State tax administration provisions.

On January 21, 1993, Tax Executives Institute released the following series of position papers on practices and procedures. The papers represent the Institute's general position on diverse administr matters that may be categorized as "level-playing field" or "administrative bill of rights" issues. to TEI's local chapters, President Bob Perlman urged the chapters to consider adapting the position in their own State and then submitting the adapted submissions (following approval) to the appropria The six submissions were developed under the aegis of the Institute's State and Local Tax Committee, McKeon, Jr. of the Biltrite Corporation. Robert E. Meehan of APAC, Inc. -- vice chair of the committ contributor to the development of the Institute's position.

State-Imposed Audit Fees

Tax Executives Institute has long opposed the imposition of fees on taxpayers to offset the State's administrative costs of conducting an audit or its legal costs incurred in defending tax appeals. We believe the adoption of such a "user-fee" approach to financing tax audits and appeals is wholly inappropriate to our voluntary self-assessment tax system.

States that impose audit fees have tended to do so in an arbitrary and discriminatory manner. For example, one State claimed that its bank audit fee was justified because a high proportion of the tax revenues from banks was perceived to be derived from the audit process. The State then proposed through regulations that an audit fee of $110 per hour be charged but offered no justification for that amount. More important, there was no mechanism provided for challenging the hourly rate or monitoring the magnitude of the fees imposed in particular cases. Such an arbitrary fee undermines our voluntary self assessment system of taxation. Although in that case the State Supreme Court struck down the State's bank audit fee, a few States continue to regularly assess the cost of audits to taxpayers.

Stated simply, taxpayers should not be required to reimburse the State for the cost of auditing their own returns. Ensuring compliance with the tax laws is a general government function and the cost of that function should be borne by all taxpayers. Although "user fees" might be appropriate under some circumstances to pay for targeted government services (for example, state park entrance fees or toll roads), it is obvious that tax audits are not conducted for the benefit of the audited taxpayers.

Interest Rates

Some States (as well as the federal government) charge taxpayers a higher rate of interest on tax deficiencies than they pay on tax refunds. Indeed, in some instances no interest is paid on refund claims. Moreover, the interest rates frequently bear no relation to the market rate of interest: the rate charged on tax assessments exceeds the rate a State could earn on timely deposited funds and the rate paid on tax refunds is significantly lower than the rate at which a State could borrow the funds. The interest rate differential and the variance from the market rate can lead a State to delay the processing of refund claims or, at a minimum, to a taxpayer perception that such delays on the part of the States are volitional.

Differential interest rates may properly be characterized as punitive in nature. Tax Executives Institute believes that the interest rate provisions of the tax law should be designed to recompense a party for the time value of money -- nothing more and nothing less. Interest rates should not be manipulated simply to collect additional revenues or, for that matter, to encourage or discourage specific taxpayer behavior. Most fundamentally, the interest rate should not change depending on which side of the transaction the government is on. In other words, the government should not undertake to view itself as a financial institution that is free to extract a high rate of interest from taxpayers with no negotiating power while paying a lesser rate.

TEI opposes the application of different rates of interest to assessments and refund claims. Failure to pay interest or to equalize interest rates diminishes the value of the taxpayer's remedy of recovering tax monies to which it is legally entitled. It also undermines public confidence in the fairness of the tax system. Not only is the payment of a market-rate of interest eminently fair, but it will minimize any incentive a State may have to unduly delay the processing of refund claims.

Contigency Fee Audits

In recent years, a number of tax-assessing jurisdictions have hired contract or third-party agents to audit tax returns and records in exchange for a percentage of the increased tax collected. In Florida, for example, the legislature has not only authorized the use of private sector auditors on a contingency fee basis, but has also provided that the fee was to be billed to the taxpayer along with the tax deficiency. Although there may be some surface appeal to contingency fee audits -- the States arguably have an opportunity to secure increased revenue with no out-of-pocket cost -- the proffered justifications for contingency fee audits are specious and the policy objections to them are overwhelming. Tax Executives Institute recommends that the States disclaim the use of "bounty hunters." Indeed, we submit that contingency fee audits are more inimical to the tax system's fairness than the use of quotas, which have been roundly and rightly condemned (and uniformly disavowed by the States).

