Background:

• Recently, the Aspen Institute reported that the total market of disadvantaged microenterprises is about 10,000,000 customers. That same Aspen report estimated that the microenterprise movement serves about 200,000 (2%) of that market per year and it calls for renewed emphasis on expanding services and scaling up products and proposes eight “new directions” for the microenterprise movement.
• For many in our industry, the response to that challenge has been to re-examine and re-invigorate our current models and products.
• CFED wonders if the sheer size of the gap between the total market size and the current product capacity call for more radical thinking about products and delivery systems.
• Two years ago, CFED launched the Self-Employment Tax Initiative (SETI) because we think it is worth exploring if tax code, with its track record in the delivery of the Earned Income Tax Credit (EITC) and its use as an asset-building strategy, might hold untapped potential as a microenterprise delivery strategy.

The case for tax code-based strategies:

• Roughly 11 million low and moderate income households (AGI under $50,000) file  “microenterprise tax forms” (“Schedule C”) every year. This is huge, annual “self-identifying” customer base.
• In effect, this makes Schedule C (“Profit and Loss From Business”) the closest thing to a universal portal for every unincorporated microbusiness in the country.
• Every year, roughly 4.4 million low-income households receive enhanced tax refunds through EITC because of their microenterprise income. The average size of those refunds is $1,700, making the EITC, without anyone hardly knowing it, the largest federal microenterprise program - $7.5 billion annually flows to those low-income self-employed households.
• IRS supports its own volunteer delivery system of tax preparers which work through community-based nonprofits which provide free tax preparation. While this parallel delivery system has some problems serving microenterprises, they could become important strategic partners with microenterprise programs for reaching out more effectively to the 11 million microenterprise tax customers.
• Right now, for-profit tax preparers, including large national chains, are the single largest supplier of microbusiness tax preparation services – with mixed results.

Self-Employment Tax Initiative:

• CFED’s Self-Employment Tax Initiative (SETI) is designed to explore these and other components that support the development of a new model that uses the tax code and tax preparation both as a (1) scaled-up delivery system and as a (2) policy tool to support start-up microbusinesses (including informal, immigrant, and minority microbusinesses).
• Through funding from the Citigroup Foundation, SETI has just completed working with 13 local nonprofit partners to demonstrate issues related to tax preparation as a microenterprise product. Some of the results of this demonstration are shown below. This project will continue with Citigroup Foundation support next year.
• While not as advanced as the demonstration work, SETI has also been researching how federal and state tax policy and practices can be used to better serve the largely ignored needs of the start-up microbusinesses facing business taxation for the first time. \
• Finally, SETI has also begun to explore how for-profit tax preparers, the largest tax advisors to start-up microbusinesses, might be mobilized into more exemplary service to the microenterprise sector.

Some results for the first round of Citigroup sub-grants

• Over 2,100 microbusinesses were served by the 13 sites (range: 10 to 629; average: 161/site).
• Six local partners served over 100 clients.
• Three start-up programs went from zero microenterprise tax returns (2005) to 198, 55 and 34, microbusiness customers in one year (tax year 2006 for returns due April 15, 2007).
• Three local partners each served in excess of 350 microbusiness taxpayer customers, and one program (served 629 microbusinesses).
• For tax year 2006, the local partners served 60% more microbusinesses than they did for tax year 2005.
• For 1,900 of these customers, business tax preparation was the only contact with any kind of business literacy service.

What we’re learning

• Some programs can rapidly ramp up their tax preparation services to include microbusinesses. One program went from zero (2005) to 198 (2006).
• Tax preparation readily lends itself to microbusiness training and literacy because Schedule C is basically a Profit & Loss Statement—an important business literacy learning tool.
• IRS regional officials disagree about whether they should allow IRS-trained VITA volunteers to do microbusiness tax preparations.
• The tax code’s “interface” with first-time microbusiness filers is broken and needs to be fixed. It drives start-up microbusinesses into the “informal” economy and frustrates the tax code from becoming an asset building tool for microbusinesses.
• Changing the microenterprise taxation systems has a receptive policy-maker audience at both state and federal levels.

SETI’s plans for Tax Year 2007

1. Initiate a new round of funding to support more advanced and replicable models of microenterprise tax preparation (Request for Proposal scheduled to be circulated by August 15, 2007).
2. Launch a website that includes policy discussions about self-employment taxation as well as practitioner resources.
3. Partnering with the private sector to explore scaling up the delivering of long-term, dedicated microenterprise support through tax preparation services.
4. Develop and disseminate microbusiness-specific tools for using the tax code to overcome the built-in obstacles to accessing retirement, health, education and other asset building opportunities.
5. Expand capacity to provide advice on selected state microbusiness taxation.
6. Engage the IRS in ways that support SETI goals to strengthen microentrepreneur tax training.
7. Communicate a “microenterprise perspective” to federal “tax gap” public discussions.