Featured Articles

Does the Tax Code Really Encourage Entrepreneurship?

Posted on August 8, 2016 by Daniel Willingham

A. Introduction

 


Americans are obsessed with entrepreneurship. We firmly believe that if we are given the opportunity to use our discipline and hard work, anything is possible.1 Perhaps more intriguing, we crave the benefits that successful entrepreneurs generate. John Case, a columnist for Inc., summed up the perceived benefits that come from high-achieving entrepreneurs by observing that start-ups "take the place of companies that shut down. They provide jobs, income, and hope for the future. Often, they create new markets, just by nosing their way into niches no one knew were there. . . . When a region booms, part of the reason is always the creation of new companies."2

 

Given America's fixation on entrepreneurship and our widely held belief in the benefits that it provides, it seems that our public policy should encourage entrepreneurship. To go one step further, because Congress often uses the tax code to encourage behaviors it deems to be favorable, one would expect the tax code to promote entrepreneurship.

The relationship between entrepreneurship and public policy was not lost on William H. Draper III in his book The Startup Game.3 Draper, who was one of the first venture capitalists to arrive in Silicon Valley in the 1950s, listed in his book five factors that must be in place for entrepreneurial networks to form. He argues that the most crucial contributor to success is a pro-entrepreneur government.4 As a result, Draper would likely want Congress to provide tax incentives for entrepreneurship.

The purpose of this article is to ask the question: Does the tax code really encourage entrepreneurship? The analysis contained herein is intended to provide ideas for entrepreneurs and their advisers to use in growing their businesses. Further, this analysis seeks to contribute to future tax policy discussions by demonstrating the importance of properly structuring investment incentives as well as encouraging the right people to become entrepreneurs and giving them the freedom to operate once they do.

B. How to Define Entrepreneurship

 


There are many ways to define which activities constitute entrepreneurship and which individuals are entrepreneurs. For example, Robert D. Hisrich, Michael P. Peters, and Dean A. Shepherd define an entrepreneur as "an individual who takes initiative to bundle resources in innovative ways and is willing to bear the risk and/or uncertainty to act."5 This is a fair representation of widely held beliefs, as the key elements in most definitions seem to include:

 

  • control and deployment of resources;
  • innovation; and
  • bearing risk or uncertainty.


Although these characteristics are found in many activities and are displayed by countless individuals, there are important distinctions among them. For example, when Steve Jobs created Apple in the late 1970s, he had a different goal in mind than, say, most middle-aged construction workers who leave their employers to start their own construction companies.6 That difference can be explained by distinguishing between gazelle businesses and lifestyle businesses.

1. Gazelle businesses. Gazelles are high-growth businesses that create most new jobs and bring about a lot of the societal benefits that people often associate with entrepreneurship generally.7 Unfortunately, they make up only 3 percent of all companies. It is important to note that not all gazelles begin or end as high growth. In fact, many might have rested passively on a plateau for decades before catching their stride and demonstrating noteworthy upside potential. Nonetheless, the important point here is that if and when the opportunity comes for upward growth, the gazelle embraces it fully.

2. Lifestyle businesses. In contrast to the enormous upside potential in a gazelle business, a lifestyle business owner resigns himself to a slower pace that allows him to remain in control.8 Instead of chasing prestigious venture capital investors and pursuing explosive marketing strategies, the lifestyle business owner merely wants to earn enough income to be reasonably satisfied. To him, the ability to work for himself, set his own hours, and select his niche based on his personal preferences far outweighs the monetary benefit he could receive by starting or working for a high-growth company.

3. Why the difference between gazelles and lifestyle businesses matters. In developing public policy, especially in the tax code, policymakers determine which behaviors they are trying to encourage while also remaining focused on which groups they want to target. People intending to form gazelle businesses have different goals and motivations than those trying to start lifestyle businesses. Although both are entrepreneurs according to the definition above, their businesses will likely differ significantly regarding upside potential, the ability to create jobs and generate new economic opportunities, and strategy toward key business decisions.

