Download Tax Code Modernization for Small Business Economic Growth

National Small Business Network
Tax Reform Priorities for Small Business
Pass-Through Entities
NSBN Policy Paper
February 2013
Although the American Taxpayer Relief Act of 2012 which passed in the last days of the 112th
Congress set the basic framework of individual tax rates for the next few years, there is still a need
for reform and modernization of the Tax Code. This is particularly true of the complex system of
taxation of business income. Starting in 2008 the SBA Office of Advocacy conducted the first of a
series of continuing Tax Issues Roundtables in conjunction with the SBA Regional Tax Policy
Advisory Chairs from the last White House Conference on Small Business.
The intent was to
identify important tax reform issues that impact small business survival and growth. Based on
continuing input from small business groups we have prioritized fifteen specific tax code
modernization issues that adversely affect the potential for small business job growth.
These tax code modernization provisions have three basic objectives –

To correct inequitable differences in tax treatment based on the form of business entity that
can have negative impacts on small business and entrepreneurial development.

To correct outdated sections of the tax code which restrict economic growth because they
have not been adjusted for inflation or changes in current business processes and
technologies.

To provide the maximum amount of targeted economic stimulus for the creation of new jobs
and business growth, with the minimum loss of current tax revenue or need for large
replacement revenue offsets which may weaken other parts of the economy.
Provision Index
1. Separate out in the individual tax code, and tax separately, pass-through business income
2. Establish separate tax rates and provisions on the first $250,000 of Small Business Operating Income
3. Provide better equity for pass-through entities on Alternative Minimum Tax impact.
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4. Remove the remaining “listed property” reporting requirements on business computers and equipment.
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5. Permanently equalize the deductibility of self-employed health insurance at the business level
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6. Simplify state income tax and BAT nexus issues for out of state businesses
7. Improve the incentive for direct equity investment in small businesses.
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8. Provide equitable employee cafeteria benefit options for small business owners.
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9 .Continue expanded Section 179 expensing to encourage business growth.
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10. Re-authorize the Section 179 inclusion of non-structural real property improvements.
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11. Modernize the qualified home office deduction.
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12. Modernize the outdated "luxury" automobile depreciation limitations.
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13. Increase the deductibility of business meals for small businesses.
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14. Update and coordinate all tax code inflationary adjustment provisions.
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15. Return the contribution date for IRA investments to the extended due date. Change Roth IRA limits
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Background:
Although taxes are necessary to collect revenue to fund governmental services, the tax code also
needs to allow businesses to expense or depreciate their costs in order to encourage re-investment and
growth that will enlarge the tax base for future years. Over the past 40 years, many statutory and
regulatory limits and restrictions were put into the tax code to increase short-term tax revenues.
These limitations have significantly restricted the ability of businesses to adequately recover their
costs of growth.
Many business tax provisions have fixed limitations that may have been reasonable at the time they
were adopted, but some have not been updated in 10, 20, 30, or even 40 years. Over that time, the
country has experienced significant inflation and major changes in the basic tools and practices of
successful business operations.
As a result, many of these outdated code limitations now put
unreasonable regulatory burdens on businesses. They also limit the ability of businesses to invest in
new equipment and technology needed to grow their businesses, and our overall economy. These
antiquated provisions have significantly reduced our economic competitiveness in the world, and
contributed to our declining economy and ability to create new jobs.
Economic Growth Impacts:
Limitations on timely cost recovery are particularly burdensome on small entrepreneurs who lead the
economy in innovation and economic growth. Without reasonable and realistically timed cost
recovery, many small businesses have inadequate capital to survive and grow. Timely cost recovery
is particularly critical for start-up businesses that are often dependent on personal savings or high
interest credit card financing. It has become even more critical because of greater restrictions on
bank credit availability since the recession.
Many employees who have been laid off by large businesses, returning military veterans, and recent
college graduates, are now finding that their best opportunity to use their skills may be to start their
own business. Their ability to succeed means the difference between their being a burden on the
economy, and contributing to it by creating investment, innovation, and new jobs for others.
Small businesses are the backbone of the American economy. According to SBA Office of
Advocacy, over 98% of US businesses are small businesses, and they employed over 50% of all US
workers. Firms with fewer than 20 employees created over 96% of total net new jobs. Small
businesses are also a significant factor in the export of traded sector goods and services, which is vital
to our economic future. Unlike many large businesses, most small businesses are also American
owned, and their jobs and profits tend to stay in the US economy. Most of today’s major businesses
originally started as small businesses. Unfortunately, the US Bureau of Labor Statistics found that
44 % of all new businesses fail within their first two years, and 66% fail within 4 years. Tax
regulations that unreasonably delay or prevent businesses from recovering their costs are a major
factor in that high failure rate.
