[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
HOW TAX COMPLIANCE OBLIGATIONS HINDER SMALL BUSINESS GROWTH
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HEARING
before the
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
HEARING HELD
JULY 22, 2015
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 114-020
Available via the GPO Website: www.fdsys.gov
______
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95-580 WASHINGTON : 2015
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HOUSE COMMITTEE ON SMALL BUSINESS
STEVE CHABOT, Ohio, Chairman
STEVE KING, Iowa
BLAINE LUETKEMEYER, Missouri
RICHARD HANNA, New York
TIM HUELSKAMP, Kansas
TOM RICE, South Carolina
CHRIS GIBSON, New York
DAVE BRAT, Virginia
AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
STEVE KNIGHT, California
CARLOS CURBELO, Florida
MIKE BOST, Illinois
CRESENT HARDY, Nevada
NYDIA VELAZQUEZ, New York, Ranking Member
YVETTE CLARK, New York
JUDY CHU, California
JANICE HAHN, California
DONALD PAYNE, JR., New Jersey
GRACE MENG, New York
BRENDA LAWRENCE, Michigan
ALMA ADAMS, North Carolina
SETH MOULTON, Massachusetts
MARK TAKAI, Hawaii
Kevin Fitzpatrick, Staff Director
Stephen Denis, Deputy Staff Director for Policy
Jan Oliver, Deputy Staff Director for Operation
Barry Pineles, Chief Counsel
Michael Day, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Steve Chabot................................................ 1
Hon. Nydia Velazquez............................................. 2
WITNESSES
Mr. J. Christopher Mihm, Managing Director, Strategic Issues,
United States Government Accountability Office, Washington, DC. 4
Mr. Donald Williamson, Professor, American University, Executive
Director, Kogod Tax Center, Washington, DC..................... 6
Mr. Troy Lewis, Vice President, Heritage Bank, St. George, UT,
testifying on behalf of the American Institute of Certified
Public Accountants............................................. 8
Mr. Les Vitale, Partner, Local Markets Group, McGladrey, LLP,
Boston, MA..................................................... 9
Mr. Stephen F. Mankowski, Partner, EP Caine & Associates, LLC,
Bryn Mawr, PA.................................................. 11
APPENDIX
Prepared Statements:
Mr. J. Christopher Mihm, Managing Director, Strategic Issues,
United States Government Accountability Office, Washington,
DC......................................................... 33
Mr. Donald Williamson, Professor, American University,
Executive Director, Kogod Tax Center, Washington, DC....... 112
Mr. Troy Lewis, Vice President, Heritage Bank, St. George,
UT, testifying on behalf of the American Institute of
Certified Public Accountants............................... 124
Mr. Les Vitale, Partner, Local Markets Group, McGladrey, LLP,
Boston, MA................................................. 137
Mr. Stephen F. Mankowski, Partner, EP Caine & Associates,
LLC, Bryn Mawr, PA......................................... 144
Questions and Answers for the Record:
Question from Hon. Alma Adams to Mr. Christopher Mihm and
Response................................................... 149
Question from Hon. Alma Adams to Mr. Donald Williamson and
Response................................................... 151
Question from Hon. Alma Adams to Mr. Troy Lewis and Response. 154
Question from Hon. Alma Adams to Mr. Les Vitale and Response. 156
HOW TAX COMPLIANCE OBLIGATIONS HINDER SMALL BUSINESS GROWTH
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WEDNESDAY, JULY 22, 2015
House of Representatives,
Committee on Small Business,
Washington, DC.
The Committee met, pursuant to call, at 11:00 a.m., in Room
2360, Rayburn House Office Building. Hon. Steve Chabot
[chairman of the Committee] presiding.
Present: Representatives Chabot, Luetkemeyer, Hanna, Rice,
Brat, Radewagen, Knight, Hardy, Velazquez, Payne, Meng,
Lawrence, Adams, and Moulton.
Chairman CHABOT. Good morning. Thank you all for being
here. Special thanks to our witnesses who have taken the time
away from their undoubtedly busy schedules to be with us here
this morning. We really do appreciate that.
Earlier this year, our Committee heard from a gentleman
named Scott, who owns a small mattress factory in Franklin,
Ohio. Scott wants to pay his taxes. He probably wishes he could
pay less but more than anything he wishes the process could be
simpler. He wants a flatter and fairer code that is more
predictable.
Scott is emblematic, I think, of many small businesses all
across this country. There are millions of Americans out there
just like Scott who feel the weight of the tax code every day.
I speak to them every time I am back in my area, back in Ohio,
and I hear the same concerns again and again. More Americans
are frustrated with the process of paying their taxes, more so
than even actually writing the check to the government. I am
sure there are exceptions, but it is far too complicated. It is
unacceptable and we must do better.
Making the tax code simpler is particularly important for
America's small business owners, as they are disproportionately
affected by the tax code's complexity. This is a finding that
unfortunately has not changed with time. Studies conducted for
the Office of Advocacy at the SBA over the past 10 years found
that small firms pay 67 percent more to comply with the tax
code than large firms do. A recent update to those advocacy
studies found that firms with less than 50 employees pay on
average over $1,500 per employee in tax compliance costs,
whereas, firms with more than 100 pay $647.
It is because of statistics like that in 2013 this
Committee asked the Government Accountability Office to examine
the dynamics of small firms and their tax compliance burden.
The GAO will be testifying today to outline their findings, and
I would like to point out that right at the end of the report,
the GAO outlines 25 separate recommendations that they have
made to the IRS over the past few years that could, and
probably would in my estimation, help reduce tax payer
compliance burdens. The IRS has implemented none of them, and
that is a problem.
To be fair, I am not only blaming the IRS for this problem.
Congress has been guilty as well. The tax code has grown to
nearly 74,000 pages. The IRS did not do that; Congress did.
This Committee is and will continue listening to the American
people and urging Washington to make the tax code simpler and
less stressful.
As I stated earlier, we have the GAO here today to discuss
their illuminating report in greater detail, and we will also
hear from tax experts who will suggest ways to reduce the
strain on small firms through comprehensive tax reform that
reduces the complexity faced by small business.
I am looking forward to the testimony of everyone here
today, and I again want to thank each one of you. And I would
also mention, originally there may have been a case where we
were going to have two panels, but I have found over the years
when we do that, oftentimes members have a certain amount of
time that they can be here and they have other Committees and
obligations and will listen to one panel and then not the
other, and this is really a much better way to hear from all of
you. And so that is why we changed that around, so if it was
any inconvenience to anybody, we apologize.
And I would now like to yield to the ranking member, Ms.
Velazquez, for her opening statement.
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
The success of the American economy relies heavily on its
vibrant small business community. Small businesses employ 50
percent of our workforce and generate nearly $6 trillion in
revenue. When talking with small business owners, we often hear
that an intense focus on the bottom line is necessary to
succeed. They know every dollar counts and devote significant
resources to work that goal.
One area every small business owner must focus on is
complying with our tax laws. The tax compliance burden on small
businesses takes many forms. Most notably is the complexity of
the code itself. With so much paperwork to fill out every year,
the majority of firms report spending more than 40 hours
preparing their tax returns.
To better understand the costs of the burden and what the
IRS is doing to reduce it, this committee requested the GAO
report at the center of today's hearing. That report reinforced
much of the anecdotal evidence we have heard on previous
occasions. The complexity of the tax code creates a number of
fixed cost items that do not scale with the size of the
company. As a result, smaller businesses are disproportionately
impacted compared to their larger counterparts.
One way to address this problem is by simplifying the tax
code. By reducing its complexity, small businesses will see
decreases in these fixed costs as the need for expert
preparation and the time commitment will both be reduced. The
complexity of the tax code cuts both ways. Taxpayers'
noncompliance costs the IRS nearly $350 billion every year
prompting numerous initiatives to close the gap. One of them is
the use of Form 1099-K to track electronic payments. By
collecting data directly from payment processors, like Visa and
PayPal, the IRS intends to cut down on underreporting and spur
more businesses to voluntarily comply.
Unfortunately, if the information does not match up or
errors are made, it could trigger costly and time-consuming
audits for law-abiding firms. In response, the IRS began the
Payment Mixed Comparison Tool (PMCT) pilot to reduce the burden
which GAO was also asked to look at. While they found IRS's
payment card matching program has the potential to reduce
noncompliance, it was unclear whether it would reduce taxpayers
burden.
GAO also found that the majority of small businesses use
pass-through entities, like partnerships and S corporations,
which prevent them from receiving a number of business friendly
tax incentives. The average corporate tax rate is just 12.6
percent compared to 31.6 percent and 29.4 percent that S
corporations and partnerships pay.
Comprehensive tax reform, not only corporate, is necessary
to spur additional economic growth in our small business
sector. In other words, small entities are not looking for
special treatment, just equal treatment with their larger
counterparts.
One of the principal tenets of tax policy is that we strive
for simplicity and some semblance of certainty. The tax rules
should specify when the tax is to be paid, how it is to be
paid, and the amount to be paid. Through comprehensive tax
reform, Congress can provide small firms with both, by limiting
yearly policy changes which will help them more easily plan
their business investments, operations, and estate planning
based on those known laws.
I look forward to hearing from today's witnesses on the
findings and recommendations contained in GAO's report. And I
thank you for being here today.
Mr. Chairman, I yield back.
Chairman CHABOT. Thank you very much.
And if Committee members have opening statements prepared,
we would ask that they submit them for the record.
And I will take just a moment to--before I introduce the
panel, to kind of explain our rules. You get five minutes to
testify. There is a lighting system. A green light will be on
for four minutes. The yellow light will let you know you have
got a minute to wrap up, and then the red light will come on
and we ask you to stay within that as much as possible, and
impose those same rules on ourselves, so we get five minutes to
ask questions.
And I will now introduce our panel. We will begin with our
first witness, Chris Mihm, the managing director for Strategic
Issues at the United States Government Accountability Office.
He leads GAO's work on government oversight and transformation
issues such as performance management and collaboration,
federal budgeting, regulatory policy, and federal tax policy
and administration. He is a fellow and former board chair of
the National Academy of Public Administration and an adjunct
lecturer in Public Administration at the University of Maryland
Graduate School of Policy, and we welcome you here this
morning.
Our next witness will be Don Williamson, professor in the
Department of Accounting and Taxation at American University.
He also serves as the executive director of the University's
Kogod Tax Center, a research institute focusing on the
interests of small business. He has also served as an adjunct
professor at American University's Washington College of Law.
Professor Washington published over 50 articles in professional
and academic journals and was recognized as the Bureau of
National Affairs' Outstanding Author for 2007. Welcome this
morning.
Our next witness will be Troy Lewis, who is vice president
and chief enterprise risk management officer at Heritage Bank
in St. George, Utah. He is also the manager of Lewis and
Associates, a small accounting firm in Draper, Utah.
Additionally, he serves as adjunct faculty in the taxation
department at Brigham Young University. He is also chair of the
Tax Committee at the American Institute of Certified Public
Accountants, whom he is testifying on behalf of today. We
welcome you as well.
Our next witness will be Les Vitale, managing director and
partner at McGladrey and Pullen in Boston, Massachusetts. Mr.
Vitale brings over 30 years of professional experience to his
clients and his broad base of knowledge includes specialties in
the traditional accounting, auditing, tax, and assurance
services. He has authored technical articles and developed
policy and procedural manuals for the firm in the areas of
quality control, staff training and evaluation, recruiting, and
technology.
We thank you all for being here, and I would now like to
yield to Ms. Velazquez to introduce our final witness.
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
Stephen Mankowski is the vice president and national tax
chair of the National Conference of CPA Practitioners, the
nation's second largest CPA organization. His firm has been
advising small firms on accounting and taxation for over 30
years, helping 2,000 clients annually. As an expert in the
field, Mr. Mankowski has participated on IRS panels regarding
compliance burden for small businesses and as a member of the
NCCPAP, partook in the electronic payment pilot program that
was examined by today's GAO report. Mr. Mankowski graduated
from LaSalle University.
Welcome to the committee. Thank you.
Chairman CHABOT. Thank you very much.
We will begin with Mr. Mihm. You are recognized for five
minutes.
STATEMENT OF J. CHRISTOPHER MIHM, MANAGING DIRECTOR, STRATEGIC
ISSUES, UNITED STATES GOVERNMENT ACCOUNTABILITY OFFICE
Mr. MIHM. Well, thank you, Mr. Chairman, and Ms. Velazquez,
and members of the Committee. It is an enormous pleasure and
honor to be able to be with you here today to discuss our
report on Tax Compliance Burden and Small Businesses. That
report is being released today and it is available, of course,
on the GAO website at gao.gov.
As this Committee is well aware, given the important role
that small business plays in the U.S. economy, reducing the
cost of compliance with the tax code frees up additional
resources to expand, hire new employees, and further
contributes to economic growth. At the same time, small
business tax issues are a significant contributor to the annual
tax gap which is the difference between taxes owed and taxes
paid on time. And as both the chairman and Ms. Velazquez
mentioned in their opening statements, and IRS takes as a given
as well, the overwhelming majority of taxpayers want to pay
their taxes in full and timely manner. It is just that we need
to make sure that we create the environment and give them the
tools that enable them to do that, including reforms to the tax
code as you pointed out. Thus, the key challenge for IRS is
that they must minimize taxpayer burden while encouraging, and
as the chairman pointed out with his reference to his
constituent Scott, making possible voluntary compliance with
the tax code.
My remarks today highlight the key findings of our report.
I know you have seen it, so in the interest of brevity I will
just hit four very key points on that.
First, most small businesses are individuals, but most
small business income is generated by partnerships and
corporations. According to Treasury analysis, small businesses
make up about 99 percent of businesses in the United States.
Treasury defines a small business for this purpose as
individuals or entities with business activity that is less
than $10 million in total income and deductions. Approximately
69 percent of small businesses, or about 1-6 million, are
individual taxpayers who report business income. The remaining
31 percent, or roughly 7.3 million, are partnerships or
corporations.
On the other hand, in 2010, individuals generated 23
percent of total income of all small businesses. This equates
to about $1.4 trillion into the economy. Small business
partnerships, S corps, and C corporations accounted for the
remaining 77 percent of small business income, and that
represented $4.5 trillion in income.
My second point. Tax compliance burdens vary across small
businesses. The variance is driven by factors such as business
asset size, by type--for example, is it a sole proprietor or a
C corporation--number of employees and industry type. Our
report details how certain tax compliance-related activities
create burden. The report groups these into general categories,
such as income tax activities, employee-related tax activities,
and third-party information reporting.
As the chairman mentioned, SBA and IRS data has shown that
there are very real costs both in terms of time and money with
small businesses in order to be able to comply with the various
requirements.
My third point this morning is that IRS does consider small
business compliance burden in its decision making, but
improvements are clearly needed. We interviewed small business
representatives, including those from the AICPA, who said that
IRS's outreach efforts have been effective in identifying
opportunity to reduce compliance burden. As one example, IRS
worked with stakeholders to develop a simplified method for
small businesses to calculate the home office deduction. That
change was introduced in January 2013. Previously, businesses
had to complete a complex property depreciation calculation. As
I am sure you have heard from your constituents over many
years, that had been a very real pain point for small
businesses.
Nevertheless, and despite that real and important progress,
stakeholders also pointed to a number of areas where IRS burden
could be further reduced. These are areas of IRS customer
service. Among others, those open recommendations that the
chairman mentioned. We have recommendations in these areas that
we believe need aggressive action from IRS and, that if
effectively implemented, could improve service and help reduce
the tax gap.
Fourth and finally, IRS's evaluation of its payment card
pilot has strengths but needs to be more fully developed. This
is obviously a point that Ms. Velazquez was making in her
statement. IRS began this pilot program in 2012, and what it
does is it compares payment data from payment settlement
entities, such as credit card companies, with income reported
by small businesses. The evaluation plan that IRS has for the
pilot has many elements of a well-designed evaluation, which is
a bit of an anomaly for IRS. They typically do not do that good
of a job with their evaluations. I mean that as a positive
statement I should say.
As a result, IRS has been able to make rapid and ongoing
assessments of pilot activities and to make changes based on
lessons learned. However, the overall evaluation lacks key
performance measures for the pilot's goals--so we do not know
whether or not it should be implemented more broadly, clear
evaluation criteria, and other elements.
With that, let me end at that point and obviously take any
questions that the Committee may have.
Thank you, Mr. Chairman.
Chairman CHABOT. Thank you very much. We appreciate that.
Mr. Williamson, you are recognized for five minutes.
STATEMENTS OF DONALD WILLIAMSON, PROFESSOR, AMERICAN
UNIVERSITY, EXECUTIVE DIRECTOR, KOGOD TAX CENTER; TROY LEWIS,
VICE PRESIDENT, HERITAGE BANK; LES VITALE, PARTNER, LOCAL
MARKETS GROUP MCGLADREY, LLP; STEPHEN F. MANKOWSKI, PARTNER, EP
CAINE & ASSOCIATES, LLC
STATEMENT OF DONALD WILLIAMSON
Mr. WILLIAMSON. Chairman Chabot, Ranking Member Velazquez,
and members of the Committee, thank you for the opportunity to
offer my suggestions for reducing the tax compliance burden on
small businesses when preparing their tax returns.
My name is Don Williamson, and I am a professor of Taxation
at American University's Kogod School of Business, where for
the past 30 years I have directed the school's Master's in
Taxation degree program. The MST program at American offers
graduate courses in federal taxation to CPAs, experienced
accountants, attorneys, and others who wish to expand their
knowledge of our nation's tax law. As part of my
responsibilities at American, I am also the executive director
at the Kogod Tax Policy Center, which conducts nonpartisan
research on tax issues affecting small businesses and emerging
entrepreneurs that will enhance compliance while reducing
compliance costs. And, for the past 25 years, I have had my own
tax preparation and tax planning practice for small businesses
in Falls Church, Virginia.
