(Archived Content)
Today the Treasury Department announced a series of legislative proposals included in the President’s FY ’05 Budget that are designed to close loopholes, halt several abusive tax avoidance transactions, and simplify the tax code. The President’s FY ‘05 Budget reflects the Administration’s continuing commitment to ensuring that all taxpayers pay their fair share of taxes, while reducing the needless cost borne by those attempting to comply. In addition, the President’s FY ’05 Budget provides for increases to the IRS’ budget to enhance compliance.
Voluntary compliance with the tax laws is threatened when taxpayers use abusive transactions to avoid paying the taxes they owe. For the past three years, the Administration has acted aggressively to restore confidence in the tax system by halting the promotion of abusive transactions and bringing taxpayers back into compliance with the tax laws. The FY ’05 budget proposals build on the Administration’s prior proposals and on information gathered through IRS compliance programs. The new legislative proposals close loopholes and target identified abusive transactions and practices. As other abusive transactions are identified, the IRS will challenge the transactions in audits, and the Treasury Department and the IRS will work with Congress to enact any legislation necessary to address the transactions.
The President’s FY ’05 Budget includes $300 million for IRS efforts to ensure compliance with the tax laws, and increases the total IRS budget by 4.8%—significantly above the average for non-defense, non-homeland discretionary spending. The budget continues a three year trend of increasing resources for the IRS to improve compliance with the tax laws, particularly with respect to abusive tax avoidance transactions, while maintaining customer service to taxpayers.
Just as abusive tax avoidance transactions threaten voluntary compliance, so too does the complexity of the tax laws. Complexity imposes needless costs on honest taxpayers simply doing their best to comply with the law. Simplifying the tax laws makes it both less painful and less costly for Americans to fulfill their civic obligations. For these reasons, it is important to continue efforts to simplify the tax laws. The new FY ‘05 Budget proposals, all of which relate to the complexity borne by individuals and families, do not represent an exhaustive list. Rather, they serve as examples of the many steps that should be taken to make the tax code easier to understand and comply with. The Administration looks forward to working with Congress in further efforts to simplify the tax laws.
“The laws must ensure that those who would shirk their civic responsibilities cannot do so by exploiting unintended loopholes, and the IRS must ensure that taxpayers do not engage in abusive tax avoidance transactions,” said Treasury Secretary John Snow. “These proposals would close loopholes and give the IRS the tools it needs to do the job. At the same time, we need to give honest Americans a better deal. We want to make it easier for those who pay their taxes, and harder for those who choose not to do so. While nobody likes paying taxes, we need to make it as simple and painless as possible. And reducing the burden of government on citizens and the economy remains a critical part of the President’s six point plan for jobs and economic growth.”
“We are committed to restoring confidence in the tax system by ending the proliferation of abusive tax avoidance transactions and simplifying the tax code,” said Treasury Assistant Secretary for Tax Policy Pam Olson. “Ultimately, there is no “silver bullet” or “one-size-fits-all” solution addressing abusive tax avoidance transactions—other than continuing to simplify the tax code and ensure that the tax results match the economic realities of the transactions. The proposals announced today make use of the information Treasury and IRS have gathered and build on actions and efforts already in progress to increase transparency.”
“Among the areas for which we propose simplification are the education provisions. You shouldn’t need a college degree to get help with your child’s education, but the education provisions of the tax code are so complex that even tax advisors struggle to understand them. Our legislative proposals would greatly simplify the provisions and make it easier for everyone to get the help they need,” Olson concluded.
“Curbing the use of abusive tax avoidance transactions by corporations and individuals is our top enforcement priority,” said IRS Commissioner Mark W. Everson. “Stiffer penalties for failing to comply with the rules on the promotion of abusive transactions will get the attention of promoters, attorneys, accountants and other advisors.”
IRS COMPLIANCE AND ENFORCEMENT PROPOSALS
Impose Penalties on the Failure to Disclose Potentially Abusive Transactions - Penalties for nondisclosure by taxpayers and promoters are either nonexistent or insufficient. The Treasury Department’s March 2002 legislative proposals would impose significant penalties on taxpayers who fail to disclose potentially abusive transactions on a return and on promoters who fail to comply with their registration and list-maintenance requirements.
