Tax Executives Institute - Federation of Tax Administrators; liaison meeting agenda; December 4, 1989.

Tax Executives Institute - Federation of Tax Administrators

Liaison Meeting

Agenda

December 4, 1989

I. Introductory Comments

Tax Executives Institute welcomes the opportunity to hold a formal liaison meeting with the Federation of Tax Administrators. As the principal association of corporate tax executives in north America, TEI brings a unique perspective to the issues set forth in this agenda. The diversity of the Institute's membership, the professional training of its members, and the continual nature of the relationship between TEI members and state tax authorities have all contributed to the Institute's solid appreciation not only for basic issues of tax administration but also for the constraints under which State Departments of Revenue are operating.

The 1980s have been a time of dizzying change in the tax system. Legislation has come fast and furious, and practically every change in the Internal Revenue Code at the federal level has prompted a similar change in one or more of the States. The overall result is a tax world of unrivaled complexity and uncertainty. The challenges of such a world, of course, confront more than the taxpayer: they confront the tax administrator as well.

TEI respectfully submits that the aggregate changes that have besotted the tax system during the last decade underscore the need for taxpayers and tax administrators to work together -- to identify issues of common concern and to seek solutions that are at once uniform, reasonable, and fair. Thus, as the 1980s come to a close, we believe it is appropriate and heartening for TEI and FTA to meet to explore a whole variety of issues. The Institute believes its liaison meeting marks a new, positive chapter in what can and should be a symbiotic relationship between State and corporate tax administrators--a portent of mutually beneficial efforts.

TEI looks forward to addressing the issues that are outlined in this agenda during our December 4 liaison meeting, and we are eager to discuss the means by which our two organizations can further cooperate with one another. In particular, TEI wishes to explore the efficacy of establishing joint task forces which can work toward the development of commonly beneficial proposals.

II. Administrative Bill of Rights

In recent years, much attention has been devoted to the need to establish uniform and even-handed procedures in respect of state tax administration. Uniformity is needed from jurisdiction to jurisdiction to reduce compliance costs, minimize confusion, and simplify audits. Governing procedures should be even-handed (as between similarly situated taxpayers as well as between taxpayers and the taxing authority) to vindicate basic principles of fairness and equity and maintain the integrity of the self-assessment tax system. Thus, TEI strongly supports the enactment of administrative or procedural "bills of rights" by the various States.

In April 1987, Tax Executives Institute submitted a detailed position paper to the National Association of Tax Administrators on several administrative issues relating to the determination and collection of state and local tax liabilities. The Institute's position, which has remained essentially unchanged, can be summarized, as follows:

A. Statutes of Limitations: A statute of limitations is designed to serve a dual purpose. It establishes time limits within which a State can seek additional tax dollars from a taxpayer through its audit process and, equally important, a taxpayer may recover tax dollars that were erroneously or illegally remitted or assessed.

Because statutes of limitations define rights of parties, they should be equally applied. Unfortunately, statutes of limitations for assessments are often of a longer duration than those for refund claims. The inequality is aggravated in those States that have shorter statute of limitation periods for its domiciled corporations than for foreign corporations. Indeed, in these latter States, we suggest that discrimination in favor of domestic corporations raises substantial constitutional questions.

To correct these inequities, TEI advocates the adoption of statutes of limitations that apply even-handedly to assessments and refund claims. TEI also urfes the abolition of statutes of limitations that differentiate between domestic and foreign corporations.

B. Interest Rates: Many States (as well as the federal government) apply different rules in respect of interest payable or owing on tax assessments and refunds. Although all States charge interest on assessments, the rate of interest paid on refund claims is often less than that charged on assessments. Indeed, in some instances no interest is paid on refund claims.

Differential interest rates may properly be characterized as punitive in nature. The amount of interest charged or credited should relate to the use (or forbearance) of money; "interest" should not be collected simply to raise revenues or to encourage or discourage specific taxpayer behavior.

TEI opposes the application of different rates of interest to assessments and refund claims. Failure 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. A more fundamental question, of course, is the propriety of paying interest (whatever the rate) on refunds. Not only would the payment of such interest be eminently fair, but it would minimize any incentive a State might have to unduly delay the processing of refund claims.