Tax policies that encourage entrepreneurship fall into two categories: those that provide incentives to investors to fund business start-ups and those that provide benefits to start-ups for engaging in specific activities.

It is crucial to be aware of the differences between gazelles and lifestyle businesses when evaluating the utility of specific policies. Policy incentives that focus on investors -- who want to maximize the return on their investments -- will benefit gazelles almost entirely. Policies that focus on the start-up could benefit both gazelles and lifestyle businesses.

C. Perspectives on Entrepreneurship

 


1. Scott Shane. Scott Shane's view of entrepreneurship is much more sobering than the idea held by many Americans.9

 

First, Shane argues that start-ups do not really grow the economy. Instead, firm formation occurs when the economy is already performing well. Thus, economic growth is the cause of entrepreneurship, not the effect.10

Second, Shane advances the notion that start-ups do not really create jobs. He notes that jobs in start-ups typically pay less, offer fewer benefits, and are more likely to disappear than jobs in established companies. This less advantageous economic outcome is not isolated to rank-and-file employees because even founders usually make less money in start-ups than they would earn if working for larger companies in the same industries, Shane observes.11

In light of these trends, Shane argues that most benefits of entrepreneurship are limited to a few highly successful companies.12 Because only a small minority of start-ups produce any meaningful benefit to business owners or society at large, Shane contends that we should stop encouraging generic entrepreneurship and instead target only the early-stage companies that have actual growth potential.13

Shane finds that companies are far more successful if they are in an industry that requires significant upfront capital or if their products are protected by intellectual property rights.14 Further, companies run by individuals with college educations -- especially those who majored in business or who have MBAs -- are far more likely to succeed than companies run by individuals without them.15 Also, someone who starts a business to seek a profit is likely to be more successful than someone who starts a business to "be his own boss" or because he is unemployed and can't find someone to hire him.16 Further, companies with sufficient funding (which Shane notes is usually around $25,000 but can vary depending on the industry) perform much better than those without.17 Other factors associated with success include having an owner who pursues the business full time (as opposed to dabbling on weekends), having several employees as opposed to a single "lone wolf," and having a real office or workspace outside of the business owner's home.18

Shane argues that public policies should encourage entrepreneurs and businesses with attributes that are more likely to lead to success.19

2. Joshua C. Hall and Russell S. Sobel. Hall and Sobel contend that to grow wealth, governments need to increase "productive entrepreneurship," which they say is generated by increasing economic freedom.20 Therefore, to grow wealth, governments should increase economic freedom.

Hall and Sobel warn that if a government fails to promote policies that encourage productive entrepreneurship, creative individuals will instead gravitate toward "unproductive entrepreneurship." These terms are defined in the table below.

             Productive                        Unproductive


 ___________________________________________________________________

       Create wealth                       Destroy wealth

       Institutions that secure            Lack strong institutions
       property rights, have a
       fair/balanced judicial
       system, enforce contracts,
       and limit government's
       ability to transfer wealth

       Productive market                   Manipulate political or
       entrepreneurship                    legal processes to capture
                                           transfers of existing
                                           wealth through unproductive
                                           political or legal
                                           entrepreneurship
                                           (lobbying/lawsuits)

The goals of public policy, as described by Hall and Sobel, involve:

  • allowing businesses to fail;
  • ensuring that tax incentives follow up with job growth reporting;
  • avoiding loan programs that lack managerial support and that encourage governmental agencies to pick winners;
  • reducing the corporate income tax;
  • reducing the individual income tax;
  • reforming workers' compensation;
  • reforming medical malpractice and other tort law; and
  • eliminating minimum and maximum wages.


D. Potentially Pre-Entrepreneurship Policies

1. Focus on investors.

a. New markets tax credit. The new markets tax credit (NMTC) was enacted as part of the Community Renewal Tax Relief Act of 2000.21 The purpose of the credit was to inject investment capital into businesses in low-income communities with the goal of helping those businesses grow and create jobs for local residents.

