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IRS Compliance Initiatives Taxpayer Burden Reduction More on ITINs Update on EITC Certification Pilot
Editor:
Editors note: Messrs. Ely and Dougherty are former chairs of the AICPA Tax Division's Tax Practice and Procedures Committee. Ms. Michnay and Ms. Bauman are members of that committee.
New IRS Compliance Initiatives Sixty percent of Americans believe that people are willing to cheat on their taxes and gamble that they will not be audited. Seventeen percent think that it is acceptable to cheat on their taxes (Written Statement Of Commissioner Of Internal Revenue Mark W. Everson Before The Senate Committee On Appropriations Subcommittee On Transportation, Treasury And General Government Hearing On Internal Revenue FY 2005 Budget Request April 7, 2004). Obviously, the IRS is concerned about these statistics on Americas view of tax compliance and enforcement and is introducing several new initiatives to encourage compliance and to improve audit coverage. Some of these initiatives will examine executive compensation, employment tax and excess-benefit transactions for exempt organizations.
Initiatives Over the past eight years, audit coverage, which is the percentage of taxpayers that the IRS selects for audit out of filed returns, has declined (see Exhibit 1). To improve coverage, the IRS is expanding its scope of compliance initiatives by (1) introducing pilot programs, which will help it to learn more about compliance; and (2) standardizing audit procedures for the future. As part of this process, the Service is looking at certain taxpayers and issues that were not a major focus of recent audits. Executive compensation initiative: Last year, the IRS began a compliance initiative for executive compensation. Under a pilot program, it selected 24 corporate returns from inventory already designated for examination by its Large and Mid-Size Business Division; for details, see Neuhauser, Tax Clinic, Executive Compensation Compliance Initiative, TTA, May 2004. These cases were selected because the IRS already had evidence on eight issues:
For each of the selected cases, the IRS is also examining Forms 1040, for executives, to determine whether that form is consistent with information reported on Form 1120. Over the past five to 10 years, executive compensation has generally not been a part of corporate audits. However, lately, revenue agents (RAs) have been frequently requesting Forms 1040 as part of their information document requests. The IRS will analyze the results of these audits to determine how to properly allocate resources to these types of returns and to issue guidelines and best practice procedures to RAs. As a result, executive compensation audits will likely be more common in the future; the IRS will be better prepared and focused in approaching examinations. Employment tax: Another area of increasing IRS focus is noncompliance with employment tax withholding. For example, the Service is looking into cash transactions, S corporations and propriety of Forms W-4, Employees Withholding Allowance Certificate, and W-2. It is considering an up-front validation of Forms W-4 to determine whether a taxpayers identification number and name are consistent. The IRS is also planning to expand its voluntary tip agreement program in the gaming industry, a program that has been successful in Las Vegas and Atlantic City. Excess-benefit transactions: Beginning in April 2004, the IRS launched an initiative to examine whether exempt organizations are complying with the Sec. 4958 excess-benefit rules. It will be contacting hundreds of exempt organizations to examine their reporting positions. Private foundations may also be contacted. As part of this initiative, the Service will also revise its procedures on examining excess-benefit transactions and will issue a new section for that in its Internal Revenue Manual. It may also offer a voluntary compliance program for taxpayers to encourage conformity with the Sec. 4958 rules.
Conclusion In response to the general decline in audit coverage and taxpayers perception that the chances of being audited are slim, the IRS hopes that by expanding its scope of initiatives, it will reach more taxpayers. As it continues to look for ways to increase coverage and encourage voluntary compliance, it will focus on reviewing more returns, either through personal contact or correspondence with taxpayers. Thus, taxpayers can expect to see more audits and a greater use of penalty provisions than before to (1) encourage voluntary compliance and (2) increase costs for those who do not comply. From Jim Dougherty, Director, and Rona Hummel, Manager, Tax Controversy, Deloitte & Touche LLP, Washington, DC
Office of Taxpayer Burden Reduction As part of its effort to reduce taxpayer burdens, the IRS formed the Office of Taxpayer Burden Reduction (OTBR) in early 2002, under the umbrella of its Small Business/Self-Employed Division (SBSE). The OTBR is a catalyst and champion of change within the IRS. It develops burden-reduction ideas submitted by taxpayers, tax practitioners, Federal agencies, Congress, etc. The ideas selected have to significantly reduce the time and money taxpayers spend on complying with their tax obligations. The OTBRs first National Director is Michael R. Chesman, who started his tax career with the IRS Office of Chief Counsel. On former IRS Commissioner Rossottis request, he came back to the IRS after a very successful career in the business world. He understands the tax system and knows it needs to be simplified. The OTBR is the means to accomplish this goal. Through the OTBR, taxpayers and tax advisers can submit suggestions that they believe will have a positive effect on reducing the tax compliance burden. Per Pub. 4109, Office of Taxpayer Reduction: A member of the Small Business/Self-Employed Division (Revised 9-03), the OTBR is focusing its efforts on four major areas: 1. Simplifying forms and publications; 2. Streamlining internal policies and procedures; 3. Promoting less burdensome rulings and laws; and 4. Assisting in the development of new, more accurate, burden-measurement methods. To submit suggestions, taxpayers have to write a letter or complete Form 13285A, Reducing Tax Burden on Americas Taxpayers. The form asks: 1. Whether the taxpayer is a business owner, tax professional or other; 2. The problem causing a taxpayer burden; 3. Which types of taxpayers or businesses are most affected (e.g., sole proprietorship, limited liability company, partnership, regular corporation or S corporation); and 4. How the taxpayer proposes to solve or remedy the problem (e.g., to simplify forms/publications, streamline policies or procedures, or change regulations or rulings or the tax law).