My written testimony describes some of the tax compliance
burdens imposed on small businesses that consume time and
resources that cannot be employed in their businesses to create
more jobs. Specifically, today, in my testimony, I want to
recommend to the Committee that our tax code be amended to
permit more small businesses to adopt the cash method of
accounting on their tax returns. Generally, a taxpayer using
the cash method of accounting recognizes income or deductions
when cash is received or paid. An accrual basis taxpayer, on
the other hand, must recognize income or expenses when all
events fixing the right or obligation have occurred, regardless
of when cash is paid or received.
As detailed in my written testimony, I believe that more
small businesses should be allowed to adopt the cash method of
accounting, rather than the current law requirement imposing
the accrual method that is uniformly considered more complex
and offers few advantages to small businesses whose chief
concern with regard to their financial condition is their cash
flow. It is important to note that the method of accounting
adopted by a business, whether the cash method or the accrual
method only affects the timing of when a business reports
income or deductions on its tax return. The accounting method a
business uses does not determine whether an item of income is
taxable or expense is deductible, and does not affect the total
income and deductions a business will recognize over its
lifetime.
However, despite the greater simplicity and better fit of
the cash method for small businesses, the entire revenue code
continues to deny the cash methods to corporations with average
gross receipts exceeding $5 million. As discussed in the
Senate's Bipartisan Tax Working Group Report on business income
tax issued this month, I urge Congress to increase the current
threshold for use of the cash method to $10 million. Raising
the threshold to $10 million will mean that 99 percent of all
businesses in the United States could adopt the cash method.
But even when the cash method is available to a small
business, certain judicial doctrines, such as constructive
receipt for the recognition of income, impose unnecessary
complication on a small business simply to accelerate the
reporting of income by, in most cases, a few months before
actual cash is received. Also, the requirement that a cash
method small business may not deduct its cash outlay to
purchase or produce inventory until that product is sold may
satisfy accounting theorists but offers no immediate tax
benefit to small businesses that expend considerable sums
creating jobs.
To further reduce the compliance burden on small business
therefore, I urge Congress to go beyond the proposals discussed
in the Senate's Bipartisan Tax Working Group Report, and enact
a simplified cash method of accounting described in detail in
my written testimony. Under this method of accounting, a small
business would simply look to its checkbook to determine its
taxable income. It sounds simple and it is. Permitting small
businesses to elect a simplified cash method of accounting will
reduce tax compliance costs, ease the burden of tax
administration, and clarify the measurement of taxable income.
Thank you again for the opportunity to testify, and I would
welcome any questions from the Committee.
Chairman CHABOT. Thank you very much.
Mr. Lewis, you are recognized for five minutes.
STATEMENT OF TROY LEWIS
Mr. LEWIS. Chairman Chabot, Ranking Member Velazquez, and
members of the Committee, thank you for the opportunity to
testify today.
My name is Troy Lewis. I am the vice president and chief
enterprise management risk management officer at Heritage Bank
in St. George, Utah. I am also a tax practitioner, adjunct
faculty member at BYU, and chair of the Tax Executive Committee
of the American Institute of CPAs. I am pleased to testify
today on behalf of the AICPA.
We applaud the leadership taken by the Committee to
consider ways to reduce the complexity faced by small
businesses when preparing their taxes. Small businesses are the
foundation of the U.S. economy, employing over half of the
private sector workforce and creating nearly two-thirds of this
nation's new jobs.
Unfortunately, compliance with federal tax laws can act as
a roadblock. Unlike large corporations, time spent by small
businesses in complying with tax laws is much more costly
because they do not have the luxury of a large customer base
with which to spread those costs.
We need to keep in mind that time devoted to tax law
compliance has an impact on business creation, job growth, and
economic prosperity. First, it is imperative that small
businesses and their tax return preparers have the ability to
communicate with the IRS when preparing their taxes and
addressing compliance issues. However, there has been
increasingly limited access to the agency. Through an informal
survey we conducted earlier this year, we learned that over
half of our members were either somewhat dissatisfied or very
dissatisfied with the services they received from the IRS. This
is no surprise considering that only 17 percent of our members
said that the agency answered their telephone calls within a
half hour. Most of our members were on hold for extended
periods of time or did not have the time to wait that long.
Let me share with you one member's experience. ``I was on
hold for over an hour and a half. When the IRS agent finally
picked up the call, they needed to transfer to another agent. I
had to wait on hold for another hour. Finally, I received a
recorded message that the office was now closed and I needed to
call again the following day.''
Unfortunately, this is not a unique experience. Many
taxpayers also experience the IRS's so-called courtesy
disconnects where the IRS disconnects a call without taking a
message if the caller has been on hold for two hours. Nothing
is more discouraging, frustrating, or inefficient for a caller
than being hung up on after waiting for nearly two hours.
We understand the IRS has new initiatives and obligations,
but taxpayer services must remain a high priority in order for
small businesses to receive the assistance they so desperately
need.
Another challenging tax compliance obligation that small
businesses recently dealt with was the tangible property
regulations. These rules, which address how businesses should
report the purchase and improving a property are almost 500
pages of technical guidance and procedures. Now, to be fair,
the regulations clarify some rules. However, they were still
significantly burdensome for small businesses. The AICPA pushed
hard for relief and stressed that time was of the essence. The
IRS finally issued partial relief on February 13th, well into
the filing season. Unfortunately, some small businesses and
their tax practitioners had already spent time and resources
attempting to comply with the regulations. If the IRS had acted
sooner, small businesses could have been spared some
administrative burden.
There are other issues that remain open in regards to the
repair regulations. Currently deducted amounts in excess of the
Safe Harbor threshold, taxpayers must prove that expensing such
amounts in the current year clearly reflects income.
However, the clear reflection of income test can be
challenging for any taxpayer, but especially for small
businesses. These rules force taxpayers to depreciate the cost
of items, such as a computer or a printer, over a number of
years. To provide meaningful relief, Congress should increase
the $500 Safe Harbor threshold to $2,500 and index the amount
annually for inflation. To further reduce burden, we also
suggest that you allow taxpayers with reviewed financial
statements to use the higher $5,000 threshold.
Finally, we encourage you to examine all aspects of the
code to reduce the complexity faced by small businesses when
preparing their taxes. For example, penalty provisions need to
consider their effect on voluntary compliance, and employers
operating across state lines need a uniform, national standard
for nonresident income tax withholding rules. The income tax
deadline should also promote an efficient flow of taxpayer
information to provide small businesses sufficient time to file
accurate returns.
In summary, small businesses and tax practitioners are
interested in, and so desperately need, tax reform to reduce
the burden that hinders growth.
Again, with that, Mr. Chairman, thank you for the
opportunity to testify, and I would be happy to answer any
questions.
Chairman CHABOT. Thank you very much.
Mr. Vitale, you are recognized for five minutes.
STATEMENT OF LES VITALE
Mr. VITALE. Thank you. Thank you, Mr. Chairman, Ranking
Member Ms. Velazquez, and members of the Committee.
My name is Les Vitale. I am a partner at McGladrey, a
national firm. I work out of the Boston office, which is
comprised of about 650 professionals. McGladrey is a firm that
has 8,000 professionals that practice in 80 cities across the
country. In addition to that, the group I practice in
specifically is a small practice group called the Local Market
Group. The Local Market Group is made up of about 50
professionals, including five partners. My client base in
particular represents about 40 small businesses with sales
ranging from under five million to up to 100 million in revenue
with employees from 10 to just about 200. All of my clients are
privately owned and many are family owned. The majority of my
client companies are S corporations.
In preparation for today's testimony, I determined that it
was best that I poll the practice group so that it was
representational of the members of my firm. In trying to come
up with some common themes, we did so, and we came up with
three challenges that I would like to present to the Committee
today. And those subjects include the TARS legislation relative
to depreciation, privacy and security, and also S corporation
basis.
So the rules with regards to TARS legislation in a word are
onerous. The depreciation rules were originally set out to
spread the timing of a deduction so there really is no question
about the fact that something is deductible. So it is a
question of not if, but when. So one of the items that was
pointed out by my colleague, Mr. Lewis, was that there are
differences between small and large companies and what they are
allowed to do under these regulations, which has created a
burden for the small client. Many of my companies do not have
what is referred to as an applicable financial statement. Large
companies, in particular large public companies, so very large
companies that have audits due, the rules therefore are
different. They are allowed larger thresholds up to $5,000. The
small clients in our practice unit, the small S corporations,
the family-owned businesses, have a $500 de minimis exception
amount only if they elect it.
When polled, the members of my practice unit said that one
of the things they have spent the most time on this year is the
administrative and compliance requirements related to the TARS
legislation. That legislation and those rules required and are
requiring the filing of a Form 3115. 3115 could take on average
from 10 to 15 hours of time. Larger corporations, even longer.
One of the suggestions and one of the recommendations that
we would make in our firm, and we have talked about this
internally, is the simplification of the election requirements
in electing safe harbor for the de minimis rules. One method
would be to simply modify the current Form 4562, which is the
current depreciation form. It could simply be redesigned to
include the questions that are asked of the 3115, and really
reduce down the time requirements to prepare that form.
We would also suggest that the safe harbor amounts be
revisited and consider raising those levels to $5,000. One of
the things that the laws do not take into account is the degree
of differences between companies. Service companies versus
innovation companies are very different. Their needs and their
investment in capital and there is really nothing in the code
and the current constitution of the forms that allows for that
flexibility.
In addition to that I wanted to cover briefly the privacy
issues. In our firm, we have had over 20 breaches in the last
four or five months. I have two going on right now. Those have
required a significant amount of time, and I know I am not here
to suggest that I have the answers to security and privacy
breach, but the time that is spent on the phone, as also
pointed out by my colleague, has been significant, and I
personally have spent probably 15 to 20 hours trying to resolve
two cases.
The last item that I wanted to cover was S corporation
basis. I have a client case right now that is under audit. The
client has closed the business. They have been in business for
about five years. They lost money each year, and the auditor
has spent three days on the audit right now at great expense to
the client, and it is all about the amount of basis that the
client had. The basis rules and my dialogue are contained in my
testimony feeder review.
Thank you very much for your time to present these.
Chairman CHABOT. Thank you very much.
Mr. Mankowski, you are recognized for five minutes.
STATEMENT OF STEPHEN F. MANKOWSKI
Mr. MANKOWSKI. Chairman Chabot, Ranking Member Velazquez,
and members of the Committee, thank you for inviting me to
testify today.
My name is Stephen Mankowski, and I am a CPA. I am the
executive vice president and tax policy chair of the National
Conference of CPA Practitioners.
Tax compliance burden has been defined in the GAO Report on
Small Businesses as the time and money spent by the taxpayer to
meet tax obligations, not the associated liabilities. An
objective of the administration and the IRS has been to
minimize taxpayer burdens and eliminate unnecessary ones.
There has been a decided change in how business is
transacted. Credit cards have become the norm. Business owners
have had to accept the payment processing, compliance, and
equipment rental costs as cost of doing business. Online sales
have caused the IRS to question the voluntary compliance of
reporting all revenue.
As a result of a 2008 law, payment card processors had to
begin reporting credit card receipts of the IRS and the
merchant in 2011 and added the number of monthly transactions
for 2012. Once a merchant annually has 200 transactions and
sales of at least $20,000, they will receive Form 1099-K,
Merchant Card and Third Party Network Payments. Initially,
1099-K results were to be placed directly on the specific lines
on tax returns. This changed as many issues arose.
Specifically, there was confusion on how sales tax gratuities
and merchandise returns were handled on 1099-K. Those same
concerns still exist and are just some of the reasons that the
IRS has not taken a stronger stance on the use of the
information on these forms.
Business owners track revenue by specific categories, such
as sales, consulting, or rental income. They do not track
revenue based on how they are paid. Trying to accurately track
revenue to match the 1099-K would actually result in an
accounting nightmare. To further complicate the recordkeeping,
businesses receive a 1099-K for each specific payment
processor--one for MasterCard/Visa, one for American Express,
one for PayPal, and another for Discover. And even a second
round if they change processing firms during the year.
From the IRS viewpoint, this form has helped increase
voluntary compliance among small businesses. Many virtual
businesses that had previously flown under the radar are now
filing income tax returns and paying taxes. In addition, the
1099-K has allowed the IRS to establish a database whereby they
can obtain a better understanding of the revenue sources within
particular industries.
The IRS instituted a pilot program for the 2015 filing
season called the Payment Mixed Comparison tool that utilizes
database. NCCPAP was invited to participate in this program,
which allows our members to enter selected data from the
client's 1099-K. The tool accesses the IRS database by a
specific merchant category code (MCC) and compares various
ratios for a business. The result tells the CPA if the results
are within the specifications of the database. A common flaw
with the 1099-K is that if the payment processor enters an
incorrect MCC code for a business, the results could be beyond
the standard deviation, which may result in an IRS notice. The
results from the tool have been strictly for the benefit of the
taxpayer and for informational purposes only.
Currently, the IRS is not capturing data from this tool.
The database will continue to improve as the volume of 1099-K
data is input into the tool. Unfortunately, the tool did not
get the expected usage due to practitioner concerns.
Specifically, many practitioners did not believe that the IRS
was not tracking results, the name of the tool was not the
best, and the tool did not go live until February 2015, after
most CPAs had already completed their training and had begun
preparing tax returns. In addition, many felt there should be a
better results besides typical or unusual. Hopefully, this
program will continue and improve next year and we will see
more uses by tax professionals. If used properly, this tool
could actually reduce taxpayer burden by addressing issues of
credit card revenue while the data is still fresh in the
business owner's mind.
The form 1099-K program also has the potential to be a
disaster. This is a repeat of warnings from NCCPAP and others
in the practitioner community when the form 1099-K matching
program was first proposed. The IRS should use all tools
possible to ensure tax compliance and close the tax gap.
However, as the GAO has correctly indicated, this is a flawed
system with no reliability of matching gross income with the
1099-K reports.
I would like to thank Chairman Chabot, Ranking Member
Velazquez, and all members of the Committee for the opportunity
to present this testimony today. I will be happy to answer any
questions. Thank you.
Chairman CHABOT. Thank you very much. I think it was
excellent testimony by all the witnesses here this morning, so
we thank you for that. And we will go ahead and open up the
questions, and I will yield myself five minutes to begin.
I will start with you, Mr. Mihm, if I can. In your report,
you identified around 25 past GAO recommendations that if
implemented could help reduce compliance burden on small
businesses. How seriously do you feel that the IRS has taken
the GAO's recommendations thus far?
Mr. MIHM. I think on the whole, Mr. Chairman, the IRS does
take our recommendations seriously. I mean, they have wide
ranging and very difficult responsibilities. We are always
making recommendations.
Chairman CHABOT. Have they implemented any of them?
Mr. MIHM. They implement quite a few. The ones that we are
talking about today are ones that we believe they have not yet
implemented, and there are still plenty of opportunities on
that.
Just as an example, the telephone answering over the last
year. 2014, if you called 67 percent of the time you could get
through. 2015, you were getting through 59 percent of the time.
I am sorry, 39 percent of the time. These are the courtesy
disconnects. What an Orwellian term that Mr. Lewis has
mentioned. The wait times----
Chairman CHABOT. The courtesy disconnect as it was referred
to, if you have been waiting on there for two hours, their
courtesy is to basically hang up on you?
Mr. MIHM. They hang up on you. Yeah.
Now, very often though you beat them to the punch because
the hang-up rate in 2014, the individual saying I cannot take
this anymore was 29 percent of the calls. It was 57 percent
this year. And that is also explained by the wait time. The
wait time in 2014 was about 17 minutes and about 28 minutes
this time. And these are averages.
What we have urged IRS to do is a couple of things. One is
that they need to benchmark their telephone assistance service.
They are not the only organization in the United States that
has a call center, and so there are plenty of other places that
they can benchmark against.
Second is that they need to then also be thinking of an
integrated strategy that considers how they can provide service
and information to taxpayers using both the phone and then also
using and augmenting the IRS website and having more of an
Internet-based strategy for getting information out there.
And then finally, they need to engage the Congress. As
their resources have been going down in recent years, they need
to make sure that they take a strategic approach, sit down with
the Congress and say these are the tradeoffs that are being
made. If there are different tradeoffs that we should be
making, please give us guidance on that. But those are all open
recommendations.
Chairman CHABOT. Thank you very much.
Mr. MIHM. Yes, sir.
Chairman CHABOT. Mr. Williamson, I will turn to you next.
Now, you are a professor and you also have a tax
preparation service yourself. What is the biggest one or two
complaints that you hear from the small businesses that you do
their taxes for?
Mr. WILLIAMSON. Well, they do not understand the law. And
when taxpayers do not understand the law, they come to
disrespect the law. And we all know what happens next, and that
is fraud, that is cheating. So what we need is simpler rules
that I, as a tax return preparer, can explain to my clients and
they can accept me to prepare the return and pay their fee to
pay their tax. I think all of us here today have said taxpayers
want to pay their tax. I hail from Utica, New York. I know the
people in Utica, New York, want to pay their tax. But the
problem is they do not understand the law.
Chairman CHABOT. And you indicated that you feel strongly
that going to a simplified cash method of accounting----
Mr. WILLIAMSON. Absolutely, sir.
Chairman CHABOT.--would be one of those critical things we
could do to make it more understandable?
Mr. WILLIAMSON. The clients I represent, and I represent
the smallest of the small probably at this table, where
$300,000 or $400,000 a year of sales on a Schedule C is a
living for your family. Those folks do not need to do
depreciation schedules and be on the accrual method and do cost
of goods sold. They know what they need. They need cash in the
bank, and they are willing to take some of that cash and pay
their tax with it.
