Comments Submitted to the President’s Economic Recovery ...



AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

Comments Submitted to the

President’s Economic Recovery Advisory Board

Tax Reform Subcommittee Public Hearing

October 16, 2009

Contact Information:

Edward S. Karl, CPA

American Institute of Certified Public Accountants

1455 Pennsylvania Avenue, NW

Washington, DC 20006

(202) 434-9228

ekarl@

Introduction

The American Institute of Certified Public Accountants thanks the President’s Economic Recovery Advisory Board, Tax Reform Subcommittee for the opportunity to appear at today’s hearing. I am Barry Melancon, AICPA’s President and CEO. The AICPA is the national, professional organization of certified public accountants comprised of approximately 360,000 members. Our members, in public practice work in 44,000 accounting firms, advise clients on federal, state, and international tax matters, and prepare income and other tax returns for millions of Americans. They provide services to individuals, not-for-profit organizations, large and medium-sized businesses, as well as America’s small businesses. The information I will share with you today is the output of 25,000 of our members who devote significant time in tax practice as evidenced by their membership in our Tax Section. Specifically, our 15 technical tax committees and 200 CPA volunteers who serve on them have consistently supported the protection of the public interest and prohibitions on the misuse of our tax system. Indeed, the AICPA has a longstanding record of support for increased and more effective IRS enforcement efforts, as well as enhanced appropriations for the Service. It is from this broad base of experience, and years of a balanced approach, that we offer our comments today.

The AICPA also has a longstanding track record of establishing high professional standards for our CPA members, including the AICPA Code of Professional Conduct and our enforceable Statements on Standards for Tax Services. These standards provide meaningful guidance to CPA members in the performance of their professional responsibilities. We believe the AICPA’s focus on professional standards contributes to the public awareness of the professionalism that is associated with CPAs, as well as the AICPA.

Principles of Good Tax Policy

Every year, discussions take place among politicians, economists, tax practitioners, and others about making changes to federal and state tax systems. Some proposed changes would make fundamental changes, for example, by replacing the federal income tax with a consumption tax. Other proposals would alter the existing federal tax system by adding or expanding tax incentives to encourage savings; modernizing the international tax rules to better address today’s global economy; or making procedural changes to improve compliance.

Every suggestion to modify tax rules – whether major or minor – raises a common series of questions on how to best analyze and compare proposals. As part of its efforts to promote sound tax policy, the AICPA has published four Tax Policy Concept Statements which discuss various principles of good tax policy. The full text of these statements has been furnished to the Tax Reform Subcommittee staff. I urge you to take these statements into account in your development of tax simplification proposals.

Tax Policy Concept Statement No. 1: Guiding Principles of Good Tax Policy: A Framework for Evaluating Tax Proposals, lays out a framework for evaluating tax reform proposals. The AICPA recommends employing the following, widely recognized indicators of good tax policy to analyze proposed changes, whether to a single regulation or an entire tax system. These ten guiding principles of good tax policy are equally important, and should be considered separately and together when evaluating the impact of the current system and reform proposals.

1. Equity and Fairness. Similarly situated taxpayers should be taxed similarly.

2. Certainty. The tax rules should clearly specify when the tax is to be paid, how it is to be paid, and how the amount to be paid is to be determined.

3. Convenience of Payment. A tax should be due at a time or in a manner that is most likely to be convenient for the taxpayer.

4. Economy in Collection. The costs to collect a tax should be kept to a minimum for both the government and taxpayers.

5. Simplicity. The tax law should be simple so that taxpayers understand the rules and can comply with them correctly and in a cost-efficient manner.

6. Neutrality. The effect of the tax law on a taxpayer’s decisions as to how to carry out a particular transaction or whether to engage in a transaction should be kept to a minimum.

7. Economic Growth and Efficiency. The tax system should not impede or reduce the productive capacity of the economy.

8. Transparency and Visibility. Taxpayers should know that a tax exists and how and when it is imposed upon them and others.

