Small Business Tax Benefits: Current Law
Updated November 10, 2021
Congressional Research Service
https://crsreports.congress.gov
RL32254

Small Business Tax Benefits: Current Law

Summary
The federal tax burden on small firms and its effects on their formation and growth have long
been matters of concern for Congress. This abiding interest has contributed to the enactment of
targeted tax relief for a number of small businesses.
This report describes the main federal tax benefits for small firms. More specifically, its scope is
restricted to tax preferences available only to small firms in a wide range of industries. As such,
the report does not include tax benefits targeted at small firms in specific industries, such as the
special deduction for small life insurance companies under Internal Revenue Code (IRC) Section
806. Nor does the report address tax provisions that benefit many small firms in a range of
industries but are available to firms of all sizes, such as the research tax credit under IRC Section
41 and the Section 199A.
The following small business tax benefits are examined here:
 expensing allowance for machinery and equipment under IRC Section 179;
 cash-basis accounting under IRC Section 446;
 tax credit for the start-up costs incurred by small firms in establishing qualified
employee retirement plans under IRC Section 45E;
 tax credit for employers who offer or start a 401(k) plan or a Savings Incentive
Match Plan for Employees (SIMPLE) that add automatic enrollment under IRC
45T;
 tax credit for the costs incurred by small firms in complying with the Americans
with Disabilities Act under IRC Section 44;
 full exclusion from the capital gains tax on the sale or exchange of qualified
small business stock under IRC Section 1202;
 exemption from the limitation on the deduction for business interest expenses
under IRC Section 163;
 tax credit for small firms that offer qualified health insurance coverage to
employees under IRC Section 45R;
 simplified dollar-value last-in-first-out accounting under IRC Section 474;
 deduction and amortization of business start-up expenses under IRC Section
195;
 ordinary income treatment of losses on the sale of eligible small business stock
under IRC Section 1244;
 ordinary loss treatment for loses on the sale of Small Business Investment
Company stock under IRC Section 1242;
 exemption from the uniform capitalization rule under IRC Section 263A; and
 use of excess research tax credit to reduce the payroll tax liability of qualified
small firms under IRC Section 41.
While available information does not allow for a precise estimate of the foregone federal revenue
linked with these small business tax preferences, recent estimates by the Joint Committee on
Taxation (JCT) suggest that foregone federal revenue might exceed $18 billion in FY2021.
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Small Business Tax Benefits: Current Law

Introduction
Small business owners in general have long been praised for their contributions to the U.S.
economy, especially their impact on job growth and innovation. Many regard small firms as a
vital source of job creation and technological innovation. Small firms have also been celebrated
as effective vehicles for advancing the economic status of minorities, immigrants, and women.
Some view the federal income tax as an obstacle to the formation and growth of small firms
because of its negative impact on incentives to work and invest. Others look upon federal taxes as
a policy tool for increasing small businesses’ rates of formation and growth. This report addresses
the ways in which federal taxes preferentially treat small firms.
Since the 111th Congress, nine bills have been enacted that established new small business tax
preferences and extended and/or modified existing ones:
 American Recovery and Reinvestment Act of 2009 (P.L. 111-5),
 Patient Protection and Affordable Care Act (ACA, P.L. 111-148),
 Small Business Jobs Act of 2010 (P.L. 111-240),
 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of
2010 (P.L. 111-312),
 American Taxpayer Relief Act of 2012 (P.L. 112-240),
 Tax Increase Prevention Act of 2014 (P.L. 113-295),
 Protecting Americans from Tax Hikes Act of 2015 (Division Q of the
Consolidated Appropriations Act, 2016 [P.L. 114-113]),
 P.L. 115-97 (also known as the Tax Cuts and Jobs Act or TCJA), and
 Setting Every Community Up for Retirement Enhancement Act of 2019
(SECURE Act, P.L. 116-94).
Small business tax benefits (or preferences) raise the question of how a small business should be
defined for tax purposes. Two considerations seem paramount in crafting such a definition: (1)
choosing the appropriate size measure (e.g., employment, assets, or receipts) and (2) deciding
whether the chosen measure should govern eligibility for each small business tax benefit.
This report serves two purposes. One is to clarify the definition of a small business for the sake of
government tax policies intended to support small firms. The other is to identify the main
nonagricultural small business tax preferences and consider the foregone revenue associated with
them.
There is considerable federal support for small firms beyond the tax code. These programs and
policies are not discussed here. Details on much of this support can be found in several CRS
reports.1

1 See CRS Report RL33243, Small Business Administration: A Primer on Programs and Funding, by Robert Jay
Dilger; CRS Report R45576, An Overview of Small Business Contracting, by Robert Jay Dilger; and CRS Report
R43695, Small Business Research Programs: SBIR and STTR, by Marcy E. Gallo.
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How Does the Federal Tax Code Define a Small
Business?
The U.S. Small Business Administration (SBA) is the primary federal agency for setting small
business size standards. Its standards determine eligibility for many of the programs the SBA
administers, and federal agencies that set aside a portion of their contracts for small firms
generally are required to use SBA size standards to determine eligibility.
The federal tax code does not rely on SBA size standards to determine eligibility for available
small business tax benefits. As Table 1 shows, most of these tax preferences use asset, receipt, or
employment size to identify eligible firms.2 The employment and receipt sizes found in the tax
code are much smaller than the sizes used by the SBA to identify small businesses by industry.3
A few tax provisions benefit small firms as a consequence of their design rather than through a
size standard. A prime example is the limited expensing allowance under IRC Section 179. It
allows businesses to expense (or deduct as a current expense) a certain amount of eligible
tangible, depreciable assets in the year they are placed in service. Although the provision’s
statutory language does not bar large companies from claiming the expensing allowance, the
limitations on its use have the effect of confining its benefits to small firms.
Different size standards are used to determine eligibility for existing federal small business tax
benefits. This lack of uniformity may have certain consequences. On the one hand, it can lead to a
seemingly arbitrary distribution of tax preferences among small companies that are similar in
lines of business and in employment, receipt, or asset size; a company may be eligible for some
preferences but not others.4 On the other hand, the absence of a uniform size standard for federal
small business tax preferences may allow lawmakers greater leeway in designing tax benefits to
support policy objectives that do not concern all small businesses.
Main Federal Tax Benefits for Small Business
In principle, all business income is subject to federal taxation, but the reality is more complicated,
as the federal tax code does not treat all business income equally.
The tax burden on business income depends on several factors. One is whether a firm is
organized for tax purposes as a C corporation or as a pass-through entity (i.e., partnerships
(including limited liability companies, or LLCs), S corporations, and sole proprietorships).
Corporate profits are taxed twice: once at the firm level and a second time at the shareholder level

