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Annette Nellen
Interesting Reports of 2009

If your schedule doesn’t permit time for reading government reports about taxes, what might you have missed in 2009?

December 10, 2009
by Annette Nellen, CPA/Esq.

Every year, many reports on various aspects of the tax system are issued by government agencies. Some eventually lead to changes in tax laws and administrative practices. This article presents highlights from a sampling of reports issued in 2009.

First-time Homebuyer Credit

Both the Government Accountability Office (GAO) and Treasury Inspector General for Tax Administration (TIGTA) issued reports on the first-time homebuyer credit (IRC §36), added to the law in 2008.

In First-Time Homebuyer Tax Credit: Taxpayers' Use of the Credit and Implementation and Compliance  Challenges (October 2009), the GAO notes that as of August 22, 2009, over 1.4 million individuals claimed about $10 billion of credits for purchases in both 2008 and 2009. About 74 percent of those claiming the credit had an adjusted gross income (AGI) of between $25,000 and $100,000 — a group that comprises about 46 percent of taxpayers. The majority of all claims are expected to be filed in 2010.

As of August 22, 2009, Nevada had the highest credit usage at 0.00776 claims-per-capita, compared with 0.00249 in Hawaii, the state with the lowest usage.

Among administrative challenges noted for the Internal Revenue Service (IRS) was that audits and collection of improperly claimed credits is labor-intensive and difficult. These challenges led the IRS to implement a pre-refund procedure, which as of September 30, 2009, led to the IRS freezing 110,000 refunds pending examination, identifying 167 “criminal schemes” and initiating criminal investigations on 115 claims.

TIGTA’s report (October 2009) highlighted abuses and blamed the IRS for not providing better controls. Per TIGTA: “19,351 taxpayers claimed $139.4 million in credits for homes they had not yet purchased but would allegedly purchase in the future. In addition, 70,005 taxpayers claimed more than $479 million in credits, despite indications that they were not first-time homebuyers. TIGTA also identified 582 taxpayers under-18 years of age who claimed almost $4 million in First-Time Homebuyer Credits. The youngest taxpayers receiving the Credit were four-years old.”

Home Mortgage Deduction

A GAO report, Home Mortgage Interest Deduction: Despite Challenges Presented by Complex Tax Rules, IRS Could Enhance Enforcement and Guidance (July 2009), describes compliance issues and data on the mortgage interest deduction. Highlights:

  • Approximately 20 percent of owner-occupied homes with a mortgage have home equity debt, totaling about $1 trillion in aggregate.
  • In 2006, 85 percent of homeowners who refinanced home debt increased the balance to obtain cash.
  • In 2006, about 39 million returns reported mortgage interest from Form 1098, Mortgage Interest Statement, with an average deduction of $11,200.
  • The home mortgage interest deduction is the third largest tax expenditure in the tax law with an $80 billion price tag in 2009.
  • Compliance issues stem from complexity of the home mortgage interest rules, inconsistent interpretations of the limits between the IRS and the Tax Court and ineffectiveness of Form 1098. Problems include deducting interest beyond the debt limits, not knowing how to determine how much home equity interest is deductible and deducting home equity interest in calculating alternative minimum tax (AMT).

The GAO suggested several changes including a checkbox on the tax return for debts in excess of the $1 million and $100,000 amounts, requiring issuers of Form 1098 to include the property address and debt balance and sending educational information to individuals who may be subject to the limitations.

An alarming highlight in a TIGTA report, Mortgage Interest Data Could Be Used to Pursue More Nonfilers and Underreporters (August 2009), was that a good number of individuals receiving a Form 1098 are non-filers or reporting less income than would support the mortgage interest amount. TIGTA estimates that roughly 136,000 taxpayers likely owe about $1.4 billion and recommended that the IRS make better use of Form 1098 in finding non-compliance.

A CBO report, An Overview of Federal Support for Housing (November 2009) explains the types of federal spending and tax expenditures devoted to home ownership and rental affordability. Highlights include:

Home Ownership Rental Affordability
  2009 (billions)
Tax expenditures $130 $10*
Federal spending $100 $40
Total $230 $50

(* low-income housing credit, accelerated depreciation)

In 2007, 30 percent of homeowners and 45 percent of renters devoted over 30 percent of their income to housing. In 2004, 68 percent of households owned their home.

Charitable Contributions

In Reporting for Charitable Cash Contributions May Not Be an Effective Way to Improve Compliance (May 2009), the GAO explored whether information reporting would reduce the tax gap stemming from charitable contributions.