9. Minimum Tax Gap. A tax should be structured to minimize noncompliance.

10. Appropriate Government Revenues. The tax system should enable the government to determine how much tax revenue will likely be collected and when.

Simplification

I do understand that simplification is a major focus for the Tax Reform Subcommittee. The AICPA has long been an advocate for simplification and fairness in the tax law. Although it may be impossible to remove all complexity from our tax laws, a significant amount of simplification is achievable and would be beneficial for individual taxpayers, businesses, the federal government, and the economy. In particular, we see significant problems for small businesses arising from the increasing complexity of the tax law. For example:

• A growing number of taxpayers perceive the tax law to be unfair;

• It greatly impedes the continuing efforts of the Internal Revenue Service to administer and enforce the tax law;

• The cost of compliance for small businesses is increasing; and

• Complexity interferes with economic decision making for small businesses.

The end result is the erosion of voluntary compliance. By and large, small businesses obey the law, but it is only human nature to inadvertently disobey a law if you do not or cannot understand the rules. The dynamic American economy is changing and moving rapidly against an unnecessarily cumbersome and, in some areas, outdated income tax system.

There are various types of simplification that if enacted would update the existing tax system, such as: (1) simplification that reduces calculation complexity; (2) simplification that reduces the filing burden; and, (3) simplification that reduces the chances of a dispute between the IRS and the taxpayer. The first two types of simplification are sometimes the easiest to identify and fix, although sometimes the repairs involve hard choices. Computers help. Forms help. But this is not just about math. The last type of problem, adding certainty to the law and thereby reducing the likelihood of disputes, is the most difficult to effectuate yet, perhaps, the most important. Clarifying law that is hard to understand must be a priority if we are to achieve a simpler system.

With that in mind, we ask that you seriously consider the Guiding Principles for Tax Simplification set forth in Tax Policy Concept Statement No. 2 when developing your proposals.

Those principles include:

1. Seeking the simplest and most transparent approaches to implementing desired policy or objectives.

2. Minimizing compliance costs in terms of both time and money, to be commensurate with the resources and abilities of the affected taxpayers.

3. Reducing the frequency of changes in the tax law.

4. Using consistent concepts and definitions.

5. Considering the ability of the IRS to administer, provide guidance on, and enforce the laws.

6. Avoiding tax laws that apply only to a limited set of taxpayers or for a short period of time.

Tax Reform Alternatives for the 21st Century

We are committed to helping make our tax system as simple and fair as possible. As mentioned before, we believe that the law’s complexity in certain key areas unfortunately may be strangling voluntary compliance; for example, such as due to the corporate and alternative minimum taxes. The lack of deliberation in the legislative process, the frequent law changes in recent years, and the increasing magnitude and complexity of the Internal Revenue Code creates serious compliance issues for small businesses.

Tax Reform Alternatives for the 21st Century, which has also been provided to the staff, is a recently updated and released AICPA publication developed to serve as a resource to those engaged or interested in the current tax reform debate. Its objectives are to provide policymakers and interested individuals with a clear understanding of the issues and alternatives involved in federal tax reform and to foster informed discussion by providing unbiased information and analysis. This report describes the nature of the issues leading to a tax reform debate, suggests a balanced approach for analyzing tax reform proposals, and summarizes key issues to be addressed.

We do understand that any serious consideration of tax reform undertaken in the near future will by necessity be influenced by the issues currently facing the country. The United States is anticipating significant events that have begun to impact federal tax revenues:

1. The baby boom generation is starting to retire, placing additional burdens on already strained entitlement programs including those where the costs of providing for health care continue to increase.

2. The 2001 and 2003 tax cuts will expire in 2010, generating additional government revenues without corresponding examination of appropriate and fair tax burdens.

3. The reach of the alternative minimum tax will grow exponentially, subjecting millions of taxpayers to unintended, higher levels of taxation, requiring more and more costly adjustments to limit its effect to the intended taxpayer group.

4. Revenue needs will increase substantially to address historic levels of debt and annual deficits as a result of recent economic challenges.