2 According to one source, the Internal Revenue Code contains at least 24 different definitions of a small business. See
Douglas K Barney, Chris Bjornson, and Steve Wells, “Just How Small Is Your Business?” National Public Accountant,
August 2003, pp. 4-6.
3 For instance, as of August 2019, the SBA uses an upper limit of 500 employees for small firms in 98 manufacturing
industries and an upper limit of $16.5 million or $22.0 million in average annual sales or receipts for small firms in
most administrative and support service industries (see CRS Report R40860, Small Business Size Standards: A
Historical Analysis of Contemporary Issues, pp. 25-30, for more details). By contrast, only firms with no more than 25
full-time employees earning $50,000 or less in wages or salaries may claim the maximum small employer tax credit for
health insurance costs under Section 45, and only corporations and partnerships with less than $5.0 million in average
annual gross receipts in the previous three years are eligible to use cash-basis accounting when they otherwise would
have to use accrual-basis accounting under Section 446.
4 For instance, two small companies with the same number of employees engaging in the same lines of business may
not be eligible for the same tax preferences because they differ in asset and receipt size.
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when profits are distributed as dividends or long-term capital gains. By contrast, the net income
of pass-through entities is taxed only at the owner or shareholder level.
Furthermore, the taxation of business income depends on whether or not the owner of a pass-
through entity pays the alternative minimum tax (AMT). Pass-through business owners paying
the AMT may or may not be taxed at lower rates than they would be under the regular income
tax. Corporations were also subject to an AMT from 1987 to 2017, but P.L. 115-97 repealed the
tax, starting in 2018.
Firm size also contributes to a company’s federal tax burden. Some tax provisions benefit small
firms but not large firms. There is no formal distinction between the taxation of small and large
firms in the tax code. Small business tax benefits include deductions, exclusions, exemptions,
credits, deferrals, and preferential tax rates whose main effect is to reduce a firm’s cost of capital
for investments and increase its cash flow.
This report focuses on federal tax benefits targeted at small firms that have the broadest reach
outside agriculture. Excluded from these benefits are tax preferences available only to small firms
in particular industries, such as life insurance, banking, and energy production or distribution, as
well as tax benefits that can be claimed by firms of all sizes, such as the Section 41 research tax
credit and the Section 168(k) 100% expensing allowance. Table 1 summarizes the key features of
each of the tax benefits examined here.
The tax benefits shown in Table 1 do not include the taxation of pass-through business profits. It
can be argued that pass-through business taxation should be included. Most small firms are
organized as pass-through businesses.5 And pass-through business profits may be taxed at lower
marginal tax rates than corporate profits distributed as dividends and capital gains among high-
income taxpayers. But these considerations do not make the tax treatment of pass-through
businesses a small business tax benefit under the definition used here, as some pass-through firms
are large in employment or receipt size.
Excluding sole proprietorships (which are almost uniformly small according to size standards), a
minority of pass-through firms are large in employment or receipt size, but they account for a
disproportionately large share of pass-through business income. According to Internal Revenue
Service (IRS) data, in 2017, small S corporations ($1 million or less in business receipts) filed
80.8% of S corporation returns but accounted for 10.2% of total S corporation business receipts;
large S corporations ($10 million or more in business receipts), by contrast, filed 2.4% of returns
but received 62.2% of total business receipts.6 A similar dichotomy exists among partnerships.
IRS data indicate that in 2018, small partnerships ($10 million and less in assets)7 filed 94.5% of
partnership returns but accounted for 25.4% of total business receipts; large partnerships ($50
million and more in assets) filed 1.5% of returns but took in 60.3% of total partnership business
receipts.8
Current federal small business tax preferences are summarized in Table 1. Each preference is
then explained in greater detail.

5 In 2015, according to the Internal Revenue Service, C corporations filed 4.6% of business tax returns, and the
remaining 95.4% came from pass-through businesses. See https://www.irs.gov/statistics/soi-tax-stats-integrated-
business-data.
6 See https://www.irs.gov/statistics/soi-tax-stats-s-corporation-statistics.
7 The IRS does not publish data on partnerships by size of receipts.
8 See https://www.irs.gov/statistics/soi-tax-stats-partnership-statistics.
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It is not known how much revenue is foregone because of the tax benefits shown in Table 1. A
2020 estimate by the Joint Committee on Taxation (JCT), which does not cover every tax benefit
in the table, suggested that their revenue cost may exceed $18 billion in FY2021.9
Table 1. Current Small Business Tax Preferences
and Their Estimated Revenue Cost in FY2021
Estimated
Revenue Cost
in FY2021
Small
Under
Business Tax
Federal Tax
Nature of the
Eligible
Current
Current Law
Preference
Code Section
Benefit
Taxpayers
Status
($ billions)
Limited
179
Allows firms to
No size limit
Permanent
$7.1
Expensing
deduct as a
Allowance
current expense
up to $1.050
mil ion of their
expenditures on
qualified
depreciable
assets placed in
service in 2021;
begins to phase
out when total
expenditures
exceed $2.620
mil ion.
Nonagricultural
446
Allows eligible
C corporations
Permanent
3.2
Cash-Basis
partnerships and and partnerships
Accounting
C corporations
with average
(including
annual gross
certain farms) to receipts of $25
use the cash
mil ion or less in
method of
the previous
accounting,
three tax years.
regardless of
whether they
maintain
inventories.

9 U.S. Congress, Joint Committee on Taxation, Estimates for Federal Tax Expenditures for Fiscal Years 2020-2024,
JCX-23-20, November 5, 2020.
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Estimated
Revenue Cost
in FY2021
Small
Under
Business Tax
Federal Tax
Nature of the
Eligible
Current
Current Law
Preference
Code Section
Benefit
Taxpayers
Status
($ billions)
Deduction and
195
Allows start-up
Firms in their
Permanent
0.3
Amortization of
businesses to
first year of
Business Start-
deduct up to
business
Up Expenses
$5,000 of
eligible start-up
expenses in the
year they begin
to operate, and
to amortize the
remaining
expenses over
180 months; the
deduction
phases out,
dol ar for dol ar,
when qualified
expenses
exceed $50,000.
Tax Credit for
44
Allows qualified
Employers with
Permanent
Less than $50
Expenses
small firms to
gross receipts of
mil ion
Incurred in
claim a
$1 mil ion or
Improving the
nonrefundable
less or 30 or
Accessibility of a
tax credit for
fewer ful -time
Business Facility
qualified
employees in
for Disabled
expenses they
the previous tax
Individuals
incur in making
year.
their facilities
more accessible
for disabled
persons.
Ordinary
1244
Allows eligible
Individuals and
Permanent
NA
Income
taxpayers to
partnerships
Treatment of
deduct any loss
Losses on Sales
from the sale,
of Certain Small
exchange, or
Business Stock
worthlessness of
qualified small
business stock
as an ordinary
loss and not a
capital loss.
Treating Losses
1242
Allows
Any individual
Permanent
NA
on the Sale of
taxpayers who
investing in an
Small Business
invest in an
operating SBIC
Investment
SBIC to deduct
Company (SBIC)
from ordinary
Stock as
income losses
Ordinary Losses
from the sale or
exchange or
worthlessness of
SBIC stock.
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Estimated
Revenue Cost
in FY2021
Small
Under
Business Tax
Federal Tax
Nature of the
Eligible
Current
Current Law
Preference
Code Section
Benefit
Taxpayers
Status
($ billions)
Exemption from
263A
Exempts
Business
Permanent
NA
the Uniform
qualified small
taxpayers with
Capitalization
firms from the
average annual
Rule
requirement
gross receipts of
that firms
$25 mil ion or
acquiring or
less in the three
producing real
previous tax
or tangible
years.
property for
resale include in
the estimated
value of their
inventory the
direct cost of
the property
and indirect
costs that can
be allocated to
it.
Application of
41(h) and
Allows qualified
Business
Permanent
NA
Section 41
3111(f)
firms to claim a
taxpayers that
Research Tax
payrol tax
have less than
Credit Against
credit of up to
$5 mil ion in
Employer Share
$250,000 with
gross receipts in
of the Payrol
their unused
the current tax
Tax
research tax
year and had no
credit for the
gross receipts in
current tax
any tax year
year.
preceding the
previous five
years.
Tax Credit for
45E
Allows qualified
Employers with
Permanent
NA
Pension Plan
small firms to
no more than
Start-Up
take a
100 employees,
Expenses
nonrefundable
each of whom
tax credit for a
received $5,000
portion of the
or more in
costs they incur
compensation in
in establishing
the previous
new qualified
calendar year.
pension plan for
employees; the
credit may be
taken in each of
the first three
years of the
plan.
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Small Business Tax Benefits: Current Law

