed 
that have been made, almost all of them except one in the right 
direction since 1958, tried to alleviate the shackles that were 
put on sub S corporations back in 1958, and that still exists. 
Shackles to try to make the corporate structure simple, but 
shackles which now make the corporate structure rigid and 
rigidity is not simplicity. They are two different things.
    Originally only ten stockholders could own stock in a sub S 
corporation. Now, thanks to a number of remedial actions by the 
Congress, that ten has risen to a 100. It ought to be about 150 
so that small banks which have to adopt the sub S form because 
they can't go into the fancy things like partnerships and LLC, 
can have a sufficient number of member stockholders to survive 
in competition with the giant banks that we have today.
    Other changes should be made. You will hear more about 
these from the other witnesses. But in my litany of history I 
point out while the rules governing sub S corporations have 
been modified over the years and improved over the years, sub S 
corporations although numerous are not the vehicle of choice 
anymore. They're not the vehicle best suited from the tax 
standpoint for a small business to use. Instead, we have 
limited liability corporations, limited liability partnerships 
and we have something called check the box where you can decide 
whether you want to be a tax nothing or a tax something when 
you go into business. Whether those regulations are valid or 
not is another question, but they are with us and who is going 
to contest them.
    All this has worked to the disadvantage of sub S 
corporations. While they are numerous, and as you pointed out 
they are competing with LLCs and others that don't have the 
strictures still limiting sub S corporation.
    [The Honorable Donald Alexander's testimony may be found in 
the appendix.]
    Chairman Akin. Thank you very much. I appreciate your 
testimony. We will look forward to getting back to you with 
some questions.
    Our next witness is James Redpath, CPA, partner, HLB 
Tautges Redpath, LTD., is that somewhere close?
    Mr. Redpath. Close enough, yes.
    Chairman Akin. From White Bear Lake, Minnesota. Did you fly 
    Mr. Redpath. Last night.
    Chairman Akin. Did you? That was a treat, was it not?
    Mr. Redpath. Yes, it was.
    Chairman Akin. Yes. Well, we appreciate your braving the 
weather and joining us here, James.
    Please proceed.


    Mr. Redpath. Chairman Akin, Ranking Member Bordallo, thank 
you for the opportunity to testify. My name is Jim Redpath. I 
am a certified public accountant and an officer at HLB Tautges 
Redpath, Ltd., a 100 person full-service accounting firm 
serving clients in the greater Minneapolis/St. Paul 
metropolitan area. Our firm, like many others, work with 
several hundred S corporations. I also serve as Chairman of the 
Advisory Board to the S Corporate Association. My goal is to 
provide you with a firsthand account of how the rules governing 
S corporations are outdated, and how those rules might be 
    I ask that my full written testimony be placed in the 
    Chairman Akin. Without objection.
    Mr. Redpath. Thank you.
    Last year, our firm was involved in creating more than 100 
business entities for clients. Of those, virtually all were 
LLCs and only a select few were S corporations.
    When S corporations were created in 1958, their benefits 
were tied to the following restrictions, as earlier stated: The 
number of shareholders was limited; the types of shareholders 
were restricted, and; only one class of stock was allowed. 
Failure to comply with those rules result in the loss of S 
corporation status and unexpected double taxation.
    In contrast, the LLC was created by states beginning around 
19977 and evolving through 1997. And the LLC is encumbered with 
none of the rules governing and limiting S corporations.
    When an entrepreneur sits down in my office to discuss 
starting a business, these differences play a leading role in 
our conversation. Why would someone subject themselves to the S 
corp restrictions and the possibility of inadvertent double 
taxation? Therefore, most new businesses choose to be an LLC. 
But what about the existing 3 plus million S corporations? 
Should they convert to LLCs? Generally the answer is no. 
Converting from an S corporation to an LLC is a taxable event 
where you pay taxes on any appreciated property owned by the 
business. In my experience, no one is willing to go through the 
pain to gain LLC status. Therefore, I believe each of the S 
corporation rules need to be reviewed to determine their 
appropriateness for the 3 plus million S corporations in 
    Another area of challenge for S corporations occurs during 
the transition of the business from one generation to the next. 
If you have a family owned business with multiple shareholders 
and multiple generations, the ability to issue different 
classes of stock really helps keep family members involved in 
the family business. But S corporations cannot issue preferred 
stock or other classes of stock. Allowing S corporations to 
have multiple classes of stock would dramatically improve their 
ability to make this transition.
     Mr. Chairman, the tax code includes a number of provisions 
designed to ensure that businesses converting from C to S 
corporations do not enjoy a tax windfall when they make the 
conversion, mainly LIFO recapture, passive investment tax and 
built-in gains tax. I believe in certain circumstances these 
provisions go too far.
