Daily Tax Update - June 28, 2011: Senate Finance Hearing Examines Ways to Simplify Code and Reduce Tax Gap

SENATE FINANCE TAX REFORM HEARING EXAMINES WAYS TO SIMPLIFY TAX CODE TO INCREASE COMPLIANCE, REDUCE TAX GAP: Today, the Senate Finance Committee continued its series of hearings on tax reform with a discussion of options to increase tax compliance and reduce the federal tax gap – the estimated $345 billion in owed taxes that go unpaid each year.  The hearing was titled "Complexity and the Tax Gap: Making Tax Compliance Easier and Collecting What’s Due".

  • In his opening remarks, Senate Finance Chairman Baucus (D-MT) said,
    "In today's tax code, the majority is carrying a heavy burden.  It's a burden of hundreds of billions of dollars in taxes that are owed but not paid.  It's a burden that prevents us from building new schools or investing in cutting-edge scientific research.  It's a burden that keeps us from paying off the debts we owe and reducing our deficits." Baucus added, "Part of the tax gap is the result of tax cheats who simply refuse to comply with the law, which increases burdens on the rest of us.  But a portion is due to taxpayer confusion and unintentional errors as well.  We can certainly all agree that the tax code is extremely complex.  According to IRS data, US taxpayers and businesses spend more than six billion hours each year complying with the filing requirements of the Internal Revenue Code.  As the Taxpayer Advocate’s 2010 annual report points out, if the hours Americans spent on tax compliance were instead spent on an industry, it would be one of the largest in the United States.  Six billion hours is equal to the work of more than three million full-time employees. Today’s hearing will focus on the issues of tax complexity and the tax gap, as well as the correlation between them."
  • Ranking Member Hatch (R-UT) stated that "Year after year, the tax code becomes more complex. This has contributed to two separate, but related, problems. First, the complexity of the code undercuts compliance. Complying with the tax code should not be a Choose Your Own Adventure story, where the complexity of the code leaves citizens guessing their tax liability. The second issue, one related to the Code’s complexity, is the tax gap...  The tax gap is the great white whale of deficit reduction. If only the government was able to collect what it is owed, our deficits would be reduced significantly."  Mr. Hatch concluded that "The ever-increasing complexity of the tax code, which is only heightened by the temporary nature of many provisions, needs to be improved upon in tax reform. We need a tax system with a more streamlined set of permanent provisions that is easier to comply with and less complex."
  • Witnesses at the hearing were:
    • Mr. Michael Brostek, Director, Tax Policy and Administration, Strategic Issues, United States Government Accountability Office
    • Ms. Nina E. Olson, National Taxpayer Advocate, Internal Revenue Service
    • Mr. David Kirkham, President, Kirkham Motor Sports
    • Ms. Kris Carpenter, Founder and CEO, Sanctuary Spa and Salon
    • Mr. Brostek discussed a new GAO report prepared for the hearing. The report concluded, "Tax expenditures add to tax code complexity in part because they require taxpayers to learn about, determine their eligibility for, and choose between tax expenditures that have similar purposes. Tax expenditures also complicate tax planning, as taxpayers must predict their own future circumstances as well as future tax rules to make the best choice among provisions. Taxpayer errors contribute to the tax gap. For example, in 2001 taxpayers underreported $6.3 billion in net income due to misreported Individual Retirement Arrangement (IRA) distributions. But taxpayers also may underclaim benefits to which they are entitled...  No single approach is likely to fully and cost-effectively address the tax gap, but several strategies could improve taxpayer compliance. These strategies could require actions by Congress or IRS. For example, Congress can simplify the tax code by eliminating some tax expenditures and by making definitions more consistent across the tax code. IRS and Congress could take steps to enhance information reporting by third parties or expand compliance checking before refunds are issued."
    • Ms. Olson testified, "Complexity promotes tax noncompliance both by increasing opportunities for inadvertent error and by creating loopholes, which may allow well-advised taxpayers to pay less than similarly situated taxpayers who are not so well advised. These loopholes also create a perception that the tax system is not fair, a view that may be used to justify 'fudging' a bit here and there to even things out. Complexity also makes compliance more difficult for the vast majority of taxpayers who are trying to comply and increases the risk that they will be subject to penalties or other automated processes, such as unjustified math error assessments, automated lien filings, and similar procedures that may burden and alienate them. The IRS Collection function’s longstanding approach of first ignoring delinquencies and then applying complicated and unrealistic financial analyses may also alienate taxpayers who have delinquencies but would like to comply. The limited research available supports what common sense would seem to suggest - namely, that penalizing, burdening and alienating taxpayers who have reasonably tried to comply is not only bad for the tax system but is also likely reduce the public’s willingness to comply rather than increase it, potentially increasing the tax gap."  Olson added, "Tax simplification could go a long way toward improving compliance and reducing the tax gap. Ideally, I believe Congress should simplify the tax code through broad-based tax reform, but if comprehensive reform is not imminent, I urge Congress to enact some of the many narrower simplification recommendations we have proposed over the years, many of which I have summarized in this statement. In addition, I believe we should generally avoid adopting enforcement procedures and penalties that alienate and burden taxpayers. If the goal of such procedures and penalties is to reduce the tax gap, we should only adopt them if objective data and research suggest that they will, indeed, achieve that goal."
    • Mr. Kirkham said, "Our complex tax system creates a very large burden on small businesses in terms of the time and money that it takes to comply with the tax laws.  To deal with the tax laws, our small business has to hire a bookkeeper, an accountant, and a professional accounting firm that has both lawyers and accountants.  If the tax system were simpler, we would be able to hire more workers with the money we currently use to pay lawyers and accountants.  The constantly changing tax laws present an ever-moving target for small business owners.  For example, no one has any idea what the tax rate will be from one year to the next.  This makes long-term planning extremely difficult.  For example, provisions in the code, such as the one on expensing of equipment, are changed frequently--dictating to small businesses when they should buy equipment.  In some years it is more advantageous to hire more workers.  In other years it is more advantageous to purchase more equipment because the business can write off the entire cost of that equipment in some years and not in others.  Our business decisions should be made based on what will cause our business to grow and create a better world for everyone and not on some tax law that has recently been changed."  Regarding the tax gap, Kirkham said, "If you want people to comply with the tax laws, they need to be easy and fair to comply with.  If you want more revenue, I would suggest you follow the Wal-Mart model and try to gain as many customers as possible by broadening the tax base and making compliance easy so everyone has a stake in our system of government.  Finally, when you choose winners, we all become losers.  History teaches us cronyism, confusion, and chaos creates recessions and depressions.  Freedom creates prosperity.  Let us be free to choose our own path in life and to create our own prosperity.  Then, and only then, will you see the unemployment rates plummet, the tax gap shrink, and the recession finally end."
    • Ms. Carpenter presented the views of a small business owner and expressed support for Senator Snowe’s bill, S. 974 (the Small Business Tax Equalization and Compliance Act), which would expand the credit for FICA taxes paid on tips to salons. Ms. Carpenter stated that "the tip-reporting burden is greatest on small business owners and compliance efforts need to be approached with these dynamics in mind."
    • For additional information, contact Philip R. West - pwest@steptoe.com or Amanda Varma - avarma@steptoe.com
    • Testimony can be accessed here:

