BRIDGE ACT—

Tax Deferral Proposal For Entrepreneurial Businesses Oct. 2008

QUESTION AND ANSWER SUMMARY

Q: When is a rapidly growing business in “No Man’s Land” for capital funding purposes?
A: First, when the firm’s financing needs are within the “capital funding gap” of $250,000 to $1,000,000, it is very difficult
and costly for growing, small businesses to obtain external funding. Second, when the return on assets is less than the
rate of revenue growth, the business cash flow becomes negative under accrual accounting even though the business
may be profitable and owe income taxes.

Q: What happens if a business fails after deferring income tax?

A: A bankrupt business generally does not have net income tax liability because of accumulated losses, but if so, it would
be collectible (as under current law) against business assets or personal assets (in the case of a proprietorship,
partnership, or S corporation). C corporations (and proprietorships with Schedule C business income) currently have a
5-year net operating loss carryback that may be used against outstanding tax deferrals. For S corporations and
partnerships, any outstanding tax deferral when the business entity dissolves would be collectible against the
shareholders or partners for their pro rata share of the net tax liability (as under current law).

Q: What tests must be met to qualify for the tax deferral?

A: The business must have a growth of 10% or more above the average annual gross receipts for the prior 2 years. A
business meeting the growth test and using accrual accounting for tax purposes with $10 million or less in annual gross
receipts would be eligible for the tax deferral.

Q: Would it be possible, using gross receipts data, to manipulate the growth figures to qualify?
A: Not likely, since the current year’s gross receipts must be 10% or more above the average gross receipts for the prior 2-
year period.

Q: How much Federal income tax deferral is authorized under the proposal?
A: The aggregate tax deferral is limited to $250,000 for each business entity, or a lesser amount should the business
exceed $10 million in gross receipts in the meantime. Partners of a partnership or shareholders of an S corporation
would be limited to a combined total of $250,000 of tax deferral for each entity.

Q: When is the tax deferral amount paid?

A: Each year’s tax deferral amount may be deferred for 2 years; payment of deferred tax may be made over the following
4-year period. Interest (Federal underpayment rate) is payable during the entire deferral period. Upon the sale or
merger or cessation of a business, any remaining tax deferral would be payable at that time. Being “acquired” would
include the sale of 80% or more of the firm’s assets.

Q: How does the IRS ruling on cash accounting affect businesses eligible for the tax deferral?
A: The Bridge Act only applies to growing businesses on accrual accounting. Growth businesses need to be on accrual
accounting to obtain outside financing and to have outside audited financial statements. The IRS ruling increasing the
cash accounting gross receipts limit to $10 million generally applies only to service businesses; it does not apply to C
corporations with average annual gross receipts of more than $5 million.

Q: Is the tax deferral a loan guarantee by the U. S. Government?

A: No, it is not a “loan guarantee,” as the Federal Government would not be guaranteeing any loans made by a financial
institution to the business. The Federal Government has established a number of loan guarantee programs, e.g., by the
Small Business Administration, Federal Housing Administration, Veterans Administration, and others.

Q: Is the tax deferral a loan by the U. S. Government?

A: A “loan” means that additional capital is contributed into the business from an outside source, with required payback
regardless of whether the firm is profitable or unprofitable. The Bridge Act, however, simply adjusts the timing of an
obligation to the Government created when the firm is profitable--it does not provide added funds from the Government.
The tax deferral can be offset by business loss carrybacks or carryforwards.
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Q: Are other sources of capital readily available to small, emerging growth businesses?
A: Very few, and generally only to the most promising and well-connected businesses. The lack of capital funding is most
urgent for growing, small businesses with funding needs between $250,000 to $1,000,000. Funding needs below
$250,000 generally are available from family, friends, credit cards, home equity credit, and banks (personal credit
basis). Funding needs between $250,000 and $1,000,000 may be available from so-called “angel” financiers, “factors,”
and in limited cases from SBA loan guarantees and SBICs that have met certain capital requirements. When a
business reaches a $1,000,000 funding level, it generally has a much better opportunity to attract capital funds from
traditional sources. A profitable $10,000,000 or more gross receipts level is more likely to support an asset-based loan
from banks and other financing sources.

Q: Are there venture capital or private equity sources of funds for small, emerging growth businesses?
A: Usually not. As the venture capital and private equity industries have grown, their investments generally are well above
the $1,000,000 funding level.

Q: What is the revenue cost of the tax deferral proposal?

A: The introduced bills (H.R. 3062/S. 1903) would sunset the tax deferral after 4 years. The Joint Tax Committee
estimates that this proposal would result in revenue “losses” for the first 4 years, which would be more than offset in the
next 6 years--for a net gain of $1.1 billion over the 10-year budget period.

Q: Why should Congress enact this tax deferral proposal?

A: Macro-economic research by Cognetics, Inc. and the Kauffman Center for Entrepreneurial Leadership along with other
economists have documented that the major force behind the net job expansion in the U. S. over the last decade has
been from smaller and mid-sized growing companies (principally, those with fewer than 100 employees). These
growing, entrepreneurial companies are fragile as they try to obtain sufficient capital and other resources to survive the
“No Man’s Land,” bridge the “capital funding gap,” and become big enough to attract adequate outside financing at a
reasonable cost to keep growing and providing expanding job opportunities.

Q: What are the benefits of the tax deferral proposal for emerging growth businesses?
A: First, the proposal will benefit thousands of emerging growth businesses with $10,000,000 or less in gross receipts,
which will help the U. S. economy to grow and expand job opportunities, with the potential of creating up to 641,000
new jobs in the first 3 years. Second, the proposal is neutral as to the types of businesses that will benefit (businesses
are eligible, whether capital-intensive or services, if they meet the growth and sales tests). Third, the proposal is a tax
deferral, payable with interest, thus minimizing the long-term revenue cost. Fourth, the proposal will provide emerging
growth businesses a source of needed capital financing when few outside sources are readily available at an affordable
cost.

Q: What is the effective date of the proposal?

A: [NOTE: The BRIDGE Act was originally introduced in the 102 nd Congress. The effective dates of the proposal would
need to be updated so that the tax deferral would be effective for a new 4-year period – for taxable years 2009 – 2012.]