Estimated
Revenue Cost
in FY2021
Small
Under
Business Tax
Federal Tax
Nature of the
Eligible
Current
Current Law
Preference
Code Section
Benefit
Taxpayers
Status
($ billions)
Tax Credit for
45T
Allows an
Employers with
Permanent
NA
Employers That
eligible
no more than
Add Automatic
employer to
100 employees,
Enrol ment to
claim a $500
each of whom
New or Existing
nonrefundable
received a
Employee
tax credit in
minimum of
Pension Plans
each of the first
$5,000 in
three years in
compensation
which the
during the
employer
previous
includes
calendar year.
automatic
enrol ment for
qualified
employee
retirement
plans.
Exemption for
163(j)
Allows eligible
C corporations
Permanent
NA
Qualified Small
small firms to
and pass-
Firms from the
deduct business
through entities
Limitation on
interest without with $25 mil ion
the Deduction
the limits set by
or less in
for Business
P.L. 115-97.
average annual
Interest
gross receipts in
the three
previous tax
years.
Source: Compiled by the Congressional Research Service from the fol owing source: Joint Committee on
Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2020-2024, JCX-23-20.
Overview of Current Federal Small Business Tax
Preferences
Expensing Allowance for Certain Depreciable Business Assets
Expensing is the fastest form of depreciation. It treats the cost of acquiring a depreciable asset
(e.g., machine tool or patent) as a current expense rather than a capital expense. As a result, the
asset’s full cost is deducted in the year it is placed into service. In the absence of expensing,
companies must recover capital costs over longer periods using the appropriate depreciation
schedule.
Under IRC Section 179, a company may expense up to $1.050 million of the cost of qualified
property—mainly machinery, equipment, standardized computer software, and improvements to
nonresidential buildings—placed into service in 2021 and write off any remaining cost using the
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appropriate depreciation schedule under the Modified Accelerated Cost Recovery System
(MACRS).10 The maximum allowance is indexed for inflation.
The allowance is subject to two limitations. One is the investment limitation, which is the amount
at which the maximum allowance begins to phase out. In 2021, that amount is set at $2.620
million; it too is indexed for inflation. Under this limitation, a firm of any size may expense up to
$1.050 million of the qualified assets it places in service in 2021. When the total cost of such
assets exceeds the investment limitation’s threshold amount, however, the maximum allowance is
reduced dollar for dollar until it reaches $0. As a result, when the total cost of the depreciable
assets a firm acquires and places in service in 2021 equals or exceeds $3.670 million, none of the
cost may be expensed.
A second limitation relates to a firm’s taxable income in the trade or business in which the assets
expensed under IRC Section 179 are used. Specifically, the maximum allowance a firm can take
cannot exceed its taxable income from such a trade or business. Any allowance in excess of
income may be carried forward up to 20 years.
There is no size limit on the companies that may benefit from IRC Section 179; rather, the
phaseout threshold makes the expensing allowance a benefit principally for smaller firms. Large
firms such as Google, Microsoft, or Amazon typically spend far more than the maximum
investment limit ($3.670 million in 2021) on assets eligible for the allowance.
Congress established the expensing allowance in 1958 to serve several purposes: (1) to lower the
cost of capital for relatively small companies; (2) to simplify tax accounting for the same group of
companies; and (3) to stimulate increased business investment during periods of weak or negative
economic growth.
In theory, the allowance can stimulate business investment in two ways. First, it lowers the user
cost of capital for investment in qualified assets, all other things being equal. The user cost (or
rental price) of capital is one of the key influences on business investment decisions. It combines
the opportunity cost of an investment (i.e., the highest pretax rate of return a company could earn
by investing in a low-risk asset like a U.S. Treasury bond) with its direct costs (e.g., depreciation,
the actual cost of the asset, and income taxes). In effect, the user cost of capital determines the
after-tax rate of return an investment must earn in order to be profitable—and thus worth
undertaking. In general, the larger the user cost of capital, the fewer projects companies can
profitably undertake, and the lower their desired capital stock. In theory, when a change in tax
law decreases the user cost of capital, businesses can be expected to increase the amount of
capital they wish to own, boosting business investment in the short run, all other things being
equal. Expensing produces a zero marginal effective tax rate on the returns to investment in those
assets under the standard economic model for determining the user cost of capital.11 Under a
progressive rate structure such as the U.S. individual income tax, the decrease in the user cost of
capital increases as marginal tax rates rise.
Second, the allowance increases the cash flow of firms using it, all other things being equal. For
firms whose cost of internal funds is lower than their cost of external funds such as debt or equity,
an increase in cash flow may enable them to undertake new investments.