The debate over the appropriate levels of federal deficits and national debt—and thus, the appropriate levels of federal revenues and spending—is far from settled. These events and concerns, along with a raft of long standing criticisms of our current tax system, provide the impetus for undertaking consideration of federal tax reform.

Current economic conditions as well as future revenue needs will affect the debate on tax reform alternatives, as some options may become relatively more feasible and attractive while others may present challenges too great to overcome or unacceptable levels of risk of further economic disruption. The report discusses the three general approaches to tax reform that have emerged over time: (1) improving the current system through revisions without changing the system’s fundamental character as an income tax having significant consumption tax elements; (2) replacing the entire current tax system (or major parts of it) with a new system of taxation, such as a consumption tax; and (3) revising the current system and also adding a consumption tax. Transitional issues also are addressed.

It is our understanding that your Tax Reform Subcommittee will only consider proposals falling in the first approach to tax reform – i.e., proposals for revising the current system, not adopting alternative structures. Chapter 4 of the report addresses that approach.

The AICPA does not take a position on the best possible solution to reforming the current federal income tax system. We do, however, encourage an in-depth debate of the issues, undertaken through an organized and logical process, with the goal of enacting good tax policy reforms in the near future. As the Administration and Congress consider federal tax reform, the unifying goals should be established now to make the effort one that is rational, thoughtful, and lasting. We recommend that the ten guiding principles of good tax policy that I discussed earlier be used as a basis for analyzing proposals.

Legislative Proposals

In addition to the broader policy concepts that we promote, the AICPA is also actively pursuing or has published positions on a number of tax legislative proposals. Most pertinent to your simplification charge are the proposals regarding simplification of the individual alternative minimum tax (AMT) and the reform of the estate and gift system.

Alternative Minimum Tax

The AICPA recognizes that eliminating the individual AMT, although preferable, may not be feasible because of the large revenue loss likely to result. As a result, the AICPA proposes thirteen alternative solutions, each one of which would reduce some of the complexity and unfair impact of the AMT as currently imposed. The full text of our proposal has been provided.

The alternative solutions include:

1. Exempt all taxpayers with regular tax AGIs under $100,000 from AMT.

2. Increase and index for inflation the AMT brackets and exemption amounts, and eliminate phase-outs.

3. Allow for AMT purposes, as are allowed for regular income tax purposes, the same:

• standard deduction and personal and dependency exemptions;

• miscellaneous itemized deductions (so that, for example, middle income taxpayers are able to deduct such items as employee business expenses for AMT);

• medical expense deductions; and

• deduction for state and local income and other taxes.

4. Allow tax credits enacted to promote important public goals – such as the low-income tax credit, tuition tax credits, etc. – to be credited against AMT liabilities.

5. Have only one AMT tax rate and set that rate to below the third lowest regular tax rate of 25 percent.

6. Require the impact of AMT on future tax legislation (i.e., whether the intended tax benefits of any change are negated by the AMT regime) to be reported with the revenue impact of proposed legislation.

7. Allow a minimum tax credit for all AMT, not just AMT attributable to deferral preferences in order to place the individual AMT on parity with the corporate AMT.

8. Liberalize the capital loss limitation rules when calculating AMT associated with incentive stock option (ISO) transactions (e.g., specifically allow a negative basis adjustment for ISO differences to be ordinary rather than capital loss).

9. Eliminate the definition of “qualified housing interest” and allow all deductible residence interest as a deduction for AMT.

10. Exclude AMT from the estimated tax penalty.

Estate and Gift Tax Reform

The AICPA has submitted to Congress, most recently in January 2009, a list of suggested reforms of the current estate and gift tax system that would promote simplification. Many of these suggestions were published and sent to Congress in 2001 as part of the AICPA’s Study on Reform of the Estate and Gift Tax System. That study focused on the complexity of the current system, taxpayer planning and compliance burdens, ease of administration and revenue constraints. The AICPA study remains a timely and relevant analysis of the current transfer tax system and hope it will serve as a valuable resource to you as you consider simplification in the estate and gift tax area. The January 2009 letter and the Study have been provided.

