American Institute of Architects Rep Calls for Small-Business Tax Relief

Madam Chairwoman Velazquez, Ranking Member Graves, and members of the Committee, I am Christopher J. Green, AIA, President of AGO Studios, a two-person architectural firm based in Avon, Colorado, and Vice Chairman of the Sustainable Building Technology Committee that developed the International Green Construction Code, the first-ever sustainable building code. I want to thank you for the opportunity to testify today on behalf of my firm and the American Institute of Architects (AIA).

The current economic crisis has affected every American, but, as this Committee knows all too well, it has hit small businesses like mine particularly hard. Moreover, the impact of this recession on the design and construction industry has been simply devastating. According to the U.S. Department of Labor, the unemployment rate in the construction industry in March 2010 was 24.9 percent, the highest by far in any industry.¹ The Associated General Contractors of America report that in the last year, 48 out of 50 states and the District of Columbia lost jobs in the construction industry.²

In my profession, the Labor Department reports that employment at architectural firms has dropped by 18 percent between 2008 and 2009.³ And that is only counting those who have applied for unemployment insurance. Many of my colleagues report being underemployed or working without pay for as long as 18 months. That is an enormous burden for workers who have families to feed and mortgage bills to pay. Worse, many young architects are simply leaving the profession, looking for opportunities elsewhere. A dearth of young talent will hamper the ability of our country to get back to building once economic conditions improve.

Architects are, by and large, small businesspeople. In fact, 95 percent of architecture firms employ 50 or fewer people.⁴ They are truly the engine that drives the design and construction industry. Architects are job catalysts -- they are the first workers to be involved in the construction process when they develop designs. Hiring an architect leads to employment in other construction-related fields, from engineers and manufacturers, to steel and electrical contractors. In fact, there is one architectural service worker for every 34 construction industry workers in this country,⁵ creating over $1 trillion in economic activity in 2008.⁶ In fact, a recent study by the George Mason University Center for Regional Analysis found that every $1 million invested in design and construction creates 28.5 new full-time jobs.⁷

Architectural activity is a harbinger of construction work: the AIA Architecture Billings Index (ABI), which surveys work on the drawing boards, is a leading indicator of construction activity nine to 12 months down the line.⁸ The most recent ABI, although showing more encouraging results than in recent months, still indicates less demand for architectural work than the month before. Indeed, the most recent issue of Bloomberg/Business Week magazine notes that the index has been contracting for 26 consecutive months. In other words, the decline in the industry has not turned around, but is merely slowing. This means that the construction industry should expect soft demand for its service for the next nine to 12 months. Clearly, we are not out of the woods yet.

Billings at my company are down 75 percent from a year ago. Construction starts are very few, primarily because clients are:

• Unable to get the necessary credit to help finance new construction or remodels. This is due to a series of conflicting banking policies that require higher levels of loan to value ratios, significantly higher levels of capital investment in a project, and revised pro forma statements that are affected by current levels of foreclosures, short sales, and other factors;

• Facing falling property values, along with new construction values that are being significantly affected by appraisals when compared to short-sale real estate transactions;

• Or municipalities that have cut back so heavily on budgets, personnel, and services that capital projects are not being considered unless absolutely necessary. In one instance in my home state, a municipal improvement project that was scheduled for last year was shelved because the company that had committed to provide financing for the project pulled out because of market conditions. That project has not been re-scheduled, affecting a number of small businesses that were counting on it to increase the vibrancy of the town center this project would have fostered.

Congress has taken some important steps over recent years to address these challenges. The American Recovery and Reinvestment Act of 2009 (ARRA), though by no means a silver bullet, is providing opportunities for work for a number of architects; in fact, the AIA's research shows that, as of March, one in four architecture firms have recorded billable hours from stimulus-funded projects.¹⁰ In addition, Congress' enactment and subsequent extension of the $8,000 homebuyers tax credit has undoubtedly made a difference in that marketplace. Lastly, this Committee's efforts to extend Recovery Act provisions that provide access to financing through the 7(a) and 504 loan programs have been indispensable.