    For example, S corporations For example, S corporations are 
subject to a corporate level tax on certain income and gains 
recognized within 10 years after they convert from C to S 
corporation. I find the built-in gains provision causes many S 
corporations to hold onto unproductive assets and business 
lines that should be sold or converted and reinvested into the 
business. Ten years is a long time. Reducing the build-in gains 
tax period from ten to seven years, modifying the passive 
investment income limitation and eliminating the passive 
investment income determination event would eliminate an 
unnecessary advantage to S corporations.
    Mr. Chairman, raising capital is always a challenge for a 
closely held business, even without the additional limitation 
faced by S corporations. When S corporations were created, the 
idea was a simple corporate form for simple business. The 
business world has changed in the past 50 years, and the 
limitations imposed on those simple businesses are now 
restricting the ability of established S corporations to access 
the capital they need. Allowing S corporations to issue 
additional classes of stock, convertible debt and allowing non-
resident aliens and IRAs as shareholders will enhance the 
ability of S corporations to access necessary capital.
    Mr. Chairman, the S corporation is the only business 
structure where you can where you can inadvertently lose your 
entity tax status. An S corporation election is terminated 
whenever the S corporation has excessive passive income, too 
many shareholders, an ineligible shareholder, or an arrangement 
that may be considered a second class of stock. Often, 
businesses are unaware that they have violated these 
restrictions and it is discovered too late. This rule has 
tangible impact on S corporations.
    In the last year I was involved in three transactions where 
the remote possibility of the entity failing to satisfy it S 
corp requirements since the day of its inception stopped the 
transaction or resulted in major modifications to the terms. 
Allowing S corporations without IRS consent to rectify an 
ineffective election or a terminating event, increases tax 
status certainty to S corporations and puts them on par with 
all other entities.
    The S corporation has proven to be a huge success, but 
times have changed, and the rules governing S corporations need 
to change as well.
    Legislation like Representative Shaw's bill H.R. 4421, 
Representative Ramstad's bill H.R. 2239, and others would 
greatly improve these rules and enable S corporations to 
continue to compete with LLCs and other business structures on 
a more even footing and promote economic investment and growth 
for S corporations. By contrast, S corporations remain 
concerned about--
    Chairman Akin. James, your time is getting a little close 
    Can you summarize things here? I mean, I think you have 
been summarizing it, but just cap it off.
    Mr. Redpath. Yes. In summary there was a proposal relating 
to an increased tax on S corporations relating to payroll 
taxes. This for small corporations would result in a 15 percent 
increase in their tax. We believe the Treasury has the ability 
to enforce the existing rule that prohibit abuse.
    Thank you for your time.
    [Mr. Redpath's testimony may be found in the appendix.]
    Chairman Akin. Thank you, James.
    And our next witness is Gregory Porcaro. Do you go by Greg 
or Gregory?
    Mr. Porcaro. Greg is fine, thank you.
    Chairman Akin. Okay. And Greg is with the American 
Institute of Certified Public Accountants from Warwick, Rhode 
    Mr. Porcaro. Sir.
    Chairman Akin. A pleasure to have you here this morning, 


    Mr. Porcaro. Thank you. It's a pleasure to be here.
    Good morning, Chairman Akin, Ranking Member Bordallo and 
other distinguished members of this Subcommittee, the American 
Institute of Certified Public Accountants appreciates this 
opportunity to present testimony on the place of S corporations 
in our society and on the need to keep them vital and 
competitive by continuing to modernize the laws that govern 
Subchapter S of the Internal Revenue Code. We request that a 
written copy of this testimony be included in the official 
record of this hearing.
    Chairman Akin. Without objection
    Mr. Porcaro. Thank you.
    My name is Gregory Porcaro and I am the Chair of the AICPA 
S Corporation Technical Resource Panel. AICPA members assist S 
corporations of all sizes and in all industries nationwide, and 
their shareholders, with choice-of-entity decisions; 
transactional planning, return preparation; and many other 
services required daily by S corporations. It is from close 
involvement with our clients that we have developed insight 
into the impact of S corps on our society and into needed 
changes that will enable S corps to continue to be a primary 
vehicle for both start-ups and existing businesses to achieve 
operational growth, expanded employee ownership, and simplified 
and practical family succession planning. Personally, I am a 
majority shareholder and tax principal in a small CPA firm in 
Rhode Island PA who serves S corporation clients ranging in 
size from $50,000 in revenue to $40 million in revenue. My firm 
annually prepares close to 600 S corporation tax returns, 
including our own.
    S corporations are active in just about every sector of our 
environment and economy from professional service, 
construction, manufacturing, retail and wholesale 
establishments; the majority of corporate businesses that we 
deal with everyday are, in fact, S corporations. Recent numbers 
indicate that there are 3+ S corporations that together have 
invested over $2.5 billion in assets, generated substantial 
revenue and contributions to our economy and employ millions of 
people. These engines of American entrepreneurship are not 
slowing down even with the fast growth of LLCs that still 
harbor certain advantages over S corporations today.