As Congress discusses tax reform, it is important that we look not
just at the corporate tax system, but also at the treatment of Small Business Operating Income of
pass-through entities which are the primary creators of new jobs in today’s domestic economy.
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Small businesses very clearly understand the importance of good fiscal management for the
sustainability of the nation as well as for their business.
Businesses are very concerned about the
out of control federal budget deficit and its potential impacts on the future of the US economy and
our citizens.
They recognize the need for program reductions and even balanced tax increases to
return to a sustainable budget level, and want to participate in that reform process.
Each issue analysis includes recommendations for correction.
Although many of these
proposals have little revenue impact, some would be significant tax expenditures and would
require some offsetting revenue. We have generally not suggested specific revenue offsets, but
recognize the need for revenue neutral tax reform for economic stability.
1. Separate out in the personal tax code income from active pass-through business
activity of the taxpayer, and calculate the tax on this income separately from the
taxpayer’s salary and investment income.
Encouraging economic growth through the tax code is complicated by the fact that there are two
business taxation systems. Most large businesses pay their taxes through the corporate tax system,
which in 2010 collected about 9% of total tax revenues. Most smaller business are subchapter “S”
corporations, partnerships, LLCs or schedule “C” or “F” filers, and pay the taxes on their business
operating income on their personal tax return along with their personal income. The SBA estimates
that over 90% of small businesses are pass-through entity taxpayers. As a result, some provisions of
the personal tax code, such as the Personal AMT, can have an unintended negative impact on small
business growth. When Congress considers economic stimulus measures or tax system reforms, it is
critical that both tax systems be changed in unison.
Most small businesses choose to organize as a pass-through entity for two reasons. During the
startup years, before they become profitable, a pass-through entity allows them to immediately offset
initial business losses against other personal income, allowing them to use the tax savings to help
finance the business. This is particularly important as conventional bank credit for business start-ups
has become harder to obtain. In later years, if they become profitable, the pass-through entity also
allows them to avoid "double taxation" at both the Corporation level and again at 20% dividend rates
at the individual level, when the profits are paid out to the stockholders. Current “C” corporation
tax rates also have little progressivity, and very narrow brackets of “small business” reduced rates,
which provide little incentive for small businesses to organize as C corporations unless they are
required to.
Although pass-through entities provide some initial advantages for small businesses, the taxation of
business income on the owner’s personal tax return also creates some disadvantages. The mixing of
business and "personal" income makes it difficult for Congress to provide equitable tax policy
incentives for business reinvestment and growth. Income resulting from direct business investment
and active operation of a business which employs workers and sells a product or service has a higher
value to our overall economy than income resulting from passive speculative activity.
By
differentiating income from active businesses, Congress can provide targeted tax stimulus with less
revenue impact by not having to provide the same tax treatment to income from passive investments
such as traded stocks. Although some of the same tax policy objectives could be achieved with a
single uniform system of taxing business income, this option is probably more practical given the
wide diversity of business sizes and types.
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Recommendation: Assuming pass-through entities will continue to be a primary method of
reporting small business income, Congress should differentiate in the tax code pass-through
income from a business in which the taxpayer actively participates as “Small Business Operating
Income” (SBOI). This would include non-salary income from partnerships, “S” corporations,
farms, and other business income reported on a personal return. This more clearly defined and
targeted “Small Business Operating Income” could then be given a different tax treatment and
rate structure to stimulate business reinvestment and job growth.
2. Provide a special tax rates on the first $250,000 of “Small Business Operating
Income”.
Congress has already raised the tax rate on higher income individuals, many of whom are small
business owners.
Proposed reductions in the corporate tax rate to 28% will potentially shift more
of the tax burden onto small businesses and individuals.
This will have a significant impact on
many small and midsize businesses that report their business operating income on the owner’s
personal return, on top of their salary and investment earnings.
This often results in the small
business income being taxed at the highest individual tax rates. When compared to the low 20% tax
rate on dividends and capital gains on highly liquid “traded stocks”, it is becomes difficult to justify
the higher risk and lower after tax return of most small business investments. Much business
operating income must also be reinvested in the business for survival and growth, leaving little cash
available to pay the taxes. It is estimated that two thirds of all small business employees’ work for
firms with 20 to 500 employees, and many owners of these firms are likely to be impacted by the new
higher personal tax rates.