Contingency fee audits have been struck down as violating public policy in at least two States. In a case involving Philip Morris U.S.A., the North Carolina Property Tax Commission concluded that a contingency fee arrangement "so offended conventional standards requiring fair, impartial, and uniform treatment of this State's taxpayers that it could not stand" -- a judgment that was affirmed by the North Carolina Court of Appeals. Similarly, the Georgia Supreme Court quickly dispatched a contingency fee scheme whereby an outside firm would audit property tax returns and receive 35 percent of any additional amount collected plus 100 percent of all first-year penalties collected. The court upheld Sears, Roebuck & Co.'s challenge to the system, stating:

The people's entitlement to

fair and impartial tax assessments

lies at the heart of our

system. Fairness and impartiality

are threatened when a

private organization has a financial

stake in the amount

of tax collected as a result of

the assessment it recommends.

TEI believes the courts have been right to focus on the deleterious effect that contingency fee arrangements can have on the impartiality and fairness of state tax systems. The Federation of Tax Administrators (FTA) has itself acknowledged these policy concerns with contingency fee audits, stating that most business taxpayers and State administrators agree that such arrangements "are not healthy for the tax system." The FTA's Summer 1991 issue of State Legal Issues Quarterly, explained that contingency fee audits "introduce extraneous issues such as motive, work habits, and the like into the audit situation -- all of which detract from the goal of objectively determining the appropriate amount of tax due."

TEI could not agree more. We believe the States should abjure the use of contingency fee arrangements. In addition, we believe that States need to be circumspect about any use of outside auditors, taking steps to ensure not only the confidentiality of taxpayer information but also the uniformity and fairness (and, separately, the perception of fairness) of such arrangements.(1)

Reports of Federal Changes and Adjustments

Nearly all States require taxpayers to report the results of federal income tax examination adjustments to the state taxing authorities. Similarly, States require taxpayers to file amended state income tax returns consistent with revisions reported on amended federal income tax returns. The purpose of the requirements is to assure that the States collect the revenues to which they are entitled that follow from adjustments to the starting point for the determination of state taxable income. Among the States, however, there is a divergence of practice on (1) the time within which to report the changes, (2) the specific events or taxpayer or government action triggering the reporting requirement, and (3) the form of the report.

Tax Executives Institute supports the adoption of uniform procedures among the States for reporting federal income tax changes. Needless confusion and complexity is created by the multiple, diverse reporting requirements. The burden of complying on a timely basis with different procedures for reporting the same information in different reporting formats to the various States is needless and wasteful. To provide certainty to taxpayers and consistency among the States, TEI recommends adoption of the following guidelines and procedures:

* A minimum period of 180 days

should be established for reporting

federal income tax changes

to state tax authorities.

* The 180-day period should commence

upon the following events:

* The signing of Federal Form

870, or its equivalent, agreeing

to the final and complete

disposition of all deficiencies

or over assessments for the

tax years. If the agreement is

subject to final approval and

signature by the Internal Revenue

Service (or Joint Committee

on Taxation approval),

the agreement should be

deemed final when the taxpayer

receives a copy of the

executed form. If the Form

870 does not resolve all issues

raised during the examination,

the Form 870 should be

considered a "partial 870," the

signing of which should not

trigger such 180-day period.

* The expiration of the statutory

time period within which

to petition the U.S. Tax Court

for redetermination of a Notice

of Deficiency.

* A signed closing agreement is

executed with the IRS under

section 7121 of the Internal

Revenue Code (IRC).

* A final decision by the U.S.

Tax Court, U.S. District

Court, U.S. Court of Appeals,

or U.S. Federal Claims Court

(followed by the expiration of

the time to appeal); a decision

by the Supreme Court of the

United States; or the court's

approval of a stipulation disposing

of the case.

* The allowance of a tentative

carryback adjustment in accordance

with IRC section

6411 based on a net operating

loss (applicable only if the

state law permits net operating

loss carrybacks).

* A simplified reporting form

should be developed that contains

a description of the items

and amounts of federal level

changes, a description of the

items and amount of state taxable

income adjustments or calculations

directly or indirectly

resulting from the federal changes,

and the effect of those items

on the calculation of a State's tax

due or refundable. Although a

single, uniform reporting form

may not be feasible because of

the substantive tax law differences

among the States, a simple

report capturing the effect of the

changes is preferable to filing an

amended state tax return.