    Today, in our brief testimony I will cover some of the 
statutory changes that we believe should be made to Subchapter 
S. Collectively, these changes would eliminate needless traps, 
inequities, and complexities, indeed, may help many 
corporations actually make an S election. Subchapter S can and 
should be modernized to expand its reach, to simplify 
transactions and remove unintended consequences.
    Start-up business survivability is a critical concern. 
Census data indicates that 20 percent of start-up companies 
disappear after one year, and 70 percent disappear after ten. 
Small businesses that struggle with and file for bankruptcy 
over operational, financial, and tax problems may be able to 
prevent these problems if they have greater access to their 
CPAs. The AICPA, therefore, supports the Small Business Tax 
Flexibility Act of 2005, H.R. 4006, and its 2006 companion bill 
in the Senate, which would give most S corporations and 
partnership start-ups the flexibility to adopt a fiscal year-
end from April through November. This flexibility would help 
spread start-up businesses' regulatory, financial, and tax 
burdens away from the busiest operational periods, thus 
increasing productivity; it will help spread regulatory, 
financial and tax workload of CPAs and other advisors 
throughout the year, thus promoting a more balanced family-work 
protocol for advisors;
    Increase the occurrence of non-extendable financial and 
regulatory deadlines, such as bank loan submissions or HUD 
filings outside of the tax season;
    Provide the same flexibility that C corporations, which are 
typically larger businesses, have in choosing the right fiscal 
year-end for the business, and;
    Provide certain start-ups with increased cash flow because 
both real and opportunity costs will be reduced as the result 
of performing these tasks outside of their busy portion of 
their business cycle.of compliance are reduced as such work is 
delayed to a less productive period of the business cycle.
    Another area of concern is a recent discussion to change 
the way S corporation shareholders pay employment taxes. The 
Joint Committee on Taxation has suggested that S corporation 
shareholders switch from the current withholding tax regime to 
the estimated tax payment system. Without addressing the merits 
and concerns of the Joint Committee at this time, we strongly 
suggest that if any changes are made, that they not be made to 
the S corporation regime, but rather that the issue should be 
studied carefully with extensive input from public to consider 
moving the partnership model closer to the S corporation model 
of payroll tax withholding. S corporation shareholders should 
not be brought into the less efficient system of self-
employment and estimated tax system because the current payroll 
withholding system substantially decreases the likelihood that 
a taxpayer will underpay their tax liability as comprehension 
and compliance with that system is much easier and less 
    Next I will mention the few suggestions that we find are of 
particular importance:
    Removal of the tax on LIFP Recapture;
    Electing Small Business Trust should be able to deduct 
interest on debt expense incurred when it borrows funds to 
purchase S corporation stock.
    In conclusion, the AICPA has a number of other 
recommendations that we do not have time to mention today. We 
ask that a letter to Senators Hatch and Lincoln describing 
these recommendations in great detail be included in the record 
of this hearing.
    Chairman Akin. Without objection.
    Mr. Porcaro. We are pleased to be able to present this 
testimony before you today and will be delighted to answer any 
    Thank you, Mr. Chairman and Members of this Subcommittee.
    [Mr. Porcaro's testimony may be found in the appendix.]
    Chairman Akin. Thank you, Gregory, for your testimony.
    Maybe in asking some questions, I will start with you. 
Gregory, you are one of the few people that did not mention 
4421. Are you familiar with that piece of legislation. I think 
it's Clay Shaw's bill?
    Mr. Porcaro. I am, sir.
    Chairman Akin. Does that bill help or harm the S corps in 
your opinion?
    Mr. Porcaro. We have been monitoring that bill at the AICPA 
since it first came about several years ago. And we believe 
those provisions are going to be significantly helpful in 
providing a lot of the flexibility that was referenced here 
    Chairman Akin. So even though you did not specifically 
mention it in your testimony, you think it is going the right 
direction then?
    Mr. Porcaro. Yes, sir.
    Chairman Akin. Okay.
    And the better questions for Mr. Sullivan, do you dispute 
that we have a tax gap?
    Mr. Sullivan. No, I do not dispute that, Mr. Chairman.
    Chairman Akin. So we do have a tax gap?
    Mr. Sullivan. We do have a tax gap. I think there has to be 
some balance in figuring out how to try to fill to the extent 
practicable that tax gap. And I think from that perspective the 
small business community differs from IRS' approach.
