    [House Hearing, 115 Congress]
    [From the U.S. Government Publishing Office]

       START-UPS STALLING? THE TAX CODE AS A BARRIER TO ENTREPRENEURSHIP

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

                                    HEARING

                                   BEFORE THE

                          COMMITTEE ON SMALL BUSINESS
                                 UNITED STATES
                            HOUSE OF REPRESENTATIVES

                         ONE HUNDRED FIFTEENTH CONGRESS

                                 FIRST SESSION

                                   __________

                                  HEARING HELD
                               FEBRUARY 15, 2017

                                   __________

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                  Available via the GPO Website: www.fdsys.gov

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                       HOUSE COMMITTEE ON SMALL BUSINESS

                          STEVE CHABOT, Ohio, Chairman
                                STEVE KING, Iowa
                          BLAINE LUETKEMEYER, Missouri
                              DAVE BRAT, Virginia
                 AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
                            STEVE KNIGHT, California
                            TRENT KELLY, Mississippi
                                 ROD BLUM, Iowa
                             JAMES COMER, Kentucky
                     JENNIFFER GONZALEZ-COLON, Puerto Rico
                              DON BACON, Nebraska
                        BRIAN FITZPATRICK, Pennsylvania
                             ROGER MARSHALL, Kansas
                                     VACANT
                   NYDIA VELAZQUEZ, New York, Ranking Member
                           DWIGHT EVANS, Pennsylvania
                           STEPHANIE MURPHY, Florida
                            AL LAWSON, JR., Florida
                             YVETTE CLARK, New York
                              JUDY CHU, California
                           ALMA ADAMS, North Carolina
                          ADRIANO ESPAILLAT, New York
                            BRAD SCHNEIDER, Illinois
                                     VACANT

                       Kevin Fitzpatrick, Staff Director
              Jan Oliver, Deputy Staff Director and Chief Counsel
                    Adam Minehardt, Minority Staff Director

                               C O N T E N T S

                               OPENING STATEMENTS

                                                                       Page
    Hon. Steve Chabot................................................     1
    Hon. Nydia Velazquez.............................................     2

                                   WITNESSES

    Mr. Kyle Pomerleau, Director of Federal Projects, Tax Foundation,
      Washington, DC.................................................     4
    Mr. David Burton, Senior Fellow, Economic Policy, Institute for
      Economic Freedom and Opportunity, The Heritage Foundation,
      Washington, DC.................................................     5
    Mr. Tim Reynolds, President, Tribute Inc., Hudson, OH, testifying
      on behalf of the National Small Business Association (NSBA)....     7
    Troy K. Lewis, CPA, CGMA, Tax Executive Committee Immediate Past
      Chair, American Institute of CPAs, Provo, UT...................     9

                                    APPENDIX

    Prepared Statements:
        Mr. Kyle Pomerleau, Director of Federal Projects, Tax
          Foundation, Washington, DC.................................    31
        Mr. David Burton, Senior Fellow, Economic Policy, Institute
          for Economic Freedom and Opportunity, The Heritage
          Foundation, Washington, DC.................................    37
        Mr. Tim Reynolds, President, Tribute Inc., Hudson, OH,
          testifying on behalf of the National Small Business
          Association (NSBA).........................................    49
        Troy K. Lewis, CPA, CGMA, Tax Executive Committee Immediate
          Past Chair, American Institute of CPAs, Provo, UT..........    78
    Questions and Answers for the Record:
        Questions and Answers from Representative Radewagen to David
          Burton.....................................................    96
        Questions and Answers from Representative Radewagen to Kyle
          Pomerleau..................................................    97
    Additional Material for the Record:
        The Like-Kind Exchange Stakeholder Coalition.................   100
        Statement for the Record from Karen Kerrigan, President &
          CEO, Small Business & Entrepreneurship Council (SBE
          Council)...................................................   104

       START-UPS STALLING? THE TAX CODE AS A BARRIER TO ENTREPRENEURSHIP

                                  ----------

                          WEDNESDAY, FEBRUARY 15, 2017

                      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, Brat,
    Radewagen, Kelly, Blum, Schneider, Bacon, Fitzpatrick,
    Velazquez, Evans, Murphy, Lawson, Chu, Adams, Espaillat, and
    Gonzalez-Colon.
        Chairman CHABOT. Good morning. I call the Committee to
    order.
        We want to thank everyone for being here. A special thanks
    to our witnesses who have taken time away from their busy
    schedules to be here with us today; we greatly appreciate that.
    We will introduce them here very shortly.
        In the coming weeks and months, Congress will have a once-
    in-a-generation opportunity to pass comprehensive tax reform,
    the likes of which we have not seen since Ronald Reagan's
    historic tax reforms back in the 1980s.
        While economic indicators remain mixed at best, there is no
    denying that new business creation remains in a long-term
    decline. We hear it from our constituents back home and from
    the witnesses who come to this hearing room to testify every
    week.
        The current Tax Code discourages entrepreneurs from taking
    the kinds of risks they once did, and this will have serious
    economic consequences, both in the short-term and in the long-
    term.
        Entrepreneurs face any number of challenges as they try to
    start a new business, but a recent National Small Business
    Association, NSBA, survey found that tax regulatory compliance
    is the number one most burdensome area.
        While there are many reasons for this aversion, including
    Obamacare and overregulation, today's hearing will focus on
    what is perhaps the greatest barrier to entrepreneurship, our
    broken Tax Code.
        For instance, there are a number of specific provisions in
    the current Tax Code that directly penalize the risk-taking
    entrepreneur. In my view, these provisions prioritize
    government growth through revenue collection over economic
    growth, and that is exactly the wrong approach. We need to keep
    the bigger picture in mind.
        America's entrepreneurs are crying out for tax relief and
    this Committee is listening to them. They want a Tax Code that
    is simpler, fairer, and flatter, so they can start and grow
    their businesses and turn their dreams into reality. As we work
    closely with Chairman Kevin Brady and our colleagues on the
    Ways and Means Committee, this Committee will ensure that small
    business and entrepreneurship is front and center for any tax
    reform effort this time around.
        The bottom line is that our current tax system is working
    against entrepreneurs too often when it should be working for
    them. We have to do better. And fortunately, with A Better Way
    agenda as our roadmap, we will do better.
        Today we will examine specific barriers in the Tax Code to
    entrepreneurship. We will also explore some possible solutions
    to tear down those barriers.
        I am looking forward to hearing from our witnesses here
    today, and I would now like to yield to the ranking member, Ms.
    Velazquez, for her opening statement.
        Ms. VELAZQUEZ. Thank you, Mr. Chairman.
        Today, one in ten Americans are self-employed. As we speak,
    another seven percent of American workers are actively trying
    to start a business. These trailblazers provide significant
    benefits to the economy. They take risks to start new
    businesses, bring new products to market, and ultimately,
    create new jobs, or even industries. As a matter of policy, we
    should be encouraging this type of risk-taking. Unfortunately,
    outdated and increasingly complex tax provisions create
    obstacles to success rather than a means of stimulating growth
    and job creation. Today's tax code contains thousands of
    provisions from the ordinary, like deductions for office
    supplies to tax credits to advance public policy goals, like
    the use of renewable fuels. This level of complexity makes
    complying with the law difficult and expensive, a burden that
    hits America's entrepreneurs hardest.
        This committee is well aware of the challenges created by
    the Internal Revenue Code and the major complications it has on
    business planning. Unlike their larger counterparts, many small
    firms cannot afford to spend significant resources on tax
    experts to assist them. Instead, many entrepreneurs spend
    countless hours trying to comply with an arcane tax code
    drawing them away from their usual business operations. These
    difficulties bring us to something that everyone on this
    committee likely agrees upon: importance and value in reforming
    our tax code. Of course, doing so will be a significant
    undertaking and the devil will be in the details.
        I agree with the chairman that in any comprehensive tax
    reform, small businesses must be front and center and not an
    afterthought. One important detail is making sure corporate tax
    reform also includes changes for our nation's 28 million small
    businesses. Successful tax reform that simplifies the code will
    give small businesses greater certainty and allow them to spend
    their time and resources on what they do best: launching new
    products and creating new jobs in their local communities.
        There have been areas of progress that suggest we may be
    able to find other common ground in reforming the tax code.
    This committee was particularly supportive of making permanent
    a number of tax extenders, such as the R&D tax credit and
    Section 179 expensing. Solidifying these changes for the long
    term gave small businesses certainty, allowing them to plan for
    the future.
        Mr. Chairman, I think all of us understand the vast array
    of tax compliance challenges facing entrepreneurs. The
    difficulty will be identifying viable solutions we can all get
    behind and hopefully implement. This will not be an easy task,
    but I do hope there is room down the road for cooperation and
    progress. I look forward to today's testimony, and I thank all
    the witnesses for the time that you are taking away from your
    businesses or jobs to be here today. Thank you.
        Chairman CHABOT. Thank you very much. Thank you. The
    gentlelady yields back.
        If Committee members have opening statements, we would ask
    that they be submitted for the record.
        And before I introduce our distinguished panel here this
    morning, just a brief overview of our timing and our rules,
    which is the 5-minute rule. Each of you will get 5 minutes. The
    green light will be on for 4 minutes. The yellow light will
    come on to let you know you have got a minute to wrap up, and
    the red light will come on, and we would ask that you try to
    stay within that if at all possible. We will give you a little
    leeway, but not a whole lot.
        So again, thank you for being here this morning. Our first
    witness is going to be Kyle--is it Pomerleau? Pomerleau, okay,
    thank you, director of Federal Projects for the Tax Foundation
    in Washington, D.C. In that capacity, he leads the tax modeling
    team, oversees the center's research, and researches and writes
    on a variety of Federal tax issues. His work has been cited in
    most major media outlets throughout the country.
        Our second witness will be David Burton, senior fellow in
    Economic Policy at The Heritage Foundation. He focuses on a
    wide swath of economic issues, including tax, securities,
    entrepreneurship, financial privacy, and regulatory and
    administrative issues. Prior to joining The Heritage
    Foundation, Mr. Burton's long career includes serving as
    general counsel to the National Small Business Association; CFO
    and general counsel to a startup, Alliance for Retirement
    Prosperity; partner in the Argus Group; vice president and
    general counsel to a multinational manufacturer; and manager of
    the U.S. Chamber of Commerce's Tax Policy Center.
        Our third witness today is Tim Reynolds, president of
    Tribute, Inc., a small software company located in Hudson,
    Ohio. Prior to purchasing Tribute in 1994, Mr. Reynolds held a
    variety of management positions with British Petroleum and BP
    America. He has also held a number of board and leadership
    positions in small business advocacy and economic development
    organizations, including previously chairing the Board of the
    National Small Business Association, NSBA. He is testifying
    today on behalf of the NSBA.
        We welcome all three of you, and I would now like to yield
    to the ranking member for the purpose of introducing our final
    witness.
        Ms. VELAZQUEZ. Thank you, Mr. Chairman.
        I am pleased to welcome Troy Lewis. Mr. Lewis is an
    associate teaching professor at Brigham Young University, where
    he received both a bachelor's and a master's degree in
    accounting. He is also a sole tax practitioner and the
    immediate past chair of the AICPA Tax Executive Committee. He
    is testifying today on behalf of AICPA. Welcome, Mr. Lewis.
        Chairman CHABOT. Thank you very much.
        Mr. Pomerleau, you are recognized for 5 minutes.