Statute of Limitations 

There are two types of limitation periods that affect corporate taxpayers: statutes of limitations that limit the normal period for state assessments and taxpayer refund claims and extensions of the normal limitation periods because of either federal tax return examinations or amended return changes.

A. Uniform Period for Assessments and Claims for Refunds

The statute of limitations serves dual purposes. First, it establishes time limits within which a state may seek additional taxes through its examination process. Equally important, it also establishes the period within which a taxpayer may recover taxes that were erroneously remitted or illegally assessed.

Since a statute of limitations defines the rights and obligations of parties, Tax Executives Institute believes it should apply equally to the States and taxpayers. The period prescribed for assessments, however, are often longer than that for refund claims. Indeed, on some types of taxes there may be no limitation period at all. Tilting the limitation period in favor of the States creates a perception that the deck is stacked against the taxpayer, encourages taxpayer cynicism, and fosters an attitude that "gaming" the tax system is perfectly acceptable -- "just look at how the State plays."

The inequity of disparate statutes of limitation is compounded where a State imposes a shorter period for assessments against domiciled corporations than it permits for assessments against out-of-state corporations. Indeed, discrimination by way of separate limitation periods that favor instate corporations raises substantial questions under the equal protection and due process provisions of the U.S. and various state constitutions.

To correct these inequities, TEI urges the adoption of statutes of limitations that apply even-handedly to assessments and refunds. TEI recommends the repeal of statutes of limitations that differentiate between instate and out-of-state corporations.

B. Suspension of State Statutes of Limitation by Unilateral State Action

A few States permit the State's taxing authority to toll the statute of limitations for assessments by unilateral actions. For example, one State provides that the limitation period for assessments is automatically tolled upon the mailing of a notice that the taxing authority will commence an examination. There is no provision permitting the taxpayer to challenge the tolling of the statute, even where the State fails to examine the taxpayer. TEI believes that procedures that permit the State to suspend the statute of limitation by unilateral action without challenge by taxpayers is highly inequitable. TEI strongly recommends that such provisions be abandoned.

C. Statute of Limitations -- Federal Changes

Almost all state revenue provisions permit the State's taxing authority to make assessments for years otherwise barred by the regular statute of limitations in order to assess additional income tax due as a result of voluntary or involuntary changes in the taxpayer's federal taxable income. Generally, in assessing any additional tax, the State may only take into account the federal changes that affect the state return. There are several state statutes, however, that authorize the taxing authority to propose other changes to a tax year that, but for the unrelated federal changes, would not be open.(2)

TEI submits that, unless the taxpayer has signed a waiver of the State's statute of limitations, a State's examination of reported federal changes should be limited to the effect of those changes on the taxpayer's state liability. The State should not be in the position of having two bites of the examination apple: once under the regular statute of limitations and again upon the conclusion of a federal tax examination. Statutes of limitation are a facet of the Law of Equity. As a matter of fairness to all, the statutes exist to quell "ancient controversies," in large part because evidence and records concerning events become stale with time. In the tax area, statutes of limitation also provide certainty to taxpayers that their tax liabilities are final. If a State is permitted to re-open and re-examine all state issues following the completion of the federal examination, the purpose of a statute of limitation is completely frustrated -- especially where taxpayers' records are mislaid or destroyed or where personnel changes leave the taxpayer with no one with personal recollection of various transactions or the accounting for the transactions.

In conclusion, TEI believes that the State or local jurisdiction's authority to assess additional local taxes should be limited to changes flowing from adjustments to the taxpayer's federal taxable income, particularly where the state or local jurisdiction has previously examined the taxpayer.

Corporate Tax Return Due Dates and Extension Procedures

In many States, the due date for filing corporate income or franchise tax returns is the same as the filing date for the federal tax return (e.g., for calendar-year taxpayers, March 15). Many substantial and important items comprising federal taxable income -- the starting point for the determination of taxable income for most States -- are subject to modification for state purposes. Thus, the determination of state taxable income is not instantaneous. Furthermore, corporate taxpayers often file consolidated federal income tax returns, a practice that few states accept. Consequently, separate federal returns must in effect be prepared for each of the members of the group for state purposes. Finally, the States' substantive tax law requirements often vary with respect to whether separate or combined unitary reports are to be filed. Indeed, even among States requiring a unitary group to file combined reports, there is a wide divergence concerning the definition of the unitary group and the manner of reporting the combined group's taxable results. Thus, extra time beyond the due date of the federal return is often needed.