    Chairman Akin. And then also, S corporations receive tax 
benefits for making an S election. Why should they receive more 
    Mr. Sullivan. Mr. Chairman, the answer on why there should 
S corp reform to make them do better really is a broad economic 
answer. And that is an examination of the success of S corps 
reveals an incredible contribution to this economy. So to say 
why should they get benefits, the answer is because when they 
benefit, the entire economy benefits.
    Chairman Akin. Let me just sort of step back for what I am 
hearing and see if I am picking up, more or less, what is going 
on. We created S corps because we needed something to help get 
small businesses off the ground. We just didn't have the right 
legal mechanism, taxing mechanism to really encourage small 
business. So we created this S corp back under Eisenhower in 
the '50s. And at the time it was good technology, but when we 
look at it today it just created a whole lot of red tape and 
hassles and a tremendous liability. It is not a liability in 
the sense of some lawyer is going to sue you out of your house. 
It is not a tax liability--well, it is sort of a tax liability, 
but it is rather that if you make some little nitpicking 
mistake, all of a sudden you can lose the whole structure that 
you organized under. Not only that, you have to pay an 
incredible amount of back taxes, which I assume might even 
destroy the viability, the financial viability of your company. 
So it has got an awful lot of gotchas in it, a lot of 
complexity to the point that people are not even recommending 
it anymore if you are starting business up.
    So we have a certain number of people almost trapped in 
this antique system. And the question is whether we are going 
to get with the program and get this thing changed.
    Now, first of all, am I stating the problem more or less 
correctly? I see nods, more or less.
    Okay. Then why has it taken us so long to get the job done? 
Does anybody disagree with what I just said? I mean, what 
groups of people would disagree? IRS?
    Mr. Alexander. No. Mr. Chairman, I might try to answer 
    If I were still back with IRS, I would be paranoid enough 
to believe that--oh well.
    Now, Mr. Chairman, you put your finger right on it. S corps 
were supposed to be simple, small structures for simple small 
people. The trouble with that is that it introduces not only 
the possibility of being wrong in many, many unnecessary ways, 
but also if you are not wrong, you know that you cannot have 
over, say back in 1958, ten stockholders and now a hundred. But 
you have that 101st stockholder and you suddenly are 
disqualified. You are disqualified because you have too many. 
Well, why too many?
    You mentioned benefits of S corps. What we are talking 
about detriments. The benefits go to a pass through entity, not 
necessarily an S corp, a partnership, an LLC that is not 
subject to any of these limitations that we are talking.
    You asked who might oppose relief from the limitations. The 
fact is my former Department of Treasury has opposed relieving 
S corp restrictions. Why? Because let us go back to the simple 
structures for simple people. They think that if you relieve S 
corps of some of these limitations, that we at this witness 
table have brought out, you suddenly are creating a problem for 
the economy, for IRS and for S corps because S corps suddenly 
get complicated. Oh, no, it does not make any sense whatever. 
If you look at the regulations under Section 701 code, and I 
hate to mention code numbers but I have got to here, you find 
that they tell you how to get that 101st stockholder and they 
tell you how to get the nonresident stockholder. What you do is 
you have your S corp join in a partnership with the excess 
stockholder or with the nonresident alien stockholder and 
suddenly that's okay. Well, that is not the way that mainstreet 
business should be conducted at all.
    Chairman Akin. More complicated than the other alternative?
    Mr. Alexander. It is much more complicated. And Treasury 
requires this complexity. Part of it is the fact that they like 
partnerships. They like LLCs; that is the wave of the future, 
that is the choice of today. So why should we do anything for S 
    Chairman Akin. So then the primary people that are opposed 
to change would be probably Treasury, would that be a fair 
    Mr. Alexander. Well, there is another problem, too. Because 
any time that you do something good for S corps, the Joint 
Staff is going to put a big number on it and it is a revenue 
loss. And you got to figure out how to get some revenue to pay 
for that revenue loss under the PAYGO rules and whether under 
the current rules you still have to pick up that revenue, I do 
not know. But the other side of it is that the bills that you 
have heard about, and particularly Mr. Shaw and Mr. Ramstad's 
bill 4421 would do a lot to try to get rid of some of these 
shackles. But it might be expensive to do it.
    Chairman Akin. All right. Well, I would love to ask some 
more questions, but my five minutes has expired and I need to 
go to the fair lady from Guam.
    Ms. Bordallo. Thank you, Mr. Chairman.
    I have a question for Mr. Sullivan. How much of a 
competitive disadvantage are S corp operating at if they 
continue to be prohibited from seeking to sell stock to 
individual retirement accounts and nonresident aliens, and 
would these sources of capital be significant? And if so, how 
would they compare to the sources of capita that currently 
exist for S corp?
    Mr. Sullivan. Congresswoman, I do not know the dollars and 
the equations that would lead up to an exact figure to say this 
is the competitive disadvantage. What we do see is that without 
the reforms allowed in Mr. Shaw's bill that would allow for a 
preferred stock, for instance, for succession planning and so 
forth. What we do see is a modernization of S corp structures. 
