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Tax Executives Institute-Internal Revenue Service liaison meeting agenda, April 27, 1990.

Tax Executives Institute - Internal Revenue Service

On April 27, 1990, Tax Executives Institute held its annual liaison meeting with the Internal Revenue Service. The written agenda for the meeting, which is reprinted below, was filed with the IRS on April 13. The agenda was developed by the Institute's Federal, International, and IRS Administrative Affairs Committees.

I. Introduction

That the tax system became increasingly complex during the 1980s is incontrovertible. Although more and more attention has been paid to the complexity of the tax law in recent years, previous efforts to simplify the tax code - especially for business taxpayers - have proven ineffective.(1)(*) It has been said that truth is the first casualty of war. This is no less the case in the battle against tax law complexity. In the last decade, simplicity has been the casualty of a series of tax bills whose common theme has not been fealty to principle but rather legislative legerdemain. A seeming distrust of taxpayers (corporate taxpayers in particular), combined with an institutional reluctance to deal with the budget deficit in a straightforward manner, has produced a stream of legislative provisions that have been difficult to understand, implement, and observe.

Apart from the complex nature of specific statutory schemes (such as the fragmentation of the foreign tax credit into myriad baskets and the superimposition of the alternative minimum tax (AMT) scheme on an already complex "regular tax" system), the magnitude and rapidity of change have contributed mightily to the complexity of the tax law. As Will Rogers said, "The difference between death and taxes is, death doesn't get worse every time Congress meets."

By one count, more than 140 public laws have been enacted since 1976 that, one way or the other, changed the Internal Revenue Code. The churning of the tax laws adds to their complexity. Tax laws may always be complicated, because the transactions to which they apply are complicated, but the 1980s' juggernaut of tax legislation has raised complexity to a new, almost insurmountable peak. This ever-changing playing field affects not only corporate taxpayers, which must contend with the changes on a day-to-day basis, but also the Internal Revenue Service, which must issue the necessary guidance and, ultimately, ensure compliance through its examination process.

The maelstrom of legislation also breeds another, perhaps more insidious form of complexity - transitional complexity - which encompasses the burdens and problems associated with the instability of the tax laws.(2) Fast, furious, and complex legislation might be understandable if significant policy goals were achieved. TEI submits, however, that a major contributor to the complexity of the tax law is the almost willy-nilly manner in which the changes have been made. There seem to be no overriding principles that mold and shape tax policy. The goal seems simply to raise revenue; while this goal is unassailable, it should not be pursued to the exclusion of sound policy and proper administration. To restore a fuller measure of order and certainty to the tax system, tax policymakers should identify and adhere to, with some degree of constancy, clear principles, rather than championing targeted provisions to address real, perceived, or perhaps chimerical abuses.

For example, if sound U.S. tax and economic policy supports minimizing double taxation on income earned abroad and deferring U.S. tax on unrepatriated earnings (and we submit it does), then proponents of proposals to dilute the foreign tax credit or chip away at the concept of deferral should be required to openly defend the proposed deviation from those principles. The incremental nature of such proposals should not relieve their defenders of the obligation to justify their proposals on policy grounds. Otherwise, taxpayers will find themselves at the bottom of the proverbial "slippery slope." We submit that the professed desire to close "tax pinholes" does not of itself justify the substantive, transactional, and transitional complexity it spawns.(3)

TEI appreciates that the power to legislate lies with Congress and that the IRS is often, like the taxpayer, a bystander to the enactment of unadministrable legislation. We submit, however, that the IRS can take a more active role in ensuring that adequate attention is devoted to compliance and administrability concerns. In its February 7, 1990, testimony before the Ways and Means Committee on "the impact, effectiveness, and fairness of the Tax Reform Act of 1986," TEI urged Congress to place greater emphasis on the administrability of particular proposals during the legislative process. After stating that the most effective safeguard would be sufficient time to analyze the administrability of specific proposals, we made the following recommendations:

* Ask the IRS to testify before

Congress specifically to address

the administrative aspects

of proposed tax legislation.

* Make a greater effort to prepare

draft legislative language

in advance of hearings and

mark-up sessions to allow the

discovery and correction of administrative

flaws before the

legislation becomes law.

* In appropriate cases, ask the

IRS to develop necessary tax

forms and schedules before a

proposal is enacted so that administrative

problems can be

identified and resolved beforehand.

Obviously, the IRS would be intimately involved in implementing all three of these recommendations. During the liaison meeting, we invite your comments on the recommendations, as well as your suggestions on how taxpayers and the IRS can work together productively to make the tax legislative process more responsive to compliance and administrative concerns.(4)

II. The Growing Constituency

for Tax Simplification

For years, Tax Executives Institute has been "harping" on the need to address the tax law's complexity. Our comments have been directed both at tax legislation and at the regulations and other forms of administrative guidance issued by the Treasury Department and IRS. As the organization of those tax professionals who must deal with the Internal Revenue Code's traps and opportunities on a day-to-day basis, the Institute has endeavored to focus on the true cost of complexity - not only in terms of the financial resources diverted from more productive activity, but also in terms of the frustrations caused and the distrust bred as more and more taxpayers come face to face with the fact that full compliance may just be literally impossible. To the extent there is any other participant in the tax system that shares TEI's front-line exposure to the cost of complexity, it is the IRS's field personnel - the people who (on a time-delayed basis) confront the tax law on the same practical basis.

The concern about complexity, moreover, is spreading: the concept of simplicity is finally commanding attention from Congress, the Department of the Treasury, the IRS, the practitioner community, and others. TEI believes that a "constituency for simplification" is growing.

