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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




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