C. Penalties

1. General Comments: Whether by express statutory authority or administrative practice, many States impose essentially automatic (or"no-fault") penalties on additional assessments of tax. These penalties are couched in such terms as "failure to pay" and "negligence." A taxpayer who had a reasonable cause for not paying his taxes is forced to accept the penalty unless the resources are available to challenge its imposition. In some instances, the penalty must be paid and its return then sought through the refund claim procedure. In light of the cost of challenging the penalty, a taxpayer may have no economic choice other than to pay an unjustified penalty.

TEI submits that automatic penalties have no place in state tax administration. They are an unnecessary irritant to the taxpaying public and, in the long run, undermine public confidence in the even-handedness of the tax system, thereby affecting taxpayer compliance.

2. Lessons from Federal Penalty Reform: TEI has been extremely active in the reform of the civil penalty provisions of the Internal Revenue Code and is pleased that the recently enacted Omnibus Budget Reconciliation Act of 1989 (H.R. 3299) contains a penalty reform package. In testimony presented to the congressional tax-writing committees, TEI set forth the following principle:

Civil tax penalties should be exacted only for deviation from a clearly defined standard of conduct that is timely established and promulgated, either by the legislature or appropriate administrative agency.

From this principle, we suggested that following conclusions flowed:

* In order to encourage compliant behavior, a penalty must relate to a know standard of conduct. Both taxpayers and the tax authority must know what is expected of them -- they must know what behavior will give rise to a penalty assertion.

* The standard of conduct must be identified in advance of the time when deviations from the standard will give rise to the penalty. Retroactive penalties can play no legitimate role in a rational tax system.

* The taxpayer to be penalized must have in fact deviated from the standard of conduct. The penalty system must be fault-driven.

TEI believes that the foregoing principles should rightly govern the reform of state penalty provisions, and we would be pleased to provide copies of the Institute's complete testimony and other submissions on penalty reform. We believe that the 1989 federal legislation contains numerous provisions and evinces certain policy positions that could beneficially be adopted by the States. In particular, we applaud Congress's enactment of a statutory "reasonable basis" exception in respect of information return and accuracy penalties. This exception, which we urge the States to incorporate into their penalty systems, will operate to minimize the mechanical assertion of penalties in situations where the taxpayer's culpability is minimal or non-existent.

D. Prepayment Requirements: In most States, a taxpayer may contest an assessment at an informal or formal hearing without first paying the tax. A few States, however, only follow this procedure during informal administrative proceedings. In those States, once the matter reaches the formal or contested case level, the taxpayer is required to pay the additional tax, penalty, and interest before continuing his appeal. In certain limited instances, the taxpayer can post a bond in lieu of paying the tax.

TEI generally opposes the imposition of any prepayment requirements. A taxpayer should have the right to exhaust administrative remedies before payment is made, at least where ultimate payment of any liability is not in jeopardy. Prepayments required at any stage of the administrative process effectively abrogate a taxpayer's due process rights. In those instances where the taxpayer is pursuing a frivolous claim or the passage of time might impair the State's ability to collect the asserted taxes, consideration could then be given to utilization of a bond. This approach would protect the State's revenue while enabling the taxpayer to pursue his case.

E. Protest Periods: The first step in the administrative process in most States is the issuance of an assessment with notification of a right to protest. The time within which a taxpayer must formally "protest" the assessment ranges from as few as 10 days to as long as 120 days. These times are really shorter in many States since the protest periods run from the date of the assessment (i.e., the date issued by the taxing authority), not the date the notice of assessment is received by the taxpayer. Moreover, although taxpayers may apply for extensions of time to file protests in many States, the standards governing such extensions are neither uniform across the States, nor are they always uniformly applied by auditors within a particular State.

TEI advocates the adoption of a reasonable, uniform time period within which a taxpayer may protest an assessment. Specifically, we submit that the protest period should be 90 days, with taxpayers' being able to obtain automatic or discretionary extension of time (say, an additional 30 or 60 days). (1) The adoption of a more realistic time table will facilitate the preparation of more complete and thorough protest and should enable taxpayers and the taxing authorities to resolve more disputes without resorting to costly and time-consuming litigation.

F. Extended Due Dates: In many jurisdictions, the extended due date for filing income or franchise tax returns by calendar-year taxpayers is September 15, which is also the extended due date for filing federal tax returns. Regrettably, inasmuch as many corporations do not file their federal returns until on or shortly before the extended due date, such taxpayers frequently have inadequate time to analyze and take into account the effect of their federal return in preparing their state tax returns.

