The current IRS organizational structure does not give IRS managers the flexibility to modernize business practices and solve taxpayers' problems, according to IRS Commissioner Charles O. Rossotti. In late January, Rossotti told members of the Senate Finance Committee that there is a solution to this organizational problem, which is widely used in the private sector, and that he plans to implement it.
Rossotti said there currently are eight intermediate levels of staff and line management between a front-line employee and the deputy commissioner, who is the only manager besides the commissioner with full responsibility for service to any particular taxpayer. He argued that this structure is "too complex and accountability is weak." IRS managers often are responsible for administering the entire Internal Revenue Code across the full spectrum of taxpayers.
The commissioner plans to revamp IRS business practices by realigning
all IRS offices into four management teams, each with a set of
services tailored to meet the needs of the taxpayers served by that
team. The four teams would specialize in
- Individual taxpayers with wage and investment income.
- Small business and self-employed taxpayers.
- Large business taxpayers.
- Employee plans, exempt organizations and state and local governments.
According to Rossotti, this organizational model provides for fewer managerial layers and clear lines of responsibility. "Managers in the new business units will be able to focus on the specific needs of the taxpayers they serve," said Rossotti, "and they will learn a great deal about the needs and particular problems that affect each group."Congress Looks for Ways to Fix the AMT
The Taxpayer Relief Act of 1997, if not amended, will increase dramatically the number of taxpayers who must use the alternative minimum tax system (AMT). The Treasury Department estimates that the AMT, which applied to 414,000 taxpayers in 1995, will affect as many as 11 million taxpayers in 2007. To prepare for the problems that will occur because so many more taxpayers must shift to the AMT system, the House Ways and Means Committee asked witnesses at a February hearing for feedback and solutions.
Committee chairman, Bill Archer (R-Texas), asked witnesses if the AMT should be completely eliminated and Rob Portman (R-Ohio) asked if they would support a minor increase in marginal rates to offset the cost of eliminating the phaseouts.
Kenneth Kies, managing partner of Price Waterhouse, Washington, D.C., told the committee that the best approach would be to index the AMT to adjust for the inflation rate. He also warned the committee to proceed cautiously in any efforts to increase the marginal rates to offset the phaseouts, because the phaseouts could be reinstated at a later date.
Michael Mares, chairman of the AICPA tax executive committee, agreed.
He said there was no simple solution given the likely revenue loss to
the government but that the government should consider
- Indexing the AMT brackets and exemption amounts.
- Allowing certain regular tax credits against the AMT.
- Eliminating itemized deductions and personal exemptions as
adjustments to regular taxable income when determining alternative
maximum taxable income.
- Eliminating many of the AMT preferences.
- Providing an AMT exemption for low—and middle—income taxpayers.
"AMT issues will become more prevalent for many taxpayers who do not see themselves as wealthy and who will believe they are being punished unfairly," said Mares. He went on to say that to fix the AMT problem the government should start with considerations of the AICPA's recommendations.An End to Marriage Penalty?
The House Ways and Means Committee heard testimony on eliminating the so-called marriage penalty. Several members of the House have urged the Ways and Means Committee to support bills, such as HR 2456, that would give married couples a choice of filing their taxes jointly or as individuals.
Currently, a marriage penalty results when married individuals have a greater tax liability than do similarly situated single individuals.
Another alternative, HR 2593, sponsored by Wally Herger (R-Calif.) would give married couples a 10% deduction on up to $30,000 of the lower-earning spouse's income. In yet another proposal, sponsored by Jim McDermott (D-Wash.), married couples filing jointly would get a standard deduction twice that of single filers.
David Lifson, vice chairman of the AICPA's tax executive committee,
said the marriage penalty should be eliminated or reduced because it
is inequitable. He suggested a number of possible methods to correct
the inequity, including
- Providing on one return a separate calculation of each spouse's
taxable income and using one tax rate schedule for all individuals.
- Providing a deduction to reduce the penalty.
- Providing a tax credit for married couples.
- Adjusting the current tax brackets applicable to married individuals.
- Eliminating the marriage penalty by adopting standard phase-outs for three income levels—low, middle- and high income taxpayers—and adopting one standard phase out method.
Although President Clinton has said he is against the marriage penalty, it is not likely that it will be eliminated soon. According to the Congressional Budget Office, a repeal of the marriage penalty would cost the government in lost revenue approximately $29 billion per year.
Treasury, Rossotti, to Address Taxpayer Rights Violations
An IRS internal audit report published in January revealed that IRS district offices across the United States have improperly used revenue statistics and goals to evaluate revenue agents and bolster collections. Despite the fact that the Government Performance and Results Act requires the IRS to use performance measurements, IRS Commissioner Charles O. Rossotti said the report demonstrates that the agency "has put too much emphasis on revenue and other statistical goals and not enough on quality customer service and respect for taxpayer rights."
The report is the second of three reports requested by the former acting IRS commissioner and chief inspector to determine the validity of allegations that the IRS was violating taxpayer rights.
