CHAPTER 4 THE SMALL BUSINESS ENTERPRISE DEFINITION OF THE TAX ENTITY Factors to be Considered in Creating a Small Business Tax Entity Creation of a new taxable entity is a far-reaching change in the income tax law. There are those who would argue that such an action substantially complicates the system. Admittedly, new sections must be added to the Internal Revenue Code, thereby increasing the total substantive tax law to be mastered by tax experts. The magnitude of additional complexity should not be judged, however, by the amount of additional work for the experts, but by the tax equity and simplification gained for those intended to be benefited. Judged by these criteria, the Small Business Enterprise (SBE) would substantially simplify the system for the small businessperson and his non-expert counselors. The new entity is designed to accomplish the following objectives: Provide consistent tax treatment for all enterprises falling Remove tax considerations in the initial choice of a legal form Provide a mechanism for removing tax biases against small business persons; Provide a mechanism for granting appropriate incentives to encourage the establishment of small businesses and avoid the danger that such incentives are utilized by other enterprises not requiring relief; O Facilitate the means of reporting and analyzing the impact of the tax laws on small business so that further changes can be formulated and evaluated; Organize all tax provisions relating to the Small Business Enterprise into one subpart of the Internal Revenue Code to facilitate understanding by the small business community. Certain guideposts must be followed in establishing a new entity receiving special tax benefits. These are summarized as follows: Protection of the Revenue The primary purpose of taxation is to To the extent that tax payments raise revenue for the operation of government. are reduced for any sector of the economy, the burden is shifted to other sectors. It is therefore necessary that a program for tax reforms be balanced by shifting the tax from the sector to be benefited to other sectors more able to bear the burden. The program proposed in this study obviously reduces the tax burden for small business. It is anticipated that, in the long run, the current reduction in taxes will result in higher revenues by (a) the establishment of new taxpaying entities and (b) the increase in size of existing firms as a result of capital being released for their expansion. The immediate negative impact is minimized by: Denying some existing preferential tax deductions to large firms; Denying SBE status to activities already receiving preferential tax treatment; Limiting most new tax incentives to enterprises falling within the Historic Tax Treatment of Small Business New tax concepts are more readily understood and accepted if they are framed in terms familiar to taxpayers and legislators. To the extent that new terminology is minimized, new concepts are more readily integrated into the planning and thinking of the business community. If a technique has proved to be easily administered and has been effective in accomplishing the purposes for which it was developed, it is appropriate to adapt the technique to achieve desired new goals. The proposed program attempts to utilize familiar and tested techniques. Technical Practicality in Drafting Workable Legislation Legislative drafting is one of the most sophisticated tasks undertaken by Congress. This is especially true of tax legislation. The goals of successful legislative drafting of a tax statute are to: Make the new provisions fit within the Internal Revenue Code Integrate the new provisions into the Internal Revenue Code in such a way as to make the new scheme readily understandable to taxpayers The proposals contained herein attempt to accomplish these objectives by organizing all materials relevant to the SBE into a single subchapter of the Internal Revenue Code, with cross references to other provisions affecting this type of enterprise. This should be helpful to small businesspersons, prospective entrepreneurs, and those non-tax-specialist attorneys and accountants who counsel the small business owner. See Appendix for a section-by-section analysis of how the Internal Revenue Code would be amended to incorporate the proposed reform measures. Tax Definition of a Small Business Enterprise The definition of the Small Business Enterprise is framed in terms of the organizational and economic characteristics of such a business outlined in Chapter 3. The definition takes into consideration the number and nature of equity owners, capitalization, gross income and the relationship of the enterprise to other business enterprises. There are further limitations as to the source and type of income. The Small Business Enterprise can be legally organized as a partnership, corporation, individual proprietorship or trust. Organization as a trust might be appropriate when: * 1/ 2/ A proprietorship is transferred to a trust to shift its income to A proprietorship is transferred to a revocable trust used under an estate plan as an alternative to a will; • A business is organized as a trust in a state placing undue A testamentary trust is operating a business under the will of a deceased proprietor. The tax definition of the Small Business Enterprise is Internal Revenue Code (IRC) Sections 671 - 678. For a complete discussion of this technique, see Dacey, How 3/ This is sometimes referred to as a "Massachusetts Trust" because, |