Testimony on Taxpayer Bill of Rights II: December 10, 1991 – Tax Executives Institute statement submitted to Senate Subcommittee on Private Pension Plans and Oversight; includes comments on reforming the designated summons
On December 10, 1991, Tax Executives Institute testified before the Subcommittee on Private Pensio if the Senate Committee on Finance on a proposal by Senator David Pryor to enact a second Taxpayer B Institute, which was requested to appear at the hearing, was represented by Tax Counsel Timothy J. M testimony vas prepared under the aegis of TEI’s IRS Administrative Affairs Committee. Reprinted belo statement that the Institute submitted in connection with the hearing. A related submission to the H Oversight Subcommittee was reprinted in the September-October 1991 issue of The Tax Executive.
I. Scope of Comments
In announcing his intention to introduce a second Taxpayer Bill of Rights, Senator Pryor referred to the initial Taxpayer Bill of Rights as a “good first step” in the process of safeguarding taxpayer rights.(1) He pointed out that the second Taxpayer Bill of Rights (T2) is intended to reflect Congress’s “growing understanding of taxpayer needs” and will help the Internal Revenue Service “achieve higher standards of accuracy, timeliness and fair play in providing taxpayer service.”
Tax Executives Institute commends Senator Pryor for developing T2 and the Subcommittee for scheduling this hearing and for its continuing oversight of the critical issue of taxpayer rights. As the principal organization of corporate tax professionals in North America, the Institute has long been an advocate for the rational and evenhanded administration of tax laws. We agree with Senator Pryor that “[s]afeguards must be built into the law to protect the taxpayer against the potentially devastating effect of [IRS] mistakes and actions.” We also believe that the Internal Revenue Code itself is in need of amendment to restore a sense of balance between taxpayers and the government in several important areas.
TEI’s approximately 4,600 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. TEI is firmly committed to maintaining a tax system that works — one that is consistent with sound tax policy, one that taxpayers can comply with, and one in which the IRS can effectively perform its audit function.
There is a growing consensus about the need to establish and safeguard taxpayer rights. As Commissioner Goldberg recognized in his September 25, 1991, testimony before the Oversight Subcommittee of the House Ways and Means Committee, “[s]afeguarding taxpayer rights means making [the tax] system work as well as we can for all Americans.” Through its effective oversight of the IRS, Congress has made the tax agency sensitive to the need for quality, fairness, and evenhandedness in tax administration. We believe this sensitivity is demonstrated by, among other things, the IRS’s response to the first Taxpayer Bill of Rights, by its support of penalty reform,(2) and by its revitalized commitment to quality and service through programs such as Compliance 2000.
There is much more, however, that can be done. Thus, although progress has been made, systemic and “cultural” barriers remain to taxpayers’ regarding the tax system as fair and equitable. We believe that this hearing underscores Congress’s recognition that the process will be an incremental one, and we believe that the development of T2 stands as an important “next step” in requiring (or permitting) the IRS to operate in an even more quality-oriented, more service-oriented manner.
Tax Executives Institute pledges its continuing support of Congress’s efforts to remedy certain systemic impediments to the equitable treatment of taxpayers. In the comments that follow, we focus on the specific provisions set forth in Senator Pryor’s summary of T2 that will bring a fuller measure of equity and fairness to the business taxpayers who comprise the Institute’s membership. Specifically, we address proposals relating to (1) the equalization of interest rates charged on tax deficiencies and paid on overdue tax refunds; (2) the expansion of the IRS’s authority to abate interest in certain circumstances; (3) the use of the designated summons; and (4) the prospective date of Treasury regulations. We also discuss other proposals that merit careful consideration as the legislative process moves forward.
II. Equalization of Interest Rates on Deficiencies and Refunds
Under section 6621(a) of the Code, a taxpayer is charged interest on underpayments of tax at a rate equal to the federal short-term rate plus three percentage points. In contrast, a taxpayer receives interest on an overpayment of tax at a rate equal to the federal short-term rate plus two percentage points. T2 would eliminate the one percentage point differential between the interest a taxpayer pays the IRS on underpayments and the interest the IRS pays a taxpayer on overpayments. TEI wholeheartedly supports the proposal.
The interest-rate differential was enacted in 1986 as a result of Congress’s concern that the interest rate prescribed in the Internal Revenue Code may have caused taxpayers “either to delay paying taxes as long as possible to take advantage of an excessively low rate or to overpay to take advantage of an excessively high rate.” In addition, Congress pointed out that financial institutions and other commercial entities do not ordinarily borrow and lend money at the same rate. See Staff of the Joint Committee on Taxation, 99th Cong., 2d Sess., General Explanation of the Tax Reform Act of 1986, at 1279 (1987).
