[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]
REPEAL OF THE INSTALLMENT METHOD OF ACCOUNTING FOR ACCRUAL BASIS
TAXPAYERS
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTH CONGRESS
SECOND SESSION
__________
FEBRUARY 29, 2000
__________
Serial 106-51
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
66-735 CC WASHINGTON : 2000
COMMITTEE ON WAYS AND MEANS
BILL ARCHER, Texas, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
BILL THOMAS, California FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana JIM McDERMOTT, Washington
DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
A.L. Singleton, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma JIM McDERMOTT, Washington
JERRY WELLER, Illinois JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
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converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of February 16, 2000, announcing the hearing............ 2
WITNESSES
U.S. Department of the Treasury, Joseph Mikrut, Tax Legislative
Counsel........................................................ 8
______
American Bar Association, Section of Taxation, Pamela F. Olson... 30
National Federation of Independent Business, and Jeremiah's
Tavern, David Crosby........................................... 23
U.S. Chamber of Commerce, and Savoy Restaurant, Darryl A. Hill... 26
SUBMISSIONS FOR THE RECORD
American Institute of Certified Public Accountants, statement.... 40
National Association of Manufacturers, statement................. 41
National Association of Professional Insurance Agents,
Alexandria, VA, statement and attachments...................... 43
Printing Industries of America, Alexandria, VA, statement........ 45
REPEAL OF THE INSTALLMENT METHOD OF ACCOUNTING FOR ACCRUAL BASIS
TAXPAYERS
----------
TUESDAY, FEBRUARY 29, 2000
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to call, at 1:04 p.m. in
room 1100, Longworth House Office Building, Hon. Amo Houghton
(Chairman of the Committee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT
Contact: (202) 225-7601
FOR IMMEDIATE RELEASE
February 16, 2000
No. OV-15
Houghton Announces Hearing to Review the Repeal of the Installment
Method of Accounting for Accrual Basis Taxpayers
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing to review last year's repeal of the
installment method of accounting for accrual basis taxpayers. The
hearing will take place on Tuesday, February 29, 2000, in the main
Committee hearing room, 1100 Longworth House Office Building, beginning
at 1:00 p.m.
Oral testimony at this hearing will be from invited witnesses only.
Invited witnesses include the U.S. Department of the Treasury,
organizations representing small businesses, and tax experts. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
The accrual method of accounting generally requires that taxpayers
recognize income in the year in which the right to receive the income
occurs, regardless of whether the taxpayer actually receives the cash
in that year. The installment method of accounting allows an accrual
basis taxpayer to defer recognition of income until the taxpayer
actually receives payment.
Repeal of the installment method for accrual basis taxpayers was
included in the Ticket to Work and Work Incentives Improvement Act of
1999, which was signed into law on December 17, 1999 (Public Law 106-
170).
Since the repeal of the installment method for accrual basis
taxpayers, concerns have been raised regarding the unanticipated
effects on small businesses. The repeal has caused hardships for the
owners of small businesses when they try to sell the business by
accelerating when taxes must be paid or by lowering the amount offered
by potential buyers.
In announcing the hearing, Chairman Houghton stated: ``It appears
that last year's repeal of the installment method for accrual basis
taxpayers has had unintended consequences for small businesses. We need
to take another look at this and first see what the Administration can
do to straighten it out, and then look to see what, if anything,
Congress can do to help.''
FOCUS OF THE HEARING:
The focus of the hearing is to review the effects of the repeal of
the installment method of accounting on small business owners and to
discuss possible regulatory and legislative solutions.
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Any person or organization wishing to submit a written statement
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and hearing date noted on a label, by the close of business, Tuesday,
March 14 , 2000, to A.L. Singleton, Chief of Staff, Committee on Ways
and Means, U.S. House of Representatives, 1102 Longworth House Office
Building, Washington, D.C. 20515. If those filing written statements
wish to have their statements distributed to the press and interested
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purpose to the Subcommittee on Oversight office, room 1136 Longworth
House Office Building, by close of business the day before the hearing.
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noted above.
Chairman Houghton. Good afternoon. We are here to discuss
the installment method of accounting for accrual basis
taxpayers. We are here to discuss this particular issue. I know
the topic may sound a little dry, but I assure you that I have
heard from many small businesses that its repeal has created
real hardships to small business owners around the country.
The accrual method of accounting, as many of you know,
generally requires that taxpayers recognize income in the year
in which the right to receive income occurs, regardless of when
the taxpayer actually receives cash. The installment method
allows an accrual basis taxpayer to defer recognition of income
in some cases until the taxpayer actually receives payment. The
repeal of the installment method has caused hardships when
owners try to sell their small businesses by speeding up when
taxes must be paid or by lowering the amount offered by
potential buyers.
The repeal of the installment method was first proposed by
the administration last February in the fiscal year 2000
budget. The repeal was included in the tax bill the Committee
passed last June. And it was finally included in the Ticket to
Work and Incentives to Work Improvement Act that was signed
into law in December. I don't believe the administration or
Members of this Committee or small business trade groups
realized last year how far reaching this proposal was.
So today marks the first step to correct the unintended
consequences. I want to thank Secretary Summers and his staff--
particularly Joe Mikrut--for working so quickly to draft
guidance to resolve some of the problems that the repeal of
this provision has caused. I am interested in hearing what they
have come up with.
I am also pleased that our colleagues, Wally Herger, John
Sweeney, John Tanner, and Jerry Kleczka have joined us. They
responded quickly by introducing legislation to repeal the
repeal, and it is my hope that we can act soon to fix this
problem that has caused so many businessowners--such as the two
witnesses we have here today--so much concern.
Chairman Houghton. Now I am pleased to yield to our
distinguished ranking Democrat, Mr. William Coyne.
Mr. Coyne. Thank you, Mr. Chairman, and thank you for
holding this hearing.
In recent months, the Ways and Means Oversight Subcommittee
has received complaints from the small business community about
the recent repeal of the installment method of accounting for
accrual basis taxpayers. The new law appears to have had
unexpected consequences for many small businesses throughout
the country.
This repeal provision was enacted into law as part of the
Ticket to Work and Incentives Act of 1999. Currently the
Department of the Treasury is finalizing regulations to
implement the new rules.
I applaud the Subcommittee chairman, Chairman Houghton, for
scheduling today's hearing. Testimony form the Department of
the Treasury, National Federation of Independent Businesses,
U.S. Chamber of Commerce, and the American Bar Association will
provide us with an analysis of what, if anything, needs to be
done in providing regulatory guidance or statutory change.
Also I would like to welcome to our hearing two former Ways
and Means Oversight Subcommittee members, Congressman Jerry
Kleczka of Wisconsin and Congressman John Tanner of Tennessee.
They have both introduced legislation this year to repeal the
installment method provisions of the 1999 act and return to
prior law. I understand we will be hearing from them for an
opening statement. Is that correct, Mr. Chairman?
Chairman Houghton. Yes.
Mr. Coyne. So Jerry and John will make their case for their
legislation in their opening statement.
Thank you.
Chairman Houghton. Thank you very much.
Mr. Herger, would you like to make a statement?
Mr. Herger. Thank you, Mr. Chairman.
I would like to begin by thanking you for scheduling this
hearing to discuss an issue which has been of great concern to
myself and literally hundreds of thousands of small business
owners throughout the United States, a repeal of the use of
installment sales for accrual method taxpayers.
Just 3 weeks ago, Congressman Tanner, Congressman Sweeney,
and I introduced legislation entitled The Installment Tax
Correction Act. This legislation will correct the damage being
done to small businesses across America by modifying the tax
law to once again allow accrual method businesses to make use
of the installment sales. It is a testament to the importance
of this issue that our legislation has already garnered the
support of a majority of the taxwriting Ways and Means
Committee members.
Our legislation does not break any new ground, it simply
restores a type of business transaction which has been in use
for more than 80 years. Since 1918, accrual businesses have
been using the installment sales method because this method
adjusts the payments of taxes to the demands of the
marketplace. In contrast, a repeal of the installment sales is
forcing small business owners who sell their businesses to pay
taxes on income they have not yet received and may not receive
for several years. In many cases, these sales are falling
through or being put on hold.
Is this good tax policy? I think we can all agree it is
not.
I was pleased by the Treasury Secretary's admission that
installment sales repeal is having an effect more broad than
what was originally intended. I look forward to hearing how
Treasury intends to assist us in fixing this problem.
Let us commit here today to correct this situation as
quickly and completely as possible on behalf of America's small
businessmen and businesswomen.
Thank you.
Chairman Houghton. Thank you very much, Mr. Herger.
Mr. Kleczka.
Mr. Kleczka. Thank you, Mr. Chairman.
Mr. Chairman, I have a statement that I would ask unanimous
consent to be made a part of the record.
Chairman Houghton. Without objection, your prepared
statement will appear in the record.
Mr. Kleczka. Thus I won't have to repeat all that has been
said by yourself and the other members.
I want to join my colleagues in supporting legislation to
reinstate the installment method of accounting. I don't believe
Congress really understood the ramifications when we passed the
repeal last year. When we were talking about the Ticket to Work
and Work Incentives Improvement Act, we were looking at dollars
to pay for the act and I think we moved in haste by repealing
the installment method.
I have also been contacted by many small business people
and tax preparers who are relating some of the ramifications. I
think through either passage of my bill, which is H.R. 3568, or
the Herger Bill, I think Congress should reinstate the
installment method. Clearly, it is having its effect. It was
not the intent of this congressman to provide a hardship for
small business people who are trying to sell or buy a business
and having to pay the tax before the bulk of the receipts are
received.
Mr. Chairman, thank you for inviting me to participate in
your Subcommittee's hearing today. I did serve on the Oversight
Subcommittee for a couple of sessions. Had I known that you
were going to be chairman, I would not have left.
[The opening statement follows:]
Opening Statement of Hon. Jerry Kleczka, a Representative in Congress
from the State of Wisconsin
Mr. Chairman and members of the Subcommittee, it is with
pleasure that I come before you to testify on behalf of
legislation I introduced to reinstate the installment method of
accounting for accrual basis taxpayers.
As we all know, H.R. 1180, the Ticket to Work and Work
Incentives Improvement Act was passed by Congress last year.
Although H.R. 1180 contained many important provisions, it
repealed the installment method of accounting for most accrual
basis taxpayers. This change of law affected all transactions
occurring after December 17, 1999.
Prior to the passage of H.R. 1180, many business owners who
sold their operations would pay taxes on the profits from the
sale over the period in which they received payments. However,
by repealing the installment method of accounting, business
owners are now faced with the prospect of paying all the
capital gains taxes owed from the sale immediately. In other
words, taxpayers will be paying taxes on money they will not
receive for many years in the future.
The intention behind repealing the installment method of
accounting was to crack down on large corporations deferring
taxes for extended periods. Instead of addressing a tax
avoidance scheme, H.R. 1180 eliminated a perfectly legitimate
method of financing sales transactions for small business
owners. Clearly, Congress did not consider the full
ramifications of this change in law.
Shortly after its enactment, I began hearing from my
constituents and tax preparers expressing concern over the
repeal of the installment method of accounting. To their
surprise and dismay, many small business owners have found
themselves facing an enormous tax bill if they decide to sell
their business' assets.
It is estimated that more than 250,000 small businesses
will be adversely affected by the repeal of the installment
method of accounting. Many sales that were not finalized by
December 17, 1999 have fallen apart and countless others will
never occur. According to the Wall Street Journal, ``While
global merger megadeals done by pin-striped investment bankers
get most of the publicity, in fact, most corporate marriages in
the U.S. are tiny, involving deals valued between $500,000 and
$2 million.''
Furthermore, those who are looking to purchase additional
assets in order to expand their operations will now find it
more difficult to find a potential seller. As a result, the
value of small businesses could be reduced by as much as 20
percent.
I understand the Department of Treasury is developing
regulations to clarify the new law. While I welcome the
Administration's participation in this important issue, I am
concerned that the rule will not address the concerns raised by
the small business community.
Because of the consequences of repealing the installment
sales method of accounting, I introduced H.R. 3568. My
legislation would reinstate the installment sales method for
all transactions occurring after December 17, 1999. This would
have the effect of continuing the tax treatment of installment
sales that existed prior to the enactment of the Work
Incentives Improvement Act last year.
Mr. Chairman, I believe the broad, bipartisan interest that
this hearing has attracted underscores the importance of
passing legislation to reinstate the installment method of
sales. As the first member of the House of Representatives to
introduce legislation on this issue, I look forward to working
with my colleagues, the Administration, and all other
interested parties to bring about a rapid enactment of this
important legislation.
Chairman Houghton. You are very generous. Welcome back.
Thank you very much.
Mr. Tanner, do you have something equally as nice to say?
[Laughter.]
Mr. Tanner. I can think about something, yes, sir. I always
brag on the chairman.
[Laughter.]
Mr. Tanner. I also have a statement, Mr. Chairman.
Seriously, I do want to say thanks to both of you for
bringing this timely hearing to pass. I used to be on the Armed
Services Committee before I came to this one, and this seems to
be the collateral damage from a tomahawk missile attack.
[Laughter.]
Mr. Tanner. There was a reason Treasury proposed and
Congress accepted the proposal last year. In fact, we passed it
twice in this Committee and in the House. But this is
collateral damage from what was an abuse. I am glad Treasury
has recognized this and we are going to work together to get it
fixed.
It is a pleasure to work with you, Mr. Chairman.
Chairman Houghton. Thank you very much, Mr. Tanner.
Mr. Sweeney.
Mr. Sweeney. Thank you, Mr. Chairman.
I, too, would like to commend you. And you know that I have
often said privately and publicly great things about you
because you are a real inspiration.
I want to commend the Committee. As a members of the Small
Business Committee and as someone who represents a district
where 90 percent of the local economy derives from small
businesses, this is obviously a great concern. There are real
human elements to the problem that we are going to try to
correct here.
I will just give you one of them.
I have constituents--George and Dorothy Long of Lake
George--who have worked all their lives building their
business, which is a resort in beautiful Lake George.
Unfortunately, they have had to reconsider their plans to
retire and sell their business off because they are faced with
three options based on the problem that exists here.
One is to take a loan out in order to pay for the capital
gains tax. Two is to break the contract that they have signed
already to conduct that sale and they would face a lawsuit. Or
three is to suffer the consequences of nonpayment of taxes. So
it put them in a very terrible position.
I will submit for the record a formal statement and I want
to thank Mr. Herger and Mr. Tanner for their work on this
effort and I look forward to the hearing.
[The opening statement follows:]
Opening Statement of Hon. John E. Sweeney, a Representative in Congress
from the State of New York
Thank you, Mr. Chairman.
I commend you and your Subcommittee for your efforts to
help small business and for holding a necessary and timely
hearing.
It is imperative that we review the installment method of
accounting for accrual basis taxpayers.
Thousands of small business sales have been inadvertently
hurt by the inclusion of a provision in the tax extender bill,
H.R. 1180, which prohibits the use of installment sales.
I applaud this Subcommittee for focusing its attention on a
problem facing small businesses across the United States.
I appreciate the opportunity to participate in this
Hearing.
As a Member of the Committee on Small Business, and a
Representative of a Congressional District where 90% of the
local economy is generated by small business transactions, I am
particularly concerned with this topic.
I was shocked by the number of small business owners whose
transactions were adversely impacted by the loss of installment
sales.
For so many families, their only equity is entrenched in
their family business.
Not only have I been contacted by many of my constituents,
but my office has heard from small business owners throughout
the United States, from Nova, Ohio to Lake George, New York to
Clearwater, Florida.
It is sad to say, but we hear this same story and the same
pleas for help over and over again.
Many small business owners signed sales contracts prior to
the enactment of this provision and are now suffering the
consequences of having to postpone their retirement plans.
These comments only scratch the surface of this growing
problem.
