[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]




   TREATMENT OF CLOSELY-HELD BUSINESSES IN THE CONTEXT OF TAX REFORM

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

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                               __________

                             MARCH 7, 2012

                               __________

                           Serial No. 112-23

                               __________

         Printed for the use of the Committee on Ways and Means



[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]








                  U.S. GOVERNMENT PRINTING OFFICE

78-663                    WASHINGTON : 2013
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC 
area (202) 512-1800 Fax: (202) 512-2104  Mail: Stop IDCC, Washington, DC 
20402-0001



                      COMMITTEE ON WAYS AND MEANS

                     DAVE CAMP, Michigan, Chairman

WALLY HERGER, California             SANDER M. LEVIN, Michigan
SAM JOHNSON, Texas                   CHARLES B. RANGEL, New York
KEVIN BRADY, Texas                   FORTNEY PETE STARK, California
PAUL RYAN, Wisconsin                 JIM MCDERMOTT, Washington
DEVIN NUNES, California              JOHN LEWIS, Georgia
PATRICK J. TIBERI, Ohio              RICHARD E. NEAL, Massachusetts
GEOFF DAVIS, Kentucky                XAVIER BECERRA, California
DAVID G. REICHERT, Washington        LLOYD DOGGETT, Texas
CHARLES W. BOUSTANY, JR., Louisiana  MIKE THOMPSON, California
PETER J. ROSKAM, Illinois            JOHN B. LARSON, Connecticut
JIM GERLACH, Pennsylvania            EARL BLUMENAUER, Oregon
TOM PRICE, Georgia                   RON KIND, Wisconsin
VERN BUCHANAN, Florida               BILL PASCRELL, JR., New Jersey
ADRIAN SMITH, Nebraska               SHELLEY BERKLEY, Nevada
AARON SCHOCK, Illinois               JOSEPH CROWLEY, New York
LYNN JENKINS, Kansas
ERIK PAULSEN, Minnesota
KENNY MARCHANT, Texas
RICK BERG, North Dakota
DIANE BLACK, Tennessee
TOM REED, New York

        Jennifer M. Safavian, Staff Director and General Counsel

                  Janice Mays, Minority Chief Counsel











                            C O N T E N T S

                               __________
                                                                   Page

Advisory of March 7, 2012 announcing the hearing.................     2

                               WITNESSES

Mr. Mark Smetana, Chief Financial Officer, Eby-Brown Company, 
  Testimony......................................................     8
Mr. Dewey W. Martin, CPA, Testifying on the behalf of the 
  National Federation of Independent Businesses, Testimony.......    16
Mr. Stefan F. Tucker, Partner, Venable, LLP, Testimony...........    25
Mr. Jeffrey L. Kwall, Kathleen and Bernard Beazley Professor of 
  Law, Loyola University School of Law, Testimony................    47
Mr. Tom Nichols, Meissner Tierney Fisher & Nichols S.C., 
  Testimony......................................................    57
Mr. Martin A. Sullivan, Contributing Editor, Tax Analysts, 
  Testimony......................................................    76

                       SUBMISSIONS FOR THE RECORD

Carrix, statement................................................   121
Center for Fiscal Equality, statement............................   125
ESOP, statement..................................................   128
Kogod Tax, statement.............................................   132
NAHB, statement..................................................   141
National Beer Wholesalers Association, statement.................   145
RATE, statement..................................................   148

 
                  HEARING ON THE TREATMENT OF CLOSELY-
                   HELD BUSINESSES IN THE CONTEXT OF
                               TAX REFORM

                              ----------                              


                        WEDNESDAY, MARCH 7, 2012

             U.S. House of Representatives,
                       Committee on Ways and Means,
                                            Washington, DC.
    The committee met, pursuant to notice, at 10:04 a.m., in 
Room 1100, Longworth House Office Building, the Honorable Dave 
Camp [chairman of the committee] presiding.
    [The advisory of the hearing follows:]

HEARING ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                    Chairman Camp Announces Hearing

              on the Treatment of Closely-Held Businesses

                      in the Context of Tax Reform

    Congressman Dave Camp (R-MI), Chairman of the Committee on Ways and 
Means, today announced that the Committee will hold the second of two 
hearings on how accounting rules cause different types of businesses--
specifically, publicly-traded and closely-held businesses--to evaluate 
tax policy choices differently. Whereas the previous hearing focused on 
financial accounting rules and publicly-traded companies, this hearing 
will focus on the special challenges faced by small and closely-held 
businesses that are less concerned with financial accounting rules but 
must confront tremendous complexity in dealing with tax accounting and 
various choice of entity regimes. The hearing will take place on 
Wednesday, March 7, 2012, in Room 1100 of the Longworth House Office 
Building, beginning at 10:00 A.M.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. However, 
any individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing. A list of invited 
witnesses will follow.
      

BACKGROUND:

      
    Unlike publicly-traded companies, closely-held companies often rely 
less on Generally Accepted Accounting Principles (``GAAP'') to report 
information to owners and creditors, although there are exceptions. 
(For example, a non-public entity with outside investors or a closely-
held entity that issues debt instruments might be required to provide 
GAAP-compliant statements.) Instead, closely-held entities tend to 
focus almost exclusively on how tax policy changes affect cash flows. 
Closely-held companies, however, face their own set of challenges with 
regard to tax complexity and uncertainty. These challenges range from 
compliance with complicated rules on inventory accounting and cost 
recovery to numerous sets of tax rules governing different business 
forms.
      
    The three major business forms from which closely-held companies 
must choose for federal tax purposes are C corporations, S 
corporations, and partnerships, although a number of other types of 
business entities exist to serve specific purposes. While C 
corporations are subject to entity-level tax and shareholders are again 
subject to tax on dividends and capital gains, S corporations and 
partnerships are ``pass-through'' entities that do not pay entity-level 
tax--rather, partners and shareholders pay tax on their share of the 
entity's income on their individual tax returns (and therefore under 
the individual rate schedule). Companies must choose to operate under 
one of these regimes, and this choice can have significant tax 
consequences. Many commentators recommend modifications to the choice 
of entity rules to reduce the potential distortions introduced by such 
rules--with ideas ranging from consolidating existing pass-through 
rules into a ``unified pass-through regime,'' making it easier for 
closely-held C corporations to convert to pass-through status, or even 
subjecting some existing pass-through entities to double taxation as C 
corporations. On the other hand, tax reform proposals that create too 
large a spread between the top corporate rate and the top individual 
rate risk exacerbating these distortions rather than reducing them.
      
    In announcing this hearing, Chairman Camp said, ``Closely-held 
businesses--including millions of small and family-owned businesses--
form the backbone of our economy, but our current Tax Code imposes a 
variety of burdens on them that public companies do not face. Tax 
compliance costs are especially high for small and closely-held 
businesses, and complex rules often prevent them from maximizing their 
ability to invest and create jobs. Higher marginal rates on 
individuals, as have been proposed by others, would stunt their growth 
even more. As part of comprehensive tax reform, the Committee must 
determine how best to reduce tax compliance costs and tax rates on 
closely-held businesses so that they can devote their resources to 
innovation and job creation, rather than to tax compliance and tax 
planning.''
      

FOCUS OF THE HEARING:

      
    The hearing will examine how the Tax Code affects closely-held 
businesses in particular, and how tax reform might improve their 
ability to grow and create jobs. To this end, the hearing will consider 
how and under which sets of rules closely-held entities should be 
taxed, as well as general burdens imposed on closely-held businesses 
such as high compliance costs and tax rates.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
written comments for the hearing record must follow the appropriate 
link on the hearing page of the Committee website and complete the 
informational forms. From the Committee homepage, http://
waysandmeans.house.gov, select ``Hearings.'' Select the hearing for 
which you would like to submit, and click on the link entitled, ``Click 
here to provide a submission for the record.'' Once you have followed 
the online instructions, submit all requested information. ATTACH your 
submission as a Word document, in compliance with the formatting 
requirements listed below, by the close of business on Wednesday, March 
21, 2012. Finally, please note that due to the change in House mail 
policy, the U.S. Capitol Police will refuse sealed-package deliveries 
to all House Office Buildings. For questions, or if you encounter 
technical problems, please call (202) 225-3625 or (202) 225-2610.
      

FORMATTING REQUIREMENTS:

      
    The Committee relies on electronic submissions for printing the 
official hearing record. As always, submissions will be included in the 
record according to the discretion of the Committee. The Committee will 
not alter the content of your submission, but we reserve the right to 
format it according to our guidelines. Any submission provided to the 
Committee by a witness, any supplementary materials submitted for the 
printed record, and any written comments in response to a request for 
written comments must conform to the guidelines listed below. Any 
submission or supplementary item not in compliance with these 
guidelines will not be printed, but will be maintained in the Committee 
files for review and use by the Committee.
      
    1. All submissions and supplementary materials must be provided in 
Word format and MUST NOT exceed a total of 10 pages, including 
attachments. Witnesses and submitters are advised that the Committee 
relies on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. All submissions must include a list of all clients, persons and/
or organizations on whose behalf the witness appears. A supplemental 
sheet must accompany each submission listing the name, company, 
address, telephone, and fax numbers of each witness.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://www.waysandmeans.house.gov/.

                                 

    Chairman CAMP. Good morning. Before we begin, I just wanted 
to say that I was saddened to learn that a former staff member 
of the Joint Committee on Taxation, Cyndi LaFuente, passed away 
earlier this week. I know she was a valued colleague and friend 
to many people in this room, and I want to express my deepest 
condolences to her family and her friends for their loss, and 
just to say Cyndi will be missed.
    Today we are continuing our series of hearings on 
comprehensive tax reform and how a flatter, simpler, and fairer 
Tax Code can lead to economic growth and job creation. Our last 
hearing focused on publicly traded companies' use of generally 
accepted accounting principles, GAAP, when compiling their SEC-
required filings. For these companies, both earnings results 
and cash flow are important to investment decisions and 
performance measurement.
    During today's hearing, we will shift gears to examine the 
other side of the coin, closely-held businesses. The complexion 
of these businesses varies greatly. They range from mid-size 
manufacturers to local law firms to the Main Street restaurants 
that sponsor local Little League teams. In this hearing, we 
will examine the rules that dictate how these entities should 
be organized for purposes of taxation, as well as general 
burdens imposed on closely-held businesses such as high 
compliance costs and tax rates.
    The difference between individual and corporate tax rates 
has an important effect on a business and how it is organized. 
For example, if individual income tax rates are substantially 
higher than corporate income tax rates, there is a clear 
incentive for taxpayers to organize business activity in 
corporate form. In addition, businesses that are subject to the 
higher individual rates may face a competitive disadvantage.
    There is little doubt that economic distortions can be 
created by a Tax Code that tilts too much in any one direction, 
and naturally one of the most effective ways to prevent that 
distortion is to create a neutral Tax Code in which the 
individual tax rates are similar to corporate tax rates.
    This is an approach that the Republicans have taken by 
calling for a top rate of 25 percent for both individuals and 
corporations. It also mirrors one of the most important 
achievements of the 1986 Tax Reform Act, cementing the 
principal of closely aligning individual and corporate rates to 
eliminate abuse and economic distortions related to business 
structures.
    According to the Joint Committee on Taxation, in 2007 pass-
through entities earned 56 percent of total net business 
income, which is taxed under the individual tax rate structure. 
Census data reveals that in 2008, pass-through entities 
employed more than 54 percent of the private sector workforce. 
Both statistics point to the strong role pass-through entities 
play in our economy, and recent proposals have raised concerns 
from many in the pass-through community.
    For instance, under the President's budget and other 
corporate reform proposals, the top statutory rate on 
individuals would rise to roughly 40 percent. At the same time, 
however, President Obama proposes to lower the corporate rate 
to 28 percent. Corporate taxpayers would enjoy a tax rate that 
is 12 percent points lower than the top rate faced by pass-
through businesses, and this will create more harm than good.
    As we continue to consider ways to transform the code from 
one that inhibits to one that spurs job growth, we must take 
steps to ensure that corporate reform is not financed on the 
backs of those who we have historically depended on the most to 
move us out of recessions, and that is small business.
    Adding to the challenges posed by a disparate rate is the 
ever-increasing tax complexity facing closely-held businesses. 
Unlike large, publicly-held companies that have armies of 
accountants and lawyers, the complexity of the Tax Code 
disproportionately hits small businesses, which tend to be 
closely-held businesses.
    The Small Business Administration found that small 
businesses face a tax compliance burden at $74.24 per hour. 
That is 67 percent higher than that faced by large businesses. 
This burden results from reporting requirements, such as 1099s, 
as well as complex accounting rules for inventories, 
depreciation, and other business activity.
    In addition to the many tax rules a business must contend 
with, it is the first tax-related decision that businesses 
make, the manner in which they should organize themselves. That 
will affect all other tax decisions from that day forward.
    Whether a business organizes as a C corporation, an S 
corporation, a partnership, or some other form of business 
entity, that decision should not be driven by tax 
considerations. Instead, it ought to be driven by what form of 
organization best suits that business and its needs.
    As we move forward on reform, this committee should ask 
when it is appropriate to tax business income on a pass-through 
basis and when, if ever, it is appropriate to subject business 
income to entity-level taxation. And given the importance of 
pass-through entities to the U.S. economies and the prevalence 
of closely-held businesses, the treatment of job creators is 
critical to tax reform.
    Our goal with comprehensive tax reform remains clear, to 
create an environment that is ripe for economic growth and job 
creation. And I look forward to hearing from our witnesses 
about how we can best achieve that goal.
    And I now yield to Ranking Member Levin for his opening 
statement.
    Mr. LEVIN. Thank you very much, and welcome to all of you. 
And I know the chairman always wants you to have your testimony 
in in advance, and you all did that, and that was really 
helpful, though in one case your testimony was 12 pages and I 
am curious how you are going to do that in five minutes.
    [Laughter.]
    Mr. LEVIN. But it let us read rather late into the evening. 
Again, welcome, all of you knowledgeable people.
    Today's hearing on closely-held businesses covers a vitally 
important topic. One of the measures of tax reform should be 
how well it promotes economic growth and job creation. So-
called pass-through businesses represented over a third of 
business receipts in 2008 and just under half of business 
income. They are a major part of our economy and a major source 
of growth and jobs.
    Because pass-through entities do not pay corporate income 
tax at the entity level, and because they range in size from 
very small businesses to very large ones, they face a different 
set of issues with respect to tax reform than do C 
corporations. To understand how pass-through businesses will be 
affected by reform, we have to understand--and that is one of 
the purposes of the hearing today--who exactly they are.
    It used to be that pass-throughs were a reasonable proxy 
for small businesses. But with the growth both in number and 
size of S corporations and especially LLCs, this identity is 
breaking down. This is vitally important, among other issues, 
as we debate the question of whether to continue the upper 
income Bush tax cuts.
    Some have sought to continue to draw a straight line 
between pass-throughs and small business to justify continuing 
the tax cut for the highest earners. But pass-throughs are 
often quite large. For instance, in 2008, 64 percent of 
partnership income was earned by partnerships with more than 
$100 million in assets.
    Small business income is also a small fraction of the 
income that would be affected by an expiration of upper income 
tax cuts. Only a small fraction, 8 percent, is associated with 
small business employers.
    This has implications for how this committee approaches the 
universal, or nearly universal, desire to encourage small 
businesses. We need to keep in mind that if this committee 
contemplates the repeal of provisions that affect the cash flow 
of small businesses, such as accelerated depreciation or the 
domestic manufacturing deduction, in order to finance a 
corporate tax reduction, pass-through entities will not benefit 
from a reduction in the corporate rate. Pass-throughs also 
would not benefit from some of the international changes that 
the committee has discussed.
    One area where I think most of us agree where we can help 
small business is complexity. In reading through your testimony 
and the excellent Joint Committee pamphlet, I think there is 
plenty of complexity for us to explore. I look forward, 
therefore, and all of my colleagues on the Democratic side do, 
to your testimony. Thank you.
    Chairman CAMP. Well, thank you very much.
    We are pleased to welcome the excellent panel of experts 
assembled before us today. And as we tackle the special 
challenges faced by small and closely-held businesses, I 
believe their experience and insight will help us to shed some 
light on this complex area of the Tax Code.
    To introduce our first witness, from Naperville, Illinois, 
I yield to the chief deputy whip, Mr. Roskam.
    Mr. ROSKAM. Thank you, Mr. Chairman. And Mr. Chairman, I 
want to thank you for extending an invitation at my request to 
Mr. Mark Smetana. Mark is the chief financial officer of Eby-
Brown, a 100-year-old family-owned business, that is a 
wholesale distributor to the convenience store industry. And 
they are located in Naperville, Illinois, and they operate out 
of seven locations throughout the United States. They employ 
roughly 2500 employees, distribute goods to over 13,000 retail 
locations, and have $4.5 billion in annual sales.
    Mark previously served as the chairman of the Private 
Company Policy Committee of Financial Executives International, 
a 15,000-member company organization. And of course, he is a 
proud graduate of the University of Notre Dame.
    Chairman CAMP. All right. Thank you, Mr. Roskam, and 
welcome, Mr. Smetana.
    Second, we will hear from Mr. Dewey Martin. Mr. Martin is a 
licensed CPA, the sole owner of a public accounting practice, 
and the director of the School of Accounting at Husson 
University in Maine. He is testifying today on behalf of the 
National Federation of Independent Business.
    Third, we welcome Mr. Stefan Tucker, a partner at Venable 
LLP here in Washington, D.C. Mr. Tucker is a former chair of 
the ABA Section of Taxation and has lectured as a professor at 
the George Washington University Law School and the Georgetown 
University Law Center.
    Fourth, I would like to yield to Mr. Gerlach to welcome our 
next witness.
    Mr. GERLACH. Thank you, Mr. Chairman. I appreciate it very 
much. We are pleased to have today Dr. Jeffrey Kwall with us on 
the panel. Dr. Kwall is the Kathleen and Bernard Beazley 
Professor of Law at the Loyola University School of Law in 
Chicago, Illinois. He also teaches at Northwestern University 
School of Law.
    He specializes in corporate and pass-through taxation, and 
has authored many publications on the subject. He is an 
undergraduate from Bucknell University in Pennsylvania, as well 
as getting his J.D. and his Masters in Business Administration 
from the University of Pennsylvania.
    But what is extra-special about the opportunity to 
introduce Dr. Kwall this morning is that he and I grew up in 
the same home town in Western Pennsylvania. We are boyhood 
friends. We were in the same Cub Scout troop, and we have many 
memories of our childhood. And I have sworn him to secrecy on 
any of those stories, Mr. Chairman.
    [Laughter.]
    Mr. GERLACH. But we are really pleased to have Dr. Kwall 
with us, and I appreciate the opportunity to introduce him this 
morning. Thank you.
    Chairman CAMP. Well, thank you, Mr. Gerlach. And you come 
very well credentialed, Dr. Kwall.
    Fifth, we will be hearing from Mr. Thom Nichols. Mr. 
Nichols is a shareholder at Meissner Tierney Fisher & Nichols 
in Milwaukee, Wisconsin, and serves as the vice chair on the 
Committee on S Corporations for the ABA Section on Taxation.
    And finally, we do like to welcome back Mr. Martin 
Sullivan. Mr. Sullivan has served at the Treasury Department, 
the Joint Committee on Taxation, and since 1995 has been a 
contributing editor for Tax Analysts.
    Thank you all again for your time today. Thank you for 
being here. The committee has received each of your written 
statements and they will be made part of the formal hearing 
record. Each of you will be recognized for five minutes, and I 
will hold you pretty tightly to those five minutes, for your 
oral remarks.
    So Mr. Smetana, we will begin with you. You are recognized 
for five minutes.

