by Roger Russell
Congress is contemplating a major crackdown on a new style of tax scam by large corporations, while the accounting profession is lobbying for what could amount to significant tax relief for the nation’s S corporations.
The Senate recently approved an economic growth package that would prevent companies from seeking tax refunds based on overstated revenues.
Congressional committees confirmed reports that MCI and Enron Corp. are in the process of collecting or filing for tax refunds or credits from the Internal Revenue Service because of tax payments on billions of dollars that they falsely claimed to have earned. Qwest Communications International Inc., which plans to restate $2.2 billion in revenue, and HealthSouth Corp., accused of overstating its earnings by more than $2 billion, are also said to be considering filing for refunds.
“The con men pay a little tax to help hide their fraud, bump up the stock price and cash in their stock options,” said Sen. Chuck Grassley, R-Iowa, chairman of the Finance Committee. “They basically have made the IRS an unwitting accomplice to their fraud.”
The Senate provision raises the criminal penalties for tax fraud to the amount of tax at issue in both an overpayment and underpayment. “This will ensure that corporate con artists pay their full freight for duping shareholders,” said Grassley, who inserted the provision as an amendment to the full package.
Separately, the American Institute of CPAs is lobbying for fiscal-year flexibility for S corporations with a proposal to allow start-up S corporations to elect a fiscal year of their own choice. “A C corporation can pick its fiscal year, but pass-through entities, such as S corporations or partnerships, are generally limited to a calendar year,” said AICPA vice president for taxation Gerry Padwe.
“The issue for the government is the fact that if a partnership or S corporation picks a year other than December 31, they pass through the profits as of the end of that year and it gives shareholders or partners some tax deferral, so the 1986 act said you have to go to a calendar year if you’re a pass-through entity,” he said.
“For accountants, adopting a calendar year means that you have to have all your accounting work completed within the first few months of the year - closing the books and auditing, or a lesser type of review engagement completed, in addition to getting tax returns prepared on a calendar-year basis,” Padwe added. “It’s a tremendous burden on financial advisors who have to deal with this in a limited time.”
Prior to the 1986 act, a pass-through entity could adopt any fiscal year that it wanted, he explained. “This helped them spread work around throughout the year more evenly.”
Although the code permits an S corporation to use any otherwise permissible fiscal year if it can establish a business purpose, in practice the IRS rarely looks favorably on granting fiscal year status to pass-throughs, according to Padwe.
“It really becomes an issue of dollars,” said Padwe. “If the sole owner of an S corporation elects a January 31 fiscal year, what he’s done is defer recognition of the S corporation income by one month, but it’s in the next fiscal year. If the S corporation elects a fiscal year which ends a month after the calendar year ends, the result is that it defers tax by a year.”
“The advantage for them to be able to pick a fiscal year is the greater availability of time, as well as the opportunity to pick a fiscal year that fits the natural business year cycle. For example, why should a ski resort end its year on December 31? It makes more sense to end on June 30 when things are slowest,” he added.
Congress is not expected to seriously debate the S corporation issue until the next legislative session, but it bears watching because of the huge number of S corporation start-ups each year.
Meanwhile, debate is hot and heavy on the issue of corporate revenue restatements. The Senate provision raises the criminal penalties for such tax fraud to the amount of tax at issue in case of overpayment due to misreported earnings.
Legally, the penalty can’t be retroactive, so the Grassley proposal is based on a company’s activity after enactment of the tax bill.<
“Even though my proposal can’t be retroactive, I don’t intend to stand by and let today’s boardroom con men slink into the shadows untouched,” Grassley said. “I’ll contact the Department of Justice’s Corporate Fraud Task Force to ensure that full and proper attention is given to these cases where payment of taxes was just part of the bag of tricks to fool shareholders. While current law isn’t as strong as I would like, it does provide for three years of jail time for tax fraud.”
“This is a back-door way to get back at the future Enrons of the world,” said Mike Chakurun, director of federal and legislative affairs at the Alexandria, Va.-based National Society of Accountants.
A committee of the American Institute of CPAs is looking at the provision, but has declined comment.