An SBA Office of Advocacy Research Report in 2005 found that a marginal tax rate reduction of
only 1% on business taxable income “…would reduce the probability of business failure by 17% for
single filers” and also “increase the probability of entry into entrepreneurial activity by 1.42% for
single filers and 2% for married filers”. Opposite negative economic impacts are probably also true
for tax increases on small business income.
Recommendation: Congress should provide a lower maximum rate equal to the “C” corporation
rate on up to $250,000 of “Small Business Operating Income”. Optionally, a 20% Small Business
Operating Income deduction could be provided for up to $250,000 of qualified income as was
proposed in the last Congress. Only income from a business in which the taxpayer materially
participates should be eligible for the lower rate. This would allow a limited amount of small
business income to be taxed at lower rates to enable equity reinvestment to finance business
growth. Calculating the tax on this income separately from other personal wage and investment
income will also prevent the taxpayers other income from pushing the tax rate on the business
income into the highest rate brackets. The reduced tax rate or deduction must also be allowed in
the AMT tax code provisions to prevent the AMT from nullifying the value of the provision.
3. Provide better Alternative Minimum Tax equity for pass-through businesses.
The Alternative Minimum Tax impact for pass-through income is much different than for
corporations, and significantly impacts tax liability on small business income. The combined
reporting of both personal and business operating income often exceeds the low personal AMT
exemption level.
This makes taxpayers calculate and pay an additional Alternative Tax on their
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business income. This is compounded by the lack of deductibility of high state income taxes on the
small business income, which in some states can exceed 10%. In contrast, the Corporate AMT only
applies if the 3-year average annual business income exceeds $7,500,000.
In January of 2013 Congress made an indexed personal AMT exemption permanent, but failed to
correct many of the underlying issues, that have a major impact on small business owners.
Taxpayer Advocate Nina Olson has repeatedly addressed this issue in her annual reports to Congress.
She has stated that if the individual AMT is not eliminated, then Congress should “…eliminate
personal exemptions, the standard deduction, deductible state and local taxes, and miscellaneous
itemized deductions, as adjustment items for Individual Alternative Minimum Tax purposes.”
Recommendation: Ideally, Congress should eliminate the burden of AMT calculation for most
taxpayers. This could be done by setting a more reasonable minimum gross taxable income
threshold of $250,000 in Adjusted Gross Income, plus any non-taxable interest income, before the
AMT calculation would even be required. The personal deduction for state and local taxes paid,
and employee business expenses should also be permanently eliminated as adjustments in the
AMT calculation.
If that is not done, the tax code should at least provide better equality in the AMT treatment of
“Small Business Operating Income” reported on a personal Form 1040 return, with the far higher
“C” corporation AMT exemption.
We recommend that an additional personal AMT exemption
be given for Small Business Operating Income of up to $250,000 that is reported on a Schedule
K1, C or F, for a business in which the taxpayer materially participates.
These limited changes would remove the AMT burden for most taxpayers and provide some
equitability for small business pass-through income in relation to the far higher C Corporation
AMT exemption amount.
4. Remove the remaining “Listed Property” reporting requirements on business
computers and communication equipment.
The Small Business Jobs Act of 2010, HR 5297, removed the outdated usage record keeping
requirements for employer provided business “cell phones”, but failed to remove the equally
burdensome and illogical requirements on similar business communication devices and portable
computers. With the merging of cell phones, computers, and cameras into single inexpensive
devices, the remaining listed property reporting requirements and deduction limitations for business
“computers” when used outside a “qualified office” also need to be removed. Since 1986, the cost of
computers has significantly decreased, and the ability and need for business people to use laptops and
smart phone computers outside of a regular office has greatly increased.
As with cell phones, if
there is a legitimate business need for the computer or PDA, there is usually little or no additional
marginal cost for any personal use of the same equipment, since most hardware is replaced long
before the end of its potential usable life. The current law is widely ignored by business people who
do not keep detailed use records on this equipment, because it no longer seems reasonable in relation
to the administrative burden.
Taxpayers should no longer be burdened with outdated and timeconsuming record keeping requirements and deduction limitations for basic business productivity
tools.
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Recommendation: Business computers, smart phones and similar equipment whether used in a
regular office, a home office, or on the road, should be removed from listed property requirements.
