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President’s Budget Proposes Major Procedural and Administrative Changes

Posted on Mar. 5, 2014

The President released his 2015 budget plan yesterday. The proposal has received lots of attention, especially its substantive proposals that would boost the EITC for childless workers and those who do not claim qualifying children, its treating carried interest as ordinary income and its curtailing the potential use of S corporations to avoid self-employment tax. The popular media has generally described the plan overall the way Reuters did in reporting that it “stands little or no chance of being approved as is by Congress, where Republicans, who control the House of Representatives, disagree with the president’s policy priorities.”

Despite the pessimistic prospect for overall legislative adoption, as with the Camp proposal we discussed last week, the President’s Budget proposal has many significant provisions that relate to tax procedure and administration. While I have not gone through the proposals in detail, there are major procedural legislative recommendations relating to regulating tax return preparers, increasing penalties for failing to file returns and identity theft, a scaling back of the TEFRA partnership regime, enhancing information reporting and withholding, worker classification, and a wholesale expansion of math error authority. I provide a brief description on many and I refer extensively to the Treasury summary of the proposals, commonly known as the Green Book.

Major Proposals

Expand the EITC Due Diligence Regime to Child Tax Credit

We have commented before in What Peeing in the Pool Can Teach Us About Tax Compliance  and other posts linked there about the benefits of due diligence and how leveraging preparers to decrease refundable credit overclaims is a policy idea with lots of merit. Green Book, p. 238.

Legislatively Overrule Loving and Provide Authority for Treasury to Directly Regulate Unlicensed Tax Return Preparers

I have written extensively on this as well, and think as a policy matter the Treasury should have this authority. Four states have imposed their own requirements on preparers, including New York this past week. Without federal legislation we will see a hodgepodge of legislation for a national problem. The direct regulation of preparers can be part of an effective overall policy to help control for refundable credit errors and other issues that have high error rates. Green Book, p. 244.

Information Reporting and Withholding Provisions

There are numerous withholding and information proposals. The theme is of course increased reporting and allowing for additional circumstances where payors may be required to withhold. Two significant proposals are 1) requiring withholding on payments to independent contractors who fail to furnish TINs and 2) requiring certain US financial institutions to report foreign persons’ account balances and sweep in to information reporting the payment of  non-U.S. source income to foreign persons.  The latter provision is meant to mirror much of the information foreign financial institutions are responsible for gathering under FATCA. In the Green Book, Treasury explains that the provisions “would facilitate the intergovernmental cooperation contemplated by the intergovernmental agreements by enabling the IRS to provide equivalent levels of information to cooperative foreign governments in appropriate circumstances to support their efforts to address tax evasion by their residents.”  Green Book, p. 203

Expand Math Error Authority

These are major changes which turn the math error regime around, shifting from specific grants in listed circumstances and allowing for a more general power that IRS can use with its discretion. From the Green Book at p. 229:

The proposal would remove the existing specific grants of math error authority, and provide that “math error authority” will refer only to computational errors and the incorrect use of any table provided by the IRS. In addition, the proposal would add a new category of “correctable errors.” Under this new category, Treasury would have regulatory authority to permit the IRS to correct errors in cases where (1) the information provided by the taxpayer does not match the information contained in government databases, (2) the taxpayer has exceeded the lifetime limit for claiming a deduction or credit, or (3) the taxpayer has failed to include with his or her return documentation that is required by statute.

I am wary of this proposal and worry that it defers too broadly to IRS and may jeopardize the rights of taxpayers, especially those who are least likely to be able or willing to challenge IRS adjustments. Math error authority gives IRS broad powers to assess and dispense with the normal notice procedures giving taxpayers right to Tax Court review. I understand the desire to allow IRS the ability to stop errors before issuing refunds but this is a powerful tool that may have unintended consequences. Requiring legislative authority–as is the case now–may be less efficient than giving Treasury regulatory authority, but as I have previously written in the Florida Tax Review and a shorter version in Tax Notes a year or so ago called Increasing Participation in the Rulemaking Process IRS often in proposing regulations does not take into account the interests of taxpayers with little or no voice in the system. I worry that this may happen with these rules.