    STATEMENTS OF KYLE POMERLEAU, DIRECTOR OF FEDERAL PROJECTS, TAX
       FOUNDATION; DAVID BURTON, SENIOR FELLOW, ECONOMIC POLICY,
     INSTITUTE FOR ECONOMIC FREEDOM AND OPPORTUNITY, THE HERITAGE
      FOUNDATION; TIM REYNOLDS, PRESIDENT, TRIBUTE, INC.; TROY K.
    LEWIS, CPA, CGMA, TAX EXECUTIVE COMMITTEE IMMEDIATE PAST CHAIR,
                       AMERICAN INSTITUTE OF CPAS

                      STATEMENT OF KYLE POMERLEAU

        Mr. POMERLEAU. Thank you, Chairman Chabot and Ranking
    Member Velazquez, for the opportunity to speak about the U.S.
    tax system and entrepreneurship.
        There are millions of entrepreneurs in the United States,
    spread across nearly every major industry. While every
    entrepreneur has a different business model and unique
    concerns, there are a few key characteristics that apply to
    many entrepreneurs throughout the country.
        Entrepreneurs tend to run losses for some time before
    turning a profit, and some never turn a profit at all. As a
    result, entrepreneurial ventures tend to be especially risky
    investments for outside investors.
        If they do develop a successful business model,
    entrepreneurs often seek to rapidly expand their operations and
    scale.
        Ideally, the U.S. Federal Tax Code would be neutral with
    regard to each of these characteristics. However, this is not
    the case under current law. I am going to outline four ways in
    which the Tax Code discriminates against entrepreneurial
    investment.
        First, the tax treatment of business losses. It is often
    the case that entrepreneurs run losses for several years before
    turning a profit. Unfortunately, the current Federal Tax Code
    is particularly detrimental to businesses whose earnings fall
    into this pattern.
        The reason for this is the fundamental asymmetry in the
    U.S. Tax Code between the tax treatment of business profits and
    losses. A business that makes a profit is subject to an
    immediate tax liability in the same year the profit is earned;
    however, a business that turns a loss is not always entitled to
    an immediate tax benefit. This is because businesses whose
    losses exceed income are required to carry over those losses
    into future tax years when they finally have income.
        Importantly, the longer a business has to wait to deduct
    its net operating losses, the smaller a tax benefit the
    business receives.
        As a result, the Tax Code is inherently disadvantageous to
    businesses that run losses for many years before turning a
    profit.
        Second, the tax treatment of capital losses. Entrepreneurs
    often rely on outside investors to provide financial capital
    for their businesses. Investments in entrepreneurial ventures
    tend to be risky, and investors may experience a long string of
    capital losses before finding an investment that produces a
    substantial capital gain. And just like business losses,
    capital losses are not always immediately deductible, creating
    a situation that penalizes risky investment.
        In general, taxpayers are only allowed to deduct their
    capital losses in any given year up to the extent of their
    total capital gains. Individual taxpayers are also allowed to
    deduct up to $3,000 in capital losses beyond those losses.
    Otherwise, they have to carry forward the remaining into future
    years where they would be deducted against future capital
    gains.
        Here again, the Tax Code contains an asymmetry. Capital
    gains are subject to an immediate tax liability, while losses
    do not necessarily yield an immediate tax benefit.
        Third, the tax treatment of business investment.
    Entrepreneurs that develop a successful business model are
    often interested in scaling their operations as rapidly as
    possible. However, the current U.S. Tax Code is especially
    burdensome on businesses that undertake significant capital
    investments due to the tax system's treatment of capital
    investment, or specifically, depreciation. Under current Tax
    Code, businesses are not allowed to deduct the full cost of
    capital investments in the first year. Instead, they are
    required to deduct their investment cost over long periods of
    time according to a set of over two dozen depreciation
    schedules.
        Because businesses value immediate deductions more than
    deductions in the future, the longer a business has to wait to
    write off the full cost, the less likely the business is to
    undertake a new investment.
        Fourth, high tax rates on business income. All three of the
    previous distortions in the Tax Code are exacerbated by the
    high marginal tax rates on businesses in the United States
    today.
        Entrepreneurs that choose to set up passthrough businesses,
    such as S corporations, partnerships, face a top Federal tax
    rate of 44.6 percent, and the rate can exceed 50 percent when
    State and local income taxes are taken into account.
        Other entrepreneurs may choose to organize their businesses
    as C corporations. These businesses are subject to two layers
    of tax. First, a 35 percent corporate tax rate, which is the
    highest in the developed world, followed by a 25 percent
    capital gains and dividends tax.
        In conclusion, the U.S. code tends to impose higher burdens
    on businesses that run losses for many years, businesses that
    are risky investments, and businesses undergoing rapid
    expansion, all of which are typical characteristics of
    entrepreneurial ventures.
        Lawmakers interested in removing these barriers to
    entrepreneurship should consider ways to mitigate these
    distortions in the U.S. Tax Code. Thank you.
        Chairman CHABOT. Thank you very much.
        Mr. Burton, you are recognized for 5 minutes. If you could
    turn that mic on. That is all right.

                       STATEMENT OF DAVID BURTON

        Mr. BURTON. Thank you, Mr. Chairman--that's better--Ranking
    Member Velazquez, and members of the Committee, for the
    opportunity to be here this morning.
        The views I express in this testimony are my own and do not
    necessarily reflect the institutional position of The Heritage
    Foundation.
        Entrepreneurship matters. It fosters discovery, innovation,
    and job creation. Entrepreneurs develop new and less expensive
    products that improve consumer well-being and account for most
    of the job creation in the United States. Moreover, the vast
    majority of economic gains from the innovation that
    entrepreneurship creates accrues to the public at large rather
    than entrepreneurs.
        Most indicia of entrepreneurial health indicate that
    entrepreneurship is in decline. Accordingly, job creation,
    productivity improvements, and welfare enhancing innovation
    have slowed and the tax system is a major contributing factor.
    It is a factor both because of the direct impact of the tax
    system on small and startup firms, but also because of the
    adverse impact on the economy overall. It imposes high taxes on
    risk-taking, harms the international competitiveness of U.S.
    businesses, and impedes economic growth. Moreover, the tax
    system is monstrously complex, imposing inordinately high
    compliance costs on small and startup firms.
        Among the four major sources of complexity in the tax law
    are the Capital Cost Recovery System; inventory accounting;
    employee benefit taxation, particularly the rules governing
    retirement savings or qualified accounts; and international
    taxation.
        Given our time constraints, I will quickly outline 12
    reforms to the current system designed to aid entrepreneurs and
    briefly discuss tax reform. Many of the incremental reforms
    proposed raise issues that need to be addressed in fundamental
    reform as well.
        First, Congress should amend Internal Revenue Code section
    179 (sic) to permanently allow capital expenses of up to $1
    million to be deducted when incurred. Expensing would simplify
    small firms' tax returns, reduce compliance costs, reduce small
    firms' cost of capital, and aid cash flow.
        Very few small employers offer retirement accounts because
    of the complexity, high compliance costs, and regulatory risk
    of doing so. It is one of the most complex areas of the tax law
    and desperately in need of simplification.
        Evidence shows that capital gains rates much above 20
    percent actually reduce Federal revenue. In addition, a high
    capital gains tax rate reduces the willingness of investors to
    invest in relatively risky startups and growth companies and
    impedes capital formation.
        Congress should also permit cash method accounting for
    firms in up to $10 million in gross receipts.
        Congress should liberalize the S corporation rules,
    particularly allowing S corporations to have more than one
    class of stock, nonresident alien shareholders, subject to 30
    percent withholding, and more than 100 shareholders. This
    latter issue is particularly important for companies that are
    trying to take advantage of the recent JOBS Act provisions
    related to crowdfunding or Regulation A where they are trying
    to use the Internet to raise small amounts of money from a
    large number of people. Unless you change those rules, they
    will not be able to take advantage of it.
        Obamacare imposes a health insurance tax that needs to be
    repealed. This is particularly focused on small companies
    rather than large companies that self-insure.
        We also need to reduce the tax rate paid on passthrough
    entities to no more than that paid by C corporations.
        We need to increase the threshold for ISOs, or incentive
    stock options.
        We need to provide full deductibility of health insurance
    purchased by the self-insured.
        We need to improve the rules and clarify the rules relating
    to whether distributions are subject to the self-employment tax
    from passthrough entities.
        We desperately need to clarify the rules governing the
    distinction between employees and independent contractors. That
    rule has been around there or that problem has been around
    since the 1970s. It has never been fixed.
        And we need to increase the unified credit amount so that
    family businesses and farms do not have to be sold to pay the
    estate and gift tax.
        Now, briefly, on fundamental tax reform, under the
    leadership of Speaker Ryan and House Ways and Means Committee
    Chairman Brady, the House Republicans put together what they
    call a blueprint. This blueprint would have an extremely
    positive impact on the economy. Our friends at the Tax
    Foundation estimate it would increase GDP by 9.1 percent over
    10 years, and I think that is about right based on other
    macroeconomic work that has been done.
        It would aid small businesses for at least two reasons.
    First, it would result in a dramatically stronger economy. And
    secondly, it would dramatically reduce the complexity and
    compliance burden experienced by small firms. And I would be
    glad to get into a lot of those details.
        Thank you very much for the opportunity to testify this
    morning.
        Chairman CHABOT. Thank you. You fit a whole lot into 5
    minutes there, so thank you very much.
        Mr. Reynolds, you are recognized for 5 minutes.

