Taxation as an SBE after Disqualification If, for any reason, an SBE becomes disqualified from SBE status (because of too much gross income or equity capital, receipt of foreign or tax-exempt income, etc.), it can requalify in any year when the deficiencies are removed. If the enterprise is a proprietorship, partnership or corporation which has elected under Subchapter S during the period of disqualification, there is no problem. If, during the disqualification period, a corporation has not elected under Subchapter S and has accumulated earnings and profits, it can re-qualify for SBE status by following the rules outlined in the preceding section. Special Tax Benefits Accorded to SBES - The SBE entity allows special tax benefits to be accorded to such enterprises without the benefits being utilized by undeserving taxpayers. The tax benefits for SBES include those to remove discrimination against them from erosion by taxation of earnings otherwise available for reinvestment, those to help them attract long-term and equity capital, and those to help them maintain themselves as viable independent economic enterprises. SBE equity owners are granted tax benefits to help them achieve security in their retirement years and facilitate the transfer of their businesses to their families upon death. The details of these specific SBE tax benefits are fully discussed in the succeeding chapters of this report. CHAPTER 6 THE MEDIUM BUSINESS ENTERPRISE; INTEGRATION OF THE CORPORATE AND INDIVIDUAL TAX PART I The Medium Business Enterprise Limitations on the size and characteristics of enterprises qualifying for special Small Business Enterprise (SBE) tax treatment preclude many enterprises from being accorded tax relief provided by these provisions. There are thousands of firms larger than the SBE which cannot, by any means be classified as "big business." These firms have special tax problems to which reform measures must be addressed. For the sake of simplicity, the enterprises in this intermediate size category are called "Medium Business Enterprises (MBE)." The Medium Business Enterprise is often a rapidly expanding firm in a technologically advancing industry or an older closely-held or family business which has stabilized in size. Its size requires more sophisticated organizational and managerial techniques than are necessary for the SBE. Usually, there is adequate financial and tax expertise available, so that the crushing burden of the complexity of the tax system, so troublesome to the SBE is not as much of a problem. The number and economic sophistication of the owners are generally greater in the case of the SBE. Except in certain professional fields, the MBE is most often organized as a corporation. The Medium Business Enterprise has two primary economic problems which might be relieved by modification of the tax law: Obtaining long-term financing, especially in the form of equity capital;1 Avoiding take-over by larger enterprises upon retirement or The limited scope of the tax relief necessary does not require the creation of a new tax entity as is the case with the Small Business Enter prise. There must, however, be a limitation placed on which firms can benefit from the preferential tax provisions. Qualification as a Medium Business Enterprise The Small Two of these Business Administration (SBA) has established detailed size standards for 3 qualification of firms for the various programs it administers. size standard criteria relate to qualifications for loans by the SBA and qualification for financial assistance by Small Business Investment Companies (SBIC) .4 The tax provisions in this report facilitating the formation and retention of long-term and equity capital are designed to benefit the same firms addressed by the SBA in its size standards for loans and SBIC assistance. It is therefore appropriate to incorporate the SBA standards into the tax law by defining a Medium Business Enterprise as any enterprise (other than an SBE) qualifying for loans by the SBA or financial assistance by SBICS. Such incorporation by reference of non-tax definitions into the tax law is not unknown.5 A further advantage of utilizing the SBA definition is that its size standards are undergoing continuing review to conform them to industry and economic fluctuations, thereby 2 For a comprehensive but concise discussion of the capital needs of Medium See statement of Hon. Frank Carlson, former U.S. Senator from Kansas on providing a mechanism for automatic updating of the system. The SBA size standards are framed in terms of gross receipts, number of employees, total 6 assets and net worth. Different criteria are adopted for different industrial classifications. Existing tax return forms can be easily adapted to provide the information necessary for a determination as to whether a particular taxpayer qualifies as an MBE. 7 Taxation of the Medium Business Enterprise - Other than being allowed to elect preferential tax provisions, the Medium Business Enterprise is taxed according to its legal form of organization. Thus, if it is a proprietorship, partnership or corporation, it is taxed as such. Corporate Modifications to Subchapter S to adapt it to the new taxing scheme are discussed in the second part of The special tax incentives accorded to MBES are fully discussed in the succeeding chapters of this report. MBES may elect to be taxed under Subchapter S. this chapter. 3/ These are contained in Part 121 of Chapter 1 of Title 13 of the Code of Federal Regulations 57 For example, see Internal Revenue Code (IRC) Sections 1242 and 1243 incorporating the definition of the SBIC from the Small Business Investment Act of 1958; IRC Section 1039 (b) (1) (A), "defining a qualified housing project" as one described in Section 221 (d) (3) or 236 of the National Housing Act; Section 167 (b) (3) (B) defining "low income rental housing" as that described in Section 8 of the U.S. Housing Act of 1937; The practice of incorporating by reference was continued by the 1976 Tax Reform Act which added the new Section 191 (d) (1) which defines a "certified historic structure" as one listed in the National Register or located in historic districts designated under specified federal, state and local statutes. Other examples of incorporation by reference could be cited. Analysis of MBE Tax Information A major problem currently confronting the SBA is the lack of an adequate data base for analysis of the For various reasons, the sources of appropriateness of its size standards. data available from government agencies, including the Internal Revenue 8 Service, are adequate for completely effective evaluation of the characteristics of enterprise requiring relief under SBA programs. As discussed in Chapter 3, the SBE is required to use the Standard Industrial Classification (SIC) designation from the Office of Management and Budget's Standard Industrial Classification Manual. The MBE is similarly required to use this classification designation. By summarizing information according to this code classification from the tax returns filed by SBES and MBES, the SBA would be provided with the data base it now lacks. All enterprise within the existing SBA definitions could be isolated and analyzed by industry. This would greatly facilitate evaluations of size standards. In addition, the information would provide a For qualification for SBIC assistance, a firm cannot have assets exceeding $9 million, net worth exceeding $4 million and average (2 year) after tax net, income of $400,000. Any firm qualifying for SBA loans also qualifies for financial assistance by SBICS 13 C.F.R. Sec. 121.3-11 For qualification for SBA loans, size standards are established on an industry A short set of questions similar to From 1120SBE, Part I (See Appendix A) For a complete discussion of these problems, see "What is à Small Business?", |