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Tax Division testifies on miscellaneous revenue proposals.

On Sept. 21, 1993, Pamela J. Pecarich, chairman of the AICPA Tax Division's Tax Legislative Liaison Committee, testified before the House Ways and Means Subcommittee on Select Revenue Measures public hearing on miscellaneous revenue measures.

The subcommittee held a series of hearings during the month of September on approximately 75 revenue-raising provisions that various members of Congress were considering using as revenue sources for future tax changes. The list of provisions was circulated to Tax Division technical committees for review. That testimony represented their feedback, as well as the thoughts of the Tax Legislative Liaison Committee and the Tax Executive Committee.

The Institute believes many of the items on the list submitted for this series of hearings should be rejected without substantial discussion. For some years, the AICPA has expressed its concern that tax legislation is being driven significantly more by revenue needs than by tax policy considerations. There are any number of proposed tax changes on the Select Revenue Measures Subcommittee's agenda that seem to fit this description, and in most instances the revenue increase from a particular proposal is not all that large. However, the Institute is concerned that it has had great difficulty (or no luck at all) in even determining the proponents of specific proposals, much less the policy rationale behind most of them. What is left, then, is a perception that many of these items are being suggested to raise revenues, the use of which will be made known at a later point.

A number of the proposals take provisions that were debated, negotiated and ultimately passed in the Revenue Reconciliation Act of 1993 (RRA), and move them one or two steps further. This back door approach for getting still more revenue from provisions that took seven months to originally craft is singularly inappropriate. For example, the badly needed simplification of the individual estimated tax system (included as part of the RRA) provides that individual taxpayers with adjusted gross incomes (AGIs) exceeding $150,000 will have to use 110% of last year's tax as a safe harbor for paying current year estimated taxes, rather than the 100% used by all other individuals. That change was the result of substantial discussion and negotiation, and resulted in what was seen as a "fair" solution to a problem that had been caused by a short-term need to raise a certain amount of revenue back in 1991. The process of correcting the difficulties caused by that casual 1991 change (made without benefit of hearings or discussion) took almost two years. Now, it has been suggested that the 110% safe harbor be raised to 115%, even before the 110% safe harbor goes into effect. Similar points may be made about with-holding on bonuses, increased from 20% to 28% in the RRA and now proposed to rise to a 36% rate before the 28% has even started.

The AICPA has also commented, over some years (most recently this spring to both the Ways and Means and Finance Committees on certain of the proposals for the RRA), about the growing tendency to chip away at the net income concept of taxation, by disallowing portions (ranging up to 100%) of items previously deductible--especially bona fide trade or business expenses. That approach continues in the current list of proposed items (e.g., disallowance of a portion of advertising expenses, disallowance of corporate interest on tax deficiencies, limits on otherwise valid business deductions for trips beginning at home). The Institute has consistently recommended that the slow move toward a tax on gross income needs to be halted, and reiterated this view at the hearing.

The AICPA also--once again--put in a plea for considering simplification as Congress enacts tax legislation. Putting still more thresholds for partial nondeductibility into the law gains relatively little revenue but can add substantial complexity. Requiring substantiation for meals and entertainment over $10 (as opposed to today's $25) will bring in virtually no revenue but will add millions of required hours a year to the recordkeeping process of American business. The changes in accounting and reporting systems will impose burdens completely disproportionate (for most of the items on the hearing agenda) to the small amount of additional revenues that will be raised by these items.

The Institute continues to remind the Congress of the IRS's limited audit resources. Complexity as a pervasive force in our tax system, combined with limited governmental resources for coping with that complexity, leads to growing disrespect for a self-assessment system relying on voluntary compliance.

With respect to the present series of hearings, the AICPA believes many of the proposals before the subcommittee add complexity while raising only limited revenue. The hearings were announced within only weeks of enactment of the RRA; individuals, businesses and practitioners should have an opportunity to live with this newly enacted law before it is subject to change. Change, in and of itself, is a source of complexity, and it is not unreasonable to ask for stability in the tax laws that will last more than a few months.

Thus, the Institute does not find much to be enthusiastic about in the list of proposals for these hearings. The AICPA commented on a number of them, but in relatively brief fashion. Some of the comments merely referred back to a general point, while others focused on specific policy issues. And, prior to enacting any of the large number of revenue raisers in these proposals, the Institute asked to be informed of who suggested the proposals and what they are intended to pay for.

The Tax Division's specific comments on some of the proposals are noted, followed by a listing of the other provisions commented on.

* A proposal to increase estimated tax payments under the safe harbor method to 115% of last year's tax liability for individuals with AGIs over $150,000: The AICPA has worked with Congress to eliminate the harsh and unworkable estimated tax provision enacted at the end of 1991. The RRA contains a simple, fair and administrable solution that was widely supported and has been highly praised. Before it even goes into effect, however, a revenue raiser is being proposed. The Institute strongly opposes this proposal; the estimated tax issue, which was originally raised by the AICPA only to correct a very serious mistake, has now been adequately addressed, and this troublesome area should not be reopened.