Several months ago, Dorothy and George Long arranged for
the sale of their resort in Lake George, New York, part of my
district.
Unfortunately, they may have to reconsider their plans.
Mr. and Mrs. Long were relying on this sale to finance
their retirement and are now faced with three options:
1.) take a loan out in order to pay for the capital gains
tax, or
2.) break their contract and face a law suit, or
3.) suffer the consequences of non-payment of taxes.
It is terrible that small business, the engine of the local
economy and the source of innovation throughout the country, is
being hurt this way.
For example, this has happened to Richard Lohnes and his
brother of Schaticoke, New York.
These gentlemen currently own an insurance agency in
upstate New York, and after a lifetime of working, over
fifty years, they planned to finance their retirement by
selling their business.
Sadly, they learned the tax bill for their sale exceeds the
first year payment -a bill they cannot afford to pay.
Due to the loss of installment sales, these men and their
families must consider temporarily postponing their
retirements.
It is ironic that after more than fifty successful years in
the insurance business, they cannot afford to recover their
hard-earned equity.
We all know and agree this provision was unintentional, so
we must work together to ensure small business sales are no
longer depressed.
Thank you, for addressing this detrimental problem to small
business across the United States.
I look forward to hearing this important testimony and
working with this committee to restore the use of installment
sales.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you very much, Mr. Sweeney.
I would now like to welcome and call on Mr. Joseph M.
Mikrut, Tax Legislative Counsel, United States Department of
the Treasury.
Mr. Mikrut.
STATEMENT OF JOSEPH MIKRUT, TAX LEGISLATIVE COUNSEL, U.S.
DEPARTMENT OF THE TREASURY
Mr. Mikrut. Thank you, Mr. Chairman.
Mr. Chairman, Mr. Coyne, Members of the Subcommittee,
members of the Full Committee, we appreciate the opportunity to
come before today to discuss the repeal of the installment
method of accounting. We especially appreciate your leadership,
Mr. Chairman, in addressing this issue so soon after the
Secretary made his statement before the Full Committee.
This afternoon I would like to quickly discuss where we
are, potentially how we got here, what we see as the effect of
the repeal of the installment method, and potentially where we
should go from here, both administratively and legislatively.
As you mentioned in your opening statement, Mr. Chairman,
there are essentially two types of taxpayers: Cash method
taxpayers and accrual method taxpayers. The cash method
taxpayer generally takes an item into account in income or as a
deduction when he receives or pays the cash with respect to
that item. In contrast, accrual method taxpayers generally take
amounts into account when the event occurs that gives rise to
the income or deduction.
The installment method of accounting is a different type of
method altogether. The installment method provides an exception
to these overall methods of accounting by allowing the taxpayer
to defer the recognition of income from the disposition of
certain property until payment is received. Under the
installment method, a taxpayer recognizes gain resulting from
the disposition of property proportionately as payments are
received on the installment note. In this regard, the
installment method more closely resembles the cash method of
accounting.
Primarily for this reason, the Treasury Department and the
administration last year proposed to repeal the installment
method of accounting for accrual method taxpayers. In addition,
the budget proposal also contained several rules dealing with
the treatment of certain pledges and other items which are
essentially cash equivalents and are not allowed under the use
of the installment method of accounting.
Soon after the 1999 Act was passed by Congress, the small
business community began to express concerns that the repeal of
the installment method of accounting for accrual method
taxpayers negatively impacted the sales of small businesses. In
particular, small business groups have asserted that the use of
the installment method to report the gain on the sale of
business enabled the seller to get a higher price for its
business and for a buyer to purchase a business for which bank
financing may not be readily available.
As a result of the enactment of the installment sales
provision, several small business groups have estimated that
the reduction in the value of small businesses has exceeded 8
percent or more.
I would like to clarify two things with respect to the
installment sales provision that was proposed by the
administration and passed by Congress just this last year.
First of all, the installment sales provision is applicable
to all accrual method taxpayers and is not limited to only
small businesses. In addition, I believe certain press reports
may have overstated the effect of the repeal of the installment
method. Again, the installment method is still available for
cash method taxpayers.
As indicated by the legislative history to the provision,
the sale of stock of an accrual method business by a cash
method taxpayer will continue to qualify for the installment
method. Similarly the sale of an interest in an accrual method
partnership by a cash method taxpayer will also continue to be
eligible for the installment reporting. On the other hand, the
effect of the legislation is that sales of assets of an accrual
method corporation or partnership will no longer qualify for
installment reporting.
These different tax treatments add to the tension that
already exists between buyers and sellers with respect to the
decision to sell assets or stock. Buyers generally want to
purchase assets in order to avoid contingent liabilities
associated with the stock and to obtain an asset basis step-up
to fair market value.
On the other hand, sellers typically want to sell stock in
order to avoid two levels of tax, To obtain favorable capital
gain treatment, and to transfer contingent liabilities
associated with the stock.
Treasury's Office of Tax Policy has met several times with
interested industry groups, including the NFIB, NAM, AICPA, the
Small Business Legislative Council, and the U.S. Chamber of
Commerce and listened to the concerns on the effects of the
repeal of the installment sale on small businesses. These
groups have requested clarification of the effect of the
installment sales provision on particular transactions.
As indicated by Secretary Summers, we intend to issue such
guidance in the near future that will address the availability
of the installment method for the most common business
disposition transactions. In addition, in analyzing the
situation further, we will issue broader guidance that should
alleviate the effect of the legislation on small businesses
regardless of the entity's form, as well as provide additional
tax accounting relief.
As the installment sales legislation as enacted by Congress
only applies to accrual method taxpayers, the threshold issue
is: Which taxpayers must use the accrual method and which
taxpayers are allowed to use the cash method? As indicated in
our most recent Treasury and IRS priority guidance plan, we
intend to issue guidance addressing the requirements to account
for inventories, and as a result, to use the accrual method.
Part of this guidance generally will allow a qualified taxpayer
with average annual gross receipts of $1 million or less to use
the cash method and thus the installment method of accounting.
Let me point out and be clear that this is a significant
change that will change not only the availability of the
installment method, but the use of the cash method as well for
all small taxpayers meeting the requirements. The details for
qualifying for this exception and the procedures to
automatically change to the cash method of accounting will be
provided in guidance that should be published in the near
future.
We believe that it is important to provide this guidance
quickly. However, we understand that the guidance may not
provide redress for all taxpayers. Consequently, providing
relief for additional transactions may require legislation.
Overall, we believe the policy of repealing the installment
method of accounting for accrual method taxpayers was sound,
that the accrual method and the installment method are somewhat
inconsistent. However, as exhibited by the comments we have
received, we now understand that the legislation has imposed
financial burdens on small businesses that override this basic
tax policy concern. As such, we are eager to work with the
Congress to develop a legislative solution to alleviate this
unforeseen impact on small businesses.
We believe that any legislative response should be targeted
to address the legitimate concerns of affected taxpayers. To
address the liquidity problems often brought up by sellers of
small businesses--traditionally businesses with less than $5
million in gross receipts--use of the installment method should
be allowed, perhaps with an interest charge as provided under
present law, regardless of the seller's method of accounting.
If there are other concerns regarding different treatments for
different types of entities--for example, partnerships or
subchapter S corporations--legislation can address these
concerns as well.
Mr. Chairman, this concludes my prepared remarks. We look
forward to working with you, Mr. Chairman, Mr. Coyne, and
Members of the Subcommittee and Full Committee in addressing
these concerns and we will keep you informed of our proposed
administrative actions.
[The prepared statement follows:]
Statement of Joseph Mikrut, Tax Legislative Counsel, U.S. Department of
the Treasury
Mr. Chairman, Ranking Member Coyne, and distinguished
Members of the Subcommittee:
I appreciate the opportunity today to discuss with you the
repeal of the installment method of accounting for accrual
method taxpayers, which was originally proposed in the
Administration's Fiscal Year 2000 budget and was enacted by
section 536 of the Ticket to Work and Work Incentives
Improvement Act of 1999, effective for sales or other
dispositions occurring on or after December 17, 1999.
Background
Items of income and loss generally are taken into account
by a taxpayer in a taxable year based on the taxpayer's method
of accounting. The cash receipts and disbursements method of
accounting (cash method) generally requires an item to be
included in income when actually or constructively received. In
contrast, an accrual method of accounting items generally
requires an item to be included in income when all events have
occurred that fix the right to its receipt and its amount can
be determined with reasonable accuracy. Accrual methods of
accounting, when compared to the cash method, generally are
acknowledged to better reflect economic income and comport to
generally accepted accounting principles. Present law places
several restrictions on the use of the cash method for income
tax purposes.
The installment method of accounting provides an exception
to these general recognition principles by allowing a taxpayer
to defer recognition of income from the disposition of certain
property until payment is received. Under the installment
method, a taxpayer recognizes the gain resulting from the
disposition of property proportionately as payments are
received on the installment note. Payments taken into account
for this purpose generally include cash, marketable securities,
and evidences of indebtedness that are payable upon demand or
are readily tradable.
The use of installment reporting was originally permitted
by Treasury regulations in 1918 for dealers and subsequently
sanctioned by Congress in 1926 for dealers and nondealers,
subject to certain conditions. As explained by the Supreme
Court in South Texas Lumber Co, 333 U.S. 496 (1948), the
installment method of reporting was enacted to relieve
taxpayers who adopted it from having to pay income tax in the
year of sale based on the full amount of anticipated profits
when in fact they had received in cash only a small portion of
the sales price. However, beginning with the Tax Reform Act of
1986 (1986 Act), the availability of the installment method has
been restricted and the benefits derived from its use have been
substantially reduced. For example, use of the installment
method was denied for revolving credit sales and sales of
certain publicly traded property by the 1986 Act and for dealer
dispositions of real or personal property, with exceptions for
farming property, timeshares and residential lots, by the
Revenue Act of 1987 (1987 Act). In addition, the 1987 Act
significantly limited the benefits of using the installment
method by imposing interest charges on the deferred tax
liability attributable to certain installment obligations and
by treating pledges of certain installment obligations as
payment, thereby triggering the recognition of income.
Administration's Proposal and Subsequent Legislation
The Administration's Fiscal Year 2000 budget proposed to
prohibit the use of the installment method to report income
from an installment sale that would otherwise be reported on an
accrual method of accounting (installment sales provision). The
proposal did not change the use of the installment method by
cash method taxpayers or the present-law exceptions regarding
the availability of the installment method for sales of farming
property, timeshares or residential lots. The Administration
also proposed to eliminate certain inadequacies in the pledging
rules by clarifying that put rights or other similar
arrangements will receive the same treatment as pledges. The
installment sales provision was proposed to be effective for
sales or other dispositions occurring on or after the date of
enactment.
As indicated in the General Explanations of the
Administration's Fiscal Year 2000 Revenue Proposals, the
installment sales provision was proposed because the use of the
installment method is inconsistent with an accrual method of
accounting and effectively allows an accrual method taxpayer to
recognize income from the sale of certain property using the
cash method. Consequently, the installment method fails to
reflect the economic results of a taxpayer's business during
the taxable year.
The policy reason underlying the installment method of
accounting is to impose tax when the taxpayer has the
wherewithal to pay the tax (i.e., when the taxpayer has
received the cash). It was difficult to reconcile this policy
reason, however, with an accrual method, which requires the
payment of tax on trade or business receivables prior to the
receipt of the related cash. Moreover, as a result of the
repeal of the installment method for revolving credit sales,
certain publicly traded property and dealer dispositions, the
law already required taxpayers to include in income amounts
that had not been collected. Allowing an exception for accrual
method taxpayers for the disposition of certain property, but
not for other property, created additional inconsistencies in
the application of accounting methods.
The installment sales provision and the pledge rule
clarification were enacted as part of the Ticket to Work and
Work Incentives Improvement Act of 1999 (1999 Act), effective
for sales or other dispositions occurring on or after December
17, 1999.
Effect of the Legislative Change
After the 1999 Act was passed by Congress, small businesses
began to express concerns that the repeal of the installment
method for accrual method taxpayers negatively impacted the
sales of small businesses. In particular, small business groups
have asserted that the use of the installment method to report
the gain on the sale of the business enabled a seller to get a
higher price for its business and a buyer to purchase a
business for which bank financing was not readily available. As
a result of the enactment of the installment sales provision,
these small business groups have estimated that the sales price
of some closely held businesses may be reduced by 8 percent or
more.
The installment sales provision was made applicable to all
accrual method taxpayers, not just to small businesses. The
ability for an accrual method taxpayer to defer a realized gain
until the related cash was received is inconsistent with an
accrual method, regardless of the size of the taxpayer's
business. The provision applies to both casual sales of
property and sales of businesses that would otherwise be
reported on an accrual method. However, the extent of the
impact of the provision on the sales of small businesses
apparently was unforeseen by policymakers and potentially
affected taxpayers and their advisors during the legislative
process.
The repeal of the installment method for accrual method
taxpayers decreases the flexibility of structuring certain
business dispositions, but does not totally eliminate the use
of the installment method in such transactions. As indicated in
the legislative history to the provision, the sale of stock of
an accrual method business by a cash method taxpayer will
continue to qualify for the installment method. Similarly, the
sale of an interest in an accrual method partnership by a cash
method taxpayer generally should continue to be eligible for
installment reporting. On the other hand, sales of assets of an
accrual method corporation or partnership will no longer
qualify for installment reporting. These different tax results
add to the tension that already exists between buyers and
sellers with respect to the decision to sell assets or stock.
Buyers generally want to purchase assets in order to avoid
contingent liabilities associated with the stock and to obtain
an asset basis ``step-up'' to fair market value. On the other
hand, sellers typically want to sell stock in order to avoid
two levels of tax, to obtain favorable capital gain treatment,
and to transfer contingent liabilities associated with the
stock.
Treasury's Response
Treasury's Office of Tax Policy has met several times with
interested industry groups, including the National Federation
of Independent Businesses, National Association of
Manufacturers, American Institute of Certified Public
Accountants, Small Business Legislative Council, and U.S.
Chamber of Commerce, and listened to their concerns about the
effect of this recent legislation on sales of small businesses.
These groups also requested clarification of the effect of the
installment sales provision on particular transactions. For
example, they requested that we address the sale by a cash
method individual of an accrual method business conducted as a
sole proprietorship; the continued viability of section 453(h),
which allows a shareholder of a liquidating corporation to use
the installment method to report the gain on the exchange of
its stock for an installment obligation of the purchaser of the
corporation's assets; and the effect of a section 338 election,
under which a stock sale is deemed an asset sale for tax
purposes, on a stock sale of an accrual method corporation by a
cash method seller.
We intend to issue guidance in the near future that will
address the availability of the installment method for most
common disposition transactions. In addition, we will issue
broader guidance that should alleviate the effect of the
legislation on small businesses, regardless of the entity's
form, as well as provide additional tax accounting relief. As
the installment sales legislation applies to accrual method
taxpayers, a threshold issue arises as to which taxpayers are
required to use an accrual method, an issue that we have been
aggressively studying in other contexts. As indicated on the
most recent Treasury and IRS Priority Guidance Plan, we intend
to issue guidance addressing the requirements to account for
inventories and, as a result, to use an accrual method. Part of
this planned guidance generally will allow a qualified taxpayer
with average annual gross receipts of $1 million or less to use
the cash method and, thus, the installment method. The details
for qualifying for this exception and the procedures to
automatically change to the cash method will be provided in
guidance that should be published in the near future.
While we believe it is important to provide clear and
timely guidance to clarify the effect of the installment sales
provision on particular transactions and certain small
businesses, we believe the law is clear that where an accrual
method entity sells assets, or is deemed to sell assets, the
installment method will no longer be available because the
method of accounting of the entity controls the transaction.
Consequently, providing relief for such transactions will
require legislation.