Permit Uniform Disclosure Rules for Potentially Abusive Transactions - Disclosure works best when the IRS has multiple sources of information about a transaction. In that case, taxpayers and promoters will understand that their failure to disclose will eventually be discovered. Current statutory requirements do not permit completely uniform and consistent rules. The Treasury Department’s March 2002 legislative proposals would change the promoter registration and list-maintenance provisions of the tax code to allow for uniform and consistent rules.
Permit Injunction Actions against Promoters who Repeatedly Disregard the Registration and List-Maintenance Requirements – Some promoters repeatedly disregard requirements in the tax code, including the registration and list-maintenance requirements. The Administration's proposal would confirm the Government’s authority to enjoin the most egregious promoters of abusive tax avoidance transactions, as it is doing currently with promoters of tax scams directed primarily at individuals and small businesses.
Impose a Penalty for the Failure to Report an Interest in a Foreign Financial Account – Individual taxpayers are required to disclose on their tax returns interests in a foreign financial account, such as bank account. Under the Administration's proposal, a new civil penalty would be imposed on the failure to disclose foreign financial accounts, which often are used in tax avoidance transactions.
Curb Abusive Income-Separation Transactions – Some taxpayers continue to engage in transactions that separate the periodic income steam from an underlying income-producing asset in order to generate an immediate tax loss for one taxpayer and the conversion of current taxable income into deferred capital gain for another. Although the Tax code prohibits these transactions for bonds and preferred stock, taxpayers have been engaging in essentially identical transactions using similar assets, such as shares in a money-market mutual fund. Under the Administration's proposal, an income-separation transaction would be treated as a secured borrowing, not a separation of ownership. Debt characterization will ensure that the tax treatment of the transaction clearly reflects income.
Eliminate Obstacles to Disclosure - Some non-corporate taxpayers and practitioners have asserted the statutory tax practitioner privilege to avoid the disclosure of the identity of taxpayers who have entered into potentially abusive transactions. Delays in the disclosure of information about taxpayers who have entered into potentially abusive transactions also may prevent the IRS from examining these transactions before the statute of limitations expires. The Administration’s proposal would expand the “corporate tax shelter” exception to the statutory tax practitioner privilege to all “tax shelters.” The proposal also would confirm that the identity of any person that a promoter is required to identify is not privileged. In addition, the proposal would extend the statute of limitations for potentially abusive transactions that a taxpayer fails to disclose on a return until the transaction is disclosed to the IRS by either the taxpayer or the promoter.
Increase Penalties for False or Fraudulent Statements Made to Promote Abusive Tax Avoidance Transactions - Existing penalties are insufficient to deter promoters from making false or fraudulent statements regarding the claimed benefits of an abusive transaction. The Administration’s proposal would significantly increase the penalty to up to 50 percent of the fees earned by the person making or furnishing the false statement in connection with the promotion of an abusive transaction.
Eliminate Abusive Transactions Involving Foreign Tax Credits - Current law provides taxpayers with a credit for certain foreign taxes in order to eliminate the double taxation of foreign income (i.e., taxation by both the United States and the country where the income is earned). Taxpayers have structured transactions in an attempt to use foreign tax credits not to eliminate double taxation but inappropriately to reduce their U.S. tax liability on unrelated foreign income. The Treasury Department’s March 2002 legislative proposals would deny foreign tax credits for foreign withholding taxes imposed on income if the underlying property generating the income was not held for a specified minimum period of time. In addition, the Administration’s proposal would provide the Treasury Department with regulatory authority in order to prevent transactions that inappropriately separate foreign taxes from the related foreign income to take advantage of the foreign tax credit rules where there is no real risk of double taxation.
10-year revenue effect of all provisions above: $1.071 billion.
Stop Abusive Leasing Transactions with Tax-Indifferent Parties - Taxpayers increasingly have used purported leasing transactions to “acquire” significant tax benefits from a tax-indifferent party, such as a municipal transit authority or foreign government, in exchange for a modest fee. These transactions do not involve any useful economic activity, such as the acquisition or financing of business assets, and instead simply move a tax benefit, including depreciation, from a party that cannot use it (the municipality or foreign government) to a party that can (the taxpayer). Congress sought to limit these transactions in 1984 but these rules have proved ineffective over time. The Administration’s proposal would sharply limit the tax benefits claimed by the taxpayer in these transactions.
