As Congress gathers information to formulate its economic stimulus package, the National Association for the Self-Employed presented the viewpoint of the small-business owners before the House Small Business Committee. NASE President Robert Hughes explained how updating the antiquated depreciation schedules and expensing limitations would create greater cash flow for small businesses and stimulate economic growth. Following is Hughes’ testimony outlining the NASE recommendation on this important issue.

Testimony of Robert E. Hughes
President of The National Association for the Self-Employed

Depreciation Schedules: How Can Congress Provide Relief for America’s Small Businesses?

Before the House Small Business Committee
October 17, 2001

Mr. Chairman, Ms. Ranking Member, and Members of the Small Business Committee, I would like to thank you for this opportunity to testify before you today to discuss current depreciation schedules and how we can make positive changes to the tax code in order to provide relief for our nation’s 24 million small businesses.

I am Robert Hughes, President of the National Association for the Self-Employed (NASE), a bipartisan, non-profit small business trade association founded in 1981 that represents over 180,000 members nationwide. Ninety percent (90%) of our membership consists of small businesses with six (6) or fewer employees. The NASE’s primary goal is to help the self-employed meet the challenges of making their businesses successful. On a personal note, I have been a certified public accountant and small-business owner for 20 years. My CPA firm exclusively serves small businesses and their tax needs, thus I have a first hand knowledge of tax concerns faced by the self-employed.

Mr. Chairman, the recent tragedies have affected our great nation both emotionally and economically. More than ever, America needs small businesses to marshal their resources and grow the American economy by doing what they do best - create, innovate, produce, build and grow. 

The advent of the Internet has made it increasingly important for the self-employed and small businesses to utilize technology and e-commerce to market and sell their products and services. IT tools help place small businesses on equal footing with larger, well-heeled competitors. Small businesses that employ IT tools, such as Internet access, have grown 46% faster than those that have not. By the year 2002, nearly 85% of all small businesses will conduct their business through the World Wide Web, keeping them competitive on a global scale. The lack of high-tech infrastructure and technology equipment remains a significant impediment to small-business expansion. The current tax code does not assist small business in acquiring the high-tech tools necessary to support continued efficiency and success.

Small business-specific tax relief and investment incentives are key pieces of the puzzle needed to help foster growth and success of small firms. The investment incentives the NASE recommends are adjusting business depreciation schedules, increasing Section 179 expensing limits for business equipment and software, and reinstating the investment tax credit. Today we are here to talk about two of these provisions: depreciation and Section 179 expensing.

DEPRECIATION
The general tax definition of depreciation is as follows:

Depreciation is a reasonable allowance for the exhaustion, wear and tear, and obsolescence of property used in a trade or business. It allows the taxpayer to deduct annually a ratable portion of the cost of the property.

Currently, our tax code states that computers and peripherals are depreciable over five (5) years and software over three (3) years. The fast pace of innovation in the high-tech sector has rendered equipment three (3) years or older to be functionally obsolete and software becomes inadequate after two (2) years. Thus, utilizing this definition, we can clearly see that the depreciation useful life requirements within our current tax code are outdated and do NOT reflect current technological advancements. In order to remain competitive, businesses need to replace their computer equipment every 2 to 3 years. Yet, their investment decisions are dictated by outdated depreciation schedules rather than sound business decisions. 

The NASE strongly feels that shortening depreciation useful life requirements for computers, peripherals, and software to two (2) years will encourage the self-employed and small businesses to invest in the technological tools they need to expand and stay competitive while also stimulating our nations’ economy. It would also lessen the extensive paperwork burdens the self-employed and small businesses have to deal with when depreciating equipment over five years. 

Along with updating depreciation schedules to conform with the actual useful life of computer technology and minimizing paperwork requirements, altering schedules would also have a positive affect on the amount of capital small businesses would have free to reinvest in their business and employees. Access to capital is one of the biggest obstacles faced by the self-employed and small businesses in our nation. It is essential for a small business to have access to capital for the purposes of investing it in ways to ensure continued efficiency, innovation and prosperity.