Any taxpayer, who can demonstrate substantial business use, should be allowed to deduct data
charges and depreciate, or expense under section 179 rules, any equipment cost, up to reasonable
cost limits. Any extra cost recreational software or accessory equipment that is not required for
business use should, of course, continue to be non-deductible.
5. Permanently equalize the deductibility of self-employed health insurance.
For the year 2010 ONLY, the Small Business Jobs Act of 2010 finally allowed self-employed
taxpayers, and partners, to deduct the cost of their health insurance, without paying payroll taxes on
the insurance cost, as is true for corporations. The equal and simple deductibility of group health
insurance regardless of the legal form of business entity has been a key issue for small businesses for
many years. Although prior Congressional action partly corrected this problem for S Corporation
stockholders, 21 million self-employed individuals are still required to treat the expense as a non
business expense even if they provide identical coverage for their employees. This results in the
taxpayer paying an additional 15.3% on the insurance expense. Because of their small group sizes,
the self-employed already pay the highest relative insurance rates. Reports indicate individual health
insurance premiums may increase another 15% to 30% in 2013 alone. This inability to deduct their
own insurance has always been an emotional disincentive for small business owners to provide group
health insurance for their other workers. As more states and the Federal government adopt universal
health insurance requirements, the impact will continued to grow, unless corrected. The National
Taxpayer Advocate has recommended correction of this inequity in her Reports to Congress.
Without new Congressional action to re-instate equal exclusion of health insurance from payroll
taxes, the 21 million self-employed will again face this health care penalty for 2013, along with other
PPACA health insurance tax increases.
Recommendation: Congress should permanently equalize the deductibility, up to a reasonable cost
limit, of individual or group health insurance at the entity level for all forms of businesses and
individuals by repealing IRC section 162(l) (4). The deductible limit should be adjusted for
average health insurance cost changes. This equality principal should have been part of the
health care reform legislation, but was not, and now needs to be corrected by additional legislation.
6. Simplify state income tax nexus issues for out-of-state businesses.
Modern electronic technology has greatly increased the ability of even small businesses to sell both
goods and services nationally without any physical nexus in a state. Unfortunately this increased
capability, combined with increased legislative and enforcement activity by revenue starved state
governments, is creating significant state tax nexus problems.
For sales and use taxes, the Congress should support continued development by the States of a
uniform national sales tax collection system to permit easy collection and distribution of state use
taxes by out of state vendors with no physical nexus. We urge the Congress to pass the Marketplace
Fairness Act of 2013, H.R. 684.
This would not present a significant administrative burden for
most businesses compared to dealing with 46 different state sales tax systems.
This also would
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provide a level playing field for in-state businesses with out-of state, or possibly even international,
competitors.
However, complying with out of state income tax or “business activity” tax laws for a small amount
of out of state business, often subject’s small businesses to significantly higher internal accounting
and tax preparation expenses, and a higher total tax liability. Although states provide some credits
for income taxes paid to other states, these calculations are complex and often have filing minimums
which can result in the taxpayer paying more total taxes than they would have paid to a single state.
Because of this complexity, many small businesses either ignore out of state income tax filings and
risk potential penalties, or reject potential out-of-state business, which restricts interstate commerce.
For services it is also very difficult to determine which states have a valid tax nexus. With the
growth of “cloud computing” and web-based applications, a person working on a computer in
Arizona, using data on a server in New York, for a business website that is used world-wide, could be
viewed as having nexus almost anywhere.
Some States are now trying to use national internet
search engine advertising contracts, which are often used by small business to offset some of their
website expenses, as a basis for claiming tax nexus. These new “Amazon Laws” have already been
adopted in New York, North Carolina, and Rhode Island, and will spread rapidly, if not controlled by
federal legislation. Other states, Such as California are trying to extend nexus just because of
contracted relationships or corporate affiliation with suppliers within the state.
The "Commerce Clause" of the Constitution makes the Congress responsible for preventing states
from enacting barriers to interstate commerce. In 1986, the Congress passed Public Law 86-272 to
remove multi-state tax nexus barriers for mail order marketing of goods. That law prohibits states
from imposing a "net income tax" on businesses if the contact with a state is "limited to the
solicitation of orders through catalogs, flyers, and advertisements in national periodicals, for sales of
tangible personal property which are approved outside the state and are filled from a stock of goods
located outside the state and delivered via common carrier or the U S Postal Service.”
This law, unfortunately, did not envision the ability of business to deliver services, as well as
products, via the internet and other electronic technologies. Many businesses also conduct limited
periods of business in other states at conferences, trade shows, and national product market centers.
