Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
May 13, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 1839 words
HEADLINE:
TESTIMONY May 13, 1999 STEPHEN BREITSTONE HOUSE SMALL BUSINESS
TAX, FINANCE, AND EXPORTS REPEALING THE DEATH TAX
BODY:
Prepared Testimony of Mr. Stephen M. Breitstone Estate Planning Attorney
Meltzer, Lippe, Godstein & Schlissel Mineola, New York The Perils of Small
Business I am an attorney practicing in Mineola, New York. The principal focus
of my practice relates to the tax, business, and estate planning for small and
closely held business. I have been practicing law since 1982 when I graduated
from Benjamin N. Cardozo School of Law of Yeshiva University, New York. I also
have my Bachelor of Science from New York University School of Business and
Public Administration and a Masters in Law from New York University School of
Law where I specialized in tax law. In addition, I was an adjunct professor at
the Cardozo Law School in the area of taxation. I am a member of the Long Island
Association Tax Policy Committee and of the New York State Bar Association Tax
Section Committee on Partnership Taxation. Although I had a very successful law
practice principally representing large corporate clients throughout most of the
1980's, I chose to leave that behind in order to move to Long Island and build
my practice at a highly respected law firm where I would work more with small
and closely held businesses. Our law practice takes many businesses from their
early stage as start up companies and helps them to grow and to prosper. Many
successful small companies become large companies and some become public
companies. However, the overwhelming majority of these companies fail to achieve
their goals. It is the primary focus of my practice to help these companies to
navigate the perilous regulatory legal and economic environment where the odds
are clearly stacked against them. Having worked closely with many founders of
closely held businesses through all stages of their development, I have come to
learn that the closely held business is the consummate example of the American
dream. The small business owner notoriously begins as the underdog. Knowing full
well that the overwhelming majority of small businesses fail they are willing to
risk their personal and financial fortunes and any perception of job security
they may have had in another occupation, to be their own boss, and to obtain a
level of independence and freedom to control their own destiny, which can only
be obtained by an extraordinary degree of ingenuity and hard work. Only in the
United States can anybody with the ingenuity and the willingness to make the
sacrifices necessary to embark upon the formation and ownership of a small
business do so if they choose. Yet, these small businesses are almost always at
an enormous disadvantage compared to their competitors. They do not have the
capital base that affords larger established entities the ability to weather
temporary economic downturns, delays resulting from excessive regulatory
intervention, and often predatory competitive forces in the market place.
Certainly, your average small business could not afford to make a mistake in its
product line or development as large corporate concerns can do time and time
again. Nevertheless, small and closely held business are responsible for much of
the growth and prosperity in our economy. I understand the majority of job
creation in this country comes from small business. Perhaps most important, the
wealth of ingenuity and technologic innovation in our economy is derived from
the entrepreneurial efforts of small business owners. The Burdens of the Estate
Tax Fall Principally Upon Small Business The adverse impact of the estate tax is
born disproportionately by successful small and closely held businesses. Large
corporations usually do not have to worry about the estate tax. Large public
corporations typically have a multitude of shareholders with no individual
shareholder owning a major percentage of the stock of the corporation.
Therefore, they need not be concerned with funding the estate tax obligations of
their shareholders since the burden of the tax, if any, falls upon the
shareholders not upon the corporation. Typically, the stock of a large
corporation can be readily disposed of in an established securities exchange so
the shareholders have little concern regarding the liquidity necessary to fund a
55 percent estate tax obligation. Ownership of small and closely held business,
on the other hand, typically constitutes an illiquid investment. The discount
rates that apply to stock of small and closely held businesses are far greater
than those applicable to public corporations. The ability to avoid the burdens
of the estate tax puts large corporate America at a substantial competitive
advantage over small businesses. As mentioned above relatively few small
businesses survive at all. For the fortunate few who are able to survive the
competitive forces and all of the other hurdles they must face, the estate tax
imposes a potentially crippling financial obligation upon small and closely held
businesses at the time when they can least afford to shoulder the burden.
Closely held businesses rarely survive the transition to the next generation.
