by Roger Russell

The Bush administration’s fiscal year 2005 budget contains legislative proposals aimed at closing numerous loopholes, curbing several abusive tax avoidance transactions, streamlining Internal Revenue Service procedure and simplifying the tax code.

“Curbing the use of abusive tax avoidance transactions by corporations and individuals is our top enforcement priority,” said IRS Commissioner Mark W. Everson. “Stiffer penalties for failing to comply with the rules on the promotion of abusive transactions will get the attention of promoters, attorneys, accountants and other advisors.”

The budget includes $300 million for Internal Revenue Service efforts to ensure compliance with the tax laws, and increases the total IRS budget by 4.8 percent — significantly above the average for non-defense, non-home­­­land discretion­ary spending. It continues a three-year trend of increasing resources for the IRS to improve compliance with the tax laws, particularly with respect to abusive tax avoidance transactions.

The compliance and enforcement proposals reintroduce several measures from the Treasury Department’s 2002 wish list, including a proposal to impose penalties on the failure to disclose potentially abusive transactions, and a change in the promoter registration and list-maintenance provisions of the tax code to allow for “uniform and consistent” rules.

The Treasury said that current penalties for nondisclosure by taxpayers and promoters are either “nonexistent or insufficient.” The proposals would impose significant penalties on taxpayers that fail to disclose potentially abusive transactions on a return and on promoters who fail to comply with their registration and list-maintenance requirements.

Since some promoters repeatedly disregard the registration and list-maintenance requirements in the tax code, the proposal would confirm the government’s authority to enjoin the most egregious promoters of abusive tax avoidance transactions, as it is now doing with promoters of tax scams directed primarily at individuals and small businesses.

A provision that may generate some controversy affects the tax practitioner privilege to avoid the disclosure of the identity of taxpayers. Since the delay in disclosure of information about taxpayers who have entered into potentially abusive transactions also may prevent the IRS from examining these transactions before the statute of limitations expires, the administration’s proposal would expand the “corporate tax shelter” exception to the statutory tax practitioner privilege to all “tax shelters.”

It would also confirm that the identity of any person that a promoter is required to identify is not privileged, and would extend the statute of limitations for potentially abusive transactions that a taxpayer fails to disclose on a return until the transaction is disclosed to the IRS by either the taxpayer or the promoter.

“This is something the IRS is frustrated about because they don’t know the identity of a lot of transactions that, if they did know, they would like to audit,” said Murray Saylor, an Atlanta-based CPA and attorney. “They want to put the pressure on the advisors. It’s another way of finding out information by going after the advisors.”

Another area the Treasury hopes to clamp down on is the use by tax promoters of statements made to market a tax “product.” The Treasury said that existing penalties are not enough to deter promoters from making false or fraudulent statements regarding the claimed benefits of an abusive transaction. The proposal would increase the penalty to up to 50 percent of fees earned by the person making or furnishing the false statement in connection with the promotion of an abusive transaction.

The proposals also include measures that would eliminate abusive transactions involving foreign tax credits, stop abusive leasing transactions with “tax-indifferent” parties, and address the tax consequences of changing beneficiaries of a Section 529 college savings plan to avoid transfer taxes.

The IRS crackdown on tax shelters has led to a provision to eliminate abusive transactions involving foreign tax credits, according to Selva Ozelli, a foreign tax expert with RIA, a Thomson business.

“Many tax shelters using tax credits have been used by multinationals during the 1990s,” she said. “Since U.S. taxpayers are taxed on worldwide income, the credit for foreign taxes exists so they are not subject to double taxation of income. While the provisions are meant to help taxpayers eliminate double taxation, some have structured transactions and used the foreign tax credit rules inappropriately to reduce their U.S. tax liability.”

“The Treasury’s latest budget proposal would deny the foreign tax credit for foreign withholding taxes imposed on income if the underlying property generating the income wasn’t held for a specified minimum period of time,” said Ozelli. “There has to be a risk of double taxation for a taxpayer to apply the foreign tax credit rules — what they’re trying to avoid is having taxpayers apply these when there is no risk.”

The administration has two proposals to improve procedures for taxpayers who want to resolve their tax liabilities. The first would permit the IRS to enter into installment agreements that do not guarantee full payment of a liability over the life of the agreement, while the second would make counsel review of accepted offers-in-compromise more efficient without diminishing oversight.

The installment agreement proposal makes good sense, according to Martin Davidoff, tax liaison committee chair of the American Association of Attorney-CPAs.

“If you can pay, say, $500 a month and that’s all you can pay, and the installment agreement would amount to $30,000 but you owe $50,000, the IRS can’t enter into the agreement because it doesn’t account for the full debt,” he said. “This would give flexibility to the IRS to take what they can get, without making the taxpayer take the offer-in-compromise route. It would be a very good piece of legislation.”

Other compliance provisions would:

● Create a new civil penalty on the failure to disclose an interest in a foreign financial account;

● Curb abusive leasing arrangements with “tax-indifferent” parties;

● Prevent the avoidance of U.S. tax on foreign earnings invested in U.S. property;

● Modify the tax rules for individuals who give up U.S. citizenship or green card status to make them easier to enforce;

● Terminate installment agreements when taxpayers fail to file returns or make tax deposits;

● Expand the use of electronic filing;

● Permit private collection agencies to support the IRS’s collection efforts; and,

● Require charitable deductions to accurately reflect the value of the donation, particularly with regard to contributions of patents, intellectual property and motor vehicles.

“We are committed to restoring confidence in the tax system by ending the proliferation of abusive tax avoidance transactions and simplifying the tax code,” said Treasury assistant secretary for tax policy Pam Olson.

“Among the areas for which we propose simplification are the education provisions,” she continued. “You shouldn’t need a college degree to get help with your child’s education, but the education provisions of the tax code are so complex that even tax advisors struggle to understand them. Our legislative proposals would greatly simplify the provisions and make it easier for everyone to get the help they need.”

Other simplification provisions contained in the budget would:

● Simplify the Earned Income Tax Credit;

● Reduce the tax burden on single parents by eliminating the household maintenance test and simply requiring that the taxpayers live with the child;

● Simplify the calculation of the capital gains tax by eliminating various special rates for particular assets, such as small business stock, real estate and collectibles. Instead, 50 percent of the gain on these assets would be taxed at ordinary income tax rates and the remainder at the standard capital gains rate. Special treatment for certain newly issued small business stock would be eliminated;

● Ease requirements for the adoption tax credit and the exclusion for employer-provided adoption expenses;

● Make uniform the various definitions of a qualifying child; and,

● Simplify the taxation of dependents by expanding the standard deduction for dependents and eliminating the “kiddie” tax.

In addition to the provisions attacking tax shelters and simplifying the tax code, the budget will also contain proposals for new savings plans and retirement accounts, according to Treasury officials.

“Many of the proposals are reintroductions of ideas that were introduced in the 2004 budget,” noted George Jones, managing editor of CCH’s Washington office. “It’s unclear at this time whether these proposals, especially the Lifetime Savings Accounts and Retirement Savings Accounts, are being reintroduced with any hope of being passed this year, or whether it’s more for political posturing and an indication of what may be worked on seriously if and when President Bush is re-elected.”

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