[WPRT 107-2]
[From the U.S. Government Publishing Office]
107th Congress WMCP:
1st Session COMMITTEE PRINT 107-2
_______________________________________________________________________
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
__________
WRITTEN COMMENTS
on
TAXPAYER RIGHTS
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13
APRIL 2, 2001
Printed for the use of the Committee on Ways and Means
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC
20402
COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM McCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM McDERMOTT, Washington
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia
SAM JOHNSON, Texas RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
MAC COLLINS, Georgia WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania XAVIER BECERRA, California
WES WATKINS, Oklahoma KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona LLOYD DOGGETT, Texas
JERRY WELLER, Illinois EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
Allison Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
Subcommittee on Oversight
AMO HOUGHTON, New York, Chairman
ROB PORTMAN, Ohio WILLIAM J. COYNE, Pennsylvania
JERRY WELLER, Illinois MICHAEL R. McNULTY, New York
KENNY C. HULSHOF, Missouri JOHN LEWIS, Georgia
SCOTT McINNIS, Colorado KAREN L. THURMAN, Florida
MARK FOLEY, Florida EARL POMEROY, North Dakota
SAM JOHNSON, Texas
JENNIFER DUNN, Washington
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisory of Monday, March 19, 2001, announcing request for
written comments on taxpayer rights............................ 1
______
KPMG LLP, Mark H. Ely, and Harry L. Gutman, letter............... 3
Nilles, Kathleen M., Gardner, Carton & Douglas, statement........ 10
Pearson, Wendy S., Pearson, Merriam & Kovach, P.S., Seattle, WA,
statement...................................................... 15
ADVISORY
FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT
CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
March 19, 2001
No. OV-2
Houghton Announces Hearing on
Request for
Written Comments on Taxpayer Rights
Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
Oversight of the Committee on Ways and Means, today announced that the
Subcommittee is requesting written public comments for the record from
all parties interested on penalty and interest provisions in the
Internal Revenue Code (I.R.C.), taxpayer privacy concerns, and other
taxpayer rights.
BACKGROUND:
Penalties and Interest
In 1988 and 1989, the Subcommittee held a series of hearings on the
penalty and interest provisions in the I.R.C. The hearings culminated
in an overhaul of the penalty and interest regimes with the enactment
of the Improved Penalty Administration and Compliance Tax Act, included
in the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239).
In the IRS Restructuring and Reform Act of 1998 (P.L. 105-206),
Congress directed the U.S. Department of the Treasury and the Joint
Committee on Taxation to conduct studies to examine whether the current
penalty and interest provisions: (1) encourage voluntary compliance,
(2) operate fairly, (3) are effective deterrents to undesired behavior,
and (4) are designed in a manner that promotes efficient and effective
administration of the provisions by the Internal Revenue Service.
The Joint Committee on Taxation completed and released its study,
Study of Present-Law Penalty and Interest Provisions as Required by
Section 3801 of the Internal Revenue Service Restructuring and Reform
Act of 1998 (Including Provisions Relating to Corporate Tax Shelters)
(JCS-3-99), on July 22, 1999. The Treasury Department completed its
report, Penalty and Interest Provisions of the Internal Revenue Code,
on October 25, 1999. The Subcommittee requested written comments on
November 15, 1999, on the penalty and interest provisions of the I.R.C.
and held a hearing on January 27, 2000.
Taxpayer Privacy
In the IRS Restructuring and Reform Act of 1998, Congress directed
the Treasury Department and the Joint Committee on Taxation to examine:
(1) the present protections for taxpayer privacy, (2) any need for
third parties to use tax return information, (3) whether voluntary
compliance could be achieved by allowing the public to know who is
required, but does not, file tax returns, (4) the interrelationship of
the taxpayer confidentiality provisions in the I.R.C. and other Federal
privacy laws including, the Freedom of Information Act, 5 U.S.C.
section 552, and (5) the impact of taxpayer privacy of sharing tax
return information for enforcement of State and local tax laws.
The Joint Committee on Taxation completed and released its study,
Study of Present-Law Taxpayer Confidentiality and Disclosure Provisions
as Required by Section 3802 of the Internal Revenue Service
Restructuring and Reform Act of 1998 (JCS-1-00, Vols. I, II, and III)
on January 28, 2000. The Treasury Department completed its report,
Report to Congress on the Scope and Use of Taxpayer Confidentiality and
Disclosure Provisions, in October 2000.
On April 5, 2000, the Committee on Ways and Means marked up and
favorably reported H.R. 4163, the ``Taxpayer Bill of Rights 2000,''
which addressed several of the issues included in the studies by the
Joint Committee on Taxation and the Treasury Department. The House
passed the bill by a vote of 421-0 on April 11, 2000.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Any person or organization wishing to submit a written statement
for the printed record should submit six (6) single-spaced copies of
their statement, along with an IBM compatible 3.5-inch diskette in
WordPerfect or MS Word format, with their name, address, and comments
date noted on label, by the close of business, Monday, April 2, 2001,
to Allison Giles, Chief of Staff, Committee on Ways and Means, U.S.
House of Representatives, 1102 Longworth House Office Building,
Washington, D.C. 20515.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. All statements and any accompanying exhibits for printing must
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect or
MS Word format, typed in single space and may not exceed a total of 10
pages including attachments. Witnesses are advised that the Committee
will rely on electronic submissions for printing the official hearing
record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. A witness appearing at a public hearing, or submitting a
statement for the record of a public hearing, or submitting written
comments in response to a published request for comments by the
Committee, must include on his statement or submission a list of all
clients, persons, or organizations on whose behalf the witness appears.
4. A supplemental sheet must accompany each statement listing the
name, company, address, telephone and fax numbers where the witness or
the designated representative may be reached. This supplemental sheet
will not be included in the printed record.
The above restrictions and limitations apply only to material being
submitted for printing. Statements and exhibits or supplementary
material submitted solely for distribution to the Members, the press,
and the public during the course of a public hearing may be submitted
in other forms.
Note: All Committee advisories and news releases are
available on the World Wide Web at `HTTP://WWW.HOUSE.GOV/
WAYS__MEANS/'.
KPMG LLP
Washington, DC 20036
April 2, 2001
The Honorable Amo Houghton
Chairman
Subcommittee on Oversight
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Re: COMMENTS ON PENALTY AND INTEREST PROVISIONS OF THE INTERNAL REVENUE
CODE
Dear Mr. Chairman:
We are writing in response to your request for comments on the
penalty and interest provisions of the Internal Revenue Code (the
``Code''). We strongly support continued examination of the penalty and
interest provisions of the Code, as well as legislation that will
encourage voluntary compliance, fairness, deter undesired behavior, and
promote efficient and effective administration.
Section 3801 of the IRS Restructuring and Reform Act of 1998
required the Joint Committee on Taxation and the Secretary of the
Treasury to conduct separate studies on the administration and
implementation of the interest and penalty provisions. Pursuant to this
study, comments were sought on the penalty and interest provisions of
the Code. In response to this request, we submitted a number of
recommendations to improve the fairness and efficacy of the penalty and
interest regime. Progress has been made on the penalty and interest
provisions. We believe however, that there is room for further reform
of the penalty and interest provisions. Therefore, we respectfully
submit these recommendations to you in order to support the continued
initiative to improve the fairness and efficacy of the penalty and
interest regime for all taxpayers.
We believe that significant improvements should be made both to the
structure of the penalty and interest provisions and to the ways in
which they are administered. While some taxpayers may factor penalties
and interest into the calculation when choosing not to comply with tax
filing or payment requirements, we believe that, in most instances, the
cause of noncompliance is due to the complexity of the law, or the
result of unique events and circumstances. The cost of penalties
imposed by the Internal Revenue Service (the ``IRS'' or ``Service''),
as well as the cost of responding to proposed penalty assessments as a
result of examinations or through IRS notices, is staggering.
We believe that assessing penalties on taxpayers who have a good
history of compliance is counterproductive. Assessing penalties against
these taxpayers often contributes to the perception that the system is
unfair and may not be conducive to encouraging voluntary compliance.
Taxpayers with good track records generally should not systemically be
subjected to penalty assessments.
The complexity inherent in calculating interest, particularly in
large scale multi-year examinations, almost always results in errors by
taxpayers and the IRS. Taxpayers and the government may be losing
thousands of dollars (or more) due to such errors. Interest
calculations must be simplified.