As stated earlier, in February the House Ways and Means Committee held hearings on the effect of the Tax Reform Act of 1986. Coincident with the hearing, Chairman Rostenkowski announced a major tax simplification study. In addition, Commissioner Goldberg, Assistant Treasury Secretary Gideon, and Joint Committee Chief of Staff Pearlman have all voiced support for efforts to earmark discrete portions of the Internal Revenue Code (for example, the international provisions) for simplification.

Actions have begun to match the rhetoric - not only in recent administrative announcements but in legislative proposals as well. The Omnibus Budget Reconciliation Act of 1989 not only simplified the AMT provisions of the Internal Revenue Code(5) and repealed the mind-numbingly complex rules of section 89, but also reformed and simplified the Code's civil penalty provisions. In addition, the IRS has taken significant steps to simplify some recordkeeping requirements through announcements of a uniform rate for computing business miles (Revenue Procedure 90-66) and suspension of the 90-day rule for notices of redeterminations of foreign taxes (Notice 90-26). Similarly, the IRS's recent fringe benefit regulations (T.D. 8256), though far from perfect, reflect a greater concern with administrative burdens and business reality than did their predecessor. (Another such example is Revenue Ruling 90-23 relating to the deductibility of business travel from a taxpayer's home to a "temporary job site.") As Commissioner Goldberg remarked at TEI's recent 40th Midyear Conference, none of these actions may represent a "major league revolution," but they mark a salutary start.

TEI commends the IRS for its efforts to date.

III. Simplicity, However, Does

Not Mean Simplistic:

The Loss Disallowance


The tax community's enthusiasm for simplification has been tested by the IRS and Treasury's implementation of the "rough justice" concept in their recently released consolidated return investment adjustment regulations. Those regulations, which disallow all losses on the disposition of a subsidiary's stock, have been criticized not only as being unduly harsh but for misusing the goal of tax simplification.

The loss disallowance regulations were issued by the IRS on March 9, 1990, in an effort to stop "son of mirrors" transactions and modify the consolidated return rules to reflect the repeal of the General Utilities doctrine. The regulations are so broad that they intentionally disallow - under the guise of simplification - deductions for true economic losses. In defending the regulations, Treasury and IRS officials have intimated that taxpayers who complain about "rough justice" regulations should not be taken seriously when they argue for tax simplification.

TEI submits, however, there is a vast difference between "rough justice" and "frontier justice." Simplification may mean many things to many people, but it cannot properly be used to justify the "lynching" of longstanding (and incontrovertible) tax law principles. A "simple, straightforward" rule that punishes taxpayers which have already suffered severe economic injury represents no justice at all. Simplification does not mandate, and cannot excuse, the promulgation of rules that exceed the scope of the statute and ignore economic realities. With apologies to Emerson, a foolish simplicity is also the hobgoblin of little minds.(6)

In repealing the General Utilities doctrine, Congress was concerned that under the general rule permitting loss recognition on liquidating distributions taxpayers might be able to create artificial losses at the corporate level. To address this concern, Congress included broad regulatory authority to prevent circumvention of the 1986 Act amendments through other provisions of the Code (including the consolidated return provisions). See Staff of the Joint Comm. on Taxation, General Explanation of the Tax Reform Act of 1986, 99th Cong., 2d Sess. 337, 345 (1987). There is absolutely no indication, however, that Congress intended to disallow all economic losses on the sale of a subsidiary's stock. Indeed, quite the opposite is the case: section 165 of the Code evinces a clear congressional intent to allow the deduction of losses. The IRS and the Treasury clearly lack the authority to promulgate consolidated return rules that disallow losses plainly sanctioned by Congress. Cf. American Standard Inc. v. United States, 602 F.2d 256 (Ct. Cl. 1979).

The loss disallowance rule thus goes far beyond the scope of Congress's repeal of the General Utilities doctrine - all in the name of a "simpler" system.(7) In promulgating the rule, the Treasury and IRS set up a false dichotomy: the choice is said to be between on horrendously complex tracing rule and the extraordinarily harsh loss disallowance rule. To our mind's eye, however, both approaches are directed at a "problem" much bigger than the one that exists.

Stated simply, specific provisions of the Code cannot and should not be administratively eviscerated under the guise of simplicity. This is especially the case in respect of changes implemented by administrative fiat. That the Treasury and IRS would disregard the notice and comment requirements of the Administrative Procedure Act (which governs the issuance of legislative regulations such as those issued under section 1502) underscores TEI's concern about the "take it or leave it" approach to tax simplification. We submit that, unless withdrawn, the loss disallowance regulations will spawn not only litigation but possibly a legislative reaction that, while ensuring the proper tax result in respect of the consolidated return rules, may undermine other simplification efforts. We urge the IRS and Treasury to keep this in mind as they formulate their response to the firestorm of criticism produced by the loss disallowance rules. Indeed, we strongly recommend that the regulations be withdrawn pending their reconsideration.

IV. Wither Now Simplification?

Modest Proposals

for Reducing Administrative


The Institute's objection to the loss disallowance regulations has not dampened its overall support for a less complex - and fairer - tax system. TEI has never subscribed to a philosophy of "simplification at any price." We have never exalted simplification over valid tax and economic policy. Rather, we have argued that ease of administration - which Congress and the Treasury have too often ignored - needs always to be taken into account.

The solution is continuing dialogue and a willingness to compromise. Thus, we welcome the statement in the preamble to the consolidated return regulations (which has been echoed by Assistant Secretary Gideon and Commissioner Goldberg) that invites proposed alternatives to the loss disallowance rule. The Institute's Federal Tax Committee is at work on comments that will recommend a more rational, equitable, and legally justifiable approach to the "son of mirrors" problem.

