Back to LLC ResourcesTRANSCRIPT OF IRS HEARING ON LIMITED PARTNERSHIP REGS RELATING TO SELF-EMPLOYMENT TAXES. May 21, 1997
PROCEEDINGS
MS. MIOSI: I think both of our speakers are here this morning, so we'd like to get started. First of all, I'd like to welcome all of you. I appreciate your coming. This is a public hearing to discuss proposed regulations issued under section 1402 of the code. These regulations provide rules for self-employment tax on proposed SECA regs. The proposed regulation and the notice for proposed rulemaking were issued in the Federal Register on January 13, 1997.
We have two speakers at this point, who have requested the opportunity to provide their comments this morning. Before we begin with the speakers, I'd like to introduce the members of our panel. On my far left is Seth Green. Seth is with the tax legislative counsel at Treasury. On my far right is Robert Honigman. Robert is the docket attorney on this proposed regulation. Robert is an attorney advisor in the office of assistant chief counsel, Passthroughs and Special Industries. On my immediate right is Paul Kuglar. Paul is the assistant chief counsel, Passthroughs and Special Industries. I'm Dianna Miosi. I'll be the moderator this morning.
Each panelist today will have an opportunity to provide their comments. They will be given ten minutes to provide their comments. If the person who is going to be the first panelist would move over to the microphone, there will be a light system set up there. The green light will go on when you've begun your presentation. There will be a yellow warning light when you have three minutes left on your presentation and then the final red, blinking light, when it's wrapup time.
We' like to provide this hearing this morning and make it as informal as possible. There may be opportunities during the speakers' presentation to ask questions. We'd like to have a dialogue going. At this point I'd like to introduce Daniel Mastromarco - I hope I pronounced that correctly.
MR. ORBAN: Actually, I'm Russell Orban. If it's okay with the panel, what we'd like to do is -
MS. MIOSI: Reverse the order?
MR. ORBAN: - reverse the rules. I'll address, basically, the regulatory flexibility aspects of it. That is the procedure with which it was put together. I think Dan is going to address the substantive part of the rule.
MS. MIOSI: That's fine, Russell. Russell is representing the Small Business Administration. At this point, Russell, you can begin.
MR. ORBAN: Thank you for this opportunity to testify regarding the amendments. My name is Russell Orban. I'm appearing on behalf of the Office of Advocacy of the Small Business Administration. This is done under the general authority of the Office of Advocacy, to monitor agency compliance with the Regulatory Flexibility Act, and as amended by the Small Business Regulatory Enforcement Fairness Act. Additionally, the Small Business Act authorizes the Office of Advocacy to represent the interest of small businesses before federal agencies. The views expressed are solely those of the Office of Advocacy and do not necessarily reflect the views of the U.S. Small Business Administration or any other government agency. First I want to establish two points today. First, the scope of this proposed regulation, the discretion that was allowed to the IRS, which was necessary to stretch this regulation to fit the exploding field of limited partnerships and limited liability corporations. The sheer number of partnerships and limited liability corporations involved, and the potential for new tax obligation for some participants, based solely on the IRS application of this numerical requirement, ceded to the IRS the type of legislative authority that the Congress intended to be covered by the Administrative Procedures Act, and therefore by the Regulatory Flexibility Act. In such cases, the law requires that analysis of the impact of such regulations on small entities to be done and to be published with the proposed rule.
Second, in the alternative - even if the IRS were to believe that the proposed regulation is merely interpretative, the IRS must still perform a regulatory flexibility analysis, because the proposed regulation requires one more thing to be done; requires one more record to be made; requires one more record to be maintained and filed; requires one more record to guide in partnership and corporate decisions, and requires one more record to be presented as proof to the IRS, on demand, at some later time. The Congress was very clear, we feel, in the SBREFA legislation, that this new requirement was to be construed as broadly as possible, therefore, we feel it covers the present proposed regulations.
