The Few, the Proud, the Tax-Free

The House has voted to eliminate capital gains taxes on investments in small businesses through the end of next year.

Sounds like a great deal, right? That really ought to stimulate entrepreneurship in America.

There’s a slight catch, however. The tax break only applies to investments in C corporations, a form of business organization that is rare among small businesses. Most small firms are S corporations, partnerships, limited liability companies, or sole proprietorships—entities whose profits pass through to their owners for tax purposes. These small businesses won’t benefit from this new tax break.

“While this bill is great rhetoric, this bill isn’t going to be effective in doing anything,” said Representative Dave Camp of Michigan, the ranking Republican on the House Ways and Means Committee.

Democrats passed “a small-business bill that doesn’t apply to the majority of small businesses,” he said.

Representative Sander Levin, the Michigan Democrat who chairs the House Ways and Means Committee, disputed Camp’s contention that this tax break, which applies to small-business stock held for at least five years, does nothing for small businesses.

The Joint Committee on Taxation, he noted, estimates that the zero capital gains rate on this stock will result in a nearly $2 billion tax cut over the next 10 years.

“That’s nothing?” Levin asked.

“What’s nothing are your arguments,” he said. “You just don’t apparently want to be caught doing anything bipartisan. It’s going to blur a political message.”

The legislation expands a tax break first passed as part of the economic stimulus, which excluded 75 percent of investments in small-business stock from capital gains taxes. President Barack Obama has urged Congress to increase this exclusion to 100 percent.

How much investment in small businesses did the 75 percent capital gains exclusion stimulate? House Democratic leaders couldn’t say today, when asked at a press conference. How much investment will a 100 percent exclusion generate? They didn’t have those numbers handy.

House Speaker Nancy Pelosi did say, however, that the zero capital gains rate “will be very important for those who will benefit from it.”

House Majority Leader Steny Hoyer found it ironic that Republicans, who usually argue that tax cuts stimulate the economy, contend they wouldn’t do so in this case.

The tax bill, which passed on a 247-170 vote Tuesday night, also would increase the deduction for startup businesses expenses from $5,000 to $20,000.

The legislation also closed a tax loophole for paper mills and limited the use of grantor-retained annuity trusts, a tax-planning tool that enables wealthy families to limit estate and gift taxes. These revenue-raising measures will help pay for a companion small-business measure that the House will vote on Thursday: the creation of a $30 billion fund that will provide cheap capital to community banks for use in making small-business loans. This proposal, first made by President Barack Obama last October, is designed to thaw the flow of credit to small businesses. It’s been endorsed by the Independent Community Bankers of America and the National Small Business Association.

Republicans, however, don’t like that proposal either—they claim it’s nothing but another bank bailout. There’s no guarantee that banks will use that money to increase lending to small businesses, they argue. The legislation, however, includes incentives for banks to do just that—they’ll pay lower dividend rates on the capital they borrow from the government if they increase their lending to small businesses and higher rates if they decrease it.

“I don’t know anyone who analyzes our businesses out there who says it wouldn’t be good to have more credit, more availability, more lending, more growth in our businesses,” said Representative Chellie Pingree, a freshman Democrat from Maine.

Republicans, however, are ready to vote against this bill. They could be joined by some Democrats who fear being accused of voting for another bank bailout.

It’s not as simple as it looks to be pro-small business.

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Kent Hoover is the Washington bureau chief for bizjournals.