PENALTY PROVISIONS
I. General Comments
A. Encouraging Voluntary Compliance
In general, the penalty provisions of the Code should encourage
voluntary compliance by taxpayers. We do not believe that it is in the
best interest of tax administration to enact penalties to raise revenue
or to punish a taxpayer arbitrarily. For the most part, taxpayers
understand that basic failures to comply with the Code--e.g., failure
to file an income tax return or to pay tax in a timely manner--will
result in the imposition of penalties and interest, and taxpayers will
try to comply with the law to avoid those adverse consequences. It
should be noted, however, that frequently the events or circumstances
that create late filing, late deposits, or late payments, for example,
are unique events in the life of a taxpayer or business. Too heavy a
sanction for an inadvertent failure to comply, especially when the
burden of compliance is heavy, may have the unintended effect of
undermining faith in the fairness of the system and discouraging future
compliance.
Sections 6038A and 6038C provide examples of penalty provisions
that do notencourage voluntary compliance. Sections 6038A and 6038C
impose reporting requirements on foreign-owned corporations. Under
these provisions, certain transactions with related parties must be
reported on Form 5472. The penalties imposed for failure to comply with
these reporting requirements are substantial--an initial penalty of
$10,000 per form and an additional $10,000 for each month (or fraction
thereof) if the reporting requirements are not met more than 90 days
after the Service sends notice to the corporation. The penalty can be
avoided if the corporation can show, to the satisfaction of the
Secretary, that there was reasonable cause for failing to provide the
required information, but it is unclear whether the reasonable cause
exception would apply, for instance, in cases where the taxpayer did
not know that the Form 5472 was required. These penalty rules would
more likely encourage voluntary compliance (and comport with basic
notions of fairness) if the penalties did not apply as long as the
taxpayer corrected the error before the error was discovered by the
IRS. This could be achieved by enacting in the foreign reporting
context a one time rule similar to the ``qualified amended return
rule'' in effect for purposes of the accuracy-related penalty. See Reg.
Sec. 1.6664-2(c)(3) (if an error is discovered and corrected before the
IRS contacts the taxpayer, no accuracy-related penalty can be imposed).
A similar qualified amended return rule should be enacted for
transactions required to be reported on Forms 5471.
B. Enacting Substantially Uniform Penalty Provisions
We appreciate that the inordinate complexity of the tax law and its
administration preclude perfectly consistent application of penalty and
interest provisions to all taxpayers. Nevertheless, we respectfully
request that greater effort be directed to enacting laws that promote
uniform treatment of taxpayers and encourages voluntary compliance.
Unfortunately, we are aware of numerous instances in which taxpayers
with similar fact patterns have received completely different penalty
treatment by the Service.
The section 6651(a)(2) and (3) failure to pay penalty leads to
particularly unfair results. For example, this penalty is imposed when
an individual taxpayer files a timely return but fails to pay the full
amount of the tax shown on the return. The failure to pay penalty is
not imposed, however, when the taxpayer files a Form 4868 and pays at
least 90 percent of the tax due. The individual taxpayer who files
timely and the taxpayer who files an extension will only be treated
equally if there is a 10 percent safe harbor for the failure to pay
penalty. The safe harbor should apply until the extension date (i.e.,
August 15). Thus, if an individual taxpayer files a timely return, pays
at least 90 percent of the tax due on April 15, and pays the remaining
10 percent by August 15, no failure to pay penalty should be imposed.
In order to treat individual taxpayers uniformly, the statute should be
amended in order that the penalty not attach until after August 15. A
similar rule applies to corporate taxpayers (see Reg. Sec. 301.6651-
1(c)(3), (4)). As noted more fully below, however, we believe that the
failure to pay penalty no longer serves its intended purpose and should
be repealed.
II. Specific Recommendations
A. Expansion of Reasonable Cause and Good Faith Exception
We recommend the enactment of statutes that provide a reasonable
cause and good faith exception to all penalties. The reasonable cause
and good faith exception to various penalties (such as the section
6664(c) exception to the section 6662 and 6663 accuracy-related and
fraud penalties) is one source of the Commissioner's authority to waive
or not enforce penalties. There are some penalties, however, that do
not have a reasonable cause and good faith exception. For example,
there is no reasonable cause exception for estimated tax penalties
imposed under section 6654 (with the exception of newly retired or
disabled individuals) and section 6655. Another example is section
7519, which imposes extremely harsh penalties with no reasonable cause
exception. We recommend the enactment of statutes that provide a
reasonable cause and good faith exception to all penalties.
We also believe that the penalty provisions should be amended to
recognize that taxpayers be afforded greater protection from penalties
in the situations in which there is an absence of guidance on how a
particular tax provision applies. For example, we would recommend that
either reliance on well-reasoned treatises (or other publications), or
the Service's failure to provide guidance on a tax law provision,
should be taken into account in determining whether the taxpayer
qualifies for the reasonable cause exception to the accuracy-related
penalty.
B. Enactment of an Objective Reasonable Cause Standard
We do not believe that the penalty provisions are generally
designed in a manner that promotes efficient and effective
administration by the Service. In addition to a subjective ``reasonable
cause'' standard to abate penalties, there should be enacted an
objective standard (i.e., one or more ``safe harbors'') for determining
whether the penalty should apply in the first instance. Given the
significant number of penalties that are abated under current law,
objective standards should narrow the group of taxpayers to which a
given penalty applies in a manner that corresponds to how the
particular penalty has been administered historically. The subjective
standard could be used as a supplementary measure to ensure that each
penalty is being administered equitably and fairly. This two-pronged
approach may very well result in more judicious initial application of
penalties, which would be far preferable to the current process of
proposing or assessing penalties and then abating a large number of
them when protests are received.
1. Waiver for First-Time Offenders
We recommend enactment of a safe-harbor provision for first-time
offenders as an exception to all the penalty provisions of the Code. In
certain cases, rather than the Service assessing a penalty and then
abating it if the taxpayer protests, we recommend enactment of a
provision that requires educational notices be used for first-time
offenders. If a taxpayer did not know of, and could not have easily
learned of, an obligation, a penalty should not be imposed on that
taxpayer for the first year in which the obligation arose. Any penalty
waiver provision enacted should take into consideration a taxpayer's
compliance history. Current law provides little relief for first-time
offenders. For example, section 6656(c) provides an exception from the
penalty for failure to deposit employment taxes for first-time
offenders. Likewise, Reg. Sec. 301.6724-1(a) also provides a waiver of
the penalty for failure to comply with certain information reporting
requirements for first-time offenders. We believe that this concept
should be expanded to all penalty provisions to ensure that the penalty
provisions are fair for innocent first-time offenders.
In the case of a first-time offense, we recommend requiring that
the Service inform the taxpayer of the amount of the penalty if the
penalty had been assessed. Any notice issued to a taxpayer should
contain information on what steps the taxpayer should take in the
future to avoid the penalty. A subsequent delinquency would result in a
penalty (unless special facts and circumstances in the subsequent year
justified reasonable cause relief).
One recent example that we encountered was the assertion of a late
filing penalty on a foreign based taxpayer who inherited property and
income from a person within the United States. The taxpayer was
initially given poor advice, but once he learned that he had a filing
requirement, he took prompt corrective action without IRS intervention.
The IRS Service Center refused the request for abatement of the late
filing penalty. While the taxpayer subsequently prevailed at Appeals,
the additional cost to do so was high.
2. Waiver in Interest of Tax Administration
We recommend adding a specific Code section that would allow the
Commissioner or National Taxpayer Advocate to waive or abate any
penalty or addition to tax if it is in the interest of tax
administration. Currently, Department of the Treasury Order No. 150-10
gives the Commissioner broad authority in the administration of the tax
law. This Treasury Order can be used to waive penalties. The waivers of
the estimated tax penalty noted in News Releases IR 88-39 (waiver of
estimated tax penalties for farmers who did not receive information
returns from Department of Agriculture by Feb. 15, 1988) and IR 88-62
(automatic IRS waiver of estimated tax penalties on retirement income
for 1987) are examples of the Commissioner's broad authority. We
believe that in certain circumstances the Commissioner's or the
National Taxpayer Advocate's waiver or abatement of a penalty may be in
the best interest of tax administration.