                       STATEMENT OF TIM REYNOLDS

        Mr. REYNOLDS. Good morning, Chairman Chabot and Ranking
    Member Velazquez, and members of the House Small Business
    Committee. I want to thank you for inviting me to testify
    today.
        My name is Tim Reynolds. I am owner and president of
    Tribute, Inc., a software company located in Hudson, Ohio. Our
    38-employee company develops and markets accounting and
    operations software for industrial distributors.
        I am pleased to be here representing not only my company,
    but also the National Small Business Association, NSBA, where I
    currently serve as an honorary trustee and am a past chairman.
        NSBA's members consistently rank tax simplification and
    reducing the tax burden among their top issues for Congress and
    the administration address. The compliance burden on taxpayers,
    because of the complexity of our code, is truly staggering.
        My company is a Subchapter S firm. As such, the income of
    my company flows to my personal tax return. I have an MBA from
    the University of Michigan. I run a company that develops and
    sells accounting software and have been in business for more
    than 20 years. Yet, I would view it as taking an irresponsible
    risk to attempt to do my own taxes. The Code is so complicated
    that I feel certain I would inadvertently run afoul of the law.
    So I have to pay an accounting firm to do these taxes.
        In fact, according to the NSBA 2015 Small Business Taxation
    Survey, only 15 percent of small business owners handle their
    taxes internally. Eighty-five percent are forced to pay an
    external accountant or practitioner. This data point should
    send a strong message to the IRS and to Congress that the Tax
    Code is far too complex.
        I firmly believe the efforts to reduce the regulatory and
    administrative burdens on small businesses must focus on
    overall simplification, eliminating the inequities with the Tax
    Code and enhancing taxpayer education and outreach.
        My company has been audited by the IRS twice. In both
    cases, the eventual result was no errors found, and therefore,
    no penalties. In one case, the initial auditor did not
    understand the rules around deferring software sales revenue.
    After multiple appeals, we were finally referred to her
    supervisor, who agreed with our interpretation of the deferral
    rules.
        My point here is that in some cases, even the IRS cannot
    easily interpret the rules. Tax simplification would reduce not
    only the cost of compliance, but possibly also the cost of
    enforcement.
        As the tax laws have evolved over the last 30 years, it has
    become full of often contradictory rules with unclear policy
    objectives that have resulted in both unintended consequences
    and unrealized intended consequences.
        I will conclude my testimony with an example that has
    impacted my firm directly. This problem has to do with the
    impact that the alternative minimum tax has on the R&E tax
    credit. As a software development company, Tribute spends a
    significant amount of effort each year on research and
    development. As such, we are entitled to take advantage of the
    R&E tax credit, which can produce tax savings available then
    for more investment and development. However, because we are an
    S corporation, I am often subject to the alternative minimum
    tax. For years, this has prevented my company from taking the
    R&E credit. This credit is meant to encourage additional
    research and development, yet I am penalized for the way my
    business is structured.
        I should note that the PATH Act of 2015 fixed this problem,
    but only for C corps. As you may know, most small businesses,
    where much of our innovation happens, are S corps, and so the
    complicated Tax Code steps on its own foot yet again in this
    area.
        So in conclusion, the cost of compliance and the complexity
    and inconsistency within the Tax Code pose a significant and
    increasing problem for small business and our economy. A
    simpler, stable tax system dedicated to investment, savings,
    and economic growth must be put in its place.
        Again, I would like to thank Chairman Chabot, Ranking
    Member Velazquez, and members of the Small Business Committee
    for the opportunity to speak today. I would be very happy to
    answer any questions that you might have.
        Chairman CHABOT. Thank you very much.
        Mr. Lewis, you are recognized for 5 minutes.

