Small businesses “were particularly harmed the last several years with the financial crisis... so rethinking the tax structure that applies to pre-revenue firms in the early-stages of developing innovative technologies is particularly important,” Bob Carroll, principal for economics and statistics at Ernst & Young, said during a press call.
In terms of jobs output, the most significant reform would come from a proposal to extend and expand a capital gains exclusion for the sale of what is known as qualified small business stock (QSBS). A House bill would make the current tax break permanent, and it would triple the current size limit ($50 million in assets) for eligible firms, giving investors a larger pool of capital-gains-exempt firms in which to invest.
On its own, by stimulating more investments in emerging firms that already contribute a large portion of the nation’s new jobs, the change would produce more than 350,000 new jobs, researchers estimate.
In terms of beckoning investors, on the other hand, small and new firms would see the biggest gains from a proposal to modify the types of losses investors are permitted to subtract from their taxable income each year. The Senate Finance Committee, for example, has floated the idea of allowing individuals to carry forward any losses from investments in research-intensive small businesses and use them to offset gains for tax purposes in the future.
The idea is that, by lowering potential costs for investors, raising capital would be easier for small firms that are in the early, research-and-development stages. Ernst & Young’s report, which was commissioned by the Coalition of Small Business Innovators, an advocacy group, suggests the change would spur an additional $10.3 billion in investments annually.
A third proposal would reform the manner in which, in the case of an acquisition or ownership change, the net losses for a small, pre-profit company can be used by the acquiring company or new owners to offset their taxable revenue. It would increase investments by $5.5 billion per year and create about 85,000 jobs, the report suggests.
One small business executive says the tax changes would give his pharmaceutical company better access to the capital it desperately needs to continue innovating.
“Right now, across the research-investor continuum, there just isn’t enough capital being committed to long-term innovation to fund all the tremendous ideas that are out there,” Jeff Hatfield, the chief executive at Vitae Pharmaceuticals in Fort Washington, Pa., said during the call, adding that “investment in research-focused small companies is often losing out to quick-return, lower-risk projects.”
Hatfield’s firm, which employs about 50 scientists, is developing drugs to combat chronic kidney disease, diabetes, and atherosclerosis. Already $100 million in the red, the company is still about four to five years and potentially hundreds of millions of investment dollars away from bringing some of its products to market.
Members of Congress have raised all three ideas on various occasions, Carroll said. However, there has not been a sustained tax reform movement to which the smaller proposals could be attached.
Soon, that may change.
A bipartisan effort to completely revise the tax code is expected to shift into high gear when Congress comes back from recess in August. Senate Finance Chairman Max Baucus (D-Mont.) and House Ways and Means Chairman Dave Camp (R-Mich.) are already traversing the country together to build support for such an overhaul, and each hopes to release long-awaited tax plans once lawmakers return to Washington.
In a conversation together earlier this month, the pair acknowledged that, while some of the nuances of their plans will vary, the goal will be the same — to eliminate exclusions, broaden the tax base and lower rates.
“There are a lot of provisions that cause some U.S. companies to be less competitive,” Baucus told members of the Washington Economic Club, referring to current tax laws. “We have to be much more competitive as a country than we are, certainly with respect to the [tax] code.”
In their efforts, both said they hope to make the laws much simpler for small employers.
“I think the concern is that people have this huge stack of papers they send in to the IRS,” Camp said. “I had a man come in, he had one retail store, and his tax preparation fee was $9,000. So the cost of compliance is enormous.”
The White House has urged lawmakers to make some of the proposed changes, too, particularly ones meant to encourage innovation. President Obama has routinely called on Congress to make permanent a routinely extended but never set-in-stone tax credit for research-and-development expenses.
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