3. Waiver for Use of Payroll Service Provider
We think the efficient administration of the penalty provisions
could be greatly enhanced by modifying the rules relating to payroll
service providers. Companies hire payroll service providers to help
comply with the filing and deposit requirements related to payroll
taxes. Payroll service providers are responsible forthe timely payment
of billions of dollars in withholding taxes to the U.S. Treasury on a
daily basis. Despite this contribution, the IRS frequently fails to
recognize the unique role such companies play. In view of the
assistance payroll service providers provide to taxpayers and the
Treasury, consideration should be given to legislation that would
provide that the use of a competent payroll services company
presumptively qualifies for reasonable cause (or ``safe harbor'')
relief from penalties. The presumption could be rebutted by proof of
action by the taxpayer that was inconsistent with reasonable cause and
good faith.
C. Expansion of Required Content-Penalty Notices
We recommend that section 6751 be amended to require that penalty
notices include the rationale for imposing the penalty and an analysis
of how it applies to the particular taxpayer. Section 6751, added by
section 3306(a) of the IRS Restructuring and Reform Act of 1998,
requires that penalty notices identify the type of penalty and how it
was computed. Current communications from the Service do not provide
adequate explanations of penalties and interest. For example, a 30-day
letter involving the accuracy-related penalty typically contains
boilerplate language announcing that ``[s]ince all or part of the
underpayment of tax'' for the relevant tax year is attributable to
``one or more of'' the accuracy-related penalties for negligence or
disregard of rules or regulations, a substantial understatement of
income tax, or a valuation misstatement, a 20% ``addition to the tax is
charged as provided by section 6662(a) of the Internal Revenue Code.''
It sets forth no rationale or analysis justifying the penalty and,
indeed, does not even tell the taxpayer which component of the
accuracy-related penalty is at issue. We do not believe that Congress
intended in enacting section 6751 for taxpayers to receive so little
helpful information in penalty notices.
Although the enactment of section 6751 is a move in the correct
direction, section 6751 would not (unless amended) require including
the rationale for imposing the penalty and an analysis of how the
penalty applies to the particular taxpayer under the particular
circumstances. Section 6751 should be amended to require that 30-day
letters inform taxpayers of their options--e.g., of explaining how to
obtain relief from penalties on reasonable cause grounds--as well as of
informing taxpayers of what they did incorrectly and of how to avoid
the penalty in the future. Under the current system, a taxpayer may
have to hire a tax practitioner to understand how to obtain a waiver of
the penalty and how to avoid the penalty in subsequent tax periods.
Voluntary compliance would be greatly enhanced if taxpayers were better
apprised of their rights and responsibilities.
D. Conversion of Certain Penalty Provisions to Interest Provisions
We recommend the conversion of certain penalty provisions of the
Code to interest provisions. We believe that where a penalty provision
is essentially a fee for the use of money, such provision should be
accurately classified as interest. For example, the individual and
corporate estimated tax penalties should be replaced with interest
charge provisions. The conversion of both estimated tax penalties into
interest charges more closely conforms the titles and descriptions of
those provisions to their effect. The penalties are essentially a fee
for the use of money that is compensatory in nature.
E. Repeal of Failure to Pay Penalty
We recommend repeal of the failure to pay penalty under section
6651(a)(2) and (3). Although, in the past, some taxpayers would
generate overpayments and underpayments to take advantage of
disparities between commercial borrowing rates and the section 6621
rates, it has been our experience that this is no longer a significant
issue. In response to the interest rate disparity that existed before
1986, Congress enacted the failure to pay penalty. The purpose of this
penalty was to compensate the government for the fact that the interest
rates on underpayments were substantially less than the commercial
rates. When the interest rates were so structured, taxpayers were
``encouraged'' to put off paying their taxes for as long as possible.
The interest rates, however, are now tied to the market interest rates
and the original purpose for this penalty has disappeared. The
government is now adequately compensated for the use of its money.
Because the failure to pay penalty has outlasted its usefulness, we
respectfully request its repeal.
F. Staying Collection Proceedings
We recommend legislation which provides that collection efforts be
stayed pending completion of the administrative and/or judicial
proceeding. For example, in some situations the Service attempts to
collect the trust fund penalty imposed under section 6672 while the
penalty is being contested administratively or judicially. It would
ease the burden on taxpayers if the Code provided that collection
efforts be stayed pending completion of these proceeding.
G. Establishment of National Office Level Oversight
In order to promote uniformity and fairness, taxpayers generally
should be subject to a similar penalty regime. Although it would be
reasonable to have penalties administered by each of the four operating
units of the Service's reorganized structure, safeguards must be
instituted to ensure that each such unit administers the penalties in a
manner that is consistent with the way each other unit administers the
penalties. In view of the potential for dissimilar treatment, we
recommend legislation establishing a National Office level function to
oversee the administration of penalties and to ensure that it is
uniform and fair.
INTEREST PROVISIONS
I. Enactment of Single Statutory Interest Rate
We strongly support enactment of a single statutory rate of
interest on corporate tax underpayments and overpayments. Under current
law, a higher rate of statutory interest is imposed on corporate tax
underpayments than on corporate tax overpayments. Charging a higher
interest rate on corporate tax underpayments is equivalent to
subjecting corporate taxpayers to a penalty equal to the interest
differential. There is no policy basis for assessing a different figure
for the time value of money depending upon whether the debtor is the
federal government or a corporate enterprise. Imposing a single rate of
interest on overpayments and underpayments would eliminate this
unjustified differential.
Imposition of a single statutory rate of interest on overpayments
and underpayments also has the advantage of being easier to administer
than the current global interest netting rule. The global interest
netting rule often requires a taxpayer to produce complex calculations
to demonstrate periods of overlap and the amounts of overpayments and
underpayments eligible for netting. Imposing a single rate of interest,
by contrast, would generally have the effect of accomplishing
``interest netting'' automatically.
Finally, imposing a single rate of interest has the advantage of
rendering moot several difficult interpretive questions raised by the
global interest netting rule enacted by the IRS Restructuring and
Reform Act of 1998. The global interest netting rule generally provides
that a taxpayer is entitled to a net interest rate of zero for
equivalent tax overpayments and underpayments during applicable periods
of overlap. Questions have been raised as to whether the global
interest netting rule applies where one taxpayer has an underpayment
and a related taxpayer has an overpayment. As explained by the Joint
Committee:
The zero net interest rate only applies where interest is
payable by and allowable to the same taxpayer. The zero net
interest rate does not apply where interest is payable by one
taxpayer and allowable to a related taxpayer. However, if the
related taxpayers joined in a consolidated return for the
underpayment and overpayment years, they are presumably treated
as a single taxpayer and may apply the zero net interest rate.
[However,] [c]ertain taxpayers are prevented by the Code from
joining in a consolidated return even though one taxpayer is
the wholly owned subsidiary of the other . . .
JCT Interest and Penalty Study, JCS-3-99, July 22, 1999, p. 95. If
the tax law imposed a single statutory rate of interest on tax
overpayments and tax underpayments, the difficult interpretive
questions raised where interest is owed by one taxpayer and interest is
payable to a related taxpayer would be eliminated.
Imposition of a single statutory rate of interest would not
however, resolve a situation in which a taxpayer has an outstanding
overpayment and underpayment during an overlapping period and interest
is either not allowable on the underpayment or not payable on the
overpayment.
II. Interest Netting Rule
A. Expansion of Global Interest Netting Rule
We recommend legislation that would expand the global interest
netting rule to apply during certain legislative grace periods when
there are overlapping overpayments and underpayments, regardless of the
fact that, under the Code, interest is not paid. For instance, the Code
provides that if the IRS processes a request for a refund within 45
days no interest may be paid on the overpayment. Interest only runs if
the overpayment is not refunded within the 45-day grace period.
Likewise, interest is not imposed on an ``addition to tax'' if it is
paid within 21 business days of the date the IRS issues a ``notice and
demand''--or request for payment (10 business days if the amount of the
penalty is at least $100,000). Despite these legislative grace periods,
in each case there is still an outstanding tax overpayment or
underpayment, and under ``use of money'' principles, interest should be
accruing. We recommend that the global interest netting rule be
expanded to apply during these grace periods. This approach would take
account of the mutuality of indebtedness between the taxpayer and the
government during the period of overlapping overpayments and
underpayments.
B. Clarification of Periods of Limitations
We recommend legislation clarifying the transition rule to section
3301(c) of the IRS Restructuring and Reform Act of 1998 (the enacting
legislation to section 6621(d)) to provide that only one period of
limitation needs to be open on July 22, 1998 in order to qualify for
global interest netting. We believe such an approach is consistent with
Congress' mandate that ``the most comprehensive interest netting
procedures that are consistent with sound administrative practice'' be
adopted. We believe that this interpretation is in accordance with the
remedial purpose of section 6621(d).