MISCELLANEOUS GUIDANCE RELEASED TODAY:
Revenue Procedure 2011-38 modifies and supersedes the guidance concerning the treatment under sections 1035 and 72 of the partial exchange of an annuity contract.  Specifically, the revenue procedure provides that the direct transfer of a portion of the cash surrender value of an existing annuity contract for a second annuity contract will be treated as a tax-free exchange under section 1035 if no amount, other than an amount received as an annuity for a period of 10 years or more or during one or more lives, is received during the 180 days beginning on the date of the transfer.  A subsequent direct transfer is not taken into account.  Other transactions will be characterized consistent with their substance.  Prior to this revenue procedure's effective date, Rev. Proc. 2008-24 will be applied with the clarification that the conditions described in section 4.01(b) or Rev. Proc. 2008-24 will be treated as satisfied if the condition was satisfied on the date of the withdrawal or surrender.

TAX BILLS INTRODUCED JUNE 24TH:

1. [112nd] H.R.2353 : To amend the Internal Revenue Code of 1986 to extend and increase the exclusion for benefits provided to volunteer firefighters and emergency medical responders.
Sponsor: Rep Larson, John B. [CT-1] (introduced 6/24/2011)   Cosponsors (3) Committees: House Ways and Means
Latest Major Action: 6/24/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

2. [112nd] H.R.2382 : To amend the Internal Revenue Code of 1986 to provide for the logical flow of return information between partnerships, corporations, trusts, estates, and individuals to better enable each party to submit timely, accurate returns and reduce the need for extended and amended returns, to provide for modified due dates by regulation, and to conform the automatic corporate extension period to longstanding regulatory rule.
Sponsor: Rep Jenkins, Lynn [KS-2] (introduced 6/24/2011)   Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 6/24/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

3. [112nd] H.R.2385 : To amend the Internal Revenue Code of 1986 to allow seniors a one-time, tax-free retirement plan distribution to pay for essential repairs to a principal residence, for medical expenses, or for expenses attributable to a Federally declared disaster.
Sponsor: Rep Jones, Walter B., Jr. [NC-3] (introduced 6/24/2011)   Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 6/24/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

4. [112nd] H.R.2391 : To amend the Internal Revenue Code of 1986 to provide a renewable electricity integration credit.
Sponsor: Rep Paulsen, Erik [MN-3] (introduced 6/24/2011)   Cosponsors (1) Committees: House Ways and Means; House Energy and Commerce
Latest Major Action: 6/24/2011 Referred to House committee. Status: Referred to the Committee on Ways and Means, and in addition to the Committee on Energy and Commerce, for a period to be subsequently determined by the Speaker, in each case for consideration of such provisions as fall within the jurisdiction of the committee concerned.

5. [112nd] H.R.2394 : To amend the Internal Revenue Code to extend qualified school construction bonds and qualified zone academy bonds, to treat qualified zone academy bonds as specified tax credit bonds, and to modify the private business contribution requirement for qualified zone academy bonds.
Sponsor: Rep Rangel, Charles B. [NY-15] (introduced 6/24/2011)   Cosponsors (1)
Committees: House Ways and Means
Latest Major Action: 6/24/2011 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

STEPTOE & JOHNSON LLP - TAX PRACTICE
Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving. Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them. Read more information on Steptoe's tax practice.