We recognize that the compromises will not be all one way: sometimes simplicity is going to cost money, and sometimes it is going to raise money. That TEI, other professional groups, and other taxpayer representatives decline to support a particular regulatory project or a full slate of revenue-raising proposals - to engage in a "robbing Peter to pay Paul" exercise without any assurance that Paul will ever see a cent of the money - does not mean that our support for simplification is insincere or hollow.

We believe that there are ways to simplify the tax code without sacrificing sound tax policy goals. For example, Notice 88-99, which deals with the application of the uniform capitalization rules in the foreign context,(8) imposes extensive administrative and compliance burdens for U.S. companies, principally in the computation of indirect foreign tax credits under section 902 of the Code. The Notice also requires the allocation of interest incurred by foreign subsidiaries against the production property of related foreign affiliates, frequently with little or no effect on the U.S. parent's tax liability in the United States.(9) TEI has previously suggested that Notice 88-99 be amended to exempt controlled foreign corporations from its reach - an action that could be taken without jeopardizing the purpose underlying the uniform capitalization rules. We renew that suggestion now.

In addition, the proposed regulations under section 414(n) of the Code contain a definition of "leased employee" that is so broad that many legitimate independent contractors are swept within its reach, creating substantial recordkeeping and compliance problems. We submit that a narrower definition could be crafted that excludes individuals hired under contract that meet the common-law definition of independent contractor, and we believe that the recommendation can be adopted without causing injury to tax policy or the fisc.

Taxpayers and government representatives may not always agree (with each other or among themselves) on how particular provisions should be simplified or where concerns of "equity" or "fairness" or revenue should override the simplification objective. TEI remains convinced, however, that progress can be made. Although we recognize that complex statutory schemes generally beget complex regulations (and, hence, that the consolidated return, Subchapter C, and foreign tax credit rules will never be truly simple), we believe that the IRS can ease compliance burdens through the issuance of safe harbors, de minimis rules, and regulations that alleviate the volume of paperwork and technical computations. Our recommendations for administrative reform and simplification are attached as Appendix I to this agenda. We believe the adoption of these proposals would benefit taxpayers and the IRS alike.

Finally, simplification must be an incremental process. The process of simplifying the entire Internal Revenue Code is overwhelming - so much so that many would not undertake the task. On a project-by-project basis, however, strides can be made. Discrete issues can be attacked and specific victories achieved. We believe there would be benefit in designating specific issues for special attention, setting up a timetable for working meetings between the IRS (and Treasury) and TEI, and holding one another's feet to the fire. (We believe such a process worked to good effect with respect to safe harbor interest rates under section 482.)

Specifically, we suggest such an approach in respect of the following issues:

* Development of a procedure in

respect of FSC estimated tax

payments (see Item B.6.a in

Appendix I).

* Development of examples in

respect of the allocation of

charitable contributions (see

Item B.1 in Appendix I).

* Refinement of Notice 88-99 in

respect of the application of

the uniform capitalization

rules in the foreign ("sister"

loan) context (see the discussion

above). Item B.3 in Appendix I).

We invite your comments on this suggestion during the liaison meeting.

V. Retroactivity: Salt in the


A. General Comments

Retroactive rules and regulations produce their own form of complexity. Consider, for example, the retroactive change from the use of year-end to month-end debt levels in computing the percentage of interest expenses that is subject to the pre-1987 allocation rules under the transitional rules for section 864(e) of the Code (Temp. Reg. [section] 1.861-13T). Taxpayers which in good faith relied upon the prior proposed regulations (which sanctioned the use of year-end debt levels) were compelled to recompute the amount of 1987 and 1988 interest expense subject to the post-1986 allocation, in some cases necessitating the filing of amended returns. Such an about-face not only unnecessarily - and unfairly - increases compliance costs for taxpayers, but ultimately diminishes the IRS's credibility.

Even if the retroactive application of new or modified rules do not constitute an abuse of discretion, it can undermine the integrity of the tax system and taxpayer confidence in the fairness of the system. Stated differently, the IRS is not required to take a hard-line approach: it can use its discretion creatively to facilitate taxpayer acceptance of new or modified substantive positions. This is especially the case where the retroactive change adversely affects a wide cross-section of taxpayers, without regard to whether the matter is first addressed through regulations, a request for private ruling, or the examination process (for example, through the technical advice process).

Section 7805(b) of the Code has been properly referred to as the tax system's "safety valve" - as a mechanism by which changes in long-standing rules can be made tolerable if not palatable. This section incorporates a "standard of equality and fairness." International Business Machines Corp. v. United States, 343 F.2d 914, 924 (Ct. Cl. 1965), cert denied, 382 U.S. 1028 (1966). TEI strongly believes that section 7805(b) should be used more frequently to temper the application of a rule or regulation. Although Chief Counsel Shashy recently expressed a similar view, other IRS representatives have insisted that retroactive rules are necessary to prevent the system from "rewarding" non-compliance. Before the IRS can hold taxpayers accountable, however, the operative rules must be known or knowable; frequently, they are not. It is in these cases, without regard to the IRS's legal authority to issue retroactive regulations, that section 7805(b) should be more commonly invoked.

