Significant problems encountered by corporate taxpayers.

September 14, 1999

On September 14, 1999, Tax Executives Institute submitted the following comments to IRS National Taxpayer Advocate W. Val Oveson conveying significant problems encountered by corporate taxpayers in their dealings with the IRS. TEI's comments took the form of a letter from Institute President Charles W. Shewbridge, III, of BellSouth Corporation. The Institute's comments were prepared under the aegis of TEI's IRS Administrative Affairs Committee, whose chair is Robert J. McDonough, Jr., of Wang Global, Inc.

Section 101(a) of the Taxpayer Bill of Rights 2 mandates that the National Taxpayer Advocate report to Congress annually on the most serious problems encountered by taxpayers in dealing with the Internal Revenue Service. On behalf of Tax Executives Institute, I am pleased to respond to your request for comments on significant problems encountered by corporate taxpayers in their dealings with the IRS. You also asked us to respond to a draft report on the "top 20" problems identified in the recently completed filing season. We understand that these comments will be used in formulating your 1999 annual report.

As the preeminent association of corporate tax executives in North America, Tax Executives Institute represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. Our members are responsible for managing the tax affairs of their companies and must contend daily with the Internal Revenue Service and with the provisions of the tax law relating to the operation of business enterprises. Our comments focus on several areas where we believe improvements can be made to meet taxpayers' needs and expectations, and to minimize their administrative burdens.

The Perennial Favorite: Complexity of the Tax Law

Complexity of the tax law has been cited as the number one problem facing taxpayers since the Tax-payer Advocate's first annual report was issued three years ago. The draft filing season report also identifies complexity as the "most serious and burdensome problem facing America's taxpayers," explaining:

   The yearly enactment of new laws as well as amendments to existing statutes
   creates confusion and misunderstanding. Even the use of computer programs
   does not eliminate the complex computations that a taxpayer often has to
   make to determine his or her tax liability.

TEI agrees that complexity of the law -- including constant changes and amendments -- remains the primary impediment to the effective operation of the tax system and the efficient management of the IRS.

Some may fear that, like death and taxes, complexity will always be with us. At least in the case of large multinational corporations, that may well be true. But the complicated nature of today's economy should not be used as an excuse for not making the law simpler. Everyone -- Congress, the Department of Treasury, the IRS, tax professionals, and taxpayers -- bears responsibility for the current state of the law. We need to work together to find solutions.

Recent legislation requiring the IRS to provide an annual report to Congress on the sources of complexity in the administration of the Internal Revenue Code makes it more likely that the need for simplification will remain paramount in enacting legislation. Another step needed is consensus on ways to simplify current law. One area where consensus seems to be growing is the need to repeal the alternative minimum tax -- a system that requires taxpayers to compute their tax liability under two separate, parallel regimes. As you acknowledged in your April 15, 1999, testimony before the Senate Finance Committee, the AMT provisions of the Code -- for both individuals and corporations -- need to be re-evaluated in terms of their complexity. We are confident that a balanced evaluation will yield agreement that the AMT's time, if it were ever here, has gone.

Complexity may also stem from the failure to act. The best example of this is perhaps the Treasury Department and IRS's issuance of only limited guidance on the proper treatment of certain expenditures as ordinary or capital in nature (which affects their current deductibility). The lack of guidance has spawned considerable audit activity as field agents have sought to capitalize expenses that have long been treated as currently deductible, based on the Supreme Court's decision in INDOPCO v. United States, 503 U.S. 79 (1992). The IRS's inability (or unwillingness) to rein in the field frustrates taxpayers, diminishes the agency's credibility, and leads to inconsistent results.

Computation of Interest

The complexity of the Code's interest provisions also hinders the efficient administration of the tax laws. The complexity is caused not only by the provisions themselves, but also by the IRS's administration of those provisions.

A fundamental cause of the problem lies with the Code's interest-rate differential. Section 6621 of the Code establishes the rate of interest to be paid on over -- and underpayments of tax. For the past 13 years, the statutory rate of interest on underpayments has exceeded the rate of interest on overpayments by as much as 4.5 percentage points.(1)

The interest-rate differential produces anomalous (and unfair) results and more complexity where taxpayers both owe money to and are owed money by the government (but the debts bear interest at different rates). This is a common occurrence for large corporations that may have overpayments and underpayments of different taxes for several years as the result of multi-year and overlapping audits. In 1998, Congress passed legislation, establishing a net interest rate of zero where interest is payable on equivalent amounts of overpayments and underpayments of tax.(2) The legislation also eliminates the differential for individual taxpayers.