Section 3301(c) of the IRS Restructuring and Reform Act of 1998 is
subject to differing interpretations. The Service interprets section
3301(c) as requiring that both periods of limitations be open as of
July 22, 1998. This interpretation does not reflect what we believe to
be the ``comprehensive netting procedures'' envisioned by Congress. See
S. Rep. No. 105-174, at 62 (1998). We think that IRS's requirement that
both periods of limitations be open as of July 22, 1998, is an
unnecessarily narrow interpretation of section 3301(c). Section 6621(d)
applies to interest periods beginning before July 22, 1998, ``[s]ubject
to any applicable statute of limitation not having expired with regard
to either a tax underpayment or a tax overpayment. . . .'' We believe
the legislative history strongly supports the view that Congress
intended that only one period of limitation need be open. The
Conference Report states that the zero net rate of interest would apply
retroactively if ``the statute of limitations has not expired with
respect to either the underpayment or overpayment. . . .'' H.R. Conf.
Rep. No. 105-599, at 74 (1998).
Furthermore, requiring only one period of limitation to be open
would be consistent with the application of the netting rules for
interest periods beginning after July 22, 1998. See Rev. Proc. 2000-26,
2000-24 I.R.B. 1257. The following example illustrates this point:
Example 1: Q Corp. had an underpayment from the 1994 tax year
that ran from March 15, 1995, until July 1, 1999 (the date on
which it was paid), and an overpayment from the 1997 tax year
that runs from March 15, 1998, until March 12, 2002 (the date
on which the refund was issued). The overlapping period of
underpayment and overpayment is March 15, 1998, through July 1,
1999. Because the 1997 return was not ``under consideration''
on December 31, 1999, Q Corp. did not take steps to protect its
right to interest netting, if any such steps are required. It
appears that the IRS is proposing that, on these facts, no
netting of Q Corp.'s 1994 underpayment and 1997 overpayment be
done for the period from March 15, 1998, to July 22, 1998--even
though netting will be required for interest periods beginning
after July 22, 1998. Therefore, in this example, the IRS will
only net the overpayment and underpayment for interest accrued
between July 22, 1998, and July 1, 1999. Because there is no
requirement that both statutes of limitation be open for
interest periods beginning after July 22, 1998, we expect that
the IRS will net the interest in this case, even though only
one period of limitation will be open.
In Example 1, the period of limitation for the 1994 underpayment
interest would have expired before March 12, 2002; however, the IRS
would still be required to net for interest periods beginning after
July 22, 1998. We do not believe it is logical to make the netting rule
dependent on when an examination concluded, especially when the IRS has
sole control over when an examination begins. It should be made clear
that IRS is required to net the overlapping overpayments and
underpayments for interest periods beginning before July 22, 1998, just
as they are required to do for interest periods beginning after July
22, 1998.
Application of the zero net rate of interest will not run afoul of
the general statutes of limitations on claims for refund, even when
only one of the limitations periods is open. Section 6621(d) requires
only that a zero net rate be applied; it does not mandate the manner in
which this is done. As long as one of the periods of limitation is
open, the interest rate on the overpayment or underpayment for that
period can be adjusted to effectuate the zero net rate. The following
example illustrates this point:
Example 2: T Corp. had a deficiency of $3,000,000 in income
tax for the 1988 tax year. That deficiency was timely assessed
on March 15, 1992. T Corp. paid the assessment of tax and
interest on April 1, 1992. Assume that the deficiency interest
accrued between March 15, 1989, and April 1, 1992, at a rate of
9 percent.
T Corp.'s 1989 tax year has been the subject of litigation in
the Tax Court. On September 10, 1998, the Tax Court entered a
decision determining that T Corp. did not have a deficiency for
the 1989 year and that T Corp., instead, had an overpayment of
$2,000,000 for that year. As a result, the IRS owes T Corp.
interest on the overpayment from March 15, 1990, through the
date of payment. Assume that overpayment interest accrued at a
rate of 8 percent during this period.
The overlapping period of underpayment and overpayment runs
from March 15, 1990 (the date the 1989 return was filed), to
April 1, 1992 (the date T Corp. paid the 1988 deficiency).
During the overlapping period, T Corp. paid interest at the
rate of 9 percent. The overlapping amount of underpayment and
overpayment is $2,000,000. If the IRS refunds the overpayment
using the 8 percent interest rate, the net rate of interest on
the overlapping amount will be 1 percent. The period of
limitation for the 1988 year has expired so, based upon current
IRS interpretation, T Corp. cannot seek a refund of the
interest rate differential--i.e., 1% of $2,000,000, accruing
between March 15, 1990, and April 1, 1992.
Even though the underpayment year was closed on July 22,
1998, the interest rate on the overpayment during the
overlapping period can be adjusted to take into account the
deficiency interest paid by T Corp. The IRS can adjust the
interest rate on the overpayment to 9 percent (the underpayment
rate) during the overlapping period to effectuate the zero net
rate of interest.
Moreover, clarifying that only one year must be open is entirely
consistent with the tax law as applied in other areas. As a general
proposition, both taxpayers and the IRS can consider, and even make,
adjustments to closed years in order to determine the correct tax
treatment in an open year. As long as no assessment or refund is being
made, the applicable statute of limitations is not being violated. See,
e.g., Commissioner v. Van Bergh, 209 F.2d 23 (2d Cir. 1954); Jones v.
Commissioner, 75 T.C. 391 (1978). See also Rev. Ruls. 56-285, 69-543,
82-49, 81-87, 81-88; PLR 9504032. This is also the approach authorized
by section 6214(b) when adjustments in years not before the Tax Court
are taken into account in order to reach the correct result for the
years at issue. See Odend'hal v. Commissioner, 80 T.C. 588, 618 (1983);
Russello v. Commissioner, T.C. Memo. 1989-391 (For purposes of
determining eligibility for income averaging, the court could look at
the correct amount of income in the base period years even though
assessment of a deficiency or refund of an overpayment would be barred
by the statute of limitations). See also Field Service Advice dated 12/
29/98 (Tax Analysts Doc. No. 1999-16631) (``Although the Tax Court is
without authority to determine a deficiency or overpayment for [the
closed year], it can consider such facts from [that year] as may be
necessary to correctly redetermine the taxpayer's tax liability for a
year with respect to which a deficiency has been determined and is
properly before the court. I.R.C. section 6214(b).'').
Because the net rate of zero can be effected by either adjusting
the interest rate in the underpayment or overpayment year--as long as
one statute is open--the taxpayer should be able to benefit from the
netting provisions. It appears that clearly Congress intended that in
drafting this statute, the interest netting rules be applied as broadly
as possible. Therefore, we recommend clarification of the law to
require that only one period of limitation--that of the underpayment
year or the overpayment year--have been open on July 22, 1998.
III. Expansion of Notice Requirement
We believe that section 6631 should be amended to require that all
bills for interest required to be paid--for both individuals and
corporations--include the Code section under which the interest is
imposed, a computation of the interest, and an explanation of how the
interest charge is determined, including the base on which the interest
is applied, the applicable interest rate, and the period during which
the interest has accrued. The notice should also include the
overlapping overpayment and underpayment periods during which the
Service is applying the net zero rate of interest.
We believe there are solid reasons to require this interest
information. For example, the Service's administration of the current
interest provisions does not always appear to be efficient and
effective. The service centers, appeals offices, and district counsel
are sometimes taking inconsistent approaches to interest computations.
We think this problem may be somewhat alleviated for individuals after
December 31, 2000, when the Service will be required to provide
individual taxpayers with notices containing both the Code section
under which interest is imposed and a computation of the interest. See
section 6631 (added by section 3308(a) of the IRS Restructuring and
Reform Act of 1998). The Code currently does not guarantee adequate
notice to taxpayers other than individuals. We recommend amending
section 6631 in order to apply to all taxpayers.