Often the success of the business is very much tied to the personal efforts of
the founder. The death of a founder can result in the business failing
altogether. For those businesses that are capable of surviving (a mere 3 and 10
family businesses survive the transition from the first generation to the second
and less than 15% survive into the third generation) substantial costs may have
to be incurred to hire high level management that can enable the business to
carry on. The death of a founder may mean loss of important contacts and
relationships which are vital to the survival of the business. If the business
is capable of enduring these events, it will be burdened with a liability that
can amount to 55% of its worth. That type of liability, even if incurred for
capital expansion substantially increases the risk, but it also increases the
returns associated with the business. However, the payment of an estate tax
burden, unlike an investment in additional capital, yields no return to the
company. This is a one way street. The payment of an estate tax can deplete the
capital of the company necessary for its very survival. Moreover, throughout the
life of a business, its owners must constantly choose between reinvesting
profits in the future growth and expansion of the business, or drawing the
maximum short term profits. It is well recognized in the tax law that owners of
closely held business often are under compensated for their efforts. They must
choose between making payroll, paying vendors, financing capital expansion, on
the one hand, and drawing for themselves. For many small and closely held
business owners, virtually all of their net worth may be tied up in the
business. The potential economic calamity wrought by the imposition of the
estate tax can be ruinous and certainly serves as a major disincentive for
investing in the business for the long term. Finally, there are numerous
techniques that have been developed by practitioners such as myself, for
avoiding the estate tax through inter vivos transfers. Unfortunately, for the
small business owner, making those transfers may be a luxury they cannot afford.
For the very wealthy, inter vivos transfers can be made of a substantial portion
of their personal worth without affecting lifestyles and the ability to provide
for health care and other needs. However, for small business owners, if
substantial inter vivos transfers are made, they may have to give up their
financial independence, which they have worked so hard to achieve, as well as
their ability to maintain their lifestyles and provide for their health care
needs. The Estate Tax System Suffers from Numerous Technical Flaws There are
many flaws in inequities in the estate tax system. As pointed out in the report
of the Joint Economic Committee dated December, 1998 (THE ECONOMICS OF THE
ESTATE TAX), the existence of the estate tax prompts a multitude of inter vivos
transactions designed to minimize or to avoid estate tax liabilities -- not
usually available to the small business owner. In addition, many economic
distortions result from the estate tax. Transactions that make little economic
sense are often contrived to avoid estate taxation. Transactions that make good
economic sense are often quashed because of estate tax implications. The
Internal Revenue Service, in its infinite wisdom often presume tax avoidance in
inter family transactions where none was intended. The effect of this is often
that transactions among family members are more heavily taxed that similar
transactions among unrelated parties. Finally, the income and estate tax systems
do not work in harmony with each other. These disparities result in transactions
that are often treated inconsistently for income and estate tax purposes.
Although tax avoidance opportunities may arise from such disparities, many
economic distortions arise as well. These concerns can be exemplified as
follows: A successful company that sells electronic components has recently made
a transition to Internet based sales. This was done as a result of the ingenuity
of the younger executives. One of these executives is the son of the current
owner and the other is unrelated. The current owner wishes to keep the younger
executives with the company by giving them an economic stake. Eventually, it is
hoped the younger executives will acquire ownership of the company. I was able
to devise a structure which would allow the younger executives to participate in
the economic growth of the company. However, much to the dismay of my clients,
the transfer to the son is subject to a gift tax even though it is on exactly
the same terms as the transfer to the non-family member. This is a function of
the chapter 14 valuation rules set forth in Section 2701 of the Internal Revenue
Code. Fortunately, practitioners such as myself have devised numerous techniques
to avoid estate taxation. However, these techniques come at great cost to small
businesses. Summary of Position Although I cannot say unequivocally I support
the repeal of the estate tax in its entirety, I believe the
thresholds for its imposition should be greatly increased. I do not believe the
extremely wealthy should be permitted to accumulate wealth generation to
generation without the imposition of estate taxes. These extremely wealthy
families continue to accumulate wealth solely due to the passage of time- even
with the current system of estate taxation. The accumulation of wealth by the
extremely wealthy puts small business at a competitive disadvantage. I may also
pose a significant barrier to entrepreneurial activities that are so fundamental
to our economic system. If successful, the persistent efforts by the Internal
Revenue Service to close so-called "loopholes" will be extremely detrimental to
small businesses unless they are accompanied by measures designed to provide
meaningful relief to small and closely held businesses.
LOAD-DATE: May 17, 1999