                       STATEMENT OF TROY K. LEWIS

        Mr. LEWIS. Chairman Chabot, Ranking Member Velazquez, and
    members of the House Committee on Small Business, thank you for
    the opportunity to testify.
        We applaud the leadership taken by the Committee to
    consider ways to promote entrepreneurship by addressing
    barriers in the Tax Code.
        Today I would like to highlight a few tax reform issues
    that directly impact small businesses and their owners. First,
    it is important to recognize that tax relief should not mean a
    rate reduction for C corporations only. Congress should
    continue to encourage, or at least not discourage, the
    formation of sole proprietorships and passthrough entities.
        If Congress decides to lower corporate income tax rates,
    small businesses should receive a lower tax rate as well.
        We recognize that providing a reduced rate for income to
    small businesses will place additional pressure on the need to
    distinguish between profits of the business and compensation of
    the owner-operators. We should continue to use traditional
    definitions of reasonable compensation and judicial guidance
    for this purpose.
        To minimize controversy, the IRS should take additional
    steps to improve compliance in this area. Partnerships and sole
    proprietorships should be required to charge reasonable
    compensation. However, we should not treat partners and
    proprietors as employees, but rather as owners whose labor is
    also subject to withholding. Including partners and proprietors
    in well-defined payroll rules should enhance enforcement in
    this area.
        If Congress decides to move forward with the 70/30 rule--
    and that is treating 70 percent of passthrough income as
    employment income and 30 percent as return of equity--we urge
    you to make this proposal a safe harbor and not a hard and fast
    rule. A safe harbor would promote simplicity for many
    businesses without sacrificing potential fairness for others.
        Next, we are concerned with and urge you to oppose any new
    limitations on the use of the cash method of accounting. The
    cash method is a simpler application, has fewer compliance
    costs, and does not require taxpayers to pay tax before
    receiving the income, which is why entrepreneurs often choose
    this method. Forcing them to switch to the accrual method upon
    receiving a gross receipts threshold would unnecessarily
    discourage business growth and impose financial hardship on
    cash-strapped businesses. We appreciate that Chairman Brady,
    recognizing the importance of the cash method of accounting,
    did not restrict its use in the tax reform blueprint.
        Another important issue for small businesses is their
    ability to deduct interest expense. Owners borrow to fund
    operations, working capital needs, equipment acquisition, and
    even to build credit for future loans. We should not take away
    or limit this critical deduction for many small businesses who,
    with little or no real access to equity capital, are forced to
    rely on debt financing.
        Another potential barrier for small businesses involves
    changing the rules around the taxation of compensation.
    Congress should not reduce an employee's ability to deduct the
    compensation paid to employees, whether in the form of wages or
    fringe benefits.
        At the same time, it is important to retain the employee
    fringe benefit exclusion. Changes in this area would impact the
    small business' ability to build and retain a competitive
    workforce.
        Discussions on tax reform have also included border
    adjustment provisions, suggesting an exclusion of export sales
    revenue and a disallowance of the deduction for any imported
    goods or services. These provisions would impact businesses of
    all sizes, including small business. For example, a growing
    number of small accounting firms are locally owned and operated
    but must participate in global alliance networks in order to
    serve their clients on international tax matters. In other
    words, border adjustment provisions could have a substantial
    impact even on small local service providers.
        Unfortunately, there are many other tax provisions that
    hinder small businesses. For example, net operating losses. If
    passed by Congress, a 90 percent limitation on the use of an
    NOL imposes an artificial restriction on a company's use of
    business losses, and it discriminates against companies with
    volatile income. These businesses could potentially pay more
    tax than companies with an equal amount of steady income over
    the same period of time.
        We urge you to consider increasing the startup business
    deduction to give entrepreneurs the startup support they need
    in the early years, as well as reforming laws for qualified
    retirement plans and for unfair penalty provisions.
        Congress should also repeal the AMT for both individuals
    and corporations.
        Finally, we recommend that Congress permit flowthrough
    entities to choose fiscal year ends for tax purposes, which
    would allow advisors to spread out their workloads during the
    year. This flexibility would help ease the burden on both
    taxpayers and their advisors.
        In my remaining time, I want to ask for your support on the
    mobile workforce legislation. Employer tracking and complying
    with all of the different State and local tax laws is complex
    and costly. We urge you to support mobile workforce legislation
    that provides a uniform national standard for nonresident State
    income tax withholding. That legislation would also provide a
    de minimis exemption from State income tax for nonresidents.
        Thank you, and I would be happy to answer any questions you
    may have.
        Chairman CHABOT. Thank you very much.
        I would comment that I think all four of the witnesses made
    great suggestions that I think we ought to seriously consider,
    and we will obviously pass these on to the Ways and Means
    Committee also in this process.
        So I will recognize myself for 5 minutes for questioning.
    And Mr. Reynolds, I will start with you if I can. You said that
    your company was audited twice and neither time did they find
    that you paid less than you were supposed to. I assume that
    that was a stressful process to go through, and I imagine it
    probably cost a lot. Can I pry and ask you, do you know
    approximately how much you all ended up paying out of pocket?
    And also, was there an opportunity cost to you spending all
    this time doing this so you were not spending it on your
    business? If you could comment on that.
        Mr. REYNOLDS. Well, certainly. There was some level of
    opportunity cost. In both cases when we were audited, it was
    important for us to involve our accounting firm in order to
    represent us as they talked with the IRS. It was particularly
    important when we had the disagreement with the initial auditor
    around how to defer software revenue, which took several weeks
    to actually end up resolving.
        So in the first case where there was no dispute, I think it
    was probably a couple thousand dollars, and in the second case,
    it was more around $6,000 or $7,000 of cash outlay to my
    accounting firm for their time in representing me.
        Chairman CHABOT. Thank you very much.
        Mr. REYNOLDS. The audits also, of course, took not only my
    time but my controller's time, bookkeeper's time, so it was a
    significant----
        Chairman CHABOT. So I am assuming it distracted you from
    your business. How many employees do you have?
        Mr. REYNOLDS. Pardon me? I have 38 employees.
        Chairman CHABOT. Thank you very much.
        Mr. Lewis, I will turn to you. I have been hearing from
    some of my constituents back in Cincinnati about business
    interest deductibility and the proposal in the Better Way
    agenda to eliminate, do away with it. How critical is interest
    deductibility to entrepreneurs as they try to launch or expand
    a business? And what impact could its repeal have on
    entrepreneurship in general do you think?
        Mr. LEWIS. That is a great question. I think you need to
    realize, to answer that question, a couple of things. Number
    one, the ability for a small business to flip a switch and grab
    equity capital is very limited. I know in theory you would like
    to say, well, you are indifferent. Someone can invest in your
    company with stock or you can go borrow, but the reality is
    borrowing is so much simpler and much easier. And that is the
    lifeblood of these small businesses. That is where they get it.
        So from their perspective, this notion that you are going
    to make it relatively neutral, that you cannot deduct
    dividends, you cannot deduct interest, will not ring true.
        Now, the tradeoff that you hear is you hear, well, you
    mentioned the Better Way, that you will be able to deduct all
    of your capital outlays, this million-dollar increase that Mr.
    Burton mentioned for section 179.
        But the reality is these small businesses already have
    that, by and large. Half a million dollars. It does not solve
    all the problems, as Mr. Burton said, but they are already
    expensing. So the only thing you would be gaining in this
    perhaps is a disallowance of that interest expense. And
    remember, these businesses run on incredibly thin margins. Most
    of them have an operating loss up front. There is a time where
    they know they are going to lose money until they can be
    profitable, so every dollar matters.
        So to answer your question, it is very critical for these
    businesses, particularly because on the other side they are not
    really picking up much in terms of immediate expensing which
    you might think with a larger company.
        Chairman CHABOT. Thank you very much.
        Mr. Pomerleau, I will move to you if I can. You mentioned
    that the current depreciation regime is very complicated, being
    comprised of more than two dozen depreciation schedules and
    requiring, I believe, 448 million hours each year for
    compliance. What is the impact of this on American businesses
    and the economy, and what do you suggest that we do about that?
        Mr. POMERLEAU. Yeah. So one of the big downsides with the
    current business Tax Code is this idea of depreciation.
    Requiring businesses to write off assets over a number of years
    basically reduces the amount they get back in those deductions.
    So if you could get a deduction of $100 up front, that is a lot
    larger of a deduction than if you took that $100 and spread it
    over 10 years. We find that if you move from this system to a
    system of full expensing, I mean, it would grow the economy by
    about 5 percent over a decade. So this is implying that
    depreciation under the current system is reducing the level of
    investment in the economy.
        Chairman CHABOT. Thank you very much.
        And I will conclude with you, Mr. Burton. You mentioned
    that repealing the excise tax imposed by Obamacare on health
    insurance premiums would be helpful to entrepreneurs. Did
    Obamacare impose any other taxes that are, in your view,
    hindering entrepreneurship?
        Could you turn the mic on again, please? That is all right.
        Mr. BURTON. The most obvious would be the Obamacare
    investment income tax, which is 3.8 percent. And so owners of
    passthrough entities or for, that matter, shareholders in C
    corporations would pay it. But there is a fairly long list of
    taxes that were a part of Obamacare.
        Chairman CHABOT. Thank you very much.
        My time has expired. The gentlelady, ranking member, is
    recognized for 5 minutes.
        Ms. VELAZQUEZ. Thank you, Mr. Chairman.
        Mr. Pomerleau, there seems to be agreement that the tax
    system is overwhelmingly complex. One of the main problems for
    businesses is deciding on which tax structure, which one of
    them offers the most advantages. Do you believe that the
    various options available make the tax law more complicated?
        Mr. POMERLEAU. Yeah, I think that that is true. So under
    current law there are several ways that you could form a
    business, and those have specific tax consequences. The big
    distinction, of course, is between passthrough entities, S
    corps, partnerships, sole proprietorships, and C corporations.
    So if you are deciding to make an investment, whether it is
    building a factory or buying a machine that is going to have a
    return for you, it matters what business form you go into. If
    you go into a C corporation, you may face a double tax. If you
    go into an S corporation, there are limitations there even if
    you do not face the double tax. So I do think that under
    current law there are a lot of calculations that business
    owners need to do that would not be necessary under a tax
    system that treats all investment equally.
        Ms. VELAZQUEZ. Thank you.
        Mr. Lewis, can you please describe the complications that
    passthrough entities may face in net operating loss
    calculation, and what can we do in Congress to address it?
        Mr. LEWIS. Okay. Thank you for the question.
        What happens, as has been said, when you have a passthrough
    entity, by definition that means the income of the business,
    although it is reported by the business, is passed through or,
    in other words, reported directly by the owners themselves. And
    most of the time, particularly in a small business setting, we
    are talking about individuals.
        So your question is if a business is owned by a bunch of
    individuals and they have a loss, how does that impact them
    individually? And the answer is when you file an individual
    1040, a business return into a 1040, you have two aspects. You
    have sort of like their personal aspect and then you have the
    business. And it is that interplay in between those two that
    creates the complexity.
        In a C corporation, as has been mentioned, it is relatively
    straightforward. If you lose money, the number kind of falls
    out. But in an individual standpoint, there is an entire IRS
    publication that takes you through how to separate out the
    business side of your dealings from your individual side, from
    your personal side.
        So some of the things that you could do would be to
    simplify the rules and maybe just say, all right, whatever the
    loss is coming from the business, without making adjustments,
    just recognize that in simplicity sake you might give up some
    equality issues, but you would gain a lot by simplicity. I
    think the theme that I have heard from the panelists that bears
    repeating is simplicity is the key. A lot of these small
    businesses are drowning in regulation, particularly from the
    tax side, and they need relief. They need to have more time, as
    Mr. Reynolds said, to spend on developing the software and
    finding customers than trying to comply.
        Ms. VELAZQUEZ. Thank you.
        Mr. Reynolds, in your testimony, you make note of the tax
    extenders passed into law in 2015 under the PATH Act. We have
    heard that 100 percent exemption of capital gains on investment
    in qualified business stock passed under this act has catalyzed
    investment in innovative startups. Would you be in support of
    allowing small businesses operating as LLCs to qualify in
    addition to corporations currently allowed?
        Mr. REYNOLDS. For the section 179?
        Ms. VELAZQUEZ. Yes.
        Mr. REYNOLDS. Yes. Yes, ma'am. I certainly would.
        Ms. VELAZQUEZ. Mr. Pomerleau?
        Mr. POMERLEAU. Yeah, I think that treating businesses
    across the board in the same way is important.
        Ms. VELAZQUEZ. Mr. Lewis?
        Mr. LEWIS. That is a really fantastic question. The ability
    under 1202 to exclude the 100 percent gain after 5 years--that
    is what you are referring to--yeah, I mean, there are several
    provisions in the Code where you should be entity neutral and
    this is one that is clearly patently not. And as a result, I
    think you have hit a very good point that should be explored.
        Ms. VELAZQUEZ. Okay. Thank you.
        Mr. Chairman, I yield back.
        Chairman CHABOT. The gentlelady yields back.
        The gentlelady from America Samoa, Mrs. Radewagen, who is
    the chairman of the Subcommittee on Health and Technology, is
    recognized for 5 minutes.
        Mrs. RADEWAGEN. Thank you, Mr. Chairman.
        I, too, would like to welcome the panel for being here
    today. Very interesting testimony.
        My first question is, and any one of you or all of you
    could answer it depending on the time, most of the proposals
    that are being talked about today will only affect the 50
    States and the District of Columbia. What proposals do you have
    for the five territories? Guam, the U.S. Virgin Islands, the
    Northern Marianas, and America Samoa have a mirror Tax Code to
    the U.S., and Puerto Rico has a different Tax Code.
        Mr. Pomerleau?
        Mr. POMERLEAU. I think that I am not really an expert on
    any of the territories' Tax Codes, but I think any of these
    issues can be applied to any of the territories' tax systems.
    It would be worth considering in any reform to improve business
    taxation.
        Mr. BURTON. Puerto Rico and American Samoa have greater
    flexibility under the law than other territories. To the extent
    the Congress drafts a pro-growth Tax Code, it will benefit the
    possessions that have mirror systems. American Samoa and Puerto
    Rico have the opportunity to adopt pro-growth simpler Tax Codes
    on their own initiative. I have some familiarity with Puerto
    Rico, not so much with American Samoa. And Puerto Rico's tax
    system is highly destructive and counterproductive and has had
