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INNOVATION
& DESIGN Home Page Architecture Brand Equity Auto Design Game Room SMALLBIZ Smart Answers Success Stories Today's Tip INVESTING Investing: Europe Annual Reports BW 50 S&P Picks & Pans Stock Screeners Free S&P Stock Report SCOREBOARDS Hot Growth 100 Mutual Funds Info Tech 100 S&P 500 B-SCHOOLS Undergrad Programs MBA Blogs MBA Profiles MBA Rankings Who's Hiring Grads | | JULY 20, 2000 MANAGEMENT Is Tax Relief Coming for Businesses That Get Sold? A 1999 law that crippled many small-business sales may soon get amended
The law, signed late last year, forces sellers to pay capital-gains taxes up front even when payment for the business is staggered over a number of years. Passed as part of 1999's Ticket to Work and Incentives to Work Improvement Act, the law affects only businesses using accrual rather than cash accounting. The accrual system records profits when they become collectible -- but not necessarily collected. Cash accounting is more closely comparable to balancing a checking account. Profits are noted only after they are received. LITTLE CHOICE. Many small businesses favor the cash system because it's easier to administer and doesn't require paying taxes on unrealized income. But the choice hasn't always been theirs to make. Tax laws require companies with income-generating merchandise to track inventories using the accrual system. What's more, the Internal Revenue Service, which pressures business to use the accural method, reads "inventory" to cover not merely retail goods but also the supplies -- or raw materials -- used by service providers. Dental and medical clinics as well as contractors and landscapers fall into that category. If you choose the wrong system and are audited, you could find yourself owing hundreds of thousands in back taxes. Amid this IRS pressure to use the accrual system, tax relief has always been available when an owner sells a business. The owner can opt for installment-sales accounting -- spreading out capital-gains payments along with the buyer's payment schedule. But the 1999 law plugged that loophole, and business owners may find that the buyer's down payment doesn't begin to cover their tax bill, says John Hexter, chairman of the National Small Business United, an advocacy group headquartered in Washington, D.C. "It turns a lucrative little business into an albatross," says Hexter, a business consultant in Cleveland. STALLED. The National Federation of Independent Business, a small-business lobbying group, argues that the new rule is keeping many small-business sales from moving forward and threatens the retirement plans for owners banking on the sale of their company. Business owners have testified that they planned to retire after selling their businesses but that the tax burden has made it impossible for them to do so. Almost as soon as the law went into effect, opponents began moving for its repeal, and both the House and Senate have been working on amendments. The House version, introduced by Representative Wally Herger (R-Calif.) with 125 co-sponsors, was attached to minimum-wage legislation and passed on Mar. 9 by a vote of 257-169. A similar repeal was attached to the Senate bill vetoing tax cuts for married couples, which passed with a 60-39 vote on July 18. For procedural reasons, all amendments were later stripped from the bill. However, the NFIB expressed optimism that the Senate's show of support would lead to full repeal of the installment-sales tax this year. The U.S. Chamber of Commerce is also pushing for the repeal. "We think its chances for passage are excellent," says Cecilia Adams, a legislative director for the Chamber. Fortunately, some small businesses won't have to wait for a legislative fix. Under IRS Revenue Procedure 2000-22, companies with average annual gross receipts of under $1 million can opt out of accrual accounting and inventory-keeping requirements. At hearings before the House Committee on Small Business in April, Tax Legislative Counsel Joseph Mikrut testified that the exemption would cover "78% of all C corporations, 85% of all S corporations, 95% of all partnerships and 94% of all sole proprietorships." NOT ENOUGH. But many think the IRS's concession doesn't go far enough. "A million dollars is a ridiculous number if you break it down to transactions," says Hexter. If you're a builder, for example, that amounts to "two homes in the right neighborhoods." And, according to Pamela Olson, a Washington lawyer and chair of the American Bar Assn.'s Tax Section, "We do not believe $1 million in gross receipts provides sufficient relief from the complexity the accrual method of accounting creates." On the other hand, two members of Congress think the IRS has gone too far. The heads of the Senate and House Small Business Committees -- Senator Christopher Bond (R-Mo.) and Representative Jim Talent (R-Mo.)-- chastised the agency in a letter dated May 4 for exceeding its authority. "Nowhere in the Internal Revenue Code do we find authorization for the Treasury to adopt a $1 million threshold," the letter stated. They contend the new IRS guideline clashes with a code provision added in 1986 that requires larger corporations to use the accrual method if they have average annual gross receipts of more than $5 million. The result is an "environment of complete uncertainty," said the lawmakers. A better solution, according to Olson and others, is using $5 million in gross receipts as the sole benchmark, leaving inventories out of the equation. That's also the gist of legislation Bond and Talent proposed this spring, but it seems unlikely to go anywhere, admits Bond's aide, Craig Orfield. Then again, after last year's legislative debacle, it may be best for Congress to correct past mistakes and not open up a new can of worms.  By Stephanie B. Goldberg Edited by Robin J. Phillips  | | |
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