Opponents of the proposal have another bone to pick with the IRS. They contend that the IRS is ignoring its obligation under the Small Business Regulatory Enforcement Fairness Act (SBREFA) of 1996 by not determining the proposal's impact on small companies.
SBREFA is designed to protect small business by making sure federal agencies perform comprehensive analyses on the potential impacts of any proposed regulations and to develop ways to reduce any negative impact. Sen. Bond and 18 other senators have complained to Secretary Rubin that no such analysis was performed in relation to the IRS proposal.
"I cannot think of any proposed regulation more in need of thorough procedural review than one involving a stealth tax increase by regulatory dictate," says Bond, who was the author of the small-business regulatory act. There are too many in the bureaucracy, he points out, "who don't realize the [SBREFA] requires them to take additional steps to protect small businesses that would otherwise be run over by the regulatory juggernaut if they did not have this protection."
Not so, says the IRS. It maintains that the proposed regulation doesn't trigger compliance with the SBREFA because it's not an express mandate that requires collection of data on small businesses. In addition, the IRS says the service has the authority to issue what it calls "interpretive" rules (i.e. parameters not spelled out by Congress that must be interpreted by government agencies).
Some argue such interpretation is well within the IRS' domain. "One of the major reasons for the IRS to exist is to interpret what Congress means," says Thomas P. Ochsenschlager, a partner in the Washington, DC, office of accounting firm Grant Thornton LLP. Congress directs the IRS to develop tax regulations and provides the service with broad parameters in which to do so, he explains.
But Orban of the SBA's Office of Advocacy disagrees that this rule is an interpretive one. Instead, he sees it as a legislative regulation and as such, he maintains, the IRS is required to issue a regulatory fairness analysis to explain the rule's impact on small business.
If the required analysis shows that a substantial number of small firms will suffer a negative economic impact as a result of the proposal, then the IRS must give small-business owners an opportunity to participate in the rule-making process. This kind of participation would include public hearings, allowing small-business owners and advocates to argue against enactment of the proposal.
Critics of the proposed regulation are also quick to point out that the paperwork requirements, not only to be in compliance with the rule but to protect a small business in the event of an IRS audit, are too excessive. For example, even if partners were not required to pay self-employment taxes on all their profits, members of LLCs and limited partnerships would still face record-keeping hassles. That's because they would have to be able to show the IRS, in the event of an audit, that they didn't meet the three tests mentioned previously. Records would have to be kept on how many hours the owners work for the partnership, whether they have personal liability, and whether they have the authority to enter into contracts.