To further demonstrate the benefits to small business owners, we have put together a depreciation model that calculates the cash flow benefits of the proposed change in depreciation schedules to two (2) years from the current five (5) years.

As we can see from the calculations, under current depreciation schedules (five years) a small business owner would have $4,330 of cash flow in the first year and the total net cost of the equipment purchased would be $45,670. Under the proposed schedule of two (2) years, the small-business owner would have $10,825 of cash flow to reinvest in his/her business while the total net cost of the equipment purchased would be $39,175. It is more than evident that the proposed depreciation schedule supported by the NASE would greatly assist small-business owners having access to capital.

Shortening depreciation schedules for computers, peripherals, and software to two (2) years has been proposed in the Small Employer Tax Relief Act of 2001 (H.R. 1037), which is supported by many members on this committee, and also in the Small Business Works Act of 2001 (S.189) sponsored by Senator Bond. 

ALTERNATIVE MINIMUM TAX & DEPRECIATION
It should be noted that the useful life years required for the Alternative Minimum Tax are different from the regular income tax. Therefore, if AMT depreciation schedules are not shortened in a fashion similar to regular tax depreciation schedules, the resulting affect will be to subject more taxpayers to the Alternative Minimum Tax. The NASE recommends that if the AMT is not repealed that at minimum, depreciation life years are adjusted to equal those for the regular income tax.

EXPENSING
One cannot address the issue of depreciation without discussing the current Section 179 expensing rules in our tax code. Most small-business owners and self-employed individuals prefer to utilize Section 179 expensing rather than depreciation because of the obvious tax benefit and reduced paperwork. Under Section 179 expensing rules, small-business owners receive the full tax benefit of their expenditures in the year they purchase their business equipment versus over a five-year period under current depreciation rules. This releases capital for small-business owners to utilize in business investment and as we stated earlier, access to capital is essential for small-business growth.

The NASE believes that to continue to encourage investment and to more adequately reflect the current costs of business equipment needed by small businesses to stay competitive, Section 179 expensing limits must be increased. The NASE proposes that investment incentives such as amending section 179 of the Internal Revenue Code to increase the amount of equipment purchases that small businesses may expense each year from the current $24,000 to $50,000 and increasing the phase-out limitation for equipment expensing from the current $200,000 to $400,000, would encourage small-business investment and in turn assist our nation’s economy. Increasing expensing limits would also assist entrepreneurs in their first year of business by reducing the net costs of initial business equipment purchases. We would also propose that purchased software be included as qualifying equipment under Section 179 expensing.

We have included a Section 179 expensing model to demonstrate the cash flow benefits of the proposed change in expensing limits. 

*includes cash flow from amount available for depreciation after utilizing $24,000
expensing limit.

As we can see from the calculations, under current Section 179 expensing rules a small-business owner would have $12,644 of cash flow in the first year and the total net cost of the equipment purchased would be $37,356. Under the proposed expensing limits, the small-business owner would have the substantial amount of $21,650 in cash flow to reinvest in his/her business while the total net cost of the equipment purchased would be $28,350. It is more than evident that the proposed increases in expensing limits supported by the NASE would also greatly assist small-business owners in having access to capital. Access to capital means greater investment in the business enterprise.

Increasing Section 179 expensing limits has been proposed in various pieces of legislation. Most prominently in the Small Employer Tax Relief Act of 2001 (H.R. 1037) and the Small Business Works Act of 2001 (S.189). 

CONCLUSION
If there is one message that the National Association for the Self-Employed would like to convey to Congress, it is that our nation’s small businesses and self-employed individuals need your assistance and they need it quickly. Many self-employed individuals and small businesses do not have the ability to survive this current economic downturn. Without assistance, their businesses will cease to exist. Two key ways that Congress and the Administration can assist them are to adjust depreciations schedules from the current five (5) years to two (2) years for computer equipment, peripherals and software and increase expensing limits from $24,000 to $50,000.