The report, which summarized the results of an internal investigation at both regional and national levels, including 12 district offices, concluded that IRS agents are heavily focused on management's priority of achieving enforcement goals. According to the report, "dollars collected" was the most important factor in setting program goals and evaluating program accomplishments, creating an atmosphere that "places taxpayer rights at risk." The report validates taxpayer testimony on taxpayer rights violations given before the Senate Finance Committee in September 1997.
"I am deeply troubled by the report's conclusion that the inappropriate use of enforcement statistics has put taxpayer rights in jeopardy," said Treasury Secretary Robert E. Rubin. "This is an unacceptable situation that must and will change."
Rossotti already has taken steps to ensure that taxpayer rights are not compromised. In October, he suspended the distribution to field offices of goals relating to revenue production and stopped the practice of ranking the 33 IRS districts on revenue collection statistics.
Rossotti also said that the IRS has established a panel to resolve employee disciplinary cases that arise from the report. The agency is conducting regular interviews in each IRS district to ensure employees are not evaluated based on revenue goals and is issuing a directive to all employees that underscores the need to comply with the provisions of the Taxpayer Bill of Rights. The IRS also requested the General Accounting Office to conduct an overall review of IRS employee performance file materials and evaluations of managers in the certification process.
New Interest Abatement Rules
Taxpayers no longer have to pay interest for certain past-due tax liabilities when the IRS is responsible for unreasonable errors or delays while a case is being processed. Thanks to recently released proposed regulations (Reg-209276-87) under Internal Revenue Code section 6404(e)(1), the IRS will abate interest resulting from delays that occur while IRS staff performs managerial or "ministerial" acts.
Delays in managerial acts—administrative acts that occur during the processing of a taxpayer's case—to which the new regulations apply include the loss of records and the exercise of judgment or discretion relating to the management of personnel. For example, during the course of an audit a revenue agent might request technical advice from the Office of Chief Counsel. The attorney assigned to the case could be granted extended leave and the case might not be reassigned during the attorney's absence.
Other managerial acts which could cause delays and for which the IRS
now may stop the accrual of interest include the following:
- Agents are sent to training courses for extended periods of time.
- Auditors are permanently reassigned.
- Agents are granted extended periods of sick leave.
- Clerical employees misplace taxpayer files.
Observation : Interest that results from a general
administrative decision, such as how to organize the processing of tax
returns or how and when to implement an improved computer system,
cannot be abated. Nor will interest be abated
- When a tax shelter case is delayed until an examination of the
shelter is complete.
- When a taxpayer and an agent disagree about certain itemized
deductions and the agent needs the advice of the Office of Chief
- When a decision is made to delay examining a taxpayer's return
until another return, for which the statute of limitations is about
to expire, is processed.
- When an error is made in interpreting a complex federal tax law.
The Tax Court also has jurisdiction to determine whether the IRS has abused its discretion in failing to abate interest for an eligible taxpayer (IRC section 6404(g)). Formerly, federal courts had no jurisdiction to review the IRS's failure to abate interest.
—Michael Lynch, CPA, Esq., associate professor of tax accounting at Bryant College, Smithfield, Rhode Island.
My Dog Ate the Records
Taxpayers are sometimes able to claim deductions for certain expenses in the absence of written evidence if they can reasonably estimate the amount of the expenses; however, one taxpayer, a law school graduate and a tax-return preparer, was not entitled to such relief. She said she couldn't produce any documentary evidence at trial because the records wouldn't fit in her car ( Browne v. Commissioner , TC Memo 1998-14).
Settlement or Severance?The president and CEO of a mortgage company was terminated and paid $1.1 million. The taxpayer excluded the payment from his tax return stating it was in settlement of a tort claim related to the injury of his personal reputation. The Tax Court found the income taxable as a form of severance pay ( John R. Wise, et ux. v. Commissioner , TC Memo. 1998-4).
It Doesn't Just Happen!Business start-up expenses are not amortizable unless a taxpayer makes the right election to amortize them. Once the election is made, these expenditures are written off over a period of 60 months or more, beginning with the month when the active trade or business begins. Proposed regulations have been issued under IRC section 195 simplifying this election process (Reg-209373-81).
Have You Checked the Contract for method?New temporary and proposed regulations (TD 8756; Reg-120200-97) explain how manufacturers and construction contractors using the percentage-of-completion method of accounting can elect not to apply the "lookback" method to long-term contracts. The election is available for contracts completed in tax years ending after August 5, 1997. However, unless the IRS consents to a revocation, the election applies to all long-term contracts completed during and after the election year.
Take Stock in These RulingsIRC section 4530(k)(2)(A) prevents taxpayers from using the installment method of accounting to report gains from the sale of stock and other securities that are regularly traded on a securities exchange. However, in a series of private rulings, the IRS has allowed the installment method to apply if the taxpayer can show that the stock cannot be sold in an established market due to federal securities law restrictions (letter rulings 9803009, 9803021 and 9803022).