Chairman CHABOT. Thank you.
Mr. Lewis, you said something which I agree with very much,
and if you want to expand upon it briefly, you said that the
time spent by your average small business person in compliance
with the tax code is time that they are not spending on what
their basic business is and having a successful business so
they can perhaps expand and create more jobs for more people.
Is that accurate, and did you want to comment on that?
Mr. LEWIS. Yes, it is accurate. And I think one thing to
keep in mind is any one particular provision when it starts out
has a reason. These tax code laws that we are talking about, at
one point there was either a motivation or something. But when
added upon the ones from last year and adding upon the ones
from last year and the last year and the last year, you find
that you have got these layers. And what we have done is we are
not taking everything away. So every single year you find
yourself getting more and more. So even if you say this
particular provision is not that burdensome, you have to take
it in context of what about the last 20 years and all of that
added together. It is simple. They have so much time in a day.
If you are taking their time by making them comply with
regulations, you are taking time away from what they do.
Chairman CHABOT. Thank you.
I will be real brief in my last question, Mr. Vitale.
Do you think it has reached the point where it is almost
impossible for a small company nowadays to do their own taxes?
Mr. VITALE. Yes. We have some very small clients similar to
the professor, and even the smallest of small clients, they
have access to TurboTax and a lot of tax programs that
supposedly could make their life easier, but we get calls all
the time from small, small companies that still need help with
that.
Chairman CHABOT. Thank you.
Mr. Mankowski, I apologize. I ran out of time, but I am
sure you will get more questions.
So I now yield to the ranking member for questions.
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
Mr. Mihm, the payment card pilot essentially compares 1099
forms from payment processors with tax returns to identify
underreporting and inconsistencies. If the information on the
forms does not match, the IRS sends out notices. What is the
benefit of a notice if it leads honest companies to have to put
in additional work to reconcile forms that may be mismatched
for unrelated reasons such as self-tax, tips, so forth?
Mr. MIHM. Yes, ma'am. There are actually two benefits. One
is before the notice goes out, you would hope that the
knowledge that IRS is receiving this payment card information
and that this matching is taking place will be an incentive to
get them to do that. IRS has seen some very early data that
they believe is showing that that is the case. Again, this is a
minority of taxpayers we are talking about.
For the other taxpayers, it is, as clearly you are implying
in the question, it is not much of an advantage for them if
they have to, in a sense, go back and correct an IRS record on
this. This gets to why we think it is so important for IRS to
have a good evaluation strategy. The potential for this pilot,
like a lot of third-party information reporting, is that it can
really reduce burden, can help improve compliance, so it could
be a big deal. And I realize that all three of those were
conditionals that I used--could, could, could. But they have to
make sure that they implement it the right way. They have to
make sure that they reach out to the stakeholders and engage
them in the design of the program, and they need to make sure
that they are actually measuring the performance so that they
know if they are actually getting more benefit for this program
or are we sending out bogus notices to people that is actually
causing more headaches for honest taxpayers.
Ms. VELAZQUEZ. An important element, of course, is the type
of outreach that the IRS will do.
Mr. MIHM. Absolutely, ma'am.
Ms. VELAZQUEZ. So when you look at tax compliance and the
effect it could have on small businesses, did you also look at
the fact that since 2010, the IRS lost 18 percent of its
budget? Does that have anything to do----
Mr. MIHM. Yes, ma'am. And that was the reference I was
making to the question of the chairman, is that the IRS needs
to engage with the Congress, given how much their budget has
gone down. Now, this has all been with added responsibilities.
You know, both in the growth of the number of taxpayers,
Affordable Care Act implementation responsibilities, other
changes to the tax laws. They are in a very difficult position
as an agency, and I realize there is not a lot of appetite to
be looking to plus up the IRS budget.
Ms. VELAZQUEZ. Right.
Mr. MIHM. Which means why do we have to engage in that?
Ms. VELAZQUEZ. But we need to understand that by cutting
the budget so that it punishes the agency, in reality, it
punishes small businesses because they will not get the type of
services needed, such as when you place a call and expect for
someone to be able to answer that call.
Mr. Mankowski, you describe how accepting credit cards and
their related fees is becoming the norm and just another cost
of doing business. However, as you stated, the complexity of
accepting different cards with different rules about deposits
and deductions adds to taxpayers' burden, how does the rising
popularity of electronic payments impact your firm's typical
small business client?
Mr. MANKOWSKI. Thank you. It has been a major impact on the
clients. They are finding that in the past where they have just
been able to just accept cash and checks, that more and more of
the population, for whatever reason, has an aversion to
carrying cash, and they are paying with credit cards even if it
is for a two dollar soda at the convenience store or wherever
else they are transacting business. So it is something that
they have really been having to assume the burden of. And with
that, they have added fees, not just with the processing fees
that are going to vary based on the type of credit card that is
being used, whether it is a points card or so forth that tend
to have higher rates, in addition to the different rates that
MasterCard/Visa, versus American Express or Discover. But now
they are also finding that in addition, because of credit card
fraud that has also been going on, that now they also have
added compliance burdens that they are required to go through,
whether it is some sort of training and annual webinars or
seminars that they need to undergo to be aware of compliance
and whether there are different rates and different services
that they are required to do if the card is present or if the
card is not present, to make sure that they are not
participating in the fraud that they are trying to prevent.
Chairman CHABOT. Thank you.
The gentlelady's time has expired.
The gentleman from Missouri, Mr. Luetkemeyer, who is Vice
Chairman of this Committee, is recognized for five minutes.
Mr. LUETKEMEYER. Thank you, Mr. Chairman. I am way over
here on the corner.
Mr. Williamson, you mentioned in your testimony cash
accounting, accrual accounting. You do business with a lot of
small businesses, and there is a thought process of lowering
the amount where you have to start going to accrual accounting.
What would that do to a lot of the small businesses you deal
with?
Mr. WILLIAMSON. It would make it a lot easier for them to
file their tax returns.
Mr. LUETKEMEYER. If you lower it to----
Mr. WILLIAMSON. Lower it? No, we are advocating raising the
threshold that would permit you to drop the cash method to $10
million. To lower that, I think you would have serious
compliance problems.
It alludes to the point I was making a moment ago about
disrespect for the system. And if people do not feel that
filing their tax return adds any value other than having their
money confiscated by the federal government, I do not know if
you would get very many correct tax returns as a result.
Mr. LUETKEMEYER. You were talking about noncompliance. I
was reading the problem with Greece this past month or so here
that they have 95 percent noncompliance with regards to
paying----
Mr. WILLIAMSON. Well, I sincerely hope we never----
Mr. LUETKEMEYER. I do not know how in the world their
economy can exist if they have got 95 percent noncompliance.
Mr. WILLIAMSON. I think we see it is not.
Mr. LUETKEMEYER. They have got a one percent problem, do
they not?
Mr. WILLIAMSON. Yes, sir.
Mr. LUETKEMEYER. You also made a comment, and I want to
follow up on this which is quite interesting, that your clients
do not understand the law.
Mr. WILLIAMSON. Yes, sir.
Mr. LUETKEMEYER. If you have small business people who do
not understand tax law, how can they make good plans? How can
they make good business decisions? How can they make good
judgments on how they want to run their business? Are you
advising them on this? Are you taking an advisory role? Or are
they just out there like a ship without a rudder? Because if
you do not understand the tax implications of the business
decisions you make, you can really mess up your business pretty
quickly.
Mr. WILLIAMSON. Precisely, Congressman. And too often that
is the case. People make business decisions without
understanding the tax consequences of them. And I like my
clients to always know they can call me and ask a question and
will not necessarily get a bill off the top, not like the
lawyers. But I would hope that they would call me. But the
problem is the law is so complex.
Chairman CHABOT. The chair will strike that last remark
from the record. Just kidding.
Mr. WILLIAMSON. But you are absolutely right, Congressman.
Businesses do not understand tax law, and too often make the
wrong decision.
Mr. LUETKEMEYER. And the complexity of it just adds to the
problem.
Mr. WILLIAMSON. Yes, sir.
Mr. LUETKEMEYER. So we are adding to that problem every
year as we go about our business here.
Mr. Lewis, you are in the banking business. I have got a
quick question for you here. We have created fewer businesses
in the last six years than we have lost, so we have actually
gone backwards. And of course, when you are talking about
creating businesses, it is small businesses that we are talking
about creating. And so have you seen in your business world,
that the tax code and the complexity of it and the cost of
compliance, all of this is a factor that has caused fewer
businesses to actually be created?
Mr. LEWIS. Yes, and that is a great question. I think the
answer in short is yes. Again, it goes back to simple algebra.
At some level there is only so many hours----
Mr. LUETKEMEYER. You better make simple algebra very simple
for me.
Mr. LEWIS. There are only so many hours in a day, and there
is only so much time and there is only so much revenue coming
in. And again, look at the banking, look at the financial
services, for instance. The last decade there has been all this
bank regulation that has come upon us. Just look at the bank
itself. What you find is you find all this additional level of
compliance that is required, and any one particular provision
makes sense. There is a reason for it. But taken as a whole, it
becomes problematic because in the end, really, as was
mentioned here, a small business owner, what really matters to
them is what they can put in their pocket at the end of the
day. It is the cash in their pocket. It is what they can do. It
is what they can consume. It is to take that money and pay for
tuition for their child. It is to take a vacation. It is to pay
a mortgage. That is what really matters. And all the rest of
this that we are discussing is getting to that bottom line.
So you asked the question, what kind of an impact does it
have? First of all, I cannot advise a client right now on the
tax law for the current year because we have the extenders that
are still out there. How can I go to somebody and tell them
what is going to happen with bonus depreciation? Or 179? They
are going out to make a decision right now. They want to make a
decision but instead they are paralyzed because they do not
know. Tell me what the law is they will say, and then I will
know how to react. You can help me, because after that it is an
Excel spreadsheet. You can run it. But before then, without
certainty, without permanency, you run into this problematic
situation where, yeah, it does impact those businesses.
Mr. LUETKEMEYER. That is interesting. You talk about 179
depreciation. Last year we did the extender I think two weeks
before the end of the year, and I have got a good friend of
mine who runs a business that he sells a lot of rock crushers
and drills and things like that for quarries. And he, over the
course of the year, sold 11 different drills. Sold 11. But he
sold six of them in the last two weeks of the year. Now, these
things cost between $100,000 and $125,000. And I can tell you
the same story with regards to farmers buying tractors and farm
equipment. They waited until the last two weeks of the year in
order to make that decision because they were looking for this
opportunity.
Mr. LEWIS. It certainly was not because of Christmas; no.
Chairman CHABOT. The gentleman's time is expired, but if
you wanted to comment.
Mr. LEWIS. I was going to say and the reality is the
commentary would be if the tax law has a shorter shelf life
than say a carton of milk, it is probably something we ought to
look at. That is going to impact them.
Chairman CHABOT. The gentleman's time is expired.
The gentlelady from North Carolina, Ms. Adams, who is the
ranking member in the Investigations, Oversight, and
Regulations Subcommittee, is recognized for five minutes.
Ms. ADAMS. Thank you, Mr. Chairman, Ranking Member
Velazquez, for hosting this hearing.
Tax burden on small businesses buried in the complexities
of the tax system is something that we must tackle head on. The
state of North Carolina is home to more than 800,000 small
businesses, which means that there are more than 800,000 small
firms in my home state that potentially have tax compliance
issues, including cost burdens associated with tax compliance.
Mr. Williamson, how should the current tax code be altered
to reduce that cost burden for small businesses?
Mr. WILLIAMSON. Well, in terms of the tax return itself, we
could make that a lot simpler. All of us have advocated here
with respect to advancing more cash method of accounting so you
do not have the need to compute your inventory, cost of goods
sold, the depreciation schedules you have to keep. Basically,
treat everything as 179 as was alluded to earlier, or as bonus
depreciation, 100 percent depreciation. And so it is simply to
prepare your tax return based upon your checkbook and the cash
that comes in, the cash that goes out, and we net the two and
that is your taxable income. That makes a very simple tax
return.
Ms. ADAMS. Okay.
Estimates by Internal Revenue Service of the size and the
composition of the federal tax gap indicate that small
businesses organized as a pass-through entity account for a
substantial share of that gap. Their contributions are thought
to be the result of honest mistakes born of the complexity of
the code and tax evasion tied to cash payments for goods and
services. How should the federal tax code be reformed to reduce
noncompliance by small businesses?
Mr. Williamson?
Mr. WILLIAMSON. Well, as far as the pass-through entities
go, and as was already pointed out here in the testimony, most
revenue for small businesses is coming through pass-through
entities. We can, again, through the cash method of accounting,
easily determine what the net profit is of the business and
allocate it to your partners or to your S company shareholders
on the K1s. The complication that arises is they need to
separately account for all the items on a partnership return or
S company return because they might impact an individual
partner or individual S company shareholder differently. That
is a problem in terms of the pass-through entities.
I would offer, and again, I think a proposal has been made,
for earlier filing of pass-through entity returns so that the
information forms through the individual partners or
shareholders would be in their hands a lot sooner, and that way
they would have more time to prepare their tax returns and that
would increase compliance.
Ms. ADAMS. Okay. I have one final question.
Minority firms often have an even harder time getting off
the ground and then staying afloat than other demographics of
small businesses, particularly as it relates to lending.
For Mr. Williamson and Mr. Mihm, have you studied the
impact that tax compliance has on minority-owned firms, and if
so, what is the rate of minority-owned firms closing their
businesses as a result of the difficulty in the tax compliance
compared to white-owned firms?
Mr. WILLIAMSON. Congressman Adams, I do not have those
statistics in front of me. I can be happy to do my best to try
to find some of that information for you but I have no
information on the relative closures of minority firms versus
nonminority firms at my fingertips. I am sorry.
Ms. ADAMS. Would either of the other gentlemen like to
respond?
Mr. MANKOWSKI. Ma'am, we do not have that information
either, but we would be happy to work with Mr. Williamson and
others to make sure we answer your needs on that.
Ms. ADAMS. Okay.
One challenge to tax compliance for small businesses may be
that the tax code has no uniform definition of a small
business, so how should small businesses be defined for tax
purposes?
Mr. WILLIAMSON. What we have done in the Tax Policy Center
is to define them as $10 million of gross receipts. If you look
at provisions of the Internal Revenue Code, Uniform
Capitalization Rules, some of the other provisions regarding,
$10 million seems to be a generally accepted threshold. And I
think that is what the GAO study used as well.
Ms. ADAMS. Would either of the other gentlemen like to
respond?
Mr. MANKOWSKI. Yes, ma'am. We have used, taking Treasury's
lead, we use $10 million, although as you point out, there are
a variety of different ways that you can do it. Number of
employees. But we use the $10 million. I should also point out
that the way IRS is organized implicitly assumes that the $10
million, their small business unit has a $10 million threshold
to the organizations or entities that it looks at.
Ms. ADAMS. Thank you.
Mr. Chair, I yield back.
Chairman CHABOT. Thank you. The gentlelady yields back.
The gentleman from New York, Mr. Hanna, who is chair of the
Subcommittee on Contracting and Workforce is recognized for
five minutes.
Mr. HANNA. Thank you, Chairman.
The tax cap that you spoke of, Mr. Mihm, and everybody
alluded to in one way or another, I would like to talk to you
about the underground economy and the propensity for it to grow
over time through difficulty in the tax code and what you see
on the ground. It is a concern to a lot of people. I mean,
there are all kinds of incentives not to pay your taxes. One of
them is other people are not. In the aggregate nature of the
1099s and collecting credit cards, that is pretty subjective.
It certainly can be. I am curious how it is fair.
And Mr. Williamson, one of the problems with going from
five to 10 on a cash basis, and what the IRS does now is if you
buy inventory on a cash basis, then basically, you are mixing
your accrual system with your cash system.
So Mr. Mihm, if you could address my question about the
underground economy and its growth. If you are prepared to do
that a little bit, or anybody who would like to.
Mr. MIHM. Yes, sir. The tax gap as you are mentioning is
enormous. I mean, IRS estimates--this is based on 2006 data--
but it is about $450 billion a year. And this is the difference
between legally owed and actually paid in a timely manner. Some
of that is clearly the underground economy, meaning that it is
nonfilers. In the technical term, this is people that ought to
be filing that just are not.
Mr. HANNA. Do you have any idea? How could anyone have an
idea what that is? But do you have one?
Mr. MIHM. Well, they have a national research program so it
is an enormously complex estimation that they do. The size of
the underground economy is probably the weakest aspect of that
estimate. A lot of that, also the tax gap source is
underreporting of people who do actually report but do not
report the full amount.
Mr. HANNA. But so much happens with compliance on the
margin.
Mr. MIHM. Yes, sir.
Mr. HANNA. Virtually everything, right?
Mr. MIHM. Right.
Mr. HANNA. So marginally, difficulty with filing, as Mr.
Williamson talked about, the cash basis, which is certainly
easier, what do you think that looks like today?
Mr. MIHM. Well, your point, sir, about it being marginal is
exactly right, and it gets to what one of the key strategies
needs to be, which is assuming that most people do want to pay
their taxes--now, we are not talking about the underground
economy in this case, but assuming that most people do want to
pay their taxes, and then making it easier for them to do so,
because in many cases where there is underreporting, the amount
of underreporting makes it hard to justify going after any one
individual. I mean, you have to in some senses to get a
deterrent effect to make sure that people always know that they
have to, but you do not want to spend a million dollars going
after $5,000. You cannot do that in all cases.
Mr. HANNA. But is that not part of the problem?