Overall, we believe the policy underlying the legislation
is appropriate. The installment method is inconsistent with an
accrual method of accounting, which generally requires a
taxpayer to pay tax on a realized gain, regardless of whether
the taxpayer has received the related cash. However, we now
understand that the legislation has imposed financial burdens
on small businesses that override this basic tax policy
concern. As such, we are eager to work with Congress to provide
a legislative solution to alleviate this unforeseen impact of
the installment sales provision.
Any legislative response should be targeted to address the
legitimate concerns of affected taxpayers. To address the
liquidity problems facing sellers of small businesses (e.g.,
businesses with less than $5 million in gross receipts), use of
the installment method could be allowed (perhaps with an
interest charge), regardless of the seller's method of
accounting. If there is concern that different types of flow-
through entities are treated differently (because sales of
partnerships may be structured to allow the buyer to obtain a
stepped-up basis and the seller to use the installment method
while sales of S corporations allow either the buyer to obtain
a stepped-up basis or the seller to use the installment
method), special rules could be provided to level the playing
field. In addition, legislation also could clarify the
treatment of sole proprietorships and address other issues
related to the use of deferred payments. Finally, any
legislative solution should promote simplification and
administrability.
This concludes my prepared remarks. We look forward to
working with you, Mr. Chairman, Mr. Coyne, and members of the
Subcommittee and full Committee in developing any legislative
proposals deemed appropriate, and we will keep you informed of
our proposed administrative actions. I would be pleased to
respond to your questions.
Chairman Houghton. Thank you very much, Mr. Mikrut.
I usually pass the questioning off to my associate here,
but I would like to ask a general question.
As you probably know, I have been pretty interested in the
tax simplification issue and the ramifications on people and
all business, particularly small business. But it just seems to
me that the repeal last year of this particular provision
really sort of flipped on its side 80 years of tax policy, and
also makes it much more difficult for small business to exist,
particularly because it is a lot easier for legal action to be
taken against these small businesses.
How do you feel about that?
Mr. Mikrut. I think over the years, Mr. Chairman, Congress
has slowly itself cut back on the use of the installment method
with respect to accrual method taxpayers. For instance, it was
no longer available to the sellers of goods, which had
traditionally been accrual method taxpayers. Likewise, the
installment method is not applicable when what you receive is
publicly traded property primarily for liquidity concerns.
We take to heart, though, your call for simplification. And
we do recognize that the repeal of the installment method for
accrual taxpayers, including small businesses, will create
complications in trying to structure transactions. I will point
out, though, that in present law, use of the installment method
with its concomitant interest charges is itself a bit of
complexity. I am not here to suggest that we are saving
taxpayers from that complexity by requiring them to pay their
tax up front, but I will point out that any solution here ought
to be both administrable by the IRS and readily applicable by
taxpayers.
Chairman Houghton. And it makes you wonder whether an
almost complete repeal of the repeal isn't the only way to go.
Mr. Mikrut. Again, Mr. Chairman, we believe from a policy
standpoint that the use of the installment method is
inconsistent with the use of the accrual method. In general,
most taxpayers that use the accrual method are larger taxpayers
who can probably more readily adapt to such complications. That
is why we have suggested in our testimony that a more targeted
direct carve-out for small businesses would be most
appropriate.
Chairman Houghton. Mr. Coyne, would you like to ask some
questions?
Mr. Coyne. Thank you, Mr. Chairman.
Mr. Mikrut, you had testified that those in the million-
dollar category or less that would be covered by your proposal
would be about 30 million businesses. Is that correct?
Mr. Mikrut. I can give you some better statistics than
that, Mr. Coyne.
In looking at 1997 return data, of the 2.2 million
subchapter C corporations, which generally are the larger
corporations--some 78 percent of those would qualify for the
million-dollar exception. With respect to the 2.4 million S
corporations, 85 percent have gross receipts of under $1
million.
With respect to the 28 million partnerships and sole
proprietorships, in excess of 95 percent of those entities have
gross receipts under $1 million. So we think providing the
million-dollar exception, as we outlined for use of the cash
method, will alleviate much of the concern small business has
raised.
Mr. Coyne. Is it accurate to say that there are 33 million
business taxpayers? Is that the figure?
Mr. Mikrut. That is correct.
Mr. Coyne. Total?
Mr. Mikrut. That is correct, according to 1997 return data.
Mr. Coyne. What types of small businesses in that 33
million figure and sales transactions would not be covered by
the Treasury's guidance?
Mr. Mikrut. I think it is approximately three million of
those taxpayers, and those are primarily subchapter C
corporations, which are in general the larger, more
sophisticated taxpayers who generally use the accrual method
for book treatment as well.
Mr. Coyne. Is there any additional legislation that you
would suggest now? I know you are going to work with the
Committee and the Committee is going to work with you in trying
to come up with additional legislation, but is there anything
you can touch on now? And could you let us know the major
features of such legislation?
Mr. Mikrut. Again, Mr. Coyne, the purpose of this hearing
is to hear the direct concerns of small businesses and other
affected taxpayers. We think any legislation should be crafted
toward those concerns.
Traditionally, Congress has defined a small business as one
that had less than $5 million of gross receipts. So in that
regard, perhaps the use of the installment method for those
taxpayers--those with less than $5 million in gross receipts--
might be appropriate. To the extent that Congress would want to
backstop that, there is under present law a requirement for
some taxpayers to use an interest charge. Perhaps the interest
charge could be applied to those taxpayers to make the
government whole for any deferral of tax.
Mr. Coyne. Thank you.
Chairman Houghton. Mr. Herger?
Mr. Herger. Thank you, Mr. Chairman.
Mr. Mikrut, I want to begin by thanking you and the
Treasury and expressing my appreciation for the effort you have
been making to help us correct this very major problem. We have
been hearing from literally thousands of small businesses
throughout the United States. I have heard from many hundreds
just from my own district. Having said that, we have just today
seen your proposal. I am really waiting to hear more from the
small business community as they begin looking at it to see if
indeed it is able to address the full concerns that we have.
I do have one question. I think about a million--in this
day and age we are talking about gross sales. Is that correct?
Mr. Mikrut. Yes, Mr. Herger. Traditionally, Congress has
used a gross receipts test to try to define a small business.
Mr. Herger. My concern is that with small business,
particularly today, you can get up to $1 million--particularly
if you have a couple of McDonald's restaurants, for example.
Maybe each business may not get over $1 million, but maybe
several together may. If someone, say, had two or three
McDonald's around town that he had built up, and he was selling
one of these for his retirement or whatever, would it be the
aggregate of his several businesses, or just that one that he
was selling?
Mr. Mikrut. Mr. Herger, we haven't put together all the
details of the proposal, but if you look at current section
448, which provides the $5 million rule for required use of the
accrual method, those rules use an aggregate concept and we
would most likely try to apply those types of rules as well.
Mr. Herger. So in other words, you would take the several
businesses--you would add it all, not just the one he was
selling? So that very well could put this individual in over
the $1 million range.
Mr. Mikrut. As Congress addressed this in 1986, you would
not want to have a well-advised taxpayer start dividing his
business into very small parts so that each one qualified for
the $1 million or $5 million exception.
Mr. Herger. And I can certainly understand that. But also
just the nature--this is not uncommon at all. You have a small
business man who may have a Burger King, and he may have two in
the same small community. I represent a very large rural area
and there are small towns. You could have one in each of the
small towns. He hasn't divided this on purpose to get out of
paying his taxes, that is just the nature of his small
business.
Mr. Mikrut. I understand, Mr. Herger. It is just very
difficult to distinguish a tax-motivated transaction from a
pure business-type transaction.
Mr. Herger. The concern that has been expressed by several
of the members--as well as Secretary Summers, I believe, in so
many words--and I don't want to put words in his mouth--when he
was before our Committee a few weeks ago he indicated that they
were not aware of the incredible ramifications of what this was
going to do. Certainly those of us as Members of Congress--as
was mentioned by Congressman Kleczka a little earlier--were not
aware of the ramifications this was going to have.
As we move forward with this, I would hope--and it would
appear that maybe it doesn't take care of all these
ramifications--I would certainly hope that perhaps the Treasury
and the administration could support our legislation that would
basically put it back like it was for 80 years and do away with
it completely.
Do you have a comment on that?
Mr. Mikrut. I also don't want to put words in the
Secretary's mouth, but I think it is clear that what we are
trying to address both administratively and with proposed
legislation are the direct concerns of small businesses. At
this point we don't believe that a complete repeal of the
repeal is necessary to do that. Clearly, it would cover
everything, but we think that a more limited approach using
traditional means by which Congress has tried to define small
business might be appropriate here. Of course, we are looking
forward to the testimony from the other witnesses to see if
that might be appropriate.
Mr. Herger. Thank you.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you.
Mr. Kleczka.
Mr. Kleczka. Thank you, Mr. Chairman.
I am still unclear as to Treasury's position on the
legislation introduced by Mr. Herger and myself which would
reinstate the repeal of the installment method.
Your proposal is to provide for continuing the cash method
for businesses with gross receipts of $1 million or less.
Current law is $5 million or less. Is it not?
Mr. Mikrut. No, Mr. Kleczka. Present law is that if you are
a subchapter C corporation or if you are a partnership that has
a subchapter C corporation as a partner, and you have gross
receipts in excess of $5 million, you must use the accrual
method of accounting.
Mr. Kleczka. So if you have $5 million or less you can use
cash accounting?
Mr. Mikrut. You can use cash accounting--and I think the
legislative history to the 1986 act makes it clear--you can use
cash accounting if you were otherwise eligible to use cash
accounting. Regulations also dating back approximately 80 years
have made it clear that where merchandise is a significant
income-producing factor in a business, there is a requirement
to keep inventories. And if there is a requirement to keep
inventories, then there is a requirement to use an accrual
method of accounting regardless of the amount of the gross
receipts.
So traditionally dealers in goods, sellers of goods had to
use an accrual method of accounting no matter what their gross
receipts.
Mr. Kleczka. But the statute at one point does talk about a
$5 million gross for a small business. What would be wrong with
Treasury using that same $5 million figure instead of the $1
million that you are proposing? What is the problem there?
Mr. Mikrut. Again, it would be overturning approximately 80
years of regulations that have been in existence. We also
believe that it would result in the improper measurement of
income, that for sellers of goods or larger businesses it is
more appropriate to use an accrual method of accounting. This
is the method of accounting that is often required to be used
for book purposes, to provide financial statements, to apply
for bank loans. It provides a clearer reflection of income. It
eliminates any timing ability for taxpayers to take in receipts
or to make prepayments and receive deductions.
We think many of these concerns are not there when the
level of gross receipts is small, $1 million. But once you
reach the $5 million plateau, general tax policy and other
considerations require the use of the accrual method of
accounting.
Mr. Kleczka. I guess we just disagree what that level
should be.
We do have two pieces of legislation to introduce. What is
Treasury's specific objection to the bills that are before the
Committee, and how would you recommend they be changed to get
Treasury's support?
Mr. Mikrut. I believe the bills are important in that they
try to address concerns that have been raised. But I think they
address more than those concerns because I think they also
address the use of the installment method of accounting by a
Fortune 500--
Mr. Kleczka. The bills repeal the repeal, so whatever was
previously current law--
Mr. Mikrut. That's right.
Mr. Kleczka. How do you suggest we change the legislation
to comply with the thinking of the Treasury Department?
Mr. Mikrut. I think perhaps the most appropriate method
would be to provide a small business exception. If you believe
a small business should be $5 million in gross receipts as
opposed to $1 million in gross receipts, that would be an
appropriate cutoff. I think that is what Congress has
traditionally tried to define a small business as.
Mr. Kleczka. So the bills would be more acceptable with a
level or definition of what type of business shall be
applicable to the cash accounting, and that would be either $1
million or $5 million, but not higher than $5 million?
Mr. Mikrut. That is correct.
Mr. Kleczka. Thank you, Mr. Chairman.
Chairman Houghton. Now I would just like to ask a
question--sort of a peripheral question--but in terms of the
installment method, which was established 80 years ago, it
wasn't $1 million and it wasn't $5 million. What was it in
1920?
Mr. Mikrut. There was no dollar threshold, Mr. Chairman.
Chairman Houghton. When did the dollar figure come into
effect?
Mr. Mikrut. In 1986, Congress again provided that a
subchapter C corporation with gross receipts over $5 million--
except for certain professions--
Chairman Houghton. So it was keyed in 1986 for the first
time?
Mr. Mikrut. Yes, and again in 1986 and 1987 Congress
repealed the use of the installment method for dealers in
goods, which were essentially accrual method taxpayers, but
continued to allow the installment method for casual sales of
property, for instance, land used in the business, maybe a
division or subsidiary, something like that, but imposed an
interest charge to the extent that the installment obligations
exceeded $5 million. And that's where we were until last year.
Chairman Houghton. Thank you very much.
Mr. Sweeney.
Mr. Sweeney. Thank you, Mr. Chairman, and thank you, Mr.
Mikrut, for all of your work and for issuing the guidance
today.
It seems that, as the prior questioners honed in, that the
difficulty we are going to have--as is usually the case when
you are trying to define delineations that will provide
benefits to some and not to others--the standard for defining
what a small business is. That is really the crux of the
disagreement. So I am going to try to hone in a little just to
clarify in my mind how we can begin to develop those
definitions.
Is it correct that the guidance that you have issued today
will not help closely held businesses operating as
corporations?
Mr. Mikrut. I believe it would, Mr. Sweeney. We haven't
issued the guidance yet. But again, as we began to examine this
issue, the small business community pointed out several
different type of transactions that the legislation affected
and requested guidance with respect to those limited types of
transactions. But the more we looked at it, we thought a more
global solution was necessary and that is why we came up with a
$1 million threshold that would apply to all businesses.
And more importantly, this $1 million threshold for the use
of the cash method is applicable not only for the installment
sales but also for purposes of reporting day-to-day operations.
That is why we think it is a significant development.
Mr. Sweeney. So the type of business structure doesn't
really matter?
Mr. Mikrut. No, it does not.
Mr. Sweeney. Would the $1 million exception apply
regardless of inventories?
Mr. Mikrut. That is correct.
Mr. Sweeney. That seems to be a new approach. What is that
based on? What precedent?
Mr. Mikrut. Again, we think the cash method of accounting
Congress reserved for less sophisticated taxpayers. One measure
of determining sophistication is the level of gross receipts.
Also in the law is a concept that as long as the accrual and
the cash method give you substantially the same results, the
cash method would otherwise be allowable. We think with respect
to gross receipts of less than $1 million the results will not
vary by that much between cash and accrual.
And finally, part of this is a very practical concern, Mr.
Sweeney. As you know, there has been a lot of litigation or
potential litigation in the area between cash and accrual
methods of accounting. It is probably not an adequate use of
IRS resources to look at businesses where gross receipts are
relatively insignificant, less than $1 million.
Mr. Sweeney. I think if there is going to be disagreement,
it will be based on the sense that many of us have that--and it
is true that when you are setting an arbitrary number to define
something clearly you are going to have these difficulties--but
I am concerned that the $1 million figure would limit the
applicability and it may not cover all kinds of circumstances.
I noticed in your statement you recognized that we need to
take approaches that would respond to those issues and concerns
of the small business community.
I look forward to working with you.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you very much.
You cut off the cash method for a business at $5 million
and kick into the accrual method, and yet the United States
government which has a budget of $1.9 trillion is still on a
cash basis.
Can you explain the difference?
Mr. Mikrut. The rule that requires a taxpayer with $5
million of gross receipts to cut off from the cash to the
accrual method is something that Congress enacted in 1986. I
believe the rationale there was that the accrual method is
generally the method that corporations use for book purposes.
There was an attempt to conform book and tax treatment with
respect to those types of entities.
I do not know why the Federal Government necessarily--nor
am I a budget expert able to explain to you why--it uses the
cash method for accounting.