    a very adverse impact in the island's economy. And they really
    need to reform it.
        But the basic themes of what any good tax reform proposes
    to be is it should lower marginal rates. You should move
    towards expensing of capital, and you should have a simple
    system. If you get those basic three things right, you are
    likely to have a positive impact on entrepreneurs.
        Mr. REYNOLDS. I cannot speak as a tax expert, but what I
    would say as a business person is that anywhere in the world in
    business, complexity equals cost. And whether it is government
    or business or the Tax Code, complexity equals cost. And to the
    extent that you can simplify your Tax Code. I think you will
    greatly benefit your economy and the businesses there.
        Mr. LEWIS. Chairman Radewagen, I think from an America
    Samoa perspective there would be a couple things I would
    suggest. Number one, as the House is considering this so-called
    border adjustability, because America Samoa and Puerto Rico and
    the other possessions are sort of in this high-risk situation,
    I think it would be critical to define whether or not those
    would be treated for domestic or international purposes if you
    proceed with the border adjustability. In other words, is a
    sale into or outside of America Samoa going to be deemed to be
    a sale to a foreign jurisdiction? Or is it going to be within
    the United States? And I think you can have an appreciation of
    the kind of severity that that might have. I think that would
    be one key thing as you are looking. Because, again, as I
    testified, border adjustability will impact small businesses as
    well as large. We live in a very global society where all you
    need is an Internet connection and you are an exporter. So I
    think that would be the first thing.
        The second thing related to small business is the fact that
    the way the filings work, the fact that the citizens of the
    possessions have Social Security numbers and a couple of years
    ago we saw a lot of ID theft because crooks would figure out if
    I can grab those Social Security numbers, they are not going to
    be the ones filing a U.S. return if they do not have U.S.-
    sourced income. I think potentially what we could work towards
    with the IRS is making these so-called IP PINs, these
    identification numbers that are available in the event that you
    have had ID theft. Right now those are pilot programs only in
    Georgia, Florida, and the District, where it is voluntary. If
    you have been subject to theft anywhere else you can grab one,
    but I think that would go a long way to helping protect the
    citizens of your possessions.
        Mrs. RADEWAGEN. Thank you, Mr. Chairman. I yield back.
        Chairman CHABOT. Thank you. The gentlelady yields back.
        The gentleman from Pennsylvania, Mr. Evans, who is the
    ranking member of the Subcommittee on Economic Growth, Tax, and
    Capital Access, is recognized for 5 minutes.
        Mr. EVANS. Thank you, Mr. Chairman.
        I would like to thank all of the people on the panel today.
        Mr. Lewis, we have heard from small businesses the need to
    make certain tax credits permanent. How does this temporary
    nature of the tax provision affect small businesses?
        Mr. LEWIS. Mr. Reynolds spoke to it, particularly section
    179. Let's look at that expense first and it will answer your
    question. If you look at section 179, the last time it was
    passed with the PATH Act in 2015, December 18th. That left
    about as much time as the shelf life of a carton of milk. Okay?
    So just 2 weeks. It is really hard to react to that. And so
    what you find is that you find that your constituents will be
    paralyzed. They will not assume anything until it is passed,
    and then at that point they have got the holidays. It is very
    difficult to put stuff into place.
        One of the things about good tax policy is certainty. So to
    answer your question, if you give the taxpayers certainty and
    you give them a playing field that they know that they can rely
    upon, they will react to it. So if you are trying to motivate
    them with a credit, whether it is the R&D credit like Mr.
    Reynolds's company, or some of the other credits, if you want
    to embrace energy credits or something else, the element of
    certainty is what trips the switch and allows people to react.
    If not, they will just sit back on the sideline and either
    discount what might happen or simply just be paralyzed and do
    nothing.
        Mr. EVANS. I kind of want to follow up to a degree.
    Deducting business startup costs can be complicated. What tax
    simplification methods could be taken to ease some of that
    complexity?
        Mr. LEWIS. Okay. So the Code section that deals with that
    is 195. And what happens is, I think as you realize, is from
    the time a business is organized until they open their doors
    and get their first dollar, kind of on the shadowbox behind the
    register, between that time period, the Code currently now
    makes us capitalize all that and recover it over some period of
    time. Shockingly, that period of time is 15 years. So you could
    expense up to $5,000, but the rest of it you have to recover
    over 180 months. That is a long time to not receive that
    benefit back to an entrepreneur who is worrying about making
    payroll the next month.
        So one of the things you could do is--why is $5,000 the
    right number? Why not think about increasing that number? Five
    thousand seems arbitrarily low when you consider that just to
    get the doors ready to open it can be a big number, it can be a
    big amount. So one of the things you could do is expense. Allow
    these startup businesses to expense a lot larger than $5,000
    and let them get immediate recovery for those costs to get the
    doors open.
        Mr. EVANS. Mr. Burton, how do you respond to concerns that
    lowering the corporate tax rate will disadvantage small
    businesses, perhaps stifle entrepreneurship?
        Mr. BURTON. I do not think lowering the corporate rate
    disadvantages small businesses in a sense. Some small
    businesses are C corps, but you want to try to have a tax
    system that treats passthrough entities and C corporations as
    closely as comparable as possible. Obviously, a
    disproportionate number of small businesses are passthroughs,
    so I have maintained that any tax reform plan has to take care
    of passthroughs as well as C corporations, and that the rate
    that passthroughs experience should be no higher than that of C
    corporations.
        And there was a period about 2 years ago where that was
    about to be forgotten. I do not think it is as serious a
    problem now. I think Congress has become much more conscious of
    that issue.
        Mr. EVANS. In your written testimony you stated that the
    Tax Code is riddled with special tax preferences. Please
    elaborate on the key tax preferences that put small businesses
    at a disadvantage.
        Mr. BURTON. Well, there is a list of them put out every
    year by the Treasury that is in the Federal budget, and by the
    Joint Committee. It is called the Tax Expenditure List.
    However--there is a really big however here--only some of them
    are what I would regard, and I think most tax experts would
    regard as genuine tax expenditures. Some of them relate on a
    very different conception of what is income, but they would
    include things like the various alternative energy tax credits.
    They would include things like the low-income housing tax
    credit. They would include things like the exclusion for
    employer-provided health insurance and all the various other
    employee benefits. And the list goes on in small micro type and
    it is probably several hundred long.
        Mr. EVANS. Thank you, Mr. Chairman.
        Chairman CHABOT. Thank you. The gentleman yields back.
    Thank you.
        The gentlelady from Puerto Rico, Ms. Gonzalez-Colon, is
    recognized for 5 minutes.
        Ms. GONZALEZ-COLON. Thank you, Mr. Chairman. Thank all of
    you for coming to the hearing today.
        Small businesses make up a large part of Puerto Rico's
    economy, as you may know. According to the SBA, about 80
    percent of the private sector workers in Puerto Rico are
    employed at small establishments, which is slightly higher than
    the percentage of U.S. Mainland. Specifically, more than half a
    million workers are employed by 45,000 small businesses. In
    that account, as we draft a new tax plan, Congress should
    continue to be mindful of the fact that Puerto Rico and the
    other territories are U.S. jurisdictions and home to U.S.
    citizens who are nationals, and that jobs in Puerto Rico and
    other territories are American jobs.
        Mr. Burton, you are very familiar, as you already said
    minutes before, but some of the disadvantages that Puerto Rican
    businesses face vis-a-vis is their mainland counterparts,
    right?
        Mr. BURTON. Very familiar is probably too strong. Familiar,
    yes, although I do not think the vast majority of the problems
    come from the Internal Revenue Code. It comes from the Puerto
    Rican tax system itself. As you know, most Puerto Rican
    businesses are exempt from income taxes, and instead of that,
    the Commonwealth of Puerto Rico imposes very high corporate
    taxes, radically higher than any other State or territory. And
    in addition, there are a host of other taxes. So the Puerto
    Rican Commonwealth tax system has an extremely negative impact
    on businesses, entrepreneurs, but also the Puerto Rican people.
    And the Commonwealth government needs to fix that.
        Ms. GONZALEZ-COLON. I agree with you 100 percent. That is
    why the new government just filed a new tax reform system to
    the island that is supposed to help the small businesses.
        Mr. Pomerleau, you mentioned that the top rates on capital
    gains and dividends, both at 25 percent, are the highest there
    have been since 1997 and 2002. What will be the ideal rates for
    optimum growth?
        Mr. POMERLEAU. It all depends on how you structure your Tax
    Code. So one thing to remember is that capital gains and
    dividends is a second layer of tax on corporate investments
    specifically. So, depending on what you do on the corporate
    side is going to bleed into what you are going to want to do on
    individual investment income. For example, there are proposals
    that can lower the tax rate at the entity level, so lower the
    corporate tax rate, but then when that income is passed
    through, you may raise the tax rate on individual investors so
    the tax rate is equalized or treated more similarly to wage
    income. But it all depends on your proposal.
        Ms. GONZALEZ-COLON. Thank you.
        Mr. Chairman, I yield back.
        Chairman CHABOT. Thank you. The gentlelady yields back.
        The gentlelady from North Carolina, Ms. Adams, who is the
    ranking member of the Subcommittee on Investigations,
    Oversight, and Regulations, is recognized for 5 minutes.
        Ms. ADAMS. Thank you, Mr. Chair, and thank you, Ranking
    Member Velazquez, for hosting this hearing on the complexity of
    the Tax Code and its impact on our Nation's small businesses.
        The State of North Carolina has over 800,000 small
    businesses, and the City of Charlotte, which I represent, is a
    great example of an innovation hub for many startups. So
    guaranteeing that these companies and entrepreneurs have a good
    understanding of the Tax Code is extremely important. So my
    questions will focus around our discussions on tax reform and
    how it can help our Nation's small businesses.
        So to start, I would like to give each of you an
    opportunity to share your thoughts on which elements of tax
    reform that promote startups and innovative businesses should
    be included in the discussions as we move forward here on
    Capitol Hill.
        Mr. POMERLEAU. Yeah, so I think that tax reform proposals
    that could help small businesses (1) expanding expensing which
    is in the House GOP blueprint; (2) better treatment of net
    operating losses. This is another proposal that is in the House
    GOP blueprint. Now, it does limit the amount you can take every
    single year, but it also allows you to carry forward those
    operating losses on an unlimited basis, so as far as you want,
    and it adjusts those losses for the cost of capital and
    inflation every single year so they do not ever lose value.
    Because one of the big problems here with the current code is
    the longer you have to wait to use your net operating loss, the
    lower the value is and that is important for entrepreneurs to
    have lots of losses over many years.
        Lower marginal tax rates would also be beneficial. Right
    now some business forms can face rates up to 44 percent or even
    higher in some States and lowering those rates down at the
    Federal level could help.
        Ms. ADAMS. Mr. Burton?
        Mr. BURTON. I agree with everything he said. I think there
    are some things he left off. Inventory accounting is a major
    complexity problem particularly for stores. It can get
    ridiculously complex, including the uniform capitalization
    rules, all the separate tracking, whether you are using LIFO or
    FIFO, and I am sure our friend from the AICPA could go into a
    great deal more detail.
        But also, I think capital gains rates matter a lot to the
    ability of entrepreneurs to be able to raise capital because
    they affect investors. And there is also the secondary factor:
    Once capital gains rates get above about 20, it actually costs
    the Federal Government revenue because people do not realize
    their gains.
        The other thing I would say is you sort of need to draw the
    distinction between small businesses that are not startups and
    others. And retirement savings and qualified accounts probably
    do not matter much to a guy who is rolling dice and starting a
    business those first couple of years, but a business like Tim's
    that has been around for a while, has employees, trying to
    think through retirement savings for his workforce and himself,
    the current complexity of the qualified account area has been
    extremely destructive. It is why so many small businesses do
    not provide retirement savings vehicles for their employees or
    for their owners. And we need to address that. It has become
    genuinely monstrously complex and it serves no real policy
    objective, no matter what your political philosophy.
        Ms. ADAMS. Mr. Reynolds?
        Mr. REYNOLDS. I agree with everything, but if I were to
    pick one thing, I would say that the efforts to level the
    playing field between passthrough entities and C corporations
    is quite critical, particularly to startup and small
    businesses. But I would say the overall metric around the
    comprehensive tax reform needs to be about simplification. We
    have a Tax Code that is 70,000 pages. If you could take it down
    to 35,000, I still would not be able to read it all, but it
    would be a big improvement.
        Ms. ADAMS. Mr. Lewis?
        Mr. LEWIS. I would, of course, echo what others have said,
    but I think philosophical simplification is the right word.
    Let's keep it simple. I think all of us would agree it is too
    complicated.
        What are some examples of that? Keep cash method of
    accounting. I think an entrepreneur can understand when I spend
    something, when I get something, that is when it is taxable.
    The complexity really comes into it when you start adding into
    this, well, when was it earned? They can follow their
    checkbook. It is much more harder, and that is where you start
    having to get additional people involved to help support. I
    think that is the philosophical view that would help with all
    of these issues.
        Ms. ADAMS. Thank you very much, gentlemen. I yield back,
    Mr. Chair.
        Chairman CHABOT. Thank you. The gentlelady yields back.
        The gentleman from Pennsylvania, Mr. Fitzpatrick, is
    recognized for 5 minutes.
        Mr. FITZPATRICK. Mr. Pomerleau, how are you? Regarding the
    tax rates for both capital gains and dividends, it is pretty
    high right now. What would you suggest a sweet spot would be to
    maximize growth and investment? What is the best rate based on
    your studies?
        Mr. POMERLEAU. So we have not studied this specifically,
    but David Burton has brought up that, at some point, the
    marginal tax rate on capital gains starts losing you revenue
    because people will delay realizing those gains in order to
    avoid the tax. So what you see looking at historical data, as
    David said, is the closer you get to 20, the better off you
    are. So if you start going higher than where we are now or,
    well, we are basically over 20 now, you may actually be losing
    revenue in the long run because people are delaying their
    realizations and pushing the gains into the future where they
    are going to yield less revenue for the Federal Government.
        Mr. FITZPATRICK. So no suggested rate to maximize
    investment?
        Mr. POMERLEAU. I do not think there is a specific sweet
    spot. I do not know if David may know.
        Mr. BURTON. Twenty percent should be the top. It is not the
    ideal rate because beyond that it not only has economically
    counterproductive effects, it costs the Federal Government
    revenue. Now, it might be 22, but that is an absolute top.
        In terms of the ideal rate, ideally, you are trying to move
    towards a consumption tax, or stated differently, a tax that
    does not double tax savings and investment. And it depends on
    the administrative structure that you choose how you treat it.
    If you treat all savings, for example, in an IRA-type