The Office of Advocacy is aware that the Service has received a number of comments challenging the merits and the substance of the proposed regulation. For the most part, the Office of Advocacy will focus its comments, primarily, on the applicability of the Regulatory Flexibility Act to the proposed rule. The Office of Advocacy disagrees with the Service's determination that, first, section 553(b) of the Administrative Procedures Act does not apply, and second, that the regulations do not impose a collection of information requirement on small entities. We, therefore, disagree with the IRS conclusion from these two findings that the Regulatory Flexibility Act does not apply to the proposed regulation. A rule that is subject to the Regulatory Flexibility Act is any rule, quote, "For which an agency publishes a general notice of proposed rulemaking pursuant to section 553(b) of the Administrative Procedure Act, or any other law."
Section 553(b) of the Administrative Procedure Act provides in part, "Except when notice or hearing is required by statute, this subject does not apply to interpretative rules." That's the section that the Internal Revenue Service is relying on. The distinction here is between legislative and interpretative rules and it is important because it is necessary for the Service to make the decision that the proposed rule is interpretative before it can claim an exemption for complying with the Regulatory Flexibility Act on its assertion that no information collection requirement is imposed on small businesses. Generally, a determination as to whether a rule is legislative and, therefore, subject in all cases to the Regulatory Flexibility Act, or interpretative and therefore not subject to the Regulatory Flexibility Act, unless there's an information collection requirement, has rested on whether the rule is the product of an exercise of delegated legislative power to make law through rules, and therefore, a legislative rule, the degree of discretion left to the IRS to fashion a rule and the scope with which the rule was fashioned.
Internal Revenue Code section 1402(a)(13), which defines net earnings from self employment and generally excludes earnings from limited partnerships, quote, "Other than guaranteed payments that partner for services annually rendered to or on behalf of the partnership" - and I emphasize - "to the extent that those payments are established to be in the nature of remuneration for services."
The discretion used by the IRS is far-ranging and required the Service's particular expertise. The reach of the statute needed to be stretched to cover the multitude of partnership arrangements, each of which is covered by a different controlling state law. That difficulty is compounded by the proliferation in the past few years of limited liability corporations, which were barely contemplated with the section 1402(a)(13) became law.
The new proposed rule establishes a standard using functional tests to determine when a partnership distribution to an individual will be classified as net income from self employment. Personal liability for debts and claims is one, contract authority and if an individual participates 500 hours per taxable year. Without regard to the Service's proposed approach, whether the Service's proposed approach is right or wrong, these tests were established that were not even hinted at in section 1402. The tacit authority delegated by Congress to establish a standard in the amount of discretion and expertise required to set that standard, provides strong evidence that the proposed rule is legislative. As such, the Service is obligated to comply with the Administrative Procedures Act and the Regulatory Flexibility Act.
As to its significant economic impact on substantial number of small entities, once it has been determined that the proposed rule is legislative, you need to find such an impact, or so certify that you cannot find such an impact within the text of the proposal.
Clearly the rule will have a widespread impact, particularly on the so-called professional limited liability corporations. Because the rule states the distribution to those professionals will always be considered net earnings from self employment, and therefore, not subject to employment taxes. The amount of assets controlled by such groups is significant. For example, partnerships related to health care, legal accounting, consulting, architectural and engineering services control about $ 48 billion worth of capital assets. The most recent partnership data that we have shows that there were 1.49 million partnerships in 1994. Of those, 283,000 were limited partnerships, 48,000 were limited liability corporations, therefore, about one- fifth of all partnerships.
The net income distributed to individual limited partnerships, so therefore, the total income which could be considered under the self-employment tax under the proposed rule was $ 13.4 billion. Even if one assumes that limited liability corporations will restructure, the restructuring should have been analyzed, in our opinion, by the Service before the rules were promulgated. This is to let small businesses know what they're facing. The analysis would let them know what they are dealing with and would give them the figures with which to comment confidentially.
If the Service determines that the rule is interpretative - a classification which we feel is wrong - the SBREFA provides that an analysis should have been done anyway where there is a collection of information requirement. This is defined as requirements imposed by an agency on persons to maintain specified records. Section 1.1402(a)-2(h)(iii) of the proposed rule would treat a partnership distribution to a partner as net earnings for self employment, if the individual participates in the trade or business for more than 500 hours during the partnership's year. At the very least, it would require the prudent partner to maintain or cause to be maintained, records reflecting the amount of hours spent participating in the partnership's business during that taxable year.