Mr. MIHM. Yes, sir.
Mr. HANNA. I mean, because what you are really doing is you
are sending a message that you are incentivizing smaller
taxpayers' amounts of money because you are only after those
people where the money is. Right? Willie Sutton.
Mr. MIHM. Yes, sir.
Mr. HANNA. But when you look at the aggregate number, you
mentioned $450 billion, that would draw you towards an opposite
conclusion. It might.
Mr. MIHM. Well, that is why good customer service is so
important. That is why third party reporting that makes
compliance relatively easy for people is so important. Because
obviously, you are making exactly the right point here. Trying
to chase the money after the fact is ultimately not going to be
very good. It is not going to be good for the businesses
because of the mistakes that could be made as the ranking
member mentioned. It is not going to be good for the IRS
because of the cost benefit of that. We need to make sure that
we have in place the right independent third party reporting.
We make sure we have the customer service.
Mr. HANNA. So even though the money is not there, the value
of going after those people who fall completely under the
radar, not paying at all, the underground economy, there is
value in that?
Mr. MIHM. Yes, sir. You cannot do that in all cases but we
need to do enough of it so that as the vice chair was
mentioning in his questions, is that we do not get basically a
sucker tax system where the people who are paying their taxes
are the criminals.
Mr. HANNA. Mr. Williamson, how do you reconcile, if you got
to 5 to 10 on a cash basis and get rid of accrual for everybody
under that, how do you reconcile--and I have got about 38
seconds--the inventory?
Mr. WILLIAMSON. That is the point. That was the point in my
written testimony, Congressman. We would eliminate cost of
goods sold and that the purchases or construction of inventory
would be deducted as those costs are incurred regardless of
when the product is actually sold.
Mr. HANNA. But are you not giving bonus depreciation to
everything that used to be called inventory?
Mr. WILLIAMSON. That is what we were saying. In a world
that we would be advocating, bonus depreciation would be
extended to inventory.
Mr. HANNA. Thank you. My time is expired.
Chairman CHABOT. Okay. Thank you very much. The gentleman
yields back.
The gentlelady from American Samoa, Ms. Radewagen, who is
the Subcommittee chairman on Health and Technology is
recognized for five minutes.
Ms. RADEWAGEN. Thank you, Mr. Chairman.
My question is for Mr. Vitale. Is it safe to say that the
higher cost associated with the tax compliance obligations that
tax professionals endure push small business owners to waste
their time preparing their own complicated taxes instead of
growing their business?
Mr. VITALE. Great question. There is probably an element of
truth to that. The fundamental problem is going to remain until
the code is simplified and clarified. The person who has
invested in their business and has a lot at stake is, more
often than not, going to eventually reach out to the
professional to try to get the right answer and the best answer
possible. And that is an expensive proposition. But the cost of
them not doing that and going the other way at the end of the
day could probably be much more costly by their failure to
comply.
Ms. RADEWAGEN. Thank you.
Thank you, Mr. Chairman. I yield back.
Chairman CHABOT. The gentlelady yields back.
I now recognize the gentleman from South Carolina, Mr.
Rice, who is chairman of the Subcommittee on Economic Growth,
Tax, and Capital Access for five minutes.
Mr. RICE. Gentlemen, thank you so much for being here
today. I heard directed stated or allusions to the fact in all
of your testimony that small businesses are the backbone of the
economy and the backbone of job creation in this country;
right? Pretty much everybody agrees with that.
Beginning in 2009, for the first time since it has been
recorded, more American businesses are closing than are
opening. Do you think this outdated and burdensome tax code has
anything to do with that, Mr. Mihm?
Mr. MIHM. That is something, sir, that we really have not
looked at directly, so I will have to defer to my colleagues on
the panel if I may.
Mr. RICE. Okay. Well, do you think overburdening government
regulation, do you think that has anything to do with it?
Mr. MIHM. Well, there are certainly, as we pointed out in
this testimony, other findings looking at regulations in
general. There are costs associated with the implementation of
regulations. There are costs to small businesses. And we have a
table that shows that for corporations, if you have less than
five employees, it can be between, you know, around $4,500 per
employee in order to comply. That is a substantive cost that is
imposed.
Mr. RICE. Do you think the complexity of our tax code
creates a barrier to formation of small business?
Mr. MIHM. Certainly, the complexity of the tax code creates
a barrier to any economic activity. It creates a barrier to
compliance. It creates a barrier to economic growth.
Mr. RICE. Mr. Williamson, for the first time, beginning in
2009 and continuing through today for the first time more
American businesses are closing than forming. Do you think our
complicated tax code has anything to do with that?
Mr. WILLIAMSON. In my personal experience, what it is
usually about is ``I better get out of business because I
cannot pay my payroll taxes for my employees.''
Mr. RICE. Mr. Lewis, do you think--same question to you. Do
you agree our tax code is a burden to formation of small
business and to continuing small business?
Mr. LEWIS. I think the tax code is certainly a contributor.
One of the things that I think is missing in most of our
regulation, which is in essence what tax law is, is we failed
to adequately address the cost benefit. I know I hear it. I see
it. People talk about it. But are we really looking at cost
benefit from the small business lens? That is the question.
Right? I mean, you will hear people, they will espouse from the
floor this is a good thing and it weighs, outweighs, but I
think the real issue is from a small business lens. One of the
things we have is a fundamental----
Mr. RICE. Mr. Lewis, it is not that I do not want to hear;
I do want to hear, but I only have five minutes left to keep
going.
Mr. LEWIS. All right.
Mr. RICE. Mr. Vitale, I am going to shift questions on you.
Since 2010, notably the date that Dodd-Frank was enacted,
bank formations have slipped from an average of 100 per year to
three per year. Do you think that will have any effect on small
business given that new banks are typically small banks and
they are typically the ones who lend to small business?
Mr. VITALE. I believe the answer is yes based upon--I will
affirm in our client base, we are a $1.6 billion revenue firm.
Sixty, 70 percent of our business is labeled as small to
midmarket, and with the reduction in the number of banks that
we have seen--community banks, local banks, we have seen many
of our clients go to alternative markets for their financing.
That financing is often much more expensive.
Mr. RICE. But the really small businesses, those
alternative markets are not really available to them, are they?
Mr. VITALE. The alternative market is usually an angel
investor or private investor, and that money is even more
expensive.
Mr. RICE. Mr. Mankowski, do you think that the slippage of
an average of 100 bank formations to three, which these new
banks are typically the lenders to new banks, do you think that
will have an effect--to small businesses, excuse me--do you
think that will have an effect on business formation?
Mr. MANKOWSKI. I think as far as business formation, not
necessarily, because a lot of the businesses, recently they
have been the byproduct of the overall economy where they have
been downsized out of their current opportunities, and now they
have exhausted their unemployment benefits and they have kind
of been forced into their own businesses. So the bank
formation, not so much of causing people to not form their
businesses, but I think it hurts them if they are looking for
additional revenue because I do agree that the smaller banks
and the community banks seem to be the ones that really are
more in tune to lending to the small businesses.
Chairman CHABOT. The gentleman's time has expired.
The gentleman from Nevada, Mr. Hardy, who is chair of the
Subcommittee on Investigations, Oversight, and Regulations, is
recognized for five minutes.
Mr. HARDY. Thank you, Mr. Chairman.
I just happen to be a small business owner myself, or at
least I used to be. And Mr. Williamson made the statement, Mr.
Lewis, just a few minutes ago, the fact that people, businesses
want to pay their taxes. And I agree. As a small business
person, I want to pay my taxes. Would you agree the reason we
want to pay our taxes is because we have to have a good, sound
foundation to make sure we are profitable in paying taxes in
order to receive revenue from banks?
Mr. LEWIS. Yeah. I mean, one way to look at it is that
small business owner is in a partnership with the federal
government. There are a lot of services, a lot of economic
ability to make money. And so there is this agreement. And the
tax code is sort of like the partnership agreement. It defines
how we are each going to behave with each other, and I think
the majority of Americans that own these small businesses are
hard-working, they are entrepreneurial, and they want to do
what is right. It is when you start adding in complexity, the
lack of certainty, the perception of inequality, I think that
is where you start getting the fringes where people start to
take a step back and either through overt or covert actions
maybe are a little less complaint. But I think the majority
want to comply.
Mr. HARDY. I believe there are a number of things that are
causing small businesses to fail, but in 2012, 64 percent of
all employees working were working for small businesses. Today,
we have the lowest number of small businesses in the last three
decades or further. Is it because of our tax regulations? Do
you think it is a combination of a number of things? Anybody
care to address that?
Mr. WILLIAMSON. Well, I will just say that it is very
difficult for my clients when they decide whether they are
going to take the next step and hire someone. As we have seen
here today, it is very expensive. Just the tax compliance costs
are very expensive. The 941s, the W-2s, the payments every two
weeks or a month. That is very intimidating for a small
businessman to take on that first, second, or third employee,
and then to have the cash flow, of course, to be able to pay
them their wage.
So regarding small businesses, that, in my practice, holds
them back as to whether they are going to hire those first two
or three people. That is a big, big deal with them, and the tax
rules impede that.
Mr. HARDY. Some months ago we had a hearing here and they
discussed other tax causes to small businesses, and once you
grow just even your business a little bit, the average, I think
it was, about $1.2 to $1.5 million per year for people to get
their taxes done once they reach a certain threshold. Have you
seen that, Mr. Williamson, on your avenues? That is just to
prepare it to get it to you folks.
Mr. WILLIAMSON. That is true. To assemble the books and
records to put them on my desk so I can do the return is quite
a procedure for them. And to ask me, or anyone at this table to
do that kind of work can be very, very expensive, and it is
very hard to find people that have the skills to assemble that
financial information for them in order to have me even begin
the tax return. No question about that.
Mr. HARDY. The 1099 form, Mr. Mankowski, why does the 1099
requires so much for small businesses, is such a burden? Can
you go into a little deeper process of what your discussion was
there?
Mr. MANKOWSKI. Yes, there are two aspects. First is that
there is common belief that there are items that to go onto the
credit card receipts that are not revenue to the business
owner, such as sales tax, gratuities, and even if someone has a
return of merchandise that they purchased.
Take a restaurant as an example. If you put your gratuity
onto your credit card, that will show up on the 1099-K, but
that is not revenue to the business owner. Another concern from
a 1099-K perspective is if you have one of your vendors that
pays you with a credit card, where normally they would issue
you a 1099-MISC depending on the type of service, if you pay
with a credit card, you no longer have that responsibility to
issue that person the 1099-MISC if their only payments were
credit cards in excess of $600 total for the year. If you now
have payments under the $600 that were totaled under with cash
or checks, you are relying on the credit card processor to
issue the 1099-MISC. In essence, it falls on the 1099-K, not
through the 1099-MISC, a form that the government is not really
using for full verification of the income for the business
owner.
Mr. HARDY. Okay. Let me ask one last question.
Mr. Vitale, as far as the IRS, can you elaborate how they
can and should be providing us better security for small
businesses and all businesses in their businesses to make sure
we are protecting that security of those tax returns?
Mr. VITALE. Sure. One of the things that I highlighted in
my written testimony was the use of PINs. We have some experts
in the office that specialize in security, cybersecurity, and I
believe the way the world is going towards a PIN-based system,
the current Social Security Number is very vulnerable, very
easy to get at. It is very easy to hack, and that is the
gateway to a lot of theft. And I believe the transition has to
happen sooner rather than later.
Chairman CHABOT. The gentleman's time has expired.
We are going to move into a second round, and we are going
to start off with Ranking Member, Ms. Velazquez, for five
minutes.
Ms. VELAZQUEZ. Thank you, Mr. Chairman.
Mr. Williamson, we know that there has been a movement away
from businesses organizing as C corporations in favor of pass-
through entities. Today, corporate tax revenue makes up less
than 10 percent of our federal revenue. What is it about pass-
through entities that make them such an attractive business
structure, and what is the effect on small firms when our tax
policy hinders their use?
Mr. WILLIAMSON. Well, that is an excellent question, and
obviously, the answer is, of course, C corporations are subject
to two levels of tax, once at the C corporation and then a
second tax when any sums are distributed to the shareholders.
That is why you have a continuing decline in C corporations,
particularly when you have S corporations available that are
corporations for all purposes other than the IRS revenue code.
And also, now you have the LLC, the limited liability company,
that provides the same limitation on personal liability of the
owners of the business. So that is why you see C corporation
numbers go down and pass through numbers go up.
Ms. VELAZQUEZ. Thank you.
Can you elaborate on whether individual tax rates influence
business decisions?
Mr. WILLIAMSON. Well, that goes in, again, and my written
testimony referred to that, is that if we are going to reduce
the corporate tax rate in this country, some consideration must
be given to small businesses; that the LLC, the S corporation,
indeed the sole proprietor, will be paying effectively higher
rates than C corporations. And C corporations do not have to
pay dividends. And the owner of a C corporation can sell the
stock rather than take distributions. So some consideration
must be given to the sole proprietorship and partnership and
LLC industry.
Ms. VELAZQUEZ. Thank you.
Mr. Mankowski, you mentioned the PMCT pilot program had
some drawbacks, including an overly simplistic, typical, or
initial response when comparing a client's data to the
database. What recommended changes would you make to better
implement the program this coming tax season?
Mr. MANKOWSKI. Thank you. As far as the implementation, if
the IRS really wants to maintain the anonymity for the users,
they really can have some of the specific results that many of
us practitioners would be looking for to know where their
ranking is inside of the usual or the unusual. So it is almost
a catch-22. How much information do you really want to get to
see where you are at in the specific categories? I think having
the ability to have it rolled out earlier this year as year two
to the practitioner community, at least for those who have been
in the pilot program already, will just add on to the number of
users that are going to be familiar with the tool that now when
they are doing their preseason training, it will be more at the
forefront that this tool exists, even to the extent to go back
and look at the 2014 tax data and see where the results came
in, meet with their business owners and say, ``Here is where
some of the results were coming out.'' Use it as a preseason
tool and potentially have the ability to advise our clients and
work with them so that they can avoid that love letter from the
IRS that they get usually about a year, year and a half after
the fact, that at least if it is addressed and have some
general information and answers when they get a letter from the
IRS if their results were out of spec, you can pull the results
out of your file and say, ``Mr. Business Owner, remember we
talked about this last year? Here is some of the information.
We have done the leg work.'' And then they are better able to
answer the notices at that point.
Ms. VELAZQUEZ. Thank you.
Thank you, Mr. Chairman. I yield.
Chairman CHABOT. Thank you. The gentlelady yields back.
In my five minutes, I would like to do something a little
bit different. We have had some great answers to some, I think,
very good questions as well. But rather than ask specific
questions, I would just like to, you know, we are making a
record here. If there is just one point that you would like to
leave with the Committee, something you would like us to
implement, or act upon, or consider, you know, I would be happy
to hear. And since I did not get to you, Mr. Mankowski, maybe I
will begin with you and we will just go down the line. But you
have got about a minute each. You do not have to take it all up
but I would ask you not to probably go any further than that.
You are recognized.
Mr. MANKOWSKI. Thank you.
As far as one parting comment, I think that the IRS has
almost been in a catch-22 recently. They have been asked to do
more and more between implement the Affordable Care Act last
year along with repair regulations, and for the current year,
also implement the Employer Shared Responsibility portions.
They are doing this with, I believe, one of the congressmen had
mentioned that their budget has been down 17 or 18 percent over
the last few years, and that is an annual decrease that they
have been getting. So they have been getting--having to do more
and more with less resources. And even now they are looking at
saying, ``Well, how come you have not done more with the 1099-
K.'' You reach a point where they are in a hiring freeze, they
cannot bring on staff, and as not bringing on staff, they are
also having the attrition from the higher level people. The
people who are not coming on now are the ones that may be a
little bit more tech savvy that can really take the service to
the next level to make it a better service for all the
practitioner and taxpayer community.
Chairman CHABOT. Thank you.
And maybe I will just--one quick thing in response. If
perhaps they should not use at least some of the resources for
targeting groups who have a certain political persuasion and
wasting resources on that, and then having to have their people
come and testify and defend themselves and records are lost and
all the rest, too. But I hear what you are saying and tend to
agree with it.
Mr. Vitale?
Mr. VITALE. Sure. I think to that point, the one
observation I have and the recommendation would be to have the
service reevaluate how it deploys its resources, where it
spends its time. With my clients with businesses, those that
are very successful have good strategic plans. They have a
plan. They invest the right time and money into the areas that
yield the best benefit.
As a case in point, in my written testimony I spoke at the
end of a client that I have under audit. The client has lost
money, restaurant business, five years, very difficult, two
partners put all their own money in, lost it, borrowed money,
paying that off, lost it. And the auditor has spent three days
auditing a company where even if she makes a change, it is not
going to make a difference. So I think those three days, 24
business hours, could be spent by people at the service doing
better things than that.
Chairman CHABOT. Thank you.
I have only got two minutes left. Mr. Lewis?
Mr. LEWIS. I will be quick.
Chairman CHABOT. You have got 45 seconds.
Mr. LEWIS. Two things. Number one, what can Congress do?
Congress can support small businesses by reforming the tax
code. It needs to be simple, it needs to be fair, and it needs
to be equitable. You give that to small business owners and
they will respond. They want it, they need it, you can give
that to them. That would be wonderful.
Second thing, IRS services. There is no substitute, there
is no additional reference point or no additional source that
we can go to to serve those clients and to serve those
taxpayers.
Chairman CHABOT. And the third one real quickly?
Mr. LEWIS. That is the second one. That is the two. Just
IRS services, focus on those.
Chairman CHABOT. Very good. Thank you.
Mr. Williamson?