 STATEMENT OF MARK SMETANA, CHIEF FINANCIAL OFFICER, EBY-BROWN 
                 COMPANY, NAPERVILLE, ILLINOIS

    Mr. SMETANA. Good morning, Chairman Camp and Ranking Member 
Levin and Members of the Committee. It is a privilege to 
testify at today's hearing regarding the treatment of 
privately-held businesses in the context of tax reform. This 
hearing comes at an important time as America's businesses 
continue to struggle with lingering economic uncertainty. This 
proves especially true for the thousands of privately-held and 
family-owned businesses in the United States.
    As Mr. Roskam noted, I currently work for a privately-held 
company. The current family ownership is in its second 
generation, and it employs about 2500 people. The longevity of 
the company has largely resulted from the family's reinvestment 
of its after-tax earnings and traditional financing.
    America's privately-held businesses are the backbone of our 
economy. Forbes Magazine estimates that the 441 largest private 
companies in the United States employ 6.2 million people and 
account for 1.8 trillion in revenue. Recognizing the importance 
of private companies is vital since any workable tax reform 
must address businesses, regardless of their form of 
organization.
    All forms of business use GAAP-based financial statements 
to measure financial performance and the financial position of 
the business. However, there are fundamental differences 
between privately-held businesses and corporations.
    Owners of privately-held companies are typically limited in 
number and have long-term investment horizons, years to 
generations, whereas investors in publicly-held corporations 
are short-term renters of the securities they own, frequently 
trading them for cash. Capital used to finance privately-held 
businesses are after-tax cash earnings and transactional forms 
of debt financing. Public corporations raise capital via 
offerings of debt and equity-traded securities to the public.
    The owners of privately-held businesses typically measure 
the value of their business in terms of free cash flows the 
business generates, EBITDA or earnings before taxes, interest, 
depreciation, and amortization, times a market multiple; 
whereas public companies measure valuation in terms of market 
capitalization, price-to-earnings ratio, and earnings per 
share.
    Most privately-held companies evaluate investment 
opportunities on an after-tax cash flow basis, whereas public 
companies evaluate the impact on the price of its stock. Tax 
policy plays a material role in evaluating those investment 
decisions for privately-held businesses.
    The recent framework for business tax reform released 
jointly by the Administration and Department of Treasury 
strongly implies that those organized as pass-through entities 
are advantaged in the current Tax Code over corporations. This 
is simply not the case.
    According to a report from Robert Carroll and Gerald Prante 
of Ernst & Young, America's pass-through businesses reported 36 
percent of all business net income but paid 44 percent of all 
Federal business income taxes.
    Furthermore, the pass-through tax regime recognizes that 
there is a fundamental difference between closely-held 
businesses enterprises and corporations, especially publicly 
traded ones. Among them are:
    Owners of pass-through privately-held companies are taxed 
on business income, whether distributed or retained in the 
business, at one level of taxation, whereas corporations pay 
taxes on all income; and their owners pay a second tax on 
after-tax earnings that are distributed to its owners, creating 
a double-tax event.
    Pass-through entities are flexible, allowing a 
disproportionate allocation of earnings to its owners based 
upon the agreed-upon equity contribution among them. 
Corporations are inflexible in the allocation of earnings to 
its stakeholders.
    In order to fairly treat all businesses and provide a 
consistent policy with which business can operate in the U.S. 
economy, tax reform must address both forms of organization. 
The stated goal of providing a competitive business tax 
environment is important. However, it should not result in 
discriminating against closely-held businesses by widening the 
amount of marginal taxes the pay on business source income, 
forcing them into an inappropriate investor/owner relationship 
with their business, double-taxing their business income as if 
they were merely an investor trader of the business, or forcing 
them to pay a second level of tax on the sale of their 
business.
    Financial professionals are already making decisions based 
on increases in marginal rates set for January 2013, expiring 
AMT fixes, increases in the tax rate on investment income, and 
an increase in death taxes on closely-held companies. Certainly 
none of these prospects can be welcome at a time when our 
economy desperately needs increased private sector investment.
    In closing, it is vital that private companies are 
recognized as critical for America's economic future. When tax 
reform does take place, we hope that their importance in our 
economy is understood and not penalized.
    I want to thank the chairman and ranking member for giving 
me the opportunity to speak before the committee today. I am 
happy to discuss these issues further and answer any questions 
you may have.
    [The prepared statement of Mr. Smetana follows:]


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    Chairman CAMP. Thank you very much.
    Mr. Martin, you are recognized for five minutes.

 STATEMENT OF DEWEY W. MARTIN, CPA, HAMPDEN, MAINE, TESTIFYING 
  ON BEHALF OF THE NATIONAL FEDERATION OF INDEPENDENT BUSINESS

    Mr. MARTIN. Good morning, Chairman Camp, Ranking Member 
Levin, and Members of the Committee. I am very pleased to be 
here on behalf of NFIB as the committee continues its series of 
hearings on tax reform. I appreciate that the committee invited 
me here today to discuss tax reform from the perspective of 
someone who is a small business owner, a tax advisor to many 
closely-held businesses, and a university professor of taxation 
for 32 years.
    I would like to discuss how taxes affect small business 
structure and propose a number of ideas for reform. 
Additionally, I will lay out some goals that I believe the 
committee should adopt when considering the impact of tax 
reform on small businesses.
    Nearly 75 percent of small businesses choose the pass-
through business structure. And, by the way, that occurred 
because of the Tax Reform Act of 1986; prior to that time, you 
could have one level of taxation at the time of liquidation of 
a C corporation. The Tax Reform Act of 1986 enforced double 
taxation that pushes everybody towards S corporation status.
    From a from a tax perspective, the pass-through model makes 
sense for the typical small business. But while many small 
businesses start as sole proprietors or as partnerships, the 
liability protection that a corporation offers is not available 
to these business structures. As a small business grows in 
size, they are very likely to elect to change to an LLC or a 
corporate form.
    While there are important liability protections offered to 
incorporated businesses, taxation that pushed C corporations 
toward ongoing costs associated with that structure versus non-
corporate structures, such as filing articles of incorporation, 
paying registration fees with States, drawing up corporate 
bylaws, and establishing a board of directors.
    Incorporation makes sense for some businesses and would 
serve as a barrier to entry for other businesses. The various 
models provide the business owner with more flexibility and 
choice to organize their business in a way that best suits 
their needs.
    As I discuss in my written testimony, I believe that three 
changes to the current law would provide additional flexibility 
to small businesses in choosing that alternative:
    First, allow corporations to own shares in S corporations, 
or at the very least, allow S corporations to own shares in S 
corporations.
    Second, allow owners of S corporations to have fringe 
benefits, just like employees of C corporations can have fringe 
benefits.
    And finally, reduce the holding period for built-in gains. 
For 2011, it is five years, 2012 going back to 10 years. Reduce 
it. Eliminate it. But take care of it. It is a difficult 
problem for conversions.
    Regarding tax reform, as the committee considers various 
proposals, I would encourage you to keep these goals in mind: 
Permanent reduction of tax rates. Do not create disparities 
between the various forms of entities. Reduce complexity--big 
one for me, especially in the classroom. And do not separate 
the business owner from the business; they are really one and 
the same.
    Small businesses need permanency in the Tax Code to make 
important business decisions, such as when to hire workers and 
when to make capital investments. And one of the main sources 
of capital for expanding a business is earnings retained from 
business profits.
    While small businesses would no doubt welcome the 
opportunity to reduce individual income tax rates from their 
current levels, at a minimum, NFIB members overwhelmingly 
support extending the current tax rates. In addition, NFIB 
members strongly support repeal of the AMT and the estate tax.
    Pass-through businesses must be included in any reform of 
the Internal Revenue Code. If the rates were to go down for C 
corporations but remain unchanged for pass-through businesses, 
it would put pass-through businesses at a competitive 
disadvantage or encourage businesses to change to a less 
favorable business structure simply for tax reasons. 
Additionally, this could lead to higher taxes for pass-
throughs, perhaps as much as $27 billion a year.
    NFIB strongly recommends that tax reform be pursued 
comprehensively, addressing both individual and corporate 
taxes. The typical small business spends about $18 billion on 
tax compliance costs, some of it to me, a small piece. There 
are some areas of the tax law that are significantly more 
complex than necessary, such as the small business health 
insurance credit, which requires me to do a five-page worksheet 
in a tax return before I can even tell whether the business 
qualifies for the credit or not. Ridiculously complex, in my 
opinion.
    Additionally, in recent years, the IRS and Congress have 
attempted to close the tax gap by forcing small business owners 
to become information collectors for the IRS or through 
increased withholdings. Two such efforts, the 1099 paperwork 
mandate in the health care law and the 3 percent withholding 
requirement, were so onerous that they were rightly repealed in 
2011 before even going into effect. Both of those requirements 
would have significant impact on my clients.
    Congress can build on the success of some reforms to the 
code that have made tax filing easier for small business. Two 
examples are the increased Section 179 deduction to the 
$500,000 level, making it permanent, and expanding the use of 
cash accounting, making it available to any business with less 
than $10 million in sales. That would be a big help to my 
clients.
    Finally, do not think of the business owner as separate 
from the business itself. Attempts to tax small business or 
pass-through income and salary income at different tax rates 
would have a significant problem for small business owners. The 
recordkeeping required to determine qualified income and to 
allocate expenses would increase the cost and burden of 
compliance for small businesses.
    Thank you very much for the opportunity to testify here 
today. I very much appreciate the fact that the Committee on 
Ways and Means is taking a serious look at reforming the 
Internal Revenue Code, and I urge you to keep in mind the 
unique challenges that face small businesses. And I very much 
look forward to hearing your questions at the end of our 
presentations. Thank you.
    [The prepared statement of Mr. Martin follows:] 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    Chairman CAMP. Thank you, Mr. Martin.
    Mr. Tucker, you have five minutes, and your written 
statement is part of the record.

     STATEMENT OF STEFAN F. TUCKER, PARTNER, VENABLE LLC, 
                        WASHINGTON, D.C.

    Mr. TUCKER. Chairman Camp, Ranking Member Levin, and 
Members of the Committee, thank you very much for the 
opportunity to appear before you today to testify in an area to 
which I have devoted my professional career for almost five 
decades--that is, the legal aches and pains that are facing 
closely-held business owners.
    I am the senior tax lawyer at the Venable law firm in 
Washington, D.C. My practice specializes in closely-held 
businesses, from the inception to the end of the business. I 
have a teaching career; I have been teaching at law schools for 
42 years, since 1969. I am currently an adjunct at the 
Georgetown University Law Center and at the University of 
Michigan Law School, and I teach business planning at Michigan.
    By the way, Chairman Camp and Ranking Member Levin, I am a 
Michigan native. I was born in Detroit. (Mr. Levin: You may 
remember the Richton and Dexter intersection in Detroit; that 
is where I lived.) I grew up in Flint, Michigan. I am a 
graduate of Flint Community College, which is now Mott 
Community College, the University of Michigan Business School, 
and the University of Michigan Law School.
    I have absolutely no political agenda today. My purpose is 
to share with you the concerns that, in my experience over the 
decades, closely-held business owners face on a daily basis, 
and suggest Federal tax reform that you should consider to 
address these concerns.
    In my experience on an everyday basis, closely-held 
business owners are particularly concerned with four issues: 
first, growing their businesses, specifically capital access 
and capital formation; secondly, protecting their personal 
assets from business risk; thirdly, protecting the business and 
its personnel from adversity; and fourthly, business 
succession. And in fact, Federal tax policy impacts on all of 
these concerns.
    I would suggest that this committee consider four 
fundamental reforms of the tax system that would enable owners 
of closely-held businesses to concentrate on what they do best, 
which is actually running their businesses. And these are: a 
single-tax regime for all electing entities; secondly, an 
entity-level tax for non-electing entities, with dividends paid 
deduction; thirdly, simplify compensation rules; and fourthly, 
tax rate parity. And everything else is detail. Let me amplify. 
Okay?
    First, on the single-tax regime, I would make this elective 
integration. I would have it apply to any entity, whether a 
corporation, a limited liability company, or a partnership. And 
I would leave the choice of entity to be determined by the 
business owner based on non-tax considerations such as State 
law issues. Effectively, we would have a check-the-box. And 
this is because many of them are concerned about State law 
concerns, and should not be concerned about tax law concerns.
    The guidance for all of these pass-through entities would 
be the partnership rules under subchapter K. And in fact, I 
would eliminate subchapter S altogether and, therefore, 
eliminate all the traps under subchapter S of the Internal 
Revenue Code.
    I believe that anyone who works for the entity and is an 
owner of an interest in the entity, irrespective of the size of 
the ownership, should be subject to withholding, FICA and FUTA, 
and receive a W-2 and not a 1099. And of course there would 
need to be a transition period to move from that taxable 
corporation into the single-tax entity.
    Secondly, on the entity-level tax for non-electing entities 
with a dividends paid deduction, I would let every entity 
decide not to elect affirmatively to be a single-tax entity but 
to be a taxable entity. But I would give them a dividends paid 
deduction for dividends passed through to shareholders, which 
is effectively what REITs do today but with special rules 
governing REITs.
    It would apply only to dividends paid out of the current 
year's income. To the extent income is retained, I believe the 
following should occur. If it is retained to acquire assets, 
tangible assets to be used in the trade or business within the 
United States, I believe that they should have a fast write-off 
on those assets, no more than five years or the current useful 
life, if shorter, thus giving them an inducement to grow their 
business within the U.S., not outside of the U.S.
    If the retained income is used to acquire tangible assets 
in the trade or business outside the U.S., let them use the 
longer current useful lives. And if it is later distributed, 
there would be no dividends paid deduction, and it would be 
taxed to the shareholders at their level.
    I think there should be simplified compensation rules. I 
think you should not have to worry about reasonable 
compensation because, in a pass-through entity, you would not 
have that issue. It would be a single-tax entity, and in big 
entity. And, in big double tax entities, golden parachutes and 
the like could be eliminated because that should be a 
shareholders concern, not a tax/IRS concern.
    Finally, there should be tax rate parity. The top rate for 
corporations that are taxed and for pass-through entity owners 
should be exactly the same. You should not have a gaming issue 
as to where you are and come up with deductions that you do not 
need.
    Thank you very much for your time, and I am glad to answer 
questions at any point.
    [The prepared statement of Mr. Tucker follows:] 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    Chairman CAMP. Well, thank you, Mr. Tucker. And I think 
your personal background might even trump Dr. Kwall's.
    Dr. Kwall, you are now recognized for five minutes.