Limited business activity of this nature should also be protected from multi-state income taxation.
Quick Congressional action can prevent this problem from growing, and reduce a major non-valueadded cost on small businesses with no Federal revenue impact. The Multistate Tax Commission
recommended as far back 2002 a model "bright line" standard. A state would only have nexus if at
least 1 of four thresholds was exceeded – The business had over$50,000 of either property, net sales,
or payroll - or more than 25% of the business' total property, sales and payroll.
Recommendation: Congress should support the efficient interstate collection of sales and use
taxes by passing the uniform sales tax collection bills which have been introduced in this Congress
But, Congress also needs to pass a modernized federal prohibition on state income, or business
activity, taxation of both services and products, including digital products, delivered from outside a
state via public carriers or electronic transmission.
A minimum state income tax nexus
exemption level should also be defined to permit limited temporary physical business activity
within a state such as for trade shows, or temporary work.
This exclusion might exempt the
lesser of the income earned during a presence of no more than 10 days, or $50,000, per year of
property, annual sales, or payroll.
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7. Improve the incentive for direct equity investment in small businesses.
Congress previously passed Section 1202 and Section 1244 of the tax code to encourage direct
investment in small business startups. Most business startups are under-capitalized and are financed
largely with expensive short-term borrowing. This is a major reason for their high failure rate. These
provisions were adopted to provide new businesses with a stable base of equity capital to survive and
grow. It is very difficult for new businesses to obtain equity capital because of the far higher risk
and lack of market liquidity of small business stock compared to other investments.
Section 1202 provided an incentive of a 50% exclusion on the capital gain from a sale of Qualified
Small Business Stock held for more than 5 years. The exclusion was temporarily raised to 75% for
stock acquired after February 17, 2009 and before Sept 27, 2010. However, the taxable portion was
subject to a 28% tax rate, rather than the 0% or 20% rates that now apply to the gain on other stock
sales. The low capital gains tax rates on safer and more liquid investments combined with the
requirement to add back 7% of the excluded gain in calculating alternative minimum taxable income
effectively eliminated much of the value of this incentive.
The Small Business Jobs Act of 2010, HR 5297, increased the Sec. 1202 exclusion to 100% for
investments held for 5 years, and fully exempted them as a tax preference in calculating the AMT.
Unfortunately, the expanded incentive only applied for stock purchased during an approximate 3
month period ending 12-31-2010. This was an inadequate time period for logical 1202 qualified
investments to be completed.
Section 1244 also provides an incentive to invest in small businesses. It allows a taxpayer to offset a
loss on that stock against other income. The maximum loss per individual, per business is $50,000.
Both of these provisions have been less effective than intended in promoting small business
investment because they do not provide an up-front tax incentive for an investor who instead, may
have to hold the stock for a long period before receiving a benefit.
The Administration’s 2012 Green Book recommended making the H.R. 5297 100% exclusion
permanent to “…encourage and reward new investment in qualified small business stock.”
Recommendation: Permanently extend the H.R. 5297 exclusions on the gain of Section 1202
qualified small business stock including removal of the add back in the AMT calculation. This
could revitalize an important tool for small business financing, particularly if capital gains rates
increase in the future. As an alternative, Congress might consider providing an alternative 10%
up-front tax credit for investment in Qualified Small Business Stock. This would help offset the
much higher risk of loss. The upfront credit would reduce the basis in the stock and should be
recaptured pro rata, if the stock is sold within 5 years. In addition, the basis for capital gains
calculation on business stock or other assets held more than 3 years should be adjusted for
inflation to encourage long-term capital investments needed for economic growth.
8. Provide equitable employee cafeteria benefit options for small business owners.
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Small businesses compete for workers with large businesses and the public sector. Because of
differing family situations, differences in benefit options that may be available through other family
members or because of different personal preferences, potential employees often want different
benefits than other workers.
The 2010 PPACA Health Care Bill included provisions for a simplified Cafeteria Plan. However,
current restrictions make them unattractive for most small businesses, other than C corporations,
because business owners cannot be part of the plan.
Current law specifically prevents sole
proprietors, partners, and sub chapter S corporation shareholders from participating in a cafeteria
benefit plan.
These illogical limitations discourage small businesses from offering employees a
very logical form of employment benefit.
Recommendation: Permanently approve a “simple” cafeteria benefit plan that could practically be
offered by all forms of businesses, for employees and owners, at a reasonable administrative cost
and with adequate provisions, such as maximum benefit amount limits, to prevent misuse.