Mr. WILLIAMSON. Yes. Strategically, you can have carve outs
for small businesses. You are considering international tax
reform as we speak. You can have carve outs for small
businesses of under $10 million so they do not have the same
level of compliance. They will not go overseas. Take a look at
the forms. Take a look at the requirements. Tactically, and I
think it has been mentioned here, the $2,500 increase to the
allowance to simply deduct anything and not have to depreciate
it.
Chairman CHABOT. Thank you very much.
And you have got my last 50 seconds.
Mr. MIHM. I will do my best not to take the full 50, Mr.
Chairman.
I think you have got excellent ideas, so I will not repeat
them, but just align myself with those and go off on a bit of a
different direction, and that is on the identity theft at IRS.
It costs them about $5.8 billion in 2013, IRS estimates, in
which they pay to identity thieves. Now, they stopped or
recovered, they estimate, about $24 billion before it goes out.
That is a real target of opportunity for them to be more
strategic in going after--and it is a priority area for them to
reduce the amount of identity theft as it affects IRS.
Chairman CHABOT. Thank you. My time is expired.
The gentleman from New York, Mr. Hanna is recognized.
Mr. HANNA. Mr. Williamson, I will get back to your cash
basis.
How do you manage? I mean, we know even if you are on
accrual now, you are on accrual. It does not matter the size
necessarily. I mean, the $5 million point for cash. But how can
you--how do you avoid cheating on your--by essentially buying
inventory, growing your business, or maybe that is what you
want to happen. How do you----
Mr. WILLIAMSON. I agree, Congressman. That is not cheating;
that is growing.
Mr. HANNA. Right. Right. But I mean does it not become
manipulative if you are essentially, with 179, you are saying
go out and buy a piece of equipment, which may or may not be
good. You have to hope the owner does that smartly. On the
other hand, you could conjecture that the same thing would
happen with inventory simply to avoid paying taxes. But I guess
that is part of your point, is it not?
Mr. WILLIAMSON. Frankly, I cannot think of anything less
manipulative than a totally cash basis of accounting, and
simply use the checkbook as we are advising.
Now, clearly, it may not be as financially accurate, and I
am not here to say that if you are filing SEC reports you need
to be on the cash basis. Certainly not.
Mr. HANNA. What you are suggesting though is ultimately it
works itself out.
Mr. WILLIAMSON. Oh, yes.
Mr. HANNA. Over time, whether you do something more one
year or not as much the next year, over a period of time----
Mr. WILLIAMSON. Over the life of the business you recognize
the same amount of income and have the same amount of expenses.
Mr. HANNA. I understand.
Mr. WILLIAMSON. It is all timing.
Mr. HANNA. Mr. Mihm, do you want to speak to that at all?
Mr. MIHM. No, sir. That is not an issue that we looked at
in any detail.
Mr. HANNA. So with the IRS cutting back on their budget, I
mean, it really is kind of, you know, everyone here has
complaints with the IRS for one reason or another. But back to
the 1099-K, I am guessing, Mr. Mankowski, that you do not like
it that much. You do not like aggregating, turning a lot of it
into guesswork, comparing businesses on the aggregate, and then
coming up with conclusions that this person or that person,
company or not, has complied or not?
Mr. MANKOWSKI. I do not believe, I mean, the form itself,
at least in my estimation, was kind of created to get a lot of
your people who have been conducting business on the Internet.
Your eBay sellers. And from that perspective, I think the form
has been very successful. There are clients that have come in
that have no idea that they had a million dollars worth of
business that they had done on eBay. So it does not mean they
made a million dollars, they just sold goods to that level.
So from that perspective, it has been accurate.
Unfortunately, the majority of businesses are not conducting
their business on the Internet, and it has really been--they
are collateral damage because they are out there reporting
their revenue as it is, and they have been doing that all
along, but they are the ones that are getting the notices.
Mr. HANNA. The ones being like Dragnet. You throw this
giant net in the water and some people deserve to be caught,
others do not.
Mr. MANKOWSKI. Right.
Mr. HANNA. But everybody may be inconvenienced based on
some subjective notion that the IRS has about the general idea
of what that business ought to be paying or this business.
Mr. MANKOWSKI. Right. Unfortunately, a lot of those
businesses that are getting the large credit card sales through
their online businesses--I will take someone, a client who is
on eBay. By the time they have their listing fees, their
shipping fees, their PayPal fees, and then their cost for the
product, they do not make a lot of money.
Mr. HANNA. I am going to take a rare moment to defend the
IRS. If you were them and your budget was going down every
year, this would be exactly what you would want to try to do,
to aggregate businesses based on numbers from 1099s, come up
with broad conclusions about who is good and who is bad.
Mr. MANKOWSKI. From that perspective, yes. I think time
will hash out what needs to be adjusted out of this form,
specifically the restaurant owner with gratuities, sales tax,
and how that is going to be affected and how they are looking,
because the IRS is sending out soft notices that as long as the
taxpayer responds, here is my brief reconciliation, here is my
gratuities, and this is my number I reported, they are fine
with that. It is just a lot of extra work on the business owner
to really go back and try to figure out whether it is right or
wrong because they do not track their revenue based upon
whether it is credit card, cash, or checks.
Mr. HANNA. Right. And if the IRS published those numbers I
suppose it would be another problem, what they are looking for,
what they are not looking for.
My time is expired. Thank you, Chairman.
Chairman CHABOT. Thank you. The gentleman yields back.
The gentleman from South Carolina, Mr. Rice, is recognized
for five minutes.
Mr. RICE. Mr. Mankowski, you were talking a minute ago,
just when I was speaking in my first five minutes, I was
talking about maybe some of the reasons why for the first time
in American history we are seeing business dissolutions outpace
business formation. And you said earlier that the IRS has had
to implement Obamacare in the last two years and we did not
give them any more resources to do that. Has not small business
had to implement Obamacare in the last two years, too?
Mr. MANKOWSKI. If you look under the IRS description of
small business being the $10 million and less, they have been
because they are the business----
Mr. RICE. Okay, they did have to implement, too.
Mr. MANKOWSKI. Yes.
Mr. RICE. Did we give them any additional resources to do
that with?
Mr. MANKOWSKI. I do not know the answer to that, sir.
Mr. RICE. Could that have something to do with the slowdown
in formation of small businesses?
Mr. MANKOWSKI. Yes.
Mr. RICE. Okay. The tax code, I was a tax lawyer and a CPA
for 25 years. This stuff is fun to me. The tax code was
designed 50-60 years ago and it was competitive at the time.
Does anybody up there believe that our tax code remains
competitive in the world?
Mr. MANKOWSKI. I will use an example that a friend of mine
recently had a baby and she was saying, ``Oh, well, over in
France, as an example, they get paid so many months of
childcare or maternity leave.'' And a quick search said,
``Well, that is great, but based on your income level, you
would be paying 40-plus percent in annual tax just to the
government compared to what you are paying now.'' So, yeah, you
may get an extra two months or so of paid maternity leave, but
every year you would be paying in 10 to 15 to 20 percent more
in tax.
Mr. RICE. Okay. I have got to keep going.
Do you think our tax code is competitive for American--does
our tax code make American business more or less competitive?
More or less?
Mr. MANKOWSKI. I would say less just from a compliance
perspective.
Mr. RICE. Do you agree with that across the board?
Mr. MANKOWSKI. Yes.
Mr. RICE. Thank you.
Do you think that that has something to do with the decline
in business formation in America? Mr. Mankowski? And I have to
ask an answer quick.
Mr. MANKOWSKI. Yes, I do.
Mr. RICE. Okay.
Next question. Did each of you have the chance--I assume
all of you had the chance to review Dave Camp's tax reform
proposal last year. I want to know just a one-word answer from
you all, would that make the United States Tax Code more or
less competitive in the world.
Mr. Mihm?
Mr. MIHM. I cannot give you a bottom line on that. We did
review it. I mean, we worked with the Committee and they used a
lot of our work as they were putting it together, but we did
not come to a bottom line decision.
Mr. RICE. You do not think it would be preferable to what
we have now?
Mr. MIHM. I really cannot speak to that, sir.
Mr. RICE. Mr. Williamson?
Mr. WILLIAMSON. I have not looked at it in quite a while
but I would say it would make American more competitive.
Mr. RICE. Mr. Lewis?
Mr. LEWIS. Representative, Dave Camp should be commended
for what he did. It showed us what real reform would look like,
and that effort itself, I know we will have issues with any
particular provision, but that overall effort, that is exactly
what we are talking about.
Mr. RICE. Mr. Vitale?
Mr. VITALE. I believe that is a better start.
Mr. RICE. And Mr. Mankowski?
Mr. MANKOWSKI. I believe it is a good start but it would
also complicate things a lot as well.
Mr. RICE. Okay. And that came out of the House Ways and
Means Committee.
Mr. Mihm, have you had a chance to review the president's
tax reform proposal?
Mr. MIHM. No, sir, we have not.
Mr. RICE. Have you seen it, Mr. Williamson? Have you gone
through it?
Mr. WILLIAMSON. I have not gone through it. I have seen
portions of it. Most notably, regarding the cash method of
accounting rules, that he will take the $25 million with some
carve outs for some qualified personal service corporations, I
think.
Mr. RICE. Mr. Lewis?
Mr. LEWIS. Yeah. The same thing as Mr. Williamson. I have
just seen particular provisions, and some of those were not
necessarily small business favorable.
Mr. RICE. Have you seen the whole package put together?
Mr. LEWIS. No, I would not say the whole package. No.
Mr. RICE. I have not either. I do not think there is one.
Mr. LEWIS. I have seen parts of it.
Mr. RICE. My point in this is I do not think the president
has made a specific proposal. I think Dave Kamp and the House
Ways and Means Committee made one. I do not think the president
has put one forward. And if we are going to get tax reform
done, we have got to have leadership. And when you look at
these things that I have been talking about, between the
imposition of Obamacare, between Dodd-Frank, ancient tax code,
you can understand, if you look at the statistics on the
decline in formation of small businesses, you can understand
why this is happening, just to put a perspective on it.
Thank you very much.
Chairman CHABOT. The gentleman yields back.
And we want to thank our distinguished panel for being here
this morning and now this afternoon. We appreciate it. I think
the GAO report has certainly confirmed that small firms are
having a tough time dealing with the tax code and we need to
simplify it and reform it. I would like to say we are close to
that. However, I like to be truthful, and I do not think we are
close to that, although we are working on it. But you all have
given us, I think, some very good ideas. And particularly as it
would affect small business folks, so thank you for that.
And I would ask unanimous consent that members have five
legislative days to submit statements and supporting materials
for the record. And if there is no further business to come
before the Committee, we are adjourned. Thank you.
[Whereupon, at 12:37 p.m., the Committee was adjourned.]
A P P E N D I X
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Testimony of
Donald T. Williamson
Kogod Eminent Professor of Taxation
Howard S. Dvorkin Faculty Fellow
Executive Director, Kogod Tax Policy Center
Kogod School of Business
American University
Washington, D.C.
Committee on Small Business
United States House of Representatives
Hearing on
``How Tax Compliance Obligations
Hinder Small Business Growth''
July 22, 2015
Chairman Graves, Ranking Member Velazquez and Members of
the Committee, thank you for the opportunity to testify on the
need to alleviate the federal tax compliance costs on small
business.
My name is Don Williamson and I am a professor of taxation
at American University's Kogod School of Business where for the
past thirty years I have been the Director of the School's
Masters in Taxation degree program. The MST program at American
University offers graduate courses in federal taxation to CPAs,
experienced accountants, attorneys and others who wish to
expand their knowledge of our nation's tax law. Our course
offerings not only include traditional classes in subject areas
such as the taxation of corporations and partnerships,
international taxation and tax policy but also more specialized
areas of the tax law such IRS practice and procedure that
address the compliance issues of this hearing.
In addition, for the past 25 years I have had my own tax
preparation and tax planning practice, LaMonaca & Williamson,
CPAs, in Falls Church, Virginia. In my professional practice I
prepare many tax returns for small businesses and represent
taxpayers daily before the IRS examination and collection
divisions.
I. Emerging Entrepreneurs and the Kogod Tax Policy Center
As part of my responsibilities at American University, I am
also the Executive Director of the Kogod Tax Policy Center
which conducts nonpartisan research on tax issues affecting
small business and entrepreneurs. The Center develops and
analyzes proposed solutions to tax-related problems faced by
small business and promotes public dialogue concerning tax
issues critical to small businesses.
Currently, the Center is focused on developing research on
the tax and compliance issues impacting ``Emerging
Entrepreneurs,'' who are America's latest iteration of small
business owners. Emerging Entrepreneurs are the workers who are
powering the evolving on-demand digital economy. These Emerging
Entrepreneurs are renting rooms, providing ride-sharing
services, running errands, and selling goods for consumers in
business transactions coordinated online and through app-based
platforms developed by companies such as Airbnb, Flipkey,
Onefinestay, Uber, Lyft, Taskrabbit and Instacart. Emerging
Entrepreneurs need maximum flexibility to grow their businesses
and enhance their contributions to this dynamic new sector of
the American economy. But, as reported by the Wall Street
Journal earlier this year, some Emerging Entrepreneurs are
facing penalty and audit exposure, despite the fact that in
some cases income earned from short-term residential rentals
coordinated through a platform provider (e.g., Airbnb,
HomeAway, Onefinestay and Flipkey) is, in fact, tax free.
Our preliminary research has identified these and other
related issues as unnecessary burdens notwithstanding that most
Emerging Entrepreneurs ``want to be honest and pay what they
owe, but the tools and resources don't exist.'' Derek Davis, in
discussion with the author, April 9, 2015. The predominantly
electronic nature of transactions conducted by this new sector
of our economy offers opportunities to reduce the burden on and
increase the compliance of Emerging Entrepreneurs. In the
coming months, we will publish tax research and corresponding
policy recommendations for the Committee to review.
II. Complexity of the Law
Over the course of my tenure as an academic and tax
practitioner I have seen with dismay the Internal Revenue Code
grow in complexity, becoming intrusive and pervasive in its
reach and incomprehensible to all but those who devote their
careers to its study. This complexity arises, in part, from the
almost annual amendments to the Internal Revenue Code that has
a profound, even paralyzing affect on small businesses
resulting in their inefficient operation and impeding their
ability to grow and create jobs.
In fact, since 2001, there have been approximately 5,000
amendments to sections of the Internal Revenue Code, about one
per day on average. Consequently, not only small business
persons but their tax advisers are overwhelmed by the
complexity resulting in steady increases in fees these advisers
charge to their small business clients.
The National Taxpayer Advocate estimates that each year
small businesses spend approximately 2.5 billion hours
preparing tax returns or otherwise meeting tax filing
requirements, the equivalent of 1.25 million full-time jobs. In
meeting these requirements 70% of small businesses use paid tax
return preparers at a cost of more than $16 billion for the
services of attorneys, accountants and other professionals.
While generating a lucrative ``cottage industry'' for tax
professionals, our nation suffers from this burden that diverts
time and resources to activities that neither encourages
business growth nor creates jobs.
Because most small business owners do not understand the
law they increasingly turn their tax filing obligations to
outside advisers for planning and return preparation of both
their income taxes as well as their employment tax obligations.
A survey conducted by the National Federation of Independent
business found that professional tax return preparers prepared,
at least in part, 91% of all tax returns filed by its members.
When small business owners believe they are unable to file
their own tax returns or understand the tax law, resentment
towards the ``system'' arises creating a cynicism and
disrespect toward our tax law that will foster non-compliance
and ultimately fraud.
Compounding this complexity and further increasing the cost
of compliance and inefficiency upon small business is the
annual crisis of the so called ``tax extenders.'' Over thirty
business provisions of the Internal Revenue Code periodically
expire, being reenacted, often retroactively, for an additional
year or two. Rules relating to the treatment of qualified small
business stock, bonus depreciation, S corporation built-in
gains tax, and most importantly, Sec. 179 expensing are vital
to the small business community and Congress should make these
provisions permanent. In the case of bonus depreciation and
Sec. 179 expensing, small businesses today must make decisions
regarding the purchase of equipment without certainty of what
the deduction will be for such acquisitions. Aside from the
additional compliance costs associated with such uncertainty,
tax planning is impossible thereby undermining growth in the
small business economy that provides most of the new jobs in
our country.
III. Legislative Recommendations
To reduce the compliance costs of small businesses in the
filing of their tax returns the Kogod Tax Policy Center
advocates two legislative proposals, i.e. a simplified cash
method of accounting and a unified rate schedule for all
businesses regardless of their legal form.
A. Simplified Cash Method of Accounting
Liberalizing the law to permit more small businesses to
adopt the cash method of accounting, rather than the more
burdensome accrual method, will reduce record keeping and tax
compliance costs with a minimal loss of accuracy or tax revenue
to the government. Even where the law currently permits a small
business to use the simpler cash method of accounting, the
requirement to maintain inventory records creates compliance
burdens that may only influence by a few months the timing of a
small business's taxable income.
Therefore, we urge Congress to not only expand the number
of businesses eligible to use the cash method of accounting as
discussed in the Senate Finance Committee Working Group Report
on Business Income Tax but to enact a ``simplified'' cash
method of accounting for small businesses that will further
reduce unnecessary record keeping and compliance burdens. We
believe such simplification will neither adversely affect the
accuracy of tax returns nor impact the ability of the IRS to
collect tax.
1. Cash Method vs. Accrual Methods of Accounting
Before describing our proposal for a simplified cash
method, I would like to explain, for the benefit of the members
of the Committee who may not be familiar with tax accounting
rules, the two major tax accounting methods used by businesses,
i.e. the cash method and the accrual method. I believe this
explanation will highlight why for small businesses the accrual
method is more burdensome than the cash method; and
demonstrates that while the accrual method may in some cases
more accurately measure economic net income, why the complexity
and cost of any additional precision is unnecessary and
ultimately provides no greater tax revenue for the IRS.