    treatment, then reinvesting capital gains would, in fact, pay
    nothing and it would only be when you withdraw it and do not
    reinvest it, and then you pay the ordinary income rate and
    other sales taxes like, for example, excuse me, other
    consumption taxes like, for example, what Chairman Brady has
    proposed. Financial transactions in principle are entirely
    disregarded.
        Mr. FITZPATRICK. I yield back.
        Chairman CHABOT. The gentleman yields back.
        The gentleman from New York, Mr. Espaillat, is recognized
    for 5 minutes.
        Mr. ESPAILLAT. Thank you, Mr. Chairman. Thank you to the
    witnesses, Ranking Gentlewoman Velazquez, for this opportunity.
        Mr. Lewis, startup businesses are often saddled with great
    cost, particularly since many of them are renters. And so when
    folks are about to start a new business they have to
    significantly invest in major capital improvement to the
    properties, which often leads them to have issues when they
    renew their lease because they have, in effect, invested in
    increasing the value of those properties. Do you see any real
    benefits, tax credits or other types of benefits, that can
    alleviate small businesses from this initial investment that
    very often leads to them shutting down before they even open?
    Are there any real practical proposals that you have that would
    alleviate that investment?
        Mr. LEWIS. Great question. From a policy standpoint, the
    AICPA does not have an official policy, but let me give you a
    sense of some ideas that you could look at, one of which is the
    section 179 we mentioned. Historically, it was just for
    personal property, stuff that you could take with you for lack
    of a better phrase. But on top of that there is some
    liberalization of that rule where you can expense more of what
    you are talking about. Allowing entrepreneurs to immediately
    expense on those initial outlays would help a lot because
    really, when you are talking entrepreneurship, you are talking
    cash flow. I mean, all the rest of this is great, but that is
    what matters to them. Their ability to make payroll is
    dependent upon their ability to keep the cash coming in. So
    anything that you can do to give them an immediate benefit back
    would be well received.
        Mr. ESPAILLAT. Thank you.
        My second question is regarding the empowerment zone, so
    what created in the past and what created in distressed urban
    and rural areas, and they provided tax credit to the tunes of
    $3,000 per employee hired within the zone. It provided monies
    for bonding authority. It also provided a serial tax on capital
    gains and the sale of assets and other types of benefits for
    several regions throughout the country that were economically
    distressed and had high levels of unemployment rates.
        How do you feel about this policy to provide tax credits
    for employees that reside within economically distressed areas?
    And do you see this as a good policy for spurring businesses
    and job creation?
        Mr. LEWIS. Is that for me?
        Mr. ESPAILLAT. Yes.
        Mr. LEWIS. Okay. Thank you.
        The AICPA put out several years ago something called Good
    Tax Policy, and we just recently updated it last month. Many of
    your staffs might be aware of it, but we listed 12 ideas that
    as you approach any tax question you ought to think in terms
    of. Things like neutrality, simplicity, transparency,
    minimizing the tax gap, things that you would just say these
    are fundamental key components of what we should be doing.
        So your question is a good one in that you are asking a
    question about the balance between simplicity, neutrality,
    maybe even certainty and convenience of payment. So my answer
    would be you would have to weigh all of those together, because
    if you just isolate the one question and you just say, well, is
    it good from this policy or that, I think you may not get the
    right answer. But you have to ask yourself where does it fit in
    the purview of all of the good policies and evaluate it that
    way.
        Mr. ESPAILLAT. Thank you. I yield back my time.
        Chairman CHABOT. Thank you. The gentleman yields back.
        The gentleman from Iowa, Mr. Blum, who is the chairman of
    the Subcommittee on Agriculture, Energy, and Trade, is
    recognized for 5 minutes.
        Mr. BLUM. Thank you, Chairman Chabot. Did I get that
    correct?
        Chairman CHABOT. You did.
        Mr. BLUM. I am slow but trainable. It took me 6 weeks to
    get that correct.
        Chairman CHABOT. I even got Blum right. Everybody else says
    ``Bloom,'' so.
        Mr. BLUM. We are making progress.
        Chairman CHABOT. Excellent.
        Mr. BLUM. And thank you to the panel for being here today,
    particularly Mr. Reynolds. I happen to be an entrepreneur in
    the software business myself, and one of my basement companies
    in the 1990s went public in spite of the government. So I feel
    your pain.
        New business startups, 615,000 in the year 2005, 615,000.
    Ten years later, down to 450,000, down 40 percent. New jobs
    from new businesses, 4.7 million in the year 2000, down to 3
    million 15 years later. U.S. startups are at 40-year lows.
        So I would like to back up and talk a little bit about the
    formation of small business as it relates to tax policy. The
    only two ways I know to start a small business as far as
    capital goes is owner's equity; you put your own money into it
    and you go to the bank for capital. And if I walk through
    this--and I will take my own example--you are working for
    someone else, typically, unless you inherit money. You are
    working for someone else. You live beneath your means and you
    save some money. You put that money in a savings account in a
    bank and the interest is taxed.
        So then you put some of the money that you have saved over
    a lifetime, typically, maybe in the stock market. And then you
    sell those stocks and the capital gains, you are taxed. You are
    taxed on your interest. You are taxed on the capital gains.
        And then you think, okay, I have got some money here to
    start a business. Do I really want to go into it? Odds are I
    could get sued. Nuisance lawsuits. We need tort reform.
    Regulations are out of control. Do I want to deal with that?
    There is a multitude of things; also, taxes.
        So I would like to ask the panelists, and Mr. Reynolds, I
    would be interested in your personal story, what can we do as a
    Congress with tax policy to encourage savings? It seems to me
    that we discourage savings and encourage consumption in our tax
    policy. You cannot start a business without capital, and banks
    are not going to loan it all to you to start a business. So we
    need to go to the front end of this and say how does our tax
    policy encourage savings? Because that is where future
    businesses come from.
        And I will open it up to whoever wants to jump in.
        Mr. POMERLEAU. I think that that is an excellent question.
    There are a lot of places in the current Tax Code where the
    Code is discouraging savings, basically double taxing or triple
    taxing savings; the issue of dividend taxes, capital gain
    taxes. You say you earn $100 in wages. You save that money. Or
    you get taxed on those wages, you save that money, you earn a
    return, and then you are taxed again when you take that out as
    a gain. I think fundamental tax reform should move away from
    this system of double taxing savings towards a single layer of
    tax on saving and investment so people are not discouraged from
    saving. And that means it will not bleed into lower investment
    and lower economic growth, which is one of the big issues under
    the current Tax Code.
        Mr. BLUM. Would you agree our Tax Code discourages savings?
        Mr. POMERLEAU. Yes. I think----
        Mr. BLUM. Not a good thing for business formation?
        Mr. POMERLEAU. Yes. I think the things that expand IRAs,
    401(k)s, that would encourage savings. I think that fundamental
    reform that moves to a consumption-based tax would do the same.
    I think the House GOP blueprint moves much closer to an ideal
    system there.
        Mr. REYNOLDS. I would just say that you cannot use an IRA
    or a 401(k) to start a business. And we can debate whether or
    not that is appropriate or not.
        Mr. BLUM. If I could interrupt, Mr. Reynolds, how did you
    finance your business when you started?
        Mr. REYNOLDS. A combination of savings and loans. And that
    was 22 years ago and it was considerably easier then.
        I think that the Tax Code is one part of the problem in
    that particular circumstance. I think certainly a shift towards
    consumption-based taxing rather than taxing on income would go
    a long way to help that problem.
        I think that as a small business person, access to capital
    is an extremely important issue, and Congress over the last 8
    years has done considerable damage to small businesses' ability
    to get loans and access capital, and I think that that is
    something that needs to be addressed perhaps outside of the Tax
    Code, but it is a very vital issue to us.
        Mr. BLUM. And I was on a bank board, a billion-dollar bank
    back in Iowa, and I was chairman of the Director's Credit
    Committee. Every business loan over a million dollars came
    through our committee. And part of the problem with extending
    or making loans to new businesses was they were not
    creditworthy because they did not have enough equity to put in
    it. But as we are talking about it here, we tax away a big
    chunk of this equity as people are saving, as capital is
    forming along the way.
        Chairman CHABOT. The gentleman's time has expired, but, Mr.
    Burton, if you wanted to respond.
        Mr. BURTON. I just want to mention one thing. I released a
    paper yesterday that systematically walks through the reform
    agenda to improve entrepreneurs' access to capital, both in the
    banking and securities regulation area. You might want to look
    at that.
        Mr. BLUM. Very good. I will. I yield back, I guess, the
    time I do not have.
        Chairman CHABOT. Thank you. The gentleman's time has
    expired.
        And the gentleman from Florida, Mr. Lawson, who is the
    ranking member of the Subcommittee on Health and Technology is
    recognized for 5 minutes.
        Mr. LAWSON. Thank you very much, Mr. Chairman.
        My question will be do you think the intangible tax on
    property should be eliminated? On personal property in the
    office?
        Mr. BURTON. You are talking at the State and local level?
        Mr. LAWSON. Right.
        Mr. BURTON. In general, yes, I do. I think that
    particularly the way that they are usually administered, they
    are very complex and bordering on random. But of course, that
    varies tremendously State by State.
        Mr. LAWSON. Right. And the reason why I question it is
    because I have been in small business for 36 years and you pay
    more money to the CPA to do the reports than sometimes what it
    calls for the taxes. And I want to make sure that I was not the
    only one that felt that way.
        Mr. BURTON. Well, I think you are right. And then a lot of
    jurisdictions have these little gross receipts taxes, little
    inventory taxes, just little this, just little that, and the
    compliance costs relative to the money raised by the State and
    local government is very, very high, and the State and local
    governments need to simplify their tax systems as well. That is
    part of what guys like Tim experience. It is not any one rule
    or any one tax. It is the combined weight of hundreds of them.
    And basically, when you add it all up, they are overwhelmed.
    And we need you as a policymaker and your colleagues at the
    State and Federal level, you need to systematically try to
    reduce these burdens. And it is not you want to raise X dollars
    or Y dollars, just do it simpler.
        Mr. LAWSON. Right. Mr. Chairman, I have one more question.
        Back in I would say maybe July through September, there was
    a considerable amount of discussion about the minimum wage
    increase and there was some major corporation, like McDonald's
    and some people, really were focusing in on it and said, you
    know, we can ask for as much as $15 an hour. The minimum wage
    increase, even though you want people to have a livable wage,
    increasing the minimum wage has sometimes a devastating effect
    on small business, and any of you all can respond to it.
        Mr. REYNOLDS. I am in the software business and none of the
    people that work for me make the minimum wage. They are all on
    salary. My customers, however, are industrial distributors and
    often have people who are working minimum wage jobs in the
    warehouse and all. I think that, if I can speak for them, which
    they may or may not want me to, but if I can speak for them, I
    think that they would say that raising the minimum wage impairs
    their ability to hire additional people in those kinds of jobs.
        Mr. LAWSON. And I think, Mr. Lewis, you have done research
    in that area?
        Mr. LEWIS. We have not. It might be more for the
    economists.
        Mr. BURTON. The minimum wage affects a relatively small
    hunk of our population, but the real question is do you want to
    make it illegal for typically young people or inexperienced
    people to work at a lower wage, lower than whatever minimum
    wage is you pick? It is necessarily going to result in some
    unemployment of those people. It is necessarily going to result
    in somewhat higher cost to the employers. But I think the right
    way to think about it is it is targeted at the people who most
    need employment experience to do better. And we want a system
    that lets people get on the first rung of the ladder, and,
    typically, the minimum wage affects the youngest and least
    experienced people in the labor market.
        Mr. LAWSON. Okay. I yield back my time.
        Chairman CHABOT. Thank you. The gentleman yields back.
        The gentleman from Nebraska, Mr. Bacon, is recognized for 5
    minutes, finally.
        Mr. BACON. I want to thank you all for being here today. As
    a 30-year Air Force guy, you are really making it clear the
    complexity that our small businesses go through, so I really
    appreciate that.
        And I want to maybe just make a note to Mr. Pomerleau, too.
    I just thank you for your comments on capital gains. I find it
    fascinating that--or actually terrible that we have the highest
    capital gains tax since the 1990s and it has not only had a
    negative impact on our businesses, but it does not help out our
    tax revenues. Do I copy you right on that?
        Mr. POMERLEAU. No, I agree with that.
        Mr. BACON. All right. So that is important. We need to fix
    that.
        And Mr. Burton, I wanted to ask you about self-employed
    when it comes to ACA and health insurance. It is probably the
    number one thing I hear from our self-employed that that is the
    number one thing we have got to fix is the cost of premiums.
    And right now I believe it is partially deductible. Could you
    give us recommendations of how we could fix this better for
    self-employed when it comes to the ACA revisions? How can we
    get this right for the self-employed?
        Mr. BURTON. One thing is the tax treatment. You just want a
    deduction for purposes of the self-employment tax, the 15.3
    percent self-employment tax. But the other question is just the
    structure of the current health insurance market. Small
    employers and self-employed people are either not group
    insurance or very small group insurance and, therefore, tend
    to, given the structure of the current marketplace, have much
    higher costs. And part of that is the Affordable Care Act and
    part of it predates that. It was not as if a group of two or
    three people had it great before the Affordable Care Act. It is
    just worse now.
        And so that I think it is a matter of changing the
    structure of the health insurance market, making it less
    bureaucratic, more competitive. And my colleagues at The
    Heritage Foundation have put together a number of proposals to
    do that. I know enough about it to be dangerous, but I am not
    fully informed of the current state of play, if you will, so.
        Mr. BACON. Well, thank you. I talked to a self-employed
    couple yesterday, with some constituents. They are paying
    $30,000 a year, $12,000 deductible. It is the highest I have
    heard yet, and that is hard for a self-employed family.
        Mr. BURTON. It is. And I was on my own until about, I do
    not know, I guess it is going to be 6 years ago now. And the
    premiums then, and in a small firm were ridiculous. And now
    they are even more ridiculous.
        Mr. BACON. Mr. Reynolds, I wanted to follow up with a
    comment you made. You are right, about 70,000 pages of tax law.
    In fact, I think I read it was 78,000. How much time and money
    does it cost you and your company to work through all the--you
    know, to do your taxes?
        Mr. REYNOLDS. Well, as I said in my testimony, we simply
    cannot do our own taxes, and so we employ an accounting firm to
    prepare our taxes along with our annual review. Despite the
    fact I am a sub S, we have to do both corporate tax submission
    and a personal one as well, and they clearly have to relate to
    each other. And so my accounting firm does both. And I think
    for 2015, the bill came in at about $15,000.
        Mr. BACON. One last question. If you could immediately
    expense capital investments now rather than having to
    depreciate them over time, what additional investments would
    this allow your company to make? What kind of impact would it