And I guess the easiest way to answer the competitiveness 
question is that we really do not want to get to a point where 
all of a sudden we wake up and say ``Oops, we are at such a 
severe disadvantage that S corps are trapped and they are not 
able to elect out of the status without paying an enormous 
toll.'' We do not want to reach that point.
    And what we do see is that as the economy has evolved, the 
rules that were originally in place that would prohibit a 
nonresident alien ownership or different classes of stock 
really no longer apply in this marketplace. And so the reform 
is not only a competitiveness issue but also a modernization 
    Ms. Bordallo. Are there any other witnesses that would like 
to answer that question?
    Mr. Redpath. I do not know the answer to that question, but 
what I do see in my practice, you know I work in the trenches 
applying these laws to hundreds of S corporations. And what we 
do see is that our S corps' competitors are organizing as LLCs. 
And those competitors are not just domestic, they are 
international. And they are not subject to these restrictions.
    You know, one of the answers to the other question is my 
clients ask me the same question all the time. You know, why 
are we limited to certain number of shareholders? Why are we 
limited to a certain class of stock? You know, why are we--
things like that. And we do not have an answer because they ask 
us, the LLCs are not and those are their competitors.
    So I see the competitive disadvantage. I obviously don't 
have the numbers that they were asking for.
    Ms. Bordallo. I would like to ask Mr. Porcaro.
    Mr. Porcaro. Yes, ma'am. Well, that same question?
    Ms. Bordallo. Yes.
    Mr. Porcaro. Again, it is hard to quantify. The only aspect 
I can see is that with regard to IRAs, in particular, the issue 
of whether the IRA funds can be utilized in some form or 
another to invest in S corporations has come up several times 
over the years. So there is definitely a large pocket of 
resources tied up in IRAs that potentially could be used as the 
alternative source of capital.
    With regard to the international implications, in every 
situation where we had such a scenario, we have had to utilize 
LLCs in order to bring in any international capital. S corps 
just do not provide a mechanism for doing that. And that is, I 
guess, the way that situation is and how much more we would be 
able to do with S corps, I am sure there is a substantial 
amount. Because even in a firm my size we see more and more 
globalization of business activities even in smaller 
    Ms. Bordallo. Mr. Alexander, would you like to put in your 
two cents?
    Mr. Alexander. Yes. Into a mike that works.
    Yes, my two cents. I agree with the statements of the other 
witnesses. And S corps, although the largest single number of 
business entities in this country, have not yet reached zero 
population growth, but they are almost there. Thanks to the 
fact that LLCs has been discussed coupled with the check-the-
box rules that Treasury happily put out have created such a 
competitive tax environment as to greatly disadvantage the S 
corp to such an extent--did I do that?
    Chairman Akin. Well, that was a nonpaid advertisement. Go 
    Mr. Alexander. We are a little distance from the Hart 
Building anyway. That is good.
    I was saying that the S corp now almost has a zero 
population growth. There are still a lot of them. Why are there 
a lot of them? Because getting out of them is so expensive, as 
the witnesses have pointed out.
    Maybe they will tell us again.
    Anyway, back to S corp. New S corps, in my experience 
anyway which is limited, of course, are not being created if 
the would be entrepreneur, the new business person has a 
choice. The far, far superior choice is the limited liability 
company or sometimes the ancient partnership where you are not 
subject to any of the limitations that we have described and 
where you have tax nirvana, S corps are far from that and they 
need not be.
    Ms. Bordallo. Thank you. Thank you very much.
    I have one other question, kind of a follow-up. Since you 
do not have the numbers, do you have studies or analysis that 
pertain to the value of the S corporation format that you would 
call to the Committee's attention? Any of you could answer 
    Mr. Porcaro. I do not know of one.
    Ms. Bordallo. None of you?
    Mr. Sullivan. Congresswoman, in my testimony we do point 
out the economic benefits of S corps and the volume and number 
of those S corps are really tremendous. And I think what Don 
Alexander was pointing out is that if you have a choice in the 
future, it is likely that you will not choose S corps. But the 
numbers are so large for existing S corps that to ignore the 
need to modernize it will be devastating to the economy.
    Ms. Bordallo. Would SBA have any of this information?
    Mr. Sullivan. We do have information about the economic 
value of S corps. We also have information about the 
disproportionate regulatory burden on small business, but we 
don't segment out the disadvantage competitively of S corps 
versus other small business.
    Ms. Bordallo. And, Mr. Sullivan, I think you were--or I am 
sorry, Mr. Alexander?
