Congressman Dave Camp (R-Mi), Chairman of the Committee on Ways and Means, has announced that the Committee will hold the second of two hearings on how accounting rules cause different types of businesses – specifically, publicly-traded and closely-held businesses – to evaluate tax policy choices differently. Whereas a previous hearing focused on financial accounting rules and publicly-traded companies, this hearing will focus on the special challenges faced by small and closely-held businesses that are less concerned with financial accounting rules but must confront tremendous complexity in dealing with tax accounting and various choice of entity regimes. The hearing will take place on Wednesday, March 7, 2012 in room 1100 of the Longworth House Office Building at 10:00 a.m.
Unlike publicly-traded companies, closely-held companies often rely less on Generally Accepted Accounting Principles (“GAAP”) to report information to owners and creditors, although there are exceptions. Instead, closely-held entities tend to focus almost exclusively on how tax policy changes affect cash flows. Closely-held companies, face their own set of challenges with regard to tax complexity and uncertainty. These challenges range from compliance with complicated rules on inventory accounting and cost recovery to numerous sets of tax rules governing different business forms.
The three major business forms from which closely-held companies must choose for federal tax purposes are C corporations, S corporations, and partnerships, although a number of other types of business entities exist to serve specific purposes. While C corporations are subject to entity-level tax and shareholders are again subject to tax on dividends and capital gains, S corporations and partnerships are “pass-through” entities that do not pay entity-level tax – rather partners and shareholders pay tax on their share of the entity’s income on their individual tax returns (and therefore under the individual rate schedule). Companies must choose to operate under one of these regimes, and the choice can have significant tax consequences. Many commentators recommend modifications to the choice of entity rules to reduce the potential distortions introduced by such rules – with ideas ranging from consolidating existing pass-through rules into a “unified pass-through regime”, making it easier for closely-held C corporations to convert to pass-through status, or even subjecting some existing pass-through entities to double taxation as C corporations. On the other hand, tax reform proposals that create too large a spread between the top corporate rate and the top individual rate risk exacerbating these distortions rather than reducing them.
Authored by Barbara A. Assendelft