Under section 45D, NMTC investors can receive a tax credit worth 39 percent of a qualified initial investment.22 This is paid out over seven years to community development entities (CDEs). The CDEs raise capital from investors, which the CDEs must invest in qualified businesses in low-income communities.

The NMTC's track record of benefiting low-income communities is impressive. According to the NMTC Coalition, 72 percent of NMTC investments were made in "severely distressed" areas in 2011.23 Also, 58 percent of NMTC investments went to communities with unemployment rates at least 1.5 times the national average.

Perhaps more impressive is that at the height of the Great Recession in 2009, CDEs invested $630 million more than what they were statutorily required to invest.24 Further, in 2010 the NMTC Coalition found that 88 percent of investors would not have devoted any money to low-income communities if not for the NMTC.25

Thus, the data suggests that the NMTC -- if nothing else -- lures capital into communities where little investment activity would otherwise occur.

b. Qualified small business stock. Section 1202 qualified small business stock (QSBS) is a strong incentive for investors who provide capital to qualifying businesses. Noncorporate investors may exclude 50 percent of gain on the sale or exchange of QSBS held for more than five years.26 It is worth noting that this percentage has fluctuated over the years and could be higher depending on when the stock was purchased.27

The amount of income that can be excluded under section 1202 is limited to the greater of $10 million28 or 10 times the aggregate adjusted basis of QSBS issued by a given corporation and disposed of by a given investor during the tax year.29

The code defines a "qualified small business" as a C corporation with aggregate gross assets of not more than $50 million before or immediately after the corporation issues the stock.30 Although most start-ups fall under this asset limitation, few are likely to be arranged as C corporations (aside from gazelle start-ups that anticipate large venture capital investments).31 Thus, QSBS may have limited applicability, but when it applies, it can be an enormous benefit.

c. Carried interest. Carried interest is the payment of long-term capital gains by an investment partnership to the profits interest of a general partner.32 Venture capital and private equity funds are structured as partnerships that provide profits interests to general partners. General partners perform labor for the investment partnership (that is, manage the portfolio companies to make them more profitable). Because the partnership owns a portion of the portfolio company, the partnership receives payments and distributes the income to its partners every time the portfolio company pays a distribution to its shareholders.33 This results in the general partners converting part of their payments in exchange for services from ordinary income to long-term capital gain, which provides a more favorable tax rate.

To be sure, this is a controversial area of the tax code opposed by many elected officials and candidates for public office.34 Many see it as unfair that venture capital and private equity fund managers, who tend to be well off, can treat payments for services as capital gain. While it remains a viable strategy, however, the structure certainly provides an incentive to invest in start-ups (or in any business as long as a fund structure is used for the investment) and thus helps start-ups obtain the capital they need to grow.

2. Focus on start-ups.

a. Research credit. The research credit is a 20 percent tax credit for qualified research expenditures (QREs). QREs include expenditures for research that are:

  • technological in nature;
  • intended to be useful in the development of a new or improved business component of the taxpayer; and
  • part of a process for researching a new or improved function, performance, or reliability or quality.35


The research credit was recently expanded to apply more broadly. Until 2015 the research credit did not apply to internal-use software. Under new proposed regulations, however, a business can claim research credits for that software as long as the software's capabilities are not limited to the business's own internal "financial management functions, human resource management functions, and support services functions."36 In other words, the software must assist in more than just the business's internal administrative operations.