  STATEMENT OF JEFFREY L. KWALL, KATHLEEN AND BERNARD BEAZLEY 
  PROFESSOR OF LAW, LOYOLA UNIVERSITY SCHOOL OF LAW, CHICAGO, 
                            ILLINOIS

    Mr. KWALL. Chairman Camp, Ranking Member Levin, and 
distinguished Members of the Committee, thank you for inviting 
me to testify at this hearing. I would like to make a couple of 
suggestions today, with a goal of trying to reduce the extent 
to which the tax law distorts business decisions, and to 
simplify the law.
    As you are aware, there are three principal closely-held 
business entities, corporations, partnerships, and limited 
liability companies. In addition, there are three alternative 
tax regimes that these enterprises can select from--two pass-
through regimes, subchapter S, the S regime, and subchapter K, 
sometimes known as the partnership regime. I am going to call 
it the K regime.
    And pass-through entity treatment, of course, means that 
the business does not pay tax. Instead, the income of the 
business is allocated among the individual owners. Each owner 
reports his or her share and pays tax at his or her marginal 
rate.
    In addition to the two pass-through regimes, we also have a 
separate entity regime, the C corporation regime, that publicly 
traded companies are taxed under. But in addition, closely-held 
enterprises can also elect that regime, whereby there is a 
corporate-level tax, an entity-level tax on the business when 
it earns its income, and then a second tax on the owners of the 
business when profits are distributed.
    I want to focus on the two pass-through systems, the S 
regime and the K regime. They both impose a single owner-level 
tax, but accessibility and the operation of the two systems are 
very different.
    The S regime is a very restrictive regime. It only 
accommodates businesses where the owners agree to share 
economic profits consistently. In other words, each ownership 
interest has to have identical economic rights, meaning 
identical rights to distributions as well as liquidation 
proceeds. As a consequence, it is relatively easy to allocate 
the income of an S corporation among the owners. It is just a 
straight proportionate allocation. Everybody picks up their 
percentage share.
    By contrast, the K regime, the partnership regime, 
accommodates any economic arrangement regardless of what the 
owners agree to. The owners can agree to splice and dice 
profits and losses however they want to do it. As a 
consequence, the K regime imposes on the tax law the burden of 
unraveling the economic arrangement of the owners to figure out 
what the proper tax reporting should be. That is difficult, if 
not impossible, because the partnership does not distribute its 
profits each year. You have got to be guessing in terms of how 
those profits would get distributed based on difficult 
agreements.
    The tax rules attempting to ensure that the tax reporting 
matches the economic arrangement are complex and difficult to 
comply with. So by virtue of this situation, my proposal is 
that rather than having two pass-through systems, the tax law 
should have a single pass-through regime that applies to what I 
call simple enterprises, and a single entity-level tax, imposed 
on complex enterprises.
    Now, ideally, all business income should be allocated among 
the owners and taxed at each owner's individual marginal tax 
rate. That ideal can be accomplished for simple enterprises, 
meaning a business entity with one class of ownership 
interests, regardless of whether that entity is a partnership, 
a corporation, or a limited liability company.
    In the case of a simple enterprise, all you have to do is 
allocate the income and deductions proportionally among the 
owners unless the owners elect out; I would allow them to elect 
out of that system. And you would implement that system by 
simply refining the existing S corporation regime, which works 
reasonably well and has a long history.
    The ideal of taxing the income to the owners, though, 
cannot be accomplished for complex enterprises, meaning any 
business entity with more than one class of ownership 
interests, regardless, again, of whether the entity is a 
corporation, a partnership, or a limited liability company.
    In the case of a complex enterprise, my suggestion is that 
you tax the income to the entity when it is earned. If you tax 
the entity, then the tax law does not have to be concerned with 
how the owners are going to split up the profits and losses. 
And you can implement that by creating an entity-level tax and 
effectively eliminating the partnership regime.
    So in conclusion, I would suggest replacing the current 
system of three elective alternative regimes with a pass-
through system for simple enterprises and an entity-level tax 
on complex enterprises because I believe that would both reduce 
the impact of the tax law on the choice of business form 
decision--it would make it purely a business decision--and 
simplify the law.
    Thank you for inviting me to participate in this hearing. I 
welcome your questions.
    [The prepared statement of Mr. Kwall follows:] 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    Chairman CAMP. Well, thank you very much. Appreciate your 
testimony.
    Mr. Nichols, you are recognized for five minutes.

   STATEMENT OF THOMAS J. NICHOLS, MEISSNER TIERNEY FISHER & 
               NICHOLS S.C., MILWAUKEE, WISCONSIN

    Mr. NICHOLS. Thank you. Chairman Camp, Ranking Member 
Levin, Members of the Committee, thank you very much for the 
opportunity to testify today on the important topic of the 
treatment of closely-held businesses in the context of tax 
reform. My testimony today reflects the views that I have 
developed over 30 years as a tax professional, working with 
closely-held business entities, as well as my role as an 
advisor to the S Corporation Association.
    When I first started practicing law in 1979, the top 
individual tax rate was 70 percent and the top income tax rates 
for C corporations was only 46 percent. This rate differential 
provided a tremendous incentive for successful business owners 
to elect C corporation status. The devil's bargain was that 
those lower taxed earnings were supposed to be taxed again when 
distributed out to the shareholders, resulting in an aggregate 
cumulative tax burden of 84 percent.
    This tax dynamic set up a cat-and-mouse game between the 
IRS and taxpayers, whereby shareholders sought to pull money 
out of their corporations in transactions that avoided the 
ordinary income tax rates, or to accumulate wealth inside 
corporations and indefinitely delay the second layer of tax. 
This is described in more detail in my written comments. The 
only winner in this struggle was the tax lawyers.
    The bipartisan Tax Reform Act of 1986 changed all this. It 
altered the relative C corporation and individual rates so that 
businesses were no longer forced into C corporation double-tax 
status.
    This allowed most closely-held business owners to migrate 
into the more rational single-tax pass-through system, which 
eliminated the need for all of that gaming that I described. 
This system has worked well for businesses and the country in 
the intervening years, and retaining these benefits will be 
critical to the success of any future tax reform efforts.
    Unfortunately, this favorable relative rate structure is 
now at risk. Right now, the top rate for C corporation and S 
corporation retained earnings is 35 percent. However, unless 
there is a change in the law, as shown in chart 4 in my 
materials, the top rate for pass-throughs will rise to nearly 
45 percent next year for partnerships and S corporations in 
certain circumstances, while the top rate on C corporations 
will remain the same. There are also proposals for a C 
corporation-only tax rate reduction, which would make the wedge 
between C corporations and pass-through businesses even larger.
    Instead, I believe that Congress should build on the 
reforms started in 1986, including continuing to move 
businesses toward a single-tax system, keeping the top rates 
for corporate, pass-through and individual income the same, and 
implementing tax reform on a basis that is comprehensive and 
not piecemeal.
    Focusing merely on the headline C corporation marginal rate 
and broadening the tax base for all businesses unavoidably 
increases the tax burden for closely-held pass-through 
entities. Since pass-through business owners employ over half 
the workforce in this country, lowering the marginal rate for 
all businesses should be the goal of comprehensive tax reform.
    In light of that, it would be appropriate to facilitate the 
continued transition away from the C corporation double-tax 
system for as many entities as possible, including maintaining 
the holding period for the built-in gains tax at five years, as 
proposed in H.R. 1478, introduced by Representatives Reichert 
and Kind, and several other proposals that are described in my 
written testimony. Adopting any or all of these changes would 
continue the trend begun with the Tax Reform Act of 1986 toward 
a more transparent, less artificial single-tax system for 
closely-held business.
    A couple of other observations. Probably the most important 
reform for closely-held businesses would be the possibility of 
extending and/or expanding the option of expensing investments 
in capital equipment.
    Most closely-held business owners intuitively evaluate 
their business on the basis of cash flow rather than financial 
statement net income; that is a matter of survival for them. 
For companies without access to capital markets, expensing is 
important.
    Others have suggested forcing the double tax on large pass-
through entities, say, entities with gross receipts over $50 
million. My written testimony outlines a whole host of problems 
with trying to implement such an arbitrary rule. Here I would 
just observe that if the goal of reform is to make American 
businesses more competitive, why would you force more employers 
into the punitive double-tax regime?
    One last tax reform proposal is the possibility of forcing 
all pass-through entities into a single, uniform structure. If 
I were designing a system from scratch, I would consider doing 
this.
    However, we already have roughly 4 million S corporations 
and 3 million partnerships. Any such proposal would unavoidably 
impose substantial additional tax and compliance costs on a 
substantial number of ongoing businesses, either the 
partnerships or the S corporations. I do not see any benefits 
that would necessarily justify such substantial a cost.
    That concludes my oral comments. Once again, I would like 
to thank the committee, and answer any questions you may have.
    [The prepared statement of Mr. Nichols follows:] 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    Chairman CAMP. Thank you, Mr. Nichols.
    Mr. Sullivan, you are recognized for five minutes.

 STATEMENT OF MARTIN A. SULLIVAN, PH.D., CONTRIBUTING EDITOR, 
               TAX ANALYSTS, ALEXANDRIA, VIRGINIA

    Mr. SULLIVAN. Mr. Chairman, Ranking Member Levin, Members 
of the Committee, thank you for this opportunity to testify. It 
is a great honor for me to be here today.
    Mr. Chairman, over the last three decades, we have seen a 
fundamental transformation in how America does business. Pass-
through businesses have grown rapidly in number and in size. 
This growth is almost entirely due to an exploration in the use 
of limited liability companies and subchapter S corporations. 
Here are the facts.
    In 1992, LLCs were virtually nonexistent. By 2008, there 
are 1.9 million of them. Between 1980 and 2008, partnership 
revenue grew from 4 to 14 percent of all business revenue, and 
over the same period, the share of total business revenue 
claimed by S corporations grew six-fold, from 3 to 18 percent.
    The United States has an unusually large non-corporate 
sector compared to other countries. A recent study found that 
the United States ranks second only to Mexico in the size of 
its non-corporate sector.
    On April 1st, when Japan cuts its corporate tax rate, the 
United States will have the highest statutory corporate rate in 
the world. There is widespread agreement that we should lower 
our rate; the issue is how to pay for it.
    One approach would be to eliminate some or all business tax 
expenditures. This approach, however, would hurt pass-through 
businesses that would lose their tax breaks and not receive any 
benefit from the rate cut.
    Pass-throughs depend most on two tax expenditures: 
accelerated depreciation, worth about 8 billion a year, and the 
Section 199 manufacturing deduction, worth about 4\1/2\ 
billion. Eliminating these tax benefits would be particularly 
harmful to smaller pass-throughs for which cash flow is 
critically important.
    Many pass-through businesses are large businesses. Here are 
the facts. In 2009, there were 14,000 S corporations with more 
than 50 million in sales. They accounted for 29 percent of all 
S corporation profit. There were 18,000 partnerships with more 
than 100 million in assets. They accounted for 64 percent of 
all partnership profit. Clearly, we can no longer equate pass-
through businesses with small businesses.
    As the search continues for revenue to pay for lower 
corporate rates, we should consider extending corporate 
taxation to large pass-throughs. It is really no different than 
any other base-broadening option. It would level the playing 
field and raise revenue that we could use to lower the 
corporate rate.
    Now, some tax experts worry about the effect on small 
business job creation if current rates are not extended for the 
top two brackets at the end of 2012. I believe, however, that 
the question of extending high-end rate cuts should not pivot 
on the effect they will have on small business owners, but on 
larger issues such as the need for deficit reduction, the 
effect on tax fairness, and their effect on the overall 
economy.
    If I could call your attention to the screen. Well, I am 
sorry, we are having technical difficulties. But the chart I am 
referring to is on page--oh, thank you. Thank you very much. 
Sorry about that.
    The figure on the screen shows a box. The box represents 
all the income affected by a rate change on the top two 
brackets. Only 30 percent is pass-through income. Only 21 
percent is related to pass-through employers. And only 8 
percent is related to small business employers.
    If we want to promote small business job creation, 
providing tax relief to all income in that big box is a very 
inefficient way to do it. By targeting tax relief to pass-
through employers, we can promote small business job creation 
at a lower cost.
    Now, to this end, Majority Leader Cantor is proposing a 20 
percent cut for pass-through businesses with fewer than 500 
employees. Unfortunately, this proposal has some serious 
technical shortcomings, as I explain in my written testimony. A 
better way to spur small business job creation would be to 
provide a permanent tax credit equal to a percentage of wages 
with a cap on the number of employees who can qualify. That 
would create more small business jobs than a rate cut for high 
bracket taxpayers at a fraction of the cost.
    Finally, a recent IRS study confirms what most of us 
already know: Small businesses are subject to a massively 
disproportionate compliance burden. I think all of us on this 
panel agree that Congress should aggressively modify provisions 
of the code that impose a large compliance burden on small 
business. That would provide significant tax relief, with 
little impact on the budget deficit. And I believe the 
proposals by Professors Kwall and Tucker on my right, about 
choice of entity, would be an excellent place to start.
    Thank you, Mr. Chairman and Members of the Committee, for 
allowing me this opportunity.
    [The prepared statement of Mr. Sullivan follows:] 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



