Statement on reforms to establish taxpayer safeguards and protect taxpayer rights.

Tax Executives Institute is pleased to submit the following comments in connection with the Subcommittee on Oversight of the House Committee on Ways and Means's consideration of proposals to establish taxpayer safeguards in dealing with the Internal Revenue Service and to protect the rights of taxpayers under the Internal Revenue Code. The Subcommittee held its first hearing on this subject on July 19, 1991.

I. Scope of Comments

Tax Executives Institute commends the Subcommittee for addressing the critical issue of taxpayer rights. As the principal organization of corporate tax professionals in North America, the Institute has long been an advocate for the rational and even-handed administration of tax laws. Our approximately 4,700 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI 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. TEI is firmly committed to maintaining a tax system that works -- one that is consistent with sound tax policy, one that taxpayers can comply with, and one in which the Internal Revenue Service can effectively perform its audit function.

In announcing the hearings, Congressman Pickle expressed the Subcommittee's interest in 'finding ways to more efficiently administer the tax system," pointing out that in recent years" the tax laws have become more complex as we have sought to close loopholes and distribute the burden of taxation more equitably." The Subcommittee has announced an ambitious agenda, including issues of taxpayer fairness, penalties and interest, and taxpayer procedural and appeal rights. As an active participant in this Subcommittee's reform of the penalty provisions two years ago, TEI has firsthand knowledge of the Subcommittee's dedication to a fair and workable tax system. The current hearings clearly demonstrate the Subcommittee's recognition that tax fairness or equity is properly measured not only by comparing the relative treatment of similarly situated taxpayers, but also by examining the relationship between taxpayers and the tax collector. If the taxpayer's relationship with the IRS is viewed as unfair or one-sided -- if taxpayers perceive that "the deck is stacked against them" -- then the public's confidence in the tax system will be eroded. We encourage the Subcommittee to continue refining the Code's interest and penalty provisions to safeguard taxpayer's rights and to balance the legitimate interests of taxpayers and the government.

The Institute pledges its support of the Subcommittee's efforts. In the comments that follow, we discuss three areas touched upon in the press release announcing the Subcommittee's hearings (Press Release No. 13): the expansion of the IRS's authority to abate interest in certain circumstances; the equalization of interest rates charged on tax deficiencies and paid on overdue tax refunds; and the protection of taxpayers who in good faith endeavor to comply with the tax laws in the absence of clear guidance from the IRS.

II. Abatement of Interest

The press release announcing these hearings states that the Subcommittee is examining the expansion of the IRS's authority to abate interest charged to taxpayers when the IRS is responsible for unreasonable delays in processing taxpayer cases. Currently, section 640(e) authorizes the IRS to abate the assessment of any or all interest for any period where the interest is attributable to an error or delay by an officer or employee of the IRS in performing a "ministerial act." TEI wholeheartedly endorses the proposal to expand the abatement-of-interest provision, especially with respect to the assessment of "hot interest" under section 6621(c) of the Internal Revenue Code. (1)

The IRS's current regulations under section 6404(e) narrowly defines "ministerial act" to encompass --

a procedural or mechanical act that does not involve the exercise of judgment or discretion, and that occurs during the processing of a taxpayer's case after all prerequisites to the act, such as conferences and review by supervisors, have taken place. A decision concerning the proper application of federal tax law (or othe federal or state law) is not a ministerial act. (2)

Under the foregoing definition, a taxpayer filing an administrative appeal of a proposed adjustment that languishes in the IRS Appeals Office for six months (e.g., because of the Appeals Officer's workload) will not be entitled to abatement of the interest accruing during the period of delay because the delay is not the result of a "ministerial act." Similarly, if the Appeals Officer requests additional information from the Examination Division and the examiner is unable to respond for several months because he is involved in another case, the interest will continue to accrue during the delay. have yet been audited. If the proposed adjustment exceeds $100,000, that interest will run at the increased rate mandated by section 6621(c) of the Code.