B. Specific Examples

Examples of areas that TEI believes are ripe for prospective treatment include:

1. Consolidated Return Investment Adjustment Regulations. The loss disallowance regulations, which were issued on March 9, 1990, are effective for taxable years for which the due date of the federal tax return (without extensions) is after March 14. Thus, for a calendar-year taxpayer, the loss disallowance rule applies retroactively to the disposition of a subsidiary's stock that occurs during 1989. Although TEI strongly believes that the section 1.1502-20T regulations should be withdrawn in their entirety pending reconsideration, under no circumstances should such a major and substantive change in tax policy ever have retroactive effect.

2. Deduction for State and Local Taxes under the Economic Performance Standard. Although the IRS has not yet issued regulations under section 461(h) of the Code - even though more than five years have passed since the enactment of the "economic performance" test - IRS officials have expressed the view that taxpayers should not be permitted to rely on several published rulings concerning the deductibility of state and local taxes as of the lien or assessment date because they were "clearly inconsistent" with the principles of the economic performance test. (This position has been taken notwithstanding statements in the legislative history suggesting that lien or assessment date accruals might still be proper under the economic performance standard.) In comments filed on February 27, 1990, TEI recommended that any decision abandoning the prior rulings should be applied on a prospective-only basis.

3. Package Design Costs. In Announcement 89-98 (issued July 21, 1989), the IRS has announced its reconsideration of the transition procedures set forth in Revenue Procedure 89-16 and Revenue Procedure 89-17, relating to the deductibility, capitalization, and amortization of package design costs.(10) To date, however, the IRS has issued no amelioratory guidance. Consequently, taxpayers continue to confront retroactive recordkeeping requirements (which literally demand the reconstruction of package design costs back to 1913). In addition, the closure of tax audits is being delayed by the IRS's inability to resolve this issue. Is it not possible for the IRS to issue a notice effectively closing the door on history and establishing safe harbor rules that will enable taxpayers to implement, and the IRS to audit compliance with, reasonable procedures on a going-forward basis?

4. Sourcing of State Income Taxes. On December 7, 1988, the IRS issued proposed regulations under section 861 relating to the allocation and apportionment of the deduction for state income taxes. The requirement that state income taxes be sourced between foreign and domestic income was made applicable for taxable years beginning after December 31, 1976, and can have substantial effect with respect to open years even before that date. The workload burden created by these regulations is tremendous, requiring the collection and analysis of additional data that is not used for any other purpose. Taxpayers simply do not maintain - and, with respect to the retroactive application of the regulations, could not have anticipated the need to maintain - the information required to perform the calculations. In addition, the regulations are based on controversial theoretical assumptions. If the regulations are not withdrawn, they should be applied on a prospective-only basis.

5. Allocation of Interest and Other Expenses. On September 9, 1988, the IRS issued proposed regulations under section 864(e) relating to the allocation and apportionment of interest and other expenses. Although not technically retroactive, the rules relating to non-recourse debt would taint the economic viability of transactions negotiated and executed months and even years before the regulations were issued. Again, a grandfather rule in respect to previously executed agreements would be appropriate.

6. Allocation of Interest: Determination of Transition Levels of Debt. On August 1, 1989, the IRS issued temporary regulations under section 864(e) relating to the determination of transition debt levels for purposes of the allocation of interest expense. The regulations state that taxpayers must use month-end debt levels, which represented a change from the year-end debt level rule set forth in prior proposed regulations. As previously explained (in Section V.A.), as a result of the change taxpayers that in good faith relied upon the prior regulations have been compelled to recompute the amount of 1987 and 1988 interest expense subject to the post-1986 allocation, in some cases necessitating the filing of amended returns. Clearly, this situation cries out for prospective-only treatment.

VI. Issues of Special Concern

to Large Case Taxpayers

TEI has long believed that tax equity and fairness may be properly measured in part by examining the relationship between taxpayers and the tax administrator. If this relationship is viewed as unfair or one-sided - if taxpayers can properly complain that "the deck is stacked against them" in their dealings with the IRS - then "simplication" of the substantive provisions and rules may be found wanting in terms of restoring the public's confidence in the tax system.

A. The Examination Process:

Proposed Changes to the

Coordinated Examination


1. QIP Team Report. As the Institute's previous submissions on the Coordinated Examination Program make clear, TEI believes that the CEP program operates to the mutual benefit of the IRS and taxpayers. Almost all taxpayers included in the CEP program are represented by the Institute's membership. We are, in other words, the program's principal customers. As "consumers" of its services, we applaud the IRS's recent initiative to improve the program, for though the CEP program is operating well, there is truth in the quality axiom, "if it's not broken, it may soon be." TEI is proud of its support of the CEP program and is pleased to have cooperated with the IRS's Quality Improvement Program team.

In its January 24, 1990, letter to Commissioner Goldberg, TEI set forth the reasons why it is unable to support the QIP team's recommendations concerning the reorganization of the CEP program. We explained that the report's centralization proposal is seriously flawed, especially with respect to the Appeals process. The Institute is concerned, not so much with the IRS's desire to centralize its resources, but with the proposed creation of a bureaucratic superstructure that would mask, not solve, the stated problems in the CEP program. Moreover, we are concerned that, by coordinating the efforts of Examination, Appeals, and Counsel through a proposed National Office Triumvirate, the IRS could undermine the independence of the Appeals Division and create a bottleneck of cases that makes the current situation look utopian by comparison. Thus, the recommendations could be counterproductive in terms of improving the currency of audits - a primary goal identified by the QIP team.

TEI is encouraged by recent reports that the IRS is "rethinking" the recommendations set forth in the QIP report. We agree that, rather than creating a new structure, the IRS should build upon the successes of programs such as the Industry Specialization and Appeals Coordinated Issues Programs. In particular, we support proposals to strengthen the role and authority of the case manager, especially with respect to the settlement of issues.