    Chairman CAMP. Thank you very much. And again, thank you 
all for being here and for your testimony.
    With most active business income and most of the private 
sector jobs coming from pass-through entities, it seems clear 
to me--and some of you articulated this--that for reasons of 
competitiveness and fairness, that tax reform should connect 
the corporate rate with the individual rate, that reduction. 
And I think somebody used the words ``tax parity.''
    We did that in the House-passed budget last year, and I 
know that the President's tax reform framework that he released 
recently, when connected with his budget, would raise marginal 
rates on pass-through entities to 40 percent while cutting the 
rate on corporations to 28 percent, as I said in my opening 
statement, which is a spread of 12 points.
    I would ask each of you to respond. Do you think it is good 
economics to try to keep the top corporate rate and the top 
individual rate as close together as possible? And what are the 
risks of having a spread between those two? And I will start 
with you, Mr. Smetana.
    Mr. SMETANA. Thank you. I think that we need to recognize, 
in the pass-through regime, you have got two sources of income 
on the tax report. You have the earned income, wages, and then 
you have the business income. And I think the big distinction 
in terms of pass-throughs is that that earned income is 
different.
    It is taken out. It is used. The business-sourced income is 
kept in the business, typically. And, as I mentioned in my 
comments, it is the primary source of capital to sustain the 
business and to grow the business along with traditional 
financing.
    So I think it is vitally important that whatever policy 
that we adopt in terms of marginal rates, we try to retain as 
much of the capital in the businesses to sustain and grow as we 
possibly can.
    So therefore, any rate regime which causes an increase in 
the amount of taxation paid on that business source income will 
retard growth, and it will retard the ability for those pass-
through entities to be competitive in an international and even 
a national scene. So therefore, I believe that one of the 
things we should try to make a distinction on is not where the 
income shows up on a tax return, but what the source of that 
income is. And I think that is very important.
    Chairman CAMP. Mr. Martin.
    Mr. MARTIN. Well, I think it would increase my fees a lot 
of they did that. I would make a lot of money because I would 
be involved in the very difficult tax planning arena of helping 
my clients pay the least amount of taxes. And it would really 
harm the form of business that they wanted to operate in.
    By the way, I played golf at Oakland Hills and the country 
club at Detroit and couple other courses, but that is the best 
I can do on this.
    [Laughter.]
    Mr. MARTIN. I think it would be very harmful to force small 
businesses to operate in a form that saves them the most tax 
liability when it is not the form they really should be 
operating in. So I think that would be a huge mistake.
    Chairman CAMP. Okay. Mr. Tucker.
    Mr. TUCKER. I think one of the things we need to be aware 
of is that small business pays an enormous amount of fees to 
accountants and lawyers to deal with the complexities that they 
have to deal with--the discrepancies in the law, deductions 
versus capitalization, and the like.
    I think a tax parity--and I am the one that used the words 
tax parity--would help immensely. I think the top rate for 
corporations that are not pass-through entities and for 
individuals should be the same top rate.
    Chairman CAMP. Mr. Kwall.
    Mr. KWALL. Chairman Camp, clearly, under existing law, I 
would agree that it is very important that there be a balance 
between the maximum individual rate and the maximum corporate 
tax rate or else, we have seen in the past, when corporate 
rates were much lower than individual rates, there is pressure 
to use a corporation as a tax shelter.
    However, under my proposal, I would not allow closely-held 
businesses access to the C corporation regime. I do not think 
they belong in that regime. And if they are outside of that 
regime, then there are two independent regimes and it would not 
be a problem.
    Chairman CAMP. Okay. Mr. Nichols.
    Mr. NICHOLS. I would certainly endorse the whole tax parity 
approach that I think everybody is advocating soon here. I do 
not think there is any question that if you change the rates to 
be significantly different for C corporations and for pass-
through entities, you are going to go back to the game-playing 
that I did experience at the beginning of my career between the 
lower C corporation tax rate, and the devil's bargain of trying 
to get that money out in some form or another without paying 
the nasty double tax.
    Any system that enhances the gaming is--at the end of the 
day it is going to start a dynamic between the IRS and 
taxpayers that, frankly, just benefits the people sitting at 
this table but does not benefit the country.
    Chairman CAMP. All right. Mr. Sullivan.
    Mr. SULLIVAN. As Professor Kwall pointed out, the gaming is 
mainly a result of the ability of small businesses to use C 
corporation status. And that should be eliminated. I look at it 
from a different perspective.
    In the rest of the world, the clear trend is to reduce 
corporate tax rates to improve competitiveness; and then 
because there are tight budget deficits everywhere in the 
world, they have to make up the revenues somewhere else. And 
where they are making up the revenue is increasing rates on 
individuals.
    S I think we have to look at this more broadly. We have 
budget deficit problems. We have competitiveness problems. And 
the rest of the world, when they have had this problem, what 
they have done is lowered their corporate rate and increased 
their individual rates. And I believe those problems can be--
the borderline can be policed with effective anti-abuse rules, 
and very simple rules.
    Chairman CAMP. Okay. I just have one other question. We 
have had suggested by some, and I think it is in the 
President's tax framework, that certain large, closely-held 
entities should be subject to a corporate tax rate or the 
double tax that comes with that. And they use the threshold, I 
believe, of gross receipts.
    My question is for Mr. Martin and for Mr. Nichols. Is it 
not better to have fewer business entities subject to double 
taxation than more? And if we cannot eliminate the corporate 
income tax, would it not be better to determine who can get 
pass-through treatment by using a business distinction, I think 
such as Dr. Kwall described, whether the entity is complex or 
whether it is publicly traded. And I would like to get your 
thoughts on that.
    Mr. MARTIN. Well, to me, the elimination of double taxation 
would be an answer to all kinds of simplification problems. If 
we allowed corporations to liquidate with one level of taxation 
and made dividends deductible, as has been mentioned here, 
many, many S corporations would go away because that is why 
they were created to begin with.
    And certainly I do not think that we should be using the 
Internal Revenue Code to decide, based on a level of revenues, 
who should be a C corp and who should not be. As long as the 
tax rates have parity, I do not see any reason to have a 
forceful choice of an entity for anybody.
    Chairman CAMP. All right. Mr. Nichols.
    Mr. NICHOLS. I would have a couple of comments on that, and 
my written testimony deals with that in more detail. The $50 
million test, for example, is extremely arbitrary. 
Theoretically, you could have one dollar of additional gross 
receipts that could trigger literally millions of dollars of 
additional tax because you are in the C corporation system 
rather than the S corporation system.
    And as I go into more detail in my written testimony, you 
are going to have to have numerous rules to deal with 
simultaneous where there are multiple entities. We have 
something like 440 pages of regulations of consolidated return 
rules to deal with corporations that voluntarily group together 
to treat themselves as one entity.
    But you would effectively have to come up with--if there 
were, let's say, two dozen affiliated entities in this 
structure you would have to come up with rules that were at 
least as complicated and probably many times more complicated 
in order to deal with that situation. That's on top of the fact 
that double-tax C corporation treatment is not the preferred 
alternative, I think, on the part of anybody here.
    So I think it would turn out to be much more unworkable 
than it may appear on its face. And I would be happy to follow 
up with more detail on that.
    Chairman CAMP. All right. Thank you very much.
    Mr. Levin may inquire.
    Mr. LEVIN. Again, welcome. And Mr. Tucker, we will not do 
it here, but let's compare notes; where we grew up, it was 
pretty close, including some of the markets we went to.
    Mr. Kwall, congratulations. Your five minutes was very 
succinct, really, very much so. In fact, all of you have been. 
And I think as we proceed with tax reform, which we must, I 
think it is useful to have a discussion like we are having 
here.
    I went back and looked at some of the Joint Tax materials 
that we received earlier, and it was really interesting. Some 
of it was a bit surprising. For example, on the distribution of 
these various entities by asset size, for C corporations, 97 
percent of assets are held by those with over 100 million. So 
we are dealing mostly with C corporations that are rather 
large.
    And it was interesting, that was more mixed as to S 
corporations, quite a bit more mixed. But as to partnerships, 
75 percent of assets are held by those with over 100 million in 
assets. So I think we need to look at facts like that.
    In terms of business shares, it was also interesting that 
now pass-throughs, this is, I think, given to us by Joint Tax, 
have 49 percent of the net income and C corporations 51 
percent. And of that, the partnerships have the larger part, 
though not a vastly larger part, of the business shares.
    Also, there was a recent article in the New York Times, 
based on figures from the Bureau of Labor Statistics that I 
think all of us should look at that. In terms of job growth, 
between April 1990 through March 2011, it said that over that 
period, employment at larger companies rose 29 percent while 
employment at smaller companies rose by less than half as much.
    But also, and the data will become, I think, clearer, they 
said, later this year, that small companies seem to be more 
nimble when it comes to various economic impacts. So I think as 
we go forth and talk about tax reform, that all of us should 
look at the materials from Joint Tax and the Bureau of Labor 
Statistics.
    Let me just ask you, Mr. Martin, in terms of the position 
of NFIB, whose members overwhelmingly support permanently 
extending the current 2001 and 2003 tax rates, has the 
organization spelled out how it would pay for that extension?
    Mr. MARTIN. If they have, they have not told me.
    Mr. LEVIN. We are talking about trillions.
    Mr. MARTIN. I understand that.
    Mr. LEVIN. When they tell you, let us know. No, seriously, 
it is a major, major issue, and I think everybody has the 
responsibility of indicating how they would pay for these items 
in view of our deficit challenge. So maybe you could ask them 
to be in touch.
    Mr. MARTIN. I will ask them to get in touch with you.
    Mr. LEVIN. Thank you.
    Mr. Sullivan, just quickly, I just want you to emphasize 
this. On page 9, and your chart shows this, you say, ``Only 
about 8 percent of ordinary, high-bracket income is generated 
by small business employers. The bottom line is that most 
income affected by the rate change has nothing to do with small 
business employment. If the goal is to promote employment at 
small businesses, providing tax relief to all income in high 
brackets is an extremely inefficient way of achieving that 
objective.''
    Could you elaborate?
    Mr. SULLIVAN. Yes. This data is actually--as people who 
work through pass-through data know, it is very hard to work 
with. It is very hard to interpret. There has been a new study 
that came out in August of last summer, a technical study from 
the Treasury Department, that made this type of linkage between 
small businesses and small business owners possible. And so we 
really weren't able to--this is new data. You have not seen 
anything like this before.
    And one thing that comes out of it is wealthy, high-income 
households, most of their income has nothing to do with--it is 
wages. It is interest income. Most of it has nothing to do with 
small business. And that is what comes out clearly in this 
data.
    Mr. LEVIN. Thank you.
    Chairman CAMP. Thank you. Mr. Herger is recognized.
    Mr. HERGER. Thank you, Mr. Chairman.
    Mr. Martin and Mr. Nichols, both of you mentioned in your 
written testimony the importance of Section 179 expensing rules 
for small businesses. Coming from a small business background, 
I have long supported the expansion of Section 179 so small 
business owners can write off their investment in the current 
tax year rather than depreciating them over an extended period 
of time.
    Could you comment further on why this policy is important 
and how small businesses would be affected if the expensing 
allowance were reduced to 25,000, as is currently scheduled to 
occur next year?
    Mr. MARTIN. Well, I can address it from the perspective of 
my client base. I think 500,000 is high enough. I don't think 
it needs to be raised, even though I think NFIB would support, 
I think, would support an increase in that expensing election. 
500,000 is high enough in my tax base.
    It is not just the complexity issue. The complexity of 
keeping depreciation records is not a big deal. I don't have 
one client that knows how to calculate depreciation; I do it 
for every one of them. So putting it into software, it is not 
really a complexity issue for me, although that is argued by a 
lot of people.
    It is the availability of capital. If you can get a 
deduction for equipment that you are buying, you are much more 
apt to buy it, for one thing. You are more apt to be more 
efficient in your business, generate more profits, put 
investment in the capital equipment industries. There are just 
a tremendous number of benefits to increasing that expensing 
election. I would be very much in favor of maintaining it at 
$500,000.
    Mr. HERGER. Thank you.
    Mr. Nichols.
    Mr. NICHOLS. I think that is a critical provision. Frankly, 
it was brought home to me early in my practice. A client called 
me up. He had just made his first million bucks, and he had 
quickly invested that million bucks buying capital equipment 
and all sorts of other things he needed in his business. He 
called me up and said, ``We have got a problem. My accountant 
tells me I owe taxes.''
    And I started to explain to him all of the depreciation 
rules and that he does not get an immediate deduction for all 
of that.
    Well, he did not let me finish. He said, ``Tom, you do not 
understand. I have no cash,'' and that, frankly, is for a lot 
of closely held business how they look at things. That is a 
matter of survival for them. That is what they look at. That is 
how they analyze their business. That is how they analyze the 
success of their business.
    So obviously, having the expensing rules available at the 
current levels or maybe even increased is very important, I 
think, for closely held business.
    Mr. HERGER. Thank you.
    That is certainly my experience, and as I talk to small 
businesses I do not think that these points can be emphasized 
enough.
    In looking at the data on privately held companies, one 
thing I found somewhat surprising is the number of very small 
companies that are organized as C corporations and subject to 
the entity level tax despite the apparent advantages of pass-
through status. According to the Joint Committee on Taxation, 
about one in four C corporations had less than 25,000 in total 
receipts in 2009. My sense is that many of these companies may 
be trapped in C corporation status by overly restrictive tax 
rules for companies who want to convert to S corporations.
    I would like to get your thoughts on why so many small 
businesses are organized as C corporations. As part of tax 
reform, should we look for ways to make it easier for closely 
held C corporations to transition into a pass-through regime? 
And starting with you, Mr. Smetana.
    Mr. SMETANA. My opinion is that the fundamental reason you 
see so many of them is that they are not getting good tax 
advice. Really for an entity, especially a small receipts 
entity, the double level taxation and the marginal rates of 
approximately 60 percent really are inappropriate for 
reinvestment.
    The other cause that we typically see is just longstanding 
small companies that were originally formed as Cs before they 
had options typically do not switch. Built in gains 
considerations are certainly a factor if they are on the LIFO 
method of accounting. They have a catch-up tax payment due. So 
there are economic reasons as well that I believe prevent them 
from converting to a more appropriate tax regime for their 
business.
    Mr. HERGER. Mr. Martin.
    Mr. MARTIN. Since the Tax Reform Act of 1986, I think I 
have only had two clients come to me where I advised them to be 
C corporations, and that was because of fringe benefit reasons. 
There are some fringe benefits only available to C corporate 
level employees, not to S corporate level employees, and that 
was going to be a significant benefit to them.
    Other than that, they have all elected to be S 
corporations. There was a forgiveness year when the Reform Act 
of 1986 was passed, which allowed people to convert without 
built-in gains. The built-in gains burden is significant. My 
policy is to ask my client are you going to retire within ten 
years. If they expect to retire within ten years, we try to 
elect S corporation and get out of it.
    There are some cases, like a cash basis business, you 
really cannot elect to be an S corporation from being a C 
corporation because you have to pay tax on all of the 
receivables in the next year. You really cannot do it. So they 
are locked into that position.
    Chairman CAMP. All right. Thank you. The time has expired.
    Mr. Johnson is recognized.
    Mr. JOHNSON. Thank you, Mr. Chairman.
    Mr. Martin, you testified that an important simplification 
measure for small business would be to increase the threshold 
for cash accounting from five million to ten million in 
revenue. Can you explain how doing so would ease the 
administrative burden for small business?
    Mr. MARTIN. Accrued income and accrued payables could just 
be completely ignored. Calculation of the wages that are due 
for vacation pay payable or sick pay payable, it takes me an 
hour at least at the end of the year to do that for a client if 
they are on full accrual method. If they are on cash method, we 
just ignore it, do not have to deal with it at all.
    So simplicity-wise it is a great benefit. The IRS has been 
pretty, I guess, accepting of small businesses because they 
passed revenue procedures for one million dollar levels for all 
businesses and $10 million levels for some businesses. I would 
like to make that $10 million for all businesses. It would save 
my clients a lot of cash flow.
    Mr. JOHNSON. Yes. Would it require some other changes to 
the code or just that?
    Mr. MARTIN. No, all you would have to do is just that. The 
phase-in last year, the last time they did it, they were very 
accepting in terms of how the phase-in was done. It was very 
easy to do, and if they did the same thing again, it would be a 
huge benefit to small business.
    Mr. JOHNSON. Thank you.