Before 2016 the research credit did not benefit many early-stage companies because it offset only federal income taxes, and most start-ups experience several years of tax losses before they begin generating income. To provide incentives for those younger companies, Congress expanded the research credit to apply to companies that are less than five years old and have less than $5 million in gross receipts to offset up to $250,000 in payroll taxes annually.37

Despite increased access for start-ups, the research credit still does not apply to all early-stage companies. QREs are limited to expenditures that are part of carrying on a trade or business.38 If the purpose of a business is to produce and sell products, it is not engaged in a trade or business until it begins stockpiling inventory and marketing and selling the products.39 For this reason, businesses that are experimenting and developing their first products do not qualify. Nonetheless, those businesses do qualify for research and experimentation deductions under section 174.40 Although the deduction is not as favorable as the research credit, it is still very much worth using when it is the only option.

b. Work opportunity tax credit. Work opportunity tax credits (WOTCs) are computed as a percentage of the salary of a newly hired employee who belongs to a targeted group.41 The credit can reach as high as $9,600 for hiring specific qualifying veterans.

Qualifying new hires must be from one of the following targeted groups:

  • qualified Temporary Assistance for Needy Families recipients;
  • qualified Supplemental Nutrition Assistance Program (food stamp) recipients;
  • qualified veterans;
  • vocational rehabilitation referrals;
  • designated community residents;
  • qualified summer youth employees;
  • qualified ex-felons;
  • qualified Supplemental Security Income recipients; and
  • long-term family assistance recipients.42


Note that a newly hired employee must work at least 120 hours in the first year of employment for the employer to claim any tax credits on the new employee's wages.43 Also, there is no limit on the number of eligible newly hired employees for which an employer can claim the WOTC.44

Because of its flexibility, the WOTC can provide enormous benefits for businesses that plan and execute properly. This includes start-ups that are growing teams but do not have much cash for the new employees' compensation.

c. Home office deduction. Generally, section 280A prohibits taking a deduction for expenses incurred to use or maintain a dwelling unit that the taxpayer uses as a residence.45 However, a taxpayer may deduct the expenses of a home office if it is used regularly and exclusively as the taxpayer's principal place of business46 or if it is used regularly as a place to meet clients or customers in the normal course of business.47

For the deduction to apply, the business use of the home must be regular48 and exclusive.49 Regular use is a facts and circumstances determination.50 Although this standard leaves plenty of room for interpretation, it suffices to say that sporadic and occasional use is insufficient.51 Ideally, taxpayers should consistently work 40 hours per week in their home offices to support the deduction.

The exclusive use requirement leaves virtually no room for compromise.52 Fortunately for taxpayers, the proposed regulations permit a deduction for a portion of the home as long as it is a "separately identifiable space."53 This does not have to be a room or any area that is "marked off by a permanent partition"; it merely has to be space that is used only for business purposes.54

Thus, entrepreneurs can get a tax deduction while operating out of their homes. By lowering the barrier of entry and reducing some early capital requirements, this deduction opens the door for more people to start their own businesses.

E. Analysis of the Tax Policies

 


1. Focus on investors.

 

a. NMTC. The NMTC has a stellar record when it comes to creating opportunities for underprivileged communities. When it was passed, James M. Talent -- then a congressman -- lauded it as "the most significant anti-poverty program to come out of Washington in decades."55

However, many of the businesses that receive the investments are restaurants, shopping centers, and hotels. They do a great job of cleaning up blighted areas and improving the economic utility of rundown regions, but most cutting-edge companies sitting on the next wave of technology are not interested in receiving money from NMTC investors. This is because the portfolio companies would have to be located in (or relocate to) qualified low-income communities. This is in addition to the numerous other requirements of the NMTC.

Thus, if businesses can get investment money through other means, they often do. For that reason, many of the businesses that receive NMTC investments have less upside potential and could often be characterized as lifestyle businesses as opposed to gazelles. For that reason, they may not be likely to substantially grow the economy.