Returning to one rate of interest for all taxpayers in respect of both under -- and overpayments would greatly reduce or eliminate the need for netting and effect a significant simplification of current law. In the absence of such a change in the law, we believe that the IRS should institute the most comprehensive netting system possible. Regrettably, the IRS's most recent guidance on the issue, Rev. Proc. 99-19, signals a reluctance to do that. For example, although it is possible to interpret the rules to permit netting when the statute of limitations is open for either the year of the overpayment or the underpayment, the revenue procedure requires the statutes of limitations for both the underpayments and overpayments be open in order to qualify for transitional relief. Such an approach continues the inequity of the current law and should be abandoned. If a taxpayer-favorable interpretation under the current law is not possible, the National Taxpayer Advocate should urge the IRS and Treasury to seek a legislative solution. (One of the frustrations of the past 17 years is the IRS's disinclination to be an agent for change in respect of the interest netting issue. Consistent with the IRS's new mission, the emphasis is not -- should not be -- on money, but fairness.)

In addition, under current law, errors in calculation by the IRS are common. For example, the IRS may fail to recognize a payment made, especially a cash bond or similar payment. For this reason, taxpayers mistrust the IRS's interest calculations and frequently incur significant expense in hiring outside consultants to review interest charges -- often without the benefit of a print-out of the IRS calculations. (They are forced to pay consultants, often on a contingency basis, for a service that should be provided by their government.) We recognize that the IRS is working to replace its computer system and thereby facilitate more accurate interest computations. We believe, however, that the IRS can do more now, for example, by routinely providing copies of a taxpayer's transcript and the interest calculations. Section 6631 of the Code (added by the IRS Restructuring and Reform Act) provides that individual taxpayers must be provided with interest calculations after December 31, 2000. This provision should apply to all taxpayers and should be implemented as soon as possible.

Administration of Penalties

In 1989, Congress simplified the law by streamlining and consolidating many of the Code's penalty provisions. A decade later, we face a similar Sissyphean task. Rather than learning from the past -- that penalties should be simple, fair, and easy to administer -- Congress, sometimes at the IRS's and Treasury Department's urgings, has piled penalty upon penalty, targeting specific areas such as transfer pricing and corporate tax shelters in perhaps well-intentioned, but mishandled efforts to encourage compliance. Penalties have become almost as complicated as the underlying provisions they seek to enforce. Dangerously, too, the enactment of new or racheting up of existing penalties deprives the system of proportionality while representing a politically expedient way of raising revenues without increasing "taxes." It is therefore not surprising that the administration of penalties is listed as a challenge in the 1998 report of the National Taxpayer Advocate, as well as the draft report on the recent filing season.

Our members' experience has shown that the standards for imposing penalties are not applied consistently (e.g., in respect of the failure to-deposit penalty) across the IRS's Service Centers. What is accepted as reasonable cause by one center may be rejected by another, though the facts are substantially identical. To further the goal of consistency, TEI recommends that some form of coordinated review of penalty application be established, perhaps in conjunction with the new IRS business units.

Moreover, notices of proposed penalties can be significantly improved. All notices should clearly state the type of penalty, the reason for its proposed imposition, and the actual calculation. This information is critical to permit taxpayers to determine the validity of the proposed assessment and to identify the cause of the problem. While the IRS has a mandate to begin providing this information for notices issued after 2000, this change should be implemented sooner if possible.

Finally, the IRS should improve the timeliness of its processing of taxpayer responses to penalty notices. In some cases, taxpayers will submit a written response to a notice within the required time frame, but the response is not processed timely, generating a second notice and a second taxpayer response. This is inefficient and places an unnecessary burden on taxpayers. Ways to act on the responses more quickly, perhaps even through the use of e-mail, should be considered.

Record Retention Issues

Among the most nagging burdens imposed on businesses by the tax law are those concerning record retention. Although taxpayers clearly have a responsibility to maintain records to support the positions taken on their tax returns, much can be done to minimize the burden that currently exists (especially for corporate taxpayers with many years under examination). Record retention agreements benefit both the taxpayer and the IRS. The judicious use of such agreements can minimize taxpayers' burdens and streamline audits. Nevertheless, hypersensitivity to the potential relevance of certain records in the future has made the IRS reluctant to enter into retention agreements. IRS districts should be encouraged to enter into agreements with taxpayers concerning what records must be retained. The key should be to reach out to taxpayers to reduce administrative burdens (and provide certainty), not to begrudgingly accept written retention agreements.