Thus, TEI's criticism of the QIP report should not be seen as a derogation of the IRS's quality initiative or the CEP program. TEI remains committed to the CEP program and will continue working with the IRS to improve the audit process for taxpayers and the IRS alike.

2. Pre-Appeals Conferencing Procedure. During his remarks to TEI's 40th Midyear Conference, Chief Counsel Shashy referred to a proposal to establish formal pre-Appeals conferences involving personnel from the Examination Division (both the team that handled the years in Appeals and the team that is handling the current audit), personnel from Appeals, and personnel from Counsel. Subsequent reports confirm that the proposal is based on a program that had previously been adopted in the Western Region.

Initial reactions to the pre-Appeals conferencing proposal from taxpayers and practitioners have ranged from skeptical to outright hostility. Notwithstanding assurances that the proposal is not intended to adversely affect the independence of the Appeals Division, taxpayers have generally interpreted the proposal as threatening the integrity of Appeals. Although Appeals personnel should not be discouraged from consulting with Examination (for example, where the taxpayer presents factual information in its protest that was not forthcoming during the audit), TEI questions the propriety of institutionalizing the practice. Such a program might cause taxpayers to conclude, with some justification, that Appeals has "already made up its mind" or, further, to wonder whether the Appeals Officer is basing his or her conclusions on information (or arguments) not set forth in the Revenue Agent's Report - and, hence, not subject to taxpayer scrutiny or challenge.

When Counsel routinely becomes involved - both as adviser to the Examination Division and as the party to which Appeals is answerable - a "stacked deck" perception becomes palpable. The more pronounced the perception, the more likely it is that taxpayers will choose to forgo the administrative process and proceed straight to litigation. Although the IRS may prefer such an approach in isolated cases, we submit that the system as a whole cannot withstand a broad-scale abandonment of the Appeals process. Moreover, even where taxpayers do not elect to forgo Appeals, the result may be to prolong the administrative process (for example, where the taxpayer adopts procedures more geared to ultimate litigation than to administrative settlement). Given the QIP report's emphasis on improving the currency of audits, such an outcome would be unfortunate.

3. The Overall Tone of the CEP Taxpayer-IRS Relationship. The QIP report and the pre-Appeals conferencing proposal reflect a growing distrust by the IRS of the corporate tax community. The QIP report is replete with references to "taxpayer procrastination" and intimations of taxpayers' "gaming" the system. We recognize that a hard-line, litigation-driven strategy may have produced favorable results in the tax shelter area, though we suggest the IRS's success owes more to legislative changes than to its strategy. We submit, however, that such an approach cannot productively be transplanted into the corporate sector. The issues are different, the level of ambiguity in the law and facts is different, and (perhaps most fundamentally) the taxpayers involved and the level of scrutiny to which they are subject, are different.(11)

Moreover, the tone of the report (and other IRS statements) shows a decided bias toward litigation. The disparagement of settlements and the Appeals process in general can only lead to a more adversarial posture on the part of taxpayers and the IRS. Such attitudes do not augur well for the CEP program which depends upon mutual respect and cooperation between taxpayers and the IRS. TEI certainly understands the statements of Chief Counsel Shashy and other IRS representatives that the IRS does not intend to hold a "fire sale" in addressing the Appeals backlog; we submit, however, that a "scorched earth" policy is equally untenable.

Finally, we address a subject of some sensitivity - recent comments by IRS representatives questioning the propriety of taxpayer strategies discussed at a TEI program. Specifically, IRS personnel have recently cited materials prepared by an outside speaker in connection with a TEI seminar as evidence of the need for strong countermeasures. The specific materials outlined various "strategies" that taxpayers might employ in dealing with the IRS - strategies such as insisting that Information Document Requests be specific or that the audit be completed within the statutorily prescribed period, or considering whether to provide materials to the revenue agent in the absence of an administrative summons. TEI is aware that such comments have been made by IRS representatives in several venues.

TEI's concerns are two-fold. First, the views expressed by outside speakers should not be ascribed to TEI (which they clearly have been). More fundamentally, we are concerned about the intimation that the views (without regard to whether they are TEI's) are verboten. TEI has long cautioned against the ramifications of the growing adversarial nature of the audit process - a development that we believe is attributable, at least in part, to the burgeoning involvement of District Counsel personnel in examinations. One consequence of such "adversariness" is a more refined focus on audit techniques and strategies by both taxpayers and the IRS. TEI respectfully suggests that it would be naive for taxpayers - faced with more (though not necessarily improperly) aggressive examining agents, themselves employing creative and innovative strategies - not to undertake to apprise themselves of emerging taxpayer strategies and techniques.(12)

When TEI raised this issue informally with a National Office representative in January, the Institute was assured that there was no concerted effort to question TEI's motives in sponsoring programs on taxpayer strategies. Notwithstanding these assurances, the comments continue to be made. We invite your comments on this subject during the liaison meeting.

B. Business Document Matching


It is undisputed that tax reform fell heaviest on the corporate taxpayer. The uniform capitalization rules, the AMT, and the expanded scope of the international tax provisions have all served to increase the administrative and compliance burdens of corporations. The corporate sector has borne the brunt of the 1986 Act and subsequent legislation through increased costs for personnel, computer time, software development, and data collection. Corporate taxpayers now face a system so complicated and perverse that tax executives are frequently reduced to performing corporate tax triage: moving from one compliance challenge to another, using band-aid approaches to stop the worst bleeding, and striving to ensure compliance.