Despite these drawbacks, the NMTC is still a better policy than many other proposals for encouraging entrepreneurship. Hall and Sobel would applaud the NMTC for allowing investors, not the government, to make decisions. They would also approve of how -- as a job creation policy -- the credit requires investors that receive NMTC allocations to demonstrate that they created jobs for their portfolio companies when they file future applications. The competitive application and allocation process ensures that investors who receive NMTCs have a track record of growing jobs.

b. QSBS. Excluding investment income has the same effect as improving one's return on investment by the amount of the tax that otherwise would have applied. For example, excluding 50 percent of gain that is taxed at 20 percent essentially creates a 10 percent tax rate for gain on QSBS. Because it allows an opportunity for lower tax rates, Hall and Sobel would likely view the QSBS exclusion favorably.

Further, the QSBS is more inclusive than the NMTC (which requires an extensive application process that only large investors can afford) and carried interest (which is limited to fund managers who can obtain investment capital from limited partners of an investment partnership) because it can apply to any investor other than a C corporation that invests in a qualified small business. Moreover, this may be the most accessible opportunity available for individual angel investors or "family/friend" investors under SEC regulation D, rule 504.56

Although the pool of investors who can benefit from QSBS seems large, few companies qualify. Most companies with gross assets of $50 million or less are S corporations or other passthrough entities. As a result, the C corporation requirement is quite limiting. However, gazelle start-ups that plan on receiving large venture capital investments tend to be C corporations. So if an investor can find a C corporation under the gross assets threshold, the $10 million and 10x limitations on the exclusion are likely to have little if any impact. Because of this tendency to encourage investment in high-growth start-ups, Shane would likely approve of the QSBS exclusion.

c. Carried interest. Carried interest certainly provides an added benefit to venture capital and private equity investors. Many commentators argue that this allows fund managers to cut their tax rate in half and treat ordinary income for services as long-term capital gain.

Although the benefits are significant for those who can receive them, this tax treatment is limited to general partners of an investment fund that manages investment capital that was mostly contributed from a group of limited partners -- which is a select group.57 Not to mention, this remains a hot political topic, so the future of this benefit is anything but certain. Still, while it remains in effect, those who receive it have an incentive to invest in start-ups and other businesses through these funds.

2. Focus on start-ups.

a. Research credit. The research credit encourages companies to devote resources to develop new technology and other new products. The 20 percent tax credit thereby encourages productive entrepreneurship along the lines of Hall and Sobel's recommendations.

As the research credit has expanded in recent years to include internal-use software58 and to offset payroll taxes,59 it has increased in importance for entrepreneurs and start-ups. Nevertheless, the research credit still fails to benefit "pre-operational" companies with activities that have not yet risen to the level of being trades or businesses. By providing less support for those businesses, the research credit is less effective for new companies that are centered on great ideas but lack the capital to fund early steps on their own. Nonetheless, the research credit encourages entrepreneurs by offering a clear incentive for start-ups that are in a position to explore new products and business operations.

b. WOTC. The WOTC encourages hiring employees in targeted groups by providing a subsidy to companies that do so. This could help a start-up build a team of employees.

Although the WOTC is primarily intended to reduce unemployment, some commentators argue that it is beneficial for start-ups. Shane would argue that the WOTC is a sound policy because it encourages start-ups to hire multiple employees and avoid the "lone wolf" strategy that he says dooms many start-ups to failure.

c. Home office deduction. The home office deduction helps make entrepreneurship more inclusive because it provides a tax benefit for those who lack the capital or other resources to purchase or lease commercial real estate. This can help segments of the population with limited ability to work outside the home. For example, it may be impractical for stay-at-home parents or those with disabilities to work elsewhere.

Still, Shane would consider this deduction a poor policy for encouraging entrepreneurial success. He finds that working from home -- as opposed to in an office -- drastically increases the failure rate of start-ups. Thus, he would argue that lowering this barrier to starting a business causes harm to those it intends to help.

F. Conclusion

 


The tax code certainly provides incentives intended to promote entrepreneurship. By capitalizing on some of the provisions described herein, entrepreneurs and their advisers should be able to help their start-ups become profitable earlier and reach new heights. By incorporating the policies articulated by Shane, Hall, and Sobel, policymakers can increase the likelihood that the right people start businesses and have the freedom to operate successfully once they do.

