Written Statement of the National Association for the Self-Employed

Small Business Access To Health Care

Roundtable of the Subcommittee on Regulatory Reform and Oversight of the House Committee on Small Business
February 25, 2003

The National Association for the Self-Employed, on behalf of our 250,000 member businesses, representing over 600,000 employers and employees, would like to express our appreciation to Chairman Ed Schrock and the members of the Subcommittee on Regulatory Reform and Oversight for the opportunity to participate today in this Regulatory Reform Roundtable.

The National Association for the Self-Employed represents the smallest business owners, those entrepreneurial Americans who, with the simple belief that they can better serve their neighbors, their families and their own futures, defy the odds against their success and embark on the quintessential American dream of building a business, of carving out their own piece of that ever-expanding pie which is the American economy. They typically are the men and women whose office occupies the corner of their bedroom, whose warehouse is their garage, whose CIO and CFO and CEO and janitorial staff share the same desk and business card, but whose names one day -- they dream and we hope -- may be as familiar to us as those of Michael Dell or Henry Ford or David Packard. But even those that just dream to be able to efficiently maintain their micro-business are the drivers of America’s economic engine. Often, the chief speed bump on the road to their success is a collective $800 billion bill called federal government regulation. And because big successes usually have small beginnings, these costs loom large to micro-businesses, which are capitalized chiefly on dreams and ideas. As Mitch Daniels has said, these “costs are not inflicted on abstractions like economies, but on each of us, on everyday citizens, with ultimately every dollar of that falling on a purchaser of a good or service, . . ..” But before it falls on that purchaser, it falls first on the small-business owner who produces that good or offers that service. Too often, he or she is forced out of the market and out of business, and the economy loses that entrepreneurial spark.

To put that $800 billion into further perspective, the total estimated regulatory burden on our economy exceeds by a wide margin the entire Gross Domestic Product of Canada and more than doubles the GDP of Mexico. Because of the expanding global reach which technology and telecommunications has afforded even micro-businesses, our members compete daily with manufacturers and producers and consultants and software engineers throughout the world.
When Americans are free to innovate and invent and create, we can compete with and beat the best the world has to offer. But an albatross of almost $800 billion dollars is hard to ignore and hard to overcome.

A report sponsored by the U.S. Small Business Administration entitled “The Impact of Regulatory Costs on Small Firms”, cited that firms employing fewer than 20 employees face an annual regulatory burden of $6,975 per employee. This same report cited that environmental regulations and tax compliance issues are particularly burdensome to small business. The NASE membership is from a diverse array of industry sectors; from consultants to manufacturers to farmers. Yet with each of the industries we represent, there are two highly prevalent regulatory burdens faced by the self-employed and micro-business communities:

• Regulations issued and enforced by the Internal Revenue Service, and
• The complexity and difficulty of regulatory compliance.

INTERNAL REVENUE SERVICE REGULATIONS

The NASE has been very pleased with the recent efforts made by the Internal Revenue Service to become small-business friendly. However, the self-employed and micro-business communities still face an overwhelming regulatory burden in complying with IRS rules. According to a study by the Tax Foundation, in 2002 businesses bore the majority of the tax compliance cost with 52.8 percent of the total cost, or $102.5 billion. The OMB estimated that in 1995 businesses spent 2.4 billion hours on tax compliance efforts. For self-employed individuals and micro-businesses three key tax issue areas are tax simplification, clarification of independent contractor status and self-employment tax on health insurance premiums.

Tax Simplification

A well-known burden on small business is the complexity of the tax code. Due to their size, micro-businesses are responsible for managing every aspect of their business. Every second spent contending with burdensome record keeping and tax preparation takes away from the time they expend running and growing their businesses.

Tax simplification would have numerous positive affects. First, easy to understand tax rules would reduce the compliance costs of the self-employed and micro-business owners, allowing them to reinvest that time and money in the success of their business. Second, a simpler tax code would raise compliance rates and lessen mistakes made in tax filings thus reducing the administrative burden of both the taxpayer and the IRS. Clarifying tax regulations allows those preparing their own taxes to more readily understand the law and their responsibility of complying. Lastly, simplifying the tax code would make it easier for taxpayers to understand important tax code provisions, such as those dealing with retirement and education savings; thus, increasing the likelihood that they will be utilized.

Independent Contractor Clarification

One specific IRS regulation that is exceedingly burdensome on the micro-business and self-employed communities is independent contractor status. Many NASE members either use independent contractors or consider themselves to be independent contractors. Disputes about who is an employee and who is an independent contractor have cost small businesses more than three-quarters of a billion dollars in IRS fines and back-taxes during the past 10 years. The existing law is supposed to provide employers with relief from potential IRS reclassification of a firm's independent contractors as employees, by prohibiting the IRS from reclassifying such workers if the employer has a “reasonable basis” for its treatment of the workers as independent contractors. A “reasonable basis” includes reliance on:

• Judicial precedent or IRS rulings;
• A past IRS audit in which there was no assessment attributable to employment taxes; and
• A long-standing industry practice of treating the workers as independent contractors.

Unless firms can meet these “safe harbor” requirements, they must abide by the so-called “20 factor test” to determine who is or is not an independent contractor. Parts of this test are more than 500 years old. Over the years, the IRS has also chipped away at many of the supposed “safe harbors.” The NASE continues to work with the IRS to clarify independent contractor status for micro-businesses, yet this still remains a pressing regulatory problem. We also actively advocate for legislation, such as Chairman Manzullo’s Independent Contractor Determination Act, reintroduced and passed by Congress, which would simplify and clarify this specific tax regulation in order to reduce the burden faced by small business.