Once a business adopts a tax year, and for most small
businesses this will be the calendar year, it must adopt an
accounting method which will determine the time at which the
business recognizes an item of income or may deduct an expense.
It is important to note that a business's accounting method
only affects the timing of when a business reports income or
deductions on a tax return. The accounting method a business
uses does not determine whether an item of income is taxable or
an expense deductible and does not affect the total income and
deductions a business will recognize over its lifetime.
Publicly traded corporations and many large businesses
generate financial statements for the SEC or commercial banks
based on generally accepted accounting principles (GAAP). Small
businesses usually do not keep their books and records in
accordance with GAAP, almost always relying upon their tax
returns to provide lenders and owners with sufficient
information to determine the success and credit worthiness of
the business.
Under the Internal Revenue Code a small business is only
required to choose an accounting method that ``clearly reflects
income'' and apply that method consistently from year to year.
Consistent with this requirement, most small businesses adopt
the cash method of accounting unless the law requires them to
use the accrual method.
a. Cash Method
A business adopting the cash method of accounting
recognizes income when it receives actual payment for the goods
or services sold, regardless of when the business sells the
good or performs the service. Similarly, a cash method business
is entitled to a deduction on its tax return only when payment
for an ordinary and necessary business expense is actually
made. However, even cash method businesses may not deduct
certain types of payments when made. For example where a
business incurs a cash expenditure that creates an asset with a
useful life of more than one year, the business must
``capitalize' the cost and depreciate (deduct) that cost over a
prescribed ``recovery period'' in which the tax law presumes
the asset will be consumed in the business. There are other
types of cash payments subject to similar treatment. Thus, even
the cash method adopts certain principles of the accrual method
described below resulting in a mismatch of the time an
expenditure is made and the time at which it can be deducted.
(1) Judicial Doctrines of Income
In addition to requirements to capitalize certain
expenditures there are several other technical requirements for
a business computing taxable income under the cash method that
are unnecessarily complex. Under the judicial doctrine of
``constructive'' receipt, a cash basis taxpayer must recognize
income even when cash has not come into the physical possession
of the business but is merely available to the business at its
discretion. Similarly, the mere receipt of a promise results in
recognizable income under the cash method if the promise is
convertible to cash before it matures, in which case the fair
market value (that is, the ``cash equivalent'') of the
obligation is recognized at the time of receipt of the promise.
Finally, under the ``economic benefit'' doctrine, a cash method
business must immediately recognize income on the receipt of
property whenever the business's right to the property is
absolute, even if not immediately assignable and even though it
cannot be immediately converted to cash.
Such judicial theories that require a business using the
cash method to pay tax on income deemed received prior to the
receipt of cash unnecessarily imposes a severe cash flow
problem on small businesses--a problem that creates only a
marginal timing benefit to the IRS, since small businesses
would most certainly receive the cash shortly after
constructive receipt, economic benefit, or a cash equivalent
arises. While these concepts offer comfort to theorists, small
businesses must pay next month's bills, and the acceleration of
any taxable income before the receipt of cash under these
theories requires small businesses to use their operating cash
to pay tax on amounts they have not yet received instead of
using that cash to run their businesses.
(2) Accounting for Expenses
An even more challenging problem encountered by small
businesses using the cash method of accounting is the
compliance costs and complexity associated with computing
deductible expenses. Generally, the cash method permits a
deduction for ordinary and necessary business expenses when
actual payment is made. Thus, a promise to pay is not
deductible until payment is actually made.
In addition to the natural confusion surrounding when and
if a payment has been made, small businesses confront even
greater difficulties when computing allowable deductions under
the cash method because of four exceptions to the general rule
that a deduction is permitted when payment is made, i.e.
prepayments, depreciation, inventory and capitalization of some
expenses. Prepayments for property or services are not
deductible if the goods or services are provided more than one
year after the prepayment. Costs exceeding $5,000 associated
with creating a new business are not deducted when paid but
amortized over 15 years. For inventory, the costs of its
acquisition or production are deducted only when the inventory
is sold. Similarly, property with a useful life of more than
one year is generally subject to depreciation, requiring its
deduction be spread over recovery periods ranging from three to
39 years.
These examples demonstrate that the current cash method of
accounting is too often not based upon cash receipts and
disbursements, but rather on principles that attempt to match
costs with income similar to the accrual method. For small
businesses that have no government regulators to whom financial
statements must be submitted and have no banks or other
creditors in need of profit and loss determinations that
conform to the rules of GAAP, tax rules based on the accrual
method serve no practical purpose when economic success and
taxable income can simply be measured on cash receipts and
expenditures--that is, cash flow. In short, while the current
cash method is substantially simpler than the accrual method,
certain refinements to the current rules could make the cash
method even simpler and more easily enable small businesses to
comply with tax record keeping and reporting requirements
without the loss of accuracy on their tax returns.
b. Accrual Method
The other major accounting method, the accrual method,
attempts to determine the time at which ``all events'' occur
that give rise to the right to income and the amount of that
income can be determined with reasonable accuracy. Similarly,
an expense may be deducted when the obligation to pay an
expense is fixed, the amount of that obligation can be
determined with reasonable accuracy and economic performance
has occurred. Thus, businesses must report income on their tax
returns when earned and may deduct expenses when incurred
without regard to the receipt or payment of cash.
The accrual method and its ``all events'' test creates
substantial complexity in an effort to better identify the
financial success or failure of a business. This complexity
calls for small businesses, whose every day well being centers
upon its cash position, to determine its financial well-being
in a manner that adds no value to its success. From the
perspective of the IRS, while the timing of income and expense
reported under the accrual method may provide some acceleration
of tax upon income that must be recognized before any cash is
received, such acceleration is clearly unfair if the cash is
never received, and may only accelerate tax collection by no
more than one year if the cash is subsequently receive shortly
after the accrual.
The complexity of the accrual method is illustrated by
prepayments. In the case of prepaid rent or interest received,
income must be reported immediately upon receipt even if ``all
events'' entitling the business to the income have not
occurred. Similarly, where goods or services have not been
delivered but cash payment has been received, the general rule
under the accrual method that delays reporting the cash
receipts on the business's tax return until ``all events'' have
occurred, i.e. the goods are delivered or services performed,
is disregarded. Thus, in the case of prepayments a business
otherwise on the accrual method finds itself using the cash
method for prepayments. Not an easy concept for a small
business owner to understand.
Another complexity of the accrual method is the necessity
to account for bad debts when a business reports as income an
account receivable for which it never receives actual payment.
Each year businesses on the accrual method must determine which
previously reported receivables are uncollectible and claim
them as tax deductions. This can be a time consuming, confusing
and expensive process. Businesses using the cash method do not
deduct bad debts because they do not include receivables in
taxable income.
Finally, even when a business on the accrual method meets
the ``all events'' test with respect to an expense, a deduction
may be claimed only when ``economic performance'' occurs.
Therefore, in the case of receiving goods and/or services from
another party, the business may deduct the obligation to pay
the other party only as the goods or services are received
regardless of when the business pays for the goods or services,
subject to an exception permitting deduction in the year of
prepayment if the other party provides the goods or services
within three and one-half months of the next taxable year.
Again, not an easy concept for small businesses to understand.
The above illustrations of the complexity required by the
accrual method of accounting demonstrate that in the case of
small businesses the purported technical accuracy resulting
from these rules offers no practical benefit to the business in
measuring its economic performance, and over the life cycle of
the business, offers no additional tax revenue to the
government.
2. Tax Accounting for Inventories
Regardless of whether a business is on the cash or accrual
method of accounting, if inventory is a material income
producing factor, the business must account for gross profit,
i.e. sales minus cost of goods sold, using the accrual method,
even if they have adopted the cash method as their overall
accounting method. Thus, a business cannot deduct the cost of
the inventory (finished goods) to the extent it has not sold
the product by the end of the business's taxable year.
Businesses selling inventory must maintain records documenting
their cost of unsold, finished goods, partially finished goods
and ``raw'' materials on hand that will be used in the future
to manufacture or product inventory. In addition, inventory
cost accounting principles call for the deduction of indirect
costs (overhead) associated with manufacturing or producing the
inventory only when the inventory is sold.
In determining its cost of inventory, a business must adopt
an inventory costing method, i.e. the first-in, first-out
(FIFO) method, the last-in, last-out (LIFO) method or the
specific identification method. The FIFO and LIFO methods
relieve businesses of the need to keep track of the cost of
each item they sell, but where the items are unique or
relatively high-cost, low volume products (e.g., jewelry,
antiques, cars, etc.) the specific identification method is
used.
As an exception to the requirement to maintain inventory
accounts, the IRS (not the Internal Revenue Code) permits a
cash method business to use the cash method to account for
their gross profit from the sale of inventory if the business's
average annual gross receipts for the three year period prior
to the current year do not exceed $10,000,000 and the
business's primary activity is to provide services to customers
but also offers a product for sale incidental to the
performance of services. Thus, a veterinarian using the cash
method of accounting need not use the accrual method to account
for the sale of medicines or other goods associated with the
business of caring for animals because such sales are
incidental to the veterinarian's professional practice. But
when the average gross receipts of the business exceeds
$10,000,000, businesses must not only account for inventory
using the accrual method, but also must apply certain ``uniform
cost capitalization'' (UNICAP) rules that require an allocation
to inventory of an array of indirect costs beyond those
ordinarily associated with producing goods. Thus, under the
UNICAP rules, a business must add to the cost of inventory a
portion of compensation paid to employees who may not be
involved in producing the inventory but may merely indirectly
support the production process.
A final illustration of the complexity of the accrual
method deals with the perceived abuse of an accrual method
business accruing (deducting) an amount owed to a related party
using the cash method. In this case the business using the
accrual method nay not deduct the amount owed to the related
party until the amount is actually paid and recognized as
taxable income by the cash method party. This issue frequently
arises where a business employs the owner or a relative of an
owner. Related parties, for this purpose, include family
members and certain businesses owned by the same individual(s).
3. Comparison of Cash and Accrual Methods
As the above descriptions demonstrate, the primary
advantages of the cash method over the accrual method are its
clarity and flexibility in measuring income and expenses and
its less cumbersome bookkeeping and record keeping
requirements. While the accrual method is generally considered
a more accurate reflection of a business's financial condition,
the price of this accuracy is mind numbing complexity and
inevitably increased compliance and record keeping costs.
However, the Internal Revenue Code limits the adoption of
the cash method to the following businesses: (1) sole
proprietorships; (2) S corporations; (3) certain corporations
engaged predominantly in the performance of services by their
owners, (4) corporations with average gross receipts over the
preceding three years of $5,000,000; (5) partnerships with no
corporate shareholder whose gross receipts exceed $5,000,000;
and (6) farms.
Suggestions for simplifying and liberalizing the use of the
cash method were made by the Treasury Department in 2007, the
Bowles-Simpson Commission in 2010 and most recently the options
proposed by former Senator Baucus and Representative Camp
described in the Senate Finance Committee's Bipartisan Tax
Working Group Report on Business Income Tax. These proposals
simplify the reporting of income and expenses on tax returns
filed by small businesses that will then reallocate resources
otherwise spent on compliance to more productive purposes,
ultimately stimulating job growth. In addition, the IRS
Taxpayer Advocate has consistently recommended simplifying
accounting methods for small business as a way to ease
compliance burdens and reduce tax administration.
4. Simplified Cash Method of Accounting (``SCM'')--The
``Checkbook'' Method
Based on this brief description of the accounting methods
available to small businesses and the observations of Treasury,
IRS and Congressional tax reform studies, small businesses
clearly need and deserve legislative relief in measuring and
reporting their taxable income and deductible expenses.
Therefore, the Internal Revenue Code should be amended to not
only permit the adoption of the cash method by more small
businesses, but also the adoption of a ``simplified cash method
of accounting'' (``SCM''). This proposed simplification of the
existing cash method of accounting will reduce time-consuming,
expensive administrative burdens on small businesses in keeping
records and reporting their income and expenses on their
returns, thereby unleashing resources that will create more
productive, job creating activities.
Besides reducing compliance costs the SCM will enable small
businesses to better understand their tax returns, thereby
reducing the general public's cynicism that the Internal
Revenue Code is replete with loopholes only accessible to
businesses with resources to employ expensive tax
professionals. In short, simplifying reporting on tax returns
will increase compliance, ease the burden of tax
administration, increase tax revenue and ultimately reduce the
gap between what taxpayers should pay and what the IRS actually
collects.
Under the SCM the computation of taxable income is reduced
to the following formula:
Cash Receipts
Less: Cash Expenses including:
Inventory
Prepayments
Materials/Supplies
Depreciable Property
Taxable Income
In short, the derivation of taxable income is based solely
on amounts actually received or paid during the tax year, by
means of examining the business's checkbook for when checks
were cut and deposits made. Under SCM, income consists only of
cash, property or services received during the tax year without
regard to imputed income under the constructive receipt, cash
equivalence, or economic benefit doctrines. While determining
and valuing the receipt of in-kind goods and services would
continue to be a problematic, small businesses would otherwise
be able to arrive at their income by adding up their bank
deposits for the year. Any timing advantage to businesses from
not being subject to the judicial doctrines just mentioned
would be minimal given that small businesses cannot, as a
practical matter, defer recognition of cash by more than a few
months without creating severe cash flow problems for the
payment of their own bills. The complexity of the judicial
doctrines does not warrant their application to small
businesses.
SCM offers even greater simplification for the
determination of deductible expenses. Under SCM, all current
expenditures, including those for the acquisition or
construction of inventory, would be deducted when paid.
Although a technical violation of GAAP's matching principle of
accounting, GAAP is not a particularly useful concept in
measuring the ability of a small business to pay tax, or even
stay in business. More than one small business that had a
profit under GAAP has failed because of cash flow problems.
Allowing for the immediate deduction of the cost of inventory
simplifies small business record keeping at relatively little
cost to the government. For a small business to say in
business, inventory paid for and deducted in one year likely
will be sold no later than the next year to ensure sufficient
cash flow for business operations. Also, permitting the
expensing of inventory before its sale recognizes the fact that
by the IRS's own admission, small businesses are not following
the rules for the computation of cost of goods sold, in that
audits reveal more than 50 percent of cost of goods sold
calculations are incorrect.
Finally, permitting the immediate expensing of depreciable
property simply adopts a 100 percent bonus depreciation
approach for acquired property with a useful life in excess of
one year and the current section 179 expense allowance for
purchased depreciable property. Thresholds and limitations
similar to the present $10,000,000 limitation for uniform
capitalization rules and the current IRS allowance for the cash
method may be adopted to restrict SCM to small businesses.
With a $10 million threshold for the general adoption of
the cash method coupled with an election to adopt the SCM,
simplification would be available to approximately 99% of all
businesses in the United States, thereby reducing the tax
compliance burden for almost every person owning and operating
a business in America.
B. Single Business Tax Rate
Perhaps even more important from the perspective of
compliance costs, small businesses need a rate structure that
is not dependent on the legal form they adopt. Currently sole
proprietorships, partnerships and S corporations are taxed at a
maximum rate of 39.6%, while the taxable income of a C
corporation is taxed at a maximum rate of 35%. Most of the
corporate tax reform proposals focus upon eliminating
deductions and credits to broaden the tax base upon which a
lower corporate tax rate would apply. If corporate tax reform
simply reduces rates on C corporations, unincorporated small
businesses will have an increased tax burden relative to C
corporation. Additionally, such a result will increase the tax
planning and compliance costs of every start-up business in
analyzing the tax burden of operating in one legal form or
another. Our tax system should not promote inefficiency by
incentivizing small businesses to make decisions based on tax
considerations, rather than for business reasons.
Therefore, rather than reduce the tax rates only on C
corporations, small businesses need a tax rate structure that
applies to all businesses regardless of their legal form. While
corporate earnings are subject to tax both at the corporate
level and the shareholder level (when distributed) and earnings
of unincorporated businesses are taxed only once, there are
well documented approaches, e.g. integration, beyond the scope
of this testimony to ensure tax neutrality in the decision of
business entity choice.
A single integrated business tax rate schedule could have
graduated rates providing a lesser tax burden to businesses
with less taxable income. A single integrated business tax rate
schedule would not be difficult to administer because income
from follow-through businesses (sole proprietorships,
partnerships and S corporations) already separately appears on
schedules on individual tax returns, Schedule C for income for
sole proprietorships and Schedule E for income from
partnerships and S corporations. Individuals would simply total
their business taxable income and apply the ``business tax rate
schedule,'' a practice no different from the special tax rate
schedule that currently applies to qualified dividends and
capital gains on Schedules B and D.
In short, what is needed is ``business tax reform'' not
corporate tax reform. A single business rate schedule will
create a uniform, comprehensive system of business taxation
that taxes all businesses equally without regard to their legal
form thereby easing the tax burden on small businesses and
increasing simplicity and fairness.
IV. Conclusion
The burden of compliance costs on small business arises
from the complexity of the tax law coupled with the almost
exponential change in the Internal Revenue Code over the past
few decades. As a result, small businesses have outsourced
their tax planning and compliance responsibilities to tax
professionals whose fees have added to the compliance burden.
The Kogod Tax Policy Center recommends that increasing the
availability of the cash method of accounting to small
businesses and adopting a uniform tax rate schedule for all
businesses regardless of their legal form will reduce the
burden small businesses currently bear in complying with their
filing responsibilities. These proposals will improve tax
compliance at lower administrative costs to businesses with
little or no loss of tax revenue to the government. Such
reforms are needed for the continued viability of our voluntary
tax compliance system.