 


FOOTNOTES


1 Scott Shane, "Why Americans Love Small Business," Entrepreneur, Mar. 22, 2013, available at http://www.entrepreneur.com/article/226176.

2 John Case, "The Wonderland Economy," Inc., May 15, 1995, available at http://www.inc.com/magazine/19950515/2686.html.

3 Draper, The Startup Game: Inside the Partnership Between Venture Capitalists and Entrepreneurs (2012).

4Id. at 156-157. The other four factors are: (1) community resources or clubs in which entrepreneurs can meet potential collaborators in a relaxed setting; (2) a nearby university that places a strong emphasis on technology; (3) a local investment community; and (4) an informed and sympathetic local press. Draper notes that he is borrowing these factors from his son, who borrowed them from a business partner, Tony Perkins.

5 Hisrich, Peters, and Shepherd, Entrepreneurship 6 (2010).

6 For a detailed description of Jobs's ambitions during the formation of Apple, see Walter Isaacson, Steve Jobs (2011). See also Brent Schlender, Becoming Steve Jobs: The Evolution of a Reckless Upstart Into a Visionary Leader (2015).

7 Marc J. Dollinger, Entrepreneurship: Strategies and Resources 14 (4th ed. 2008). See also Joshua Zumbrun, "Hunting for Gazelles," Forbes, Oct. 30, 2009 , available at http://www.forbes.com/forbes/2009/1116/careers-small-businesses-unemployment-hunting-for-gazelles.html.

8 Sean Ogle, "7 Reasons Most People Should Build Lifestyle Businesses, Not Start-Ups," Forbes, Sept. 21, 2012, available at http://www.forbes.com/sites/theyec/2012/09/21/7-reasons-most-people-should-build-lifestyle-businesses-not-start-ups/#1627adde6cdc.

9See Shane, The Illusions of Entrepreneurship (2010); and Shane, "Why Encouraging More People to Become Entrepreneurs Is Bad Public Policy," 33(2) Small Bus. Econ. 141 (2009). Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University's Weatherhead School of Management.

10Id. at 146-152.

11Id. at 152.

12 Note that these high-growth companies would be gazelles under the definition provided above.

13Id. at 160.

14Id. at 112-116.

15Id. at 120.

16Id. at 121-122.

17Id. at 80 and 161.

18Id. at 164.

19Id. at 6.

20See Hall and Sobel, "Public Policy and Entrepreneurship," University of Kansas School of Business Center for Applied Economics (July 2006), available at https://business.ku.edu/sites/businessdev.drupal.ku.edu/files/images/general/Research/TR%2006-0717--Entrepreneur%20(Hall%20%26%20Sobel).pdf.

21 P.L. 106-554. See also LMSB-04-0510-016, "New Markets Tax Credit" (May 2010). To support the argument that this is a moderate policy with bipartisan support, note that the law was passed when President Bill Clinton and a Republican Congress -- which previously sought his impeachment -- joined forces.

22Id. See also section 45D. This provision was renewed in the "fiscal cliff" deal passed by Congress. See American Taxpayer Relief Act of 2012, P.L. 112-240 (Jan. 3, 2013).

23 NMTC Coalition, "The New Markets Tax Credit: Progress Report 2012" (June 2012), available at http://nmtccoalition.org/wp-content/uploads/NMTC-2012-Progress-Report.pdf. "Severely distressed" communities are in significantly worse shape than the statutory requirement of "low-income communities."

24 NMTC Coalition, "The New Markets Tax Credit: 10th Anniversary Report" (Dec. 2010), a vailable at http://nmtccoalition.org/wp-content/uploads/NMTCC-10th-Anniversary-Report.pdf.

25Id.