Self-Employment Tax on Health Insurance Premiums

Many micro-business owners will tell you that they feel that there is an inherent bias in the tax code towards large businesses. One example of an inequity in the Internal Revenue Code relates to the self-employed and their health insurance premiums.

All employees who receive compensation from employers pay FICA taxes. FICA comprises Social Security (6.2 percent) and Medicare (1.45 percent) taxes. Employers are required to withhold from gross compensation a total of 7.65 percent for FICA. In addition to the FICA withheld from the employee, the employer is required to “match” the FICA withholding. Therefore, the employee and employer contribution for FICA is 15.3 percent of compensation (subject to applicable annual limits).

The self-employed also pay into the Social Security Fund at a rate equivalent to employees and employers. FICA tax for the self-employed is called “self-employment tax”. The self-employment tax is computed at the same rates (15.3 percent) as employee/employer FICA and is subject to the same annual limits.

The tax inequity faced by the self-employed when purchasing health insurance lies in the fact that Schedule C filers (sole-proprietors) and Schedule E filers (partners in partnerships with earned income and 2 percent owners in S Corporations) do not receive a “business deduction” for heath insurance premiums. The premiums are not deducted for purposes of the self-employment tax and, accordingly, the sole proprietor(s), partners in partnerships and S corporation owners pay self-employment tax (15.3 percent on self-employment income up to $86,000) on the insurance premiums. The self-employed are the only segment of the business population that has to pay this extra tax on health insurance.

C corporations, on the other hand, receive a deduction for health insurance premiums as an ordinary and necessary business expense for all employees including owners. Since the premiums paid for health insurance are not considered compensation to the employee or employee owner, they are not subject to FICA taxes for either the employee or the employer.

To achieve tax equity between all forms of business entities, the self-employed must receive exclusion of health insurance premiums from self-employment tax regardless of the entity form under which they choose to operate. Health insurance premiums of the self-employed should be deductible on Schedule C or E as an ordinary and necessary business expense rather than the deduction above the line on Form 1040. This is not only a fairness issue but, in a time when health care costs are skyrocketing for small businesses, it is an important solution to make health coverage more affordable for the self-employed.


REGULATORY COMPLIANCE ASSISTANCE

In 1999 alone, federal regulatory agencies issued 4,495 non-major rules and 58 major final rules. The IRS issued 265 rules in an effort to clarify our nation’s remarkably complex tax code. The EPA issued 701 final rules under the Clean Air Act, the Comprehensive Environmental Response Compensation and Liability Act (CERCLA), The Clean Water Act, The Toxic Substances Control Act and others. The FCC issued 263 final rules. The Agricultural Marketing Service issued 91 final rules. And the nation’s fishing industry saw NOAA issue 280 rules regulating their activities. This does not even include the regulation tally of the Department of Labor and OSHA.

The ultimate regulatory burden that is faced by the self-employed and micro-businesses is the simple difficulty of complying with any and all regulations affecting their business. This burden imposed on micro-business is disproportionate to that of larger businesses because smaller firms cannot spread the overhead costs associated with hiring accountants and attorneys, and the general cost of paperwork burdens and staff needed to try and comply with the maze of federal regulations.

As mentioned earlier, due to their small size, micro-business owners are responsible for managing every aspect of their businesses. At times this is a daunting challenge and the NASE hears from our membership that the first hurdle in regulatory compliance is knowing what regulations they must comply with. The second burden is then figuring out how to comply with these regulations. Small businesses in general do not feel comfortable with calling the various federal agencies to ask questions and seek compliance assistance. The majority of micro-business owners, while not fond of the regulations imposed on them, are willing to comply with regulations. They simply want to know what is expected of them and how to comply in the most cost effective manner. The NASE feels that the self-employed and micro-business communities need more assistance with regulatory compliance. We strongly support the expansion of the SBA-sponsored Small Business Development Center Program to allow for regulatory compliance assistance.

For twenty years, the Small Business Development Center Program has been assisting America’s small business owners and aspiring entrepreneurs. Over the last twenty years the SBDC network has provided counseling and training assistance to over 8 million clients. Last year alone SBDC service centers provided counseling and training assistance to approximately 600,000 potential and current small business owners. In 1996, Congress amended Section 21(c)(3) of the Small Business Act, by directing Small Business Development Centers to provide information on small-business concerns regarding compliance with regulatory requirements. The network has struggled to effectively meet that mandate because in the half-decade since that amendment was enacted, increases in SBDC program resources have been very modest. It is simply not possible to effectively meet the compliance assistance needs of the small-business community when resources to address the program’s historical core responsibilities are increasing at less than the rate of inflation. The NASE advocates for more monetary resources to be appropriated to the SBDC program specifically for regulatory compliance assistance. We strongly feel that no written guidebook, online or phone compliance assistance can outweigh the benefits of the one-on-one assistance micro-business owners and self-employed individuals receive at their local Small Business Development Centers.

Conclusion

In conclusion, the National Association of the Self-Employed would again like to thank this Committee for the opportunity to express the concerns of America’s micro-business owners. We hope you will continue your valuable efforts to alleviate of the regulatory burden on America’s micro-business and self-employed communities. The members of the NASE who hope to turn the American dream into an American success story depend upon your vigilance on our behalf.