Staying Small and SBA’s New Size Standards By Steven J. Koprince Small government contractors sometimes become victims of their own success: as they grow, they may exceed the size standards in their primary industries, losing the ability to compete for set-aside procurements. For some companies, whose average annual receipts or employee counts greatly exceed the applicable size standards, the only option to regain small business status may be a fundamental corporate change, such as selling a division or splitting the company in two. But if a company appears to barely exceed the ceiling, a closer analysis of receipts, taking into account permitted exclusions, may reveal that the company is actually a small business. And in many industries, help is on the way for companies close to the size standard ceiling, in the form of significantly increased size standards. Exclusions from Annual Receipts SBA’s regulations define receipts, for size purposes, as “total income” plus “cost of goods sold,” as the terms appear on IRS tax forms. However, the definition does not end there. A business is entitled to exclude certain monies from its receipts, including: (1) net capital gains and losses; (2) taxes collected for and remitted to a taxing authority, such as sales or other taxes collected from customers; and (3) proceeds from transactions between the business and its affiliates. The second two exclusions are worth a brief closer look, because the U.S. Small Business Administration has held that they are broader than some businesses might think. For many years SBA narrowly interpreted the tax exemption. As recently as 2009, the SBA’s Office of Hearings and Appeals (OHA) held that the exemption did not apply to New Mexico’s state “transaction” tax, which was imposed upon businesses but commonly passed through to customers. But in a decision issued earlier this year, Size Appeal of Hal Hays Construction, Inc., SBA No. SIZ-5217 (2011), OHA adopted a broader view. It held that a business could exclude monies collected under Arizona’s Transaction Privilege Tax and remitted to the state, even though the tax was a tax on vendors, not customers. OHA noted that other states, including California and Michigan, have systems similar to Arizona’s, implying that taxes in those states may also be excluded from annual receipts, even though the taxes may not operate as true sales taxes. In the same case, OHA also reaffirmed that while a business must count the average annual receipts of its affiliates, it need not double-count those receipts—a relatively easy mistake to make. For example, assume Company A purchases a widget manufactured by its subsidiary, Company B, for $50,000, then resells the widget to a third party for $60,000. The sale of the item would be reflected on both companies’ receipts, but should only be counted once, when Company A resells the widget to a third party. The $50,000 transaction between the affiliates should be excluded from the size calculation. Be careful about this exclusion, however, because it is limited: OHA has held that the one-way reassignment of assets from the books of one affiliate to another (such as the purchase of a subsidiary) does not qualify for the exclusion, because there is no risk of double-counting. Increased Size Standards For companies bumping up against size ceilings in NAICS Sector 54, Professional, Scientific and Technical Services, help may soon be on the way in the form of upwardly revised size standards. Last month, SBA proposed increasing size standards for 35 industries in Sector 54, as well as one industry in NAICS Sector 81. Many of the proposed revisions call for large increases. For instance, SBA has proposed doubling the size standards in a number of industries, like Administrative Management and General Management Consulting Services (541611) and Other Scientific and Technical Consulting Services (541690) from $7.0 million to $14.0 million. In several other industries, such as Architectural Services (541310), SBA proposed even greater size increases, from $4.5 million to $19.0 million. The government is accepting public comments on the proposed increases until May 16, after which the SBA will formulate a final rule. At this point, it is unclear whether the new rule will take effect this year or in 2012, but either way, it is evident that many businesses in Sector 54 soon will be operating under significantly higher size ceilings. For companies in other NAICS codes, increases may also be on the horizon; SBA’s adjustments to Sector 54 are part of a comprehensive, sector-by-sector review of size standards across all industries. In sum, for businesses coming uncomfortably close to a size standard ceiling, a long-term solution may one day present itself in the form of revised SBA size standards. Businesses operating primarily in NAICS Sector 54 will be among the first to benefit. In the meantime, some small government contractors may be able to stave off a size problem by closely examining their annual receipts and excluding pass-through taxes and the proceeds of inter-affiliate transactions. Steven J. Koprince is an associate with PilieroMazza, PLLC in Washington, DC. His practice includes all aspects of federal government contracting, with an emphasis on small business matters.