Chairman Houghton. I didn't really expect you to have that
answer. [Laughter.]
Mr. Tanner.
Mr. Tanner. Thank you very much, Mr. Chairman.
I think this has been an interesting discussion. I think
there is room for agreement here with everyone. I think we are
talking about two different things. I don't know who would
change their day-to-day accounting. We are talking about the
sale of a business, which is a one-time event in the lifetime
of a small business, not a year-to-year situation.
Number two, you stated that you were concerned that our
bill addressed more than the problem. I am a little concerned
that your solution is more narrow than the problem. So I think
we have some work to do to see where we can work together to
make the end result we all want come to fruition.
Thank you for your time, Mr. Chairman. I am going to have
to go to another meeting, but I sincerely appreciate the
invitation and the opportunity to speak. We will work with you
and Treasury to see what we can come up with.
Chairman Houghton. Thank you very much, John, for being
with us.
Mr. Weller.
Mr. Weller. Thank you, Mr. Chairman.
I missed the opening statements, but I do have an opening
statement I would like to submit into the record.
Chairman Houghton. Without objection, your prepared
statement will appear in the record.
[The opening statement follows:]
Opening Statement of Hon. Jerry Weller, a Representative from the State
of Illinois
We are here today to hear testimony about the inadvertent
effect that a provision included in ``The Tax Relief Extension
Act of 1999'' is having on small businesses. Section 536 of
that Act modified the installment method of accounting and
generally prohibited the use of the installment method of
accounting for sales of property by taxpayers that use the
accrual method of accounting. It appears that the impact of
this Installment Sales provision goes well beyond anything
hinted at in the President's Budget for 1999 which first
introduced this repeal provision. While the provision appeared
to target larger, accrual method businesses when they sold a
particular asset or assets, its real effect will be to reduce
the value of closely held businesses when they are sold in
their entirety. These small business run the gamut -from dry
cleaners and mom and pop convenience stores to insurance
agencies and other small service providers.
I have already heard from many independent insurance
agencies located in and around Joliet in my home district that
this provision is crippling the value of their agencies that
they have worked lifetimes to create. I believe that it is
essential that we take corrective action immediately to ensure
that small business owners like the independent insurance
agents in my district do not suffer from such needless
punishment. I hope that the hearing we are holding today will
be the first step toward that goal.
Mr. Weller. Mr. Chairman, first I want to thank you for
conducting this hearing. This is an issue I have heard about
from back home--folks who run dry cleaners, mom and pop
convenience stores, and particularly some insurance agents. The
other day they were looking for someone's head because they
took a look at the impact of this provision in last year's law
in the budget and have come to the conclusion that it really
has a big impact on the value of their agency. These are
middle-class guys and gals that have worked very hard to build
something they would like to pass on to their kids and they are
already threatened by the estate tax, which can have an impact
on passing that on to their children.
They now see that because of this change the value of this
asset they would like to pass on to their kids has diminished
as well.
It is my understanding that this idea came out of the
Treasury Department last year.
I would ask Mr. Mikrut, was this Treasury's idea?
Mr. Mikrut. I think this is an idea that has been around.
In the deliberations for the 1986 Act, Congress considered
this. The theory then was that the accrual method and the
installment method are somewhat inconsistent methods of
accounting and therefore the installment method should be
reserved for the cash method taxpayers.
Mr. Weller. As I stated, it is having a negative impact on
middle-class people who are trying to build up an asset they
want to pass on to the next generation.
I really want to commend my friend, Mr. Herger, for taking
the lead on working to repeal this provision which is hurting a
lot of people.
I am trying to get a great understanding of it. Who was the
villain you were trying to slay when you proposed this last
year?
Mr. Mikrut. There was no particular transaction or
particular abuse, Mr. Weller, we were trying to direct it
toward. Again, we were trying to reconcile the different
methods of accounting and we thought that accrual method and
the installment method just did not line up as well as the
installment method and the cash method. That is where we drew
the line.
Mr. Weller. Wouldn't you agree that for these insurance
agents and these small business people it was working at that
time? Shouldn't we admit now that it was a mistake and make
this change?
Mr. Mikrut. I think the price effect was unforeseen. I
think the inability for certain small businesses to get bank
financing and therefore have to extend seller financing was
unforeseen. And I think, again, any legislative response should
be to try to address those types of concerns.
I will point out, Mr. Weller, that the concern you had of
your insurance agent who passes on his agency to his heirs--
they should not be impacted by the provision. Again, the
installment sale provision only applies to gains. When you pass
on your business to your heirs, they get a step-up--
Mr. Weller. How about if they decide, for retirement
purposes, they want to sell their agency? They have been
building up the value of this agency and decide it is time to
retire, and that is their retirement income? And you have
reduced the value of that asset.
Mr. Mikrut. It would have an effect in that case, yes.
Mr. Weller. You have indicated here that you have a
proposal which is very narrow. I have always wondered about
your Administration's definition of targeted relief, because it
usually means that very few people get very little. In this
case you are proposing a very targeted relief, which is only $1
million. A lot of small businesses today have over $1 million
in gross sales. They may not make any money, but they have $1
million in gross receipts. You have indicated in comments to
other Members of this Subcommittee that you might be willing to
raise that threshold to $5 million.
Why do we even need a threshold? Doesn't an income
threshold just complicate the Code? I think one of the goals we
all have is to simplify things for people. Before we adopted
the change you recommended last year, things were a lot
simpler. Now we are making it more complicated. And then the
solution that you are offering complicates it all the more.
Mr. Mikrut. I will agree, Mr. Weller, that a threshold
generally creates some level of complication. I will point out,
though, that the $1 million threshold--looking at 1997 tax
return data, amounts reported on those returns, not the average
of the 3 years, which would normally be lower--would exempt 78
percent of C corporations, 85 percent of S corporations, and 95
percent of partnerships and sole proprietorships would be under
the $1 million threshold. If you were to go up to $5 million,
those percentages become much greater.
We think the $1 million threshold we have proposed, subject
to the aggregation rules Mr. Herger was discussing, would
exempt a great number of taxpayers.
Mr. Weller. How does your proposal impact closely held
small businesses that operate as corporations? Are they given
relief under your proposal?
Mr. Mikrut. Yes, Mr. Weller, we would apply this across the
board to all forms of business entities.
Mr. Weller. I see I have run out of time.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you very much.
Mr. McInnis.
Mr. McInnis. Thank you, Mr. Chairman.
Sir, this was effective December 17, 1999. Is that correct?
Mr. Mikrut. Yes.
Mr. McInnis. In your opening remarks you said you intend to
issue guidance in the near future that will address the
availability of the installment method for the most common
disposition transactions.
Is it your intent to make that retroactive to December
1999?
Mr. Mikrut. Yes, Mr. McInnis. Again, methods of
accounting--most of the businesses this would apply to we are
simply clarifying that they continue on the cash method and
therefore would not trip into the installment method provision.
We fully intend to clarify that small gap period of essentially
one to 2 weeks where the installment method would be available
to those businesses as well.
Mr. McInnis. So in essence, based on your guidance, there
will be no gap?
Mr. Mikrut. We would hope not. That is right, sir.
Mr. McInnis. When is your guidance going to come out?
Mr. Mikrut. As soon as we can address the details we were
discussing with Mr. Herger, and in addition looking at other
ways we could be helpful in providing additional guidance as to
the use of the cash versus the accrual method.
Mr. McInnis. Your threshold is $1 million?
Mr. Mikrut. Yes, $1 million of average annual gross
receipts, which is usually a 3-year rolling average.
Mr. McInnis. And in the past we did not have a threshold
over what was repealed. There was no threshold, was there?
Mr. Mikrut. There was a threshold for a different form of
the installment method that required the use of an interest
charge if you received over $5 million annually of installment
obligations.
Mr. McInnis. The problem we have today was really the
result of--it kind of slipped through. We didn't envision the
difficulties--neither Treasury nor the Congress. Now you are
suggesting a partial repeal, not to go back to where we were,
but does Treasury see an opportunity to grab some territory
through the confusion? Is that you don't support a full repeal?
Mr. Mikrut. No, Mr. McInnis. We believe in the policy of
the use of the installment method being restricted to cash
method taxpayers. We now understand that that had a significant
and unforeseen effect upon certain small businesses. We are
trying to address those situations where the business or the
non-tax policy considerations override this policy concern.
Mr. McInnis. Thank you.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you, Mr. McInnis.
Any other questions?
[No response.]
Chairman Houghton. If not, thank you very much, Mr. Mikrut.
We appreciate your testimony.
Chairman Houghton. I now call upon the next panel, which is
David E. Crosby, Co-Owner, Jeremiah's Tavern, Rochester, New
York--the garden spot of the country--on behalf of the National
Federation of Independent Business; Darryl A. Hill, Owner-
Operator, Savoy Restaurant, on behalf of the United States
Chamber of Commerce; and Pamela F. Olson, Chair-Elect, section
of Taxation, American Bar Association.
Please take your seats.
Mr. Crosby, we will begin with your testimony.
STATEMENT OF DAVID CROSBY, CO-OWNER, JEREMIAH'S TAVERN,
ROCHESTER, NEW YORK, ON BEHALF OF THE NATIONAL FEDERATION OF
INDEPENDENT BUSINESS
Mr. Crosby. Thank you.
Good afternoon. My name is David Crosby. I am the co-owner
of Jeremiah's Tavern in Rochester, New York. Jeremiah's is a
90-seat neighborhood restaurant located in the Upper Monroe
area of Rochester. On behalf of the 600,000 members of the
National Federation of Independent Business, I appreciate the
opportunity to present the views of small business owners on
the subject of repealing the installment sales provision.
I would ask that my written testimony be submitted for the
record and I will summarize my remarks here.
As you have already heard, the installment sales provision
is literally blocking the sale of small businesses across the
country. Others have described the technical reasons why this
is the case, let me state the bottom line reason: The
installment sales provision greatly increases the downpayment
necessary to purchase a business or commercial property.
Let me explain using my own experience.
We started Jeremiah's Tavern by purchasing its current
location in 1978. In 1982 we started buying houses around the
original property so that we could use the backyards to expand
parking. Except for two small mortgages, all those properties
were purchased using seller financing. If this tax provision
had been in effect at the time, I am confident that Jeremiah's
would not exist today. I seriously doubt our original $15,000
downpayment would have covered all the taxes and closing costs
owed by the previous owner when we bought this building. If he
had been forced to pay all those taxes up front, he could not
have afforded to sell his building to three under-financed
entrepreneurs.
Now we are facing the other end of the issue. From the
beginning, we planned to grow our business until we could
afford to retire. Now that plan is in jeopardy. The banking
community is not receptive to financing restaurants and rental
properties, which means we must carry the note.
Under the old rule, we could spread whatever capital gains
we realized over the life of the note. As an accrual method C
corporation, we now have to pay tax in that first year. That
means it would likely cost us money to sell our business. Gene
has two children in college and my daughter starts next fall.
We can't afford to go an entire year with negative income. So
unless we can find someone who can pay cash or get a loan, we
can't sell our business.
And my situation is not unique. When I first became aware
of the provision, I called my accountant to determine if it
would affect us. After he gave me the details, he told me that
he was in the middle of a sale that was in danger of falling
apart. The seller cannot afford to pay the capital gains tax
due if the sale is structured as an asset sale, and the buyer
is unwilling to purchase the stock of the business rather than
just the assets.
Buyers rarely are willing to purchase stock in a closely
held business. In this case, the buyer offered $2 million less
for the company if he had to buy the stock.
Another concern I have is, What happens if the buyer fails
to make all the promised payments? A friend of mine sold his
restaurant to a buyer who went bankrupt 2 years later. My
friend was forced to take back the business and spend the next
2 years rebuilding it so he could sell it again. If this had
happened under the new law, he would have two problems: First,
rescuing a badly damaged business, and second, recovering taxes
he had paid on income he never received.
Finally, what happens if I die unexpectedly? Under the buy-
sell agreement I have with my partner, my family will receive
the proceeds of a life insurance policy as partial payment for
my share of the business. The remaining payments will be
handled through an installment sale. Under the new law, my
family would not only deal with the loss of their father and
husband, but also face a huge tax bill as well.
For these reasons, I strongly encourage this Committee to
support the Herger-Tanner Bill to repeal the installment sales
provision. This new law destroys plans that have been formed
over years and decades, creates new insurmountable obstacles
for young entrepreneurs trying to get started, and it
unnecessarily complicates transactions that are already full of
complications.
What really concerns me is that the IRS will get the same
amount of taxes whether we use the installment method or not.
This prohibition does not increase taxes collected by the IRS,
it just speeds them up. All this harm is caused by a provision
that doesn't really raise any new revenues.
I thank the Committee for the opportunity to speak today. I
also thank the chairman and the other Members of the Committee
for taking the lead to reverse this provision. I would be happy
to answer any questions.
Thank you.
[The prepared statement follows:]
Statement of David Crosby, Co-Owner, Jeremiah's Tavern, Rochester, New
York on behalf of the National Federation of Independent Business
Good morning. On behalf of the 600,000 members of the
National Federation of Independent Business (NFIB), I
appreciate the opportunity to present the views of small
business owners on the subject of repealing the installment
sales provision.
My name is David Crosby. I am the co-owner of Jeremiah's
Tavern in Rochester, New York. Jeremiah's is a 90 seat
neighborhood restaurant located in the Upper Monroe area of
Rochester. We opened our doors on August 25, 1978 with one
building, three partners and no employees. Today, we have grown
to four buildings, eighteen apartments, four store fronts, and
34 employees. Our first year we had about $250,000 in sales.
This year we should top $1.3 million.
Jeremiah's has also grown as a presence in the community.
We have held fundraisers for the local YMCA, the Hillside
Children's Center, and we contribute thousands of dollars in
gift certificates every year to various charities. We hold
charity golf tournaments. We donate food to our neighborhood
association. We even donate chicken wings to two area high
schools for their senior class parties.
In addition to being an NFIB member, I am also the incoming
president of the local Restaurant Association chapter.
As you have already heard, the installment sales provision
is literally blocking the sale of numerous closely-held
businesses. Others have described the technical reasons why
this is the case. Let me state the bottom line reason--the
installment sales provision greatly increases the down payment
necessary to purchase a business or commercial property. Let me
explain why using my own experience.
When we started Jeremiah's Tavern, we financed the purchase
of the building with seller financing. In 1982 we started
buying houses around the original property so we could use the
back yards to expand parking. Except for two small mortgages,
all the financing was private because the banks wanted no part
of the restaurant or non-owner occupied rental property.
If this tax provision had been in effect at the time, none
of this would have taken place! I seriously doubt our original
$15,000 down payment would have covered all the taxes and
closing costs owed by the previous owner when we bought his
building. If he had been forced to pay all those taxes up
front, rather than over the life of the note, I doubt he could
have afforded to sell his building to three under-financed
entrepreneurs.
Now we are facing the other end of the issue. From the
beginning, Gene and I planned to grow our business until we
could afford to retire. We have IRA's, but the bulk of our
retirement income will come from the sale of the tavern and the
surrounding properties. Before this provision took effect, I
planned to continue to work for four or five more years and
then sell.
Now that plan is in jeopardy. We have always assumed we
would finance the sale of the business ourselves. The banking
community is still not receptive to financing restaurants and
rental properties. While we have developed an excellent credit
record over the past twenty years, it's not our credit that
counts. Banks won't even look at a young potential restaurant
buyer.
Which means we must carry the note. Under the old rule, we
could spread whatever capital gains we realize over the life of
the note. As an accrual method C-Corp, we now have to pay that
tax in year one. I do not know of anybody capable of paying
enough cash up front to cover the tax we would owe, let alone
the other costs involved. That means it would cost us money to
sell our business. Gene has two children in college. My
daughter starts next fall. We can't afford to go an entire year
with negative income.