    have if we fixed this?
        Mr. REYNOLDS. We are a services firm, so we do not have a
    lot of fixed assets. But what it would do if I can add, the
    kind of capital investments that we make generally are around
    the improvement of our facilities and making a better workplace
    would certainly accelerate our plans around that. I think, you
    know, we are a small business and we have to parcel things out
    over a period of time and it will allow us in general to act
    much more quickly.
        Mr. BACON. Thank you. Mr. Chairman, I yield back. Thank
    you.
        Chairman CHABOT. The gentleman yields back.
        The gentlelady from California, Mrs. Chu, is recognized for
    5 minutes.
        Mrs. CHU. Thank you, Mr. Chair.
        Well, there are many current tax policies that create
    inequities between small and large U.S. businesses, so I would
    like to address this question to Mr. Lewis. Certainly, the two
    most consistent burdens for small businesses are the cost of
    complying with tax provisions and the growing complexity of the
    Tax Code. I saw this firsthand as a member of the Board of
    Equalization in California, which was our State's elected tax
    board.
        We saw that too many small business owners had difficulty
    taking advantage of credits that they qualified for because of
    the complications. The IRS National Taxpayer Advocate found
    that the requirements of the Tax Code were so difficult that
    individuals and businesses spent 6.1 billion hours a year and
    this resulted in $163 billion spent in compliance costs. So how
    does this complexity create advantages for firms that can
    devote resources to identifying tax loopholes?
        Mr. LEWIS. Well, I think one of the fundamental things to
    recognize is that the complexity impacts not only the large
    companies, but also the small, and so it impacts them both. The
    severity would depend upon their circumstances and their
    industries.
        To give you an example, the Small Business Health Tax
    Credit that was part of ACA, relatively ineffective in terms of
    compliance because it is rather complicated. So even those who
    could qualify for that credit found it difficult to comply
    because of all the requirements and everything that went into
    it. So sometimes in our efforts I think to create incentives
    congressionally speaking, I think we need to always consider
    the implications of simplicity in them because right now to
    your point, there are a lot of credits out there and incentives
    that I think people do not avail themselves of because they
    simply are not aware.
        Mrs. CHU. And let me now ask about tax extenders and tax
    certainty, Mr. Lewis. Often Congress passes legislative
    modifications to this Tax Code in the form of tax extenders at
    the end of the year. However, the uncertainty surrounding which
    tax relief provisions will be renewed makes planning for
    startups and small businesses difficult. In fact, it was not
    until 2015 and the PATH Act that Congress finally extended some
    very important tax provisions, like the research and
    development credit and the section 179 expensing and made it,
    in fact, permanent. So how does this uncertainty impact small
    businesses and startups who are attempting to plan financially
    for the future?
        Mr. LEWIS. Yeah, you hit on a great point. Companies and
    individual owners of small businesses simply will not react.
    There are three ways you can do it. One, you can just be
    cavalier and go cowboy as it were, and you can just assume that
    Congress is going to do what they are going to do and go with
    it. But that is not most small business people's fate. They
    live by cash flow. They cannot just guess.
        So to your point, in 2015, what I observed personally is I
    observed a lot of people sitting on the sidelines, waiting and
    waiting, constantly calling their CPAs or their tax providers
    and asking at what point are we going to have certainty?
        December 18th, and let's be clear, for those purposes you
    mentioned, the section 179, it is not good enough to just
    simply charge the equipment and you are good for the year. You
    actually have to put it in service. So think about what your
    life is like on December 18th or 19th and how much flexibility
    you have in those 2 weeks' time period between then and the end
    of the year to buy, receive, and actually put into service some
    equipment when probably most of your staff is away for the
    holidays. It has a traumatic impact.
        At that point in the process, the way I would say it is
    rather than you proactively managing or motivating someone to
    behave, all you are doing is just sophistically scorekeeping.
    At that point it is just, well, what did I actually do? And did
    I take advantage of what was there now that it has happened? As
    opposed to January 1, knowing with assurance what you can rely
    upon.
        Mrs. CHU. And finally, Congress has created tax incentives
    to encourage business investment, but some tax experts have
    pointed that one-time tax breaks create complexity. Do you
    think there are times when there should be exceptions made for
    temporary targeted incentives?
        Mr. LEWIS. Well, I will say historically you are correct,
    that you have had times where there have been one-time off
    incentives. But I would go back to what I talked about with the
    good tax policy. There are various elements that you have to
    balance. One is you want neutrality. You want to have it be
    neutral and not necessarily motivate one way or the other. You
    want it to be simple. You want it to be certain, easy to
    administer, equity, and fairness. It can be in some payment.
        So the answer to your question is you have got to consider
    all those in any one particular situation. And it would just
    depend. There is no perfect tax law. If you just listen to that
    list I just gave you, you will observe that there is this
    tradeoff. Right? And so at some point it might make sense to
    embrace one or the other because you are going to have to do
    that, but, again, it would be a fact-specific situation.
        Chairman CHABOT. The gentlelady's time has expired.
        The gentlelady from Florida, Ms. Murphy, who is the ranking
    member of the Subcommittee on Contracting the Workforce, is
    recognized for 5 minutes.
        Ms. MURPHY. Thank you all for being here. I represent a
    district in Central Florida where small businesses are a
    significant part of the economy. But the district is also the
    youngest district in Florida, being home to the University of
    Central Florida, which is the second largest university in the
    country. And the millennial generation and the younger
    generation, there are studies that are showing that they are
    engaged in the gig economy more significantly and that that is
    going to grow significantly over the next 10, 20 years.
        And as such, they are considered to be self-employed. With
    the Social Security and Medicare taxes, they are generally paid
    as a part of a combined rate of 15.3 percent, half paid by the
    employer, the other half paid by the employee.
        In the case of self-employed individuals, they paid both,
    as if they are both the employer and the employee.
        So I guess my question for you is that would you consider
    this an inequity to sole proprietorships? And then more
    broadly, what kinds of changes do you think are necessary in
    the Tax Code to support this growing gig economy, the growing
    prevalence of self-employed individuals?
        Mr. BURTON. Well, let me just jump in real quick because I
    address that subject in my written testimony, and it is a
    problem that has been lingering since the 1970s that really
    needs to get fixed. There is a great deal of uncertainty about
    classification issues and whether someone should be treated as
    an independent contractor or an employee. And the IRS basically
    addresses this with a 20-factor test, and any test that has 20
    factors is necessarily going to be arbitrary and uncertain
    because there is no real way to know how the IRS is going to
    weight the various factors.
        And so what I have proposed in principle is to have bright-
    line tests for who is an employee, bright-line tests for who is
    not an employee, i.e., is an independent contractor, and in the
    middle ground allow either the employer or potentially the
    employee to elect subject to backup withholding probably at a
    25 percent rate.
        As to your other question about is it an inequity that
    self-employed people have to pay both the employer and employee
    share, the answer to that I think is no. The clear point is
    that there is a wedge imposed by the Social Security payroll
    taxes or Medicare or any other tax between what the employer
    has to pay tax inclusive and what the employee gets after
    taxes. And that wedge should be the same whether you are an
    employee or whether you are self-employed. And that is what the
    self-employment tax does.
        Mr. LEWIS. I can tell you from a practical standpoint that
    when I teach a group of students about the self-employment tax,
    particularly most of them being in this economy that you
    mentioned, it comes as a--I think the word is shock because
    typically I am teaching them in the winter and they are
    recognizing that they have got a whole lot of reckoning from
    the summer prior that they have not necessarily thought about.
    So maybe part of it is an educational process if nothing else,
    but the first time that they get hit with this it is an eye-
    opener. And if you are in the UCF community, you are going to
    see this a lot.
        In terms of the equity of it, I think the Congress is going
    to have to deal with the fact that the tax base is moving.
    Right? The fact that we are so global and that you have got
    this economic shift between traditional going to work for the
    plant and manufacturing to this. Everyone is sort of self-
    employed, whether it be the driver for hires or the rentals
    that people have. We are just shifting to where people are more
    in tune with their own financial circumstances. You are going
    to have to address that somehow in the tax law and recognize
    that that is a big portion that is going to continue to grow.
        Mr. BURTON. I once got asked who is FICA when they saw
    their first paycheck.
        Ms. MURPHY. Thank you. And I yield back the rest of my
    time.
        Chairman CHABOT. FICA is a very important part of our life,
    is he not? Or she? Thank you very much. The gentlelady yields
    back.
        Our last questioner, I believe, will be the gentleman from
    Illinois, who was at the markup that I otherwise would have
    been at if I was not here because we are both on Judiciary, who
    is the ranking member on the Subcommittee on Agriculture,
    Energy, and Trade, Mr. Schneider.
        Mr. SCHNEIDER. Thank you, Mr. Chairman.
        Let me take personal prerogative. I am excited to be back
    on the Small Business Committee and working with you to make
    sure that we are helping what is the engine of our economy:
    small businesses that need to have the confidence and see the
    path to grow and prosper. So thank you very much.
        The first question, just a quick question for Mr.
    Pomerleau, you talked about the issue of capital losses being
    offset against capital gains. And my understanding is the
    reason that is, is because capital gains are treated at a
    different tax rate than ordinary income. And so just real
    briefly, how would you adapt that as you are recommending to
    allow unlimited capital losses be offset against income?
        Mr. POMERLEAU. Yeah. So I do not necessarily believe you
    need to offset on an unlimited basis, and one of the challenges
    here is that when you have run out of capital gains, the only
    thing left is say labor income, and that labor income is being
    taxed at a higher marginal tax rate than your capital gains. So
    if you get to deduct against that, you are actually receiving a
    larger benefit than you should. So I think it has to be done in
    the context of a larger reform that rethinks how income is
    taxed. Because one of the challenges with having special tax
    rates on special types of income, whether it is passthrough
    income versus wage income or wage income versus capital income,
    is you run into these little administrative snags. So I think
    it would have to be done in the context of a larger----
        Mr. SCHNEIDER. I think that emphasizes the point all the
    witnesses made. Thank you for being here, first of all, because
    I know how busy you are, but the idea that any type of tax
    reform we do has to not just be corporate tax reform, but
    include passthroughs and individuals.
        Mr. Lewis, I am going to turn to you for as second, and you
    may have anticipated this question. I want to talk about cash
    accounting. And you talk about the importance of cash
    accounting for small business and entrepreneurs. But there are
    a whole group of businesses that are not typically considered
    entrepreneurial; for example, dentists and lawyers. Can you
    touch on who cash accounting affects besides the typical
    entrepreneurial startup business?
        Mr. LEWIS. Yeah. Cash accounting is critical to small
    business. One group of businesses where cash accounting is sort
    of mitigated is those that where inventory is a significant
    portion of what they are doing. So the idea is if you are
    buying a lot of stuff for resale, that is kind of a little
    different circumstance. But most of these startup businesses at
    some level will be entitled to use cash.
        But here is the key point. At some point, arbitrarily we
    set a deadline and say, okay, once you get beyond this point,
    now you need to move into accrual. And whether you set that
    limit at 10 million or at 25 million or some other limit
    perhaps, you need to recognize that that is going to have
    implications.
        Specifically with respect to pass-through entities, such as
    CPA firms, because the profits are passed through to the
    owners' individual tax returns a threshold at any level would
    directly impact an owner's individual tax return because that
    owner would be required to pay tax on income he or she has not
    been paid for by the client.
        I mean, we are in a country where we want to say to
    somebody, you know, within reason, grow your business. That is
    what creates jobs. That is what creates opportunities for other
    people. And so whether it is the capital aspect we have been
    talking about or whether it is freeing them up through the Tax
    Code, but that is why I was so emphatic saying that we have got
    to keep the cash method of accounting. And perhaps even look at
    expanding it because to your point that at some level an
    arbitrary ceiling will restrict growth, whether that is through
    merger or organic growth. But at some point, if I know as an
    entrepreneur that once I get beyond a certain point I am
    disincentivized because now I am going to add complexity and
    add all the cost, I am not going to be that interested.
        Mr. SCHNEIDER. Thank you. I do not know if any of the other
    witnesses want to touch on that?
        Mr. BURTON. Well, I agree it is very important,
    particularly for small firms. The principle underlying the
    Better Way plan is it is a cash flow tax, so it should address
    most of these issues when it is fully flushed out. I would hope
    it would do it both in terms of the general accounting method,
    also inventory and so on. It is a huge simplification to
    premise your tax accounting on cash rather than accrual.
        Mr. SCHNEIDER. So I will close with this and, Mr. Reynolds,
    it touches on something you talked about with your audits of
    having to explain to the IRS how your business works. Small
    businesses are different, but they are the engine. They are
    oftentimes family-owned businesses with multiple family members
    and they are pillars within the community. The time you take to
    come here to advocate on behalf of small business, to educate
    so many members of Congress, I cannot emphasize how important
    that is. The message has to be heard by our colleagues that we
    need to help small businesses have the confidence to step
    forward, to step up, and ultimately succeed to give us the
    growth we need. And with that I will yield back my time.
        Chairman CHABOT. Thank you. The gentleman yields back.
        And we want to thank the panel here for I think wonderful
    testimony here this morning and now this afternoon. I think the
    questions were great and we are obviously in the middle of tax
    reform, and we hope this is going to be a bipartisan process as
    much as possible. And as my colleague likes to say, there is no
    such thing as a Republican small business or a Democratic small
    business. They are just small businesses, and I think you all
    are getting the short end of the stick when it comes to the Tax
    Code right now.
        So hopefully, some of the reforms that we are able to
    implement will positively affect small business
    entrepreneurship and, therefore, job growth all over America.
    So thank you for playing a very important role in that here
    this morning.
        I would ask unanimous consent that members have 5
    legislative days to submit statements and supporting materials
    for the record.
        Without objection, so ordered.
        And if there is no further business to come before the
    Committee, we are adjourned. Thank you.
        [Whereupon, at 12:36 p.m., the Committee was adjourned.]
                                A P P E N D I X