9. Continue expanded Section 179 expensing to encourage economic growth.
The Section 179 small business expensing provisions are a key factor in helping small businesses,
particularly new start-ups, survive and grow by improving their ability to quickly recover the costs of
investments in new equipment. This provides a major stimulus to the general economy from
increased purchasing capability, particularly with the limited credit available to small and new
businesses. The expensing limit was increased to $500,000 by the Taxpayer Relief Act of 2012 for
2013, but will revert back to $25,000 in 2014 without Congressional action. Congress also extended
the ability to expense “off-the-shelf” business software in the year of purchase.
The Act also extended for 2013, only, the expiration of IRC 179(c) (2). This provision allows
taxpayers to revoke a Section 179 election on an amended return. This option is important for
owners of “pass through” entity businesses, particularly those who own interests in multiple
businesses. This is because the maximum Sec. 179 expensing limits are applied at both at the
individual business level and at the final taxpayer level. A change in election is often needed when
the owner taxpayer receives too much pass-through expensing, because assets or income were
accidently excluded from the original return, or the IRS re-classifies an expensed item as a capital
asset. Unless the originating business has the option to change the Section 179 expensed amount on
an amended return, a recipient taxpayer could be allocated a deduction greater than they are allowed
to use. Any excess is permanently lost. The excess reduces the taxpayer’s business basis without
providing any offsetting deduction, resulting in a permanent loss. It is important that IRC 179(c) (2)
be made permanent regardless of the level of expensing limit.
Recommendation: Make permanent a $250,000 expensing limitation for Section 179 property,
so businesses can plan for future new equipment investments when they are needed under
consistant rules. Make permanent, the ability to revoke Section 179 expensing on amended
returns and the option to expense “off the shelf” computer software for all businesses.
10. Make permanent the Section 179 inclusion of non-structural real property
improvements.
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In 1958, when Section 179 was first approved, the US economy was strongly manufacturing oriented
and most small businesses needed to purchase production equipment. Over the last 50 years, the US
economy has become more service and innovation oriented and the capital expenditure needs of
small businesses have changed.
To compete for customers and clients, businesses today need functional and attractive facilities in
which to conduct business. Better facilities also help businesses attract and retain more highly
skilled employees. New businesses often face significant remodeling costs to prepare a business
property for their use, and older businesses need to regularly update their facilities. These
improvements must then be recovered over a long period of time. Currently most real property
improvements have to be depreciated over 39 years. This may be appropriate for new construction,
but is far too long for most commercial remodeling cycles. This can consume a large amount of the
business’ initial capital, and make it difficult for the business to survive and grow. Congress has
recognized the changing capital investment needs of businesses by reducing the depreciable life of
qualified leasehold improvements, qualified restaurant improvements, and qualified retail
improvements to 15 years in recent short-term stimulus measures. These provisions should be made
permanent.
The Taxpayer Relief Act of 2012 extended the inclusion of up to $250,000 in certain real property
improvements to qualified leasehold, restaurant, and retail facilities under Sec. 179 for 2013 only.
The language of this legislation unfortunately prevents business taxpayers who also own the property
from taking the same expensing without creating a separate ownership entity for the property. This
should be addressed in future legislation.
Recommendation: Congress should make permanent the provisions in the Tax Payer Relief Act of
2012 as it relates to expensing building improvements under Section 179 up to $250,000 or the
maximum Section 179 limitation, if it is reduced. This limited expensing should also be allowed
for all types of businesses and for real property owned by the business. For more expensive
improvements which must be depreciated, Congress should permanently shorten the standard
depreciation period for nonstructural leasehold, restaurant, and retail real property improvements
to 15 years. These changes would have significant short-term and long-term economic stimulus
effects.
11. Modernize the qualified home office deduction.
Currently, home-based businesses represent 52 percent of all American firms and generate 10 percent
of the country’s total GDP, or economic revenue based on SBA research. In the future, that
percentage is likely to grow as new technologies and the Internet make new business models possible
and increase the ability of people to work remotely. Working from the home has become more
attractive because of the increased costs of commuting, high commercial real estate and parking
costs.
Many workers also want to have more involvement with their children and families. The
government should also have an interest in promoting working at home as a way to reduce the need
for new highway construction, conserve energy, and reduce “green-house gas” emissions from
unnecessary commutes to a distant business office.
Internal Revenue Code Section 280A(c) (1) defines the requirements that must be met to deduct
home office expenses. It generally permits a deduction for a home office in a taxpayer’s residence
only if it is used “exclusively on a regular basis and meets one of two specific use requirements.