TEI submits that the taxpayer in such situations should not be penalized by the imposition of a higher interest rate for the IRS's failure to act. Specifically, we believe that section 6404(e) should be amended to provide for the mandatory abatement of interest under section 6621(c) during the period attributable to a delay by the IRS in considering the taxpayer's administrative appeal of proposed adjustments. For example, the abatement of the higher interest rate could commence 180 days after the taxpayer files its administrative appeal and end on the date of a "final determination" -- i.e., the issuance of a statutory notice of deficiency when the case is unagreed, or a Form 870 or Form 870-AD when the case is agreed. (3) The proposed abatement of the "hot interest" increment of an assessment of interest would be consistent with the tax policy decisions made by Congress in enacting section 6621(c). As originally proposed by participants in the 1990 Budget Summit, the provision would have disallowed the corporate deduction for interest attributable to periods after December 30, 1990. (4) (No proposal was included in the House Bill.) The proposal was amended in the Senate to provide a "trigger" for the disallowance 30 days from the earlier of the issuance of a 30-day letter or a statutory notice of deficiency. (5) The modification was a response to taxpayer concerns about the punitive effect of the proposal; it was considered inappropriate to impose a penalty (even in the form of a higher interest rate) on unidentified amounts. The notice requirement was retained in the final legislation.

Congress's intent in enacting a notice requirement is simple and, we believe, undeniable: to apprise the taxpayer of the issues in controversy and to afford the taxpayer the opportunity to pay the disputed tax before interest begins to run at the higher-than-market rate. Such a purpose is not served, however, by IRS delays in processing the taxpayer's appeal. To penalize the taxpayer for these delays is, quite simply, unfair, and at odds with the Subcommittee's commitment during the 1989 penalty reform process to impose penalties only on culpable taxpayer behavior.

Therefore, TEI recommends that the Subcommittee provide for the abatement of the higher section 6621(c) rate during the period attributable to a delay by the IRS in considering the taxpayer's administrative appeal of proposed adjustments.

III. Equalization of Interest

Rates on Deficiencies

and Refunds

Under section 6621(a) of the Code, a taxpayer is charged interest on underpayments of tax at a rate equal to the federal short-term rate plus three percentage points. In contrast, a taxpayer receives interest on an overpayment of tax at a rate equal to the federal short-term rate plus two percentage points. (6) The Subcommittee's press release states that the Subcommittee is considering equalizing the intererst rates charged on tax deficiencies and paid on overdue tax refunds. TEI wholeheartedly supports eliminating the interest rate differential.

The interrest rate differential was enacted in 1986 as a result of Congress's concern that equal rates on overpayments and underpayments may have caused taxpayers "either to delay paying taxes as long as possible to take advantage of an excessively low rate or to overpay to take advantage of an excessively high rate." (7) In addition, Congress pointed out that financial institutions and other commercial entities do not borrow and lend money at the same rate. (8)

TEI believes the policy underlying the interest rate differential was flawed when the provision was enacted and remains flawed today. When the interest rate was determined every two years (as it was before enactment of the Economic Recovery Tax Act of 1981), the spread between the section 6621 rate and the market rate could have become substantial and therefore encouraging taxpayer "gamimg." With the changes adopted in 1981 and 1982 (requiring frequent adjustments of the rate and the daily compounding of interest), however, the potential for any significant differential was eliminated. Moreover, the Tax Equity and Fiscal Responsibility Act of 1982 changed the time period when interest on refunds would commence running, thereby eliminating the limited ability of taxpayers to "overpay to take advantage of an excessively high rate."

Quite candidly, the suggestion that an interest rate differential is justified because "financial institutions" borrow and lend money at different rates misses the point. The government should never view itself (or strive to be viewed by taxpayers) as a lending institution. Taxpayers have no freedom to negotiate interest rates and terms with the government, as they might with a commercial establishment.