IV. Interest Abatement on Account of Equity and Good Conscience
We recommend amending section 6404 to allow the Service to abate
interest in situations that do not necessarily involve a ministerial or
managerial act, but that warrant abatement on grounds of equity and
good conscience. The ``ministerial'' and ``managerial'' requirements
are unnecessarily limiting, vague, and do not focus on the equities of
the case. In addition, we recommend modifying the Commissioner's
abatement authority to include the abatement of interest on all taxes,
such as employment taxes. Section 6404(e) only allows the abatement of
interest on taxes subject to the deficiency procedures. Because
employment and other taxes are not subject to the deficiency
procedures, interest on those taxes is not subject to abatement. See
Woodral v. Commissioner, 112 T. C. 19 (1999). There can be situations,
however, when interest on employment taxes should be abated because of
unreasonable errors or delays by the Service. Section 6404(e) could be
easily modified to account for these situations.
We recommend enactment of a statute that requires abatement of
interest in situations where delays in IRS decisions or case actions
have contributed to large interest assessments in relation to the tax
owed.
We recommend amendment to the net worth requirements for Tax Court
review of the Service's failure to abate interest. In certain cases the
net worth requirements bar relief, resulting in inequity.
V. Clarification of Code Provisions' Status as Penalty or Tax for
Interest Purposes
Section 6601(e)(2) sets forth the general rules for imposing
interest on penalties and additions to tax. It is not clear, however,
whether and when penalties other than those imposed by chapter 68 are
subject to interest--e.g., the penalties imposed by sections 5761,
6038A, 6038C, and 7261-7273. It is also unclear how interest accrues on
certain ``taxes''--e.g., the tax imposed by section 4979 on excess
contributions to a retirement plan. We recommend that these issues be
clarified in a manner that encourages compliance (i.e., that does not
unnecessarily ``stack'' sanctions).
Certain interest rules act primarily as penalties and their
application may result in the impermissible stacking of penalties. For
example, the ``hot interest'' provision in section 6621(c) on large
corporate underpayments compensates the government for the use of its
money and effectively penalizes the taxpayer an additional two percent.
In addition, before 1990, section 6621(c) imposed a 120 percent
interest rate on tax-motivated transactions. This section was repealed
for returns due after 1989, but the higher interest rate continues to
apply to tax-motivated transactions that occurred in earlier years. Not
only does this provision act as a hidden penalty, but it also results
in the dissimilar treatment of similarly situated taxpayers.
Accordingly, we strongly recommend that all rules regarding
interest should be based upon use of money principles as opposed to
raising revenue or to the imposition of a penalty.
Respectfully submitted,
Mark H. Ely
National Partner-in-Charge
Tax Controversy Technical Services
Harry L. Gutman
Partner-in-Charge
Tax Legislative and Regulatory Services
Washington National Tax
Statement of Kathleen M. Nilles, Esq., Gardner, Carton & Douglas
I am a tax lawyer practicing in Washington, D.C. I have been
involved in federal tax law for the past 16 years. Following law
school, I worked for five years as a tax associate in private practice.
Then I served as tax counsel to the Committee on Ways and Means. As Tax
Counsel, I was responsible for advising the Committee on tax compliance
issues, including IRS penalties and interest.
Since leaving Government service in early 1995, I have represented
a variety of clients as a tax partner in the law firm of Gardner,
Carton & Douglas. We currently represent the Partnership Defense Fund
Trust, an organization funded by and formed to defend the interests of
several hundred individual investors in the partnerships described
below. This statement is submitted exclusively on the Trust's behalf.
We do not represent any individual partners in these partnerships.
In connection with the Oversight Subcommittee's review of the
penalty and interest provisions in the Internal Revenue Code, I would
like to bring to the Subcommittee's attention a situation that has
drastically affected the lives of thousands of taxpayers throughout the
country. It is the kind of situation that this Committee attempted to
address in the IRS Restructuring and Reform Act of 1998. To date,
however, the IRS has failed to incorporate Congressional intent--both
in its published guidance and in its actual administration of the tax
law. Thus, I would urge Congress to consider whether stronger
legislative measures are needed.
The Situation of the Individual Taxpayers Who Invested in Hoyt
Partnerships
From 1977 through 1997, approximately 3,000 individuals and couples
throughout the United States were induced to invest in one or more of
over 100 separate partnerships set up by Walter J. Hoyt, a nationally
recognized cattle breeder. Twenty years later, many of these investors
are confronting a fate much worse than the mere loss of their original
investment in these now bankrupt partnerships. Pursuant to a complex
fraud in which the partnerships' promoter inappropriately allocated a
limited number of cattle among several partnerships resulting in excess
deductions, many Hoyt investors have received tax, penalty and interest
assessments totaling ten to twenty times their original investment. As
a result of factors beyond their control, these individual investors--
who are largely middle-class wage earners--typically face IRS
liabilities of $200,000 to $600,000.\1\ The enormity of these
liabilities has caused great emotional distress and threatened many
investors' financial and retirement security.
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\1\ One reason why the interest portion of these liabilities is so
large is that the IRS has imposed a penalty form of interest, known as
``tax-motivated interest,'' for tax years 1983 through 1988.
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The Hoyt partnerships, although fraught with fraudulent
misrepresentations and bookkeeping irregularities, were not a typical
tax shelter. Mr. Hoyt and his family were nationally recognized cattle
breeders. In the years 1984 to 1994, Hoyt's cattle operations owned
between 4,000 and 10,000 head of cattle. The cattle were kept on ten to
twelve separate ranches owned by the Hoyt partnerships with a combined
acreage totaling over 500,000 acres, as well as on other leased land.
The Hoyt investors could not have individually discovered the fraud.
Indeed, it took IRS auditors and federal prosecutors years to develop
sufficient evidence to verify their longstanding suspicions.
For several years after the IRS Criminal Investigation Division
first began to investigate the Hoyt operations, Walter J. Hoyt was
allowed to continue to conduct business as usual, to promote more
partnerships, and to retain his role as the Tax Matters Partner
(``TMP'') for the approximately 118 separate partnerships he formed and
promoted. In addition to failing to remove him as TMP, the IRS failed
to take any of the following possible actions against him:
The IRS failed to file an injunction against Mr. Hoyt as a
tax return preparer. See IRC Sec. 7407.
The IRS failed to file an injunction against Mr. Hoyt as a
promoter of an abusive tax shelter. See IRC Sec. 7408.
The IRS failed to disbar Mr. Hoyt from practice before the
IRS as an ``Enrolled Agent.'' \2\
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\2\ From the late 1970's until 1997, Mr. Hoyt used his continued
Enrolled Agent status as proof that he was a legitimate tax advisor.
The IRS finally removed Mr. Hoyt's Enrolled Agent status in 1997 and as
TMP in 1999.
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An IRS officer, with substantial experience on this case,
recognized that the investors were ``unwitting victims'' of Walter J.
Hoyt's fraud. Appeals Officer William McDevitt filed a statement in
1997 in which he described the taxpayers as ``unwitting victims,''
``unsophisticated in tax matters,'' and ``confused by the'' Tax Court's
1989 decision in Bales v. Commissioner.\3\ The Bales case held that the
partnerships were bona fide businesses and seemed to confirm most of
Hoyt's assertions and theories.\4\ Officer McDevitt concluded that
``proposing penalties against these investors would only be likened to
pouring salt into their open wounds . . . it would amount to adding
mere numbers to already uncollectable amounts.''
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\3\ Statement of Appeals Officer William McDevitt, Appeals
Supporting Statement (Dec. 23, 1997).
\4\ In Bales v. Commissioner, T.C. Memo 1989-568, the Tax Court
found that a Hoyt cattle partnership was not an abusive tax shelter;
however, the Court also held that certain deductions for expenses in
excess of the partners' actual investments should be disallowed.
---------------------------------------------------------------------------
Notwithstanding the Bales decision in October 1989, the IRS
continued auditing the Hoyt partnerships, disallowing all claimed
deductions and making adjustments consistent with the position that the
partnerships constituted abusive tax shelters. In 1993, the IRS and Mr.
Hoyt as TMP settled the 1981 through 1986 partnership tax years. The
settlements meant that essentially all claimed deductions and losses
allocated to the investors from the partnership returns would be
disallowed, while substantial income that would have accrued to the
Hoyt family was minimized.
The individual partners first received notice of their 1981 through
1986 personal tax liabilities from the settlement (via Form 4549
computational adjustment notices) beginning in 1998. The 1987 through
1996 tax years remain unresolved, with the selected dockets for the
1987 through 1992 tax years having been tried and other dockets
awaiting trial.