* * *
Thank you for the opportunity to testify today. I welcome
any questions from the Committee or its staff. In addition, I
or any others at the Kogod Tax Policy Center would be pleased
to respond to any other questions you may have in the future.
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INTRODUCTION
Chairman Chabot, Ranking Member Velazquez, and Members of
the House Committee on Small Business, thank you for the
opportunity to testify today on ``How Tax Compliance
Obligations Hinder Small Business Growth.'' My name is Troy
Lewis. I am the vice president and chief enterprise risk
management officer at Heritage Bank in St. George, Utah. I am
also a sole tax practitioner, adjunct faculty member at Brigham
Young University and Chair of the Tax Executive Committee of
the American Institute of Certified Public Accountants (AICPA).
I am pleased to testify today on behalf of the AICPA.
The AICPA is the world's largest member association
representing the accounting profession, with more than 400,000
members in 145 countries and a history of serving the public
interest since 1877. Our members advise clients on federal,
state and international tax matters, and prepare income and
other tax returns for millions of Americans. Our members
provide services to individuals, not-for-profit organizations,
small and medium-sized business, as well as America's largest
businesses.
The AICPA applauds the leadership taken by the Committee to
consider ways to reduce the complexity faced by small
businesses when preparing their taxes. Small businesses are the
foundation of the U.S. economy, employing over half of the
private-sector workforce and creating nearly two-thirds of this
nation's net new jobs over the past decade and a half.\1\
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\1\ Small Business Administration Office of Advocacy, Frequently
Asked Questions, September 2012.
Unfortunately, compliance with federal tax laws can act as
a road block in the growth of small business. Unlike large
multi-national corporations, the time spent by small businesses
in complying with tax laws is much more costly because small
businesses do not have the luxury of critical mass and a large
customer base with which to efficiently spread non-value added
compliance costs. Time devoted to complying with tax laws has
an impact on business creation, job growth and economic
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prosperity of these small businesses.
At the same time, we recognize that tax compliance is
necessary. However, to help small businesses grow, Congress and
the Internal Revenue Service (IRS) should seek to lessen these
compliance burdens on all small businesses. When evaluating
whether or not a tax compliance requirement should be mandated
for a small business, a cost/benefit analysis should first be
considered. Nowhere is it more important to ask if the end
result is worth the effort than in the area of tax compliance
for small businesses.
Using this cost/benefit approach, may I suggest a few areas
where Congress can act to reduce the burden of tax compliance
in a way that allows small businesses to grow without creating
undue hindrances.
IRS TAXPAYER SERVICES
It is imperative that small businesses and their tax return
preparers have the ability to communicate with the IRS when
preparing their taxes and addressing compliance issues.
However, there has been increasingly limited access to the
agency and, as reported by IRS Commissioner John Koskinen,
``abysmal' level of taxpayer service this year.\2\
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\2\ Commissioner Koskinen, Prepared Remarks of John A. Koskinen
Commissioner, Internal Revenue Service, Before the National Press Club,
dated March 31, 2015.
Our members have expressed their deep concerns regarding
their ability to effectively represent small businesses and
other taxpayers in an environment where the IRS service levels
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are so degraded that:
During the 2015 tax season, the IRS answered
only 37% of the telephone calls received from taxpayers
seeking to speak with an assistor;\3\
\3\ National Taxpayer Advocate Report, Volume I: FY 2016 Objectives
Report to Congress; Part II: Review of the 2015 Filing Season, dated
July 14, 2015.
The average hold time for the Practitioner
Priority Service telephone line reached 47 minutes;\4\
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and
\4\ Joint Operations Center, Customer Account Services, Account
Management Paper Inventory Reports, Inventory Age Report, (Jan 1 - Apr
6 statistics).
According to the National Taxpayer Advocate,
the IRS's ability to process taxpayer correspondence in
a timely manner declined by 16% since 2014, leaving a
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backlog of almost 79,000 cases.\5\
\5\ Id.
Through an informal membership survey we conducted earlier
this year, we learned that over half of our members were either
somewhat dissatisfied or very dissatisfied with the services
they received from the IRS this filing season. This is no
surprise considering that only 17% of our members responded
that the IRS generally answered their telephone calls within 30
minutes. Most of our members were on hold for extended periods
of time and other members noted that they generally had to end
their own calls because they did not have the time to wait on
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hold for an IRS agent to answer.
As reported by one of our members, ``I was on hold for over
an hour and a half. When the IRS agent finally picked up the
call, they needed to transfer to another agent. I had to wait
on hold for another hour. Finally, I received a recorded
message that the office was closed and I needed to call again
the following day.''
Many of our members also experienced what the IRS refers to
as ``courtesy disconnects.'' According to the IRS, they
terminate telephone calls from small businesses and other
callers, without taking a message or getting contact
information, if the caller has been on hold for two hours. As
of April 18th this year, approximately 8.8 million calls
received by the IRS were subject to their ``courtesy
disconnect'' policy, which represents an increase from
approximately 544,000 over last year.\6\ Nothing is more
discouraging, frustrating or inefficient for a caller (whether
they are a small business or a tax preparer calling on behalf
of a small business) than being hung up on by the IRS after
waiting on hold for two hours.
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\6\ National Taxpayer Advocate Report, Volume I: FY 2016 Objectives
Report to Congress; Part II: Review of the 2015 Filing Season, dated
July 14, 2015.
Our survey also indicated similar, unacceptable patterns
with regards to delays in written correspondence. On average
over half of the correspondence sent to the IRS is not
responded to within 90 days of receipt.\7\ Often small
businesses are anxiously awaiting a response to a notice.
Furthermore, the longer the response tine by the IRS, the more
interest and penalties are accrued as the small business
attempts to resolve their issue.
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\7\ Joint Operations Center, Customer Account Service, Account
Management Paper Inventory Reports, Inventory Age Report, (Jan 1 - Apr
6 statistics).
We appreciate and understand that the IRS has new
initiatives and vital unmet obligations and responsibilities
(such as addressing identity theft), but taxpayer service must
remain a high priority in order for small businesses to receive
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the assistance they need on tax issues.
GOOD TAX POLICY
In order to reduce the overall tax compliance burden on
small businesses, the AICPA urges the Committee to consider
comprehensive tax reform that focuses on simplification,
transparency and other Principles of Good Tax Policy.\8\ We
believe it is important to promote a tax system that is
perceived as balanced, fair to all, administrable, economically
efficient, transparent, and neutral in its effect on economic
activity.
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\8\ AICPA's Tax Policy Concept Statement No. 1: Guiding Principles
for Good Tax Policy: Framework for Evaluating Tax Proposals, issued
March 2001.
Our current tax system is heavily burdened by complexity.
Multiple and duplicative tax calculations, definitions, and
preferences lead to taxpayer confusion and, thus, errors and
frustration. Attempts to adjust tax liabilities through special
rules affecting taxable income rather than the rate schedule
add to complexity. Business provisions that require retention
of records solely for tax purposes increase compliance costs.
We urge consideration of removing duplicative rules and
definitions, and reducing recordkeeping and calculations, to
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achieve simplicity, without adding new complexities.
It is also important for an effective tax system and
informed citizenry that taxpayers understand the tax system and
how it affects them. Clarity of the tax consequences of
taxpayers' regular activities is a must. Transparency also
helps improve voluntary compliance.
Additionally, it is critical for taxpayers to have
certainty to perform any long-term tax planning. Permanence of
tax provisions can have substantial impacts on the growth of
small businesses. The uncertainty of tax legislation creates
unnecessary confusion, anxiety and administrative financial
burdens. Without permanency in the Internal Revenue Code
(``Code''), we are concerned about the following consequences:
Impact on a company's financial accounting
and reporting;
Complexity and administrative burden for
taxpayers and the IRS;
Adverse impact on small businesses and
ultimately jobs and growth;
Effect on economic decisions and tax
payments; and
Lack of transparency and certainty with
short-term, retroactive extensions
We recognize that it is not always possible for each tax
provision and the overall tax system to equally meet each of
the ten principles of good tax policy. However, it is important
to carefully balance these principles to achieve a respected
and administrable tax system.
TANGIBLE PROPERTY REGULATIONS
A challenging tax compliance burden that small businesses
had to deal with this year was the new final tangible property
regulations (TD 9636). These tax rules, which address how
businesses should report the acquisition and improvement of
tangible property, comprise almost 500 pages of technical
guidance and procedures.
While we appreciated that the regulations clarified some
rules and provided several small business favorable provisions,
we were concerned that they were significantly burdensome for
many small business taxpayers because of the required
retrospective analysis and reporting requirements.
The AICPA pushed hard for relief and stressed that time was
of the essence as a significant portion of the burdens placed
on small businesses (and their tax practitioners) would occur
prior to filing season. However, despite these pleadings, the
IRS issued the much-needed relief, Rev. Proc. 2015-20, on
February 13, well into the filing season. Unfortunately, some
small businesses and their tax practitioners had already spent
time and resources attempting to comply with the new
regulations prior to the IRS's issuance of relief. If the IRS
had acted in a timely manner, small businesses could have been
spared some administrative burden.
Currently, small businesses must prove that expensing such
amounts ``clearly reflects income'' to deduct amounts higher
than the $500 threshold. The clear reflection of income test
can be challenging for any taxpayer, especially for small
businesses. The test is based on the taxpayer's facts,
circumstances, and interpretations of those facts and
circumstances by the taxpayer and IRS. Thus, it is arbitrary
and often difficult to apply. Large businesses (e.g., taxpayer
with an AFS), however, are allowed the higher $5,000 threshold.
Subjecting small businesses to the clear reflection of income
test at merely $500, adds unnecessary complexity and compliance
burdens to small businesses.
There are other issues that remain open in regards to the
repair regulations. The AICPA recommends that you take
immediate action to increase the $500 de minimis safe harbor
threshold for taxpayers without an AFS to $2,500, and provide
for annual adjustments for inflation, to offer meaningful
relief to small business taxpayers. To further reduce
administrative burden on these rules, we also recommend that
you expand the AFS definition to include a reviewed set of
financial statements \9\ to permit more business to benefit
from the higher $5,000 de minimis safe harbor threshold.
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\9\ For a detailed explanation of the differences between a
compilation, a review, and an audit, please reference the AICPA
Comparative Overview document.
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CIVIL TAX PENALTIES
An additional concern \10\ for small businesses is the
numerous unfair or untargeted penalty provisions in the Code
pertaining to tax compliance. Penalties should deter bad
conduct without deterring good conduct or punishing small
businesses which are acting in good faith.
\10\ AICPA comment letter on ``AICPA Tax Penalties Legislative
Proposals,'' dated April 11, 2013; and AICPA report on ``AICPA Report
on Civil Tax Penalties,'' submitted April 11, 2013.
Targeted, proportionate penalties that clearly articulate
standards of behavior and that are administered in an even-
handed and reasonable manner encourage voluntary compliance
with the tax laws. On the other hand, overbroad, vaguely-
defined, and disproportionate penalties, particularly those
administered as part of a system that automatically imposes
penalties or that otherwise fail to provide basic due process
safeguards, create an atmosphere of arbitrariness and
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unfairness that is likely to discourage voluntary compliance.
For example, penalties should apply prospectively to future
conduct and not retroactively to conduct that was appropriate
at the time the conduct occurred. Good tax policy would also
suggest that we avoid strict liability provisions that do not
grant the IRS discretion to take into consideration the facts
and circumstances of a particular business' situation.
The AICPA points out the following specific penalty-related
issues with the current system below.
Repeal Technical Termination Rule
The AICPA recommends a repeal of section 708(b)(1)(B)
regarding the technical termination of a partnership as it is a
trap for the unwary.\11\ Under current law, when a partnership
is technically terminated, the legal entity continues, but for
tax purposes, the partnership is treated as a newly formed
entity. The current law requires the partnership to select new
accounting methods and periods, restart depreciation lives, and
make other adjustments Furthermore, under the current law, the
final tax return of the ``old'' partnership is due the 15th day
of the fourth month after the month-end in which the
partnership underwent a technical termination.\12\
\11\ AICPA submitted letters and written statement on Option 1 and
Option 2 of Chairman Camp's Small Business Tax Reform Draft: See Option
1 comments at ``AICPA testimony on Small Business and Pass-through
Entity Tax Reform,'' dated May 17, 2013; and Option 2 comments, ``AICPA
Comments on Option 2 of Chairman Camp's Small Business Tax Reform
Discussion Draft'' dated July 30, 2013.
\12\ For example, a partnership that technically terminated on
April 30 of the current year due to a transfer of 80% of the capital
and profits interests in the partnership to be timely filed must file
its tax return for that final tax year on or before August 15 of the
current year.
A technical termination most often occurs when, during a
12-month period there is a sale or exchange of 50% or more of
the total interest in partnership capital and profits. Because
this 12-month time frame can span a year-end, the partnership
may not realize that a 30% change (a minority interest) in one
year followed by a 25% change in another year, but within 12
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months of the first, has caused the partnership to terminate.
In practice, this earlier required filing of the old
partnership's tax return often goes unnoticed because the
company is unaware of the accelerated deadline due to of the
equity transfer. Penalties are often assessed upon the business
as a result of the missed deadline. Although ignorance is not
an acceptable excuse, this technical termination area is often
misunderstood and misapplied. The acceleration of the filing of
the tax return, to reset depreciation lives and to select new
accounting methods, serves little purpose in terms of abuse
prevention and serves more as a trap for the unwary.
Late Filing Penalties
Sections 6698 and 6699 impose a penalty of $195 per partner
related to late-filed partnership or S corporation returns. The
penalty is imposed monthly not to exceed 12 months, unless it
is shown that the late filing is due to reasonable cause.
The AICPA proposes that a partnership (or S Corporation),
comprised of 50 or fewer partners/shareholders, each of whom
are natural persons (who are not nonresident aliens), an estate
of a deceased partner, a trust established under a will or a
trust that becomes irrevocable when the grantor dies, and
domestic C corporations, will be considered to have met the
reasonable cause test and will not be subject to the penalty
imposed by section 6698 or 6699 if:
The delinquency is not considered willful
under section 7423;
All entity income, deductions and credits
are allocated to each owner; and
Each partner/shareholder fully reported its
share of income, deductions and credits of the entity
on its timely filed federal income tax return.
Failure to Disclose Reportable Transactions
Taxpayers who fail to disclose a reportable transaction are
subject to a penalty under section 6707A of the Code. For
penalties assessed after 2006, the amount of the penalty is 75%
of the decrease in tax shown on the return as a result of the
transaction (or the decrease that would have been the result if
the transaction had been respected for federal tax purposes).
If the transaction is a listed transaction (or substantially
similar to a listed transaction), the maximum penalty is
$100,000 for individuals and $200,000 for all other taxpayers.
In the case of reportable transactions other than listed
transactions, the maximum penalty is $10,000 for individuals
and $50,000 for all other taxpayers. The minimum penalty is
$5,000 for individuals and $10,000 for all other taxpayers.
The section 6707A penalty applies even if there is no tax
due with respect to the reportable transaction that has not
been disclosed. There is no reasonable cause exception to the
penalty. The Commissioner may, however, rescind all or a
portion of a penalty, but only in the case of transactions
other than listed transactions, where rescinding the penalty
would promote efficient tax administration and only after the
taxpayer submits a lengthy and burdensome application. In the
case of listed transactions, the IRS has no discretion to
rescind the penalty. The statute precludes judicial review
where the Commission decides not to rescind the penalty.
The AICPA proposes for an amendment of section 6707A to
allow an exception to the penalty if there was a reasonable
cause for the failure and the taxpayer acted in good faith for
all types of reportable transactions, and to allow for judicial
review in cases where reasonable cause was denied. Moreover, we
propose an amendment of section 6664 to provide a general
reasonable cause exception for all types of reportable
transactions, irrespective of whether the transaction was
adequately disclosed or the level of assurance.
9100 Relief
Section 9100 relief, which is currently available with
regard to some elections, is extremely valuable for taxpayers
who miss the opportunity to make certain tax elections.
Congress should make section 9100 relief available for all tax
elections, whether prescribed by regulation or statute. The
AICPA has compiled a list \13\ of elections (not all-inclusive)
for which section 9100 relief currently is not granted by the
IRS as the deadline for claiming such elections is set by
statute. Examples of these provisions include section
174(b)(2), the election to amortize certain research and
experimental expenditures, and section 280C(c), the election to
claim a reduced credit for research activities. We do not
believe small businesses are likely to abuse or exploit
hindsight, as the IRS would continue to have discretion as to
whether to grant relief for each specific request.
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\13\ AICPA comment letter on ``Tax Reform Administrative Relief for
Various Statutory Elections,'' submitted January 23, 2015.
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Form 5471 Penalty Relief
On January 1, 2009, the IRS began imposing an automatic
penalty of $10,000 for each Form 5471, Information Return of
U.S. Persons with Respect to Certain Foreign Corporations,
filed with a delinquent Form 1120 series return. When imposing
the penalty on corporations in particular, the IRS does not
distinguish between: a) large public multinational companies,
b) small companies, and c) companies that may only have
insignificant overseas operations, or loss companies. This one-
size-fits-all approach inadvertently places undue hardship on
smaller corporations that do not have the same financial
resources as larger corporations. The AICPA has submitted
recommendations \14\ regarding the IRS administration of the
penalty provision applicable to Form 5471. Our recommendations
focus on the need for relief from automatic penalties assessed
upon the late filing of Form 5471 in order to promote the fair
and efficient administration of the international penalty
provisions of the Code.
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\14\ AICPA comment letter on ``Recommendations - Automatic
Penalties assessments Policy with the Late Filing of Form 5471,'' dated
March 26, 2013.
