11 April 2008

House Considers Small Business Tax Breaks

The U.S. House of Representatives in considering seven new tax breaks for small businesses:

1. Simplify the "Home Office" deduction provisions.

2. Allow taxpayers who can prove substantial business use of electronic equipment to deduct a greater portion of the cost without having to keep detailed records.

3. Allow a small business person who uses an automobile for work-related purposes over 75% of the time to recover the true cost of the vehicle (with a price of at least $25,000) during the standard 5-year recovery period. Continue to adjust the price for inflation.

4. Allow small firms to use shorter depreciation schedules--that are in line with today's technological and market realities.

5. Allow self-employed entrepreneurs to deduct cost of health insurance premiums in the same manner as large firms.

6. Raise the small business limit for deduction of business meals and entertainment to 80% or 100%.

7. Restore incentives to prompt those with capital to invest their money in U.S. small businesses.

From the Tax Profs Blog.

I have previously gone on record supporting proposal #5.

I am modestly supportive of proposals #1, #2 and #3 which are simplification measures for tax breaks that a currently highly policed by the IRS because they are often abused to treat personal expenses as business expenses. The changes would provide a framework for allowing non-abusive deduction amounts that provide rough justice, and would allow IRS enforcement to focus on more serious compliance issues. The price floor on the deduction in #3, however, is particularly irksome, as it encourages businesses to overspend on business vehicles in a way that tends to also be environmentally unfriendly.

#4 is largely irrelevant because small businesses tend to expense most of their capital expenditures rather than depreciating them. Honestly, relief from the amortization period for organizational costs would be more useful. The most legitimate reason for depreciation and amortization rules to be more lenient for small businesses has nothing to do with technological or market realities. It flows from the fact that the average small business survives less than five years.

I oppose #7, a capital gains tax break for investments in small corporations, which is an unnecessary sop to lucky and rich investors. The current capital gains tax rate for gain on C corporation stock in small businesses under Section 1202 is already a mere 14% and is self-employment/FICA tax free. Dropping that rate to 7.5% or less isn't going to make a big difference to investors.

Also, capital gains on pass through entity investments are less of a concern, because ownership interests in partnerships, limited liability companies and S-corporations receive basis adjustments (i.e. increases in the deemed purchase price for capital gains tax purposes) equal to a pro-rata share of undistributed income that are not available to C corporation share owners, so the 15% capital gains tax rate applicable to closely held businesses is imposed on a gain much smaller than the difference between the purchase price and the sale price of the investment in most cases. Colorado also already provides tax breaks for local capital investments that produce gains.

Investors in small businesses are far more motivated by loss limitations (which are appropriately present in the tax code to prevent tax shelter abuses), by the possibility of phantom tax liability (taxes on undistributed profits), and by non-tax considerations than they are by the happy possibility that they might have to pay a 20% combined state and federal income tax on a large capital gain.

I strongly oppose #6 which leads to abusive expense account living.

Two more tax bills that recently cleared the Ways and Means committee in the U.S. House of Representatives are discussed here.

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