low income housing and real estate in general. The tax law has, in fact, often been used as a tool for economic incentive and development. Why, then, is small business, the backbone of the capitalistic system, denied special tax consideration? It has been demonstrated that the system as it exists is unfairly biased against the small businessperson. The small businessperson does not ask for preferential tax treatment, but merely desires the biases inherent in the present tax law in favor of big business to be modified to accommodate him. The essence of this argument is "the deinfitions are not clear enough" the difficulty of defining the object of the tax bounty. It is easy to pinpoint with some accuracy the types of economic activities which have received special tax treatment. Low income housing can be defined. The creation of the SBE and MBE demonstrate that small business can also be defined. (See Chapters 4, 5 and 6) "it will be too costly or confing to administer" Many revisions of the tax structure necessitate further complications to an already bewilderingly complex system. These further complications require more detailed administration by the Internal Revenue Service and other agencies, which cost more for the government, and ultimately the taxpayer. In the case of many tax reform proposals, this argument has considerable merit. In the case of small business tax reform, however, a major aim is tax simplification. If simplification can be effectively achieved for the small business taxpayer, it can be achieved for those agencies which administer the law. The proposals contained herein seek to accomplish this objective. "it will mean trouble in other parts of the economy" This argument seems to have several aspects. First, it is argued that giving one segment of the economy a tax advantage will upset the competitive balance. Second, it is argued that tax incentives to one segment of the economy will necessitate an unfair burden of revenue production to be shifted to other segments. Third, many types of tax incentives benefit one industry, or one geographic region more than others (e.g. oil and gas exploration incentives.) As they affect small business tax reform, these arguments have little validity. As to the first and second arguments, it has been demonstrated that reform will help to correct an already existing bias against small business. As to the third, the recommendations herein will not benefit a particular industry or region, but will benefit all small businesses throughout the Nation. Aside from objections to tax reform in general, another reason why small business has been neglected tax-wise is the legislative process itself. The Congressional committees and other government agencies intimately involved with the welfare of small business have neither the manpower nor the vast technical expertise necessary to cope with the problems involved in comprehensive tax legislation. Their resources are often strained to accomplish the primary objectives for which they are responsible. Given the lack of resources, these instrumentalities should be applauded for the excellent results they have achieved to date. Necessarily, however, their tax activities must usually be limited to reviewing pending legislation to determine the impact on small business. This "watchdog" approach does not lend itself to comprehensive creative small business tax thinking. CHAPTER 3 THE SEARCH FOR A TAX DEFINITION OF SMALL BUSINESS PART I - DEFINITIONS OF SMALL BUSINESS IN THE TAX LAW Existing Definitions of Small Business in the Tax Law 1 In the context of taxation, Congress has rarely attempted to define "small business." Consistency has not been a goal for the few existing definitions. In the 1958 small business tax provisions, for instance, three different definitions were developed for three different purposes. Other tax provisions, usually arising as exceptions to tax reform measures, directly or indirectly define "small business. ness."2 The definitional criteria utilized include gross receipts, 3 number of owners, 4 equity capital,5 5 income, and the size of a business interest as compared with a taxpayer's 1/ Internal Revenue Code (IRC) Section 1244 defines small business in IRC Section 44/(e) (small farm) added by the 1976 Tax Reform Act; Section 613A (small oil producer) added by the oil and gas reform provisions enacted in 1975. 2/ 3/ IRC Section 447 (e) 5/ small farm. Subchapter S election IRC Section 1244 - ordinary loss from sale or worthlessness of small 8 Tax benefits are sometimes granted to limited amounts of investment. Presumably, this technique gives the greatest relative relief to small business enterprises. The technique is deficient, however, because it grants the same tax relief to a large enterprise. This is an unwarranted drain on the revenue. Nowhere in the tax law is there a comprehensive systematic definition providing an adequate framework for addressing the practical economic and administrative realities confronting the small business person. Those provisions allegedly granting relief to small business are at best inconsistent, uncoordinated, and lacking in the uniformity necessary for a program of tax reform. Existing Taxable Entities The income tax law definitions of taxable entities are legalistic rather than economic. Tax entities result from their legal form of organization under state law rather than from their size, type of business activity, or other The taxable business entities are: economic characteristics. Individual Proprietorships The owner of a proprietorship includes 9 the income and deductions of his business in his individual income tax return. Although taxable income of the business is calculated on a special form, the taxpayer's business income is combined with his non-business income, and tax is levied on his total income in the year it is earned. The tax is imposed at the 10 appropriate individual rates which are steeply graduated from 14% to 70%. 6/ IRC Section 11 - imposing lower tax rates on corporations with income 7/ 8/ IRC Section 303 redemptions of small business stock to pay death taxes; Sections 6166 and 6166A deferring estate tax payments for estates consisting largely of small business interests. IRC Section 179 - Allowing additional first year depreciation on limited amounts of investment in qualifying personal property. Note that although this section is entitled "Additional First Year Depreciation Allowance for Small Business," the provision does not define small business, so that its benefits are available to all business, whether large or small. Corporations A corporation is a taxable entity separate from its owners (shareholders). This reflects the independent legal existence of the corporation under state law. Income is taxed to the corporation when earned. The rates applied to corporations are only slightly graduated, ranging currently 11 14 from 20% to 48%. If the income is distributed to the shareholders in cash or other property, the amount of the distribution is usually taxed again to the shareholder at his individual tax rate.12 The so-called "double taxation" of corporate income has invoked criticism from taxpayers and legislators for many years, and creates financing problems more fully discussed in Chapter 6. Some relief has been provided by the dividend received exclusion for individual share13 holders, and the dividend received deduction for corporate shareholders. Tax deferral can be accomplished by operating in the corporate form. Often, corporate tax rates are lower than the rates applicable to the individual shareholders. Although corporate income is subjected to the corporate tax when earned, it is not subjected to the individual tax if it is retained in the corporation rather than being distributed. In the case of a proprietorship or partnership, on the other hand, income is subjected to the individual tax when earned. To discourage high bracket shareholders from accumulating earnings in their corporations merely to shield themselves from high tax on distributions, a penalty tax is imposed on unreasonable accumulations in excess of $150,00015 Another penalty is imposed to discourage the use of a corporation to shield passive investment income from high individual taxation. 16 |