The Office of Advocacy anticipates that the IRS might contend that nothing in the rule compels recordkeeping, but the Office of Advocacy believes a new, stricter standard imposes a de facto recordkeeping requirement. As such, SBREFA requires the burden on small businesses to be analyzed, with an opportunity for public comment on that analysis.
As to our recommendations, because it is the Office of Advocacy's opinion that this proposed rule is clearly subject to the Regulatory Flexibility Act and has demonstrated significant economic and recordkeeping impact on a substantial number of small entities, we recommend that the Service withdraw its proposed rule, or at the very least, prepare an initial regulatory flexibility analysis so that the impact on small partnerships can be taken into account by the regulators so that small businesses can better understand what the impact will be on them.
In the alternative, if the Service does not withdraw the proposed rule, the deadline for comment should be extended to give small businesses and the community time to read more deeply into that proposed rule to understand its impact and to comment more intelligently. For this purpose, it would be helpful to have an initial regulatory flexibility analysis as soon possible so that businesses can be fully informed about how the rule will affect them.
If upon analysis the Internal Revenue Service believes that the proposed rule is legislative and therefore subject to the RFA, but will not have a significant economic impact on a substantial number of small business, the Commissioner is required to so certify in a new notice of proposed rulemaking and support that finding with factual information. We thank you for the opportunity to comment.
MS. MIOSI: Thank you. Any questions? Thank you very much, Mr. Orban.
MR. ORBAN: Thank you.
MS. MIOSI: Our next speaker is Dan Mastromarcos, representing the Coalition to Stop New Payroll Taxes.
Good morning.
MR. MASTROMARCO: Good morning. Thank you for having this hearing today and hearing us out. I am joined, if the record can reflect and if there's no objection, by David Burton, who is a partner in my firm with me. For lack of a better name, we've established the name of the Coalition to Stop Payroll Taxes. We're with the Argus Group in Washington, D.C., which is a law and government relations firm, but we represent a significant section of the small business population that is concerned about this rulemaking from the private sector's perspective.
Some of these members - and I have a copy which I can hand out as an exhibit to you - include the National Small Business United, National Restaurant Association, Small Business Council of America, Small Business Survival Committee, the United States Chamber of Commerce, the National Federation of Independent Businesses, National Association of Manufacturers, American Health Care Association, even the Helicopter Association International, the American consulting Engineers Council, Securities Industry Association and the housing industry, the American Seniors Housing Association, the National Apartment Association and other travel and tourism related entities such as the American Society of Travel Agents and United Motorcoach Association.
Together, the entities represent a good portion of that two hundred eighty some thousand limited partnerships and 48,000 LLCs that are out there. It is their combined opinion that this rulemaking is - it certainly is clever in certain respects, but it is fatally flawed, and it is our opinion that it should be withdrawn.
Now let me begin by explaining why. In the risk of sounding slightly redundant with respect to what Russ said, there are really four tiers or levels of concern that many small businesses have about this rulemaking. One is procedural. Another is policy. Another is technical, and another is statutory.
Now, let me begin I think by what is the most important for many of these organizations, and that is the procedural requirements. Perhaps Russ and I may be the only ones on this side of the table that agree with that. Because for the past 17 years or so, since the enactment of the Regulatory Flexibility Act, the Internal Revenue Service has maintained that virtually every rule that is promulgated is interpretative in nature. I couldn't disagree more with that. I think that if the rule is interpretative, then we have some problems. Because if, for example the rule is interpretative, as logical corollary, the Internal Revenue Service didn't even have to provide notice and comment to taxpayers, wouldn't even have had to provide it in the Federal Register. In fact, the rule could have been retroactive in nature. We could have just told taxpayers that they are subjected to it - and no one would agree that that's right. So, we're locked with the assumption, we suppose, that the Service did this just out of benevolence, that they put it in the Federal Register - even though it's interpretative, they did it just to alert taxpayers because it's the correct thing to do.