TEI believes the concept underlying the interest rate differential was seriously flawed when the provision was enacted and remains flawed today. When the interest rate was determined every two years (as it was before enactment of the Economic Recovery Tax Act of 1981), the spread between the section 6621 rate and the market rate may have become substantial and therefore arguably encouraged taxpayer “gaming.” With the changes adopted in 1981 and 1982 (requiring frequent adjustments of the rate and the daily compounding of interest), however, the potential for any significant differential was eliminated. Moreover, the Tax Equity and Fiscal Responsibility Act of 1982 changed the time period when interest on refunds would commence running, thereby eliminating the limited ability of taxpayers to “overpay to take advantage of an excessively high rate.”
Quite candidly, the notion that an interest rate differential is justified because “financial institutions” borrow and lend money at different rates is without merit. The government should never view itself (or strive to be viewed by taxpayers) as a lending institution. Taxpayers have no freedom to negotiate interest rates and terms with the government, as they might with a commercial establishment.
What is more, since many tax adjustments result in deductions or other items simply “rolling over” from one year to another, thereby producing an underpayment in the first year and an overpayment in the subsequent year, the differential operates to penalize taxpayers. For example, assume that a taxpayer underpaid its tax liability for 1988 by $100 and overpaid its liability for 1989 by the same amount because of its erroneous decision to deduct an item in the earlier, rather than the later, year. Assume further that the error was discovered in 1991. Finally, for illustration purposes, assume that the interest rate on tax deficiencies during all periods is 11 percent, that the interest rate on tax overpayments is 10 percent, and that interest is not compounded. In this situation, the taxpayer would owe interest of $33 in respect of its 1988 underpayment ($11 in each of 1989, 1990, and 1991), and the taxpayer would be entitled to interest of $20 on its 1989 overpayment ($10 in each of 1990 and 1991). Thus, the IRS would receive a net benefit of $13, even though the underpayment existed for only one year (thus entitling the IRS to $11 of interest). In other words, even assuming that the one-percent differential were justifiable, the IRS would realize an undeserved windfall of $2.(3)
Finally, TEI believes that the interest rate differential is not only unnecessary, but also undermines one of the basic goals of tax reform: to restore faith in the fairness of the tax system. Other provisions of the Code provide adequate safeguards against any taxpayer manipulation of interest rates.
For the foregoing reasons, we endorse the elimination of the interest-rate differential. Further, we recommend that Congress also repeal the ill-conceived “hot interest” provision of section 6621(c), which provides a further two-percent increase in the interest rate on large corporate underpayments (an underpayment of more than $100,000) 30 days following the issuance of a notice of proposed adjustment (a “30-day letter”) or a notice of deficiency (a “90-day letter”).(4)
III. Abatement of Interest
Currently, section 6404(e) authorizes the IRS to abate the assessment of any or all interest for any period where the interest is attributable to an error or delay by an officer or employee of the IRS in performing a “ministerial act.” T2 would repeal the “ministerial act” requirement and provide for a mandatory abatement of interest for unreasonable IRS errors and delays. TEI, wholeheartedly endorses the proposal to expand the abatement-of-interest provision.
As Senator Pryor’s summary of the provisions of T2 acknowledges, the IRS’s current regulations under section 6404(e) narrowly defines “ministerial act,” as follows:
a procedural or mechanical act
that does not involve the exercise
of judgment or discretion,
and that occurs during the processing
of a taxpayer’s case after
all prerequisites to the act,
such as conferences and review
by supervisors, have taken
place. A decision concerning
the proper application of federal
tax law (or other federal or
state law) is not a ministerial
Under the foregoing definition, a taxpayer filing an administrative appeal of a proposed adjustment that languishes in the IRS Appeals Office for six months (e.g., because of the Appeals Officer’s workload) will not be entitled to abatement of the interest accruing during the period of delay because the delay is not the result of a “ministerial act.” Similarly, if the Appeals Officer requests additional information from the Examination Division and the Examiner is unable to respond for several months because he is involved in another case, the interest will continue to accrue during the delay. Delays may also be caused by an IRS decision to reexamine an issue or to consolidate the case with a later year that may not have yet been audited. Finally, delays may be caused by administrative foul-ups in reviewing and approving the appeal settlement. In this regard, we understand that a recent IRS “peer review” analysis of the Coordinated Examination Program revealed that more than half of the delays in the examination of large companies are attributable to the IRS.