However there is much more to be done. As the ABI figures show, we are still at least a year away from having a healthy business environment in the design and construction industry. With that in mind, I would like to propose a number of tax-related policy initiatives that Congress should take -- and one Congress should avoid -- in order to help small businesses get back on their feet.

That is why the AIA, along with a broad coalition of environmental, business, real estate, and design and construction groups, strongly supports H.R. 4226, the Expanding Building Efficiency Incentives Act of 2009, introduced by Reps. David Reichert (R-WA), Ron Kind (D-WA), Geoff Davis (R-KY), Earl Blumenauer (D-OR), Christopher Lee (R-NY), and Tom Periello (D-VA). This bipartisan legislation would extend and expand several important energy efficiency tax incentives for homes and commercial buildings.

In particular, the AIA has long backed expanding the Energy Efficient Commercial Buildings Tax Deduction (Section 179D). This deduction has made an enormous difference in the ability of commercial, institutional, and public building owners to finance construction and retrofit projects that achieve 50 percent energy savings over a 2001 baseline.

Because the provision allows for the deduction to be assigned to the designer of the energy efficient property in the case of a public building, many architects, engineers, and energy service companies have been able to take advantage of it to lower their tax burden. In fact, one accounting firm, Engineered Tax Services of Florida, has reported it has secured almost half a billion dollars in tax deductions for architecture firms in the last year alone -- with nearly half going to firms with 50 or fewer employees. Think about that: greener buildings, lower energy costs, and money back in the pockets of small design firms.

This deduction has a proven track record. But it is clear that the economic downturn has precluded many commercial building owners from taking on green projects. Increasing the deduction from $1.80 per square foot to $3.00 per square foot will make the deduction more attractive and help put designers and contractors back to work. For this reason, more than 80 organizations and companies have joined the AIA in sending a letter to Congressional leaders in support of this increase.¹¹

In addition, enhancements to the Section 179D deduction would increase its impact. One such enhancement would be to allow nonprofit building owners to assign the deduction to the designer, similar to public building owners. Also, it has come to our attention that there is a technical issue relating to the ability of partnerships and S corporations to benefit from the assignment of the deduction in the case of public buildings. Guidance clarifying these rules would provide certainty to partnerships and S corporations, consistent with Congress' intent. We are happy to provide more details on both of these issues.

As I indicated earlier, Congress has taken a number of important steps to provide liquidity to small businesses, but the challenges we face are much greater than the solutions offered so far. Therefore, I am very pleased that Chairwoman Velazquez has introduced H.R. 4841, the Small Business Tax Relief and Job Growth Act of 2010, which would help small businesses gain access to capital and create jobs.

As an architect, I am particularly pleased that the legislation would expand the scope of Section 179 to make deductible structural improvements and improvements to real property. This not only will help small businesses invest and grow, but will lead to the hiring of design and construction professionals. If Congress is serious about job creation and economic recovery, it will pass this legislation and send it to the President.

ARRA created a subsidy to help defray the cost of COBRA insurance for unemployed workers. Under ARRA, the government picks up 65 percent of the tab. This provides significant relief for workers who have been laid off from their jobs, in that they only have to pay 35 percent of the premium.

However, there was a consequence of this provision that impacts businesses, particularly small ones. Employers are required to pay 100 percent of the benefits up front and then obtain reimbursement later from both the insurance company and the government (via a tax subsidy). This is a significant burden for small businesses that have already been forced to lay off employees, and it creates cash flow problems that could lead to additional layoffs. This is especially true because beneficiaries have 90 days to enroll in COBRA. Should they wait, employers must then pay for the full three months of benefits at one time.

Let me be clear: the COBRA subsidy program is a good program that the AIA supports and believes needs to continue for as long as this economic crisis persists. However, we recommend that the program be improved to ensure that beneficiaries continue receiving the benefit while not unduly burdening small businesses.

A current government program, the Health Coverage Tax Credit (HCTC) provides an advanceable credit for a portion of qualified health insurance premiums, including COBRA, purchased by taxpayers who meet certain qualifications. We believe that this program could be expanded to include individuals involuntarily terminated from small businesses.