    Mr. Alexander. I believe that there are some studies that 
could be helpful, although perhaps not exactly in point in your 
excellent question. I think the GAO has studied S corps, 
although not as recently as all of us would like. But Joint 
Committee on Taxation has also studies the S corp situation 
although sometimes they are not as concerned about these 
limitations as we at this table would hope that it would be.
    Ms. Bordallo. Thank you. Thank you very much.
    Mr. Chairman.
    Chairman Akin. Thank you. Let me ask a radical question. 
What would happen if we just said we are going to get rid of S 
corps and let everybody that has an S corp convert over to LLC 
with no penalties, no review of back taxes? Just say if you 
want to shift over, you can just go from one to the other. 
First of all, is that a radical idea? Would that be hard to do 
politically or financially, or how would that work? Would that 
make sense to do? Is there anything in an S corp that an LLC 
doesn't have?
    Mr. Alexander. Well, there are certain things for banks 
that an LLC does not have because a bank by law, as I 
understand it, has to operate as a corporation. So you would 
have to, I think, change the rules.
    Chairman Akin. You would have to deal with something 
relative to banks? It would be smaller banks then?
    Mr. Alexander. Yes. I think the banks, small banks would 
need to have sort of a special rule. A federal law could of 
course override or a federal law could replace that 
restriction. Because I think it is in federal laws, perhaps in 
state law. But apart from that, and I would like to hear the 
people that actually deal with this situation on the ground, 
but I think as far as I am concerned if there were no toll 
charge on moving from S to the faxed favored entity, LLC, I 
would strongly recommend that all the S corporations that I 
represent immediately move.
    Mr. Redpath. A couple of comments I have. And one would be 
relating to ESOPs and ESOPs owning S corporations. And there 
are many S corporations that have ESOPs as shareholders. And 
ESOPs, you know, currently could not be sponsored by 
partnerships or LLCs. So we would have to deal with that as an 
    The other thing is just applying the partnership rules to 
corporate structure may be difficult. There are a variety of 
different rules in the partnership area relating to the 
allocation of income, the allocation of debt, calculation of 
basis; many things in the partnership area which LLCs are taxed 
under. That would need to be addressed to determine how they be 
allocated at the corporate world.
    My personal opinion is these fixes that are proposed by 
H.R. 4431 and 1239 go a long way to helping the S corporation. 
They really do. I believe that many of my clients, given the 
option to convert to an LLC or if these rules may stay as an 
LLC just because of some of the things I just mentioned.
    Chairman Akin. In other words, there is a conversion cost 
just because you are doing some things a different way?
    Mr. Redpath. There is a conversion cost and there is the 
application of the tax law itself. Just simply indicating that 
a corporation now would be taxed as a partnership, there are 
many things that need to be addressed under the partnership tax 
regime as to how that applies to a corporation.
    Chairman Akin. If somebody wanted to do that, could that be 
defined before such a conversion were made? If you talk about 
simplification, which you know to some degree, simplification 
is a good thing. The LLCs are working pretty well, is there 
really a need to keep the S corps around? I am not opposed to 
making the modernizations, but I guess that was my question: 
Why do we really have two things doing the same job in a way?
    Mr. Porcaro. I would like to make a comment relative to 
what Mr. Redpath said or to emphasize it. The application to 
tax law for partnerships is substantially complicated than 
Subchapter S. And what I have found and people have converted 
or utilized LLCs without the proper guidance, have actually got 
themselves in the situation they did not anticipate. 
Contribution of property to partnerships, for example, carry 
with them a toll of up to seven years depending upon how that 
property is dealt with, either by sale or distribution.
    So there are reasons why Subchapter K works and there are 
reasons why Subchapter S works. So I have never really felt 
that I think there was a proposal was to do just that, make 
like either a smaller no-tolled charge to convert and just 
merge everything to Subchapter K. I believe the reason why we 
have the different subchapters is because they all do different 
things. And in certain circumstances the S corp is the way that 
a business should be functioning and in certain circumstances 
the LLC definitely has some aspects to it that are beneficial. 
And I do not know if we could sufficiently bridge the tax 
application and compliance from Subchapter K to S without more 
than just a nominal cost, outside of revenue costs. I mean just 
an administrative cost for taxpayers in general.
    It is not as simple, I guess, is the way I see it, as all 
    Chairman Akin. I guess my question is one of the things 
that was argued when we cut capital gains and things was that 
when we create all these complicated tax rules, what we are 
starting to do is we are starting to force some corporate 
structure into some pattern which may not be economically the 
most efficient way to run the business. So that the more 
transparent that we can make the tax code, it gives the people 
that run the businesses the flexibility to be as productive as 
possible. And when we tie up all kinds of resources because if 
you touch this, you are going to get zapped with taxes on it, 
we basically have all this money sitting around which could be 
invested in a better way. So at least the concept that I 
subscribe to and that I think a lot of people have talked about 
is that when you back your tax code off and make it less 
specific so that people have flexibility to properly manage 
their resources, otherwise, people will not make the most 
appropriate investments. It just makes us more productive and 
more competitive. And clearly we are in an increasingly global 
environment where competition is critical that we are 
competitive. So, that was why I was asking that question.