TEI submits that the taxpayer in such situations should not be penalized for the IRS’s failure to act. We therefore endorse the proposed amendment of section 6404(e) with respect to the mandatory abatement of interest during the period attributable to an unreasonable delay by the IRS. In addition, we recommend that the committee report include examples of what constitutes an unreasonable delay during the taxpayer’s administrative appeal of proposed adjustments. For example, the abatement of interest on a deficiency could commence 180 days after the taxpayer files its administrative appeal and end on the date of a “final determination” — i.e., the issuance of a statutory notice of deficiency when the case is unagreed, or a Form 870 or Form 870-AD when the case is agreed. To impose a cost on the taxpayer for th e IRS’s delays is, quite simply, unfair and at odds with the Congress’s commitment during the 1989 penalty reform process to impose penalties only on culpable taxpayer behavior. The situation is especially egregious with respect to the assessment of “hot interest” under section 6621(c) of ;he Code which increases the interest rate by two percentage points on large corporate underpayments where the underpayment remains outstanding more than 30 days following the issuance of either a 30-day or a 90-day letter.
IV. Designated Summons
Enacted as part of the Omnibus Budget Reconciliation Act of 1990, section 6503(k) of the Code grants the IRS authority to issue a “designated summons” directing the production of documents or other information in connection with the audit of a return. The term “designated summons” is defined as any summons issued for purposes of determining any tax if such summons is issued at least 60 days before the expiration c f the period for assessment arid clearly states it is a designated summons. The issuance of such a summons suspends the statute of limitations for assessment of tax until after a final resolution of the court proceeding to enforce or quash the summons. At present, the statute does not require the IRS to notify the taxpayer that a designated summons is about to be issued. As the summary of T2 acknowledges, “[w]hile there may be situations where the use of a designated summons late in the audit process may be appropriate, nonetheless the IRS should not be allowed to surprise taxpayers who reasonably and in good faith believed that the statute of limitations was soon going to expire.”
T2 would require the IRS to first seek the requested documents or other information informally. In addition, the IRS would be required to notify the taxpayer in writing that the issuance of a designated summons was imminent and the reason any response previously received was insufficient. The taxpayer would also have the right to a conference within 15 business days of the notice.
We applaud Senator Pryor for recognizing the need to strike a balance between the IRS’s legitimate right to information with the taxpayer’s right to receive timely notice of the IRS’s intent. The designated summons procedure is an exceedingly powerful tool that was intended to be used against uncooperative taxpayers. We believe that the proposed notice requirement, coupled with well-developed internal clearance procedures, will go far in ensuring that the designated summons is not used to routinely extend the statute of limitations even where the taxpayer is cooperative.
V. Prospective Date for Treasury Regulations
T2 would generally require all regulations issued by the Treasury Department implementing broad legislative guidelines to be effective prospectively from the date of issuance in final, temporary, or proposed form. In addition, taxpayers would be deemed to have satisfied the necessary requirements of the statute in the absence of such guidance if they made a good faith effort to utilize a reasonable interpretation of the statute that resulted in substantial compliance.
TEI wholeheartedly agrees that prospectivity must play an essential role in the implementation of simpler and more administrable tax rules. Retroactive application of adverse rules and regulations can undermine the integrity of the tax system and taxpayer confidence in the fairness of the system. We question, however, whether the issuance of proposed regulations should ever trigger a statute’s effective date.(6) Since proposed regulations are not technically binding on the taxpayer and may be changed substantially or withdrawn completely before being issued in final form, we believe it would be more equitable to require prospectivity from the issuance of final regulations.
Moreover, as T2 inherently acknowledges, a rational and fair tax system must recognize that taxpayers who endeavor in good faith to comply with our amorphous body of tax law should not be subject to costs and burdens of ex post facto changes in the rules, including the cost of preparing and filing amended returns. The Institute has long believed that taxpayers should only be held accountable for clearly defined standards of conduct that are timely established and promulgated by Congress, the Department of Treasury, or the IRS. Therefore, we endorse the provision in T2 to permit taxpayers to utilize a reasonable interpretation of the statute in the interregnum between enactment of the statute and the issuance of final regulations.
VI. Other Issues
Finally, there are several provisions of T2 potentially affecting business taxpayers that TEI believes merit further consideration as the legislative process moves forward. Specifically, we believe the ramifications of the following proposals need to be carefully considered:
The Ombudsman and Problem Resolution Officers. T2 would provide that the Ombudsman is to be appointed by the President and confirmed by the Senate and that Problem Resolution Officers (PROs) are to report directly to the Ombudsman rather than to the local District Director (as under current law). TEI members report that their experience with the Ombudsman and PROs has generally been excellent. Although some changes may be desirable to enhance the visibility of the PRO (especially with respect to individual taxpayers), care must be exercised to ensure that the level of service currently provided is not compromised.