One of the guiding principles of IRS Modernization is to understand and solve problems from a taxpayer's point of view. Regrettably, Rev. Proc. 98-25 (which addresses retention requirements in respect of computer-generated records) discounts the utility of retention agreements. In order to obtain an agreement, taxpayers are required to prove a negative -- that records are unnecessary and that they will, therefore, not become material to an examination. As a result, the procedure sets an unreasonably high, if not impossible, standard for taxpayers to satisfy to obtain a record retention agreement.

By adopting a more realistic view and focusing on what documents should be retained, the IRS can enable taxpayers to enhance the efficiency of their operations and improve IRS's own examination practices. Since taxpayers are under an affirmative obligation to keep adequate books and records, the taxpayer should be empowered to identify the records that are material to an examination and, hence, retained or destroyed. In addition, the IRS will foster voluntary compliance.(3)

Moreover, guidance procedures addressing the retention of computerized records should be issued more frequently than once every six to eight years. The momentum of technological change affecting systems software, hardware, and other record-retention technologies and the increasingly competitive environment in which most businesses operate challenge taxpayers to run harder and faster just to keep pace. IRS computer audit specialists, whom the Chief Counsel's Office consults in respect of ADP system record-retention matters, are only now undertaking detailed examinations of the sophisticated Database Management Software (DBMS) systems and Electronic Data Interchange (EDI) technology that many taxpayers implemented or expanded substantially during the 1990s. Indeed, ADP systems and DBMS software have generally been replaced by even more comprehensive and integrated enterprise resource planning (ERP) software and hardware systems.

The lag in guidance on ADP systems frustrates taxpayers and the IRS alike in their mutual desire to expedite the efficient examination process. Hence, TEI believes that the IRS should adopt a goal of issuing a revised revenue procedure every two years that addresses ADP systems and electronic record retention requirements. In addition, we recommend that the guidance on imaging systems and other technologies (now set forth in Rev. Proc. 97-22, 1997-1 C.B. 652) be considered contemporaneously with, or even be incorporated into, the guidance on ADP systems so that the entire spectrum of requirements for electronic record storage and retrieval is addressed comprehensively. Such an approach would serve both taxpayers and the IRS by providing timely guidance on the most effective utilization of technology for tax support.

Stable Funding of the IRS

Last year Congress took an important step in reforming and restructuring the IRS and insisting that the agency use business models to become more customer focused. In its report two years ago giving impetus to IRS reform, the National Commission on Restructuring the Internal Revenue Service stressed the need for stable funding of the agency, recommending that funding be maintained at the current level for at least three years. TEI endorsed that view and recently urged the House and Senate conferees to restore $135 million in budget cuts (which apparently will be done). To effect meaningful reform, the IRS must be able to fund all programs and activities at their current level. Thus, the Institute believes that the lack of stable funding for IRS programs must be counted among the top problems facing taxpayers.

Conclusion

TEI appreciates the opportunity to recommend issues to be included in the National Taxpayer Advocate's upcoming report to Congress. If you have any questions or need additional copies of these comments, please do not hesitate to call Timothy J. McCormally of the Institute's professional staff at [phone].

(1) The rate on underpayments of tax by a corporation is the federal short-term rate plus 3 percentage points; the overpayment rate is the federal short-term rate plus 2 percentage points. In addition, "large corporate underpayments" are subject to an interest rate equal to the federal short-term rate, plus 5 percentage points (the so-called hot interest provision), while large corporate overpayments bear interest at the federal short-term rate plus 0.5 percentage point. The higher large corporate underpayment interest rate applies only to periods after the "applicable date." The calculation of the applicable date differs. If deficiency procedures apply, the applicable date is the 30th day following the earlier of the date on which (a) the first letter of proposed deficiency that allows the taxpayer an opportunity for administrative review in the IRS's Office of Appeals, or (b) the statutory notice of deficiency is sent by the IRS. If the deficiency procedures do not apply, the applicable date is 30 days after the date on which the IRS sends the first letter or notice that notifies the taxpayer of the assessment or proposed assessment. Although the hot interest rules are especially unfair (since they produce a differential of 4.5 percentage points), TEI believes the "normal" 2.5 percentage point differential is also indefensible.

(2) The provision applies to interest for periods beginning after July 22, 1998.

(3 Regrettably, there have been inconsistencies in the willingness of various IRS districts to employ retention agreements. We believe that such agreements should be encouraged generally and hope that the impending IRS reorganization (with its emphasis on taxpayer service and its move away from a geographically based organization) will foster both consistency and greater amenability to employ record retention agreements.3