    Now, Mr. Nichols, you testified the proposal in the 
President's corporate tax reform framework to increase the 
threshold for small business to use cash rather than accrual 
accounting from five million to ten million in revenue would 
not benefit the vast majority of closely held businesses. Can 
you elaborate on why you think that is the case?
    Mr. NICHOLS. I must admit that I am not as familiar with 
the President's proposal.
    Mr. JOHNSON. Neither am I. Do not worry about it.
    Mr. NICHOLS. But just to be honest, I think there are a lot 
of closely held businesses that for banking and other reasons, 
end up using generally accepted accounting principles anyway, 
and they get used to using the generally accepted accounting 
principles in terms of analyzing their business and their 
profits and losses.
    I would not want to say that it would not help anybody, 
because there are no doubt situations where it would. On the 
other hand, there are many businesses for whom I do not think 
it would make a great deal of difference, and there are some 
that will actually affirmatively elect accrual basis treatment 
simply because it is easier to keep both their tax accounting 
and their regular books on the same basis.
    So in terms of the list of things that would be useful and 
helpful for closely held business, I cannot say that this would 
have no value, but I do not think it would be at the top of my 
list.
    Mr. JOHNSON. Thank you, sir.
    Thank you, Mr. Chairman. I yield back.
    Chairman CAMP. Thank you.
    Mr. Neal is recognized.
    Mr. NEAL. Thank you, Mr. Chairman.
    Since 1986, the number of corporations has dropped 28 
percent while the number of pass-throughs has grown by 102 
percent. The 1986 pass-throughs earned 40 percent of all 
business income. Today they account for nearly 60 percent of 
the income earned by all businesses.
    Some have suggested that this change is in large part due 
to tax considerations, as Mr. Herger noted, and others have 
taken a different position, indicating that multiple reasons 
exist for this shift, including the growth of the service 
sector, ease of administration, and the fact that you can get 
limited liability and still get pass-through treatment.
    To the witnesses here, what are your views on the reasons 
behind this shift? Mr. Sullivan, you touched upon this. And 
what do you think about the trend and whether or not it is a 
problem?
    What implications does the increasing proportion of 
business income that is being taxed as individual income have 
for an issue that is close to all of us, and that is the issue 
of tax reform?
    We will perhaps start with you, Mr. Sullivan.
    Mr. SULLIVAN. The invention of the limited liability 
company was in the mid-1990s or the early 1990s, and that after 
the 1986 Act just made it open season for larger businesses to 
have the advantages of limited liability and the exemption from 
the corporate income tax. The problem that this causes, it is a 
benefit for these companies, but there is a disparity. Some 
large businesses pay corporate tax. Some do not, and that is an 
arbitrary distinction with no economic basis.
    Mr. NEAL. The other members of the panel? Yes, please, Mr. 
Nichols.
    Mr. NICHOLS. I think the treatment of closely held 
businesses is a matter of critical importance, but if we start 
to focus on having different systems for the two, that is 
problematic.
    And I would want to respond to something that was said 
earlier. If we start to focus and we essentially allow publicly 
held and larger corporations to essentially retain earnings at 
a lower rate, which is what I think has been suggested, and we 
do not allow pass-through entities to retain their earnings at 
that same lower rate, that to me is an arbitrary advantage that 
you are giving to the larger corporations, and I see no reason 
to do that.
    Another thing is the pass-through system itself: it is the 
most logical one I have seen. I have seen business owners 
convert especially around the Tax Reform Act of 1986 convert 
from a double tax system to a single tax system, and they 
literally stopped spending as much time worrying about taxes 
because they paid taxes once. They pay them right away. They 
reserve for them, and then they are done. And then they think 
in terms of their business.
    So from the standpoint of moving forward on tax reform, 
pushing toward a single tax system is very beneficial and at 
the end of the day constructive in my opinion.
    Mr. NEAL. Mr. Kwall.
    Mr. KWALL. In terms of the shift, I think a large part of 
it was attributable to the 1986 tax reform and two changes that 
occurred at that time. One was the parity between individual 
and corporate tax rates that was created because prior to 1986, 
corporate tax rates were much lower. It was aspirational to use 
the C corporation regime to get the advantage of those lower 
corporate tax rates.
    Secondly, after 1986, you could no longer sell a C 
corporation business without the imposition of a heavy 
corporate tax on the gain. It used to be just one shareholder 
level tax on the gain when you sold a C corporation business, 
but now there is a big tax at the corporate level. It is a 
capital gain, but there is no reduced capital gains rate for 
corporations. So it is a prohibitive cost on any business that 
thinks it is going to be successful.
    Mr. NEAL. Mr. Tucker.
    Mr. TUCKER. I think you are seeing two things. Number one, 
the Internal Revenue Service recognizes the limited liability 
company would be taxable as a partnership, not a corporation. 
It started in Wyoming in 1977, but it wasn't until the late 
1980s that the Revenue Service allowed it. That enabled your 
client to have a shield from liability as a limited liability 
company, even if they were managers, even if they were the 
business people running the business.
    Corporations have enormous risk of complexity, equity 
versus debt, reasonable compensation, audits on a continuing 
basis, and you need simplicity, lack of complexity and the 
ability to run the business, not to be afraid of taxes at all 
times.
    Mr. NEAL. Mr. Smetana, you had your hand up and then we 
will come back to Mr. Martin. Just a few seconds.
    Mr. SMETANA. Quickly, again, it goes back to the 
fundamental economic principle of business. Privately held 
companies, closely held companies elect this form and it is 
increasingly so because they get to retain more cash in the 
business. That is a fundamental economic driver of growth and 
maintenance and jobs and economic activity at these 
corporations.
    I would also make a comment that whether you are in a pass-
through regime or a corporation, the entity is still covering 
the tax. So I think it is an important distinction to make that 
that cash does still come out of the business regardless of 
which regime you are taxed on.
    Chairman CAMP. All right. Thank you. The time has expired.
    Mr. Brady is recognized.
    Mr. BRADY. Thank you.
    I would like to follow up with Chairman Camp's questioning 
in favor of taxing income of closely held businesses only once. 
The White House often speaks of the pass-through business form 
as if it is some type of loophole that is used to avoid the 
double taxation business income that applies to C corporations.
    In fact, in the corporate tax reform framework, the 
President recently proposes to double tax the income of certain 
unspecified large pass-throughs. So my question: in this 
struggling economy, as we look for companies to invest and 
create jobs, what would the President's proposal do by 
proposing double taxing some of our pass-throughs?
    Mr. Smetana, and we will run down the row.
    Mr. SMETANA. Sure. We actually did an analysis of the 
President's proposal. First of all, the increase in the 
marginal tax rates would cause our company to only retain 
approximately 40 cents of every dollar of profit we earned 
versus 60. That would certainly decrease our opportunities in 
terms of reinvestment and growth.
    Secondly, the provisions related to lengthening out the 
depreciation schedules also moving us to the corporate regime 
and the elimination of the last in, first out accounting method 
for companies that hold inventory would create an additional 
five to $6 million a year in taxes to our corporation, again, 
reducing our ability to fund the business and invest in the 
business.
    And certainly the LIFO impact on us, on a business that 
holds inventories in an inflationary environment over the last 
three decades would cause roughly an $18 million tax burden on 
our company that we would have to pay over some amount of time, 
again, money that we would have to find either out of future 
earnings or borrow against, which again would limit our ability 
to grow and maintain the company.
    Mr. BRADY. The President or at least the White House views 
LIFO as some type of accounting gimmick, some type of subsidy 
loophole that businesses apply to. It is a traditional form of 
accounting, and that change would, in my understanding, hit 
companies with inventories in a major way.
    Your thoughts? Is that a loophole?
    Mr. SMETANA. I believe that is a sound economic principle 
if our objective is for companies to maintain a sustained 
inventory investment, and simply put, the LIFO method of 
accounting allows a company to reinvest every dollar of profit 
on the increase in that inventory cost back into inventories.
    Otherwise companies would have to find either 40 or 60 
cents, depending on which tax regime they are, in our case 40 
cents of every dollar of profit. We would have to either borrow 
or take out of other economic activity just to maintain the 
same amount of inventory investment.
    Mr. BRADY. Thank you.
    Mr. Martin, on the original issue of taxing pass-throughs 
in a double sense.
    Mr. MARTIN. I have already expressed that I am very much 
opposed to double taxation. I like to think of the word 
``fairness,'' and when I stand up in front of my classroom and 
I am teaching 30 students about the tax law, I am very quick to 
tell them that certain things in the law are fair. Some of them 
have no equity at all and it does not make any sense, but are 
there maybe for social reasons or whatever. There have been 
allusions today to generally accepted accounting principles. 
Generally accepted accounting principles recognize what is 
known as the matching principle. LIFO very much adopts the 
matching principle which says that we match current cost with 
current revenues. The non-LIFO methods of accounting do not, 
and they are very expensive for companies to adopt. LIFO has 
not been a big deal because inflation has not been rampant over 
the last ten years or so, but there are some heavy industrial 
companies that have been using LIFO for a long time. If LIFO 
were disallowed, they would pay a heavy penalty.
    Mr. BRADY. That is what I understand. Thank you.
    Mr. Tucker.
    Mr. TUCKER. I think one thing that people forget is in a 
pass-through entity, the owners are taxed irrespective of 
whether they receive distributions and, therefore, very often 
they are being taxed without receiving the cash, as somebody 
noted before, but the cash is being used for the business. They 
have elected to do that. They are willing to do that.
    To penalize them either because they are bigger or to 
penalize them because of some other reason would result in 
double taxation, and they are already paying the taxes on the 
income. But taxing the companies that grow these businesses 
because the growth has been in pass-through entities is wrong. 
It is just erroneous.
    Mr. BRADY. At the end of the day the economy suffers.
    Mr. TUCKER. Everybody suffers, the economy and workers.
    Mr. BRADY. Thank you.
    Mr. Kwall.
    Mr. KWALL. You really need a rationale for double taxation, 
and under current law, the rationale seems to be public 
trading. If you are publicly traded, you are subject to double 
taxation.
    So if the line is to be moved, there should be a rationale 
for the movement, and you also want a line that is going to 
work well and work as a good division.
    I think public trading historically has worked reasonably 
well. So if you are going to substitute some other standard, 
you need to make sure that it is going to do the job and 
actually----
    Mr. BRADY. Rationale is not necessarily a prerequisite to 
policy changes as you know in Washington.
    Thank you all very much, Mr. Chairman.
    Chairman CAMP. Thank you.
    Mr. Tiberi is recognized.
    Mr. TIBERI. Thank you, Mr. Chairman.
    Just two questions if the panelists could answer them 
quickly, and some of you talk about them in your testimony, the 
two questions. The Chairman has been quite clear that he 
believes that we should provide comprehensive tax reform or go 
in that direction. Some in this town believe that we could just 
do corporate only and that would be fine.
    If we could start from the left and go to my right, what 
would your opinion on that be?
    Mr. SMETANA. We need to have comprehensive reform, period.
    Mr. TIBERI. Mr. Martin.
    Mr. MARTIN. I agree we need comprehensive reform as well. 
We cannot have divergence of tax systems. You just add 
tremendous burden on small business.
    Mr. TUCKER. I like being in the center. I am neither on the 
left nor the right. On the other hand, I truly believe we need 
comprehensive tax reform. It is time for it. It is really time.
    Mr. TIBERI. Thanks.
    Mr. KWALL. I would agree with my colleagues. We are 
definitely in need of comprehensive reform.
    Mr. TIBERI. Mr. Nichols.
    Mr. NICHOLS. My guess is we are going to have unanimity on 
this one. I do not think there is any question that 
comprehensive tax reform makes sense. Comprehensive tax reform 
makes sense, and anything other than that essentially risks us 
going back to the game playing that we had before the Tax 
Reform Act of 1986. There is no need to go backwards.
    Mr. TIBERI. Mr. Sullivan.
    Mr. SULLIVAN. Let me put it even a little more strongly 
than the panel has put it. I believe you should start with 
small businesses and then move to the larger businesses because 
I have been around a few years. There is a tendency to forget 
small businesses once the big issues come up. To prevent that 
bias from occurring, start with the small and the large will 
take care of itself.
    Mr. TIBERI. Thank you.
    I met with a group of farmers from Ohio yesterday. In your 
testimony, Mr. Smetana, you mention about privately held 
companies and their need for planning, long-term planning, and 
these farmers were talking about that. In fact, as you probably 
know, farmers sometimes plan not only decades but generations, 
and one farmer in particular was distressed over the Tax Code 
and how complicated it had become to him and his family.
    Can you talk about the differences in comprehensive tax 
reform--we can start again from my life--and how we should 
apply the differences between closely held family enterprises 
versus publicly held companies and the differences between 
long-term planning versus short-term planning?
    Mr. SMETANA. Sure. I think it is a very important 
distinction because, as I said in my testimony, most privately 
held or closely held companies have time frames that are years 
or even generations, and so, therefore, there are several 
considerations.
    One is certainly the sustainability of the business, and 
that is largely based on the amount of cash flow that the 
company can generate on an annual basis and over a period of 
time and retain in the business to sustain itself.
    On the longer term basis, the shift in generation to 
generation is extremely important, and you need closely held 
companies, particularly family owned ones. Because of the 
onerous level of taxation at the time of death of an owner, we 
have created a situation in this country where the mere form of 
organization creates a distortion between a company that is one 
owned by a closely held family versus one that is owned in a 
different form of structure to the point where the family owned 
business, in effect, has to have enough liquidity or try to 
plan if they possibly can for enough liquidity to pay the tax 
at the time of death of one of the owners.
    What typically results is that, as some of my colleagues in 
FEI have said, we end up doing unnatural acts to try to prevent 
a catastrophe at the time of death and the loss of jobs and 
economic activity, and that typically results in diverting 
economic activity away from the business to try to preserve 
that.
    It just do not seem to make sense to me that at a time when 
we are trying to preserve jobs and trying to preserve economic 
activity that the death of an owner should cause some 
interruption in that activity, especially on a going concern.
    Mr. TIBERI. Thank you.
    Mr. Martin.
    Mr. MARTIN. I think most of you received a copy of a study 
by Mr. Carroll who basically identified the agricultural 
industry as the hardest hit industry in this country if we had 
different tax rates for businesses whether they are owned as C 
corporations or are owned as pass-through entities, so a very, 
very unfair result I think.
    My clients operate from the checkbook. Small businesses 
want to know if they have enough money to pay the payroll every 
week. They are only thinking about succession if I force them 
to or if they get to the age where they really have to or if 
they have children who are kind of pushing the issue on them to 
deal with it. They do not want to talk about it. They do not 
want to deal with it. It is a closely held situation with 
families.
    Small businesses are on a short-run decision making 
process. They fire people last. They hold onto them because 
they believe in them. They trust them. When they hire them, 
they have longevity. If you work for a small business, even 
though there is very rarely a union, you have longevity with 
that business. They support you in that position.
    Chairman CAMP. All right. Thank you.
    Mr. Davis is recognized.
    Mr. DAVIS. Thank you, Mr. Chairman.
    I would like to follow along a little on that line of 
questioning, just having worked in the manufacturing world and 
its various tiers before coming to the Congress. I think that 
the underlying premise in this discussion is we want to address 
the rate issue, which is very real, but there is another other 
tier of issues underlying that. I have an example I want to put 
out and seek some comment on how we harmonize this, knowing 
that our premise for discussion is a revenue neutral reform.
    And it is very exciting to be part of the dialogue to try 
to change the underlying process to stimulate the creation of 
job, especially encouraging small business owners.
    Let's look at the automotive industry as an example. The 
OEM or their Tier 1 suppliers invariably are international 
businesses. They will be located in multiple sites, integrated 
information and financial systems, supply chains that transcend 
the borders. Rates become a big issue. Those companies are 
operating on an accrual basis by and large. They are dealing 
with capital investment in a different way than, say, the Tier 
2 or Tier 3 suppliers might be addressing the issues, to Mr. 
Martin's point, functioning from the checkbook.
    I have worked with a lot of suppliers that, in fact, did 
that, very successful businesses, but they were much more cash 
oriented. They were often cash basis accounting. They did not 
like the idea of rates, but for the most part, they were pass-
through entities for all practical purposes because you 
typically had a family or a collection of families that had 
started this business and grew it, where LIFO is a huge issue.
    Capital investment for machine tools, I watched a number of 
businesses, two in particular, that walked away from, say, 
purchasing five axis vertical mill technology because they were 
