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NewsNotes

JCT Penalty Study * Offers in Compromise

Lesli S. Laffie, J.D., LL.M.

Miscellaneous

JCT Penalty Study

In accordance with provisions of the Internal Revenue Service Restructuring and Reform Act of 1998, on July 22, 1999 the Joint Committee on Taxation (JCT) submitted a penalty and interest study to the House Ways and Means Committee and the Senate Finance Committee. The JCT staff recommends the following actions:

Provide one interest rate for both individual and corporate taxpayers; the applicable Federal rate, plus 5%, would apply to both underpayments and overpayments.

Exclude interest paid by the IRS from the income of individual taxpayers.

Convert the current penalty for failure to pay estimated tax into an interest provision.

Increase the threshold at which taxpayers are subject to an interest charge for underpayment of estimated tax from $1,000 to $2,000 and allow both tax withheld and certain estimated tax paid throughout the year to be considered in determining whether the threshold has been met.

Repeal the current penalty for failure to pay tax. If a taxpayer has not entered into an installment agreement with the IRS by the fourth month after assessment, an annual 5% service charge would apply. For taxpayers who agree to an automated withdrawal of each installment payment directly from their bank account, the current $43 fee on installment agreements would be waived.

Allow abatement of interest if gross injustice would otherwise result.

Expand the circumstances under which interest may be abated to include periods attributable to any unreasonable IRS error or delay.

Allow abatement of interest if the taxpayer is repaying an erroneous refund based on IRS calculations.

Allow abatement of interest to the extent interest is attributable to the taxpayer's reliance on IRS written statements.

Allow taxpayers to deposit amounts in a "dispute reserve account," a special interest-bearing account within Treasury, that would stop the running of interest on tax underpayments and allow taxpayers to earn interest generally to the extent that a deposit is not applied to an underpayment.

Repeal the modified safe harbor that applies to individuals with adjusted gross income in the preceding tax year in excess of $150,000. All taxpayers would be subject to the same safe harbor, which would require that estimated payments be made based on either 90% of current-year's tax or 100% of prior-year's tax.

Provide only one interest rate per underpayment period.

Change the definition of "underpayment" to allow existing underpayment balances to be used in underpayment calculations for succeeding estimated tax payment periods.

Require taxpayers to use a 365-day year for all estimated tax underpayment calculations, regardless of whether the tax year is a leap year.

Raise the minimum standards for undisclosed positions for both taxpayers and tax preparers such that, for each undisclosed position on a return, the taxpayer or preparer must reasonably believe that the tax treatment is "more likely than not" the correct tax treatment under the Code.

Raise the minimum standards for disclosed positions for both taxpayers and preparers such that, for each disclosed position on a tax return, there must be at least substantial authority.

Change the preparer penalty from $250 per occurrence to the greater of $250 or 50% of the preparer's fee for first-tier violations (i.e., use of a return position that does not meet the above-described recommended minimum preparer standards); change the preparer penalty from $1,000 per occurrence to the greater of $1,000 or 100% of the preparer's fee for second-tier violations (i.e., understatements stemming from willful or reckless disregard of rules or regulations).

Apply a higher standard of behavior to IRS conduct, similar to that which would be imposed on practitioners by the JCT recommendations made elsewhere in the study.

Require the IRS to publish annually statistics on the number of payments made and the total amount paid out under Sec. 7430 for taxpayers' reasonable administrative and litigation costs, as well as a summary of the administrative issues raised as to these payments and how these issues were resolved by the IRS.

Require the IRS to improve the supervisory review of the imposition of penalties (as well as their abatement), to provide greater uniformity in penalty and interest administration and application.

Require the IRS to develop information systems to provide better statistical information on abatements and the reasons and criteria therefor.

Require the IRS to shorten significantly the current 45-day processing time for address changes.

Require the IRS to establish administrative systems that assure that the taxpayer's proper representative receives the proper notice directly from the IRS.

Require the IRS to consider whether recent technological ad-vances (e.g., e-mail and fax) permit use of alternative means of communicating with taxpayers.

The study also contains pension, trust and corporate tax shelter provisions and is available on the Web at www.house.gov/jct.

Regulations

Offers in Compromise

According to IR-99-64, temporary and proposed regulations (TD 8829, NPRM REG-116991-98, 7/19/99) reflect changes made to the offer in compromise program by the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98). Sec. 7122(c), as amended by IRSRRA '98 Section 3462(a), requires that the IRS develop guidelines for determining when a compromise offer is adequate and should be accepted to resolve a dispute. According to the legislative history, in certain circumstances, factors such as equity, hardship and public policy are to be evaluated in the compromise of individual tax liabilities.

Current Regs. Sec. 301.7122-1 (which is being removed) permitted compromise only on grounds of doubt as to liability, collectibility or both. While Temp. Regs. Sec. 301.7122-1T(b) allows compromise on those bases, it also permits it when either (1) collection would create economic hardship or (2) exceptional circumstances exist such that collection would be detrimental to voluntary compliance. In either case, compromise is allowed only if it will not undermine compliance.

According to Temp. Regs. Sec. 301.7122-1T(b)(4)(B), factors supporting a determination of economic hardship include:

The taxpayer is incapable of earning a living because of a long-term illness, medical condition or disability, and it is reasonably foreseeable that his financial resources will be exhausted in providing his care and support.

Liquidation of the taxpayer's assets to pay outstanding tax liabilities would render him unable to meet basic living expenses.

The taxpayer is unable to borrow against the equity in his assets and disposition by seizure or sale would have sufficient adverse consequences such that enforced collection is unlikely.

Under Temp. Regs. Sec. 301.7122-1T(b)(4)(C), factors supporting a determination that compromise would not undermine compliance include:

The taxpayer does not have a history of noncompliance with the Code's filing and payment requirements.

The taxpayer has not taken deliberate actions to avoid payment of taxes.

The taxpayer has not encouraged others to refuse to comply with the tax laws.

Temp. Regs. Sec. 301.7122-1T(b) (4)(D) and (E) contain numerous examples explaining the types of cases that can be compromised under the new rules. Temp. Regs. Sec. 301.7122-1T(j) states that the regulations are effective for compromises submitted after July 18, 1999.