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MOBILE WORKFORCE
Another burden on small businesses that Congress should
address involves the tremendous burden of tracking and
complying with the many different state non-resident employee
tax withholding and reporting rules for just a few days of work
by an employee in a non-resident state. The state personal
income tax treatment of nonresidents is inconsistent and often
bewildering to multistate employers and employees.
H.R. 2315, the Mobile Workforce State Income Tax
Simplification Act of 2015, introduced by Representative Bishop
on May 14, 2015, addresses this issue. We are pleased that
members of this Committee cosponsor this bill, and hope many
others of you will also consider cosponsoring it. The AICPA
strongly supports H.R. 2315 and urges Congress \15\ to enact
this legislation to help small businesses in this country ease
their non-resident state income tax withholding and compliance
burdens.
\15\ AICPA written testimony before the House Committee on the
Judiciary Subcommittee, Regulatory Reform, Commercial and Antitrust Law
on Nexus Issues: Legislative Hearing on H.R. 2315, The ``Mobile
Workforce State Income Tax Simplification Act of 2015,'' H.R. 1643, the
``Digital Goods and Services Tax Fairness Act of 2015,'' and
H.R.--the ``Business Activity Tax Simplification Act of
2015'', dated June 2, 2015.
Small businesses must understand each of the states'
treatment of non-resident employee withholding and assessment
of taxes and the unique de minimis and definitions. Currently,
43 \16\ states plus the District of Columbia impose a personal
income tax on wages, and there are many different requirements
for withholding income tax for non-residents among those
states. There are seven states that currently do not assess a
personal income tax.\17\ Employees traveling into all the other
states are subject to the confusing myriad of withholding and
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tax rules for non-resident taxpayers.
\16\ Note that New Hampshire and Tennessee, which are included in
the 43 states, do not tax wages and only subject to tax interest and
dividends earned by individuals.
\17\ The seven states with no personal income tax are Alaska,
Florida, Nevada, South Dakota, Texas, Washington and Wyoming.
A number of states have a de minimis threshold, or
exemption for non-residents working in the state before taxes
must be withheld and paid. Others have a de minimis exemption
based on the amount of the wages earned, either in dollars or
as a percent of total income, while in the state. Further
complicating the issue is that a number of these states have
reciprocity agreements with other, usually adjoining, states
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regarding the withholding of non-resident state income taxes.
Where many businesses once tended to be local, they now
have a national reach. This change has caused the operations of
even small businesses to move to an interstate basis. Because
of the interstate operations of these companies, many providers
of services to these companies, such as certified public
accountants (CPAs), find that they are also operating on an
interstate basis. What once were local taxation issues have now
become national in scope, and burdens must be eased in order to
promote interstate commerce and ensure businesses run
efficiently. These burdens take significant resources away from
operating their business.
The complex filing rules impact everyone who travels for
work. The recordkeeping and the requirement of having to
withhold and file many state non-resident tax returns for just
a few days of work in various states is overly burdensome and
too complicated for both employers and employees. Additionally,
the amount of research that goes into determining what each
state law requires is expensive and time-consuming. A small
firm or business will often be required to engage outside
counsel to research the laws of the other states on an ongoing
annual basis.
This issue affects all industries--retail, manufacturing,
real estate, technology, food, services, etc. The current
system as a whole unnecessarily creates complexity and costs
for both employers and employees, without yielding a
substantive benefit to most states. H.R. 2315 is needed to
solve this problem and burden for small businesses.
Having a uniform national standard for non-resident income
taxation, withholding, and filing requirements, as H.R. 2315
provides, will enhance compliance and significantly relieve
these unnecessary administrative burdens on businesses and
their employees. Additionally, H.R. 2315 provides a needed 30-
day de minimis exemption before an employee is obligated to pay
taxes to a state in which they do not reside. Many small
businesses need Congress to enact this legislation.
TAX RETURN DUE DATE SIMPLIFICATION
Another challenging compliance issue for small businesses
is the current illogical order of due dates for various types
of tax returns. Taxpayers and preparers have long struggled
with problems created by the inefficient timeline and flow of
information. Federal Schedules K-1s are often delivered late,
sometimes within days of the due date of taxpayers' personal
returns and up to a month after the due date of their business
returns. Late schedules make it difficult, if not impossible,
to file a timely, accurate return. The current inefficient
timeline of tax return due dates is a problem for taxpayers as
well as their tax practitioners.
The AICPA strongly supports this provision. It would
alleviate the problems mentioned above by establishing a
logical set of due dates, focused on promoting a
chronologically-correct flow of information between pass-
through entities and their owners. The proposal includes the
changes as follows:
Current Tax Due Dates:
March 15: S corporation and C corporation
Forms 1120S and 1120; and
April 15: Individual, Trust and Estate, and
Partnership Forms 1040, 1041, and 1065
Proposed Tax Due Dates:
March 15: Partnership Form 1065;
March 31: S corporation Form 1120S; and
April 15: Individual, Trust and Estate, and
C Corporation Forms 1040, 1041, and 1120
The provision would also revise the extended due dates to
be six months after the original filing due dates for all these
forms, except the trust and estate Form 1041, which would be
extended five and half months.
The AICPA urges you to support this provision to change the
dates for tax returns of partnerships, S corporations and C
corporations because it would:
Improve the accuracy of tax and information
returns by allowing corporations and individuals to
file using current data from flow-through returns that
have already been filed rather than relying on
estimates;
Better facilitate the flow of information
between taxpayers (i.e., corporations, partnerships,
and individuals);
Reduce the need for extended and amendment
tax returns; and
Simplify tax administration for the
government, taxpayers, and practitioners.
CONCLUDING REMARKS
The AICPA has consistently supported tax reform
simplification efforts and permanent tax legislation because we
are convinced such actions will significantly reduce taxpayers'
compliance costs and encourage voluntary compliance through an
understanding of the rules. The uncertainty of tax legislation
creates unnecessary confusion, anxiety and administrative
financial burdens. Good tax policy would promote a tax system
that is balanced, economically efficient and transparent.
We encourage you to examine all aspects of the tax code to
improve the current rules that have led to compliance hurdles
for small businesses and administrative complexity. For
example, additional relief is needed for small businesses with
regards to the tangible property rules, penalty provisions need
to consider their effect on voluntary compliance, and employers
operating across state lines need a uniform standard on non-
resident income tax withholding rules. The income tax deadlines
should also promote an efficient flow of taxpayer information
to provide small businesses sufficient time to file timely,
accurate returns.
Finally, if small businesses are going to be allowed to
grow, it is imperative that the IRS's taxpayer service issues
are addressed. Small businesses and their tax preparers need to
be able to contact the IRS regarding their compliance issues.
Again, Mr. Chairman, thank you for the opportunity to
testify. I would be happy to answer any questions.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
NATIONAL CONFERENCE OF CAP PRACTITIONERS
22 Jericho Turnpike, Suite 110 T: 516-333-8282
Mineola, NY 11501 F. 516-333-4099
Mr. Chairman and members of the Committee, thank you for
inviting me to testify today. My name is Stephen Mankowski. I
am a Certified Public Accountant, member of the American
Institute of CPAs (AICPA) and the National Executive Vice
President and National Tax Policy Chair of the National
Conference of CPA Practitioners, (NCCPAP - the countries'
second largest CPA organization). NCCPAP is a professional
organization that advocates on issues that affect Certified
Public Accountants in public practice and their small business
and individual clients located throughout the United States.
NCCPAP members serve more than one million business and
individual clients and are in continual communication with
regulatory bodies to keep them apprised of the needs of the
local CPA practitioner and its clients. Accompanying me is Ms.
Sandra Johnson, National President of NCCPAP.
My firm has been preparing tax returns for over 30 years.
My firm annually prepares well over 2,000 small business and
individual tax returns as well as sales tax, payroll tax
returns, highway use tax returns and 1099 informational
returns. We are in the trenches with clients discussing their
tax, financial and personal issues, and the impact events and
proposed tax law changes may have on them. Although our clients
are mostly in the Pennsylvania, New Jersey and Delaware area,
we serve clients in over 30 states and also provide services to
clients in Canada and Europe. In this respect our practice is
the same as many members of NCCPAP and other smaller CPA firms
throughout the United States.
Tax compliance burden has been defined in the GAO report
``SMALL BUSINESSES IRS Considers Taxpayer Burden in Tax
Administration, but Needs a Plan to Evaluate the Use of Payment
Card Information for Compliance Efforts'' as the time and money
spent by the taxpayer to meet tax obligations. This includes
federal, state and local obligations, but NOT liabilities. The
time spent on tax compliance related activities can include
working with paid professionals, tax planning, record keeping,
filing and submitting tax forms, learning tax laws, and working
with the IRS and other jurisdictions on tax related issues. The
monetary burdens can include the expenses of accounting and tax
professionals, tax and accounting software, payroll services,
and legal fees. An objective of the Administration and the IRS
has been to minimize these burdens and eliminate unnecessary
ones. For purposes of my testimony, I will simply use the term
taxpayer burden to refer to tax compliance burden.
My first exposure to taxpayer burden was in November 2012.
I was invited to represent NCCPAP and participate in an IRS
panel with other tax professionals at IRS headquarters to
discussed compliance burdens for both individuals and small
businesses. As a CPA, I had always viewed my role as one to
reduce client burden. I had not viewed my role as a source of
taxpayer burden as indicated in the GAO report, which says that
CPAs and tax services are part of the monetary burden of
business owners. We take many of the above tasks away from the
business owner to allow him/her to focus on running their
business. So it is easy to see how this team can be easily
mistaken. This new appreciation of what comprises taxpayer
burden has allowed me to be an even better resource for my
clients.
It seems that every year business owners are more in tune
with how specific tax legislations could affect their business.
Clients often ask how the Tax Extender legislation will affect
their operations and what the Section 179 deduction limit is
for the current year. While the answers tend to be similar--if
you need a piece of equipment, you should buy it--that answer
is not always the right answer for a business owner. Often the
tax impact of the Sec. 179 deduction can be a deal-breaker.
Equipment costing $100,000 could have a net cost of $60,000
with these write-offs. The $40,000 tax savings is often the
deciding factor when making the purchase. While the IRS does
not have control over which of the Extenders are passed, it is
still a significant factor in assessing taxpayer burden.
Over the last few years, there has been a decided change in
how business is conducted. As consumers have been more
reluctant to carry cash, customers have forced the hand of many
businesses that have historically limited payment options to
cash or checks to now accept credit cards. Initially, business
owners might have added a surcharge for these transactions, but
with savvy consumers, credit cards and the related fees have
simply become yet another cost of doing business. And another
element of taxpayer burden. These business owners quickly
realized that they cannot simply apply one rate for these
transactions. Even after researching the processing firms to
obtain the best processing rates, they learn that MasterCard
and VISA have different merchant fees when compared to American
Express and Discover. If the consumer uses a credit card that
includes member programs or ``points'', an even higher
processing rate may be charged by the merchant bank. In
addition, there might also be monthly and compliance fees as
well as equipment rental costs. And if that's not enough, the
processing companies do not always deposit funds in the same
manner. Most will simply deposit the gross amount of the charge
and deduct the processing fees as a separate transaction. Yet
many companies will deposit the net amount after deducting the
processing fees, which makes the merchant's record keeping more
complicated.
Most business owners have accepted these changes in how to
conduct their business and accurately report their income. The
IRS questioned the voluntary compliance of reporting all
revenue, especially with the surge in online sales through
PayPal. Under a 2008 law, the processing companies had to begin
reporting credit card receipts to the IRS and the merchant in
2011 and had to add the reporting of the number of monthly
transactions for 2012. This data appears on Form 1099-K,
Merchant Card and Third Party Network Payments. This form must
be issued once a payment processor once a merchant annually has
200 transactions and sales of at least $20,000.
Initially, the IRS had added rows onto personal returns on
Schedule C and Schedule E as well as the business returns to
incorporate the revenue information from Form 1099-K. However,
prior to the start of the filing season, the IRS eliminated the
requirement to complete these fields because too many issue
arose creating much confusion. Specifically, there was
confusion on how to treat sales tax, gratuities, cash back and
returns on the 1099-K. Those same concerns still exist and are
just some of the reasons that the IRS hasn't taken a stronger
view on the use of the information on these forms.
The Form 1099-K has been a new source of taxpayer burden
for the small business owner. Business owners track revenue by
specific categories (i.e. sales, repairs, consulting, rent,
etc.). They have not needed to track revenue based on how they
are paid. Trying to accurately track revenue in the same way as
the 1099-K presents data would result in an accounting
nightmare. To further complicate the record keeping, businesses
receive a Form 1099-K for each specific payment processor. So,
if the business accepts MasterCard/VISA and American Express
they would receive a form from MasterCard/VISA and one from
AMEX. If they also use Paypal, they would receive a third form.
If they changed their payment processing company during the
year, additional forms would be received from the new
processing company. The overall burden to accurately track
revenue by each credit card type can be significant and
generate no results that benefit the owner.
Another issue with the Form 1099-K revolved around payments
for vendors that would receive a Form 1099MISC. Any payments
related to these services would not be included on the Form
1099MISC. This adds a different and unique level of taxpayer
burden as this would relate to both the payer and recipient.
Just as businesses are not setup to track revenue by payment
source, the payer would have an additional burden to exclude
credit card payments from the total payment they are required
to report on Form 1099MISC to the recipient.
From the IRS viewpoint, however, this form has helped
increase voluntary compliance among small businesses. Many
virtual businesses that had previously flown under the radar
(part of the underground economy) are now filing income tax
returns and paying taxes. In addition, the Form 1099-K has
allowed the IRS to establish a database whereby they can obtain
a better understanding of the revenue sources of a particular
industry. Even though the IRS has not been able to assess
taxpayers based solely on these databases, the IRS has been
sending letters to taxpayers whom they feel have significantly
under reported revenue. Initially, the IRS was accepting
reasonable responses to these notices, but with the additional
data in their databases, the IRS has a better understanding of
the egregious filers, specifically those businesses reporting
that 100% of their revenue was from credit card transactions.
To assist tax professionals, the IRS instituted a pilot
program for the 2015 filing season called the Payment Mix
Comparison Tool (PMCT). NCCPAP was invited to participate in
the program. This program allows our members to enter selected
data from the client's Form 1099-K (Merchant Category Code
(MCC), zip code, total transactions and total revenue) along
with the total business income into a tool. PMCT accesses the
IRS database and compares various ratios for a business with a
specific MCC code against the Form 1099-K. The result tells the
CPA if the results are within specifications of the database. A
common flaw with the Form 1099-K is that if the payment
processor applies an incorrect MCC code for a business, the
PMCT results could be beyond the standard deviation which nay
result in an IRS notice.
The results from the PMCT have been strictly for the
benefit of the taxpayer and is for informational purposes only.
Currently, the IRS is not capturing data from this tool. The
database will continue to improve as the volume of historical
data input into the tool increases. The PMCT, unfortunately,
did not get the expected usage due to a few practitioner
concerns. Specifically, the name of the tool was not the best,
many practitioners did not believe that the IRS was not
tracking the results and the fact that PMCT did not go live
until the beginning of February 2015 after most CPAs have
completed their training and had already begun preparing tax
returns. In addition, many felt that there should be a better
result besides ``typical'' or ``unusual'' depending on where in
the range their client's data fell. Hopefully, this program
will continue next year and will see more usage by tax
professionals. If used property, PMCT could actually reduce
taxpayer burden by addressing issues of credit card revenue
while the data is still fresh in the business owner's mind.
In conclusion, taxpayer burden exists on two primary
levels--time and money--to remain in compliance with today's
complicated tax codes. Often, both components are viewed as
one, except when contacting the IRS. Staffing and budgetary
issues have resulted in longer than expected wait times and
reaching IRS employees that are not able to address the
caller's issues and concerns. Compliance with tax codes and
dealing with new forms adds to taxpayer burden. New forms, such
as Form 1099-K, are a prime example. The results may be of use
to the IRS, but does not have any practical use for the
business owner. Businesses do not tracked revenue by number of
transactions or type of payment. Any attempt at verifying the
data on the Form 1099-K would be fruitless, especially in
industries, such as restaurants where customers charges often
include gratuities and sales tax, neither of which are revenue
to the business.
Accepting credit cards has become the norm. Most businesses
historically have included all of their sales, regardless of
source. With the information on Form 1099-K, the IRS now has a
means to ensure that all business, especially virtual ones, are
tax compliant with regard to credit card sales. With this form
comes additional burdens to the taxpayer including how to
reconcile sales to the revenue reported on these forms. The
question that the taxpayer needs to answer is how to best run
his or her business. If the business owner has systems in place
to accurately track all revenue, the burden of reconciling the
Form 1099-K data should be minimal. It is extremely important
that the IRS has the tools to determine tax compliance and
reduce the tax gap.
As various states learned that the IRS was beginning the
income matching program, many decided to use this as a tool to
understand the sales mix of credit cards vs. cash and checks.
Currently these states have also indicated that they have no
plans to use this information for audit selection or any
purpose other than the collection of information. However,
neither the IRS nor the participating states have assured the
tax practitioners or business communities that this information
will not be used in the future as a tool for audit selection
despite its flaws.
This program has the potential of a disaster. This is a
repeat of warnings from NCCPAP and others in the tax
practitioner community when the Form 1099-K matching program
was first proposed. It is well understood that the IRS should
use all tools possible to find tax cheats. However, as the GAO
has correctly indicated, this is a flawed system with no real
ability of matching gross income with Form 1099-K reports.
Additionally, the ratio tools now being used are very imperfect
as certain assumptions used (such as NAICS codes) will skew the
information.
Thank you for the opportunity to present this testimony.
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