[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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            Small Business Committee Document Number 115-003
              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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