uncertain about what their depreciation schedules were going to 
be, you know, dealing with that aspect.
    England has tried some interesting approaches in 
harmonizing these issues at some various reforms. There is a 
lot of talk around the world about different schedules, you 
know, and how to deal with these issues. I am going to premise 
my question as someone who wants to see us go got a territorial 
system, have the ability of this rate issue to be addressed, 
but what I would like you to comment on in terms of reducing 
complexity, especially for small business: how do we address 
this issue of maybe giving the smaller businesses some options 
to address the issues like LIFO, to address the issues like 
depreciation, to encourage capital investment when they are 
functioning on the checkbook or cash basis and still hit 
revenue neutrality?
    Maybe start with Mr. Smetana first and then open it up to 
the panel.
    Mr. SMETANA. Sure. A couple of quick comments. First of 
all, I think there are a lot of allusions to the size of the 
corporation, and I will just say I think in the case of 
deciding policy, in this case size does not matter. It is 
really the form of organization and what we are trying to do 
with the economic activity within that business.
    You know, me and my colleagues compete with companies of 
different sizes. So I think the level playing field is to 
create all businesses, regardless of their form or size to be 
able to have the same advantage.
    With respect to simplicity though, I do think that we can 
recognize that smaller formed companies do have some more 
complexities than larger ones in terms of maintaining current 
Tax Code and compliance, and I do think that it would be 
appropriate to look at levels and limits that are appropriate 
and typically used by smaller entities to have access to 
quicker deductions than perhaps larger companies with respect 
to recognizing that fact without changing the fundamental text 
related to the form of the organization.
    Mr. DAVIS. Thank you.
    Mr. Martin.
    Mr. MARTIN. I would say that I do not know how to make it 
revenue neutral, but for a small business to have----
    Mr. DAVIS. Let's imagine CBO actually has formularies that 
reflect the way you actually do business for a moment.
    Mr. MARTIN. Okay. When I was a representative to the White 
House Conference on Small Business in 1986, the number one 
issue voted by the representatives there was to have no changes 
in the tax laws for two years. Small businesses would love to 
have no changes in the tax law for two years or more in terms 
of managing their business. That just gets it out of their mind 
completely. They do not have to worry about it. They do not 
have to call me once a month to ask me what the issues are.
    I would say adopt the changes you are going to adopt, and 
then somehow put limitations on some future Congress. I know 
that is not something that is done, but small business would 
love to have that fixed right.
    Mr. DAVIS. Mr. Tucker.
    Mr. TUCKER. I would like to concur with what was just said. 
One of the worst things that we face every single day is not 
knowing what the law is going to be next year or the year 
after, and therefore, are you embarrassed because you made an 
investment this year and only got to write off 25,000, but if 
you had just waited until next year, it would have been 100,000 
or 500,000?
    You need to bring stability into the Internal Revenue Code 
for all business.
    Chairman CAMP. All right. Thank you.
    We do have the prospect that we are facing of all tax 
policy expiring at the end of this year. So we really do not 
have the option of not doing anything.
    Mr. Reichert is recognized.
    Mr. REICHERT. Thank you, Mr. Chairman.
    So-called flow-through entities or those businesses that 
pay taxes through individual codes play a huge role in our 
economy, as you all know. Fifty-six percent of the jobs in 
Washington State where I am from are sustained and created by 
these businesses, and they account for 69 million people across 
the United States, and they cannot be neglected in the tax 
reform effort that we are involved in here.
    So, Mr. Nichols, first I want to thank you for your 
comments supporting the extension of the five-year built in 
gains holding period. This shorter, more reasonable holding 
period unfortunately expired along with other tax extenders at 
the end of last year, and as you mentioned, I have introduced 
bipartisan legislation, H.R. 1478, with Mr. Kind from 
Wisconsin, to improve many of the rules governing S 
corporations, including making permanent an extension of the 
five-year built in gains holding period.
    And, Mr. Martin, you mentioned this is one of the issues 
that you pointed out would be very important for us to address 
going forward also.
    The IRS statistics suggest that thousands of U.S. 
businesses should be sitting on appreciated assets that could 
be put to better use. In an economy short of capital, it just 
makes sense to allow these businesses increased access to their 
own capital.
    Mr. Nichols, can you explain the purpose of the built in 
gains tax and why the five-year holding period is more 
reasonable than the ten-year holding period?
    Mr. NICHOLS. Well, the built-in gains tax was originally 
adopted primarily to prevent people in C corporation status to 
convert and avoid essentially the double tax on the sale of the 
business, and I have never been convinced that paying only one 
tax is a tax loophole and paying two taxes is appropriate 
policy, but that was the policy, it seems, behind the built-in 
gains tax.
    In terms of how the built-in gains tax works to free up 
capital, essentially I have got a situation. Fortunately it is 
a client who has already been an S corporation for a while, but 
they have got a piece of property, and they want to buy a new, 
bigger piece of property, expand their business, hire more 
employees. If they were subject to the built-in gains tax, what 
they would have to do is sell their old property, pay double 
tax on that property, and then essentially turn around and 
invest those proceeds in the new property.
    Now, they cannot qualify for Section 1031, the like-kind 
exchange rules, because they have got to operate their old 
facility for a period of time before they can move into the new 
facility. And so as a consequence, if they were seriously 
considering doing exactly that, but if they were in a position 
where they would have to pay double tax, which is what the 
built in gains tax regime is, they would essentially be trapped 
into that for five years or ten years.
    Obviously, five years is a heck of a lot better than ten 
years in terms of waiting to utilize this capital.
    Mr. REICHERT. Thank you.
    Mr. Martin, would you like to comment?
    Mr. MARTIN. I had a client that I asked when he was going 
to plan to retire at age 50 and he said age 60, and then at age 
55, he decided that he had had enough. He had converted on my 
advice at age 50 to be an S corporation, and I said to him at 
the time, ``You know, when you convert, you cannot sell your 
principal piece of real estate here which is fully depreciated 
and worth a lot of money for ten years.''
    And that is what happened. He sold the rest of his 
business. He did not sell the real estate until the ten-year 
time frame was up. That was not good for him. That was not good 
for the economy. It was not good for the buyer who bought the 
piece of property, but here was the tax law dictating what 
would happen in his operation of his business. It was kind of 
crazy.
    You know, five years is a whole lot better than ten years. 
Five years kind of takes into account unusual things that 
happen unbeknownst to all of us.
    Mr. REICHERT. Well, thank you, gentlemen, for your answers, 
and I yield back.
    Chairman CAMP. Thank you.
    Mr. Roskam is recognized.
    Mr. ROSKAM. Thank you, Mr. Chairman.
    And, again, Mr. Smetana, thank you for coming at our 
invitation to give a perspective.
    In our district in suburban Chicago, we have got a 
tremendous amount of pass-through entities who are job creators 
and employers and just a tremendous amount. I was at a company 
not long ago touring the plant floor, and the owner said to me, 
``Congressman, the smart move is for me to put three-quarters 
of a million dollars into this production line, but I am not 
going to do it, and one of the reasons, not the only reason, 
but one of the reasons,'' he said, ``was Washington tells me I 
am rich, and I am not going to do it.''
    You mentioned sort of the long-term planning in terms of 
the pass-throughs. You mentioned the generational aspect. Could 
you reflect on that, just be a little bit more expansive on it?
    What is the impact when Washington tells Eby-Brown you are 
rich?
    You know, Congressional Research Service a couple of weeks 
ago reported that nearly 60 percent of all business income is 
reported through the individual income tax system, and 62 
percent of that amount is reported by those that the President 
calls wealthy.
    Can you give us the lay of the land on how that has an 
impact at your end of the rainbow?
    Mr. SMETANA. Sure. As I said, you know, we were a family 
owned company for, you know, decades, and we were not big at 
one time, but we became big, and the reason we became big is 
because the family was able to reinvest its after-tax cash 
flows back into the business, with a little help from the banks 
from time to time to finance the business to grow.
    So you know, the fact that we are big and the fact that the 
family has been able to commit to the business and grow its 
employee base, grow its asset base, grow economic activity, you 
know, is really the fundamental point about it. The fact that 
we are large should not really dictate whether the family can 
keep 40 cents or 60 cents of its profits. In fact, I would 
clearly tell you that if the family only got to keep 40 cents 
of its profits, we would be a smaller business than we are 
today with less employees, less assets, less economic activity.
    I also think that fundamentally, as Mr. Kwall talked about, 
there is an important distinction between the double taxation 
regime over corporations which is mostly public formed 
corporation. An investor in a public corporation is really a 
trader of securities, and if the government wants to tax that 
trading activity as a separate economic activity, I suppose it 
can decide to do so.
    But to try to equate that with the income derived out of a 
closely held business which is left in the business; closely 
held owners do not actively trade the business as a holder of a 
C corporation stock does, a publicly held C stock; so, 
therefore, I think you have to make that distinction in tax 
policy, and I think that distinction helps those privately and 
closely held investors make decisions to reinvest in their 
business.
    Clearly, from our perspective as we look at our business 
planning, the most important things to us are the ability to 
retain as much cash as we can in the business on an after-tax 
basis and the certainty which we have when looking out forward 
when we make decisions. And our investment decisions in 
business are not typically a quarter at a time or a year at a 
time, but multi-year in nature.
    It has been very difficult over the last several years to 
make those decisions, and I would submit to you that many 
investment decisions are not being made because the fear of the 
marginal rate increase, which has been delayed from time to 
time, but only at the last minute, which has really put a crimp 
in making good economic decisions for the long term.
    Mr. ROSKAM. This Committee and this Congress in the coming 
months are going to have decisions to make as it relates to the 
extension of the 2001 and the 2003 tax cuts and those rates. 
What is the impact on your business if those individual rates 
go up?
    Mr. SMETANA. As I mentioned before, Mr. Roskam, we are 
facing an increase in our marginal rates of four or five 
percent. Certainly under the President's proposal, if we lose 
AMT preferences, it could go higher, especially with sourced 
income from higher taxed States.
    We have been able to take advantage of the faster 
depreciation rules over the last few years, and our owners have 
invested tens of millions of dollars back in the business 
because the after-tax cash flows of those investment decisions 
have been aided.
    So from our perspective it would reduce our after-tax cash 
flows, and it would certainly make an impact on the kinds of 
investment decisions that we make going forward.
    Mr. ROSKAM. And the employee opportunities, I would assume?
    Mr. SMETANA. Absolutely. We have been fortunate that we 
have been able to grow our business. We are in a relatively 
stable industry, and our business has been successful. We have 
been able to add jobs over the last several years and increase 
that economic activity accordingly.
    Mr. ROSKAM. Thank you for waving the Sixth District flag. I 
yield back.
    Chairman CAMP. All right. Mr. Gerlach is recognized.
    Mr. GERLACH. Thank you, Mr. Chairman.
    My question really is sort of a follow-up to what Mr. 
Roskam just asked. If I heard correctly from the panel a number 
of minutes ago, there seemed to be some general consensus that 
in our tax reform efforts we ought to sort of try to align the 
maximum marginal rate for corporations and individuals and make 
that as consistent and comparable as possible so that you do 
not have an inappropriate shift of entities.
    If that is the case, there seems to be a developing 
consensus in Congress and within the Administration that 
perhaps the maximum tax rate for corporations ought to be 
around 25 percent.
    The House passed a budget last spring calling for a maximum 
rate of 25 percent. I think just looking out ahead, perhaps we 
will do the same again this spring. The President just put 
forward a corporate reform proposal which I think is a maximum 
rate of 28 percent with maybe on manufacturers of 25 percent, 
so clearly within the same ballpark of discussion.
    So based upon that, if we can have all the panelists answer 
the question, would you agree then that the maximum individual 
rate of taxation under any tax reform proposal ought to be 25 
percent?
    And just start maybe with Mr. Sullivan. You are the 
closest, and then just work up the panel.
    Mr. SULLIVAN. Well, I think I am going to be the contrarian 
here. I think this line-up of the rates, which my attorney and 
CPA friends obsess on, is the tail wagging the dog. We have 
larger considerations: deficit reduction and competitiveness. 
We need to lower our corporate rate. When we do that, we have 
to find revenue elsewhere.
    One place that you may have to look is at raising taxes on 
individuals to make up that difference. We do not want to do 
it, but there are not many options.
    Mr. NICHOLS. I would go in the other direction. It is 
absolutely critical on a marginal basis that we have a low 
marginal rate, and I think we proved up until the Tax Reform 
Act of 1986 that if you have varying rates for varying types of 
income, that it is going to essentially cause tax lawyers and 
tax accountants to intermediate between those two rates to 
prevent the government from essentially getting the full 
benefits of the various differing rates that it wants to 
achieve.
    The simpler the tax system you have the better. I would 
make one other important point, and this is virtually universal 
for the taxpayers that I represent. Their biggest fear is that 
there is going to be an attempt to essentially solve all of our 
fiscal problems and, frankly, many of the world's problems, by 
essentially, quote, taxing the rich and they today worry about 
how much their marginal income tax rates are going to go up.
    What you need to have is a system whereby everybody is 
paying taxes. Everybody is paying taxes maybe not at the same 
rate, but at similar rates, and everybody is benefitting from 
government so that essentially there is buy-in both as far as 
revenue and also as far as expenses so that people are 
similarly motivated.
    Mr. KWALL. I do not really have a view as to what the rate 
should be, but if current law continues, it is clearly 
destabilizing to have a corporate rate that is significantly 
lower than the individual tax rate. We have been there before, 
and what happens is it puts a heavy burden on the government to 
preclude taxpayers from trying to shift income to corporations 
and to resurrect penalty taxes that require the business to 
justify its needs for its earnings. The Government has to find 
these cases and try to pursue them to avoid the tax avoidance.
    Again, in my view the better solution is to keep closely 
held businesses out of the C corporation form. If you do that, 
then you have really got two separate systems, but if you are 
not going to do that, then I would agree that you want to 
maintain that parity.
    Mr. TUCKER. I am an advocate of parity. I would also like 
to remind everyone that we also have an estate and gift tax. 
Whatever these people have earned and have left after taxes is 
going to be subject to an estate or gift tax, and you go back, 
unless the law is changed rather quickly for next year, to 
about a million dollar exemption and a 55 percent estate tax 
rate, and I think you need to take that into account as well 
for small businesses and small business owners.
    They are not rich at that kind of level. They are simply 
not.
    Mr. MARTIN. Well, we have expressed several times that 
parity is important. I do not know what the rate should be 
either, but as close as it can possibly be I think is better 
for business planning, and let's have some permanency, like the 
extenders that we deal with every year or every two years. 
Let's do some things on a permanent basis so small businesses 
can plan.
    Mr. SMETANA. I think you are in an unenviable position of 
having to try to correct a fiscal situation with only working 
at one side of the equation. As financial professionals, we can 
hardly ever turn around our companies and improve them if we 
are only dealing with revenue and not dealing with spending.
    But to your point, I think the policy and goal of our 
Government should be to take the least amount of taxes from its 
people to sustain the Government for the spending that it feels 
it is required to do. So whether that is 25, 28, 15 percent, I 
think you have got to look at it on balance with the total 
expenditures of this Government and what we should be providing 
to our citizens.
    Mr. GERLACH. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman CAMP. Mr. Buchanan is recognized.
    Mr. BUCHANAN. Thank you, Mr. Chairman.
    I want to thank our witnesses today.
    As a guy that has been in business 35 years and started in 
1976, I remember my first entity was a C corporation, and then 
they came to me, the tax professionals, in the 1980s with an S 
corporation because it gave you the liability protection, and 
then they came to me and all of our entities lately have been 
LLCs because it gives you flexibility and distributions and all 
of the other things.
    But I want to make one point that Mr. Smetana mentioned. 
Let's just take a bank or a lot of times you have got a lot of 
people who are franchisors or they are dealers, and the 
factories or the banks require even if you made 500 and even if 
you want to take it out, you cannot take it out.
    Now, many people believe that in the end they might make 
500, and they have got 100 employees. That is a lot of exposure 
and risk, but they might take 100 out and leave 400 in, but 
many times my experience has been that people require you to 
keep the capital in. So it is almost like a C corporation.
    Now, all of that being said, I hear up here that, you know, 
all we talk about, even the White House and the Administration 