10-year revenue effect: $33.725 billion.
Require Charitable Deductions to Reflect Accurately the Value of the Donation - The tax laws encourage donations to charities. Some taxpayers, however, recently have claimed deductions for contributions of patents, intellectual property, motor vehicles, and other property that far exceed the value of the property donated. The Administration’s proposal would impose additional appraisal requirements and limit, in the case of patents and certain other intellectual property, the amount that can be deducted so that the charitable contribution deduction allowed matches the value of the donation.
10-year revenue effect: $4.771 billion.
Prevent Misuse of Tax-Exempt Casualty Insurance Companies - The tax laws provide that certain small casualty insurance companies are not subject to federal income tax. The Treasury Department and the IRS are aware that some taxpayers have established insurance companies to claim tax-exempt status and improperly accumulate investment income tax-free. The Administration’s proposal would prevent individuals from using this targeted exception to inappropriately earn investment income tax free.
10-year revenue effect: $1.184 billion.
Address the Tax Consequences of Changing Beneficiaries of a Section 529 College Savings Plan - The Administration’s proposal would resolve issues arising from the funding of section 529 college savings plans, changes to the beneficiaries or account owners of these plans, and distributions and withdrawals from these plans. Current law is unclear and these issues cannot be fully addressed through regulations. Until these issues are resolved, these ambiguities will permit taxpayers to avoid transfer taxes. The Administration’s proposal makes the rules administrable and equitable and, therefore, would protect the fisc and further encourage savings for college expenses through these increasingly popular plans.
10-year revenue effect: $194 million.
Tighten the Deduction Limitation for Interest Paid to Related Parties - Current law denies a deduction for certain interest paid by a corporation to a related party to the extent the corporation’s net interest expenses exceed 50 percent of its taxable income (computed with certain adjustments). This limitation only applies if the corporation's debt-equity ratio exceeds 1.5 to 1.0. Because of the opportunities available under current law to inappropriately reduce taxes on U.S. operations through the use of foreign related party debt, the Administration proposes to tighten the limitation for related party interest expense. The Administration proposal would eliminate the current law 1.5 to 1 debt-equity safe harbor and reduce the income threshold from 50 percent to 25 percent for related party interest. This proposal also would limit the carryforward period for disallowed interest and eliminate the carryover of limitation under current law so that taxpayers cannot use disallowed interest expense in another taxable year.
10-year revenue effect: $3.116 billion.
Prevent Avoidance of U.S. Tax on Foreign Earnings Invested in U.S. Property - Under current law, U.S. shareholders of a controlled foreign corporation must include in income their pro rata share of earnings of the corporation that are invested in certain U.S. property. Deposits with banks are excluded from the definition of U.S. property subject to this rule, however, so that taxpayers operating through foreign subsidiaries are not discouraged from using the U.S. banking system. This exception has been interpreted in a manner inconsistent with the underlying policy. For example, certificates of deposit have been issued by a U.S. affiliate in a transaction structured to take advantage of the bank exception. Under the Administration's proposal, the exception for deposits with persons carrying on the banking business would be modified to eliminate this potential for abuse.
10-year revenue effect: $234 million.
Modify Tax Rules for Individuals Who Give Up U.S. Citizenship or Green Card Status - If an individual gives up U.S. citizenship, or terminates long-term U.S. residency, with a principal purpose of avoiding U.S. tax, the individual is subject to an alternative tax regime for 10 years. The Administration proposes to improve compliance with the expatriation rules by: (1) replacing the subjective “principal purpose” test with an objective test, (2) providing that individuals who expatriate continue to be taxed as U.S. citizens or residents until they give notice of the expatriating act or termination of residency, (3) providing special rules for individuals who are physically present in the U.S. for more than 30 days per calendar year, (4) subjecting certain gifts of stock of closely-held foreign corporations by these individuals to U.S. gift tax, and (5) requiring annual reporting for these individuals.
10-year revenue effect: $273 million.