26 Section 1202(a)(1).

27 Tina M. DeSanty, "Sec. 1202: Small Business Stock Capital Gains Exclusion," The Tax Adviser (May 2013), available at http://www.thetaxadviser.com/issues/2013/may/clinic-may2013-story-07.html. For planning purposes, it appears that investors should anticipate a benefit of 50 percent.

28 Section 1202(b)(1)(A).

29 Section 1202(b)(1)(B).

30 Section 1202(d)(1).

31 Large venture capital investors tend to prefer C corporations over other entity choices because C corporations require standard controls (i.e., board of directors, shareholder meetings, minutes kept at all meetings, etc.) that are not statutorily required in limited liability company operating agreements. Venture capitalists prefer standard requirements over having to insert unique provisions into various legal agreements. S corporations are not an option because they are allowed to issue only one class of stock, and venture capitalists typically demand to own preferred stock in portfolio companies. Still, C corporations are not as tax-favored as other entities and are less flexible to operate, so if a company does not want or reasonably anticipate receiving large venture capital investments, C corporations may not be the best option.

32 Note, "Taxing Partnership Profits Interests: The Carried Interest Problem," 124 Harv. L. Rev. 1773, 1776 (2011).

33 Victor Fleischer, "Two and Twenty: Taxing Partnership Profits in Private Equity Funds," 83 N.Y.U. L. Rev. 1 (2008).

34 Jackie Calmes, "Carried Interest Tax Break Divides Again, After Trump Revives the Issue," The New York Times, Sept. 18, 2015, available at http://www.nytimes.com/2015/09/19/business/carried-interest-tax-break-divides-again-after-trump-revives-the-issue.html.

35 Section 41(d)(1)(B), (d)(1)(C), and (d)(3)(A).

36See REG-153656-03.

37 Section 41(h)(2); and Dean Zerbe, "R&D Tax Credit and Small Business -- Tax Deal Changes Everything," Forbes, Dec. 16, 2015, available at http://www.forbes.com/sites/deanzerbe/2015/12/16/rd-tax-credit-and-small-business-tax-deal-changes-everything/#6f50291200f7.

38 Section 41(b)(1).

39Jackson v. Commissioner, 864 F.2d 1521 (1989).

40 Section 174.

41 Section 51(b)(1).

42 Section 51(d).

43 Section 51(i).

44 Section 51.

45 Section 280A. An obvious exception to this general rule is the interest payments made on a home mortgage.

46 Section 280A(c)(1)(A).

47 Section 280A(c)(1)(B).

48 Prop. reg. section 1.280A-2(b)(1).

49Langer v. Commissioner, T.C. Memo. 2008-255.

50 Prop. reg. section 1.280A-2(h).

51Borom v. Commissioner, T.C. Memo. 1980-459 (holding that a judge's use of his carport as an office to manage his farmland from time to time was insufficient to support the home office deduction).

52Langer, T.C. Memo. 2008-255 (noting that the "combined personal and business use of a section of the residence precludes deductibility"). But cf. Rayden v. Commissioner, T.C. Memo. 2011-1 (holding that "the mere nonbusiness passage from one room to the next can be classified as a de minimis personal use of the room and will not disqualify the exclusivity requirement of section 280A(c)(1)"). The court in Rayden made clear that the de minimis exception is very narrow, finding that it was not de minimis for out-of-town family members to use an area of the house for "maybe one or two nights per year."

53 Prop. reg. section 1.280A-2(g)(1). If the entire house is not used for business purposes, the taxpayer can deduct the mortgage principle costs in proportion with the square footage of the house used for business purposes.

54 Prop. reg. section 1.280A-2(g)(1).

55 146 Cong. Rec. H6821 (2000). Talent later served as a U.S. senator for Missouri.

56 17 CFR section 230.504. This is commonly referred to in the start-up community as rule 504 or the family/friends provision.

57 Limited partners of those funds generally consist of high-net-worth individuals, corporations, and tax-exempt entities.

58See REG-153656-03.

59 Section 41(h)(2).


END OF FOOTNOTES