So, unless we can find someone who can pay cash or can get
a loan, we can't sell our business. My future plans are
dictated not by our hard work and the economy in Upstate New
York, but rather by a tax provision proposed by the Clinton
Administration. My retirement plans have been in the making for
twenty-five years. I took me years to save the $10,000 I used
to start this restaurant and twenty-two years to build the
business to the point it could be sold. Now, we're starting all
over again.
My situation is not unique. When I first became aware of
the new provision, I called my accountant to determine whether
it would affect us. After he gave me the details, he told me
that he was in the middle of a sale that was in danger of
falling apart. The seller cannot afford to pay the capital
gains tax due if the sale is structured as an asset sale, and
the buyer is unwilling to purchase the stock of the business
rather than just the assets. In an asset sale, the buyer gets
increased depreciation. In a stock sale, the buyer assumes any
liabilities -known or unknown -in a stock purchase. Therefore,
the value of the company is significantly less to the buyer. In
this case, the buyer offered $2 million less for the company if
he had to buy the stock.
Another concern I have is what happens if the buyer fails
to make all the promised payments? A few years ago, a friend of
mine sold his restaurant to a buyer who went bankrupt two years
later, defaulting on his promised payments. My friend was
forced to take back the business and spent the next two years
rebuilding it so he could sell it again! If this had happened
under the new law, he would two problems -first rescuing a
badly damaged business and, second, recovering taxes he paid on
income he never received.
Finally, what happens if I die unexpectedly? Under the buy/
sell agreement I have with my partner, my family will receive
the proceeds of a life insurance policy as partial payment for
my share of the business. The remaining payments will be
handled through an installment sale. Under the new law, then,
my family will not only deal with the loss of their father and
husband, but also face a huge tax bill as well!
For these reasons, I strongly encourage this Committee to
support the Herger/Tanner bill to repeal the installment sales
provision. For small business owners like myself, the impact
goes far beyond the immediate effect of paying the capital
gains tax upfront. It destroys plans that have been formed over
years and decades. It also creates new obstacles for young
entrepreneurs trying to get started and unnecessarily
complicates transactions that are already full of
complications.
What really annoys me about this provision is that the IRS
will get the same amount of taxes whether we can use the
installment method or not. This prohibition does not increase
taxes collected by the IRS--it just speeds them up. All this
harm caused by a provision that doesn't really raise any new
revenues.
I thank the Committee for the opportunity to speak today. I
also thank the Chairman and the other members of this Committee
for taking the lead to reverse this provision, and I would be
happy to answer any questions.
Chairman Houghton. Thank you very much, Mr. Crosby.
Mr. Hill.
STATEMENT OF DARRYL A. HILL, OWNER, SAVOY RESTAURANT, ON BEHALF
OF THE U.S. CHAMBER OF COMMERCE
Mr. Hill. Good afternoon, Mr. Chairman.
My name is Darryl Hill and I am the owner of the Savoy
Restaurant, a small business headquartered here in Washington,
D.C.
I would like to give special commendation to Congressmen
Herger, Sweeney, and Tanner for proposing this much needed
legislation.
I assure you, considering the nature of the business of the
previous witness, restaurants aren't the only small businesses.
It is just a coincidence that we are in the same line of
business.
Our enterprise employs 65 individuals dedicated to
providing excellent top quality food in a warm, friendly
atmosphere. I am also a member of the U.S. Chamber of Commerce,
the world's largest business federation. I appreciate this
opportunity to relate my story on the repeal of the installment
method of accounting for accrual basis taxpayers, and its bad
effects on the small business community.
When you enter a small business, all small businessmen
generally think about one thing: An exit strategy. Most exit
strategies have two solutions: You sell your business, or you
die. The second exit strategy is not one I want to opt for, so
I am concerned with the first exit strategy.
Over the last 25 years I have started, owned, operated, and
sold many successful small businesses. Every enterprise has
created jobs and investment for the community. When the time
came for me to sell, I provided a great opportunity for the
next owner to succeed and be a productive member of society. In
every case I was able to reinvest the proceeds of the sale into
my next small business.
Also, because bank financing is generally not available, in
virtually every sale I have had to finance the purchase by
taking back the note. A situation which my accountant tells me
would be financially prohibitive under the recent change in the
law.
It also takes a bastion of creative financing to make these
small business sale works. I have been on both sides. I have
been a buyer and I have been a seller. If this law were
previously enacted, most if not all of my arrangements to buy
and sell would have been financially impossible. It just
wouldn't have happened.
Buyers only have so much money to put down, they are
generally not bank-financeable, generally small businesses are
not attractive to venture capitalists at the outset, and
brokers want their money at the time of settlement. And God
forbid, as a previous witness stated, if you offer credit and
someone goes bankrupt, then you have a double problem.
In my previous life, I was a director of an organization
called the Greater Washington Business Center, which had as its
mission the development of minority and small and disadvantaged
businesses. In almost every case in these type of businesses,
these purchases are done on an installment purchase basis.
Women and minorities and disadvantaged businesses will be
severely affected by this act because they won't have the
entre. This would put quite an imposition on them.
Ladies and gentlemen, it is grossly unfair for the
government to require me to come up with cash in order to sell
my business and to pay taxes on money I have not received. I
have labored many years reinvested a lot of tax dollars in
order to build equity in my enterprises. Current law would have
a chilling effect on the transfer of small business ownership,
denying many people like myself from enjoying the fruits of
small business ownership.
I do understand that the consequences of this legislation
were unintended. Now that the lawmakers realize the effect on
small business, I strongly urge the Congress and the
administration to act quickly to pass the Installment Tax
Correction Act.
I just have an analogy and a couple of comments on the
testimony given by Joe Mikrut from the Treasury Department.
He cited that 85 percent of small businesses have gross
receipts of $1 million or less. That is quite true, but those
businesses of $1 million or less generally have nothing to
sell. They are just not affected by this. Most of those are
individuals, sole proprietorships who hang out their shingles,
consultants and so forth. The businesses above $1 million are
the ones affected by this act.
Second, the act itself--if you took the statistics another
way and instead of measuring it in numbers of small businesses
if you measured it in gross receipts, you would find that the
statistics were reversed and 85 percent of the gross receipts
come from businesses of $1 million or more. So I think you have
to look at who is getting hit here, and it is the guys in the
$1 million and up bracket who are affected by this.
I thank you for allowing me to testify here today and
strongly urge you to pass this legislation.
[The prepared statement follows:]
Statement of Darryl A. Hill, Owner, Savoy Restaurant, on behalf of the
U.S. Chamber of Commerce
Mr. Chairman and members of the Committee, my name is
Darryl Hill and I am an owner of the Savoy Restaurant, a small
business headquartered in the District of Columbia. Our
enterprise employs 65 individuals dedicated to providing
excellent top quality food in a warm friendly atmosphere. I am
also a member of the U.S. Chamber of Commerce--the world's
largest business federation, representing more than three
million businesses and organizations of every size, sector, and
region. I appreciate this opportunity to relate my story, and
to express the views of the U.S. Chamber on the repeal of the
installment method of accounting for accrual basis taxpayers
and its effects on the small business community.
I hereby ask that my entire oral and written statement be
incorporated into the record.
Background
The provision denying installment sale treatment for
accrual basis taxpayers was originally in the Administration's
FY 2000 budget proposal. The Chamber provided live testimony
against the provision before the Ways and Means Committee on
March 10, 1999. Also, the Chamber's opposition to the provision
was included in written testimony for the Ways and Means
Committee's, March 10 hearing on revenue provisions in the
Administration's FY 2000 budget. Written testimony was
submitted in opposition for the Finance Committee's April 27
hearing on revenue provisions in the Administration's FY 2000
budget.
Repeal of the installment sale method then resurfaced in
the waning days of the first session of the 106th Congress
during the Administration's attempt to negotiate an offset with
Congress on the cost of the ``extenders package,'' HR 1180. The
repeal of the installment sale treatment for accrual basis
taxpayers was passed and signed into law on December 17, 1999,
as a provision in the Ticket to Work and Work Incentives
Improvement Act of 1999 (PL 106-107).
As a result of its enactment, it appears that many small
business owners attempting to structure the sale of their
accrual method businesses by means of an asset sale with them
providing ``seller-financing,'' may be required to report their
total gain in the year of sale, i.e., recognize the profit,
irrespective of when payment is actually received. However,
prior to the law change, the installment sale method could have
been elected irrespective of the accounting method of the
business sold and gain would not have been recognized until the
tax year in which payments were actually received by the
seller.
Asset Sale Method of Selling a Business
The traditional method by which small business owners sell
closely owned enterprises is by the asset sale method. In most
of these cases, the seller will self-finance the purchase with
an installment sale note secured by the assets of the sold
business. The seller's corporation transfers ownership of all
assets and goodwill to the purchaser's newly formed taxpaying
entity, usually a C-corporation or an S-corporation. The seller
then has the flexibility of retaining the shell corporation for
a variety of reasons. The purchaser operates the business free
from any potential hidden liabilities that may have been
imbedded in the seller's corporation. To the average patron,
the transition is seamless and the business shows no visible
signs of change except the new ownership team.
The new law is having, and will continue to have, a
dramatic negative impact on small business owners attempting to
structure an exit strategy for the sale of their business or
for the partial sale of assets from an ongoing business. For
most small business purchases, traditional bank financing is
not available to fund the sale of a business, thus requiring
the selling owner to hold any balance due over and above the
down payment. The purchaser would then remit installment
payments over time on the remaining balance to the seller.
Before the change in the law, the seller could defer the
tax by reporting the gain as the installments were received.
The gain on the sale by the seller would then be reported and
the tax liability would accrue at the time the installment
payment was received by the taxpayer. With the new provision,
the total gain would be required to be immediately recognized
and reported, subjecting the taxpayer to the full tax liability
on the sale regardless of how much actual cash is received. The
tax liability could exceed the cash generated for the sale by
several times in the first year, severely distressing the
business and its owners. In addition, the business broker
usually requires his fees at the time of settlement
exacerbating the demand for cash at the time of sale.
Adverse Consequences for Small Business
In the short time since it became law, this provision--
which denies the installment sale treatment for accrual basis
taxpayers--has had an unintended and significant negative
financial impact on many small business owners attempting to
sell their enterprises.
Small business owners who would have previously been
allowed to elect the use of the installment sale option in the
sale of a closely held business are experiencing dramatic
reductions in sales price in order to execute a contract. It is
estimated that a devaluation of 8.2 percent in the equity of a
business is the average.\1\ If this figure were applied to only
a fraction of the estimated six million small businesses, the
hundreds of billions of dollars the owners would loose in
equity would dwarf the $2 billion the government hopes to
collect from this onerous tax law change over the next 10
years. This is inequitable and unfair to those small business
owners that labor and sacrifice their whole lives in order to
achieve a small sense of financial security. This also amounts
to a hidden tax on those who, on average, make less than
$50,000 a year and, in many cases, depend on the sale of their
business for their retirement.
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\1\ Mike Adhikari, Illinois Corporate Investments Inc., ``Analysis
of Installment Sale Repeal (ISR), 175 Olde Half Day Rd., Lincolnshire,
IL 60047.
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The recently enacted provision sets an artificial barrier
to the traditional methods for small business ownership changes
and has had a chilling effect on the ability of an owner of a
small business to sell. An important ingredient in structuring
an exit strategy is flexibility. Bank financing is generally
not available to the purchaser. The new law dramatically
reduces the ability for a purchaser to tender enough money to
cover the sellers closing costs and taxes. Sellers are
reluctant or incapable of entering into a transaction that
requires out of pocket expenditures.
Small business ownership has been the vehicle by which many
people, including women and minorities, have achieved financial
empowerment. In many cases, this has been accomplished by the
purchase of existing businesses on the installment method.
Restricting or complicating the process of transferring
ownership inhibits the means by which all people can access the
doors of economic prosperity by being your own boss.
Many small business owners use the sale of their businesses
as the primary means of funding their retirement. For some, the
worth of their business reflects the majority of their life
savings. Denying the use of the installment sale treatment for
accrual basis taxpayers has frustrated many business owners in
developing an exit strategy for retirement. To look forward to
living the first years of retirement strapped for cash due to
the tax requirements necessary to orchestrate a sale and the
subsequent years at a reduced rate due to the devalued equity
in the business is unfair and bad policy.
My Personal Experience with the Installment Sale Method For Accrual
Basis Taxpayers
Over the last 25 years, I have sarted, owned, operated and
sold many successful small businesses. In every enterprise, I
have created jobs and investment in the community. When the
time came for me to sell, I provided a great opportunity for
the next owner to succeed and be a productive member of
society. In every case I was able to reinvest the proceeds of
the sale into my next small business. Also, in virtually every
sale, I have had to finance the purchase by taking back a note,
a situation my accountant tells me would be financially
prohibitive under the recent change in the law. If this law
were previously enacted, most if not all of my arrangements to
sell would have been financially impossible. Buyers only have
so much money to put down on a purchase. Brokers want their
money at the time of settlement and I need a certain amount of
cash to live on and reinvest in my next venture.
Ladies and Gentlemen, it is grossly unfair for the
government to require me to come up with cash in order to sell
my business to pay taxes on money I have not yet received. I
have labored many years and reinvested a lot of taxed dollars
in order to build equity in my enterprises. The current law
will have a chilling effect on the transfer of small business
ownership denying many people like myself from enjoying the
fruits of small business ownership.
I do understand that the consequences of this legislation
were unintended. Now that lawmakers realize its effects on
small business, I strongly encourage the Congress and the
Administration to act quickly to pass H.R. 3594, The
Installment Tax Correction Act.
Conclusion
Bank financing for the sale of small businesses is
generally not available. For those selling a closely held
business, flexibility is an important ingredient in structuring
an exit strategy. The recently enacted provision sets an
artificial barrier to the traditional methods for small
business ownership changes and has had a dramatic negative
impact on the process. Restricting or complicating the ability
of small business owners to ``cash out'' of their businesses
after laboring to achieve a level of success is destructive and
bad policy. The U.S. Chamber of Commerce believes the provision
denying accrual basis taxpayers should be fully and quickly
repealed.
I want to thank you for allowing me the opportunity to
testify here today.
Chairman Houghton. Thank you very much, Mr. Hill. I
appreciate your testimony.
Ms. Olson.
STATEMENT OF PAMELA F. OLSON, CHAIR-ELECT, SECTION OF TAXATION,
AMERICAN BAR ASSOCIATION
Ms. Olson. Good afternoon, Mr. Chairman, Congressman Coyne,
and members of the Oversight Committee. My name is Pam Olson
and I am the chair-elect of the ABA section of Taxation and
testifying this afternoon on behalf of the section of Taxation.
With me today is Fred Witt, the immediate past chair of our
Real Estate Committee and a principal drafter of our testimony.
We appreciate the opportunity to appear before the
Committee today. We believe the repeal of installment sales
treatment for accrual method taxpayers is a topic deserving of
prompt action. In short, we believe the repeal was a mistake.
It adversely affects small and closely held businesses
attempting to sell business assets, it creates traps for the
unwary, and it eliminates the certainty and consistency the
installment sales rules brought to sales of assets for
contingent payments. And that latter point is not just a small
business point.
First, some background on installment sales treatment. This
is ground that has already been trod this afternoon, but I
think it is worth treading it again because we reach a very
different conclusion from the conclusion reached by the
Treasury Department.
Generally, an accrual method taxpayer is required to
recognize income when all events have occurred that fix the
right to receipt and the amount can be determined with
reasonable accuracy. The installment method is an exception
that permits a taxpayer to report the recognition of gain from
the sale of capital assets in the year payment is actually
received.