talk about lowering the corporate income tax to 27 percent or, 
our thoughts here in terms of the corporate to be more 
competitive in the world 25, but again, I want to get back to 
the point. I do not know how you can lower the taxes for 
corporate entities without dealing with Sub S and LLCs because 
of their growth. Because people will go back and the tax 
professionals will come back in and tell you to be a C 
corporation.
    So we have got all of this discussion about raising taxes, 
but all of these pass-through entities are going to be tied to 
the tax rate. So you have got them going down to 25, and you 
have got the guy who is running the company going up to 39, 
many times in the same entities.
    So I guess, Mr. Martin, I will start with you. Dealing with 
a lot of businesses, do you see under any circumstances where 
you could lower C corporations without really lowering it for 
small businesses and medium size businesses that are pass-
through entities?
    Mr. MARTIN. Well, I think the lowest C corporation rate, a 
huge company, multinational level, probably brings more taxable 
income back to this country because right now big companies do 
their planning to ship business overseas where tax rates are 
lower. So hopefully that increased revenue would somehow offset 
that.
    What we need to keep in mind is the point that was made 
earlier. The typical pass-through entity takes out their salary 
at a reasonable level; takes out of that pass-through entity 
the amount of money they need to pay their taxes; and leaves 
the rest of it in there. Sometimes that is because creditors 
require it. Most of the time it is because that is the only way 
that growth is going to come about.
    If you think about an accrual basis entity, you are 
required to use the accrual method. You cannot grow if you do 
not have cash because you have got to invest in receivables and 
inventory. One of the biggest problems small businesses have is 
growing too fast. If you grow too fast, you cannot find the 
increased receivables in inventory and you can go out of 
business.
    Mr. BUCHANAN. I have one thing to add to that. In today's 
environment, in the last three or four years a lot of banks--I 
am from Florida--especially in Florida, but in other parts of 
the country, are not lending. So they have to leave the money 
in there.
    Mr. Tucker, anything you want to add to that?
    Mr. TUCKER. Two things. One is my clients are all small 
business people. They all leave money in the entity even though 
they are taxed on the money.
    The second thing is a lot of them have debt that is being 
paid down, and when you pay down debt, because my clients do 
not like to be in debt, you get no deduction. So you are doing 
it with after-tax dollars. To keep taxes for entrepreneurs up 
here and to have C corporations' taxes down here without parity 
is truly inequitable.
    Mr. BUCHANAN. I want to add a second question. I know a lot 
of these guys that are in the top tax brackets. Most of them I 
know, most of them I have known for 30-some years. They are 
usually the job providers in the community. So really what are 
we doing if we want to grow?
    The talk up here is three things: jobs, jobs, and jobs. 
Well, who provides those jobs? Most of the folks that, you 
know, have 25 to 200 employees are these pass-through entities. 
So if we are going to have them pay more in taxes, all we are 
going to do, in my opinion, is hurt more jobs.
    Mr. Kwall, do you have any thought on that? Yes, go ahead.
    Mr. KWALL. In evaluating the consequences of creating a 
system where the corporate rate is lower than the individual 
rate, you really have to take account of in terms of estimating 
revenue, the potential fleeing from pass-through entities in 
that situation. In 1986 what ended up happening is everybody 
fled from the corporate tax when individual rates came down and 
heavier burdens were put on the corporate tax. So that has just 
got to be done.
    Mr. BUCHANAN. Mr. Nichols, anything?
    Mr. NICHOLS. Just a quick point, and that is there is a 
temptation, of course, to not essentially tax everybody all at 
the same rate. If you are going to raise rates, raise rates on 
some and not necessarily on others, but frankly, that is what 
got us into the hodge-podge that we have got in the Tax Code 
now. I think it is much better to take the courageous approach 
and essentially face the revenue needs we have and get a system 
that works over the long term.
    Mr. BUCHANAN. Thank you, Mr. Chairman. I yield back.
    Chairman CAMP. Mr. McDermott is recognized.
    Mr. MCDERMOTT. Thank you, Mr. Chairman.
    I could not help it. I was watching this down in my office, 
and I came up because I wanted to ask a question. I felt like 
Russell Long had come out. I was looking around for his 
picture, but I think he is over in the Senate. His theory of 
taxation, as you know, was do not tax you; do not tax me; tax 
that guy behind the tree.
    And I have a feeling that we are sitting here talking about 
where the guy behind the tree is. Then I thought about the fact 
that former Ways and Means member, who must have learned 
something on this Committee; I mean, I cannot assume that he 
sat here and did not learn a thing, Mr. Cantor, presented an 
interesting tax proposal that he hopes to jumpstart the 
economy. He says the provision would provide a 20 percent 
reduction on small business income.
    But then I read what is going on in the press, and the 
Small Business Association and the independent business people, 
they are not throwing their arms around this proposal and 
saying it is a good idea.
    So tell me about Mr. Cantor's proposal. Why is the small 
business community not just in here beating down our doors to 
have that happen?
    Anybody can answer that.
    Mr. SULLIVAN. Well, I do not have any idea why because it 
seems like a proposal which would be highly beneficial to them.
    Mr. MCDERMOTT. Does anybody else have anything? Why are the 
small business organizations not endorsing this?
    Mr. MARTIN. I think primarily because of--nobody has told 
me this--but added complexity in the tax law and how you define 
what that number is going to be that they get to deduct. I just 
do not know how that number is calculated. I have not even seen 
the proposed legislation. So I do not know what he is putting 
through.
    Mr. MCDERMOTT. You took the words out of the mouth of Chris 
Waters. He said, ``Just for our members, the top two important 
issues are keeping the marginal rates low and reducing the 
complexity.'' That is NFIB, right?
    And what you are saying is the Majority Leader of the House 
has introduced a bill that is making people more anxious 
because it introduces more complexity. That is his solution to 
this problem it sounds to me like.
    I mean, I was here under Clinton when we set the Clinton 
rates. Okay? I was here in 1993 when we did that vote, 1994, 
and the country was booming, and so now everybody says we have 
got to reduce the rate somehow because that is the only way we 
can get the country going again, and what I hear also is from 
Mr. Buchanan and others, the banks are not lending.
    I mean, let's talk about what the real problem here is. 
Small business people's problem is the banks will not lend to 
them unless they have got--I just tried to get my loan 
refinanced on my house because I thought a 3.9 percent interest 
rate was pretty interesting. They wanted to have my pay stubs 
for the last three months, and they wanted to have proof that I 
had--you know, I can see why a small businessman would go crazy 
dealing with this, and I do not understand why the Minority 
Leader would put one out to make it more complex.
    I mean, what would be the purpose of that? Has anybody got 
an answer?
    [No response.]
    Mr. MCDERMOTT. I yield back the balance of my time.
    Chairman CAMP. All right. Mr. Smith is recognized for five 
minutes.
    Mr. SMITH. Thank you, Mr. Chairman.
    Certainly I can appreciate this discussion about the 
complexity of the Tax Code and adding new preferences in the 
Tax Code. The last I checked, there has been more than one bill 
introduced or suggestions for our Tax Code that would add more 
complexity, which certainly does concern me.
    But in a broad sense, I mean, we talk about confusion and 
frustration and instability of the Tax Code, but for the CPAs 
here on the panel, how often do you encounter someone, aside 
from the instability and the short-term nature of a lot of 
these tax policies; how often do you encounter a client who 
would say, ``Gosh, in going back I wish I could go back and 
redo some planning perhaps''? But how many of them think 
retroactively and then would apply that moving forward?
    Mr. TUCKER. I am not a CPA, but I can tell you that in my 
practice my clients both look back and look forward. The 
problem with looking forward is you cannot assure the client of 
any stability looking forward. It is not just complexity. It is 
stability, and they do not understand what is going to happen 
next year, for example, extenders, non-extenders, tax rates, 
and everything else.
    So they look back and they say, ``If I had done this at 
that time, I could have saved taxes. I could have done 
something different. I could have paid less taxes in the long 
run.''
    It is a balancing act, and very often my clients, being 
entrepreneurs, are, frankly, upset with planning we did before 
because the law changed, and they did not know it was going to 
change and we did not know it was going to change. So I think 
stability has to be part of focusing on complexity. You need to 
provide stability for the people in this country and the 
entities in this country.
    Mr. SMITH. Okay. Anyone else? Mr. Martin.
    Mr. MARTIN. I would say that my client base does not look 
back. It is not profitable to look back. You cannot change 
things that have already happened. If they ask me about some 
advice that I gave them before, it is always on the basis of 
what we knew at the time.
    It is a struggle enough to get my clients to look forward 
far enough to make huge business decisions that will affect 
them in the long run. They are operating today. Do not look 
back. It is fruitless to look back.
    Mr. SMITH. Mr. Smetana.
    Mr. SMETANA. I would concur. We are forward looking. You 
need to be in your business. I would say that over the last 
several years we have tried to make behavior by the tax 
policies we have instituted particularly around depreciable 
lives and fast expensing, and I think what we run the risk of 
is similar to a shopper in a retail store. They keep looking 
for the sale. So they defer their purchases until that sale 
occurs, and I have a feeling that we continue down this path of 
just short-term policy fixes and short-term incentives to try 
to change behavior and what we are really deferring are the 
kind of long-term investments that are necessary for business 
to thrive and survive and grow.
    Mr. SMITH. Okay. Mr. Nichols.
    Mr. NICHOLS. And I would certainly concur in everything 
that was said on the subject before. I would add one other 
thing, and that is clients, good clients that are running 
successful business, do not want to do tax planning. They would 
be very comfortable and would be delighted to have a stable 
system and, frankly, they want to work on that next sale. They 
want to get sales to go up. They want to figure out that new 
technique that is going to reduce cost. That is what they want 
to focus on, and they resist the idea of, frankly, paying 
people like us and others because of the complexity or the 
uncertainty of where things are going to be.
    They want to do their business, and if we could just let 
them do that, we would all benefit.
    Mr. SMITH. Now, I guess in light of this topic though, you 
know, we know that the Tax Code has so many tax preferences, 
hundreds, many of which are temporary in nature, and there are 
more proposed as we have heard several times this season. 
Obviously, the beauty of a tax preference is always going to be 
in the eyes of the beholder, aside from the rate, but perhaps a 
rate can impact that a little bit.
    How high of a priority should reducing preferences in the 
Tax Code be as we tackle tax reform? Mr. Sullivan.
    Mr. SULLIVAN. Thank you.
    Well, it should be an extremely high priority. It 
simplifies the Tax Code, and it will allow much lower rates, 
make the system fairer and promote economic growth. As you say, 
the benefit is in the eyes of the beholder. The hard part is 
the politics. The economics are very simple.
    Mr. SMITH. Mr. Kwall.
    Mr. KWALL. The most stable tax would be a low rate, broad 
based tax. So to the extent that preferences can be reduced and 
rates can be brought down, that approach is the ideal.
    Mr. SMITH. Perhaps we should resist adding further 
preferences in our Tax Code.
    Mr. KWALL. Definitely.
    Mr. SMITH. Okay, and Mr.----
    Chairman CAMP. I think we are out of time.
    Mr. SMITH. Thank you.
    Chairman CAMP. Ms. Jenkins is recognized.
    Ms. JENKINS. Thank you, Mr. Chairman, and thank the panel 
for being here today. This has been very interesting.
    Mr. Kwall, your testimony calls for requiring all complex 
businesses, those with one or more class of stock to be taxed 
at the entity level potentially, stating this would eliminate 
their ability to pass losses through to their shareholders. 
This would limit the ability of start-up businesses to raise 
capital.
    I am concerned with this rule that only the simplest of 
businesses be allowed to pass their income and losses through 
to their owners would make it harder for start-up businesses to 
raise capital since they can only pass the losses they incur in 
the early years through to their investors if they have the 
simplest of capital structures.
    So, Mr. Kwall, I guess for you might be: Do you share this 
concern and could your proposal be modified to allow real 
economic losses to be used currently by those start-ups that 
are in a loss position in their early years?
    And then I would be interested if anyone else would like to 
comment.
    Mr. KWALL. Thank you, Congresswoman Jenkins.
    That is actually a very good question. When I talk about 
simple enterprises my assumption is that system really govern 
the majority of closely held enterprises. In other words, a 
simple enterprise basically would mean that they are not going 
to have preferences with respect to distributions or economic 
preferences with respect to issuing different types of stock or 
membership interests so that some interests would be preferred 
and others would not be.
    So first of all, hopefully the bulk of new enterprises 
would fit under that simple regime and losses would pass 
through.
    Ms. JENKINS. Okay.
    Mr. KWALL. To the extent that a more complicated ownership 
structure was used under my system, it is true the losses would 
not pass through, but that is a default regime. I guess that is 
a cost of choosing a more complicated economic arrangement.
    So the real question would be how necessary a more complex 
arrangement would be to a business that thought it was in that 
situation.
    But it is clearly something that needs to be thought 
through. I agree with you completely.
    Ms. JENKINS. Okay. Thank you.
    Mr. Tucker.
    Mr. TUCKER. I really disagree. I think the concept of two 
classes of ownership creating a complex business rather than a 
simple business is not focusing on the entrepreneur. Most of my 
entrepreneurial clients are very concerned about capital 
formation and capital access, about protecting their personal 
assets from the business risk, and business succession.
    All of that goes to two classes of something. I would 
rather bring in equity than debt because I will have somebody 
who will have a share of the ownership, but will not have an 
obligation on my part to pay them. With business succession, I 
may have family members who are going to run the business, and 
they would have a voting class of stock, and I might have 
people who are going to be in the business and have a non-
voting class. I think the great bulk of my entrepreneurial 
clients would be caught under the definition of ``complexity,'' 
not ``simplicity,'' and I think we need to move away from that. 
We need to have pass-through entities.
    Ms. JENKINS. Okay. Sure.
    Mr. KWALL. One point of clarification. A simple enterprise 
could have voting and non-voting stock. It cannot have 
different kinds of economic interests, but you could have stock 
that was voting and stock that was non-voting.
    Ms. JENKINS. Okay. That helps.
    Mr. Nichols.
    Mr. NICHOLS. I would second Mr. Tucker's comments, but I 
guess I would have a more fundamental comment, and that is I 
think we are clearly in a situation where we need to have rate 
parity. I think everybody agrees on that, and so as a 
consequence, that is something that we should not avoid by 
doing this and we should not try to avoid it by doing this.
    The other principle I would apply here is ``if it is not 
broke, don't fix it.'' At the end of the day I am not quite 
sure there is something that would be so bad policy-wise or 
even at all bad policy-wise, frankly, that would cause us to 
disrupt what people are doing today in order to get to 
something that might theoretically be better on the basis of 
theory; I am not sure how much policy consideration is behind 
it.
    Ms. JENKINS. Okay. Mr. Sullivan, I know you made note of 
this in a recent Tax Notes article. Do you have any thoughts on 
this?
    Mr. SULLIVAN. Well, I think the details need to be worked 
out, but the theme keeps coming up over and over again. If you 
are starting up a business, all you want to do is your 
business. These entity choices are way too complex, and 
Professor Kwall is offering an easy alternative for a start-up 
business that does not want to be concerned about taxes.
    Ms. JENKINS. Okay. Thank you.
    Thank you, Mr. Chairman. I yield back.
    Chairman CAMP. Thank you.
    Mr. Paulsen is recognized.
    Mr. PAULSEN. Thank you, Mr. Chairman.
    I just want to raise a couple of points because it seems 
like there is pretty much unanimous agreement that parity is 
important in terms of comprehensive approach to tax reform for 
both large and small businesses. You know, we are not going to 
pass one bill that is going to address one side of it and then 
you can count on us passing another bill that is going to catch 
up with it, right? That is just not going to happen.
    We talked a little bit about family ownership, but we have 
not talked much about employee ownership, and I just think it 
is important, too, that we make sure that employee ownership is 
also remembered as a key component of existing tax law, and I 
think it is important that we keep employee ownership actually 
in mind as we move forward through larger comprehensive tax 
reform because there are huge benefits to employee owned 
companies.
    And I know that there are some of my colleagues that go 
back to 1994 when the rates were raised. You know, this is 18, 
20 years ago. The world has changed. It is a lot more 
competitive. It is a lot flatter. Small businesses, in 
particular, have to compete on a global scale that they have 
never had to compete on before as well.
    But let me ask you this question. I will start with Mr. 
Nichols. Can you highlight some of the restrictions on S 
corporations? And could we consider updating some of those 
restrictions?
    It was mentioned, I think, a little bit earlier about the 
importance of a five-year built in gains period, for instance, 
but are there any other proposals that could be considered 
outside of the context of larger comprehensive tax reform, such 
as the limits on the types of shareholders allowed for an S 
corporation to help open up opportunities for any businesses 
that are, for instance, trapped in that C corporation area?