On May 18, 2000, the Tax Court released its decision entitled
Durham Farms. In Durham Farms, the Tax Court held that the investors in
seven Hoyt partnerships are precluded from deducting any cattle-raising
expenses for 1987 to 1992, because sufficient evidence was not produced
to establish that the seven Hoyt partnerships owned any cattle. In
light of this decision, a federal judge has asked the IRS and
partnership attorneys to work out final settlement. However, several
hundred cases still are pending in Tax Court.
In February 2000, a jury in a U.S. District Court found Walter J.
Hoyt III and two of his co-defendants guilty of mail fraud, money
laundering and conspiracy. To date, Walter J. Hoyt has not been
arrested for any tax-related criminal charges.
Recent Congressional Focus on the Hoyt Partnerships
W. Val Oveson, testifying as the IRS National Taxpayer Advocate at
a January 27, 2000, Oversight Subcommittee hearing on penalty and
interest reform, described the Hoyt situation (and others similar to
it) as follows:
One of the problems taxpayers are bringing to the Taxpayer
Advocate Service with increasing frequency involves TEFRA
partnerships determined to be tax shelters. Taxpayers, as early
as the 1970's and up through the 1990's, invested in a number
of partnerships whose major, if not only, purpose was to
shelter income from tax liability.\5\ For a number of reasons,
audits of shelter cases can be quite extensive and Tax Court
proceedings fairly lengthy. Thus, for taxpayers who do not
settle these cases, but await the results of litigation, final
resolution can leave them with liabilities dating back 10 years
or more with penalty and interest accruals to match.
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\5\ Note: Although Mr. Oveson's statement generally describes the
situation of the Hoyt investors, the Hoyt partnerships do not fit the
definition of a tax shelter (i.e., an organization whose major or
exclusive purpose is to shelter income).
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The enormity of these liabilities has caused taxpayers to
seek assistance from a number of sources, including their
Congressional representatives and various functional areas
within the Service, including my office, to abate all or part
of the accumulated liabilities or to suspend collection action.
Some taxpayers have filed for bankruptcy protection. More than
most, shelter cases can reflect the burden associated with the
past and current penalty and interest structures. Very few
taxpayers are prepared to pay or can pay penalty and interest
accumulations that may date back to the 1970's.
Some say that these taxpayers should have known that the results of
their investments were too good to be true. Nevertheless, I believe we
should not focus on blame at this point. We need to work to get these
taxpayers back into full compliance, possibly through installment
agreements or the expanded offer-in-compromise criteria. I believe that
tax shelters are an abuse of our system and the investors should be
penalized. I also concede that the investors owe interest for the time
they had the use of the government's money. I question, however,
whether it is the function of the government and our penalty and
interest regimes to punish these taxpayers to the point that they
become insolvent and unable to pay even a fraction of these
liabilities.
Statement of W. Val Oveson, National Taxpayer Advocate, Internal
Revenue Service, before the Subcommittee on Oversight, Committee on
Ways and Means (January 27, 2000) (emphasis added).
Subcommittee Chairman Houghton highlighted the Hoyt investors'
situation in his Opening Statement at that same hearing to illustrate
the heavy burden of compounded interest on tax liabilities that take
years to resolve:
I doubt that there is anyone on this panel who hasn't heard
more than one heartbreaking story from constituents who find
themselves facing crushing back taxes, penalties and interest
payments because they were unable to comply with a tax code
they have no hope of understanding. Albert Einstein once said
that compounded interest is the most powerful force in the
universe. Taxpayers whose interest payments far exceed their
underlying taxes can well appreciate the truth of his words.
Just yesterday my staff met with representatives of a group
of investors who were defrauded by an enrolled agent. His
promotional materials targeted working people, promising them
``quality investments for folks that dream about owning a piece
of the country.''
* * * * *
Today, nearly all of the investors face back taxes, penalties
and interest--going back in some cases to the 1970's--because
their deductions were disallowed. One of the investors, Ed Van
Scoten, says the IRS is trying to collect about half a million
dollars from him. ``Who are they trying to kid?,'' he asks.
``They could never get $500,000 from me if I worked five
lifetimes.''
In some cases individual investors first received notice from
the IRS of their 1981-1986 tax liability beginning in early
1998. The interest clock was running all this time.
The unscrupulous will always prey on the unsuspecting, but
something is seriously wrong with a penalties and interest
regime that adds to the problems faced by the victims of this
sort of scam.
Statement of Congressman Amo Houghton (R-NY), before the Oversight
Subcommittee of the Committee on Ways and Means (January 27, 2000).
Congressional Mandate To Expand Offer in Compromise Criteria
Section 7122 of the Internal Revenue Code authorizes the IRS to
settle tax cases with taxpayers under appropriate circumstances for
less than the full amount of tax, penalties and interest owed. In the
IRS Restructuring and Reform Act (``RRA'') of 1998, Congress amended
Section 7122 and directed the Secretary to prescribe guidelines to
determine when an offer-in-compromise should be accepted. See Code
Sec. 7122(c) as added by Section 3462 of the RRA. The legislative
history of this amendment clearly indicates what members of the tax-
writing committees wanted the IRS to address:
The Conference Report of the 1998 RRA directs that ``the
IRS [in formulating these rules] take into account factors such as
equity, hardship, and public policy where a compromise of an individual
taxpayer's income tax liability would promote effective tax
administration.'' H. Conf. Rep. No. 599, 105th Cong., 2d Sess. 289
(1998) (emphasis added).
The legislative history also specifies that the IRS should
utilize this new authority ``to resolve longstanding cases by forgoing
penalties and interest which have accumulated as a result of delay in
determining the taxpayer's liability.'' Id.
Consideration of factors such as equity and public policy
represents a significant expansion of the traditional grounds for
settling tax cases. Formerly, offers-in-compromise were limited to two
situations: (1) doubt as to liability and (2) doubt as to
collectibility.
IRS Proposed Regulations on Expanded Offer in Compromise Tests
On July 21, 1999, the IRS issued proposed regulations which clearly
do not incorporate the Congressional mandate of encouraging offers-in-
compromise in longstanding cases in which penalties and interest have
accumulated as a result of delay. Instead, the regulations continue the
traditional focus on economic factors while giving short shrift to
equity and public policy considerations. Specifically, the regulations
provide that if there are no grounds for compromise based on doubt as
to collectability or liability, a compromise may be entered into to
promote effective tax administration when:
(i) collection of the liability will create economic
hardship; or
(ii) regardless of a taxpayer's financial circumstances,
exceptional circumstances exist such that collection of the
full liability will be detrimental to voluntary compliance by
taxpayers; and
(iii) compromise of the liability will not undermine
compliance by taxpayers with the tax laws.
Temp. Reg. Sec. 301.7122-1T(b)(4)(i) through (iii).
The regulations provide specific factors for determining when the
first and third prongs are satisfied, but no specific factors are
provided for determining when the second prong--``exceptional
circumstances''--may be satisfied. Unfortunately, the temporary and
proposed regulations only offer two examples of cases of ``exceptional
circumstances:''
(i) the first involves a taxpayer who suffered a serious
illness and was unable to manage his financial affairs during
such time; and
(ii) the second example involves a case where a taxpayer
relied on incorrect advice from the IRS in an informal E-mail
response concerning the rollover period for an IRA account.
Temp. Reg. Sec. 301.7122-1T(b)(4)(iv)(E) (examples 1 and 2).
The regulations provide a third example that involves embezzlement
of payroll withholding taxes. This example could be viewed as
illustrating equitable considerations in the case of a victimized
taxpayer. However, the example is classified as a financial hardship
example because paying the accumulated taxes, penalties and interest
would cause the taxpayer's business to fail. Temp. Reg. Sec. 301.7122-
1T(b)(4)(iv)(D) (example 4).
In practice, the IRS continues to view ``exceptional
circumstances'' with the same narrowly focused lens as it always has.
In the IRS view, the overriding factor is the taxpayer's ability to pay
(i.e., financial hardship). This exclusive focus on financial factors
to the exclusion of equitable considerations is evidenced in a recent
letter from the IRS Chief Counsel's Office to Representative John M.
McHugh (R-NY) in response to his inquiry about how the IRS planned to
deal with Hoyt investor partners who are facing large interest
accumulations:
Taxpayers may at any time enter into an offer in compromise
with regard to their tax liability. We understand that, in many
cases, taxpayers will be unable to pay their liability in full,
and an offer in compromise based on doubt as to collectibility
will be considered under the established procedures for such a
request. There are no special rules for Hoyt Partnership
investors . . . .