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(1) The “principal place of business” requirement allows a deduction for a home office if it is “the
principal place of business for any trade or business of the taxpayer”, but the requirement is severely
limited by regulations.
Unfortunately, for many small businesses the inability “to conduct
substantial administrative activities” at their regular place of business” is often the result of a lack of
time, as well as a lack of space. Small business people can have a legitimate business need for a
home office in which they can regularly work, even if it is not the “principal place” of business where
they physically serve their customers.
(2) The “used by patients, clients, or customers” requirement has been interpreted by the IRS to
require clients or customers to be physically present in the home office. IRS regulations state that
conversations with taxpayers by telephone and electronic media do not constitute meeting with
clients. The actual IRC code only requires that it be “a place of business which is used by patients,
clients, or customers in meeting or dealing with the taxpayer in the normal course of his trade or
business.” Today, many businesses deal with their customers without any physical presence. Major
and minor business transactions are now fully completed, through websites, emails, and faxes, or on
the telephone. The old physical presence requirements are obsolete and block reasonable recovery
of expenses for home-based businesses.
The code, in contrast, allows a clear deduction for home offices and other business uses in separate
“free standing structures” on a residential property “…such as a studio, garage, or barn” without
meeting these other requirements. Why should some taxpayers who can afford a large house with a
detached building be exempted from these home office use requirements, when poorer taxpayers
living in smaller houses or multi-family dwellings are not?
Even if a taxpayer meets one of the above use tests, the Code also requires any home office to be
used “exclusively” as a place for business. This is a much higher standard than is applied to regular
fully deductible business office locations.
It is a reality of today’s business world, where
employees carry cell phones and work on computers connected to the internet, that most workers
conduct some personal business and receive some personal calls or emails during the day at their
place of business. This is also true in the public sector, where GAO investigations have found that
even IRS employees use their computers for personal email and activities in the IRS Building. It is
both unrealistic and unreasonable not to also allow some de minimus personal activity in an
otherwise qualified home office area.
The current regulations and case law do not provide sufficiently clear and equitable standards for
deductibility. Many at-home workers are afraid to deduction the use of a home office for fear of
audits on vague issues, the extra record keeping and the required calculations. The existing home
office requirements are unrealistic and outdated by the realities of today’s technologies, and current
business practices, and need to be modified.
Recommendation: Congress should modernize the definition of a qualified home office for
entrepreneurs who have a need to use an area of their home on a regular basis for a normal
business activity. The “principle place of business” requirement should be modified in statute to
allow a home office when it is needed to regularly perform work activities outside the principle
business location. The “exclusive use” requirement should also be changed to allow de-minimus
personal activity comparable to that which occurs in a regular business office, and the statute
should be changed to clarify that use of the office for electronic business activities by phone, fax or
internet has the same validity as when used for physical customer interaction.
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12. Modernize the unrealistic “Luxury” automobile depreciation limitations.
The tax code defines passenger automobiles as 5-year property under ADS standards for cost
recovery. However, in 1984 Congress limited the ability to expense or depreciate what they thought
were “luxury” automobiles used for business by enacting Section 280F(a)(1). These limits have
only increased by about 22% since 1987 because of a restrictive calculation formula based on the
characteristics of 1984 car, even with general inflation of over 90% in that time.
The limits on non-bonus depreciation or Sec. 179 expensing for automobiles purchased in 2013 are
$3,160 the first year, $5,100 the 2nd year, $3,050 the 3rd year, and $1,875 for each succeeding year.
That means that during the “normal” 6-year recovery period, a business could actually only fully
recover the cost of about a $16,940 vehicle.
Based on the normal deduction limits, without bonus
depreciation, it would take 12 years to recover the cost of a $25,000 car. With average use of only
15,000 miles a year, a car used 100% for business would have 180,000 miles at the end of that 12year period. Many business users easily exceed that mileage yearly. To consider an automobile
costing less than $17,000 a “luxury car” is simply unrealistic. The only vehicles that still sell below
this depreciation limitation are small compact cars. None of these vehicles are designed to transport
five adults, nor are suitable for many valid business uses such as transporting samples. Most of these
cheaper cars are also imported, which has helped contribute to the decline of American auto
manufacturers. The depreciation limitations also cause businesses to keep older, more polluting, and
less fuel-efficient vehicles in use. The tax code should encourage business owners to regularly
replace business vehicles, not unreasonably discourage it. Removing this antiquated provision will
stimulate business purchases of new vehicles, and help rebuild the American auto industry.