10 For more details on the current expensing allowance and its economic effects, see CRS Report RL31852, The Section
179 and Section 168(k) Expensing Allowances: Current Law and Economic Effects, by Gary Guenther.
11 See Jane G. Gravelle, “Effects of the 1981 Depreciation Revisions on the Taxation of Income From Business
Capital,” National Tax Journal, vol. 35, no. 1, March 1982, pp. 2-6. In effect, under expensing, the after-tax rate of
return on an investment becomes equal to the pretax rate of return. This happens because expensing reduces costs and
after-tax returns by the same proportion, which is determined by the tax rate.
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Table 1 shows that the IRC Section 179 expensing allowance may result in a $7.1 billion revenue
loss in FY2021. But the allowance does not necessarily produce a revenue loss. Its revenue effect
generally depends on the aggregate amount of U.S. investment in qualified assets in a particular
tax year. During periods of rising business investment, the allowance should generate substantial
revenue losses because a portion of that investment is expensed under IRC Section 179. But the
opposite should happen in periods of declining investment, when the revenue gains from previous
use of the allowance exceed the revenue loss from new uses of it. Any shift from revenue loss to
revenue gain simply reflects the timing of depreciation deductions under current law.
Firms that write off the entire cost of an asset in the year when it is placed in service under IRC
Section 179 cannot claim additional depreciation allowances against future profits from expensed
assets. In effect, they exchange a lower tax liability in the present for larger tax liabilities in the
future. Companies that make this trade-off come out ahead, particularly in the case of long-lived
assets, if the present value of allowable depreciation deductions is greater with expensing than it
is with other depreciation schedules.
Amortization of Business Start-Up Costs
A key concept underlying the federal income tax is that business taxable income should exclude
all reasonable costs incurred in earning it. This concept underlies IRC Section 162(a), which
generally allows companies to deduct the full amount of ordinary and necessary costs paid or
incurred in conducting a trade or business. The concept also implies that costs paid or incurred in
starting or organizing a business should not be treated as current expenses, as they are not directly
related to the conduct of a trade or business. Instead, because start-up expenses represent an
attempt to create a capital asset (in this case a business) with a useful life likely to extend beyond
the year when it begins to operate, they should be capitalized, added to the owner’s basis in the
business, and recovered when the business is sold or shuttered.
IRC Section 195 (as amended by the American Jobs Creation Act of 2004 or AJCA, P.L. 108-357)
deviates from this concept by permitting individuals who incur business start-up and
organizational costs after October 22, 2004, to deduct up to $5,000 of those costs in the year a
new trade or business begins to operate. This deduction is reduced, dollar for dollar (but not
below zero), by the amount by which eligible expenditures exceed $50,000. Expenditures that
cannot be deducted may be amortized over 15 years, beginning in the first month the new trade or
business earns income. To benefit from the $5,000 deduction, a taxpayer must have an equity
interest in the trade or business and actively participate in running it.
The Small Business Job Creation Act of 2010 (P.L. 111-240) raised the deduction to $10,000 and
the phaseout threshold to $60,000 for qualified expenses incurred or paid in 2010 only. These
higher amounts have not been reinstated.
To qualify for the deduction, start-up and organizational costs must meet two requirements. First,
they must be paid or incurred as part of an investigation into creating or acquiring an active trade
or business, starting a new trade or business, or an effort to produce income or profit before
starting a trade or business with the aim of eventually converting the activity into an active trade
or business. Second, the costs must be similar in kind to costs that would be deductible if they
were paid or incurred in connection with the expansion of an active trade or business.
Taxpayers with start-up and organizational expenses that entered a trade or business on or before
October 22, 2004 (the day the $5,000 deduction first became available) were allowed to amortize
those expenditures over a minimum of five years, beginning in the month the new trade or
business began to operate.
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The option to deduct as much as $5,000 in start-up and organizational costs in the first year of
operation permits the owner of a new firm to reduce taxable income in the year when the business
begins. Without such a provision, the expenses could not be recovered in full until the owner sells
his or her interest in the business, or in part until five years after the business started, when the
expenses could be amortized. As a result, the option accelerates the recovery of certain business
expenses and may boost the cash flow of small start-up firms when their access to funds may be
limited. For firms that lose money in their first year of operation, the deduction, if used, simply
adds to their net operating losses, which may be carried forward up to 20 years to lower future
taxes.12
Cash-Basis Accounting
IRC Section 446 requires firms to compute their taxable income using the same method of
accounting they regularly employ in keeping their books, provided that method clearly reflects
income for tax purposes. A taxpayer’s method of accounting clearly reflects income if it treats
items of income and deductions consistently from one tax year to the next. Permissible methods
of accounting include the cash-receipts method, the accrual method, the installment method, the
long-term-contract method, the crop method, the special methods for research and development
expenditures, and the method for soil and water conservation expenditures.
Two accounting methods are widely used in the private sector: cash-basis and accrual-basis.
Under the former, income generally is recorded when it is received in the form of cash or its
equivalent, and expenses generally are recorded when they are paid, regardless of when the
income is actually earned or the expenses are actually incurred.
Under accrual-basis accounting, income and expenses generally are recorded when the
transactions giving rise to them are completed or nearly completed, regardless of when cash or its
equivalent is received or paid. A firm using accrual-basis accounting records income when its
right to receive it is established and records expenses when the amounts are fixed and its liability
for them is established.
Each accounting method has its advantages. Cash-basis accounting is much simpler to administer
and allows firms greater control over when items of income or deduction are recognized for tax
purposes. In contrast, accrual-basis accounting generally yields a more accurate measure of a
firm’s economic income because it matches income with expenses with greater precision and
rigor.
Under certain circumstances, the accrual method must be used for tax purposes. For instance,
when keeping an inventory is necessary to the operation of a business, a taxpayer must use the
accrual method in computing taxable income—unless the IRS determines that another method
clearly reflects income and may be used instead. Inventories are considered necessary if a firm
earns income from the production, purchase, or sale of merchandise. Subchapter C corporations,
partnerships with C corporations as partners, trusts that earn unrelated business income, and
authorized tax shelters generally are required to use the accrual method of accounting.
But there are some exceptions to these rules. Starting in 2018, any partnership or C corporation
with average annual gross receipts of $25 million or less in the three previous tax years may use
the cash method of accounting, regardless of whether they keep an inventory. This amount has
been indexed for inflation since 2019; the receipt threshold is set at $26 million in 2021. Self-

12 Under the American Recovery and Reinvestment Act of 2009 (P.L. 111-5), eligible firms with net operating losses in
the 2008 tax year could carry them back up to five years. Only firms with average annual gross receipts in the past
three tax years of less than $15 million were allowed to take advantage of this expanded carryback.
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employed persons, S corporations, and qualifying partnerships and personal service corporations
also have the option of using the method. As these exceptions suggest, many eligible firms are
relatively small in receipt size.
In effect, the cash method has the potential to extend the same benefit to small firms as the IRC
Section 179 expensing allowance does: deferral of income tax payments. The federal tax code
generally operates on the principle that a firm receives income when it gains the legal right to be
paid for something it provides. But under the cash method, firms have the option of deferring the
payment of taxes, or taking advantage of lower tax rates, by shifting deductions and income from
one tax year to the next.
Despite the cash method’s potential benefits, it may not always be in the interest of eligible firms
to use it. For example, a small business might be better off using accrual-basis accounting if it
needs to periodically issue accurate and reliable financial reports. Cash-basis accounting can
distort a firm’s financial position in at least two ways.13 First, because it records transactions
involving only cash or its equivalent, the method excludes transactions involving exchanges of
assets or liabilities. Second, the determination of net income under cash-basis accounting can be
manipulated by recording revenues or expenses before or after goods and services are produced
or sold.
Exemption from Limitation on the Deduction for Business Interest
Expenses
Before the enactment of the 2017 TCJA, the federal tax code generally allowed firms to deduct
interest and other borrowing expenses incurred in the pursuit of a trade or business without limit
in the year they were paid or incurred, under IRC Section 163. There were a few exceptions. No
deduction was allowed for interest paid on tax-exempt bonds, interest from unregistered
obligations, interest paid on insurance contracts, and interest paid on original discount, high-yield
obligations.
The TCJA modified this treatment by limiting the amount of interest and other borrowing costs a
company was allowed to deduct. IRC Section 163(j), as amended by the 2017 act, caps the
amount of qualified interest expenses (including floor-plan financing interest payments) it may
deduct at 30% of its adjusted taxable income.14 Interest that cannot be deducted in the current tax
year may be carried forward indefinitely, subject to certain restrictions for partnerships and S
corporations.
Many small firms are not affected by the limitation on the interest deduction. Specifically, firms
with average annual gross receipts during the previous three tax years (2018-2020) of $26 million
or less are exempt from this limitation.
Tax Incentives for Equity Investment in Small firms
Several small business tax preferences encourage equity investment in qualified small firms that
otherwise may have trouble raising needed funds. The preferences, which are described below, do