This is how it would work: after recently terminated workers enrolled in COBRA, the existing HCTC infrastructure would be used to verify eligibility and invoice the beneficiary, who would in turn send their contribution (35 percent of the monthly premium) to the Treasury. The Treasury would then send 100 percent of the premium directly to the beneficiary's health insurance plan, relieving the small business of its "middle-man" status.

The HCTC advance payment infrastructure is already in place and, as such, there would be limited costs in expanding its use for the COBRA subsidy. Additionally, this fix would ensure that people who have lost their jobs due to the recession get relief from COBRA costs, while helping businesses of all sizes begin to rebuild their practices, stimulate the economy, and eventually rehire workers. We urge Congress to adopt this plan.

It has been reported that the Ways and Means Committee is seriously considering a proposal to significantly increase taxes paid by S corporation shareholders. Under current law, S corporation income is not directly taxed, but instead flows through to shareholders who are taxed at the individual level as ordinary income. Income flowing from the S corporation may be classified as either salary paid to shareholders or as earnings distributions. A shareholder who performs services as an employee of the S corporation is subject to payroll taxes on amounts received as salary, but does not pay payroll taxes on amounts received as earnings distribution.

Although the details of the proposal currently under consideration are unclear, it is my understanding that the proposal would expand the application of payroll taxes to active shareholders of S corporations "primarily" engaged in "the performance of services." I understand that there is concern that some S corporations misclassify salary compensation as earnings distributions in order to avoid paying payroll taxes. However, my fear is that the proposal will entrap millions of small business owners who are legitimately and correctly classifying salary and earnings distributions, with limited public policy benefit.

The S Corporation Association has written to Ways and Means Committee Chairman Sander Levin (D-MI) to express its concerns over this proposal, stating: "By targeting service sector S corporations, this proposal would increase taxes on small business owners who are fully complying with the law. It will add to the tax code's complexity by creating new categories of business activity that will have to be defined and litigated. And, by blurring the line between income from labor and income from capital, this proposal will set the stage for future increases in payroll taxes on more capital-intensive sectors such as manufacturing and agriculture." The AIA joined 14 other organizations in signing that letter.

We understand that part of the motivation for this proposal is to find ways to offset the loss of revenue of various tax incentives, including, possibly, the ones I outlined earlier. As a small businessperson, I know all too well the importance of balancing the books. I believe that Congress and the Administration need to make deficit reduction a top priority. However, I am concerned that increasing some taxes on small businesses at the same time you are lowering others will not only hamper economic recovery, but will add more complexity and uncertainty to the tax code.

Although this hearing is focused on tax issues, I wanted to reiterate the fact that access to credit is by far the largest issue facing our industry. SBA loans are absolutely vital, but many of the rules and regulations are too strict, preventing many businesses from qualifying. In addition, I believe that the amortization of loans should be changed from 20 to 30 years, which will help drive recovery by reducing businesses' debt burden.

In conclusion, I would like to thank Chairwoman Velazquez, Ranking Member Graves, and the members of this Committee for giving me the opportunity to testify before you today. I also commend you for your dedication over the last two years in raising awareness of the problems that small businesses face in this economy and your leadership in advancing legislation that helps small business drive the recovery. The challenges that we as small businesspeople face are serious, but so is our commitment to play a leading role in rebuilding and renewing our country.

Thank you.

²http://www.agc.org/cs/news_media/press_room/press_release?pressrelease.id=568

³ Bureau of Labor Statistics

⁴http://info.aia.org/aiarchitect/thisweek09/1009/1009b_firmsurvey.cfm

⁵ U.S. Department of Labor

⁶ www.census.gov/const/C30/total.pdf

⁷ www.naiop.org/foundation/contdev.pdf

⁸ www.aia.org/aiaucmp/groups/aia/documents/pdf/aias076074.pdf

⁹ www.aia.org/advocacy/federal/AIAB081324

¹⁰ www.aia.org/advocacy/AIAB082671

¹¹http://www.efficientbuildings.org/PDFs/CBTD_MoC_Letter.pdf