    Mr. NICHOLS. There are a number of things that could be 
done, and I think they could be done without dramatic, perhaps 
not even significant, losses of revenue. A lot of the 
restrictions on S corporation status, such as on the nature of 
shareholders and actually even the types of entities that can 
elect S corporation status and various other things, have been 
in the code for some time, but they do not really need to be 
policy-based and do not need to be retained.
    Let me give you an example. Nonresident aliens were 
excluded because, when it was originally enacted, people were 
worried that the nonresident aliens would not pay tax. So were 
partnerships and corporations and various other ineligible 
entities.
    What we have done or what Congress has done for several of 
those is it has essentially said, okay, we are going to let a 
certain type of trust, an electing small business trust, or we 
are going to let certain tax exempt organizations, we are going 
to let you be a shareholder, but in return for that what we are 
going to do is we are going to tax you effectively at the top 
rate.
    So is the same is done for these other restrictions, the 
Government gets its revenue, but essentially the corporation is 
enabled to have a partnership as a shareholder or a nonresident 
alien as a shareholder. I am not quite sure there is any loser 
in that transaction. It just essentially gives more flexibility 
to closely held business, and I do not think it would lose a 
lot of revenue.
    Mr. PAULSEN. Okay. Mr. Tucker.
    Mr. TUCKER. What I teach my students is that there are five 
things you could do to reconcile S corporations with 
partnerships within the S corporation regime. Number one, you 
could take out any limit on the number of shareholders.
    Number two, you could let anybody be a shareholder, 
including not just the nonresident alien, but a partnership or 
a C corporation or an S corporation could be a shareholder.
    Number three is you could reconcile inside basis and 
outside basis. Right now in a partnership, partners share 
inside basis for debt, but in an S corporation you only get 
basis if you put money in or lend money to the S corporation.
    Number four, we have something in the partnership regime 
which says if you die and get a step up in basis on your 
partnership interest, there is an election to reconcile inside 
basis with outside basis, and we could do that for the S 
corporation as well.
    And finally, we could allow any kind of stockholder, 
preferred, non-preferred or anything, without having an issue 
if you wanted to do it. My proposal would be, fine, let's 
eliminate S corporations and let them use the partnership 
regime, which would be the simpler way of doing it.
    Mr. PAULSEN. Mr. Martin, let me just ask this before time 
runs out. You represent a large stakeholder group from a small 
business perspective. How much time do your members spend 
navigating the Tax Code?
    I mean, you know, what is the best story, the best anecdote 
that really just paints the best picture of why this is so 
critical to address?
    Mr. MARTIN. They do not spend a lot of time because they 
call me on the phone.
    [Laughter.]
    Mr. MARTIN. And, yes, I bill them for it, but what is 
stressful to them is the changing tax laws. I get numerous 
calls in November every year about Section 179. What is it this 
year? Is it likely to change before December 31, because they 
are thinking about capital investments now for things that they 
need to operate their business? Should they do them now or do 
them in the next six months? That is a huge issue for them, is 
just the stability.
    My clients wrestle with payroll taxes like crazy because it 
is an abomination of the Small Business Administration. It is a 
huge cost to administering payroll taxes, but not the income 
tax law.
    Mr. PAULSEN. Thank you, Mr. Chairman. I yield back.
    Mr. HERGER [presiding]. Mrs. Black is recognized.
    Mrs. BLACK. Thank you, Mr. Chairman.
    There I think has been a really great discussion here and a 
lot of good questions that were asked. When you come down to 
the end of us last members all of the questions have just about 
been asked, but I want to follow up on what my colleague was 
just saying about how much time this takes, and, Mr. Martin, 
you said the timing is not really the biggest issue with the 
employer. It is more just the stress.
    Obviously, we have talked a lot about complexity and the 
fairness and the uncertainty, but I do want to go to what is 
the actual cost. Can you determine the actual cost of this kind 
of complexity and what these businesses need to go through with 
the complication of the Tax Code?
    Can you give me an idea of what this actually costs the 
business, a percentage of what it might cost them?
    Is there a way to be able to evaluate that?
    We can just go right down the line, whoever would like to 
answer that question.
    Mr. SMETANA. I can just speak for our situation. So we are 
family owned. We have two shareholders, brothers, that own the 
company. We operate in seven states. We are U.S. domestic only. 
So we are not as complex as most larger businesses, but we 
spend hundreds of thousands of dollars a year on federal and 
State tax compliance. We do it both with internal staff people 
and as well as hiring experts from tax accounting firms to help 
us deal with all of the complexities.
    In addition, there is a cost to compliance and 
recordkeeping by deploying sophisticated accounting systems, 
particularly those that have to track three or four different 
types of depreciation, records given the various regimes that 
are out there.
    So in our case it is a big dollar, and that is money coming 
out of the business in reinvestment. My colleagues at FEI have 
similar experiences.
    Mrs. BLACK. And let me just follow up on that for just a 
second. Then I do want to hear from the rest of you, but just 
to draw to that conclusion, I think, down the line, would you 
be able to hire more people and expand your business?
    Then ultimately I think at the end of the day what we have 
to consider on all of this is that the cost to the consumer of 
the product on the other end, and as we talk about this, I 
think so many times that is forgotten, that the cost of 
whatever the service of that product is is increased, and it is 
really harder for those at the lower income because the end 
result really impacts those at the very lowest income in 
purchasing that good or that service.
    So would you say if you did not have this kind of 
complexity you could make things a little easier and you could 
use those dollars to grow your business and, therefore, grow 
jobs?
    Mr. SMETANA. Absolutely. As we said, the key to business 
economic growth is after-tax cash flows, and whether you spend 
it on income taxes directly or on the cost of preparing those 
taxes, it reduces the amount of money you have to sustain the 
business.
    Mrs. BLACK. Others? Mr. Martin.
    Mr. MARTIN. It is difficult for me to estimate what it 
would cost, but there are a couple of provisions. One I 
mentioned, the health care credit. It is crazy for me to have 
to spend the time that I do because the law is so complex I 
cannot figure out whether I need a benefit without spending the 
time.
    The domestic production activity deduction is another one 
that the guidelines that we follow are extremely loose. Again, 
I feel like it is malpractice if I do not get my client the 
$300 deduction they should be entitled to. So I have to go 
through the calculations for it, incredibly complex, all of the 
job credits that are out there. I do not have any small 
business clients that hire people because they are going to get 
a job credit. They hire someone because they need someone to 
help run the business.
    Mrs. BLACK. Thank you. Thank you.
    Others? Mr. Tucker.
    Mr. TUCKER. I think there are two costs. One is the cost of 
planning, which takes both financial resources and human 
capital, which is often not measured, but two is for the 
clients who do not come in advance on planning. The cost of 
some foot fault is even much more expensive, and I think they 
do not realize that a lot of times until the foot fault occurs. 
And we need simplicity.
    Mrs. BLACK. Mr. Nichols.
    Mr. NICHOLS. I had really only two points. I know there is 
limited time, but, number one, in terms of complexity, there is 
no question on several of the things that have been raised. The 
items that actually on an ongoing basis affect how closely held 
business calculate their taxes and things like that, there is 
no question that that complexity could be improved upon, and in 
particular, it would be best in terms of tax reform to resist 
the temptation to micromanage and to have more global rules 
that are essentially applicable and rely on the economy to weed 
things out rather than to micromanage.
    The only other thing that I would say with respect to 
complexity is we have talked about choice of entity and forcing 
people, let's say, to a single pass-through regime. I am not as 
worried about complexity there because essentially once a 
business has elected a particular pass-through regime, that is 
its entity. It has got its entity, and you are actually adding 
to their complexity if you force them into a new entity.
    There is complexity, but it is complexity for the law 
students. It is complexity for the tax advisors, but you are 
not helping closely held business if you force a disruption on 
their tax planning.
    Mrs. BLACK. Thank you.
    And I think I am out of time, and I yield back. Thank you.
    Mr. HERGER. Mr. Berg is recognized.
    Mr. BERG. Thank you, Mr. Chairman.
    I really appreciate the panel being here. I started a small 
business from the ground up, and we worked our way through a 
lot of these things. The comments that we have heard today are 
really right on.
    You have a small start-up business. I mean, you do not have 
an accountant full time. You do not have an attorney that is 
looking at the regulations, looking at the rules, and quite 
frankly, a lot of the decisions on what type of organization 
you are going to be as a tax entity kind of are made at the 
last minute with some advice.
    And talking about those people who went through a C 
corporation and for tax reasons cannot get out of it and have 
struggled and every year the tax liability gets more and more 
severe, you know, as I approach tax policy for business, my 
goal is to say that people will make business decisions based 
on business principles. And very secondarily or third they 
would say, ``What are the tax implications?''
    Instead I think we have reversed that where people are 
saying, ``Before we make this business decision, what are the 
tax implications?'' So it is almost backwards in terms of if 
you want to build a better mousetrap, beat the competition to 
do these things. There are all kinds of barriers within the Tax 
Code.
    The least amount or I should not say the least, but one of 
the biggest is the uncertainty in the Tax Code. I mean, who 
knows what is going to be our tax come January 1 of 2013? You 
know, no one.
    So I do not know where we are going or where I am going 
with my questioning, but there is a lot of frustration I have. 
I think probably the first thing would be to, you know, really 
look at the President's budget and what kind of an impact that 
is going to have on business. Probably specifically is where we 
have a corporate rate that is lowered and a personal rate that 
is increased.
    I would just like the panel to respond to how do you see 
that impacting the small business that we are talking about.
    Mr. SMETANA. Sure. As I mentioned earlier in my statements, 
we analyzed the President's and the Treasury's proposal, and 
the impact of not bifurcating, you know, business source income 
out of closely held from the individual regime would cost our 
company literally millions of dollars both in terms of the loss 
of certain of the current tax preferences around capital and 
inventory investment as well as the material increase in the 
marginal rates that our businesses would pay in taxes in the 
pass-through regime.
    So it would certainly have a dampening effect with respect 
to the economic activity that we could plan going forward by 
having less capital with which to work.
    Mr. MARTIN. We are talking about less job creation. We 
cannot afford it.
    Mr. TUCKER. We are talking about more complex here. We are 
going to go back to the personal holding company, accumulated 
earnings tax, and all the other things that are done to offset 
this, and it is just the wrong direction to go, sir.
    Mr. KWALL. I would start with an ideal income tax that 
would tax income to the owners at the owner's marginal rate. So 
whenever you are trying to duplicate like that, it is just 
really inconsistent with the ideal.
    Mr. NICHOLS. To a great extent I am going to reiterate. 
When you stray from rate parity and the single-tax rate, 
corporate owners will respond to the incentives. They may not 
like them, but they will respond to the incentives, and at the 
end of the day if the next change incentivizes it, either as a 
result of complexity or otherwise, they will move to C 
corporation or other status just on a temporary basis. Then 
there is a lot of lawyer work to get them out, and if the tax 
rates are too high or they are different for other people, they 
will respond. They will adjust, and the people that will be 
hurt, I think, are the new entrants into the labor market or 
the newly unemployed, who are the last people that at the end 
of the day businesses would be hiring if things went well.
    Mr. SULLIVAN. Well, I am going to be the contrarian again. 
Again, that is the tail wagging the dog. We need a competitive 
tax system. We need to raise revenue. We have to lower our 
corporate taxes because those larger corporations are 
internationally competitive.
    If there is not enough revenue, you may have to consider 
raising taxes on individuals. These rules are anti-abuse rules. 
If businesses are not pushing the envelope, they do not have to 
deal with these anti-abuse rules. There is no reason for a new 
business to seek C corporation status. So I have no sympathy 
for a corporation that goes in that direction.
    Mr. BERG. Clearly, in my mind if there is a 40 percent tax 
rate and a 28 percent tax rate, people are going to go to the 
28 percent tax rate, which from my perspective, the way I 
started this is exactly opposite to what we want people to be 
doing.
    I mean, I think if we want to raise revenue, we have got to 
grow jobs, period. And that is my concern with the President's 
proposal on taxes. It creates more uncertainty, and it is not 
growing jobs.
    I have got one more question.
    Chairman CAMP [presiding]. Well, your time has expired, and 
we have got one more person.
    I would just say that lowering rates is not the same as 
lowering taxes. There is a difference there, and so you do not 
necessarily have to go somewhere else in the economy to raise 
taxes.
    Mr. Reed is recognized for five minutes.
    Mr. REED. Thank you, Mr. Chairman, and I am the last one. 
So that always brings a smile to the panel's face whenever I 
get to ask the questions.
    [Laughter.]
    Mr. REED. Going last here, I will say I echo the sentiments 
of my colleagues, and also being one of the colleagues that 
started a small business like myself, and we talked a lot about 
the time pressures, obligations of starting a business and then 
having to deal with these issues. I can vividly remember in the 
beginning when my CPA called me and asked me to get a document, 
and it took me two days to find the document. I was so 
frustrated, and he actually did not need the document at the 
end of the time. So I was almost firing him on the spot, but 
you know, the bottom line is I have been there, and small 
business owners across America are frustrated with this Tax 
Code, and I am so glad to be part of an effort to try to reform 
it, and we will do our part on that.
    What I am hearing is a general theme from each and every 
one of you that we should be focusing on the certainty and the 
stability in the code, looking at the rates to make them 
competitive, and combining the individual and corporate rate.
    One thing that I do not know if we spent enough time on and 
I am interested in exploring and going down further is does 
anyone feel that the underlying business activity of the 
taxpayer, is that something that should be taken into 
consideration when we are setting tax policy.
    And the reason I bring that up is as a new member down here 
in Washington, D.C., I hear a lot of politicians talk about bad 
guys, oil and gas industry, and there are provisions in the 
code that treat folks differently just because of the business 
activity upon which they are engaged when it comes to their tax 
burden.
    Can anyone tell me is that something that is good policy to 
advance as we go through comprehensive tax reform, or is my gut 
telling me the right thing and that we should avoid looking at 
business activity as a reason why tax policy should be set?
    Mr. Tucker, please.
    Mr. TUCKER. Are we not really trying to look at the ability 
to create jobs? Do service businesses noted create jobs just as 
manufacturing businesses create jobs, just as real estate 
creates jobs?
    If that is what we are looking at, I think the type of 
activity is totally irrelevant. Our objective should be to 
create jobs, be able to collect tax from the people who are 
earning money and go forward.
    Mr. REED. I appreciate that. Anyone else? Mr. Nichols.
    Mr. NICHOLS. Well, I would say, and corresponding to and 
following up on that and certainly not disagreeing with it, and 
that is the trick, you need to be careful, but the trick is to 
treat all businesses, I think, comparably. Obviously they 
differ, but at the end of the day, there are certain 
fundamental principles.
    If you follow the cash, people are making money. Then that 
is a good time and an appropriate measure of whether or not 
taxation is appropriate. Now, I realize that is an 
oversimplification, but in general, you should not favor, you 
know, insurance company taxation versus oil and gas taxation 
versus manufacturing.
    I represent some of those. I do not represent all of them. 
Essentially the goal should be not favoring one industry over 
another, not picking winners and losers, and not micromanaging. 
The more simple, straightforward, then the economy, the 
capitalistic system, will figure out who is going to invest in 
what industry based on actual profits rather than tax 
considerations.
    Mr. REED. I appreciate it.
    Mr. Sullivan.
    Mr. SULLIVAN. Well, I know you have been lobbied, and when 
I was on staff, I was lobbied, and every lobbyist comes in and 
tells you, ``How can you raise my taxes when I am creating 
jobs?'' And everybody says that. It is jobs, jobs, jobs.
    We have to have the discipline to understand that when we 
help one person, we are taking something away from another, and 
that is just the balance sheet. It is just the math, and what 
we want to do is not provide anybody with special privileges 
because in the long run what you do not see is most job 
creation will be created by not giving that lobbyist the 
special tax break.
    Mr. REED. I appreciate that.
    With that I will yield back, Mr. Chairman. I have got a 
couple of seconds left and I will let you enjoy them.
    Thank you.
    Chairman CAMP. All right. Well, thank you.
    And I want to thank all of our witnesses. This was an 
excellent hearing.
    I appreciate your time and your testimony today.
    And with that, this hearing is now adjourned.
    [Whereupon, at 12:26 p.m., the committee was adjourned.]
    [Public Submissions for the Record follows:]


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



                                 