13 See Robert Libby, Patricia A. Libby, and Daniel G. Short, Financial Accounting (Chicago: Irwin, 1996), p. 111.
14 Adjusted taxable income is a company’s regular taxable income calculated without (1) items of income, gain,
deduction, or loss not allocated to a trade or business, (2) business interest income, (3) net operating losses, (4) the IRC
Section 199A deduction for qualified pass-through business income, and (5) deductions for depreciation, depletion, or
amortization in the years before 2022. Floor-plan financing interest is the interest paid or accrued on debt used to
finance the acquisition of motor vehicles held for sale or lease to customers and secured by a seller’s inventory.
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so by increasing potential after-tax returns or reducing potential after-tax losses on such
investment, relative to other investment options. The same tax benefits are not available to
individuals investing in large firms.
Full Exclusion of Capital Gains on Eligible Small Business Stock
Two key considerations in determining the income tax liability for many individuals are the
recognition of income as ordinary or capital gain, and the difference between long-term and short-
term capital gains or losses.
A capital gain or loss arises when a capital asset such as a stock or bond is sold or exchanged. If
the selling price is greater than the acquisition or purchase price, the transaction produces a
capital gain. Conversely, a capital loss results when the reverse is true.
Capital assets held longer than 12 months and then sold or exchanged give rise to long-term
capital gains or losses; sales or exchanges of capital assets held one year or less generate short-
term capital gains or losses. Short-term capital gains are considered ordinary income and taxed at
regular income tax rates. By contrast, long-term capital gains are considered capital income and
taxed in 2021 at 20% for single filers with taxable income of $445,850 or more and joint filers
with taxable income of $501,600 or more; 15% for single filers with taxable income between
$40,400 and $445,850 and joint filers with taxable incomes between $80,800 and $501,600, and
0% for single filers with taxable incomes below $40,400 and joint filers with taxable incomes
below $80,800.
IRC Section 1202 allows noncorporate taxpayers (including partnerships, LLCs, and S
corporations) to permanently exclude from gross income the entire gain from the sale or exchange
of qualified small business stock (QSBS) held for a five or more years. The exclusion is 100% for
QSBS acquired after September 27, 2010. For QSBS acquired between August 11, 1993, and
February 17, 2009, 50% of any gain on its sale or exchange was excludable. The exclusion was
75% for QSBS acquired between February 18, 2009, and September 27, 2010.
There is a limit on the gain that a taxpayer may exclude. In any tax year, the gain cannot exceed
the greater of 10 times the taxpayer’s adjusted basis in all QSBS issued by that firm and sold or
exchanged by the taxpayer during that year, or $10 million—reduced by any excluded gains from
sales of the same stock in previous years. This means that the amount a taxpayer may exclude
over time from the sale of a single firm’s QSBS cannot exceed $10 million. Any remaining gain
is taxed at a fixed rate of 28%.
To qualify for the partial exclusion, small business stock must satisfy several requirements. First,
the stock must be issued after August 10, 1993, and acquired by the taxpayer at its original issue,
either directly or through an underwriter, in exchange for money or property, or as compensation
for services rendered to the issuing corporation. Second, the stock must be issued by a domestic C
corporation whose gross assets do not exceed $50 million when the stock is issued. Third, at least
80% of an eligible corporation’s assets must be deployed in the active conduct of one or more
qualified trades or businesses during “substantially all” of the requisite five-year holding period
for QSBS. Assets used for working capital, start-up activities, and research and development meet
the active business test, even if they are intended to develop future lines of business. Specialized
small business investment companies licensed under the Small Business Investment Act of 1958
also meet the active business test, making their stock eligible for the gain exclusion.
All trades and lines of business are eligible for the IRC Section 1202 gain exclusion except
health, law, engineering, architecture, hospitality, farming, insurance, finance, and mineral
extraction. Stock issued by the following small C corporations is also ineligible for the exclusion:
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current or former domestic international sales corporations (DISCs), regulated investment
companies (RICs), real estate investment trusts (REITs), real estate mortgage investment conduits
(REMICs), financial asset securitization investment trusts (FASITs), cooperatives, or C
corporations that have claimed the possessions tax credit under IRC Section 936.
The gain exclusion for QSBS is intended to improve the access of qualified start-up firms to what
some would call “patient” equity capital. It attempts to do this by increasing the potential after-tax
returns an investor can earn on QSBS, relative to the potential after-tax returns on other
investment opportunities, over a minimum of five years. Under current law, the maximum capital
gains rate is 20% and the exclusion is 100% of realized gains from the sale or exchange of QSBS
acquired after September 27, 2010. A full exclusion yields an effective capital gains tax rate of
0% for QSBS. Proponents of the 100% exclusion say it is needed to compensate for the
uncertainty and asymmetric information that can make it difficult for new start-up firms to obtain
needed funding for activities critical to their survival and growth.
Little research has been done on the gain exclusion’s effects on QSBS issuers. There is some
evidence that the exclusion reduces the cost of capital for C corporations issuing QSBS. In a 1999
study of IRC Section 1202, David Guenther and Michael Willenborg found that the prices of
QSBS issued by a sample of firms after the enactment of the tax provision were “significantly
higher than the issue prices before the change.”15 At the same time, there were no significant
differences in the issue prices for a sample of firms that were ineligible to issue QSBS. The
authors concluded that at least some of the future benefits from the capital gains rate reduction
were captured by issuing corporations in the form of higher stock prices, instead of those benefits
going to investors.
Still, some are critical of the gains exclusion. Alan Viard of the American Enterprise Institute,
while recognizing the efficiency gains from using equity instead of debt to finance new
investments, has argued that the IRC Section 1202 gain exclusion distorts the allocation of
investment capital within the U.S. economy. As he noted in a 2012 article, the tax preference
encourages equity investment in very small companies in certain industries only and may be
claimed by certain investors only, not by all investors.16 In his view, the rules governing the
exclusion diminish its potential economic effects.
Losses on Small Business Investment Company Stock Treated as Ordinary
Losses without Limitation
Generally, losses on stock investments are treated as capital losses for tax purposes. They may be
used to offset any capital gains a taxpayer has in the same tax year. Individuals may also use any
combination of short-term and long-term capital losses to offset up to $3,000 in ordinary income
in a tax year.
Under IRC Section 1242, however, individuals who invest in small business investment
companies (SBICs) are permitted to deduct from their ordinary income all losses from the sale or
exchange or worthlessness of their stock. This exception from the general rule is intended to
encourage equity investment in SBICs by lowering the potential after-tax loss on such an
investment, relative to potential after-tax losses on other investments.

