by George G. Jones and Mark A. Luscombe
Just prior to the August recess, the Senate Finance Committee held a hearing on ways to close the tax gap — the gap between taxes due and taxes being collected.
The testimony of Commissioner of Internal Revenue Mark Everson at the hearing provides the latest glimpse into the areas of focus of the IRS to close that gap. His testimony provides an outline for tax professionals of what changes to expect from the IRS in the immediate future.
The tax gap
One initial problem that the IRS faces is that it does not have a very good idea of the size of the tax gap that it is facing. With its last formal study of noncompliance being at least 15 years old, the IRS is in the process of compiling updated compliance data through its recent National Research Program.
The results of other, more informal surveys, however, are not good. They indicate that more people state that they are willing to cheat on their taxes, and also that more people believe that others are more likely to cheat on their taxes. Such attitudes, unless reversed, tend to undermine the voluntary compliance system and contribute to a widening of the tax gap.
Commissioner Everson stated that the tax gap included three components: filing non-compliance, payment non-compliance and reporting non-compliance. He believes that one of the main contributors to the tax gap is the complexity of the tax law. Complexity has added to the cost of compliance and encouraged technical readings of the tax law to achieve results unintended by Congress. He identified several key areas of focus aimed at narrowing the gap.
Identifying priorities
The IRS has identified a number of compliance priorities. The first is discouraging and deterring egregious non-compliance through combating abusive tax schemes and abusive transactions. The commissioner highlighted the Son of Boss settlement initiative as a example of a more aggressive settlement offer that required paying not only all of the tax and interest, but also some penalties.
He pointed out that the IRS had become concerned that too many tax professionals are looking at compliance with the tax laws as a business decision, with the possible penalty for non-compliance not being severe enough to discourage abusive transactions.
He indicated that more than 1,500 taxpayers elected to accept the Son of Boss settlement, 85 percent of those known to the IRS and an additional 300 taxpayers that the IRS was not aware of. While some contest the extent of this success, it seems non-debatable that we can expect more aggressive settlement offers in the future.
Most recently, the IRS announced, in Information Release 2004-97, that it had concluded some settlement negotiations to shut down aggressive transactions involving real estate mortgage investment conduits that included the payment of a 20 percent penalty. And the IRS had not yet even included this transaction on its list of abusive transactions.
The IRS also is addressing non-compliance through early disclosure of questionable transactions. These efforts focus on enforcing the requirement that taxpayers provide requested information on returns, that promoters register certain transactions and that promoters provide the IRS with lists of participants upon request.
The IRS’s well-publicized summonses against accounting firms and law firms are an essential part of this effort. Overall, the IRS has been very successful in enforcing its summonses in court, although it had a recent setback in the BDO Seidman case in the federal district court in Illinois. In that case, the court ruled that the accounting firm was protected by the attorney-client privilege from turning over to the IRS documents passed to and from its lawyers in connection with its role in the sale of an abusive tax shelter.
The IRS is also seeking greater statutory authority to enhance its arsenal of tools and to impose stiffer penalties for non-compliance. In addition, the IRS is seeking better and more rapid information from taxpayers through additional required information on returns and through the promotion of electronic filing, which permits the IRS to access more return information more rapidly.
A new Schedule M-3 for large and midsized corporations will highlight differences between financial accounting net income and taxable income. Another goal of the IRS is to audit the returns it receives closer to the filing time, rather than letting them sit around for a couple of years before getting attention.
Once the IRS identifies an abusive transaction, it intends to improve upon the aggressiveness of its response. This involves the issuance of public guidance on transactions in greater quantity and more rapidly than before, to deter other taxpayers from jumping on board. It also involves directions to field agents to focus on these transactions in taxpayer and promoter audits and to insure uniform development of similar cases.
The professional standards route
The IRS is also working to insure that attorneys, accountants and other tax practitioners adhere to professional standards and follow the law. The IRS Office of Professional Responsibility has been doubled in size.
The IRS is also in the process of revising Circular 230. Focusing attention on promoters and return preparers is viewed as a more efficient use of resources than focusing on individual taxpayers, and it also provides a source of information on the taxpayers utilizing abusive schemes and transactions.
Commissioner Everson reported at the hearing that the IRS Small Business/Self Employed Division, as of June 2004, was investigating 927 promoters and return preparers. Since the beginning of 2000, the Department of Justice has obtained injunctions against 67 promoters and preparers.
The IRS is focused not only on abusive tax shelter transactions but also on outright criminal activity, both domestic and offshore. As discussed in this column in the Aug. 9-22, 2004, issue, the IRS is also focused on tax-exempt and governmental entities and the key role that they play in facilitating many abusive transactions.
Other areas of focus
The IRS is trying to promote compliance through further improvements in customer service. Areas of focus include improved and increased service options for taxpayers, greater ease of participation in the tax system by the public, and simplification of the tax system.
The IRS is also continuing to try to convince Congress and the administration that it needs more resources to do its job effectively. The IRS is starting to get a more receptive response to its requests for additional funding than in the late 1990s. The IRS is also beginning to allocate more of its resources to the fight against non-compliance.
Another key effort being undertaken by the IRS is greater cooperation between the IRS and the state revenue departments, as well as foreign tax authorities. The IRS has already improved its information sharing with the states with such programs as document-matching programs comparing state filings and federal data, the sharing of money service bureau examination information, and a federal/state offshore credit card matching initiative. The IRS hopes that it will start to see a greater flow of information back from the states to assist in detection of non-compliance.
Summary
It seems fairly clear that the amount of non-compliance has been increasing. Recent Senate hearings included criticism of the IRS for not having an effective plan to combat non-compliance and for not utilizing informant information effectively.
Commissioner Everson responded with an outline of a fairly detailed plan to combat non-compliance, while also tossing the ball back to Congress somewhat by emphasizing the need to simplify the tax code, to provide better statutory tools to combat tax shelters, and to provide more adequate resources to the IRS to do its job effectively.
The IRS’s latest plan to close the tax gap appears to be a potentially effective one, and it is already showing some tangible results. But elements of the plan reflect more what the IRS hopes to be able to do than what it has actually done to date. Better resources and more effective use of those resources will be critical to seeing the plan through to fruition.
Tax practitioners should, however, be alert to these new areas of emphasis to more effectively do their jobs and save themselves from unwelcome public scrutiny.
George G. Jones, J.D., LL.M., is the managing editor of Federal and State Tax, and Mark A. Luscombe, J.D., LL.M., CPA, is the principal analyst of Federal and State Tax, at CCH Inc., in Riverwoods, Ill.