TEI recommends that the extended due date for state returns be moved to no earlier than the 15th day of the 10th month following the end of the taxable year (October 15 in the case of a calendar-year taxpayer). Such a change would afford taxpayers time to analyze the federal data necessary to file the state returns and would probably reduce the number of amended state returns that are filed.

G. State Imposed Fees: In recent years, some States have moved toward imposing fees on taxpayers to offset a State's administrative costs, particularly legal fees, and these fees may be charged without regard to whether audit adjustments are made.

TEI opposes the adoption of a "user-fee" approach to financing tax audits as wholly inappropriate to the tax system. We submit that the cost of administering the tax system is a legitimate expense of government that should be borne by all taxpayers. After all, a taxpayer is not compensated for the costs it incurs during a State's audit examination, nor is it generally able to recover legal costs incurred in pursuing a matter either administratively or judicially.

H. Federal and State Waivers: In most States, the Department of Revenue may make an assessment for years otherwise barred by the statute of limitations to exact from a taxpayer additional income tax that becomes due as a result of 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 department of Revenue to propose any changes to a tax year that, but for the federal changes, would not be open.

TEI submits that, unless the taxpayer has signed a waiver for state tax purposes, the State's examination in such cases should be limited to the effect of the federal changes on the taxpayer's state tax liability. As a matter of fairness, taxpayers' rights in respect of this matter should be similarly limited. (2)

The development of uniform and equitable administrative procedures is an area where the interests of taxpayers and tax administrators coincide. Tax Executives Institute wishes to explore the means by which the Institute can work with Federation of Tax Administrators and other appropriate bodies (either governmental or private) to achieve the enactment of a comprehensive and reasonable procedural "bill of rights" by the States. We recommend that particular attention be given to establishing a joint TEI-FTA task force to work on this project.

III. Prospectivity and Retroactivity -- Effect of Decisions

In its April 1987 submission to the National Association of Tax Administrators, TEI discussed the troublesome situation where taxing authorities endeavor to apply decisions favorable to taxpayers on a prospective-only basis, thereby rendering the taxpayer's victory hollow. The frustration and ill-will caused by such an approach to pro-taxpayer decisions is exacerbated by the inverted approach these same States take to pro-state decisions: retroactive application for all open tax years against all similarly situated taxpayers.

Since the Institute filed its initial submission, the controversial nature of States' prospective-only approach has done anything but abate. On December 6, the Supreme Court of the United States will hear argument (for a second time) in two cases addressing the constitutional limits on the State's ability to retain previously collected taxes that have been declared unconstitutional. TEI filed a brief amicus curiae with the Court in McKesson Corp. v. Florida (No. 88-192) and American Trucking Associations v. Arkansas Highway and Transportation Department (No. 88-325), in which the Institute urged the Court to rule that the unconstitutionally collected taxes involved in those cases must be refunded.

In its brief, TEI devoted considerable attention to the standard of review the courts should use in evaluating whether a State's effort to apply a pro-taxpayer decision on a prospective-only basis should be sustained. We argued that where constitutional interests are implicated (as they are in McKesson and ATA), the State's burden should be extremely high. Although not addressed in the brief, we believe a similar standard should apply to non-constitutional decisions.

With particular regard to the "form of retrospective relief" that should be ordered, TEI stated in its brief that any "hardship" a State might otherwise incur could be mitigated in accordance with a refund policy crafted by the legislature or, in the absence of legislation, by the courts. For example, a State might provide that taxes unconstitutionally collected (plus an interest factor) could be claimed as a credit on the affected taxpayer's future years' tax returns. Alternatively, the taxes at issue could be refunded in installments.

TEI appreciates that States must cope with the revenue and long-term policy effects of adverse court decisions. We suggest, however, that the states' actions in this area must be tempered by a due regard of the effect of their actions on the overall integrity and equity of the tax system. This is true, moreover, without regard to whether the Supreme Court, as a matter of constitutional law, mandates the immediate refund of unconstitutionally collected taxes. (3)

Although the resolution of this issue will understandably be affected by the Supreme court's decision, during the liaison meeting we would be interested in discussing various approaches the States are considering toward the McKesson-type issue. We also wish to discuss (in the non-constitutional context) the general question of adopting a balanced, "good for the goose, good for the gander" approach to the prospectivity/retroactivity issue.