Well, there's another corollary to this and there's another corollary after that. But one of the corollaries to this is that, if it's interpretative, it doesn't have the force of law. What happens when a taxpayer, then, complains in a court - in a federal court - and says that we should apply state law principles of what a limited partner is? Do they have to adher to the federal government's interpretation of this? Because by your own admission, the rule is interpretative and therefore does not have the force of law. Let me - I think the record should reflect a decision - or at least the reasoning of a decision that was decided almost one year ago today in the District Court for the District of Columbia about this very issue, Associated Builders and Contractors, Incorporated versus Secretary Reisch. Here the court said - without getting into the details of it, the ruling - "The label that the agency puts on a rule is not conclusive, rather it is what the agency does in fact as explained in national family planning interpretative rules are those which clarify statutory or regulatory terms" - clarify, explain existing law, and remind us of duties we already have under the law. Whereas legislative rules accomplish more than that.
For example, a rule is legislative if it attempts to supplement a statute, not simply construe it. Rules are legislative when they fill in gaps and resolve inconsistencies left by the statute. For example, perhaps a change in the environment, more LLCs have come up. Rules that affect a change in existing law or policy, and I think that we could look at almost every comment letter filed by the groups out there and they would say this would be a change in existing policy. Rules that grant rights and pose obligations or produce other significant effects on private interest - significant effects on private interest. Rules are legislative if they finally determine rights to which they are addressed and do not leave the agency free to exercise discretion. See, section 553(b) was enacted - according to Texaco versus Federal Power Commission to give the public an opportunity to participate in the rulemaking process, and to enable the agency promulgating the rule to have the benefit of this type of input.
But, as I mentioned, there's one other corollary. What is the other corollary? The other corollary is that by saying the rule is interpretative, the Service can escape, they believe, the Regulatory Flexibility Act. That certainly is patently untenable as a result of 17 years of claiming that rules are interpretative and not legislative; but here they say that even though Congress sought to strengthen the Regulatory Flexibility Act, it doesn't apply because the rule is interpretative, except the Regs Flex Act would apply if there's a collection of information requirement, and that's what Mr. Orban has pointed out.
I think that it is - I would add on top of what Mr. Orban said that there clearly is a collection of information requirement that's here, because I would suggest to this group that the collection of information requirement doesn't need to be much. According to Representative Hyde in the consideration of the bill, the Regs Flex Act and SBREFA changes, "The IRS should take an expansive approach in interpreting the phrase, 'collection of information' when considering whether to conduct a regs flex analysis. The rule requires facts" - and then they give a specific example - "to be maintained by many more than ten persons, and it's impact would be substantially greater than the impact of a collection requirement of ten persons."
Well, one would say that, well, we keep track of hours today. For example, for dealing with a nonservice sector law, this is something that we already do. Well, it really isn't. Because what you're saying is that, at the end of that 500 hours, immediately, right at that cliff - right at that effect, all of a sudden the world changes for that person. All of a sudden, all of the earning, the distributed earnings, are subject to the SECA wage base, at that point in time. That's a very big obligation, then, for that firm to insure that that 500-hour point - where that 500-hour point is located. I would say that other procedural rules are breached as well, including I think the Executive Order 12866, which is supposed to require cost benefit analyses with these type major rules.
Seth, I know that of course you're here. It would be interesting to know whether Treasury Department had done an analysis to determine what the cost of this rule is, probably less than - maybe around $ 100 million or so. I don't know. But the point is, you know, if we don't know whether or not the rule was a major rule, then how can we say in the special analysis section of it that it simply does not have that impact? In just a statement that it's interpretative, a statement that it's not subject to the Executive Order, is not sufficient.
One other point - two other points. We think that it abrogates the statute on which it is designed to interpret. I mean, even if we assume that the rule is not interpretative, even if we assume that it doesn't impose a collection requirement, even if we assume that the rest of the procedural requirements are there, it still abrogates the statute. Because the statute may be wrong today in the view of the Treasury Department - may not reach the right result. But that statute doesn't reach the right result does not give us the power to change that statute through a regulatory process. In effect, what we have here is an awkward legislative proposal, in my view.
I mean, section 469 imposed a materiality - material participation standard. That was done through a legislative means. Could we have done that through a rulemaking process? I think that the 1402 standard is very clear.
I'd also add one other point very quickly in closing. Even if this were advanced as a legislative proposal, I think we've got unsound tax policy here, because we've got a proposal which is regressive in nature, which affects lower income people more than upper income people, that imposes a cliff effect that is unnecessary, and that imposes other definitional requirements that are difficult.