Attorney-Client Privilege. T2 would amend the Federal Rules of Evidence to provide that disclosure of information to outside independent accountants will not destroy the attorney-client privilege. TEI believes that materials transmitted to certified public accountants in order to satisfy their need for documentation of the company’s tax liability should be protected from disclosure. Because T2 would enhance the protection provided in respect of such materials, it cannot help but further the public policy underlying the securities law. Consequently, the Institute encourages Congress to give the proposal special consideration.
Secretary’s Power to Suspend Rules. T2 would grant the Secretary broad powers to suspend rules that, because of changed circumstances since the enactment of a provision, would cause a hardship to a group of taxpayers. TEI agrees that the Secretary should be given authority to temper the unintended and unforeseen results of legislation. Moreover, we recommend that the statute clarify whether the Secretary’s refusal to exercise the authority to provide relief would be subject to taxpayer challenge.
Tax Executives Institute appreciates this opportunity to present its views on reforms to establish taxpayer safeguards and protections and would be pleased to answer any questions you may have about its positions. In this regard, please do not hesitate to call [Reginald W. Kowalchuk, TEI’s International President] at (416) 866-6095, or Timothy J. McCormally of the Institute’s professional staff at (202) 638-5601.
Comments on Reforming the Designated Summons
December 20, 1991
On December 20, 1991, Tax Executives Institute filed the following comments with the Senate Finance Committee’s Subcommittee on Private Pension Plans and Oversight of the Internal Revenue Service on proposals to amend the designated summons provisions of the Internal Revenue Code. The comments supplement the Institute’s testimony at a December 10 hearing on proposed taxpayer bill of rights’ legislation (which is reprinted elsewhere in this issue). Taking the form of a letter from TEI President Reginald W. Kowalchuk to Senator David Pryor, Chairman of the Subcommittee, the comments were prepared under the aegis of its IRS Administrative Affairs Committee, whose chair is Linda B. Burke of the Aluminum Company of America.
Tax Executives Institute thanks you for the opportunity to testify on the Taxpayer Bill of Rights II (T2) before the Senate Finance Committee’s Subcommittee on Private Pension Plans and Oversight of the Internal Revenue Service. As we stated at the December 10 hearing, the Institute is pleased that several provisions of T2 address the rights of corporate taxpayers and will restore a better sense of balance to the taxpayer-IRS relationship. We agree that Congress, the IRS, and taxpayers must move forward to strengthen taxpayer rights and protections. T2 is a logical and necessary “next step” in that process.
We wish to take this opportunity to supplement our written testimony on one subject addressed by T2 — the use of the designated summons under section 6503(k) of the Internal Revenue Code. As you know, such a summons suspends the statute of limitations on assessment if it is issued at least 60 days prior to the expiration of the period for assessment and clearly states it is a designated summons. Many taxpayers are concerned about the scope of the designated summons and about its potential use (or abuse) by the IRS to improperly extend the statute. Thus, we are pleased that T2 will address the designated summons.
The designated summons procedure was enacted last year as part of the 1990 budget accord. The legislative history of section 6503(k) states that the designated summons was enacted because “the IRS frequently requests informally that the taxpayer provide additional information necessary to arrive at a fair and accurate audit adjustment, if any adjustment is warranted.” Not all taxpayers, however, cooperate by providing the requested information on a timely basis, according to the Conference Report. H.R. Rep. No. 101-964, 101st Cong., 1st Sess. 64 (1990). Thus, the intent of the statute was to provide the IRS with a powerful enforcement tool against uncooperative taxpayers.
Quite candidly, the designated summons stands as a good example of why legislation should not be developed without public hearings and oversight. The provision is flawed for several reasons:
* The statute is completely one-sided. The purpose of the statute of
limitations is to let the parties know that at some point the tax year
under audit will be closed and that they can move on to new matters.
The basic statute of limitations is evenhanded: the IRS has three years
to audit the taxpayer and assess additional tax liability, and the taxpayer
has three years to file an amended return and seek a refund of
overpaid taxes. The designated summons, however, skews that balance
between taxpayers and the IRS. It permits the IRS — perhaps arbitrarily
— to render the statute of limitations irrelevant in respect of corporate
taxpayers. Moreover, although the designated summons gives the
IRS additional time to assess deficiencies, it does not confer on taxpayers
a correlative right to seek a refund.
* The provision can be invoked in spite of the taxpayer’s overall cooperative
response to previous requests for documents. Thus, even if the
taxpayer has acted in a totally reasonable manner, the IRS can issue a
designated summons and extend the statute. Moreover, there is no
requirement that a taxpayer even be given notice that a designated
summons is about to be issued.