Letter of Deborah A. Butler, Assistant Chief Counsel (Field
Service), Internal Revenue Service to The Honorable John M. McHugh
(June 4, 1999). Thus, although Congress specified in the 1998 RRA that
the IRS should consider equity and public policy and to resolve
``longstanding cases'' by foregoing penalties and interest, the IRS has
shown no inclination whatsoever to provide for significant interest
abatement based on equitable considerations or exceptional
circumstances.\6\
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\6\ At the Ways and Means Oversight Subcommittee hearing on January
27, 2000, Treasury Tax Legislative Counsel Joseph Mikout testified: ``.
. . Treasury's position remains that it is appropriate that situations
involving abatement of interest be narrowly drawn.''
---------------------------------------------------------------------------
Conclusion
Where innocent taxpayers are victimized by a tax shelter promoter
and the process of adjudicating the tax liabilities takes as long as 20
years, equitable factors are strongly present. The broader issue raised
by the fraud perpetrated on the Hoyt partnership investors is how such
equitable considerations should be taken into account in determining
whether a portion of a taxpayer's total liability (e.g., the interest)
should be compromised or abated.
In 1998, Congress determined that interest abatement should be part
of the new offer-in-compromise procedures in certain situations. As
noted above, Congress directed the IRS to take into account factors
like ``equity'' and ``public policy.'' However, two years later, the
IRS has yet to develop reasonable guidelines to facilitate offers in
compromise that give proper attention to these factors.
If the IRS continues to exhibit resistance to Congressional intent,
Congress may want to revisit the issue in a legislative context. The
Joint Committee on Taxation staff has recommended that abatement of
interest be utilized if a ``gross injustice'' would otherwise result if
interest were to be charged. It is anticipated that such authority
would be used infrequently. Although I believe that the IRS already has
the authority to address situations of gross injustice under the
expanded offer-in-compromise authority of RRA 1998, enactment of a new
statutory remedy may be necessary.
Attached hereto is a proposed statutory amendment that would
clarify Congressional intent with regard to the offer-in-compromise
criteria that should apply to long-standing cases involving equity.
PROPOSED STATUTORY AMENDMENT FOR IRS OFFERS-IN-COMPROMISE
Present law
Section 7122 of the Internal Revenue Code gives the IRS the
authority to settle cases for less than the full amount of tax,
penalties and interest owed. In the IRS Restructuring and Reform Act of
1998 (RRA '98), Congress directed the Secretary to develop guidelines
for offers-in-compromise incorporating criteria other than the
traditional grounds for such settlements--doubt as to liability and
collectibility. The RRA '98 Conference Report specified that the
factors to be taken into account when considering an offer-in-
compromise include equity, hardship and public policy. The legislative
history also specified that the IRS should utilize this new authority
to resolve longstanding cases in which penalties and interest have
accumulated as a result of delay.
Reason for statutory amendment
The IRS has expressed uncertainty about the standards that should
apply with regard to abatement of interest on equitable grounds in the
offer-in-compromise context. IRS proposed regulations issued in 1999
failed to provide workable guidelines for IRS field personnel.
Consequently, Congressional intent is not being effectuated. In
particular, such intent is not being effectuated in situations where
penalties and interest have accumulated as a result of delay and
equitable grounds are present. H.R. 4163, the Taxpayer Bill of Rights
2000, contains a provision which provides for the abatement of interest
on equitable grounds if a gross injustice would otherwise result (i.e.,
if interest were to be charged); however, this provision would be
effective only for interest accruing on or after the date of enactment.
Proposed statutory amendment
Section 7122 of the Internal Revenue Code should be amended to
provide the IRS with authority to abate penalties and interest
accumulated as a result of delay where equitable grounds or exceptional
circumstances are present. The amendment should also clearly state that
the IRS may exercise such authority to abate penalties and interest
notwithstanding the provisions of section 6404.
Effective date
This amendment applies to proposed offers-in-compromise submitted
after the date of enactment.
PROPOSED STATUTORY AMENDMENT FOR OFFERS-IN-COMPROMISE
Evaluation of Offers--Section 7122 of the Internal Revenue Code of
1986 (relating to compromises of civil or criminal cases arising under
the internal revenue laws prior to reference to the Department of
Justice) is amended by adding at the end of subsection (c) the
following new subparagraph:
`(3) Interest and Penalties--Notwithstanding the provisions
of section 6404, the Secretary may use his authority under this
section to resolve longstanding cases by foregoing penalties
and interest, in part or whole, which have accumulated as a
result of delay in determining the taxpayer's liability and
taking into account equity or other exceptional
circumstances.'.
Statement of Wendy S. Pearson, Esq., Pearson, Merriam & Kovach, P.S.
I am a tax lawyer and partner in a small law firm in Seattle,
Washington that specializes in federal tax controversies. Each of the
attorneys in our firm are former IRS counsel or Department of Justice
Tax Division counsel. The combined experience of the law partners in
handling federal tax matters extends more than 50 years.
Our firm presently represents over 250 individuals who were
partners and investors in cattle and sheep breeding partnerships
promoted by Walter J. Hoyt III. Mr. Hoyt was recently convicted for
fraudulently inducing the investors to purchase interests in the
partnerships and misrepresenting the number and quality of livestock
operated by these partnerships. These selfsame partnerships have been
audited by the Internal Revenue Service for more than 20 separate tax
years (called the ``Hoyt Project''), with many of the tax years
remaining unresolved as long as 15 years after the IRS began the audit.
For purposes of the review of penalty and interest provisions of
the Internal Revenue Code, we would like to present to the Oversight
Subcommittee some information and insights about the inequitable impact
of penalty and interest provision on taxpayers who become unwitting
victims of a tax shelter promoter. Our colleague, Ms. Kathleen Nilles
of the law firm Gardner, Carton & Douglas, has suggested to this
subcommittee that prior Congressional action in the IRS Restructuring
and Reform Act of 1998 (RRA 98) was intended to ameliorate the impact
of interest and penalties on individual taxpayers like the Hoyt
investors, but that the IRS has failed to effectuate such Congressional
intent. We echo those comments and urge Congress to clarify its intent
or to consider stronger legislative measures.
We will not reiterate here the factual background of the Hoyt
Shelter Project as explained by Ms. Nilles in her comments dated April
2, 2001. We offer the following additional information to assist the
subcommittee in its evaluation of the IRS effectuation of legislative
intent and the adequacy of current tax law to address tax
administration issues that arise in cases like this.
The Impact of Hoyt's Fraud on Taxpayers
The following scenarios depict some of the typical investors whom
we represent. We have submitted offers in compromise (under 26 U.S.C.
Sec. 7122) for these investors, wherein we have requested interest
abatement due to the ``longstanding'' nature of the cases and equitable
consideration of their retirement or medical needs in determining the
minimum acceptable offer. The IRS has indicated that RRA 98 does not
serve as a basis for abating interest and that interest will not be
abated for Hoyt investors under the offer in compromise program, namely
because the IRS does not believe that it contributed to a delay in the
resolution of the cases and it does not want to abate interest in tax
shelter cases. Similarly, the IRS has indicated that the minimum offer
will be based on the net realizable value of assets and income, without
consideration of equity and retirement needs. Further, the IRS has
indicated that pending offers of Hoyt investors will not be processed,
because each investor is a general partner in a Hoyt partnership with
pending litigation (i.e., no one can get out until the partnership
litigation is over).
The impact of the IRS position and policy on these investor cases
can be illustrated as follows. You will see that these taxpayers not
only lose their entire investment to Hoyt's fraud, but they lose their
entire life savings to pay the tax, penalties and interest attributable
to Hoyt's fraud.interest attributable to Hoyt's fraud.
------------------------------------------------------------------------
------------------------------------------------------------------------
(1) RETIREMENT/MEDICAL EXAMPLE
Retired Couple: Husband is 67, Wife is 65; Initial Tax Year of
Investment--1983
------------------------------------------------------------------------
INVESTMENT
Amounts paid to Hoyt including Tax $ 97,228
Refunds Received
Tax Refunds Received ($ 67,698)
------------
Net out of pocket loss $ 29,530
TAX LIABILITY
Tax Only $ 83,445
Interest (Including Tax Motivated $243,743
Interest)
Penalties (87-96) $ 31,639
------------
TOTAL $358,827
ASSETS/INCOME
Savings $ 11,500
Life Insurance (cash value) $ 17,528
Burial plots (cash value) $ 5,900
Vehicle Equity $ 1,000
Home Equity (Manufactured home) $112,850
Total Assets $148,798
Monthly Income (Social Security and $ 3,150
Small Pension)
============
TRADITIONAL IRS MINIMUM OFFER PAY $153,598
------------------------------------------------------------------------
Total value of all assets PLUS discretionary income () 48
months.