    We have been joined by a fantastic Congresswoman from the 
great State of New York. And would Ms. Kelly want to make a 
question or comment?
    Ms. Kelly. Thank you. I appreciate your turning to me.
    I will just make a comment that I have started several 
Subchapter S corporations. And for the people who are just 
entering a small business who need the corporate shield which a 
Subchapter S, and I am talking about liability here, when you 
are looking for that liability corporate shield if you are true 
very small business, a Subchapter S is a very easy and 
economical way to get into a corporate position. It's not an 
impervious veil, but it is certainly something that does help. 
And I am concerned about changing some status.
    For instance, the single taxation status, I would be 
interested in your view on whether or not you think that ought 
to be changed.
    Limited shareholders, I would be interested in what you 
think about that.
    And I am very concerned about the liability protection. 
Liability protection is one of the most common reasons that 
people who start small businesses go into any kind of a 
corporate structure. You do not have to be a corporation to do 
business in this country. And so I would be interested to hear 
you address those couple of issues: Liability protection and 
single taxation and the shareholder limitations. And I wonder 
if I could just start maybe with you, Mr. Porcaro, and move 
this direction down.
    Mr. Porcaro. Well, with regard to single taxation, are you 
referring to just the pass through structure that we have now?
    Ms. Kelly. Yes.
    Mr. Porcaro. Well, it has been experience that that is a 
very efficient way to deal with the small business environment 
where many times the complication of a corporate structure are 
not always adhered to, and the manner of that would be in a 
larger entity. And so there is not always a fine line in the 
small business owner's mind as to the corporate pocketbook 
versus their own So in many cases having this ability to have 
this pass through limits their exposure to a tax liability they 
may not have had. It is basically all going to be taxed at one 
level. And if they erroneously classify an item, whether it 
should have been personal or business related, it will flow to 
them and they will pay that one tax because that is how it 
should have been in the first place.
    With regard to the limited number of shareholders, to be 
frank with you in my particular practice the current limitation 
of a 100 shareholders has been more than adequate. We do not 
have any S corporations with more than 10.
    And I just looked at some Internal Revenue Service 
statistics, and there are not that many S corporations with 
more than 50.
    So I do not know--and now with the single family, the 
family election which can bring in multiple generations, I do 
not see that as being a real restriction as it used to be. The 
steps that have been taken have been tremendous in helping 
avoid that problem in my experience.
    And the liability issue, I cannot really comment on not 
being an attorney because I have attorneys tell me that in some 
respects the LLC provides better liability protection depending 
on the state in which you are organized in than a corporation 
might. So I do not know if that is true.
    I know in Rhode Island the jury is really kind of still out 
because we have not had a case that has challenged the limited 
liability protection of an LLC.
    Ms. Kelly. Thank you.
    Mr. Porcaro. You are welcome.
    Ms. Kelly. Mr. Redpath?
    Mr. Redpath. Yes. Thank you.
    Single taxation is how we create virtually all new 
entities, small closely held businesses, whether we use an LLC 
or an S corporation; either one does that. It is a benefit of 
both and that is something that I believe just needs to be 
there for the small business to compete.
    Rarely do we ever create a S Corporation subject to double 
    The number of shareholders, you know, is an issue that as 
Mr. Alexander pointed out people get around that. They get 
around that by creating partnerships with S corps as partners. 
And so there are ways to increase the number of shareholders 
with S corporations.
    What we are more interested in is the classes of 
shareholders and the types of shareholders. And allowing S 
corporations to benefit the same as LLCs with regards to who 
can own the stock and what your ownership rights are.
    With respect to a LLC and a corporation, I agree with you, 
a corporate entity structure has been around much longer, much 
simpler. If you read an LLC operating agreement or member 
control agreement, it is a very complicated document. When you 
read corporate bylaws, you can actually maybe understand them. 
So I agree with you from that standpoint.
    Ms. Kelly. Thank you.
    Mr. Alexander?
    Mr. Alexander. My two cents again.
    First, on the issue you raised on limited liability. I 
agree with Mr. Redpath, that is absolutely essential. 
Absolutely essential. And you have that in an LLC form in all 
the states that have adopted them. And I think all the states 
have at this point. You have it also in an S corp and you have 
it in a C corp. But why on earth would anyone use the C corp at 
least at the beginning of a business organization's life? No 
    Single tax? Sure.