* The extension of the statute of limitations under section 6503(k) is not
limited in scope to issues relating to the summoned documents. Thus,
the IRS could issue a summons for certain documents and then proceed
with its audit for weeks, possibly months, as the propriety of the summons
is considered by the courts. Although a court may eventually stay
the enforcement of the designated summons, the IRS is free to develop
further issues during the pendency of the judicial proceeding.
* There is no requirement that a designated summons be issued to the
taxpayer; it can be issued to a third party. Thus, the failure of an
unrelated third party to respond to the summons could have the effect
of suspending the taxpayer’s right to a timely adjudication of his tax
* Finally, the taxpayer does not have any means to directly contest the
summons. To obtain judicial review of the propriety of the summons,
the taxpayer must refuse to comply and then wait for the IRS to seek
enforcement in court. Not only does this place the taxpayer in the
untenable position of defying the summons in order to challenge its
validity, but, again, it extends the statute of limitations during the
period the summons is being challenged.
Even without the designated summons, the IRS has a broad range of weapons in its arsenal to use against recalcitrant taxpayers. For example, if the statute of limitations is about the expire, the IRS can issue a statutory notice of deficiency that disallows all deductions and credits claimed. In such a case, the burden of challenging such a disallowance is on the taxpayer. There is no general need for an open-ended statute that strips taxpayers of their right for a final, timely resolution of issues.
In conjunction with its review of taxpayer rights and safeguards, the Subcommittee is studying the use of the designated summons by the IRS. TEI is pleased that the initial proposals set forth in T2 would remedy some of the problems associated with the designated summons. T2 would require that the IRS first seek the requested information informally (presumably by issuing a formal Information Document Request) before issuing a designated summons and provide written notice of why the taxpayer’s response to such a request is not sufficient. T2 would also provide a right to a conference concerning the written notice. These requirements will help ensure that the designated summons will not be used routinely against cooperative taxpayers.
In addition to the T2 restrictions, the Subcommittee should consider other safeguards for taxpayers with respect to the designated summons, including (1) the right to challenge the summons directly in court, (2) a requirement for IRS National Office approval before issuance of the summons, and (3) a limitation on the issuance of the designated summons to unrelated third parties. In addition, to ensure that the IRS does not abuse its designated summons power, consideration should be given to providing that if a court refuses to enforce the summons, the statute of limitations will expire as if no summons had been issued. The Institute would be pleased to work with your office and the Subcommittee staff to develop appropriate restrictions on the unwarranted use of the designated summons procedure. (1) We note that Representative Pickle has introduced related legislation (H.R. 3838) in the House of Representatives. (2) The Institute commends Senator Pryor for the leadership role be took in 1989 with respect to penalty reform. We must express our disappointment, however, with subsequently enacted provisions (such as the transfer pricing penalty under section 6662(e)(3)) that contradict the principles that underlie the 1989 changes. (3) Section 6402 authorizes the IRS to “net” the interest amounts in such situations, thereby ameliorating the harsh effects of the interest-rate differential. The goal of netting would be to put the parties (the government and the taxpayer) in the same economic position they would have been in had the overpayment been immediately applied to pay (or pay down) the underpayment. Under a fair netting regime, the IRS in the example would be entitled to only $11 of interest — the $2 windfall would be eliminated. Notwithstanding the statutory provision and the mandates contained in the legislative histories of both the 1986 and 1990 Acts that the IRS develop “comprehensive crediting procedures,” no such procedures have yet been developed. See H.R. Rep. No. 99-841, 99th Cong., 2d Sess. II-785 (1986) (Conference Report); H.R Rep. No. 101-964, 101st Cong., 2d Sess. 1101 (1990) (Conference Report). Although the need for netting will be minimized by the elimination of the interest-rate differential, we recommend that Congress renew its mandate to the IRS that comprehensive netting rules be developed. (4) Such “hot interest” is to be assessed without regard to whether any delay in the payment of the underlying tax liability is attributable to the taxpayer or the IRS. Under current law, in situations where the “hot interest” provision comes into play, the difference between the rate charged on large corporate underpayments and the rate paid on tax overpayments becomes three percentage points. (5) Temp. Reg, [sections] 1.6404-2T(b)(1). At least one court has held that the IRS’s refusal to abate interest under section 6404(e) is not reviewable by the courts. Horton Homes, Inc. v. United States, No. 90-8225 (11th Cir. July 23, 1991). (6) At the same time, whether or not a taxpayer complied with proposed regulations would clearly be relevant in determining whether a taxpayer made a good faith effort to comply with the statute.
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