Small businesses agreed to a 110% safe harbor as a simple and safe alternative to the very complicated prior rules. Increasing this amount to 115% (or anything above 110%) will result in many small businesses and individuals opting out of this safe harbor rule and having to do much more complicated tax calculations three and four times a year as an alternative.

* A proposal to repeal the Sec. 1374(d)(2)(A)(ii) taxable income limitations on the recognition of built-in gain of S corporations: This proposal would remove the taxable income limitation used by S corporations when computing their built-in gains tax liability. The limitation defers the payment of built-in gains tax in years the corporation may be suffering real economic losses, and may not have the resources to pay the tax. The proposed change would be a significant reversal of Congress's application of this tax.

Sec. 1374 is designed to maintain a double-level tax on appreciation in assets that accrued in a corporation before it elected S status. To accomplish this, Sec. 1374 imposes a potential corporate-level tax on asset dispositions over the 10 years following the conversion. The amount of recognized built-in gain on which an S corporation must pay tax in any year is limited to the corporation's taxable income for that year.

Recognizing that taxpayers could abuse such limitations, Congress included a suspense account mechanism in Sec. 1374 that causes any gain not taxed by virtue of the taxable income limitation to be taxed the following year, subject to a taxable income limitation in that year. Only after the passage of the 10 years following conversion to S status does the corporation's exposure to the built-in gains tax expire.

The tax policy justification supporting the taxable income limitation and its predecessor, the "net income limitation," is twofold. First, without such a limitation, an S corporation is in a worse position than a similarly positioned C corporation, which is not taxed in excess of its income. Filing an S election should not result in an acceleration of the corporation's tax liability.

Congress was clearly embracing the "wherewithal to pay" concept when it modified Sec. 1374 in 1988. In its report on the 1988 Act, the Ways and Means Committee noted that "it is appropriate not to impose the built-in gains tax in a year in which the taxpayer experiences losses." The AICPA believes this approach is the proper one and a wherewithal mechanism must remain in Sec. 1374. To do otherwise would expose more than 1.5 million S corporations (the vast majority of which are small businesses) to tax assessments in situations in which they lack sufficient resources to manage their ongoing operations.

Last year, this proposal was dropped out of HR 5646. Earlier in 1988, this idea was proposed for inclusion in S 2238, the technical correction bill under consideration that year; again, the matter was dropped. The taxable income limitation is good tax policy. It should be maintained and its proposed repeal should be removed from the bill.

Other provisions commented on include:

* A proposal to change the foreign tax credit to a deduction.

* A proposal to freeze the standard mileage rate used to determine deductible automobile expenses incurred for the business use of such vehicles at the 1993 level for the 1994 tax year, and thereafter to round down the amount computed by the IRS to the nearest whole cent.

* A proposal to limit the business mileage deduction for trips beginning at a taxpayer's home to mileage in excess of 10 miles.

* A proposal to repeal the safe harbor under Section 530 of the Revenue Act of 1978, relating to the classification of workers as independent contractors, for construction industry employees.

* A proposal to disallow deductions for compensatory damages under certain environmental laws and a proposal to clarify the treatment of environmental remediation costs by specifying the types of such costs that must be capitalized or requiring that all such costs be amortized over a uniform period of years.

* A proposal to require that a portion of advertising expenses be capitalized and amortized over a period of years.

* A proposal to tax political campaign committees of Federal candidates at the same rate of tax applicable to state and local candidate committees (i.e., the highest corporate rate).

* A proposal to impose a 30% excise tax on expenditures of tax-exempt organizations for lobbying (including amounts paid as salaries and an allocable portion of support costs).

* A proposal to include contacts with regulatory agencies (except local and use agencies) in the definition of lobbying for purposes of the existing Sec. 501(c)(3) restrictions.

* A proposal to deny corporations a deduction for all (or part) of interest paid to the IRS on tax underpayments.

* A proposal to increase the rate of interest payable on corporate tax delinquencies.

* A proposal based on a provision in HR 5270, as introduced in the 102d Congress, to modify the method by which income from the sale of inventory is sourced.

* A proposal to require written substantiation of any meal or entertainment expense claimed as a business deduction; alternatively, a proposal to require written substantiation of any meal or entertainment expense in excess of $10.

* A proposal to limit the deduction for wagering losses to 80% of the amount otherwise deductible.

* A proposal to amend the like-kind exchange rules to require that Sec. 1031 property received must be "similar or related in service or use" to be property exchanged, except in the case of condemnations.
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Title Annotation:American Institute of Certified Public Accountants Tax Division
Author:Karl, Edward S.
Publication:The Tax Adviser
Date:Nov 1, 1993
Previous Article:Tax treatment of living benefits under life insurance policies.
Next Article:Avoiding built-in gain recognition on distribution of appreciated property.

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