Expand E-filing

The proposal would require all corporations and partnerships with $10 million or more in assets to file their tax returns electronically. In addition, regardless of asset size, corporations with more than ten shareholders and partnerships with more than ten partners would be required to file their tax returns electronically. Regulatory authority would be expanded to allow reduction of the 250-return threshold in the case of information returns such as Forms 1042-S, 1099, 1098, 1096, 5498, 8805, and 8966.

In addition, for taxpayers who prepare the returns electronically but still file the old fashioned way, the proposal requires Treasury to require that the returns have a scannable code so IRS could easily convert the returns to electronic format. Green Book, p. 227.

Address Employee Leasing Company Employment Tax Liability

Essentially makes the leasing company jointly and severally liable with their clients for employment taxes. Green Book, p. 207.

Worker Classification

The proposal would permit the IRS to require prospective reclassification of workers who are currently misclassified and whose reclassification has been prohibited under current law. The reduced penalties for misclassification provided under current law would be retained, except that lower penalties would apply only if the service recipient voluntarily reclassifies its workers before being contacted by the IRS or another enforcement agency and if the service recipient had filed all required information returns (Forms 1099) reporting the payments to the independent contractors. For service recipients with only a small number of employees and a small number of misclassified workers, even reduced penalties would be waived if the service recipient (1) had consistently filed Forms 1099 reporting all payments to all misclassified workers and (2) agreed to prospective reclassification of misclassified workers. It is anticipated that, after enactment, new enforcement activity would focus mainly on obtaining the proper worker classification prospectively, since in many cases the proper classification of workers may not have been clear. (Statutory employee or nonemployee treatment as specified under current law would be retained.)

The proposal sensibly requires service recipients to disclose to the providers notice “when they first begin performing services for the service recipient, that explains how they will be classified and the consequences thereof, e.g., tax implications, workers’ compensation implications, wage and hour implications.” Green Book p. 211

TEFRA Changes

The proposal requires streamlined audit and adjustment procedures that are elective now for certain large partnerships for any partnership that has 1,000 or more partners at any time during the taxable year. Green Bok, p. 217.

Shareholder Personal Liability for Unpaid Corporate Income Tax of Certain C Corps.

This refers to a shelter transaction where C corps do the following:

In a typical case, an intermediary entity borrows funds to purchase the stock of the C corporation from the C corporation’s shareholders, and the consideration received by the C corporation from the sale of its assets is effectively used to repay that loan. These transactions are structured so that when a C corporation’s assets are sold, the C corporation is ultimately left with insufficient assets from which to pay the tax owed from the asset sale. In many cases, the intermediary does not pay the corporate income tax liability and is judgment-proof, frustrating the IRS’ ability to collect taxes that are legally owed. Green Book, p. 214

Eliminate Nonrefundable Deposit Requirement for Offers In Compromise

This would reverse legislation requiring taxpayers to submit a 20% nonrefundable deposit along with offers. Green Book, p.220.

Make Repeated Failure to File Income Tax Returns a Felony

This would arise from a failure “to file tax returns in any three years within any five consecutive year period, if the aggregated tax liability for such period is at least $50,000, would be subject to a new aggravated failure to file criminal penalty.” Green Book, p. 222.

Extend General Three-Year SOL on Assessment When Certain State or Local Adjustments

This proposal “would create an additional exception to the general three-year statute of limitations for assessment of Federal tax liability resulting from adjustments to State or local tax liability.” Green Book, p. 224

Increase Penalty on Preparers For Understatements of Tax that Occur as a Result of a Paid Preparer’s Willful or Reckless Conduct

See Green Book, p 247

Increase Criminal Sanctions for Tax-related Identity Theft and Create a New Civil Penalty for Tax-related Identity Theft

Green Book, p. 241-42

Additional Whistleblower Protections, Including Protection Against Retaliation and Requirement that Whistleblowers Maintain the Confidentiality of Tax Return Information Received in Administrative Proceedings

Green Book, p. 235-36

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