The wrong rule, the wrong process for the wrong vehicle. That's why we think it should be withdrawn.
MR. GREEN: I'd just like to ask one question. You're saying that you think it's inconsistent with the statute. Do you think that the only thing that matters under the statute is what you have stamped on your forehead, that if - the only thing that matters is whether or not the thing written across your forehead is "limited partner," is that what you think the statute says?
MR. MASTROMARCO: Except I don't - can you elaborate on that a little bit more. I'm not sure I understand.
MR. GREEN: In other words, I'm not sure exactly what you're objecting to. I understand you were running out of time, maybe you want to elaborate.
MR. MASTROMARCO: Sure.
MR. GREEN: But, one of the things that the regulation does is it takes certain people, who under state law maybe described as limited partners, and says nonetheless for federal tax purposes that determination is not binding. Is that the aspect of the regulation which you object to?
MR. MASTROMARCO: No.
MR. GREEN: It's some other aspect.
MR. MASTROMARCO: No, no. I mean - if you were to go right to the heart of the matter, from a policy perspective -
MR. GREEN: No, let's start with the statutory interpretation question. We are, I agree, bound by the statute, so -
MR. MASTROMARCO: Okay, let me back it up then even further than that. I don't think we should frankly - but I will respond to that, because I think that it's an important question. But I don't think that we should be here talking about the merits of it, to be perfectly honest with you.
The first part of my discussion here was how the procedural rules were breached. I don't think that this is the correct proceeding to be carrying on this type of debate on the substance of this issue. I don't think we should be talking about the merits of it.
MR. GREEN: I understand your concern, but - but - but -
MR. MASTROMARCO: Now that being said, now -
MR. GREEN: - just two issues with that. First of all, we may or may not end up agreeing with you on those matters, and even if we were to end up agreeing with you, it can only help to get more substantive input at earlier proceedings. Even if we were going to scrap this whole thing and start over, it would help to have substantive comments.
So, without prejudging the issues that you discussed earlier -
MR. MASTROMARCO: My concern, Seth, in response to that - and I appreciate that, because those are my sentiments and I'd be happy to - the Coalition that we represent hasn't really discussed a lot of the substantive details, but I'll speak off school and give you my - for whatever benefit it's worth - of my viewpoint.
The major crux of the problem here is that the SECA wage base was meant to tax the return on compensation and not return on capital, entrepreneurial risk or other types of earnings and economic returns. What this is - when we impose - when we define what a limited partner is not, by saying that it is not, it is equal to - a general partner is equal to, with a few exceptions, those that work more than 500 hours. Or, those that are, you know, part of a service business - and I think you've got some problems there because you're using a 448 definition, which - I mean, consulting is a pretty broad category there.
But once you say that, then, you've insinuated a triggering mechanism - imported a triggering mechanism that will in effect cause LLCs and limited partnerships to have the wrong result, a result that is inconsistent and not consonant with the result achieved with respect to S Corporations.
MR. GREEN: The statute is different for S Corporations and partnerships, right? I mean, just all other things to decide, can we agree with that? That S Corporations is salaried paid. Partnerships is what 1402(a)(13) says and now we're here to figure out what we think that means -
MR. MASTROMARCO: Right.
MR. GREEN: - different from salaried paid. Agreed?
MR. MASTROMARCO: Uhm hum.
MR. GREEN: Okay, so, I guess what I'm saying is, I'm giving you the pen for a couple minutes here.
MR. MASTROMARCO: Okay.
MR. GREEN: There's an LLC out there, and it taxes the partnership under federal tax law. Who's the general partner and who's not a general - who's a limited partner and who's not a limited partner? You tell me.
MR. MASTROMARCO: Well, I think that you've got a difficult question there. I mean, how do you define - how does one define what a limited partner is?
I think there are other issues there, too. What's a guaranteed payment, for example. You could have also affected that definition as well. But I think you've got to go back, Seth. My view would be that we cannot be this far divergent from what Congress thought a limited partner was at the time they wrote 1402(a)(13).
MR. GREEN: I agree.