First set forth in Treasury regulations in 1918, codified
by Congress in 1926, the law has permitted accrual method
taxpayers and cash method alike to sell business assets for
installment payments and report the gain in the year cash is
actually received. The policies underlying the installment
method were best summarized by the Supreme Court in
Commissioner v. South Texas Lumber Co. as follows: The
installment basis of reporting was enacted, as shown by its
history, to relieve taxpayers who adopted it from having to pay
an income tax in the year of sale based on the full amount of
anticipated profits when in fact they had received in cash only
a small portion of the sales price. Another reason was the
difficult and time-consuming effort of appraising the uncertain
market value of installment obligations.
In the Installment Sales Revision Act of 1980, just 20
years ago, Congress streamlined the rules, made them easier for
taxpayers to apply, and applied them to sales for contingent
payments. Since 1980, Congress has enacted a number of
limitations on the use and benefits of installment reporting
while maintaining its simplicity and fairness.
In our view, the limitations that have been placed on the
use and benefit of installment reporting adequately address any
potential problems with it.
As against the strong policy reasons supporting installment
sales treatment, we understand there was essentially one
reason, and that reason was reiterated earlier this afternoon
in support of repealing the installment method: that the
installment method is inconsistent with the accrual method
because by allowing deferral of recognition the annual economic
results of an accrual method taxpayer's business are not
properly reflected.
We believe this quest for theoretical purity is an
insufficient basis for overturning 80 years of consistently
applied tax policy. We also believe it fails to withstand
careful scrutiny.
The accrual method of accounting requires the recognition
of income from business operations in the year the income is
earned and the right to receive the amount is fixed, without
regard to the time payment is received. While a taxpayer may be
expected to pay taxes on ordinary profits earned from business
operations, the non-recurring sale of a capital asset falls
into an entirely different category. The imposition of
immediate taxation on the anticipated gain from the disposition
of a business or substantial capital asset, such as real
estate, places a burden on the business seller that is unfair,
unexpected, and cannot be justified by the rationale underlying
the accrual method of accounting.
The installment sales method adjusts the payment of taxes
to the demands of the marketplace. In our experience
representing business taxpayers, arms-length buyers and sellers
have opposing views of the market and objectives in negotiating
a business asset sale transaction. Buyers want the lowest
possible price and nothing down, and sellers want the highest
price with cash paid in full at closing. It is against these
market forces that an installment sale is finally negotiated.
The ability of the seller to take back an installment note for
the balance of the sales price without being subject to an
immediate tax liability maybe the most critical issue in the
transaction.
In the case of contingent payment sales, the tax
consequences could be even worse. Not only will tax be due
immediately on the fixed component of the sales price, but the
IRS would likely assert that the contingent amount must be
valued and reported as taxable income in the year of sale. The
result? An installment seller would be taxed on amounts that
are only estimated and might never be received.
We have a number of examples of the adverse effects of the
repeal contained in our written statement, which has been
submitted for the record.
In conclusion, let me just say that the repeal of
installment sales reporting reverses 80 years of sound tax
policy without any compelling reason or abuse cited. This
change adversely affects the price and liquidity of small and
closely held business assets, and will substantially increase
complexity for taxpayers and the IRS alike.
I would be pleased to answer any questions the Committee
might have.
[The prepared statement follows:]
Statement of Pamela F. Olson, Chair-Elect Section of Taxation, American
Bar Association
My name is Pamela F. Olson. I appear before you today in my
capacity as Chair-Elect of the American Bar Association Section
of Taxation. This testimony is presented on behalf of the
Section of Taxation. It has not been approved by the House of
Delegates or the Board of Governors of the American Bar
Association and, accordingly, should not be construed as
representing the policy of the Association.
The Section of Taxation appreciates the opportunity to
appear before the Committee today. We believe the repeal of the
installment method of accounting for accrual method taxpayers
is a serious topic deserving prompt action.
As you are aware, following a proposal set forth in
President Clinton's Fiscal Year 2000 Budget Proposal, Congress
repealed the installment method of tax accounting for accrual
method taxpayers in the Tax Relief Act of 1999 (Title V,
Subtitle C, Section 536), enacted as part of the ``Ticket to
Work and Work Incentives Improvement Act of 1999'' (H.R. 1180).
The repeal of installment sales treatment for accrual method
taxpayers will adversely impact small and closely held
businesses attempting to sell business assets, because they
will be taxed immediately even if payments are received years
later. Immediate taxation of business sellers, and its chilling
effect on the marketplace, simply does not represent sound tax
policy. For these and other reasons outlined below, we
respectfully request that Congress reenact prior law which, for
over 80 years, has permitted accrual method taxpayers to sell
business assets for installment payments and defer the gain
until the year cash is actually received.
Background: The 80-Year History of Installment Sales.
A brief review of the history of installment sales provides
an important framework for discussion. Generally, an accrual
method taxpayer is required to recognize income when all events
have occurred that fix the right to receipt and the amount can
be determined with reasonable accuracy. The installment method
is an exception that permits a taxpayer to defer the
recognition of gain from the sale of capital assets until the
year payment is actually received. The treatment given
installment sales was recognized almost from the inception of
the income tax laws. Although first set forth in Treasury
regulations promulgated in 1918, Congress codified the
installment method of tax reporting in Section 212(d) of the
1926 Revenue Act. The policies underlying the installment
method were best summarized by the Supreme Court in
Commissioner v. South Texas Lumber Co., 333 U.S. 496, 503
(1948):
The installment basis of reporting was enacted, as shown by its
history, to relieve taxpayers who adopted it from having to pay
an income tax in the year of sale based on the full amount of
anticipated profits when in fact they had received in cash only
a small portion of the sales price. Another reason was the
difficult and time-consuming effort of appraising the uncertain
market value of installment obligations.
In the Installment Sales Revision Act of 1980, P.L. 96-471,
96th Cong., 2d Sess. (1980), Congress streamlined the rules and
made them easier for taxpayers to apply. Since 1980, Congress
has enacted a number of limitations on the use and benefit of
installment reporting. Installment treatment is not available
for dealer dispositions, it does not apply to the sales of
publicly traded property, and gain is recognized if the seller
monetizes the installment note through a pledge transaction. To
further limit the benefit, there is an interest charge for the
tax deferral to the extent a taxpayer holds installment notes
in excess of $5 million.
Reason For Repeal
We understand there was essentially one reason cited in support of
repealing the installment method for accrual method taxpayers--the
installment method is inconsistent with the accrual method because, by
allowing deferral of recognition, the annual economic results of an
accrual method taxpayer's business are not properly reflected.
This reason fails to withstand careful analysis and is insufficient
to overturn 80 years of consistently applied tax policy. The accrual
method of tax accounting reflects a business's economic performance by
requiring the recognition of income in the year in which the income is
earned and the right to receive the amount is fixed, without regard to
the time payment is received. Coupled with the economic performance
requirement for deductions, the accrual method matches income and
deductions from operations in a manner that measures a business's
economic results each year. However, the installment exception
essentially applies only to nonrecurring dispositions of business
assets. While a taxpayer should be expected to pay taxes on ordinary
profits earned from business operations, the nonrecurring sale of a
capital asset falls into an entirely different category. The imposition
of immediate taxation on the anticipated gain from the disposition of a
business or substantial capital asset, such as real estate, places an
unexpected and unfair burden on the business seller.
Market Effect of Repeal on Business Sales--Liquidity, Price and Deals
That Will Not Be Done
Since 1918, the installment sales method has been an
important rule in our Federal income tax system, because it
adjusted the payment of taxes to the demands of the
marketplace. In our experience representing business taxpayers,
arms-length buyers and sellers have opposing views of the
market and objectives in negotiating a business assets sale
transaction. Buyers want the lowest price and nothing down and
Sellers want the highest price with cash paid in full at
closing. It is against these market forces that an installment
sale is finally negotiated. Often the buyer only has 10 to 20%
of the purchase price in cash, but the seller is convinced the
cash flow generated by the asset will enable the buyer to pay
the balance over a period of years. The ability of the seller
to take back an installment note for the balance of the sales
price without being subject to an immediate tax liability may
be the most critical issue in the transaction. In today's
marketplace, it is difficult to find a bank willing to lend to
a small business buyer. Small business buyers cannot access the
capital markets or draw down on their bank line of credit.
Simply put, in today's tax and economic environment, sellers
take back an installment note because there are no other viable
financing options available.
In addition to adversely affecting the liquidity of
sellers, repeal of installment treatment will tend to depress
the price paid by small business purchasers. A small business
buyer is often limited in the amount it can pay for business
assets. In order to increase the sales price, a business seller
may increase the term of years or agree to a fixed price with
an additional contingent or ``earnout'' based on future
performance of the assets sold. After repeal of installment
reporting for accrual taxpayers, the tax consequences of
structuring such an arrangement may be devastating. As the
payments are spread over an increasing number of years, so will
the burden of immediate taxation in the year of sale be
increased. For example, assume an accrual method taxpayer sells
a building (with adjusted basis $100) for $1,100 payable $100
cash and $100 a year for 10 years. In the year of sale the
taxpayer will report the full $1,000 gain and, assuming a 35%
tax rate, will have an immediate tax due of $350. Since the
taxpayer only received $100 cash down, the asset sale will have
produced negative cash flow of $250--meaning the taxpayer will
need to find additional cash of $250 just to pay taxes.
In the case of a contingent payment sale the tax
consequences could even be worse. Not only will tax be due
immediately on the fixed component of the sales price, but
under the original issue discount and installment reporting
regulations the IRS might assert that the contingent amount
must be valued and reported as taxable income in the year of
sale. If this interpretation of the regulations were upheld, an
installment seller would be taxed on amounts that are unknown
and might never be received. Taxpayers will resist this
treatment and argue that the ``open transaction'' doctrine
applies to defer taxation on the contingent piece until actual
payments are received. So, in addition to the adverse effect on
price and liquidity, repeal of the installment method for this
group of taxpayers raises the possibility of unnecessary
complexity and increased controversy between taxpayers and the
IRS.
Examples of Transactions Adversely Affected By Repeal
Passthrough entities exist, in great part, to serve the
needs of the small or closely held business owner. With the
numerous restrictions placed on the use of the cash method of
accounting, and based on our experience with business clients,
we expect that the vast majority of S corporations, business
partnerships and limited liability companies taxed as
partnerships use the accrual method of accounting. Accordingly,
we believe many common transactions will be adversely affected
by this change in law.
Employee Buyouts.
It is common for a retiring owner or family group to sell
to key employees. The employees typically lack the cash to
complete the purchase, hence the owner must act as the lender
and take back an installment note. This is a ``win-win''
transaction; the retiring owner is selling an illiquid asset
and receiving a stream of cash (with interest) paid over a
period of years, and the employees are realizing a life long
dream of becoming the owners of the business. With bank
financing difficult or impossible to obtain, the ability to
seller-finance, without an immediate tax burden, is essential.
We are aware of a number of these types of transactions that
have been canceled since December 1999 due to the change in the
law.
S Corporation Selling Assets.
We understand that most S corporations use the accrual
method of tax accounting and thus, under the change in law made
last year, cannot use the installment method to sell business
assets or the entire business. The entire gain is taxable in
the year of sale even though the installment obligations,
payable years later, are immediately passed through to the
cash-basis shareholders. Although the individual cash method
shareholders could sell their stock on the installment method,
as pointed out in the 1999 legislative history, buyers
generally want to purchase assets and will refuse to assume,
directly or indirectly, the contingent liabilities inherent in
the acquired S corporation entity. As a result both the price
and liquidity of S corporation businesses have been adversely
affected.
S Corporation Selling Assets to Family Under Succession Plan.
For the reasons stated above, repeal of the installment
method will negatively impact family succession planning.
Unless all of the family members involved are willing to
transfer stock in the family S corporation, it will no longer
be possible to sell corporate assets to younger family members
using the business profits to pay the senior family members and
fund their tax liability over a period of years.
S Corporation Selling Assets and Liquidating.
A common plan when the owners of an S corporation wish to
sell their business is the adoption of a plan of complete
liquidation for the S corporation, followed by distributions of
the cash and notes received from the sale to the shareholders
as liquidating distributions. Under prior law, the distribution
of an installment note to the shareholders in complete
liquidation was not a taxable disposition and the shareholders,
in effect, took the place of the S corporation for purposes of
installment reporting. After the 1999 repeal of the installment
method for accrual method taxpayers, whether the S corporation
sells assets and liquidates or the buyer buys stock and makes a
Section 338(h)(10) election, the shareholders will be required
to pay tax on the sale immediately.
Accrual Method Partnerships.
For partnerships, we believe the change produces
unneccessary complexity and creates a trap for the unwary.
If an accrual method partnership sells its assets for an
installment note, the full gain must be recognized and passed
through to its partners. On the other hand, if the cash method
partners sell their partnership interests, the installment
rules apply and there is no gain recognition until payments are
received. This rule applies even if one buyer acquires all of
the interests in the partnership. This means that if the buyer
desires to purchase less than all of the partnership's assets,
full gain must be recognized on the installment notes received.
Moreover, often one of the partners wants to withdraw from the
partnership and receive a liquidating distribution at the time
of the sale. However, it is not clear that the gain realized on
the sale can be specially allocated to the departing partner
who actually receives the distribution, and thus taxation of
the transaction will unnecessarily complicate matters for all
of the partners.
We appreciate your interest in this matter. The Section
would be pleased to work with the Committee and its staff on
this important issue.
Chairman Houghton. Thank you very much, Ms. Olson.
We will go to the questioning now.
Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
Mr. Kleczka is the main sponsor of H.R. 3568, which would
return the situation to prior law. Inasmuch as the panel will
support that provision, I would like to yield to Mr. Kleczka
for questioning.
Mr. Kleczka. Thank you, Mr. Coyne.
Mr. Chairman, I don't really have any questions of the
panel except to thank them all for appearing today.
Mr. Hill, in your testimony, you adequately pointed out the
problem with the Treasury proposal of $1 million. We all think
$1 million is a lot of money--and in fact it is--but in a
business, having gross receipts--underscoring ``gross''--of $1
million covers a lot of small businesses today. I have to agree
with the panel that the $1 million Treasury figure is arbitrary
and something that this panel and this Congress is going to
have to talk about.
After listening to not only Treasury but to this panel as
well, I would think that $5 million would not be out of line,
bout we can talk about that later.
Ms. Olson, you also pointed out that we are talking about
non-recurring transactions. That also must be underscored.
These are not normal everyday business transactions. This is
something that just happens on occasion. It doesn't happen
every year. If we are looking for abuses in the Tax Code, we
should look at those, find those, and get rid of them.
But clearly this was not one of those abuses, so I would
hope that--in fact, I know you do support legislation I
introduced to return back to the old method. If in fact we need
a cap of a dollar amount, clearly I don't think it should be
any less than $5 million. Possibly the panel can respond to
that, the $1 million Treasury proposal versus the higher
amount.
Mr. Hill.
Mr. Hill. Defining small business is a complicated and
intricate procedure. What may constitute a small steel mill,
for example, may be very much different than a small
restaurant. I don't think it is as simple to just put a number
on it. I think the Treasury and this body and this panel should
work--I think you should repeal the act and then start all over
again.
Mr. Kleczka. Restore the old act?
Mr. Hill. Yes, restore the old act and then start again. I
think Treasury can better define what it wants to get at and
then you can go from there.
Mr. Kleczka. I think a better way to put it would be like
the chairman stated, repeal the repeal.
Ms. Olson.
Ms. Olson. I would like to say that I agree. We ought to
start by repealing what was done last year and then start over.
The ABA has previously testified before this Committee that we
would support, as a simplification measure, the use of the cash
method of accounting for small businesses, which we defined by
reference to section 448 and section 263 as $5 million or more.
We think the $1 million is too low to be particularly useful
and that small businesses up to $5 million should be able to
use the cash method.
I would also say that we don't think that just allowing
small businesses to use the cash method and therefore to still
be eligible to use the installment method of reporting
addresses all of the problems that have been created by the
repeal.
