Statement of Senator Chuck Grassley
Senate Finance Committee Hearing, “C, K, or S: Exploring the Alphabet Soup of Small Business Choices in Advance of Tax Reform”
Thursday, June 5, 2008
Taxpayers have a wide variety of entities to choose from when starting a small business.These small business owners can operate as a limited liability company, an S corporation, apartnership, a limited liability partnership, a sole proprietorship, or a farm sole proprietorship. The abbreviations for these entities, such as LLCs, LLPs, and LPs, look like they might be found in abowl of alphabet soup rather than in our tax laws.
However, over the years, the number of entities keeps increasing. The tax laws relating tosmall businesses have also grown increasingly complex over time. For example, the partnership taxstatutes and regulations are one of the most complex set of rules found in our tax laws. Consideringhow complex the rest of our tax laws are, that’s saying something. Some of this complexity existsbecause we give partnerships a lot of flexibility when allocating income, losses, and deductions totheir partners. However, a lot of the complexity found in the partnership tax rules arose in responseto abuse by partnerships that were trying to unfairly take advantage of these rules.
Similarly, the tax rules for S corporations have grown more complex over the years. Inresponse to this complexity, a lot of taxpayers’ gut reactions are that the tax system should besimplified. However, taxpayers usually want the tax system simplified unless it means they haveto pay more taxes. Another thing taxpayers care about is having the freedom to conduct theirbusiness the way they want. The wide variety of entity choices currently available allows smallbusiness owners much freedom in deciding how to structure their business.
One of these choices, the limited liability company, has become increasingly popular. TheLLC offers the best of all worlds – limited liability, a single level of tax, and great flexibility inallocating income, deductions, and losses. Even though an LLC provided these attractive features,people were originally hesitant to form an LLC, because the caselaw relating to LLCs was not asdeveloped as the case law relating to S corporations or partnerships. However, as this case law hasdeveloped, small business owners have used the LLC with greater legal certainty. Similarly, theLLP has been utilized to a greater degree in recent years. I should also note that the S corporationremains a very popular entity choice for new businesses.
With the growing number of entity choices comes growing complexity. This complexityimposes large administrative costs to hard-working small business owners that must comply withthese complicated tax laws. Also, the complexity means small business owners can’t be confidentthat they’ve received all the benefits coming to them, or that they haven’t paid more than they owe.When looking at simplifying our tax laws for small businesses, we must also consider the fact thattaxpayers like having choices and flexibility in arranging their business affairs, and they don’t wantto get hit with a tax increase just for the sake of simplification.
While we all agree something should be done and we should be open-minded about whatreform would look like, I’d like to remind everyone that if we allow the bipartisan tax relief plansof 2001 and 2003 to expire at the end of 2010, it will result in a huge tax increase on smallbusinesses. According to the Treasury Department’s publication titled Topics Related to thePresident’s Tax Relief that was released last week, about 74 percent of the tax returns that willbenefit this year from lowering the top tax rate from 39.6 percent to 35 percent are flow-throughbusiness owners. Also, about 82 percent of the 29.2 billion dollars in tax relief this year fromlowering the top tax rate will be received by flow-through business owners.
If we fail to act to prevent this bipartisan tax relief from expiring at the end of 2010, we willbe taking money from the pockets of small business owners. This is money these small businessowners could use to hire more workers or spend in our economy on goods and services. Accordingto the U.S. Small Business Administration, small businesses employed over 58 million workers in2005, which is more than all other firms combined. Our small business owners, including ourfarmers, are the backbone of our economy. We should not break our economy’s backbone byhammering it with a dramatic tax increase.
Another reason we should prevent the bipartisan tax relief plans of 2001 and 2003 fromexpiring is that the top individual rate and the top corporate rate are currently the same. When thetop rates are different, taxpayers frequently attempt to unfairly take advantage of this difference.
I look forward to the testimony from our distinguished panel. We have an accomplishedcross-section of witnesses that includes professors, CPAs that have spent many years in the privatesector working for small businesses, and a member of a think tank who has held high-level taxpositions in the federal government. I appreciate all four witnesses’ dedication to the debate aboutsmall business tax reform. I look forward to their testimony.