15 David A. Guenther and Michael Willenborg, “Capital Gains Tax Rates and the Cost of Capital for Small Business:
Evidence from the IPO Market,” Journal of Financial Economics, vol. 53, no. 3 (1999), p. 401.
16 Alan D. Viard, “The Misdirected Debate and the Small Business Stock Exclusion,” Tax Notes, February 6, 2012, p.
741.
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SBICs are privately owned, regulated investment corporations that are licensed by the Small
Business Administration to provide equity capital, long-term loans, and managerial guidance to
firms with a net worth of less than $19.5 million and an average net income of less than $6.5
million in the previous two years.17 SBICs use their own capital and funds borrowed at favorable
rates made possible by SBA loan guarantees to invest in qualified firms. For tax purposes, most
SBICs are treated as C corporations.
Ordinary Income Treatment of Losses on Sales of Small Business Stock
IRC Section 1244 allows taxpayers to treat a loss from the sale, exchange, or worthlessness of
eligible small business stock as an ordinary loss rather than a capital loss. For taxpayers, ordinary
losses are treated as business losses in computing a net operating loss.
To qualify for this treatment, a stock must meet four requirements. First, it must be issued by a
small business corporation after November 6, 1978. A small business corporation is a domestic C
corporation whose cash and property received as a contribution to capital and paid-in surplus total
less than $1 million when the stock is issued. Second, an individual or partnership must acquire
the stock in exchange for cash or other property (but not stock and securities). Third, during the
five tax years before a loss on a qualified stock is recognized, the small business corporation must
obtain more than 50% of its gross receipts from sources other than passive income such as
royalties, rents, dividends, interest, annuities, and stock or security transactions. The amount that
may be deducted as an ordinary loss in a tax year is capped at $50,000 for single filers and
$100,000 for joint filers.
Uniform Capitalization of Inventory Costs
Firms that earn income from the production, purchase, or sale of merchandise are required to
keep inventories to account for the cost of goods sold in a tax year. This cost is subtracted from
gross receipts in the computation of taxable income. In most cases, the cost of goods sold is
determined by adding the value of a firm’s inventory at the beginning of the year to purchases of
inventory items made during the year and subtracting that amount from the value of a firm’s
inventory at the end of the year.
IRC Section 263A requires business taxpayers that produce real or tangible property or buy such
property for resale to “capitalize” (or include in the value of their inventories) both the direct and
indirect costs of the property included in inventory. This provision, known as the uniform
capitalization rule, was added to the federal tax code by the Tax Reform Act of 1986. In general,
direct costs are considered to be the material and labor costs related to the production or
acquisition of goods; indirect costs refer to all other costs incurred through the production or
acquisition of goods (e.g., repair and maintenance of equipment and facilities; utilities; insurance;
rental of equipment, land, or facilities; and some administrative costs). Taxpayers have some
discretion in assigning indirect costs to property from production or purchase, but the cost
allocation methods should yield results that make sense for particular trades or businesses.
Some small firms are exempt from the uniform capitalization rule. Specifically, it does not apply
to firms with average annual gross receipts of $25 million or less in the last three tax years that
acquire tangible or intangible property for resale. This exemption is beneficial because eligible
firms have lower administrative costs, face less complexity in complying with income tax laws,

17 For more information on SBICs, see CRS Report R41456, SBA Small Business Investment Company Program, by
Robert Jay Dilger.
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and can exercise more control over the timing of business expense deductions, opening up
opportunities for tax deferral.18
Simplified Dollar-Value LIFO Accounting Method for Small Firms
As noted earlier, businesses that keep inventories to account for the cost of goods sold are
required to determine the value of their inventories at the beginning and at the end of each tax
year. Doing this item by item is time-consuming and costly; so many taxpayers use estimation
methods based on certain item or cost flows.
One such method is known as “last-in-first-out” (or LIFO). LIFO assumes that a firm’s most
recently acquired goods are sold before all other goods. Consequently, LIFO assigns the most
recent unit costs to the cost of goods sold and the oldest unit costs to the remaining inventory at
the end of the year. The method is likely to be advantageous when the cost of many inventory
items is rising, because it yields a lower taxable income and inventory valuation than other
methods. There are various ways to use LIFO. One widely used application is known as the
dollar-value method. Under it, a taxpayer accounts for the value of its inventory according to a
pool of dollars rather than a pool of inventory items. Each dollar pool includes the value of a
variety of inventory items and is measured by the dollar value of the items in the year when they
were first added to the inventory. The dollar-value method is complicated and costly, putting it
beyond the reach of many small firms.19
IRC Section 474, which was added to the tax code by the Tax Reform Act of 1986, allows
qualified small firms to use a simplified dollar-value LIFO method. It differs from the regular
method in the pooling of inventory items and the estimation of the base-year value of pooled
items. Firms with average annual gross receipts of $5 million or less in the three previous tax
years may use the simplified LIFO method.
Nonrefundable Tax Credit for Pension Plan Start-Up Costs of Small
Firms
Under IRC Section 45E, certain small firms may claim a nonrefundable tax credit for a portion of
the start-up costs incurred in setting up new retirement plans for employees. The credit, which
was enacted as part of the Economic Growth and Tax Relief Reconciliation Act of 2001,
originally was scheduled to expire at the end of 2010. But the Pension Protection Act of 2006
permanently extended it. It is a component of the general business credit under IRC Section 38
and thus subject to its dollar limitations and rules for carryover.
The credit is equal to 50% of qualified plan start-up expenses paid or incurred in each of the first
three years a qualified pension plan is available. There is a dollar limit on the annual amount of
the credit. Specifically, the credit is the greater of $500 or the lesser of $5,000 or $250 for each
employee who is eligible to participate in a plan. This means the credit can be expected to range
from $500 to $5,000, depending on the number of eligible employees. The Setting Every
Community Up for Retirement Enhancement (SECURE) Act of 2019 (P.L. 116-94) increased the
maximum credit from $500 a year to $5,000.