Finally, TEI believes that the interest rate differential is not only unnecessary, but also undermines one of the basic goals of tax reform: to restore faith in the fairness of the tax system. (9) We suggest that current law provides adequate safeguards against any taxpayer manipulation of interest rates. The interest rate differential should be repealed.

IV. Taxpayer Procedural Rights

The Subcommittee's press release expresses concern about the protections accorded taxpayers who make a "good faith" effort to comply with the tax laws during the period between enactment of the law and issuance of clear guidelines and final regulations. As the Subcommittee recognizes, a rational and fair tax system must recognize that taxpayers who endeavor in good faith to comply with our amorphous body of tax law should not be penalized. In this regard, the Institute has long believed that the following principle should govern the enactment and imposition of penalties:

Civil tax penalties should be exacted only for deviation from a clearly defined standard of conduct that is timely established and promulgated, either by Congress or the Treasury Department and the Internal Revenue Service.

A penalty cannot function as intended (i.e., to encourage compliant behavior) unless taxpayers know in advance what behavior is expected of them. TEI submits that a penalty should never be exacted from a taxpayer who makes a good faith effort to comply with the law in the absence of clear guidance.

Moreover, when broad grants of authority are given to the Treasury Department to promulgate regulations, Congress should consider making the statute effective only upon the issuance of final regulations. Retroactive application of rules and regulations can undermine the integrity of the tax system and taxpayer confidence in the fairness of the system. In its simplification recommendations last year, the Majority Tax Staff of the Ways and Means Committee suggested that the Treasury Department be required to make all rules and regulation implementing broad guidelines effective on a prospective-only basis. TEI agrees that prospectivity must play an essential role in the implementation of a simpler and more equitable tax system.

V. Conclusion

Tax Executives Institute appreciates this opportunity to present its views on reforms to establish taxpayer safeguards and protection and would be pleased to answer any questions you may have about its positions. In this regard, please do not hesitate to call the undersigned [Michael J. Bernard] at [phone] or Timothy J. McCormally of the Institute's professional staff at [phone].

Notes

(1) Section 6621(c0 provides for a two-percent increase in the interest rate on large corporate underpayments (an underpayment of more than $100,000) 30 days following the issuance of the proposed adjustment (a "30-day letter") or a notice of deficiency (a "90-day letter"). Such "hot interest" is to be assessed without regard to whether any delay in the payment of the underlying tax liability is attributable to the taxpayer or the IRS.

(2) Temp. Reg. S 1.6404-2T(b)(1). At least one court had held that the IRS's refusal to abate interest under section 6404(e) is not reviewable by the courts. Horton Homes, Inc. v. United States, No. 90-8225 (11th Cir. July 23, 1991).

(3) An argument could be made that interest should be entirely abated where the IRS's delay continues for an unconscionable period of time. Because of the revenue associated with such a proposal, the Institute has confined its formal recommendation to the "hot interest" increment of any interest assessment.

(4) See Joint Committee on Taxation, Description of Proposed Amendments to the Revenue Provisions of the Budget Summit Agreement (JCX-28-90) at 35 (Oct. 10, 1990).

(5) S. 3209, 101st Cong., 2d Sess. S 11341 (Oct. 18, 1990).

(6) This differential is exacerbated in those situations where the "hot interest" provision of section 6621(c) comes into play; in such a situation, the difference between the rate charged on large corporate underpayments and the rate paid on tax overpayments becomes three percentage points.

(7) Staff of the Joint Committee on Taxation, 99th Cong., 2d Sess., General Explanation of the Tax Reform Act of 1986, at 1279 (1987).

(8) Id.

(9) The penalty imposed by the interest rate differential is exacerbated for multinational corporations by the allocation and apportionment rules. Interest received by taxpayers on tax overpayments is allocated to U.S. gross income, whereas interest paid by taxpayers on deficiencies must be allocated and apportioned on a worldwide basis, to foreign-source income (thereby minimizing, if not eliminating, the tax benefit of the interest deduction). Such asymmetrical treatment is inequitable and heightens the complexity of the tax laws.