IV. National Wage Reporting System

There have been several suggestions recently in respect of the formation of a federal-state partnership to promote compliance by both educating the public and assisting federal and state officials in joint examination/enforcement efforts. For example, the IRS Commissioner's Advisory Group last year made several recommendations aimed at fostering cooperation between federal and state tax officials.

TEI believes that a federal-state partnership -- particularly in the area of wage and information reporting -- should be encouraged. Duplicate reporting requirements by federal and state governments waste both government and taxpayer resources and serve only to intensity taxpayer frustration with the self-assessment system.

One area we believe is especially ripe for federal-state cooperation is wage reporting. Many state laws are virtually identical to federal law. In addition, wage information is often required to be reported to other non-tax government agencies (such as the federal Social Security Administration and the state unemployment compensation agencies). The burden of such duplication is substantial in terms of both cost and time. Productivity cannot help but suffer.

TEI supports further consideration of a national wage-reporting program. Information (such as that currently required on federal Forms W-2 and 1099) could be reported to a centralized location that would in turn make the data available to authorized federal and state officials. Such a national data base would promote efficiency and uniformity of treatment, enhance compliance, decrease the administrative burden on taxpayers, and reduce errors in reporting and transmitting wage information -- to the benefit of governments and taxpayers alike.

TEI recognizes that the establishment of a national system raises legitimate privacy and confidentiality concerns. We believe, however, that these concerns can be reduced by making the data accessible only to authorized officials and by educating the public on the effectiveness of these safeguards.

We also recognize that a joint federal-state program raises undeniable issues of comity and "turf." The daunting nature of the challenge should not dissuade interested parties from moving ahead on this project, which would benefit federal and state governments as well as taxpayers. We invite the FTA's comments on this subject during the liaison meeting.

V. Electronic Funds Transfer 

States are beginning to require payment of corporate taxes via electronic funds transfer (EFT). The trend toward imposing EFT requirements is attributable to developments in the use of electronic data interchange (EDI), as well as to the States' desire to increase cash flow by accelerating the time at which taxes are remitted. (With EFT, there is no "float.")

The taxes in respect of which EFT requirements have been imposed vary from State to State. For example, some States limit EFT to the remittance of severance or withholding taxes, whereas others impose the requirement in respect of corporate income taxes as well; still others accord taxpayers an option to use EFT (rather than making its use mandatory). More fundamentally, the States that have imposed an EFT requirement have established different data formats for the remittance of data and many States that are planning EFT systems are developing their own proprietary data formats. There is no uniformity: disparate EFT requirements among the States stand as a veritable Tower of Babel -- confusing taxpayers, increasing their compliance costs, and generally denying them the benefits offered by EDI technology.

There are essentially three primary EFT methods that have been developed. The first is the Automated Clearing House (ACH) credit method, under which the taxpayer initiates a transfer of money the day before the due date from its bank to the State's bank. The second method is the Fed Wire system, under which the taxpayer initiates a transfer from its bank's wire room to the wire room at the State's bank. The third option is the ACH debit method, under which a subcontractor of the State's authorized bank collects the payment transactions called in by taxpayers, consolidates and reformats payment data for the bank, and provides payment and remittance data to the Department of Revenue.

There are pluses and minuses to the three methods. Taxpayers generally prefer the ACH credit method, because it is less expensive than wire transfers; minimizes the possibility of late payment penalties through record-of-payment notification to the State; and enables the taxpayer to maintain the integrity of and control over its bank accounts (i.e., precludes the State's employees from directly accessing the taxpayer's normal bank accounts). The Fed Wire method deprives the taxpayer of control over the actual time funds are transferred once a transfer is requested and is comparatively more expensive than the other methods. The Fed Wire method, however, is less objectionable to taxpayers than the ACH debit method which accords the State direct access to the taxpayer's general bank funds. (To place taxpayer misgivings about the ACH debit method into perspective, consider whether the States would accept such a method in respect of amounts owed to taxpayers as refunds.)