In the current environment, the last thing the corporate sector needs is another onerous, unnecessary compliance program - such as a program to require the filing of Forms 1099 in respect of payments to corporations - that imposes substantial costs but adds little value to the tax administration system. Thus, TEI commends the IRS for opposing the imposition of a business document matching program.(13) IRS officials have been forthright in noting that the costs, administrative problems, and lack of concrete data on the amount of unreported income demonstrate that such a program is ill-advised and unwarranted.

Although we might rightly be said to be "preaching to the choir," we wish to affirm our view that there is no evidence that large, publicly held corporations fail to report any income. Such companies are subject to stringent reporting requirements by government agencies and their financial statements must be reviewed and certified by independent auditors. This safeguard is complemented by the companies' lack of incentive (for financial reporting purposes) to underreport income: they generally wish to report as much earnings as possible. What is more, financial controls represent a clear "audit trail" for IRS examiners to follow to confirm that income is correctly reported (especially in respect of continually audited CEP taxpayers). As the IRS itself has acknowledged, "internal financial controls established by larger corporations to protect the interests of their stockholders make it difficult to hide corporate income from tax agencies." "Gross Tax Gap Trends According to New IRS Estimates, Income Years 1973-1992," Statistics of Income Bulletin, Vol. 8, No. 1, at 24 (Summer 1988).

A corporate document matching program presents myriad practical obstacles (including special problems that would face accrual and fiscal-year taxpayers) which the IRS has effectively addressed in its congressional testimony. We commend the IRS for its continued resistance to the implementation of such a program and offer our assistance in those efforts. In this regard, what are the results of the IRS's select audit of Form 1099 compliance among large corporations (which we understand was undertaken in late 1988 as a result of congressional and General Accounting Office requests)?

C. Estimating the Corporate

Tax Gap

Regrettably, justification for a corporate matching program (discussed in Section VI.B.) is rooted in reports concerning the corporate tax gap and other materials that paint corporate taxpayers as a legitimate target for enhanced compliance efforts. A case in point is the IRS's 1988 report entitled, "Gross Tax Gap Trends According to New IRS Estimates, Income Years 1973-1992," Statistics of Income Bulletin, Vol. 8, No. 1, at 23-28 (Summer 1988). In connection with its April 1989 liaison meeting with the IRS, the Institute noted that the statistical basis for the report was flawed. Concluding that the net effect of the IRS's report was to cast corporations as tax scofflaws, we made the following specific observations:

* The "gross" voluntary compliance

rate among corporations

in 1988 was 82.4 percent. Thus,

the study confirms that the

vast majority of corporate taxpayers

comply with the tax


* The size of the tax gap is based

on audit adjustments proposed

by IRS examiners - even

though a large number of such

adjustments are reversed by

the IRS itself as cases work

their way through the administrative


* The estimated increase in the

tax gap (tax dollars not voluntarily

paid) is attributable in

large measure to the growth of

income tax liabilities through

real expansion of the economy

and through inflation, not to

growing noncompliance.

* The estimated increase in the

tax gap assumes that there will

be no change in compliance

rates. Thus, an increase in

income tax liabilities will, by

virtue of simple arithmetic,

lead to an increase in the tax


* Perhaps most fundamentally,

the IRS has insufficient data to

identify the various components

of the corporate tax gap.

In spite of these errors, however, the report remains the basis for legislative "reforms" of corporate tax provisions and in the redeployment of IRS audit resources. Earlier this year, Congressman J.J. Pickle, as Chairman of the House Ways and Means Oversight Subcommittee, announced the results of that Subcommittee's study of the effects of an IRS budget shortfall. Two items in that study could well become the basis for future remedial legislation or stepped-up compliance efforts by the IRS:

* The Subcommittee reported

that "[f]or the first time in history,

less than 1 percent of all

income tax returns will be

audited posing a serious threat

to the country's voluntary tax

system. Approximately 83 percent

of the tax owed in income

from legitimate economic activities

is voluntarily reported

and paid. However, the `tax

gap' - an estimate of the difference

between the amount of

taxes voluntarily paid in a taxable

year and the amount of

taxes that would have been

paid if all taxpayers had filed

complete and accurate returns - is

approaching $100 billion

a year and continues to grow.

Despite growing noncompliance,

the IRS continues to experience

budgetary problems

and, as a result, critical compliance

initiatives have been

cancelled or delayed."

* The Subcommittee reported

that "[a]lmost $60 billion in

taxes owed to the government

remains uncollected because

the IRS does not have the necessary

resources to pursue delinquent

taxpayers. In many

instances, billions of dollars

have been lost forever because

the statute of limitations for

IRS action has expired."

TEI appreciates that the IRS is in the process of refining its tax gap statistics. In particular, we support the effort to develop "net tax gap" figures, which we assume the IRS will present to the Oversight Subcommittee at its April 19, 1990, hearing on the tax gap. We must express concern, however, about recent suggestions that the IRS could productively use tax accrual workpapers in estimating the tax gap in respect of large-case taxpayers. Based on comments by Roger L. Plate (Director of the IRS Research Division) during a March 16, 1990, meeting with representatives of TEI and the American Institute of Certified Public Accountants, TEI understands that the IRS no longer believes the use of tax accrual workpapers would facilitate a fair determination of the tax gap. In this regard, the Institute has held a follow-up meeting with the AICPA and undertaken to develop alternative approaches, which we will provide to the IRS as soon as possible.

D. Corporate Estimated Taxes

At prior liaison meetings, TEI has discussed how current law effectively requires large corporations to overpay their estimated taxes, without the benefit of interest, in order to avoid an underpayment penalty under section 6655 of the Code. This Hobson's choice does not confront other taxpayers because they may generally avoid the section 6655 penalty by availing themselves of a statutory safe harbor. Regrettably, the Omnibus Budget Reconciliation Act of 1989, which substantially reformed the Code's penalty provisions, did not address the corporate estimated tax rules - which operate as a "non-penalty penalty."