Mr. Kleczka. Thank you very much.
Chairman Houghton. Thank you very much.
Mr. Herger.
Mr. Herger. Thank you, Mr. Chairman.
I want to thank you, Mr. Hill, for bringing out a very
important point, and that is that $1 million can vary an awful
lot. If someone is being paid for their services, perhaps $1
million is much more than it would be as it is in your
restaurant business where you are going through your gross--
your margin of profit may be very, very narrow of that $1
million, whereas someone who is receiving payment for services
may be much more. Therefore that is a major inequity. I
appreciate you for bringing that out, as several have.
We have just received today the Treasury's recommendation
of how they would correct it. Ms. Olson, I don't know how much
you have been able to look at it or really analyze it, but what
is your general analysis of their recommendation?
Ms. Olson. With respect to their recommendation that they
issue guidance allowing taxpayers with gross receipts under $1
million to use the cash method of accounting, we would support
that. It is a proposal that the Tax section has supported in
the past, but we would go with a higher number. We would go
with something more on the order of $5 million.
With respect to the remainder of it, I am wearing a big
orange button that says ``simplify''. The Tax section has
joined with AICPA and TEI in an effort to work together to find
ways to simplify the tax law. My biggest concern about what
Treasury has suggested today is that it is another layer of
complexity upon complexity and it seems to us that a far
preferable way to go is just go back to the drawing board and
start over. We don't think there are abuses out there that need
to be addressed with a repeal of the installment method of
accounting, so we would like to see old law returned.
Mr. Herger. Thank you. That is very helpful.
As I visit with my constituents, particularly our small
business people, one thing we continually here is that the tax
system needs to be simplified. It is just so complicated now.
Even the smallest of businesses are required to go out and pay
large sums of money for a CPA to figure out the system. It
would be so much easier to just go back as it was. We are
human, the Treasury is human, we as Members of Congress voted
on this and certainly contributed to it as well. It would make
much better sense to just go and repeal what we did and start
over again on how we can make it more simple.
Mr. Crosby, do you have any further comments?
Mr. Crosby. Yes.
The NFIB continues to push for the repeal of the provision.
In my particular instance, our business will gross over the $1
million cap this year, so the Treasury issue would not apply to
us. I believe that when you start looking at thresholds you
create a situation where anyone who is either just below or
just above the threshold--those who are below the threshold are
in a position where they may find it necessary to put the
brakes on the growth of their business because they don't want
to cross that threshold. Those who are just above the threshold
are in a position where they may be tempted to tamper with
their business to put themselves back under the threshold.
So I think the position of the NFIB is sound and we should
repeal it and not have thresholds.
Mr. Herger. Another very good point. If anything, we do not
need the government throwing monkey wrenches into our system to
be slowing down business growth and slowing down the hiring of
new people.
I thank you very much and I yield back my time, Mr.
Chairman.
Chairman Houghton. Thank you very much, Mr. Herger.
Mr. Sweeney.
Mr. Sweeney. Thank you, Mr. Chairman.
I want to thank the panelists as well. Mr. Crosby is a
fellow New Yorker. Welcome and thank you very much. Mr. Hill,
it is good to see you again. I thank both of you for putting a
real human face on what the implications are here.
Ms. Olson, you have given us some very sound technical
analysis, and I thank you for that.
I have really two areas I would like to question.
The first relates to discussing the cash method versus the
accrual method.
I am a member of the Small Business Committee, as I
mentioned before. I am concerned that in part this may be an
effort by the IRS to broaden its efforts to impose accrual
accounting on more small businesses. With that background, I am
concerned that the IRS may be using the installment issue to
issue broader guidance on whether a business uses cash or
accrual methods.
As we have mentioned, Congress has set the cash accrual
threshold at $5 million. I am very concerned here that the IRS
may be attempting by regulation to impose the $1 million and
set some precedents that may cause some real harm.
I would like to hear comments from any of you regarding
that, which have not been said, and whether you share in my
concern regarding the IRS' attempt to impose accrual accounting
on small businesses.
Ms. Olson. I am not sure whether I think this is an effort
on the part of the IRS to impose the accrual method more than
it has been used, but I would note that anytime you introduce
additional rules, the additional rules create additional
complexity. When there is additional complexity, there are
people who won't understand what the rules are, and some of
those people include IRS agents who are trying to do their jobs
and understand the law, but can't always get it right.
So it is certainly possible that the effect of the rules
would be to take service businesses, for example, who don't
maintain inventories who would not be required to use the
accrual method of accounting currently and end up with an audit
where it would be suggested that they should be on the accrual
rather than the cash method of accounting. That could certainly
happen in the future.
Mr. Sweeney. In conjunction with that, I want to get a
sense from the panel on how you would feel about using an asset
threshold as we try to look at the arbitrariness of what is
happening here.
The Tax Code in section 1202 that defines C corporation is
at $50 million in assets, I believe. Considering that many gas
stations have more than $50 million in sales and insurance
agencies must include policy revenue in their receipts, $1
million or $5 million wouldn't come close for such businesses.
Can you discuss further how we would begin to define small
businesses and give us a sense of establishing thresholds?
What would your recommendation be?
Mr. Hill. I tend to agree with Mr. Crosby. I think
thresholds may not be the answer here. I think there are other
ways of defining small business, if it is necessary to define
at all. It is a complex issue. But it is not so simple to put a
dollar amount on it because $5 million means different things
to different classes of business--severely different. It would
be a boon to some and a hardship to others.
Ms. Olson. I agree with that statement. I would also say
that we don't think that just fixing this for small business is
the right thing to do. The repeal of the installment method for
accrual taxpayers doesn't just affect small business. In the
area of contingent payment, it affects large C corporations as
well with the result that there is likely to be an increased
amount of controversy as taxpayers try to move to a different
method of reporting their income altogether.
Right now you have an interest charge already if the
taxpayer receives an installment obligation in excess of $5
million. That seems to me to be enough of a tightener on the
use of the installment method of reporting. I wouldn't do
anything more. I wouldn't put in a rule that limited it to
small businesses.
Mr. Sweeney. I would take it then that you would disagree
with Mr. Mikrut's testimony or his perception that the guidance
that is going to be offered by Treasury does take care of
closely held corporations? In a real tangible way, it does not.
Ms. Olson. No, I don't think it will. I think there is more
work to do.
Mr. Sweeney. Thank you very much.
Thank you, Mr. Chairman.
Chairman Houghton. Thank you, Mr. Sweeney.
I just have one question to Mr. Crosby.
If you repeal the installment method, what effect does that
have on your life? What effect does that have on your
retirement plans?
Mr. Crosby. If it is repealed and it returns to the way
that it was prior to December, it puts me back in a position
where I feel like I have some control over the next several
years of my life. My partner and I have spent roughly 25 years
buying, building, and growing a business all along with the
intention that we would use the proceeds from the sale of that
business when we chose to retire. Whether that is 3 or 4 years
from now or beyond, I can't say with certainty.
But the issue that I see with the new provision is that in
the first year after we sell the business we can be saddled
with an enormous tax burden that we can potentially--as we
hopefully begin retirement years--we could be faced with a
situation where we would literally have to go to a bank to get
financing to borrow money to pay our obligations to the
government. To me, that seems like a particularly unfair way
for a person who has worked very hard growing a business over a
lot of years to start out retirement.
Chairman Houghton. Thank you very much. That helps.
Mr. Coyne.
Mr. Coyne. Thank you, Mr. Chairman.
I just had a question for Mr. Hill.
You are representing the Chamber. Is your testimony applied
just to small businesses, or are you talking for all small and
large businesses?
Mr. Hill. We are talking about businesses in general, small
and large.
Mr. Coyne. So it is not limited to the--
Mr. Hill. But our focus is on the small businesses because
we think this bill is onerous on that level.
Mr. Coyne. So the focus is on small businesses, but really
all businesses?
Mr. Hill. Ultimately.
Mr. Coyne. Thank you.
Chairman Houghton. We have been joined by Mr. Neal of
Massachusetts.
Mr. Neal, would you like to ask questions?
Mr. Neal. Thank you, Mr. Chairman.
This question came up last week when I addressed the Boston
Bar Association and their Tax section.
Ms. Olson, can we patch the current law? Or should we start
over?
Ms. Olson. It is my view that you should start over. You
should repeal the repeal and go back. If there are changes that
need to be made, you should make those changes directly. But in
our view, there is no abuse that has been identified, no
problem that has been identified, that justifies the repeal of
the installment method to begin with. We think you should start
by going back to where you were.
Mr. Neal. Thank you.
Thank you, Mr. Chairman.
Chairman Houghton. Anybody else have any other questions?
[No response.]
Chairman Houghton. If not, thank you very much for being
with us.
There being no further business before the Subcommittee,
the hearing is adjourned.
[Whereupon, at 2:25 p.m., the hearing was adjourned.]
[Submissions for the record follows:]
Statement of American Institute of Certified Public Accountants, Tax
Division
Mr. Chairman and Members of this Distinguished
Subcommittee:
The American Institute of Certified Public Accountants
(AICPA) is the national, professional organization of certified
public accountants comprised of more than 330,000 members. Our
members advise clients on federal, state and international tax
matters and prepare income and other tax returns for millions
of Americans. They provide services to individuals, not-for-
profit organizations, small and medium-size businesses, as well
as America's major businesses, including multi-national
corporations. Many serve businesses as employees. It is from
this broad base of experience that we offer our comments.
The AICPA appreciates the opportunity to provide written
testimony on the subject of Section 536 of the Ticket to Work
and Work Incentives Improvement Act of 1999 (P.L. 106-170)
(Act). This section of the Act added section 453(a)(2) to the
Internal Revenue Code of 1986 (IRC), effectively repealing the
use of the installment method of accounting for most accrual
method taxpayers. The AICPA, as do numerous small business
trade and membership associations, believes that Congress
should reinstate the ability of accrual basis businesses to
utilize the installment method of accounting on the sale of
assets and of the business. The issue is one of equitable
treatment for closely held or small businesses, and reinstating
that ability would reverse the adverse economic impact on small
business created by enactment of Public Law 106-170 last year.
Further, there is no historical basis for limiting the
installment method to cash basis taxpayers. The installment
method of tax accounting was promulgated, enacted and upheld
for the purpose of relieving the tax burden on small businesses
without regard to conformity with book accounting principles.
While this provision also affects larger, accrual method
businesses when they sell a particular asset or assets, its
real effect has been to harm small and closely held businesses.
When such businesses are sold, the new owner may wish to
acquire assets rather than the stock of the business
corporation (to avoid taking on the business liabilities, for
example), and common practice is for payment to be made over a
number of years in installments. Most such businesses use an
accrual accounting method (tax law requires them, for example,
to use an accrual method of accounting with respect to
inventories). However, under the Act, they will now be forced
to report the full gain from the sale of the business in the
year of sale, even though payment for the assets will be made
years into the future, and the first year payment may well not
even cover the tax due on the sale.
This provision is already having a significant effect on
the sales of small businesses. We have heard directly from
numerous CPAs whose clients have had and are having trouble
selling their businesses; many negotiated transactions for the
sale of all or part of a taxpayer's business have recently
fallen apart. As a result of the change in tax law, either the
purchaser finds it uneconomic to pay the full purchase price up
front, or the seller finds that he or she will have to produce
funds from sources outside the business to pay part of the now
immediately due, full tax on the sale. Alternatively, sellers
are forced to take a substantial cut in sales price to persuade
a buyer to accelerate the payments in the year of sale or they
abort the transaction completely.
A sale of stock by a cash method shareholder is sometimes
an option to transfer a business. More often than not, however,
the buyer is not interested in purchasing the stock because
doing so transfers the corporate liabilities to the new
stockholder. In the case of an S corporation, because of unique
shareholder restrictions, a stock purchase is often not even an
option. Further, it is still not clear whether a deemed asset
sale by an S corporation under section 338(h)(10) could be
treated as a stock sale for this purpose. Again, from a
practical standpoint, the inflexibility of requiring a stock
purchase compounds the problem of market illiquidity because it
further reduces the pool of willing buyers.
The use of the installment method of accounting for tax
purposes is widespread. It is used by all types of taxpayers,
small and large, both C and S corporations, sole
proprietorships, partnerships and individuals. It is used by
businesses that are selling assets piecemeal but it is also
used for the sale of an entire business. Regardless of whether
a business is winding up or just selling assets, it may finance
the sale by taking back a note. This is especially true for
small businesses where financing may not be readily available
to the purchaser and the seller becomes the financier of last
resort. Before the change in the law, the business could defer
tax by reporting the gain in installments, recognizing gain as
the note was collected. This resulted in a deferral of the
income tax and was consistent with the cash collected from the
sale. With the new provision, the gain is immediately
recognized. Tax liability could exceed cash generated from the
sale by several times in the first year, severely distressing
the business and its owners.
We believe the broad nature of the Act's language leaves
Treasury relatively little room in solving this problem through
regulation because there is no room in the statute for
exceptions, particularly for the sale of small businesses.
There are some highly complex fixes and exceptions that may be
available to a few taxpayers, but regulatory responses,
overall, would simply be small bandages on a large wound, even
if the administrative response were generous.
To provide the measure of relief which approaches the level
of hardship currently being suffered by small business owners
contemplating a sale of their business, we strongly believe a
legislative solution is necessary. Congress should make it
simple and fair for all business owners to pay the often
substantial tax due from the successful sale of their business
when the sales price is received in installments over many
years.
We welcome the opportunity to discuss this matter with you
further.
Statement of National Association of Manufacturers
The National Association of Manufacturers (NAM) appreciates
the opportunity offered by Subcommittee Chairman Houghton to
comment on the recent repeal of the installment method of
accounting for accrual basis taxpayers. The NAM--``18 million
people who make things in America''--is the nation's largest
and oldest multi-industry trade association. The NAM represents
14,000 members (including 10,000 small and mid-sized companies)
and 350 member associations serving manufacturers and employees
in every industrial sector and all 50 states. Headquartered in
Washington, D.C., the NAM has 10 additional offices across the
country.
Repeal of the installment sales provision, which was
originally proposed by the Administration in its fiscal 2000
budget proposal, was included in P.L. 106-170, the Ticket to
Work and Work Incentives Improvement Act of 1999, enacted on
December 17. Unlike many other negative tax law changes, the
provision became effective on enactment and did not include any
binding contract language or transitional rules. This tax law
change is having and will continue to have a significant
negative impact on sales of small enterprises. We urge Congress
to act quickly to restore the ability of accrual method
taxpayers to use the installment method of accounting for asset
sales.
Impact of the Tax Law Change
The impact of the installment sales provision goes well
beyond anything hinted at in the explanation of the revenue
proposals in the President's Fiscal 2000 Budget or the
legislative history of P.L. 106-170. While the provision
appeared to target larger, accrual method businesses when they
sold a particular asset or assets, its real effect is to reduce
the value of closely held businesses when they are sold in
their entirety.
In the past, many small and medium manufacturers used the
installment method in business sales for a variety of reasons,
including the ability to spread the capital gains tax payment
over the life of the sale. The installment method also has
benefits beyond those related to taxes. It enables sellers to
be more flexible in structuring the sale and to get a higher
price for the business and it allows buyers to purchase a
business for which bank financing is unavailable. The
installment method also ensures that the seller will continue
to have a financial interest in the ongoing success of the
business.
The conference report on the Ticket to Work and Work
Incentives Improvement Act states that when a cash method
taxpayer sells stock in an accrual method business-either an'S
or C Corporation-the seller could use the installment sales
method. However, in sales of closely held businesses, the stock
sale is not always possible or most efficient. Even when stock
exists, many sales of small businesses are structured as asset
sales, for a variety of non-tax reasons. One of the most common
reasons is that the buyer is interested in the assets of a
business but not the imbedded liabilities that come with buying
the stock. In fact, potential buyers sometimes refuse to buy
the stock of a closely held company.