How the Process Works The IRS will evaluate and prioritize proposals, using several criteria: (1) number of taxpayers affected; (2) total taxpayer time and out-of-pocket savings; (3) adverse effect on voluntary compliance efforts; and (4) feasibility, given IRS resource limits and objectives. Any ideas about changing the tax law are submitted directly to Congressional representatives. The Burden Reduction Council (BRC) is the vehicle by which proposals are vetted and resources allocated to each accepted burden-reduction initiative. It can also develop its own proposals. The BRC comprises members from all IRS divisions; Treasury is an ad hoc member. To obtain broad taxpayer buy-in, five IRS Area Managers from the SBSE Taxpayer Education and Communication office contact local tax professionals for ideas and suggestions. The OTBR interacts with the Industry Issue Resolution (IIR) program, which conducts reviews biannually, with March 31 and August 31 submission deadlines. (Detailed information about the IIR program can be found in Rev. Proc. 2003-36.) As part of the burden-reduction program, the IRS is developing a new burden measurement. According to Mr. Chesman, the previous method did not allow for any what ifs. For example, if a line was added to a form, the burden was attributed to all taxpayers, not just to those required to complete that line. The new method will be very elastic and include the what ifs. For example, adding an additional three lines on a form could reduce a taxpayers burden, if it eliminates another form or worksheet.
Success Stories Tom Copeland, the Director of the Redleaf National Institute, a division of Resources for Child Caring, submitted four ideas to the IIR program. One, which provided recordkeeping and other relief for home childcare providers who deduct food fed to their charges, was selected. As a result, a safe harbor was provided. Mr. Copelands comments on the process were extremely positivethe IRS was accessible and easy to work with and took action within a few months. As to the IRS, it feels that the safe harbor will save family childcare providers approximately 10 million hours of recordkeeping; see Rev. Proc. 2003-22. A few of the other successful projects, according to Mr. Chesman, have been, for example, an increase in the Form 1040, Schedule B, threshold; elimination of Form 1120, Schedules L, M1 and M2 for small businesses; and allowance of the standard mileage rate for four cars instead of one. In 2005, the IRS plans a complete redesign of Form 941, Employers Quarterly Federal Tax Return, and Schedules K-1. Other burden-reducing ideas in the discussion stage are (1) simplifying the 1011 various extension forms with different due dates and automatic extensions; (2) annualizing Form 941 for certain taxpayers; redesigning Form 940, Employers Federal Unemployment (FUTA) Tax Return; and simplifying Form 1040.
How to Participate Mr. Chesman wants to (1) hear from the tax professional community and (2) develop a substantial inventory of constructive proposals. Tax advisers with ideas should complete Form 13285A or send a letter to:
They can also e-mail a proposal to sbse.otpbr@irs.gov. A proposal sent by U.S. mail or an e-mail should answer the four questions posed on Form 13285A (see above). Form 13285A is available on the IRSs website at www.irs.gov/pub/irs-pdf/f13285a.pdf. From Ruth Ann Michnay, CPA, MBT, EA, Ruth Ann Michnay, P.A., St. Paul, MN
In December 2003, the IRS implemented significant changes to its individual tax identification number (ITIN) program; see Olmstead, Tax Practice & Procedures, ITIN Application Changes, TTA, April 2004, and Laffie, News Notes, ITIN Program Revisions, TTA, February 2004.
Reasons for Change According to IRS Commissioner Mark Everson, about 25% of the 7 million ITINs issued since 1996 have never actually appeared on a tax return. Further, a General Accounting Office (GAO) study (GAO-04-529T), Individual Taxpayers Identification Numbers Can Be Improperly Obtained and Used (3/10/04), concluded that the IRS remains limited in its ability to verify applicants identities. The report provides an example of GAO staff obtaining an ITIN, prior to December 2003, by submitting bogus documents through the mail and using the number to open a bank account and obtain an ATM card. At a March 11, 2004, hearing before the House Oversight Subcommittee, written testimony by the Treasury Inspector General for Tax Administration reported that ITIN issuance is rising sharply, with a 36% increase between 2001 and 2002; it suggested that the current problems surrounding ITINs are likely to get worse.