18 See Paul G. Schloemer, “Simplifying the Uniform Inventory Capitalization Rules,” Tax Notes, vol. 53, no. 9,
December 2, 1991, pp. 1065-1069.
19 For more details on this method, see U.S. Congress, Joint Committee on Taxation, Impact on Small Business of
Replacing the Federal Income Tax, JCS-3-96, April 23, 1996, pp. 18-19.
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The credit applies to the ordinary and necessary expenses of administering a plan and informing
employees about its benefits and requirements. These include the costs of setting up a plan and
operating it from day to day; operational expenses include recordkeeping and accounting, legal,
and trustee services.20 Any new 401(k) plan, 403(a) annuity plan, savings incentive match plan for
employees (SIMPLE IRA), or simplified employee pension plan qualifies for the credit. Only
firms with fewer than 100 employees, each of whom received at least $5,000 in compensation in
the previous year, may claim the credit.
In effect, the credit gives qualified small firms an incentive to establish pension plans for
employees by lowering the after-tax cost of setting up and administering these plans over the first
three years they are available. As a 2010 SBA report pointed out, start-up costs can be
considerable on a per-employee basis for companies with relatively few employees.21 Available
data on pension benefits by employer size provide no clear evidence that the credit has increased
the share of small employers offering pension plans. According to the Employee Benefit Research
Institute (EBRI), the percentage of firms with fewer than 100 employees sponsoring pension
plans was lower in 2013 than it was in 2002, the first year the credit was available.22
Nonrefundable Tax Credit for Automatic Employee Enrollment in
Small Employer Retirement Plans
The SECURE Act added a second tax credit for qualified small employer retirement plans: IRC
Section 45T. The credit is identical to the IRC Section 45E credit, except for the amount of the
credit and its purpose.
An eligible employer may claim an IRC Section 45T credit of $500 for each of the first three
years it adds automatic enrollment to current or new employee retirement plans. It applies to the
same plans as the IRC Section 45E credit does. Thus, an eligible employer could receive a total
tax credit of $16,500 during the first three years it offers a qualified employee pension plan with
automatic enrollment: three years of the maximum IRC Section 45E credit comes to $15,000 (3 x
$5,000 per year) plus three years of the IRC Section 45T credit (3 x $500 per year).
Employers with fewer than 100 employees, each of whom received at least $5,000 in
compensation during the previous year, are eligible for the IRC Section 45T credit. Automatic
enrollment leads to greater employee participation in employer plans.23

20 Yusi Lou and Anthony P. Curatola, “Taxes: Tax Credits for Pension Plan Start-Up Costs,” Strategic Finance
Magazine, June 1, 2020.
21 See Kathryn Kobe, Small Business Retirement Plan Availability and Worker Participation SBA Office of Advocacy,
contract no. SBA-HQ-06M0477 (Washington: March 2010), p. 22.
22 In 2013, according to an EBRI report, 10.3% of firms with fewer than 10 employees sponsored pension plans; the
share in 2002 was 16.5%; for firms with 10 to 49 employees, the 2013 share was 24.0%, and the 2002 share 31.4%; and
for firms with 50 to 99 employees, the 2013 share was 36.1%, and the 2002 share 46.9%. See Employee Benefit
research Institute, “Employment-Based Retirement Plan Participation: Geographic Differences and Trends, 2013,”
Issue Brief, no. 405 (Washington, Oct., 2014), Figure 2, p. 11; and “Employment-Based Retirement and Pension Plan
Participation: Declining Levels and Geographic Differences,” Issue Brief, no. 262 (Washington: October 2003), Figure
2, p. 7.
23 Linda J. Blumberg, John Holahan, and Jason Levitis, How Auto-Enrollment Can Achieve Near-Universal Coverage:
Policy and Implementation Issues, Urban Institute Issue Brief, June, 10 2021, https://www.urban.org/sites/default/files/
publication/26326/412723-Automatic-Enrollment-Employee-Compensation-and-Retirement-Security.PDF.
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Nonrefundable Tax Credit for Expenses Paid or Incurred in
Improving Business Access for Disabled Persons
Under IRC Section 44, an eligible small firm may claim a nonrefundable tax credit for expenses
incurred in making its facilities more accessible for disabled employees. The credit is equal to
50% of eligible expenditures in a tax year above $250 but not greater than $10,250. A firm may
claim no more than $5,000 of the credit in a tax year. In the case of a partnership and S
corporation, this ceiling applies separately at the entity level, and at the partner or shareholder
level. The disabled-access credit is a component of the general business credit under IRC Section
38 and thus subject to its dollar limitations and rules for carrying the credit back and forward.
A firm may claim the IRC Section 44 credit if, during its previous tax year, its gross receipts (less
returns and allowances) totaled no more than $1 million, or its full-time workforce did not exceed
30 persons.
An eligible firm may also deduct (under IRC Section 190) up to $15,000 a year for qualified
expenses for the removal of architectural or transportation barriers to accessing its facilities by
elderly or handicapped persons. The deduction has to be reduced by the amount of any IRC
Section 44 credit a taxpayer claims.
Virtually any amount an eligible firm spends to bring its business into compliance with the
Americans with Disabilities Act of 1990 (P.L. 101-336, ADA) qualifies for the credit. The
expenses must be reasonable in amount and required by law. Eligible expenses include the cost of
removing architectural, communication, transportation, or physical barriers to making a business
more accessible to or usable by disabled individuals; providing interpreters or other effective
methods of making materials understandable to hearing-impaired individuals; and supplying
qualified readers, taped texts, and other effective methods of making materials understandable to
visually impaired individuals.
The credit is intended to lower the net cost to small firms of complying with ADA mandates, and
to encourage them to hire more disabled persons. Although the credit has been available since
1990, it remains unclear how effective it has been in achieving its intended goals of stimulating
increased investment in making workplaces more accommodative to the special needs of disabled
persons seeking employment.24 In a 2002 report, the then-named General Accounting Office
(GAO) noted that it could find no studies of the effectiveness of the credit and that few businesses
were even aware of it.25 It appears that no such studies have been done since 2002.
Nonrefundable Tax Credit for Employee Health Insurance
Expenses
The Patient Protection and Affordable Care Act (ACA, P.L. 111-148) added a tax credit (IRC
Section 45R) for small employers that make nonelective contributions to employee health plans.
An employer’s contribution is nonelective if it does not lower participating employees’ salaries or
wages.
Eligible for-profit employers have been able to take the credit since 2010. From 2010 through
2013, the maximum credit was equal to 35% of the lesser of the total amount of an employer’s
nonelective payments during a tax year to a qualified employee health insurance plan through a