    Number of shareholders. I was interested to hear those that 
actually work more than I do in this area that a 100 is 
sufficient. I have heard from the community bankers that a 100 
is great, but that more would be better.
    We do look back six generations now to find all the members 
of the family going back to a single ancestor six back treated 
as one shareholder. Think about that. You can sure bring in a 
lot of shareholders that way if you have a big family. So maybe 
the 100 shareholder limit does not create a real problem except 
in the very limited area of community banks. But it surely 
creates a huge problem when you are talking about the types of 
shareholders; nonresident aliens forbidden except through the 
mechanism that we have discussed of a partnership and an S 
corporation getting together.
    And of preferred stock, no mezzanine capital. That 
limitation never made much sense, but somehow Treasury thought 
it was appropriate. Why? I do not know, but maybe Mr. Sullivan 
can say what the Department was doing?
    Mr. Sullivan. Congresswoman Kelly, first of all on your 
question of limiting liability, I think actually that questions 
extends even far beyond the tax code. And I commend the Small 
Business Committee in the House particularly for continuing to 
push small business liability relief because it is a huge issue 
and transcends little different parts of the tax code into an 
overall threat and drag on the small businesses economy. So I 
echo the detailed tax related comments, but then also urge the 
Committee not to let up in your push for small business 
liability reform overall.
    You asked about expanded shareholders. I would defer really 
to this distinguished panel. And I think what has come out of 
this hearing is that the shareholder requirements of Subchapter 
S do need to be modernized, whether that be different classes 
of shareholders that Mr. Redpath mentioned or an expansion as 
Don Alexander talked about related specifically to community 
    The single tax system, and actually in the President's 
Commission on Tax Reform that was one area that they encouraged 
policymakers to look at and Subchapter S certainly prioritizes 
the single tax system. And for that reason I join the 
President's Commission and actually echo their recommendations 
that you do focus in on the single tax systems and enhance ways 
to make that even better through Subchapter S.
    Ms. Kelly. Thank you.
    That single tax system, as Mr. Redpath pointed out, 
sometimes it's a very, very blurred lined. An rather than set 
up an impossible rule that we cannot enforce or that is going 
to put a chill factor on our ability to form Subchapter S and 
appropriately pay the taxes, it is far better to have that line 
clear, defined and single I think. So I appreciate your 
comments on that.
    And I am sure that my time must be up, so I will yield 
    Mr. Akin. Well, we are pretty good shape on time. I 
promised we would get out of here in about an hour, and I think 
we are pretty close to that. So things are working out.
    Anybody want to ask one more? Yes.
    Ms. Bordallo. I would like to ask this of Mr. Alexander. He 
seems to have such a long history on this subject.
    Do you expect that there is a significant tax gap? I know 
this was brought up earlier, but I do not remember really what 
the answer was, for filings from S corporations? And what do 
you believe the Internal Revenue Service will do in response if 
there is a significant tax gap for S corporations? What should 
American small business owners be expecting here?
    Mr. Alexander. Commissioner Everson is enforcing the law. 
The tax law was not enforced very well and very effectively, 
efficiently or fairly a few years ago. The problem is that IRS 
may be overdoing it a bit and Mr. Sullivan indicated his 
concerns about that in the S corporation field.
    Pass through entities do present a problem for the tax 
collector, and I used to be a tax collector. However, the fact 
that the problem is presented to the tax collector doesn't mean 
that the tax collector should not be fair and reasonable. But 
the tax collector needs to be thorough because we do have a 
very large tax gap in this country. The IRS estimate is about 
$300 billion yearly after taking into account--after netting 
out what the IRS will likely collect from those who had not 
made their full and proper contribution. Actually, the gap is a 
lot bigger than that because that includes only the legal 
sector and only part of the types of taxes that we impose in 
this country. For example, the estate tax ``gap'', whatever it 
may be, is not included in IRS' figure.
    If the laws were fully effective, our tax laws produced 
what they should produce, we would not have a deficit at this 
time. But you cannot make that happen in a democracy. There is 
bound to be some slippage, and there should be some because 
otherwise IRS' is bearing down on some people very hard indeed 
while missing others, particularly in the legal sector that, 
let us say, do not rush forward to pay their taxes on money 
that they obtained illegally in the first place.
    There is a problem. There is a problem in small business, 
regrettably. But largely in the businesses that deal in cash. 
If the business finds, and perhaps this does not rise to the 
level of calling something like that a business, that cash is 
the way that it handles its transactions, it is very unlikely 
to share with the tax collector the amount that should be paid.
    Ms. Bordallo. Thank you. Thank you very much.
    Thank you, Mr. Chairman. No further questions.
    Chairman Akin. With no further questions, with thanks to 
our witnesses, the Committee stands adjourned.
    [Whereupon, at 11:15 a.m., the Subcommittee was adjourned.]
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