Assumption for this couple: $100 discretionary income per IRS standards.
------------------------------------------------------------------------
Comments:
Taxpayers have to liquidate all assets and obtain a loan for equity
in the home, even though there is no additional income to pay for the
home loan. Does not allow for any ``extraordinary expenses'' such as
home repair, home modifications due to illness, additional medical
costs for serious illness, or the purchase of a new car when vehicles
need replacement. The wife is very ill with no chances of recovery. A
T. Rowe Price Retirement Analyzer shows that this couple will run out
of money in 2012, because they have to obtain a home equity loan to
cover medical and other living expenses if the IRS takes all of their
cash assets in the offer. The loan would be necessary to account for
inflation and for any extraordinary expenses such as increased medical
costs and home maintenance.
Accordingly, equity allowances for special medical needs and
retirement needs are important to these taxpayers.
------------------------------------------------------------------------
------------------------------------------------------------------------
(2) INTEREST ABATEMENT EXAMPLE
Widow, 68; Initial Tax Year of Investment--1984
------------------------------------------------------------------------
INVESTMENT
Amounts paid to Hoyt including Tax $ 57,507
Refunds Received
Tax Refunds Received ($ 24,310)
------------
Net out of pocket loss $ 33,197
TAX LIABILITY
Tax Only $ 63,724
Interest (Including Tax Motivated $143,216
Interest)
Penalties (87-96) $ 24,562
------------
TOTAL $231,502
ASSETS/INCOME
Retirement Accounts $ 36,000
Annuities $ 70,000
Vehicle Equity $ 6,000
Home Equity $140,000
Total Assets $252,000
Monthly Income (Social Security and $ 3,100
Small Pension)
============
TRADITIONAL IRS MINIMUM OFFER PAY $231,502
------------------------------------------------------------------------
Total value of all assets PLUS discretionary income () 48
months.
Assumption for this taxpayer: $100 discretionary income per IRS
standards.
------------------------------------------------------------------------
Comments:
Taxpayer will be considered capable of paying the tax liability in
full. To do this, she must liquidate all assets and obtain a loan for
equity in the home, even though she has insufficient additional income
to pay for the home loan. It also does not allow for any
``extraordinary expenses'' such as home repair, home modifications due
to illness, additional medical costs for serious illness, or the
purchase of a new car when vehicle needs replacement. The offer does
not allow for the retention of assets to subsidize retirement needs
during her life expectancy.
Accordingly, interest abatement and consideration of retirement
needs under equitable provisions is important to this taxpayer.
------------------------------------------------------------------------
------------------------------------------------------------------------
(3) INTEREST ABATEMENT EXAMPLE
Retired Couple: Husband is 72, Wife is 67; Initial Tax Year of
Investment--1984
------------------------------------------------------------------------
INVESTMENT
Amounts paid to Hoyt including Tax $ 96,184
Refunds Received
Tax Refunds Received ($ 69,969)
------------
Net out of pocket loss $ 29,530
TAX LIABILITY
Tax Only $160,255
Interest $392,361
(Including Tax Motivated Interest) $ 77,453
Penalties
------------
TOTAL $630,069
ASSETS/INCOME
Retirement Accounts $203,319
Stocks & Money Market $ 12,245
Cash $ 20,459
Vehicles (2) Equity $ 20,000
Home Equity $250,500
Total Assets $506,523
Monthly Income (Pension & Social $ 2,830
Security)
============
TRADITIONAL IRS MINIMUM OFFER PAY $520,923
------------------------------------------------------------------------
Total value of all assets PLUS discretionary income () 48
months.
Assumption for this couple: $300 discretionary income per IRS standards.
------------------------------------------------------------------------
Comments:
The taxpayers must sell everything and obtain a loan for equity in
the home. Note, the additional amount due over the value of assets is
from the present value ($14,400) of discretionary income of $300.00/
month. They have no means of acquiring this additional $14,400.00 to
satisfy the minimum offer. The minimum offer also does not allow for
any ``extraordinary expenses'' such as home repair, home modifications
due to illness, additional medical costs for severe illness, or the
purchase of a new car when vehicles need replacement.
Accordingly, interest abatement is important to these taxpayers.
------------------------------------------------------------------------
------------------------------------------------------------------------
(4) RETIREMENT EXAMPLE
Widow, 78; Initial Tax Year of Investment--1984
------------------------------------------------------------------------
INVESTMENT
Amounts paid to Hoyt including Tax $ 67,153
Refunds Received
Tax Refunds Received ($ 41,833)
------------
Net out of pocket loss $ 25,320
TAX LIABILITY
Tax Only $ 88,908
Interest (Including Tax Motivated $206,724
Interest)
Penalties $ 34,319
------------
TOTAL $329,951
ASSETS/INCOME
Retirement Accounts $ 13,000
Mutual Funds $ 2,000
Vehicle Equity $ 3,000
Home Equity $ 12,000
Total Assets $ 30,000
Monthly Income (Social Security) $ 2,406
============
TRADITIONAL IRS MINIMUM OFFER PAY $ 30,000
------------------------------------------------------------------------
Total value of all assets.
Assumption based on IRS standards: No discretionary income.
------------------------------------------------------------------------
Comments:
Taxpayer must liquidate all assets and obtain a loan for equity in
the home, even though she does not have sufficient income to pay for
the home loan. It does not allow for any ``extraordinary expenses''
such as home repair, home modifications due to illness, additional
medical costs for severe illness, or the purchase of a new car when
vehicle needs replacement. It does not allow taxpayer to retain any
assets to support her living needs during her life expectancy.
Accordingly, consideration of retirement needs under equity
provisions is important to this taxpayer.
The IRS Handling of the Hoyt Tax Cases Does Not Promote Effective Tax
Administration
Notwithstanding the many shortcomings in the IRS handling of the
Hoyt Project cases, the current IRS position on the resolution and
closure of these cases impairs effective tax administration. For the
majority of Hoyt investors whom we represent, they are unable to pay
even a fraction of the principal tax liability, let alone the interest
and penalties thereon. Even if one were to accept the IRS' unwavering
conviction that these taxpayers deserve to be punished for investing
inan abusive tax shelter, what end is served by rendering them
penniless? Similarly, accepting the premise that the interest charged
on their tax deficiencies is to exact a cost for the use of money \7\
in order to encourage proper tax reporting (or deter improper
reporting), how does the imposition of that charge serve such purposes
when the government has acknowledged that the taxpayers had no idea
that they were making improper tax claims because they were being
defrauded? \8\
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\7\ Note, the investors were required to pay Hoyt at least 75% of
their tax benefits. And in most instances, the investors paid Hoyt all
of their tax benefits plus additional amounts out of pocket. Thus, Hoyt
had the use of the government's money for the entire period of time the
IRS chose not to shut him down.
\8\ In the recent prosecution of Hoyt, the government made its case
based on the fact that the investors were unwitting victims. Similarly,
the IRS Appeals Officer in the Hoyt audits concluded the investors were
unwitting victims.
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More to the point, the interest charges on these cases stem from
the longstanding nature of the audit and case administration. Clearly,
no one can disagree that a tax shelter audit project begun in the late
1970's and ongoing to date is a longstanding case. And, Congress
recognized in RRA 98 that effective tax administration may be served by
abating interest in longstanding cases, regardless of fault or reasons
for the delay in resolution of the cases. I submit that RRA 98 was
intended to remedy and ameliorate the effect of cumulative interest and
penalties on precisely taxpayer cases such as this one. And, the IRS
handling of offers in compromise in these cases illustrates the fact
that there will be no instance in which the IRS considers the abatement
of interest to be justified (except as set forth in the interest
abatement provisions under 26 U.S.C. Sec. 6404(e)). The IRS position is
inconsistent with RRA 98 and does not promote effective tax
administration.
We urge the Subcommittee to adopt the Offer in Compromise reform
proposals submitted by and through our colleague, Kathleen Nilles, as
part of the new taxpayer Bill of Rights being considered by the
Subcommittee for this year.
Thank you for your consideration of these comments.
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