Exceptions to ITIN Procedures In general, taxpayers requesting an ITIN expressly to comply with income tax filing obligations must file a completed Federal return with Form W-7, Application for IRS Individual Taxpayer Identification Number. However, this requirement has four exceptions. Exception 1: Passive incometreaty benefits or third-party withholding. To obtain an ITIN under this exception, a taxpayer must include documentation with the Form W-7 showing ownership of the asset that generates income subject to information reporting or withholding requirements. For example, a holder of financial accounts would provide evidence of opening an account and having an ownership interest in the account. Exception 2: Other income (wages, salary and compensation)treaty benefits or foreign student receiving scholarship or fellowship. Exception 3: Third party reportingmortgage interest. To obtain an ITIN under this exception, a taxpayer must include documentation with Form W-7, showing evidence of a home mortgage loan, such as a loan commitment letter or a brokers listing agreement. Exception 4: Disposition by foreign person of U.S. real property interest. An ITIN may be required by foreign persons, to apply for a withholding certificate to reduce or eliminate withholding on a disposition of U.S. real property. An ITIN is obtained in this case by including a completed Form 8288-B, Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests, and a copy of the sales contract, with Form W-7. Taxpayers can obtain more information about ITINs in IRS Pub. 1915, Understanding your IRS Individual Taxpayer Identification Number ITIN, issued Feb. 27, 2004.
ITIN Comment Period The IRS accepted ITIN comments through June 15, 2004 and was particularly interested in comments on the following: 1. How can Form W-7 and its instructions be simplified or clarified? 2. Should the four exceptions (discussed above) to the requirement of attaching a completed return to Form W-7 be modified? Are additional exceptions needed? 3. What steps, if any, should the Service consider to improve the acceptance agent program, under which ITIN applicants may submit a Form W-7 with supporting documentation, to an acceptance agent for review and submission to the Service?
Additional Questions In the authors experience, the IRS also needs to address the following questions:
The ITIN program is certainly in a state of transition as the IRS tries to balance tax administration goals, taxpayer privacy rights and homeland security issues. The ITIN program is likely to undergo additional changes after the IRS evaluates the public comments on the new procedures. From Christine C. Bauman, Ph.D., CPA, Director of the Low Income Taxpayer Clinic, University of WisconsinMilwaukee, Milwaukee, WI
The Downsized EITC Certification Pilot Program In 2003, the IRS announced plans to undertake an earned income tax credit (EITC) certification program, targeting nearly 45,000 taxpayers in 2003 and 2 million in 2004; see Bauman, Tax Practice & Procedures, EIC Verification Initiatives, TTA, July 2003. However, in August 2003, the IRS announced (IR 2003-97) that it would downsize and revise its original EITC precertification program. As a result, it: 1. Delayed the programs launch date to the 2004 filing season, sending out audit notices during the last two weeks of December 2003. 2. Reduced the pilot sample size of high-risk taxpayers from 45,000 to 25,000 for the 2004 filing season. According to the Service, the reduced sample size was adequate to perform statistical analysis and provide an accurate assessment of the programs future course. 3 Agreed to direct additional resources to EITC outreach efforts. 4. Changed its view of the project from a precertification program to a test pilot, agreeing to seek outside expertise to validate sample selection and data. Although it remains unclear how the pilots success will be measured, the IRS stated that it will carefully assess the pilots results and performance before deciding on how to proceed with the program. 5. Introduced a revised Form 8836, Qualifying Children Residency Statement, to conduct the pilot certification. Form 8836 is required to be filed with the taxpayers 2003 tax return, but cannot be filed electronically. The EITC portion of the taxpayers refund is held pending review and acceptance of the taxpayers supporting documentation of child residency.
Preliminary Findings As of May 5, 2004, the IRS revealed that:
Processing Procedure For taxpayers who participated in the certification pilot program for the 2004 filing season, the Service will not send a balance-due notice until the entire verification process is completed and all deficiency procedures are followed. If a taxpayer does not agree with the IRSs decision, he or she can exercise appeal rights. In addition, by calling (800) 294-2723, taxpayers or tax advisers can speak to an IRS assistor in the EITC certification pilot, who can discuss the Services decision on the taxpayers EITC claim and residency documentation. From Christine C. Bauman, Ph.D., CPA, Faculty Director of the Low Income Taxpayer Clinic, University of WisconsinMilwaukee, Milwaukee, WI |
