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Friday, April 12, 2013

Small Business Tax Benefits: Current Law and Main Arguments For and Against Them

Gary Guenther
Analyst in Public Finance

The federal tax burden on small firms and its effects on their formation and growth have long been issues of legislative concern for Congress. This interest helped pave the way for the enactment during the 111th and 112th Congresses of several laws intended, in part, to reduce this burden or keep it in check. The American Recovery and Reinvestment Act of 2009 (P.L. 111-5), the Small Business Jobs Act of 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-240), and the American Taxpayer Relief Act of 2012 (P.L. 112-240) each contained provisions offering tax benefits to small companies.

This report describes the main federal tax preferences that benefit small firms and examines the main arguments for and against them. It addresses tax preferences that can be claimed by qualified small firms in a wide range of industries and excludes those targeted at small firms in specific industries, such as the special deduction for small life insurance companies under Section 806 of the federal tax code. The following small business tax benefits have a broad reach outside agriculture and are among the tax preferences examined here:

  • the taxation of small firms as passthrough entities; 
  • the graduated rate structure for the corporate income tax; 
  • • the expensing allowance for machinery and equipment under Section 179 of the Internal Revenue Code; 
  • the exemption of some small corporations from the corporate alternative minimum tax; 
  • cash-basis accounting; 
  • a tax credit for a portion of the costs incurred by small firms in establishing pension funds for employees; 
  • a tax credit for costs incurred by small firms in complying with the Americans with Disabilities Act; 
  • the partial exclusion from the capital gains tax on the sale or exchange of qualified small business stock; and 
  • a tax credit for small firms that offer qualified health insurance coverage to employees. 

While available information does not allow for an estimate of the federal revenue cost of all the small business tax preferences examined here, estimates by the Joint Committee on Taxation and the Treasury Department’s Office of Tax Analysis suggest that it may exceed $11 billion in FY2013.

Tax preferences for small businesses raise several policy issues. For some, a key question is whether or not they can be justified on economic grounds. In the absence of such a justification, small business tax benefits may create more economic harm than good.

Date of Report: April 3, 2013
Number of Pages: 46
Order Number: RL32254
Price: $29.95

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