Curb Frivolous Returns and Submissions - Penalties may apply to frivolous positions taken on a tax return. Penalties do not apply to other submissions, such as offers-in-compromise (OICs), offers to enter into installment agreements, and requests for collection due process hearings, that may be based on frivolous arguments and that may be filed for the purpose of delaying or impeding tax administration. The Administration’s proposal would increase the penalty for frivolous returns and allow the penalty to be applied to frivolous submissions that are not withdrawn after IRS request. The IRS would be permitted to disregard non-return frivolous submissions that are not withdrawn.
10-year revenue effect: None.
Terminate Installment Agreements when Taxpayers Fail to File Returns or Make Tax Deposits - The IRS cannot terminate an installment agreement even if a taxpayer fails to file required returns or fails to make required federal tax deposits. The Administration’s proposal would permit the IRS to terminate an installment agreement in these situations.
10-year revenue effect: None.
Streamline the Handling of Collection Due Process Cases - The Tax Court and the U.S. district courts have jurisdiction over collection due process cases, and which court has jurisdiction over a particular case depends on the type of tax involved. The jurisdiction rules are unnecessarily complicated and have been used by some taxpayers to delay tax administration. The Administration’s proposal would consolidate jurisdiction over collection due process cases in the Tax Court.
10-year revenue effect: None.
Improve Procedures for Taxpayers Seeking to Resolve Their Tax Liabilities - The Administration has two proposals to improve procedures for taxpayers seeking to resolve their tax liabilities. The Administration’s first proposal would permit the IRS to enter into installment agreements that do not guarantee full payment of a liability over the life of the agreement. This will permit the IRS to work with a broader range of taxpayers who desire to resolve their tax liabilities. The Administration’s second proposal would make counsel review of accepted offers-in-compromise more efficient without diminishing oversight over the offers that are accepted.
10-year revenue effect: $505 million.
Make the Payment of FMS Fees for Levies More Efficient - The Financial Management Services (FMS) processes certain IRS levies. The Administration’s proposal would permit FMS to retain a portion of the amount collected as its fee, thereby reducing Government transaction costs, while still crediting the taxpayer with the full amount collected. Revenue: No revenue effect.
10-year revenue effect: None.
Expand the Use of Electronic Filing - The IRS has taken a number of steps to expand the availability and increase the use of electronic filing, which reduces costs and speeds processing for both taxpayers and the Government. The Administration’s proposal would extend the April 15 filing date to April 30 for returns that are filed electronically, provided that any tax due also is paid electronically. This proposal would encourage more taxpayers to file electronically and allow the IRS to process more returns and payments efficiently.
10-year revenue effect: None.
Permit Private Collection Agencies to Support the IRS’ Collection Efforts - The IRS’ resource and collection priorities do not permit the IRS to continually pursue all outstanding tax liabilities. Many taxpayers are aware of their outstanding tax liabilities but have failed to pay them, and the IRS cannot continuously pursue each taxpayer with an outstanding liability. The Administration's proposal would allow private collection agencies, or PCAs, to support the IRS’ collection efforts in specific, limited ways. The proposal would enable Government to reach these taxpayers to obtain payment while allowing the IRS to focus its own enforcement resources on more complex cases and issues. PCAs would not have any enforcement power and would be carefully monitored to ensure that taxpayer rights are carefully protected.
10-year revenue effect: $1.531 billion.
SIMPLIFICATION PROPOSALS
Reduce Burden on Single Parents - Over 20 million single parents raising children are entitled to tax relief in the form of a more generous standard deduction and lower rates. But in order to qualify for the relief, single parents must satisfy the household maintenance test, a complicated set of rules that is difficult to understand and hard for the IRS to administer. The test also imposes a significant record-keeping burden on the single parent. The proposal would eliminate the household maintenance test and simply require that the taxpayers live with their child.
Simplify the Earned Income Tax Credit (EITC) - To qualify for the EITC, taxpayers must satisfy requirements regarding filing status, the presence of children in their households, investment income, and their work and immigration status in the United States. These rules are confusing, require significant record-keeping, and are costly to administer. The proposal would: (1) allow some estranged spouses who live with their children to claim the EITC if they live apart from their spouse for the last six months of the year; (2) allow certain taxpayers who live with children but do not qualify for the larger child-related EITC to claim the smaller EITC for very low-income childless workers; and (3) eliminate the investment income test for taxpayers who are otherwise EITC eligible. The proposal would also improve the administration of the EITC with respect to eligibility requirements for undocumented workers.