Depending on the structure of the sale, the loss of the
installment sales provision will reduce the sale price of a
closely held business, in some cases by as much as 20 percent.
For instance, a seller may be forced to sell the stock, rather
than the assets of his business so that he can use the
installment method. Because of the potential liabilities that
go along with the stock, an owner is likely to get a lower
price for his business.
In other cases, the loss of the installment sales rule will
prevent a sale from going forward. Many sales of small
businesses are seller financed, in part because small business
buyers have a difficult time obtaining commercial financing.
Without the installment sales provision, a seller offering
seller financing now has to pay the tax on his capital gain at
the time of the sale rather than spreading the payments over
the term of the installment note.
Under the deprecation recapture rules, a small business
owner using the installment method already is required to
recognize any recapture income in the year of the sale.
Requiring the owner to also recognize capital gain at the time
of the sale places yet another financial burden on the seller.
In many cases, the seller may not have enough cash to pay his
total tax bill, making it difficult or impossible to go through
with the deal.
The loss of the installment sales rule also can exacerbate
the problems faced by families when a business owner dies. In
the United States today, two-thirds of family-owned businesses
do not survive into the next generation, often because of the
burden of estate taxes. Families are forced to sell the
business to pay the estate tax liability. As noted above,
repeal of the installment treatment could make it more
difficult for a family to sell a business and/or reduce the
price they are able to get for the business.
Proposed Treasury Guidance
After the changes in the installment sales rules were
enacted last December, we were hopeful that regulatory guidance
could ameliorate the impact of this change on our small and
medium manufacturers. However, this is not the case. The
proposed guidance outlined by Treasury on February 29, while
helpful to some small businesses, will not address the
situation faced by our small and medium members.
For instance, one of the Treasury proposals would allow
business taxpayers with average annual gross receipts of $1
million or less to use the cash method and, thus, the
installment sales method. While this will provide relief to
some taxpayers, it could force some taxpayers to choose a
method of accounting for tax purposes, rather than business
purposes.
Moreover, even if our members decided to use the cash
method, very few, if any, would fit into this category. Based
on a 1999 survey of our small and medium members, only 17% of
our members have annual sales of less than $3 million and its
estimated that a much lower number have annual sales of $1
million or less.
Legislative Fix
In previewing the guidance at the Oversight Subcommittee
hearing on February 29, Joseph Mikrut, Treasury's tax
legislative counsel, acknowledged that a legislative fix is
needed to ``alleviate this unforeseen impact of the installment
sales provision.'' In particular, he suggested that sellers of
small businesses with less than $5 million in gross receipts be
allowed to use the installment method.
Unfortunately, the possible legislative fix outlined by Mr.
Mikrut does not go far enough. The carve-out for businesses
with less than $5 million in gross receipts would benefit, at
most, one-third of our small and medium manufacturers. It would
create winners and losers within our industry, with about two-
thirds of our small and medium members unable to use the
installment method.
Conclusion
In comments before the House Ways and Means Committee on
February 8, Treasury Secretary Larry Summers acknowledged that
the provision has had a broader impact than initially
anticipated. We believe that total repeal of the provision
enacted in December is the fairest, simplest and most effective
way to address the problem faced by small business owners who
are selling their businesses. On behalf of the National
Association of Manufacturers (NAM) and our 14,000 member
companies, I urge you to support immediate legislation to undo
the damage inflicted on small businesses by changes in the
installment sales rules enacted last year.
Statement of the National Association of Professional Insurance Agents,
Alexandria, VA
The National Association of Professional Insurance Agents
(PIA National) applauds Chairman Houghton and the Ways and
Means Subcommittee on Oversight for holding today's hearing to
discuss last year's repeal of the installment method of
accounting for accrual basis taxpayers. PIA National represents
180,000 insurance professionals nationwide, many of whom are
small business owners. The topic of today's hearing is of vital
importance to our members. We appreciate this opportunity to
present our views and real life testimonials from a number of
our members who have already begun to experience the
devastating affects of this unexpected change in tax law.
In short, insurance agencies are more difficult to sell and
acquire, and could lose as much as 15% of their value as a
result of tax provisions included in the Ticket to Work and
Work Incentives Improvement Act of 1999. These provisions force
agents to pay taxes on the sale of their agency all at once
even if the proceeds of the sale are received in installments
over several years. In some instances, tax liability exceeds
the agent's first year revenue, making the sale impossible or
forcing the agent to borrow money to pay taxes. The new law
equally disadvantages buyers. Unable to spread the purchase
price over a number of years, buyers are forced to secure
financing or deplete savings to acquire an agency.
As you can see, the provisions prohibiting the use of the
installment sales method by accrual basis taxpayers are already
having a negative impact on the sale of small enterprises such
as many insurance agencies. The net impact is that many
insurance agencies are now worth considerably less money. This
potentially devastating problem is compounded by the fact that
many agents use the proceeds from the sale of their agency to
finance their retirement.
The installment sales method is used by small businesses
for a variety of reasons. It enables sellers to be more
flexible in structuring the sale and can lead to a higher
purchase price. Buyers unable to secure financing often prefer
the installment method. It also ensures the seller will have an
interest in the ongoing success of the business, which is
important for buyers when a large portion of the purchase price
is attributable to good will, as is the case with an insurance
agent's book of business. We see no good public policy reason
why small business owners who happen to be accrual basis
taxpayers should be prevented from using the installment sales
method.
While the onerous tax provision is not new--it was also
included in the President's FY 2000 budget proposal and the tax
relief bill ultimately vetoed last year--its consequence for
small business owners is just recently surfacing. The provision
was originally designed to target larger accrual method
businesses when they sold particular assets or a portion of
their ongoing concern. Unfortunately, as we now know, it also
ensnares closely held businesses such as insurance agencies
when they are sold in their entirety. This is an unintended
consequence and it should be fixed.
Fortunately, legislation has been introduced in the House
and Senate to repeal the new tax law prohibiting use of the
installment sales method by accrual basis taxpayers. PIA
supports these efforts and implores the Ways and Means
Committee to move quickly on H.R. 3594 introduced by
Congressman Wally Herger (R-CA). This bill already has well
over 100 co-sponsors and is universally supported by the small
business community. We appreciate this opportunity to present
our views and look forward to working with the Committee and
Congress as a whole to see H.R. 3594 enacted into law.
Attachments A-D are letters from PIA members explaining in
their own words the chilling effect this new law has had on
their livelihood.
Shenandoah Insurance Agency
Stuarts Draft, VA 24477
February 8, 2000
Honorable Robert W. Goodlatte
United States House of Representatives
Washington, DC 20515
Dear Congressman Goodlatte:
I am writing to ask you to join Congressman Walter Herger (R-CA) in
his plan to introduce legislation to repeal the Ticket to Work and Work
Incentives Improvement Act of 1999. This is my story:
During the year of 1999 I placed my insurance agency on the market
and in the fall of 1999 I concluded the sale. In fact the buyer and I
signed a buy and sell agreement in December 1999 about the time
President Clinton signed the Act which went into effect the day the
President signed. The buy and sell agreement went into effect January
1, 2000. Soon after January 1, 2000 I met with my CPA who informed me
because of this Act I would probably owe taxes on the sale of $30,000
plus which because of the Act would be a one time payment. I was not
aware that such an Act was even being considered by the Congress and I
now find out that this was something that Congress did on the last day
of your session last fall. I like hundreds of small businesses use the
sale of our business as retirement income and we planned to pay income
tax on the interest that we receive from the sale but now we are being
hit with another tax.
I do not understand why you, the other members of Congress and
President Clinton tell us in the press that you want to cut our taxes
and at the same time pass the above mentioned Act.
I sincerely hope that you will join Congressman Herger in his
effort to strike this unfair provision from the tax code as it will
kill the sale of every small business in the country.
Thanking you for the help that you can give me on this matter.
Sincerely yours,
William S. Swecker
Bohmer Agency, Inc.
Brooten, Minnesota 56316
February 8, 2000
Honorable Collin C. Peterson
United States House of Representatives
Washington, DC 20515
Dear Congressman Peterson: RE: Wally Herger's Upcoming Tax Bill
I am writing to ask that you co-sponsor legislation that will soon
be offered by Rep. Wally Herger (R-Ca). The Professional Insurance
Agents (PIA) organization informs me that a correction in the tax
provisions contained in the ``Ticket to Work and Work Incentives
Improvement Act of 1999'' is needed. It seems that we small,
incorporated businesses are being caught up in a tax correction aimed
at larger businesses.
I have a small insurance agency in Brooten, Minnesota and am forced
to use the accrual basis of accounting since I am dealing with
insurance companies. With the current law I would have difficulty
selling all, or a portion, of my stock to one of my employees: I would
be unable to finance them with an installment contract if I have to pay
all the taxes ``up front.'' In addition, if I chose to sell the agency
outright only large existing agencies will be able to afford to
purchase my agency. I don't think this is what was intended by the
existing law.
I haven't been able to thank you in person for the help you gave
our community in organizing a cooperative frozen food plant several
years ago. THANK YOU. I have reminded local people of your assistance
and am still your strong supporter.
Please feel free to call me at (320) 346-2234 or write me if you
have any questions of me. I appreciate your assistance in this matter.
Thank you.
Respectfully,
David W. Bohmer
Balland-Zimmerman Agency
Baltimore, Maryland 21202-3311
February 28, 2000
Representative Ben Gardin
Unites States House of Representatives
Washington, DC 20515
Dear Representative Gardin:
As a small businessperson and professional insurance agent in your
district, I am writing to ask that you co-sponsor legislation soon to
be offered by Rep. Wally Herger (R-CA) which repeals onerous new tax
provisions contained in the Ticket to Work and Work Incentives
Improvement Act of 1999. The new law effectively prohibits the use of
the installment sales method by accrual basis taxpayers and will have a
tremendous negative impact on all small business owners wishing to sell
their business.
I have been in the insurance business for 54 years, and have been
taxed on an accrual basis. This year was to be my final one, and I had
planned to sell the agency to another agent, and on an installment
basis. The new law would force me to pay all taxes up front, reducing
the value of the agency to me as well as to the buyer. As I understand
it, the new law was intended to target large businesses that were
selling off one or more assets, but it's impact would fall hardest on
the transfer or sale of small businesses like independent agencies.
This was an unintended consequence and should be fixed.
The installment method of selling an insurance agency is one of
long standing. It allows more flexibility in structuring the sale of
their business and buyers often prefer the installment method as it
ensures that the seller has an interest in the business' on going
success. This is important to the buyer when a large portion of the
purchase price is attributable to good will.
I am counting on you to remedy this terrible situation faced by all
small business owners and to co-sponsor repeal measures. I look forward
to hearing back from you on this topic.
Respectfully yours,
William S. Stack
Frederickson-Brown Insurance Service, Inc.
Canon City, Colorado 81212
February 28, 2000
PIA
Attn: Allison Lewis
Re: Ticket to Work Act of 1999
Dear Allison:
Please stress to those involved what a tremendous hardship this
bill places on small businesses in general.
I have worked for 26 years at Frederickson-Brown Insurance and plan
to retire the end of this year. If I am required to pay all of the tax
on the sale of my agency in the first year, it would be impossible
since the income will be spread over a period of 20 years. This law
will prevent the use of installment sales and could cripple small
business owners selling their businesses or passing them along to other
stockholders or family members. Thanks for all of the hard work being
done by PIA.
Sincerely,
Brad Knotek
Statement of the Printing Industries of America, Alexandria, VA
Mr. Chairman and members of the committee, thank you for
providing an opportunity for the Printing Industries of America
to provide comments on the installment method of reporting
income from an installment sale that would otherwise be
reported on an accrual method of accounting. PIA is the
nation's largest graphic arts trade association with more than
14,000 members nationwide.
Although little was said about this provision before it was
included as an offset to the tax extenders included in the
Ticket to Work and Work Incentives Improvement Act of 1999, the
unanticipated consequences have caused uproar in the small
business community. Since repeal of the installment method of
reporting sales for accrual basis taxpayers was signed into law
on December 17,1999 (Public Law 106-170), I have received
numerous calls from our members concerned about the effect the
disallowance could have on their current and future business
plans. Countless businesses will be adversely affected if this
repeal is allowed to stand unheeded.
Until this year, sellers have been able to set up sales of
the assets of their businesses by financing a note using the
installment method. Owners were able to defer capital gains
taxes until the year payments were actually received. This was
particularly important since many small business sales must be
financed by the seller, because traditional bank financing is
often not available to the average buyer.
As the committee is aware, the December change in law will
now force business owners to pay taxes on sales in the first
year, rather than when payments are actually made. Because many
small business owners simply do not have the cash on hand to
pay the taxes now required in the year of the sale, sellers are
faced with limited options such as lowering the sale price or
borrowing the money from a bank.
Either of these scenarios would place new burdens on a
small business owner as they often use the sale of their
business to finance their retirement. An unexpected reduction
in expected income could very well require continued work
rather than selling to retire. Another unfortunate circumstance
that could result from this requirement is the position a
seller would be put in if the buyer were to go bankrupt a
couple of years down the road. In this instance with the
current law, an individual would already have paid taxes on
money he now will never receive.
A difficult situation arose for a New England member
recently, as a result of the disallowance of the installment
sales method of accounting. This particular member happens to
be the proud ten-year owner of a direct mail printing company
employing approximately 45 employees. This printer was in the
process of purchasing a mailing house company, which employs
approximately 195 employees, in an attempt to add to the
current growth of his direct mail printing company. He had
arranged a loan with the sellers of a mailing house company,
which would come from the proceeds of the sale of the company
to our member. This money was crucial to our member in order to
obtain approval from the bank for the loan to buy the mailing
house company.
At the time when the repeal was signed into law in December
of 1999, our member and the sellers of the mailing house
company were nearing the end of their negotiations and were
almost ready to close. However, the tax implications of the
newly enacted law almost caused the sellers to balk on the deal
as the realization of the additional tax responsibility dawned
on the sellers. It was only their desire to sell to a fellow
small business owner that kept them from pulling out of the
deal altogether. In order to close the deal, our member had to
agree to a repayment schedule at a higher interest rate and on
an accelerated basis. He also agreed to give the amount of
money equal to the taxes due in the coming year or pay a
significant penalty in addition to the amount borrowed from the
sellers. Our member continues to hope for a ``repeal of the
repeal'' in order to relieve this incredible burden placed on
him as a result of the disallowance of the installment method
of reporting this sale. If repeal is not enacted by the time
the taxes are due on this sale, our member will be forced to
borrow this sum of money and go further into debt in order to
satisfy the terms of the agreement.
Further, our member has expressed his concern as to the
continuation of the business plans of the people involved in
the sale. Should this provision remain intact, many business
owners, including our member, may have to consider selling to a
consolidator, instead of to their current management or perhaps
a family member, in order to get the price needed to sustain
future plans and retirement.
Our member has said that for years it has been his plan to
finance the sale of his business when he is ready to retire.
However, with the current law, this option would probably not
be considered due to the tax responsibilities of the current
law. This will certainly curtail the employee advantage in this
scenario and limit the future of small businesses while at the
same time encouraging sales to larger companies.
Is this really what Congress would want? Do we want to make
selling a small business company so difficult as to endanger
the future of small businesses overall in our community; those
same small businesses that have been a staple for providing
jobs and economic growth in our communities for years on end?
For the reasons provided in this statement, the Printing
Industries of America urges your support for a complete
``repeal of the repeal,'' as this is the only way to keep the
playing field level for the small business community. On behalf
of printers across the nation, PIA encourages you to support
H.R. 3594, sponsored by Representative Wally Herger, for a
complete repeal of the disallowance of the installment method
of sales. Thank you for the opportunity to submit this
statement into the record.
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