Specifically, under section 6655, corporate taxpayers are generally subject to a penalty if they fail to estimate their tax liability and make quarterly deposits equal to either (i) at least 90 percent of their (subsequently determined) actual tax liability, or (ii) 100 percent of their prior year's tax liability. The "prior year's tax" option is not available to so-called large corporations - roughly corporations whose taxable income is $1 million or more in any of the preceding three years.

Because they are not permitted to utilize the prior year's tax rule, large corporations must base their quarterly deposits on estimates of their current year's tax liability. The existing task is a literally impossible one in light of the complexity of the tax laws, the rapidity with which they have been changed in recent years, and the fact that the numerous adjustments to financial income can accurately be done only annually. Consequently, the large corporate taxpayer faces the following choice:

* paying a penalty (under section

6655) for underestimating

its liability, or

* overpaying its taxes (in order

to avoid the penalty).

The second option (which, quite candidly, large corporations are generally required to choose not only by internal business exigencies - the desire to avoid penalties) does not come without cost. The cost is the effective denial of interest on the amount of the compelled overpayment by operation of section 6611(e), which provides that interest on an overpayment will not begin to run until the filing of a claim for refund.(15)

TEI suggests that a reform of the corporate estimated tax provisions of the Code is long overdue. Although we question whether a valid tax policy reason exists for denying "large corporations" the availability of the prior year's tax rule under section 6655, we suggest that either of the following alternatives (among others) would temper the unfairness and unrealistic nature of the current rules:

* Alternative One: No penalty

would be imposed if the taxpayer

makes estimated tax

payments based on a specified

percentage (say, 120 percent)

of the average of its tax liability

in the preceding three (or

more) years (after taking into

account credits).(16)

* Alternative Two: In the event

the taxpayer overpays its estimated

taxes, interest (at the

rate prescribed by section

6621(a)(1) of the Code) would

be paid to the taxpayer on the

amount of the overpayment


i. the later of the due date of
 the estimated taxes or the
 date the payment is made,

ii. the date such overpayment
 is refunded (or applied to a
 subsequent liability).

A third approach, which would be less satisfactory than the foregoing options but would be superior to current law, is to craft a prior year's tax safe harbor that would have the effect of transmuting the current estimated tax penalty into a straight interest charge. Thus, if the taxpayer's estimated tax installments equalled or exceeded (say) 100 percent of its prior year's tax, no penalty would be charged on any underpayment, but interest would be charged from the date the taxes should have been paid to the date they were paid. This alternative would have the effect of reducing the financial effect of the payment rules (by making the amount deductible as interest) as well as eliminating the possible stigma of a penalty's being imposed on essentially non-culpable behavior.

We would be pleased to work with the IRS and Treasury Department in refining the proposal and in effecting real reform f the corporate estimated tax provisions.

E. The Offset Program

For the past few years, the agenda for TEI's liaison meetings with the IRS National Office has included an item relating to the business master file (BMF) offset program. We have no doubt that the IRS has grown as weary of discussing this issue as we have. Nevertheless, given the recent reinstitution of the BMF offset program, we feel compelled raise - once again - our memebers' concerns.

Last year, the IRS announced that the BMF offset program would be reinstated effective July 1, 1989. In spite of IRS acknowledgements that corporate concerns with respect to the program were legitimate and assurances that adequate safeguards would be built into the system, the offset program persists as the proverbial thorn in the corporate taxpayer's side.

Based on discussions with representatives of the Returns Processing and Accounting Division, we understand that modifications were made in the program as recently as January of this year. Our understanding is that (except where the taxpayer has a history of delinquency) offsets will not occur until at least 10 weeks have elapsed from the time a notice is sent to the taxpayer. We also understand that the Service Centers have the capability of "marking" the accounts of large corporations on an ongoing basis, thereby effectively removing them from the automatic offset program and enabling Service Center personnel to deal with and resolve discrepancies before any offset is effected.

TEI appreciates the cash management imperative that drives the reinstitution of the offset program. We continue to be concerned - in light of the problems that arose between the July 1989 reinstitution of the program and the January 1990 modifications - about the overall efficacy of the program in respect of large corporations. (We are in the process of gathering information from our various chapters on the problems that persist in the program, which we will forward in due course to the IRS.) At a minimum, we believe that there would be a benefit in the IRS's fully explaining the program. In this regard, we would be pleased to publish an IRS description of the program in a future issue of our bimonthly publication, The Tax Executive.

(*) Numbered notes are printed at the end of the agenda (page 184). (1) There can be no doubt that the law is simpler for those individuals whose return filing obligation was eliminated by the Tax Reform Act of 1986 or who are eligible to claim the standard deduction. For other individuals and practically all business taxpayers, however, the opposite is true. See "Codified Confusion: Tax Law Is Growing Ever More Complex, Outcry Even Louder," Wall Street Journal, at A1, col. 6 (Eastern Edition, April 12, 1990).

(2) Although the effects of transitional complexity might be thought to dissipate quickly, that is not the case. Not only do some provisions have long phase-in periods (e.g., the adjusted current earnings provisions of the AMT), but broad delegations of rulemaking authority to the Department of the Treasury and the IRS postpone the day when taxpayers are provided with meaningful guidance on what a new provision means. Taxpayers may also e compelled to work simultaneously with the new and old laws during the transition period. As a result, a given year's tax return can implicate both, multiplying not only the taxpayer's recordkeeping and compliance burdens but the IRS's auditing challenge as well.