Consolidate and Simplify Higher Education Tax Benefits - Taxpayers are faced with a range of options to reduce their taxes to pay or save for higher education. Taxpayers often have difficulty determining which alternative is best for them. In addition, the provisions are confusing and difficult to apply. The Administration proposes to simplify the choices students and parents face by consolidating the various provisions into two credits: the Hope credit and an expanded Lifetime Learning credit. The new Lifetime Learning credit would cover student interest (up to $2500) and would apply on a per-student rather than a per-taxpayer basis. The phase out limits for both credits would be raised, and the dollar limits would be indexed. The definitions of “qualified higher education expense” and “qualified higher education institution” would be made uniform throughout the Code. Other changes would be made to increase uniformity of definitions.
Make Computing the Child Tax Credit Easier - Taxpayers are required to satisfy income tests to determine the refundable child tax credit and the EITC. The requirements are different for the two credits. As a result, taxpayers must calculate their income twice. In addition, the credits have different US residency requirements. The additional child tax credit also requires families with three or more children to compute the amount of the credit twice to determine the higher amount. The proposal would use the same income and residency tests for the refundable child tax credit and the EITC. The proposal would also provide one computation to determine the credit amount.
Simplify the Taxation of Dependents - The standard deduction for over 12 million dependents is determined by a complicated formula. The formula results in the filing of tax returns with very small amounts of tax liability. Additionally, special rules called the “kiddie tax” apply to investment income of young dependents. The “kiddie tax” requires complex calculations involving the parents’ and siblings’ income and tax rates. The proposal would simplify and expand the standard deduction for dependents. In addition, the proposal would tax young dependents based on their income alone and not on the income of their parents and siblings as well.
Simplify the Calculation of the Capital Gains Tax - Special tax rates apply to gains on certain types of assets like small business stock, real estate, and collectibles. These special rates complicate tax forms, worksheets, and instructions for all taxpayers with capital gains. The proposal would eliminate the various special rates for particular assets. Instead, fifty percent of the gain on these assets would be taxed at ordinary income tax rates and the remainder at the standard capital gains rate. In addition, special treatment for certain newly-issued small business stock would be eliminated.
Make Adoption Easier - The adoption tax credit and the exclusion for employer-provided adoption expenses (taxpayers may not use both provisions for the same expenses) are phased out for higher-income families resulting in unnecessary complexity. The proposal would eliminate the income phase-out for adoption tax benefits.
Ease Compliance Burden for Unemployment Insurance - Household employers must separately pay Federal and state unemployment insurance taxes for their employees. This separate requirement is extremely burdensome. As a result, household employers and workers often fail to properly report those wages. The proposal would allow household employers to annually report and pay a combined federal and state unemployment tax to the federal government. Unemployment insurance benefits for household employees would continue to be paid by the state and reimbursed by the federal government.
Make Uniform Various Definitions of a Qualifying Child - Families with children may be eligible for reduced taxes or for refundable credits through the dependent exemption, the head of household filing status, the child tax credit, the child and dependent care tax credit, and the earned income tax credit (EITC). Each of these tax benefits uses a definition of a qualifying child that is different in some way from the others. In addition, for some of these benefits, the taxpayer must provide over half the costs of supporting the child (the “support test”). Having different definitions of a qualifying child for different tax benefits is confusing for taxpayers and leads to errors. In addition, the support test, when it applies, is difficult to understand and requires taxpayers to keep extensive records. The proposal would make the definition of a qualifying child the same for each of the five child-related tax benefits. In addition, the support test would be eliminated. Instead, taxpayers would be required to live with the child for over half the year, which is a much simpler test to apply.
10-year revenue effect of all simplification provisions: -$5.756 billion.
ADDITIONAL IRS FY ’05 BUDGET INFORMATION
Total IRS Funding – The President’s FY 2005 Budget increases the total IRS budget by 4.8% to $10.674 billion.
Business Systems Modernization – The Presidents FY ’05 Budget provides an installment of $285 million for the IRS to continue efforts to overhaul its antiquated computer system. Recent independent studies have shown that modernization needs to be resized to focus efforts on those programs which are proving to be successes.
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