For 2001, an estimated 46 percent of individuals claiming a cash charitable contribution deduction misreported the amount. In this group, about 79 percent overstated their donations and 21 percent understated the amount. Overstatements tend to stem from inadequate substantiation, giving cash to non-qualified organizations and deducting payments where the payor received a benefit from the payee. Error rates were about the same for self-prepared returns as for those completed by paid preparers.

GAO found that requiring charities to file information returns would be costly and could reduce contributions if individuals do not want the government to know where they donated money or for a charity’s volunteers to have access to sensitive information. Costs would include employing techniques to protect sensitive donor information, particularly Social Security numbers. Any de minimis exemption for information reporting would diminish the effect of the reporting. GAO also noted that it is not yet known if the stricter requirements for charitable contribution deductions added by the Pension Protection Act of 2006 (P.L. 109-280) will improve compliance.

TIGTA also studied compliance issues in Taxpayers Claiming Unsubstantiated Vehicle Donations Avoid Paying Millions in Taxes (October 09). TIGTA found that for 2007, approximately 92,000 taxpayers claimed donations for vehicles that were not properly substantiated. Consequently, about two-thirds of these taxpayers may have avoided about $17 million of taxes. TIGTA also found that “in a significant number of cases,” charities had not filed Form 1098-C, Contributions of Motor Vehicles, Boats and Airplanes, which is required when the vehicle has a claimed value in excess of $500.

TIGTA recommended that the IRS improve matching for Form 1098-C, process problem returns using math error authority and outreach to charities to ensure better compliance.

Education Credits

A TIGTA report, Taxpayers Erroneously Claim Education Tax Credits, found significant compliance problems with the Hope Credit (IRC §25A). Problems found due to claiming the Hope credit beyond the first two years of college:

2006 2007
# claiming for three years 203,000 169,000
$ claimed erroneously $300 million $232 million

TIGTA also found that over 58,000 of the taxpayers improperly claiming the credit for the third year of college in 2006 continued the error for a fourth year, resulting in total improper claims aggregating almost $80 million for 2007.

Problem areas noted:

  • Lack of math error authority for the IRS to immediately disallow an improper claim.
  • Difficulty in identifying erroneous claims.
  • The ability of educational institutions to report either amount paid or amount billed (IRC §6050S). About 80 percent of reporting forms only show the amount billed.
  • “[T]he IRS does not use Form 1098-T in its Automated Underreporter (AUR) matching program and does not accept Form 1098-T as proof of educational expenses when a taxpayer’s return is audited. As a result, educational institutions are needlessly expending approximately 5.1 million hours each year to complete Forms 1098-T and an estimated $3.8 million to mail the Forms to students.”

Making Work Pay Credit

In Millions of Taxpayers Could Owe Taxes As a Result of Making Work Pay Credit (November 2009), TIGTA states that 15.4 million individuals (about 10 percent of taxpayers) likely had 2009 withholding adjusted for the MWPC by too much due to such reasons as having more than one job, having joint income greater than the eligibility levels or being a dependent. This figure includes about 6.3 million individuals receiving pensions who were adversely affected due to use of withholding tables that reflected the MWPC. TIGTA estimates that 1.2 million of the individuals will be negatively affected by estimated tax penalties aggregating $24.5 million. The IRS observed that these individuals may be able to seek a penalty waiver and will note that on form instructions.

Collegiate Sports

A CBO report, Tax Preferences for Collegiate Sports (May 2009), was prepared at the request of the Ranking Member of the Senate Finance Committee to provide background on whether, due to commercialization, such activities should not enjoy the same tax preferences as schools. CBO discussed policy options of limiting charitable contributions, limiting use of tax-exempt bonds and taxing all or a portion of college sports income. No recommendations were made in the report.  

Clean Water Taxation

The GAO released a report on various options for generating $10 billion annually to establish a clean water trust fund. In Design Issues and Funding Options for a Clean Water Trust Fund (July 2009), GAO identified the following possible sources which could be used separately or in some combination:

  • An excise tax on one or more items that affect wastewater, such as “beverages, fertilizers and pesticides, flushable products, pharmaceuticals and water appliances and plumbing fixtures.”
  • An excise tax on water usage.
  • An industrial discharge tax.
  • An additional tax on corporations similar to the Corporate Environmental Income Tax that was previously used for the Superfund program.

Conclusion

The reports summarized above highlight a variety of tax compliance problems, flaws in the tax law and possible law and policy changes. Congress has already responded to some of the reports, such as through hearings or law changes. For example, in extending the first-time homebuyer credit, the Worker, Homeownership and Business Assistance Act of 2009 (PL 111-92; 11/6/09) added an age limit and requires claimants to attach their closing statement to their return.

Topics noted above will continue to garner attention and we’ll likely see some new topics in 2010 reports.

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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.