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Annette Nellen
Annette Nellen
Remembering Forgotten Tax Issues

With so many issues in our tax system, itís easy for some to get lost.

January 29, 2009
by Annette Nellen, CPA/Esq.

With numerous tax reduction provisions expiring at the end of 2010, a broken AMT (Alternative Minimum Tax) system, tax shelter concerns, a desire to modify rules that make it tough for U.S. firms to compete globally and a nagging tax gap, the upcoming tax agenda could be one of major reform. If that happens, it is important for a comprehensive review of the current system similar to the one that occurred prior to the enactment of the Tax Reform Act of 1986.

This comprehensive review should include revitalizing some key design and compliance issues that seem to have fallen by the wayside in recent years despite significant study of them in the past. This article describes some of these tax issues that need revitalization and reconsideration because of their significance today. These forgotten tax matters include depreciation, corporate integration, worker classification and the penalty system. The last two have received some attention recently, but more is needed.

Studies

There seems to be no shortage of government studies of our federal tax system. It is not uncommon for tax legislation to include provisions that call upon the Treasury, Joint Committee on Taxation (JCT), Government Accountability Office (GAO) or even the National Academy of Sciences, to prepare a report on some aspect of the tax system. In 2001, the GAO reported that between January 1, 1986 and March 21, 2001, Treasury and IRS had 87 tax studies to provide to Congress (GAO-01-301R).

These studies tend to be detailed and comprehensive, but often ignored. The topics noted in this article are no exception.

Depreciation

Depreciation rules are relevant to discussions on changing our business tax system to a consumption tax, improving competitiveness and promoting investment. It is an area that warrants thoughtful consideration in any tax reform discussion.

The Tax and Trade Relief Extension Act of 1998 (PL 105-277) called upon Treasury to prepare a comprehensive report on depreciation rules and possible improvements. “Congress was concerned that the present depreciation rules may measure income improperly, thereby creating competitive disadvantages and an inefficient allocation of investment capital.” (Treasury, Depreciation Recovery Periods and Methods (PDF), July 2000)

The report explains depreciation theories and notes several problem areas of the existing rules including the outdated system for determining depreciable lives.

Integration

Integration of the corporate and individual systems to eliminate double taxation and the economic distortions it causes has been discussed for decades. Several government reports exist on ways to integrate the systems, including:

The AICPA has also studied corporate integration. In 1975, it released a tax policy statement — Elimination of the Double Tax on Dividends. The report was updated in 1993 (The Tax Adviser, February 1993).

With the upcoming expiration of the lower rate on dividends, President Obamaís plan to increase the capital gains rate, a desire to lower the corporate tax rate, international competitiveness concerns and a few proposals to tax all businesses similarly (such as the USA Tax (H.R. 4159; 110th Congress)), corporate integration needs to be an active part of the current tax reform agenda.

Worker Classification

Effective guidance for distinguishing between employees and independent contractors has been on hold since the Revenue Act of 1978 placed a prohibition on the issuance of regulations and revenue rulings (“Section 530” (PDF) of the Act).

The GAO has issued numerous reports over the past three decades on the problems of worker classification and how to make the rules clearer. Most recently, the National Taxpayer Advocate’s 2008 report to Congress included legislative recommendations on improving worker classification rules (PDF). In addition, a congressional hearing was held in May 2007 and the JCT (Joint Committee on Taxation) prepared a background report (JCX-26-07 (PDF)). In 2007, the IRS issued a new Form 8919 (PDF), Uncollected Social Security and Medicare Tax on Wages. This form does not fix the classification problem though, it just helps the IRS identify potential classification errors (Worker Classification — Is Congress Ready to Take Action?).

In recent years there have been hearings and reports on healthcare and retirement plans. Any reforms in these areas must consider worker classification. In contrast to a single hearing on worker classification in the 110th Congress, there were over 10 dealing with healthcare and retirement savings.

Penalties

The 1984 Treasury report, Tax Reform for Fairness, Simplicity and Economic Growth (November 1984), included a chapter on simplifying penalties. At that time, Treasury reported that there were more than 75 civil tax penalty provisions (Chapter 20 (PDF)). Treasury offered the following reasons for improving the penalty structure:

“The penalty provisions under existing law are overly complex and often result in inconsistent treatment of similar violations. Penalties have been added piecemeal to the Code as new filing and reporting requirements have been legislated. The inconsistencies in the present penalty structure undermine horizontal equity among taxpayers and make the penalty provisions difficult to understand and administer.” (PDF)

In 1989, an IRS Task Force issued a report on civil tax penalties. In 1999, Treasury issued Report to the Congress on the Interest and Penalty Provisions of the Internal Revenue Code (PDF), mandated for simplification purposes by the IRS Restructuring and Reform Act of 1998 (PL 105-206). The Act also mandated a similar report from the JCT (JCS-3-99 (PDF)). The JCT report includes an analysis of penalty structures in other countries. A hearing was held on the reports in November 1999 (JCX-79-99 (PDF)).

The 2008 National Taxpayer Advocate report to Congress includes a section on reforming the penalty regime. Per this report, there are now over 130 civil penalties (PDF).

There are several reasons justifying greater attention to the penalty system today, including the following:

  • Subsequent to the 1998 Act, additional information reporting rules (such as IRC §6050W, Returns Relating to Payments Made in Settlement of Payment Card and Third-Party Network Transactions) have been enacted and numerous new deductions and credits have increased the complexity of the law. These changes increase the potential for mistakes and thus, the imposition of penalties, raising issues of fairness.
  • Penalties should help improve voluntary compliance. Continued work on reducing the tax gap should include consideration of whether existing penalties are designed well enough to ensure compliance.
  • A 2007 GAO report (GAO-07-1062) observed that adjusting penalties for inflation should improve their effectiveness and increase revenue.

Conclusion

The four issues noted in this article are by no means the only well-studied issues that seem to have fallen by the wayside. Others include simplification and return-free filing.

With so many report mandates, it is easy to forget about the reports as time passes and new issues arise. One technique for ensuring better attention to the reports is to require not only a due date for the drafters, but also a specified date for a congressional hearing on the report. Another technique is for practitioners and taxpayers to help Congress remember.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.