    [GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

        The Small Business & Entrepreneurship Council is grateful
    that the Committee on Small Business is investigating the
    challenges of the U.S. tax code as they related to
    entrepreneurship and small business growth. Small business
    owners are excited about the prospect for tax reform in the
    coming year. We are hopeful that the Congress will move forward
    with a modern framework that brings simplicity, fairness and
    lower taxes to our nation's small businesses and entrepreneurs.
    As committee members well know, strong and sustainable economic
    and job growth is dependent upon a successful small business
    sector, as well as healthy startup activity.

        The Small Business & Entrepreneurship Council (SBE Council)
    is a nonpartisan advocacy, research and education organization
    dedicated to protecting small business and promoting
    entrepreneurship. For twenty-four years, SBE Council has worked
    to advance a range of initiatives and policies to strengthen
    the ecosystem for startups and small business growth. Our
    organization and its members deeply appreciate the work and
    dedication of Small Business Committee members, and we have
    been honored to work with the committee since our founding.

        While entrepreneurship in the U.S. has improved over the
    last several of years, the downward trend in new business
    creation remains. This started well before the Great Recession
    but obviously new business creation tumbled hard during this
    dark economic period. Unfortunately, entrepreneurship has never
    fully recovered. From 2009-2011 there were more business
    closures than startups, according to the SBA Office of
    Advocacy. The trend has slightly reversed course, but our
    economy does not have near the volume of entrepreneurial
    activity and business entities (as a share of the relevant
    population) that existed prior to the Great Recession.

        According to an analysis published by SBE Council's chief
    economist Raymond Keating, the significant decline in new
    business creation during the last decade has been felt across
    the board--among unincorporated and incorporated self-employed,
    startups and employer firms. Mr. Keating's ``gap'' analysis
    finds an estimated shortfall of anywhere from 867,000 to 4.8
    million businesses over the past decade, with ``3.7 million
    missing businesses being quite reasonable based on a
    combination of the most often cited self-employed and employer
    firms data.''

        Economic conditions and uncertainty, access to capital,
    regulatory uncertainty, and the aversion to risk are some of
    the reasons as to why individuals have not pursued, or are not
    pursuing, entrepreneurship. From SBE Council's perspective,
    making policy changes that help to reduce risks along with
    reforms that lower government costs and burdens is especially
    critical to enabling higher startup activity. The tax code is
    one such area that requires an overhaul, with small business
    health and growth being a priority for how this is
    accomplished.

        SBE Council is on record supporting various principles and
    proposals for tax reform, including: lower rates for all
    businesses entities, full expensing, low capital gain taxes,
    the elimination of AMT and death taxes, and making reporting
    and compliance as simple as possible.

        It is our hope that members of Congress also use this
    opportunity to update or modernize various measures in the tax
    code that advance simplicity and cut compliance costs, which
    are especially painful for startups and new business owners.

        Here are some of those ideas:

        Update the Threshold for Self-Employment Taxes: When I talk
    to people who help teenagers and young entrepreneurs start
    businesses, they continually report that these risk-takers are
    totally turned off by a complex tax code that immediately eats
    their profits. Self-employment taxes kick in at $400, which is
    15.3 percent of profits. The $400 threshold has not been
    changed since the 1950s, yet the standard deduction on federal
    income tax is adjusted annually. If the self-employment tax
    floor has been adjusted at the same rate as the standard
    deduction, it would be more than $6,000. It makes sense to
    update it, and relieve entrepreneurs of the burden that hits
    their businesses at such low business revenue levels.

        Liberalize the 100% Capital Gains Exclusion for Startups:
    SBE Council fully supported efforts that made the 100% capital
    gains tax exclusion permanent for startups. But the exclusion
    needs to be improved upon so that more startups benefit from
    it. First, the exclusion is limited to C corporations, and SBE
    Council believes it should be made available to S corps, LLCs
    and other business entities. Secondly, the exclusion is
    disallowed in ventures involved with personal services, law,
    banking, finance, leasing, hospitality, health, farming and
    mining. There is innovation occurring in all these spaces, and
    in several of these sectors consumers and small businesses
    would benefit from more competition and choices. The targeted
    and limited exclusion, as it now stands, is picking winners and
    losers in the marketplace and ignores how most businesses--and
    in this case new businesses--are organized. Ideally, capital
    gains taxes would be eliminated altogether, but if the current
    exclusion is going to be retained it can be made more robust to
    help drive startup activity across all industry sectors.

        Update and Clarify the Independent Contractor Test: SBE
    Council believes it is important to modernize the current test
    given the prevalence of the ``gig'' economy and the need for
    clarity. The current 20-factor test is arbitrary, but can be
    simplified to three or four factors. We believe there is an
    approach to reforming the 20-factor test that demonstrates
    contractor independence through written contracts, how the
    contractor is compensated, expenses incurred by the contractor,
    and how the work is performed. Businesses should be encouraged
    to do business with individuals who want to contract on a per-
    project basis, and on their own terms. The ``gig'' economy
    supports this freedom, and the government should not deter
    opportunity through the subjective and outdated 20-factor test.

        Indexing 1244 Small Business Stock to Inflation to Boost
    Capital in Startups: Again, here is an opportunity to update
    existing law, which has not been done since 1978. This minor
    change could unlock and mobilize more capital toward startups.
    Qualified small business tax (loss) treatment under Section
    1244 of the tax code allows for investors to deduct losses
    taken on investments in C Corp startups to be deducted against
    ordinary income. This measure was passed as part of the Small
    Business Investment Company Act of 1958, the aim of which was
    to mobilize more capital into job-creating startups.

        The current thresholds under Section 1244 were last updated
    in 1978, which are: First $1,000,000 of outside, individual tax
    payer(s) (angel investors) capital gets 1244 treatment;
    $100,000/yr of 1244 losses deductible against ordinary income
    (for joint tax return); and $50,000/y of 1244 losses deductible
    against ordinary income (for filing single).

        The Consumer Price Index has risen 363% since 1978. If the
    above thresholds were inflation adjusted, the levels would be:
    $3,630,000 of outside investors' capital would qualify for de-
    risking under 1244; $363,000/yr of 1244 losses could be
    deductible for joint filers; and $181,500/yr for single filers.

        Conclusion

        Tax reform is a key opportunity to help startups grow and
    thrive, existing small businesses to better compete and take
    more risks through smart investments, and encourage greater
    levels of entrepreneurship. SBE Council and our team of experts
    and small business member-advisors look forward to working
    further with the Small Business Committee to identify
    additional opportunities to fix the tax code for entrepreneurs,
    and advance a bill to the President's desk for his signature.
    Thank you for the opportunity to submit this statement for the
    record.

                                  SBE Council

      301 Maple Avenue West, Suite 100  Vienna, VA 22180
                                 (703)-242-5840

                      sbecouncil.org  @SBECouncil

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