Regrettably, the complexity of the federal tax law and the horrific reporting and compliance burdens engendered by that complexity frequently do not permit taxpayers to file their federal returns until on or shortly before the extended federal due date. Thus, taxpayers faced with a state return filing date coinciding with either the original or extended federal date often have inadequate time to analyze and report the adjustments required to prepare their state tax returns.

To alleviate the compliance burden associated with coincident state and federal return filing dates and redundant state extension procedures, Tax Executives Institute recommends that --

(1) the States adopt a uniform,

automatic extension procedure

triggered by the filing of

the federal extension request,

and

(2) the original and extended due

dates for filing state tax returns

be no earlier than 30

days following the applicable

federal income tax return due

date. (For a calendar-year

taxpayer, the original and extended

due dates would be no

earlier than April 15 and October

15, respectively.)

Such changes would afford taxpayers the time to properly analyze the federal data for state adjustments and would reduce the number of amended state return filings that must be reconciled and examined by state auditors, thereby conserving the State's limited administration and examination resources.(3)

Pending Technical Projects

As of February 1, 1993, the Institute's committees had the following technical projects on their agendas:

Federal Tax Committee

Committee Chair: David F. Nitschke)

* Comments on Proposed Federal Tax Legislation.

* Comments on Corporate Information Reporting Proposals (Payroll and

Other Federal Taxes Subcommittee).

* Comments on the Proposed Investment Adjustment Regulations.

* Comments on Scope and Application of Supreme Court's Decision in Indopco

(including its application to environmental remediation expenditures).

Follow-up Comments on Rev. Proc. 92-20 (Relating to Changes in Methods

of Accounting).

* Possible Comments on Proposed Consolidated Return Regulations relating

to Allocation of Alternative Minimum Tax Credit.

* Possible Comments on Components-of-Costs Method of Computing LIFO 

Index.

* Monitoring of Proposals for Single Wage Reporting System (Payroll and

Other Federal Taxes Subcommittee).

International Tax Committee

(Committee Chair: Lisa Norton)

* Comments on Proposed International Tax Legislation.

* Comments on PFIC Regulations.

* Comments on the Competent Authority Process.

* Comments on Rev. Proc. 91-22 relating to Advance Pricing Agreements.

* Comments on Temporary and Proposed Section 482 Regulations (including

Regulations on Section 482 Penalty).

* Possible Comments on Treasury International Study.

IRS Administrative Affairs Committee

(Committee Chair: W. Remi Taylor)

* Comments on Rev. Proc. 91-59 (Record Retention Agreements) (Coordination

with Tax Information Systems Committee).

* monitoring of Initiatives relating to Coordinated Examination Program.

* Comments on IRS Nonfiler Program,

* Comments on Penalty Administration Handbook.

* Possible Comments on Rev. Proc. 92-85 relating to Section 9100 Relief

State and Local Tax Committee

(Committee Chair: Harry F. McKeon, Jr.)

* Comments on Source Taxation of Nonresident Pensions.

* Possible Comments on Utah State Tax Administrative Procedures.

Tax Information Systems Committee

(Committee Chair: Anthony P. Verdino)

* Comments on Rev. Proc. 91-59 (Records Retention Agreements) (Coordination

with IRS Administrative Affairs Committee).

Anyone interested in participating in the development of comments on any of the above issues should contact the appropriate committee chair or Timothy J. McCormally at TEI Headquarters. (1) For an excellent review of the issues raised by contract audits, see Evatz & Zakrzewski, Keep the Money at Home: The Illusory Promise of Contract Audits, 43 Tax Executive 251 (July-August 1991). (2) In States that rely upon waivers of the federal statute to extend automatically the State's right to assess additional tax, there often are local or municipal tax statutes that provide a similar extension for additional assessments for years beyond the normal statute of limitations. In assessing additional tax, the local jurisdiction takes into account federal and state changes that affect such local returns (even though it was the federal changes alone that gave rise to the waiver). (3) Since almost all States require corporations to file estimated taxes in advance and, further, require payment of any remaining balance due with an extension request, a one-month shift of a State's corporate income or franchise tax return extended filing due date should not adversely affect state revenues.