Recommendation: Depreciation and expensing limits for vehicles should be adjusted to allow a
person who needs to use an automobile for business to fully recover the cost of a $25,000 vehicle,
with 100% business use, during the standard 6-year recovery period. That amount should be
periodically adjusted for average vehicle costs.
13. Increase the deductibility of business meals for small businesses.
The 1995 White House Conference on Small Business identified the importance of the business meal
deduction to the success of small business.
They often do not have appropriate space at their
business to meet and work with important clients, referral sources or suppliers. Large businesses
often have meeting and conference rooms at their facility which are tax deductible.
Small
businesses, particularly home based businesses, may have only their dining room table. They often
have to use restaurant meals as an opportunity to prospect for business and to complete transactions
with clients.
Research has indicated that increasing the deductibility of business meals to 80%
would increase restaurant sales by $12 Billion and create an overall economic impact of $24 Billion.
Existing code provisions limit excessive meal or entertainment expenditures.
Recommendation: Increase the deductible percentage of documentable business meal expenses to
80% at least for small businesses.
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14. Uniformly update all tax code dollar limitations.
Many tax code provisions and limitations have not been updated for inflation in 20, 30 or even 40 or
more years, causing taxpayers to ignore them. A good example is the antiquated limits on business
promotional gifts, which are an important sales generating tool for small businesses. In 1962,
Congress passed Public Law 87-834, which limited the deductibility of a business gift to $25. This
amount has never been adjusted for inflation. After 50 years, that $25 gift would now cost $187.
Although inflation has not been a major issue for the last few years, increased world demand for
commodities, and the potential for significant increases in the money supply to pay off Federal
obligations, may result in much higher inflation again in the future. If tax brackets and deduction
limitations are not regularly adjusted for inflation, it will result in significant tax increases as a
percentage of GDP, by inflating more taxpayers into higher rate brackets.
Other tax provisions were written with inflation “indexing” provisions, but vary both on the formula
for calculation and the frequency or timing of when they are indexed. These inconsistencies make it
difficult for the IRS to coordinate taxpayer education on limitation changes and difficult for taxpayers
to find current limit information.
Recommendation: Review the Internal Revenue Code for fixed limitations and provisions which
are long overdue for inflationary adjustments, such as the business gift limit, and update them.
Then adopt a standard inflationary adjustment provision to replace the myriad of specific
provisions in the code, and attach that standard indexing adjustment to all limitations significant
enough to require periodic adjustment. The provisions should require a reasonable minimum
inflation change before adjustment, and be rounded.
15. Return the contribution date for IRA investments to the extended due date.
Prior to the Tax Reform Act of 1986, standard IRA contributions, like all other retirement plan
contributions, were permitted up to the earlier of the extended due date of the return, or when the
return was filed. Their due date is now April 15th, with no extensions. This causes a burden on
taxpayers who have to make IRA contributions at the same time that both prior year final tax
payments and their current year first quarter estimated tax payment are due. This often results in
taxpayers, particularly small businesses, sacrificing their own IRA contribution to meet other
expenses.
Recommendation: Return the due date for IRA contributions to the due date of the return,
including all permitted extensions, as allowed for other retirement plans.
Because the income limitations on converting standard IRA accounts to Roth IRA accounts have
been removed, Congress should also remove the income limits on direct contributions to Roth
accounts. This would eliminate the need for a two step process of contributing to a regular
account and then having to convert it to a Roth account.
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This report was prepared for the White House Conference on Small Business Regional Tax
Policy Advisory Chairs by Thala Taperman Rolnick, CPA (Region 9) and Eric Blackledge
(Region 10) with input from other Regional Tax Chairs, tax advisors and other small business
representatives.
The Tax Policy Advisory Chairs were originally elected from each of the 10 SBA Districts by
the 2100 Delegates at the last White House Conference on Small Business to represent small
businesses on federal taxation issues. They have continued to work for the adoption of the tax
and regulatory recommendations of the White House Conference, and to represent the interests
of small businesses on other Federal tax policy Issues as the National Small Business Network.
In addition to working with Congressional and Treasury staff, a number of the Tax Chairs
have testified before Congressional Committees, and several have served on the IRS Advisory
Council and Electronic Tax Administration Advisory Council.
For further information please visit our website at www.NationalSmallBusiness.net
or contact us at –
National Small Business Network
P O Box 639
Corvallis Oregon 97339-0639
Email [email protected]
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