MR. MASTROMARCO: And I think that the underlying - you know, premise here is that the state laws have changed from the - you know, the Uniformed Limited Partnership Act in existence, you know, since 1918 in those.
I think one of the comments that you've received suggest - - and I agree with this, is that partners - limited partners have always - - was contemplated and were able to participate in the business. So, the participation - it's the triggering mechanism, it's the material participation standard that is troublesome.
MR. GREEN: Even though you yourself said that what SECA is about turns on compensation.
MR. MASTROMARCO: Yes.
MR. GREEN: Which tends to, in my mind, relate at least in part - - perhaps not solely. You know, there are other aspects of the regs that we have not talked about in which someone who has a general partner-like interest can still obtain the SECA exclusion.
MR. MASTROMARCO: Oh, I think it gets partly - what you're saying is, because somebody has worked more than 500 hours - let's go back to the service sector, for example. What you're really saying is that, if they've worked more than 500 hours, it doesn't matter what they've done, what the real value of that labor is. I mean, Seth, to cut to the center of the target of this issue, what I think the right answer is that we're seeking to achieve and the means by which we achieve that right answer, I think, is incorrect in respect to this rulemaking, both in the substance of the rulemaking and the process of the rulemaking; but, that of course being repeated three times -
MR. GREEN: Right, we've discussed -
MR. MASTROMARCO: - I'll say this. The right answer is, what is the reasonable compensation that is paid to this individual?
MR. GREEN: Does the statute allow that?
MR. MASTROMARCO: I think that if the statute does not allow that, you're in a box. And I think -
MR. GREEN: Okay, I'm in a box.
MR. MASTROMARCO: Okay.
MR. GREEN: And I guess the question is, sitting in my box what am I supposed to do?
MR. BURTON: If I may, the statute basically is there's a presumption that it's not subject to SECA, it's not remuneration unless it's established to be remuneration.
MR. GREEN: No, no, no. That is once I've determined who is and is not a limited partner. My question is, how am I supposed to go about determining who is and is not a limited partner.
MR. BURTON: Well, you can more or less state categorically that the regulation sets up a 500-hour rule that has no basis in limited partnership law, and states categorically that service partnerships can't have limited partners, per se, which has almost no basis in law, and certainly no basis in the legislative history. The legislative history was meant to very narrowly circumscribe what could be characterized as wages. The regulation does precisely the opposite.
MR. GREEN: I'm not sure I completely agree with that characterization. Nonetheless, the question I'm trying to get at is - - take the example of something which is not a state law limited partnership so that I don't have state law labels to look at.
Does that mean that nobody's a limited partner? Does that mean that everybody's a limited partner? How do I decide? If I make a decision for those entities, which are tax law partnerships, but not state law partnerships, is it appropriate to create this dichotomy between people who have their legal rights with respect to the business and the extent to which they participate in the business, should they be treated differently?
MR. MASTROMARCO: Well, I think maybe you might - one might argue that it wouldn't - that it's not necessarily inequitable to do so. To do so I treat them differently. Because in going into this business, the laws were known to these people in terms of what entity, what selection that they - what capacity they decided - you know, in what capacity they decided to work.
But, getting back to the original point I think, Seth, that was kind of lost in this very good dialogue here, however, is that you have to, I think, put yourself in the shoes of those that wrote 1402(a)(13) and the atmosphere that existed then in terms of limited partnership law, to determine what in a general consensus was a limited partner back at the time that that law was written?
MR. GREEN: I would suggest quite strongly that a practicing attorney in a state law registered limited liability partnership was not in their mind, with all due respect.
MR. MASTROMARCO: But, with all due respect, if that were a limited partnership, clearly - not with respect to LLCs - if it were really a limited partnership, then in that case, the Congress did know what limited partnerships were, and they knew that there was a distinction, for example, between corporations and partnerships. They knew the four primary distinctions between them in Larson versus Commissioner in 7701 - and they knew basically there was a distinction between limited partnerships and general partnerships in terms of limited liability and who could buy into the partnership.
But one of the things that - and I hate to sound circuitous - but one of the things that clearly was not in their mind was that someone would not be a limited partner if they were in a service limited partnership, or if they worked more than 500 hours for a limited partnership.
MR. GREEN: Doesn't the legislative history suggest to you that they really thought limited partners were passive people?