(3) Frequently, the layering of change is seemingly done without thought. For example, sections 401(a)(17), 414(q), 414(s), and 415 of the Code currently contain different definitions of the term "compensation." The myriad provisions, among plan sponsors,administrators, and participants.

Other provisions may ensnare unintended victims. The passive foreign investment company (PFIC) provisions were enacted or the limited purpose of removing the economic benefit of tax deferral and the ability to convert ordinary income to capital gain that was available to U.S. investors in foreign investment funds. The enacted definition of a PFIC s so broad, however, that many corporations with active businesses have been classified as PFICs - including corporations whose U.S. shareholders are already subject to tax under Subpart F of the Code (which is also directed at passive income). We submit that no sound policy reason exists for including controlled foreign corporations (CFCs) within the PFIC provisions. Although the Treasury Department has conceded the current scheme is overbroad and unnecessarily complex, it has resisted specific efforts to reform the PFIC provisions.

(4) For TEI's recommendations for reducing regulatory complexity - including a suggestion that working groups be set up on discrete projects - see Section IV and Appendix I.

(5) Even after the revision of the adjusted current earnings (ACE) provisions of the Code, the administration of the AMT regime remains excruciatingly complex. We continue to believe that the AMT provisions could be further simplified without unduly affecting revenue.

(6) Thus, a gross receipts tax would be simple, but no responsible official is promoting it as a substitute for the income tax - certainly not as something that can be done administratively without the benefit of legislation.

(7) It is more than a little ironic that the loss disallowance regulations - whose authors effectively concede that they jettisoned statutory and tax policy considerations in favor of simplification - originated in the same agency that produced the proposed regulations on the sourcing of state income taxes. Those regulations, which were issued under section 861, are horrifyingly complex and create appalling (and hypothetically based) compliance problems. What is more, in the sourcing regulations, the goal of simplification (or, simply, administrability) was sacrificed in favor of the "correct" tax result only after an incredibly nimble reading of extant Supreme Court precedent on the nature of state income taxes.

(8) Notice 88-99, 1988-2C.B. 422, extends the application of section 263A(f) of the Code (requiring that interest expense with respect to the production of certain property be capitalized) to the interest expense of all parties related to the taxpayer, including foreign subsidiaries outside the consolidated group.

(9) For example, assume that a U.S. parent owns foreign subsidiaries in Italy and Germany. The German company has substantial production property with no debt, while the Italian company incurs substantial interest expense. Under Notice 88-99, the interest expense of the Italian company must be allocated to, and capitalized over the life of, the German assets. Such calculations - especially for multinational corporations that may have dozens (or even hundreds) of construction projects and debt instruments in myriad countries - cannot be accomplished with a mere flick of a computer switch. The compliance burden imposed on these companies under Notice 88-99 is tremendous.

(10) In the announcement, the IRS also reaffirmed the substantive result of Revenue Ruling 89-23 that such costs must generally be capitalized under section 263A of the Code.

(11) After all, tax shelters flourished because of the co-called audit lottery - a "game" that CEP taxpayers, which by definition are under continual audit, are unable to "play."

(12) Thus, we believe it is a natural reaction for taxpayers to seek to learn the IRS's strengths and weaknesses, its strategies and constraints, as well as the sanctions that the IRS could choose to impose, why it may or may not choose to do so, and what the taxpayer's options are if the IRS does choose to impose (or threaten) the sanctions. Just as an effective program of agent training must focus on taxpayer motivations and strategies, so oo must meaningful taxpayer training programs devote some attention to understanding the motivations and constraints that confront IRS audit (and Appeals) personnel.

(13) In October 1988, the House Government Operations Committee issued a report entitled "Implementation, by IRS, of a Document Matching Program for Income Paid to Business Taxpayers Should Produce BIllions of Additional Dollars of Tax Revenue." The 1988 report recommends that the IRS develop information-matching programs for business taxpayers comparable to the program already in place for individual taxpayers. The report was prepared following a March 1987 hearing before the Subcommittee on Consumer and Monetary Affairs and a General Accounting Office study issued in July 1988. See Tax Administration: IRS' Efforts to Establish a Business Information Returns Program (GAO/GGD-88-102). The GAO report makes reference to a December 1981 study, The Business Master File Information Returns Program Study Report, prepared by the IRS on the subject.

(14) Indeed, if the figures are adjusted to reflect assessed amounts, the voluntary compliance rate for corporations in 1988 increases to 86.9 percent - higher than the compliance rate would be even higher if adjusted to reflect the results of litigation (i.e., the judicial rejection of IRS positions). Similarly, the aggregate "gap" would be reduced if the figures were adjusted to reflect overpayments by taxpayers which are subsequently refunded.

(15) The filing of a tax return could constitute a claim for refund, but for most calendar-year large corporations, their tax returns will not be filed until close to September 15 (the extended due date of their return), though an outstanding tax would have to be paid no later than March 15. Thus, there could be, at a minimum, a six-month period during which no interest would be paid on the amount of the overpayment.

(16) Such a rule would be comparable to the temporary safe harbor established by the Treasury Department in light of the momentous changes worked by the Tax Reform Act of 1986. See T.D. 8132, 52 Fed. Reg. 10049 (March 30, 1987).
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Title Annotation:includes appendix on administrative initiatives
Publication:Tax Executive
Date:May 1, 1990
Previous Article:TEI recommendations on simplifying the Internal Revenue Code.
Next Article:Comments on capitalization of interest in the foreign context.

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