By Thomas P. Ochsenschlager, CPA, JD
You’ll be forgiven if you haven’t read the nearly 1,000 pages of House Ways and Means Committee Chairman Dave Camp’s (R-MI) tax reform proposal, the Tax Reform Act of 2014. After all, Camp’s last year as chairman is an election year when congressmen traditionally take positions but little action, and we have a deeply divided Congress, with Republicans controlling the House and Democrats, the Senate. So, the nearly unanimous opinion of Washington insiders is that it is going nowhere.
That being said, all his ideas shouldn’t be summarily dismissed. Camp’s proposal presents many ideas that are likely to get traction as a future Congress looks for ways to stimulate the economy, generate revenue, simplify the tax code or perhaps all the above as Camp contends his proposal would. Let’s just look at a few of these that would impact small businesses.
Advantages for Small Businesses
- The proposal would reduce the top marginal tax rates for individuals to 35 percent and corporations to 25 percent. (Income from passthrough entities engaged in manufacturing would be subject to a rate of 25 percent at the individual level.)
- The cash method would be available to all businesses with average gross receipts of $10 million or less or “sole proprietor” businesses, even those with inventory. However, it would significantly accelerate income for many businesses with receipts greater than $10 million, such as large law firms and public accounting firms currently using the cash method.
- Generally, the proposal would require longer depreciation periods and the straight line method. Small businesses, however, would be permitted to expense up to $250,000 of purchases (phased out beginning with purchases exceeding $800,000), including software and certain real estate each year. While this is less than the $500,000 threshold available last year, it is significantly greater than the $25,000 effective this year.
- Both the individual and corporate alternative minimum tax (AMT) would be repealed, a significant step towards simplification.
- The proposal would increase the amount taxpayers could deduct from $5,000 to $10,000 (phased out as these costs exceed $60,000) of start-up and organizational costs.
- It would simplify the determination of whether someone is an employee or independent contractor by replacing the 20-factor test the IRS currently uses with a test based on certain sales or service criteria, a written contract meeting specific requirements and 5 percent of the first $10,000 paid to the recipient is withheld and paid over to the IRS.
- A permanent extension of the five-year (as opposed to 10-year) test for determining “built-in-gains” at the time of the conversion from C corporation to S corporation.
Disadvantages for Small Businesses
- Materially active owners of an S corporation would be subject to employment taxes on 70 percent of all the income from an S corp.
- The following measures would be repealed:
- section 1244 that under current law excludes 50 percent of the gain from the sale of certain small business stock held for five years;
- the tax deferral available under current law for like-kind exchanges;
- section 199 manufacturing deduction; and
- percentage depletion.
Camp’s proposal is provocative in that it takes on many popular tax incentives and sacred cows. Unfortunately, this Congress doesn’t want to engage in a major debate, picking winners and losers before November.