MR. MASTROMARCO: No, it doesn't.
MR. GREEN: Okay.
MR. MASTROMARCO: It doesn't and so that premise, I think I would not agree with, but I would also, Seth, disagree from this perspective: I think that even if one were to assume that - assuming arguendo that that's true. I also think that the mechanism by which we simply equate a unit of time that a person spends in a capacity - 500 hours - with complete and thorough assignment of all distributive income to them as subject to the SECA wage base is the wrong answer. I think the right answer is, what was that compensation worth?
Certainly they would have to be participants in that. They would have to work, that's part of the triggering mechanism, and I think that's maybe where the AICPA might actually be coming out on this particular one. But I think that that could be one triggering mechanism: Does the person work more than 500 hours. But once you cross that threshold and you've identified that, then the question becomes, well, how much of the earnings were a return on capital; and how much were a return on the labor and the compensation?
I think you have to almost ask yourself this question: If we were in business and we put in a tremendous amount of money, which unfortunately we have to do today to return a certain amount of earnings to us, we're still working 80 hours a week. I mean, we're going to put in a tremendous amount of work with our own business, but we've already - we've paid for capital stock, we've bought lots of equipment for this business, and would anybody maintain that we could operate a restaurant standing on a street corner without any of the trappings of the restaurant or any of the business around us and make as much money as we would if we had a building at the Post Office Pavillon or something of this sort, where part of the earnings that inured to us from the capital expenditures in that business.
I think the question that we have to ask is almost an arms- length question: How much would that business have to pay to have somebody -
MR. GREEN: I couldn't agree more, but you're talking now about the right, ideal world. I'm - as we sit, way back at the end - - I think this is really the beginning. I think this is about as far as we can get. The statute says, "If I determine you're a general partner, it's all SECA." Whether that's the right answer or the wrong answer.
MR. MASTROMARCO: Of course, that is the wrong answer.
MR. GREEN: But that's what the statute says. Right?
MR. MASTROMARCO: Uhm hum.
MR. GREEN: And then if it says it's a limited partner, what is actually paid to you is a guaranteed payment.
MR. MASTROMARCO: That's why there are so few general partners.
MR. GREEN: That and personal liability, I would suggest, is another very important reason.
MR. MASTROMARCO: It's certainly another one, right.
MR. MASTROMARCO: On the other hand, there are a lot of sole proprietorships.
MR. GREEN: Which are also penny - every penny you earn, whether or not you flex your invested capital. I'm not here to defend the way the statute is written.
MR. MASTROMARCO: Then there are also S Corporations, which consume most of the earnings of small businesses.
MR. GREEN: Right, and they have a different regime. I'm not here to defend either the S Corp regime, the sole proprietor regime, or the limited partnership regime, I'm here to interpret them.
MR. MASTROMARCO: I think it's an interesting academic question to try to determine how in a rulemaking one could squeeze their hat together to try to come up with a rule that reaches the right result. What I'm suggesting to you is that it cannot be achieved in that manner; and what I'm suggesting to you is that also while this is an interesting academic discussion, Seth, I'll get back to the original point concerning the process.
It is absolutely wrong to call this rule interpretative when it has these very serious impacts on these two significant forms of entity that exist out there; and that this rule is substantive and should have been subject to the APA.
MR. GREEN: I will simply say I can't agree that it's academic, because people are facing this issue.
MR. MASTROMARCO: Well, my only reason -
MR. GREEN: Whether or not we issue a reg - whether or not we issue a reg, people have to resolve this issue. In particular, LLC members must know that the statute gives them more freedom.
MR. HONIGMAN: Mr. Orban, did you have something you wanted to say?
MR. ORBAN: Yeah, I was just - I wanted to add on to his comments that a certain amount of what you're talking about, which is substitute, also depends on good information to make the correct substitute decisions on how you're going to pare out who's a limited partner and who's not; what is required under the law in a legislative function like this. That's where I think the regulatory flexibility comes in, that's where I think the Administrative Procedure Act had in mind that this information be collected and analyzed when it comes to small businesses so you could make intelligent determinations.
MS. MIOSI: Any additional comments or questions? Thank you very much for attending this public hearing today.