Cleanup InfoTaxpayers with a proposed environmental cleanup plan can now request written guidance from the IRS on deducting or capitalizing related costs (revenue procedure 98-17, 1998-5 IRB).
Driving DeductionsThe optional standard mileage rate for 1998 for the business use of your automobile is 32.5 cents per mile. A deduction of 12 cents per mile is allowed for the charitable use of your car and 10 cents per mile if your car is used for moving or medical reasons (revenue procedure 97-58).
—Michael Lynch, CPA, Esq., associate professor of tax accounting at Bryant College, Smithfield, Rhode Island.
BUSINESS/INDUSTRYIRS Guidance on Environmental Cleanup Projects
For a two-year period that began on February 2, 1998, taxpayers may seek written guidance from the IRS on the capitalization or deductibility of environmental cleanup costs incurred during multiyear projects under revenue procedure 98-17 (1998-5 IRB 1). This new procedure is similar to one the IRS proposed last year (revenue procedure 97-7, 1997-1, IRB 8). Generally, 98-17 removes some procedural impediments to resolving all of the tax issues associated with an environmental remediation project.
The environmental cleanup guidance could cover years for which a return has been filed, is under examination or is before an IRS appeals office. It also could cover future years. The IRS will not provide guidance, however, if the taxpayer (or a related party) is litigating the issue under discussion.
The written guidance applies only to the costs of activities that the
taxpayer describes in its request for a ruling. These may include
costs for assessment, mitigation, removal or remediation of
environmental hazards, whether latent or imminent, on the taxpayer's
property or other property. An environmental cleanup project may
consist of one or more related cleanup activities, such as
- Studying, remediating and monitoring soil and groundwater at a
former manufacturing site.
- Removing and replacing asbestos in manufacturing equipment located
at several of the taxpayer's operating plants.
- Removing underground storage tanks, treating contaminated soil and groundwater, and removing asbestos from a retail facility where the taxpayer intends to begin operations.
Observation : Revenue procedure 98-17 signals that it is the IRS's intention to continue addressing capitalization issues one by one, taxpayer by taxpayer. The IRS has resisted suggestions that it issue "generic" guidance on distinguishing between costs that may be deducted on a current basis and those that should be capitalized. But, environmental remediation would be particularly amenable to broad guidance as projects tend to have similar characteristics.
Generally, the procedure set forth in 98-17 allows taxpayers to obtain unified consideration of issues that otherwise might be dealt with on a piecemeal basis as federal income tax returns are audited. A company undertaking an expensive remediation project may welcome this opportunity to put the tax issues to rest early. Some may want to first explore the benefits of this procedure, possibly by using the pre-submission conference procedure announced by the IRS last spring.
—Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.
Interest Expense Incurred in Property Settlement Is
IRC section 1041 provides that a taxpayer recognize no gain or loss on property settlement transfers that are incident to a divorce. Instead, these transfers are treated as gifts with the recipient taking a carryover basis. Because of liquidity and cash flow problems, property settlements may involve multiyear transfers, promissory notes and loans. If a taxpayer incurs interest expense related to such transfers, can he or she deduct that interest?
As part of a divorce settlement, John Seymour received stock, real estate and the family residence. In return, he transferred to his former spouse cash plus a $625,000 note payable in semiannual installments over 10 years, with interest. On his tax return, Seymour deducted the interest as part investment interest and part qualified residence interest. Relying on the interest allocation rules of temporary regulations section 1.163-8T, he argued he was entitled to allocate the debt related to the assets he had received and to deduct the interest expense accordingly.
The IRS denied the interest expense deduction, arguing that all interest was nondeductible personal interest since section 1041 treats the settlement transaction as a gift.
Result : For the taxpayer. The Tax Court pointed out that in Gibbs (TC memo 1997-196) it previously had held that interest received as part of a property settlement was includable in income. The interest was not excludable under section 1041 because that section applies only to the gain or loss on property transfers, not to separately stated interest income. This conclusion is consistent with IRS notice 88-74, and private letter rulings 8928010 and 9031022, which say that section 1041 does not prohibit a taxpayer from taking an interest expense deduction if the debt was incurred to acquire a residence. Therefore, the interest expense Seymour incurred on the note he transferred to his spouse may result in deductible interest depending on the assets received.
To determine the deductible portion, a taxpayer must first allocate the debt to the residence, if appropriate. This would be the case if the taxpayer incurred the debt to acquire or improve the residence and the note is secured by the residence itself. The fact that it may be subordinated to an existing mortgage is immaterial. After allocating the debt to the residence, any remaining debt is allocated to other property the taxpayer receives. Then, each property should be examined to determine if it qualifies as investment property or as a passive activity. To the extent it does, the interest is deductible. The remainder is nondeductible personal interest.
Taxpayers attempting to deduct interest must be able to point to a
note or agreement that specifically requires an interest payment. The
fact that the property settlement occurs over several years will not
permit the taxpayer to impute interest expense, except in very unusual
John L. Seymour v. Commissioner , 109 TC no. 14,
Prepared by Edward Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa .