The House Committee on Small Business held a hearing to discuss the biggest tax problems for small businesses.
If you talk with small business owners often, as members of the committee do, you know that individually they may be affected by one particular part of the tax law or another, said committee chairman Rep. Sam Graves, R-Mo. But taken together, small business owners consistently tell us that they are impacted by higher taxes, new taxes, increasing tax code complexity, uncertainty and the additional time required to resolve issues with the Internal Revenue Service. All of this means they have little ability to plan with confidence, and less time to grow their companies.
In conjunction with the hearing Wednesday, the National Small Business Association released the 2014 Small Business Taxation Survey, which showed that complexity and inconsistency within the tax code continue to plague small businesses, with nearly one out of three spending more than $10,000 per year on administration of federal taxes.
More small businesses today say that the administrative burden of federal taxes is their key concern than say the financial burden, said NSBA president and CEO Todd McCracken in a statement. Our tax system punishes work, investment, risk taking and entrepreneurship and is unquestionably broken.
The survey indicated that 86 percent of small business owners need to hire an outside tax practitioner or accountant to handle their taxes. Small businesses ranked income taxes and payroll taxes as the two most burdensome taxes, both financially and administratively. The majority of the small businesses surveyed, 83 percent, are pass-through entities and pay taxes on business income at the individual level.
NSBA vice chairman Tim Reynolds testified at the hearing. He owns a small company, Tribute Inc., in Hudson, Ohio, that develops and markets software for industrial distributors.
Although NSBAs members operate a wide variety of businesses, they all consistently rank reducing the tax burden among their top issues for Congress and the administration to address, said Reynolds. The compliance burden on taxpayers, because of the complexity of our Code, is truly staggering. While the actual tax liabilities for small firms is a huge issue, the sheer complexity of the tax codealong with the mountains of paperwork it necessitatesis actually a more significant problem for Americas small businesses. We tend to be an easy target since, unlike big corporations which have large staffs of accountants, benefits coordinators, attorneys, personnel administrators, etc. at their disposal, small businesses often are at a loss to keep up with, implement, afford, or even understand the overwhelming regulatory and paperwork demands of the federal government and tax code.
According to the NSBA Small Business Taxation Survey, he noted, only 12 percent of small-business owners handle their taxes internally, so 86 percent are forced to pay an external accountant or practitioner. This data should send a strong message to the IRS and Congress that the tax code is far too complex, he said. Furthermore, when asked to rate the most significant challenge posed by the federal tax code to their business, the majority, 53 percent, picked administrative burdens while 47 percent highlighted financial burdens as the most significant challenges to their business posed by federal taxes. The time it takes is not the only administrative burden either. Almost half report they spend more than $5,000 annually on the administration of federal taxes in the form of accountant fees, internal costs, legal fees and so on. This is before they even pay their actual taxes! In my companys case, the bill for preparing the companys taxes and my personal taxes as the owner of a Sub S corporation was $13,650.
Another witness at the hearing, Rick Endres, appeared on behalf of his company, the Washington Network Inc., and as a member of the ASCII Group, a trade association of small and midsize information technology providers.
On a state level, members recently asked ASCII to contact each state tax division with nearly two dozen questions related to uncertainties about when they should be charging taxes for services provided to their clients, he said. For companies like mine who do business in the D.C. area, that means incurring the cost of staying updated on various tax interpretations and laws in Virginia, Maryland and the District of Columbia. On a federal level, the challenge is just as difficult because of uncertainties with the ever-changing tax code and the ever-increasing number of regulations.
He noted that the ASCII Group realized the effect that the complex federal tax code has had on the success of its members and so became involved due to the efforts led by CompTIA (the Computing Technology Industry Association) through their TechVoice initiative, which raises awareness on Capitol Hill about issues such as the tax code facing the small and midsize IT business community. Small business owners work an incredible amount of hours, and every hour and every dollar spent on trying to figure out how to comply with the tax code is time not spent on growing their business so they can hire more people, said Endres.
Professor David Kautter, managing director of the Kogod Tax Center at American Universitys Kogod School of Business, told the committee that he has been a tax practitioner for over 40 years and was previously director of national tax for Ernst & Young. Over the course of my career as a tax practitioner, I have witnessed, with much disappointment, the tax law grow increasingly complex in its structure, pervasive in its reach and incomprehensible in its nature, he said. There is little doubt that the nearly paralyzing complexity, overwhelming length and constantly changing nature of our federal tax laws are having a profound effect on small businesses, affecting not only their decision making but impeding their ability to grow and create jobs.
Based on surveys conducted in the past three years by the Kogod Tax Center, he sees the main sources of the biggest tax problems for small businesses coming from the complexity and constant change in the tax laws.
Most small business owners simply have very little idea of what is expected of them under the tax law and have given up trying to understand either the substantive provisions of the tax law or their compliance obligations, said Kautter. They increasingly rely on outside tax advisers for tax planning and tax return preparation for both income taxes and employment taxes. They worry about making a mistake that will cost them time, money and their reputation because they unknowingly made a mistake, so they have outsourced their tax planning and tax compliance obligations.
Donald Marron of the Urban Institute and the Urban-Brookings Tax Policy Center told the committee that the U.S. tax system is needlessly complex, economically harmful and often unfair.
Tax compliance places a large burden on small businesses, both in the aggregate and relative to large businesses, he added. The Internal Revenue Service estimates that businesses with less than $1 million in revenue bear almost two-thirds of business compliance costs and that those costs are larger, relative to revenues or assets, for small firms than for big ones. At the same time, small businesses are more likely to underpay their taxes. Because they often deal in cash and engage in transactions that are not reported to the IRS, small businesses can understate their revenues and overstate their expenses and thus underpay their taxes. Some underpayment is inadvertent, reflecting the difficulty of complying with our complex tax code, and some is intentional. High compliance costs disadvantage responsible small businesses, while the greater opportunity to underpay taxes advantages less responsible ones.
Marron acknowledged that the tax code offers small businesses several advantages over larger ones. Provisions such as Section 179 expensing, cash accounting, graduated corporate tax rates, and special capital gains taxes benefit businesses that are small in terms of investment, income or assets. However, several of those advantages expired at the end of last year and thus are part of the current tax extenders debate, he noted. These provisions include expanded eligibility for Section 179 expensing and larger capital gains exclusions for investments in qualifying small businesses.
Many small businesses also benefit from the opportunity to organize as pass-through entities such S corporations, limited liability companies, partnerships and sole proprietorships, said Marron. These structures all avoid the double taxation that applies to income earned by C corporations. Some large businesses adopt these forms as well, and account for a substantial fraction of pass-through economic activity. Policymakers should take care not to assume that all pass-throughs are small businesses.
He pointed out that tax reform would likely shift the relative tax burden of small and large businesses and recalibrate the tradeoff between pass-through and C corporation structures. A revenue-neutral business reform that lowers the corporate tax rate while reducing tax breaks would likely favor C corporations over pass-throughs and might well reduce some tax preferences targeted at small businesses, said Marron. The net effect will depend, however, on the details and may vary among businesses of different sizes, industries and organizational forms. Reform provides an opportunity to reduce compliance burden on small businesses.
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