24 The credit was a component of the Omnibus Reconciliation Act of 1990 (P.L. 101-508).
25 U.S. General Accounting Office, Incentives to Employ Workers with Disabilities Receive Limited Use and Have an
Uncertain Impact, GAO-03-39 (Washington: December 2002), p. 19.
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“contribution arrangement,” or the total amount of nonelective contributions that would have
been made if each employee had enrolled in a qualified health plan with a premium equal to the
average premium for the small-group market in the state where an employer is located. The credit
does not apply to employer-paid premiums above the average premium for a state’s small-group
market; it applies only to the average premium.
Starting in 2014, an eligible for-profit employer may claim the credit for no more than two
consecutive tax years (e.g., 2016 and 2017) if it offers one or more qualified health plans through
a state-based health insurance exchange. Each state was required to establish such an exchange by
2014. The maximum credit in 2014 and thereafter is equal to 50% of the lesser of
 the total amount of employer contributions for qualified health plans offered
through a health insurance exchange, or
 the total amount of employer contributions that would have been made if each
employee had enrolled in a qualified health plan with a premium equal to the
average premium for the small-group market in the rating area where the
employees receive coverage.
In 2021, employers with 25 or fewer full-time employees who earn an average annual
compensation of $55,600 or less can benefit in varying amounts from the credit; the full credit
may be claimed only by employers with 10 or fewer full-time employees whose average annual
compensation is $27,800 or less.
The credit a firm may claim is phased out by the sum of the following two amounts:
 amount of the credit multiplied by a fraction equal to the number of full-time
employees above 10 divided by 15, and
 amount of the credit multiplied by a fraction equal to a firm’s average annual
wages above $27,800 (2021 only) divided by $27,800 (2021 only).
Several rules governing use of the credit affect its effective rate. The credit is a component of the
general business credit (GBC), and thus subject to its limitations. Unused GBCs may be carried
back one year or forward up to 20 years. Any credit not used by the end of the 20-year carry-
forward period may be deducted in its entirety in the next tax year. Since 2011, employers have
been able to take the credit against both the regular income and alternative minimum taxes. But to
prevent employers from deriving two tax benefits from the same expenditures, any employer
taking the credit must reduce its deduction for employer-paid health insurance premiums by the
amount of the credit.
The credit is intended to increase the number of small employers with low-to-medium wage
employees that offer employee health insurance. Congress added the credit to the ACA in part to
address long-standing concerns about gaps in domestic employer-provided health insurance
coverage. While most large employers have offered health benefits to employees, a much smaller
share of small employers have done so, and that share is even smaller for small employers with
mostly low-wage workers. In 2020, for example, 99% of firms with 200 or more employees
offered health insurance to employees, compared to 55% of firms with 3 to 199 employees.26
Available evidence suggests that the IRC Section 45R credit’s impact has fallen short of initial
expectations. According to the 2020 survey of U.S. employer health benefits by the Kaiser Family

26 See KFF, Employer Health Benefits: 2020 Annual Survey, p. 47, https://www.kff.org/report-section/ehbs-2020-
section-2-health-benefits-offer-rates/.
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Foundation, 59% of firms with three to nine employees offered employee health benefits in 2010,
the first year that the credit was available; that share had dropped to 48% by 2020.27 According to
a 2016 GAO report, relatively few firms used the credit between 2010 and 2014, compared with
its potential usage. GAO noted that initial estimates of the number of eligible firms ranged from
1.4 million to 4 million, but total claims for the credit averaged only 183,200 between 2010 and
2014.28
GAO concluded that the credit was not large enough to convince large numbers of small
employers to offer or maintain employee health benefits. It cited several reasons for this
outcome.29 Relatively few employers qualify for the full credit. The credit phases out if a firm
employs more than 25 people, or if its average annual wage exceeds an inflation-adjusted cap
($55,600 in 2021). The credit covers the average premium in the small business market in the
state where the firm is located; if a firm pays a premium above that amount, the credit does not
apply to the excess. The credit is temporary: since 2014, it can be used only in two consecutive
years. Some eligible firms may be deterred from claiming the credit because of its complexity and
the recordkeeping required to compute it.
Legislation to Expand or Enhance Small Business
Tax Benefits in the 117th Congress
A few bills have been introduced (but not acted on at the committee level) in the 117th Congress
to enhance current small business tax benefits or establish new ones. The following table
identifies those bills and summarizes the ways in which they would benefit small firms. The same
criteria used to identify existing federal small business tax benefits are employed here to select
qualified bills. Specifically, to be included in the table, a bill must provide one or more tax
benefits targeted solely at small firms in more than one industry that meet the bill’s eligibility
requirements. The list of bills is updated as necessary.
Table 2. Small Business Tax Benefit Bills in the 117th Congress
Bill Numbers
Summary of Tax Benefit(s)
H.R. 476
Would enhance the Section 41 tax credit for qualified
research expenditures for qualified research performed
in designated “innovation centers” by (1) increasing the
credit rate from 20% to 30% for the regular research
credit, the university basic research credit, and the
energy research credit; (2) raising the credit rate for
the maximum alternative research credit from14% to
21%; (3) making eligible employee training expenses
incurred by firms located in an innovation center
eligible for the Section 41 credit; and (4) expanding the
range of small firms allowed to use up to $500,000 of
their unused research credit to offset the employer’s
share of the payrol tax.

27 Ibid.
28 U.S. Government Accountability Office, Small Employer Health Tax Credit: Limited Use Continues Due to Multiple
Reasons, GAO-16-491T, March 22, 2016, pp. 4-6, https://www.gao.gov/assets/gao-16-491t-highlights.pdf.
29 Ibid., pp. 5-10.
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Bill Numbers
Summary of Tax Benefit(s)
H.R. 885
Would create a new tax credit (Section 45U) for
purchases of specified personal protective equipment
by eligible small firms in any year when the President
declares a national emergency with regard to COVID-
19. The credit would be subject to an annual limit of
$25,000 per taxpayer. The credit could be claimed by
firms with fewer than 500 employees, firms that adhere
to the size standards for federal assistance set by the
Small Business Administration, sole proprietors, and
independent contractors. The credit would become
part of the general business credit under Section 38,
and thus subject to its limitations.
H.R. 2984/S. 1422
Would establish a new tax credit (Section 45U) for
firms of all sizes equal to 20% of the excess of current-
year qualified employee training expenses over average
annual expenses in the three previous years. Eligible
small firms that cannot use their entire current-year
credit would have the option of applying as much as
$250,000 of that credit to the employer share of
payrol taxes. Sole proprietors, partnerships, and C and
S corporations whose gross receipts in the current tax
year do not exceed $5 mil ion are eligible for this
option.
S. 1979
Would expand the range of small firms eligible to apply
unused Section 41 tax credits against the employer
share of a firm’s payrol taxes and raise the dol ar limit
for such an offset. Specifically, the bil would allow firms
with current-year gross receipts up to $20 mil ion and
no gross receipts in a tax year before the preceding
eight tax years to benefit from this option. The bil
would also increase the amount of unused Section 41
credits that could offset payrol taxes from $250,000 to
$1 mil ion.
S. 2387
Would modify the Section 199A deductiona for eligible
business income so that only pass-through business
owners with taxable income below $500,000 could
claim the deduction. No such limit exists under current
law. This proposal has the potential to effectively limit
use of the deduction to relatively small businesses.
Source: Compiled by the Congressional Research Service.
a. For more information on the Section 199A deduction, see CRS Report R46402, The Section 199A Deduction:
How It Works and Illustrative Examples, by Gary Guenther.

Congressional Research Service

21

Small Business Tax Benefits: Current Law

Author Information

Gary Guenther

Analyst in Public Finance

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Congressional Research Service
RL32254 · VERSION 22 · UPDATED
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