Regardless of the method used, there are several fundamental issues that should be addressed: the desirability of uniformity among taxing jurisdictions; the need to provide generaous lead time to allow taxpayers to implement an EFT program; and the appropriateness of providing an initial grace period during which no penalties will be asserted where the taxpayer makes a good faith effort to comply. Questions also exist in respect of the uniform treatment of holidays and weekends and the method of proof of payment by the taxpayer.

TEI understands that the FTA conducted a survey of corporate taxpayers in September to determine the capabilities of large corporations to remit tax payments using EFT together with standardized data formats for the remittance data. We further understand that, based on the data collected, the FTA intends to develop a standardized data format for the taxpayer's remittance data to accompany its EFT payment.

TEI commends the FTA for its initiative in attempting to develop standardized data formats. If successful, the FTA's efforts will facilitate both the payment and recording of electronic tax payments. During the liaison meeting, we request a status report on the FTA's survey and its efforts to develop a standardized data format. We similarly invite your suggestions on how TEI might complement the FTA's efforts.

VI. Administration and Collection of Local Sales Taxes 

Although state constitutions generally require that state taxation be uniformly applied to persons and subjects, this concept has not been employed in the sales and use tax area. State legislatures have broad power in selecting subjects and transactions for taxation as well as empowering localities to levy taxes. Local governments may be authorized by state constitution or statute to levy a local sales tax. Often, the State administers and collects such taxes. Problems may arise, however, when the locality (i.e., the borough, county, or city) administers and collects the tax.

The administration and collection of sales and use taxes by the locality produce significant administrative burdens for taxpayers. Variations -- or merely the possibility of variations -- from locality to locality (from purely administrative issues such as the mode and time of payment to more substantive issues such as the definition of the tax base) lead to increased compliance and audit costs, as well as confusing and duplicative recordkeeping requirements. Additional problems are encountered when the rate of local tax differs from the state sales tax and from locality to locality within a given State.

To promote the more efficient administration and collection of sales and use taxes, TEI recommends that all taxable transfers within a State be covered within the scope of a single law. We also recommend that consideration be given to consolidating the collection and audit functions of the local tax at the state level.

We recognize that the above recommendation would require the enactment of new legislation in those jurisdictions where the tax function is exercised by the locality. We submit, however, that the attainment of lower compliance costs and efficient collection procedures is a proper goal. We request your views on this issue during our liaison meeting.

VII. Corporate Tax Disclosure Law

Legislation has been introduced in Massachusetts that would require the Massachusetts Secretary of State to publish annual reports containing certain information extracted from corporate excise tax returns. The bill would apply to publicly traded corporations required to file annual reports with the Securities and Exchange Commission. It would require the publication of information such as the name of the corporation and address of its principal office; its total gross profits; any deduction or other offset that reduces income subject to taxation or any credit that reduces the tax liability by more than five percent; its total net taxable income; the value of its tangible property taxable in Massachusetts or taxable net worth, whichever is applicable; the percentage used to establish what portion of its total tax is due Massachusetts for the tax year in question; and its net income according to its books reported on its federal tax return.

TEI is concerned about the forced publication of sensitive tax information. Such information has traditionally been treated as confidential. Indeed, under federal law the unauthorized disclosure of tax return information may subject a government official to civil and criminal penalties. We believe that, because of the complexity of state allocation and apportionment formulae and corporate tax codes, the publication of such information could well lead to public confusion about the nature and extent of the corporate tax burden. Moreover, to the extent the law requires the disclosure of information contained on a taxpayer's Form 1120, it raises federal issues.

TEI is interested in discussing this proposal during the liaison meeting. In particular, we welcome your comments on any steps taken by the FTA to address the issues presented by the Massachusetts disclosure bill.

(1) In this regard, IRS Commissioner Goldberg has advised the Institute that the Internal Revenue Service is actively considering extending the protest period for corporate taxpayers (especially those in the Coordinated Examination Program).

(2) In an analogous situation, many local tax statutes empower a local department of revenue to assess for years beyond the statute of limitations in order to collect additional local tax resulting from changes in the taxpayer's state taxable income. 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). We submit that the local jurisdiction's authority to assess additional local tax should be limited to changes flowing from adjustments to the taxpayer's federal taxable income.

(3) It is also true without regard to whether the State's loss on the merits of a particular case is due to a constitutional violation or to the interpretation of the applicable statutory or regulatory provision.