The AICPA recommendations include:

1. Increase (and index for inflation) the exemption to eliminate the filing and tax burdens for all but the very wealthiest Americans.

2. Retain the full step-up in basis for inherited assets and avoid the complexities of carryover basis.

3. Create a uniform exemption amount for estate, gift, and GSTT purposes.

4. Make permanent the technical changes Congress made to the generation-skipping transfer tax (GSTT) in 2001.

5. Reinstate the full state estate tax credit, or provide another mechanism (such as a surtax) that would allow states to uniformly “piggyback” on the federal estate tax.

6. Provide broad-based liquidity relief, rather than targeted relief provisions.

7. Provide portability of the estate, gift and GSTT exemptions to a surviving spouse to simplify estate planning and estate administration for married couples.

Compendium of Legislative Proposals - Simplification and Technical Proposals

In addition to pursuing major legislative proposals such as AMT simplification and estate and gift tax reform, this year the AICPA initiated a project to publish an annual compendium of legislative proposals focused on simplification and technical revisions that should not be controversial. The goal is to promote simplicity and fairness and to correct certain perceived technical problems in the Internal Revenue Code. The first such compendium, released in July 2009, has been provided.

The proposals in the compendium include:

1. Repeal full vesting on partial termination of qualified retirement plans

2. Harmonize and simplify education incentives

3. Simplify the Kiddie Tax

4. Remove cell phones and other personal digital assistants (PDAs) from classification as “listed property”

5. Standardize the allowable mileage rates for business expense, medical expense, and charitable contribution purposes

6. Allow certain attorney fees and court costs as deductions for AGI

7. Revise the due date of the reporting requirements for foreign bank and financial accounts

8. Allow for abatement of a section 6707A penalty if the taxpayer acts reasonably and in good faith

9. Repeal the section 7122(c)(1) requirement to provide a 20 percent partial payment with a lump-sum offer in compromise

10. Amend section 118 to apply to partnerships

11. Allow spouses (and divorced spouses) to transfer partnership suspended losses to one another

12. Allow S Corporations to have nonresident aliens as shareholders, and permit nonresident aliens to be potential current beneficiaries of electing small business trusts

13. Allow estates and trusts to deduct all administrative costs

Civil Tax Penalties

Finally, we would like to raise the fundamental and important role of civil tax penalties. Civil tax penalties should be, above all else, fair. Penalty provisions should be carefully crafted by Congress and sensibly administered by the executive branch to ensure that penalties deter bad conduct without deterring good conduct or punishing the innocent. Targeted, proportionate penalties that clearly articulate standards of behavior and that are administered in an even-handed and reasonable manner encourage voluntary compliance with the tax laws. On the other hand, overbroad, vaguely defined and disproportionate penalties, particularly those administered as part of a system that automatically imposes penalties or that otherwise fails to provide basic due process safeguards, create an atmosphere of arbitrariness and unfairness that is likely to discourage voluntary compliance.

Our tax system depends for its success upon voluntary compliance with the tax laws. “Civil tax penalties should exist for the purpose of encouraging voluntary compliance and not for other purposes, such as the raising of revenue.” Twenty years ago, Congress enacted the Improved Penalty and Compliance Tax Act (IMPACT), which overhauled the then-existing civil tax penalty regime and reiterated that the core goal of penalties is to encourage voluntary compliance. Unfortunately, in the twenty years since IMPACT, numerous penalty provisions have been enacted that are not directed toward, and do not achieve, the core goal of encouraging voluntary compliance. In part, this likely is due to the government’s understandable interest in combating tax shelters. However, this loss of direction also has resulted from ad hoc efforts to craft penalties and an increase in the use of penalties, rather than the substantive tax laws, to drive tax policy.

We are concerned about the current state of civil tax penalties and have offered, in a separately submitted report, some suggestions for improvement. Specifically, we have addressed the following issues:

• The trend away from voluntary compliance as the primary purpose of civil tax penalties;

• The lack of clear standards in some penalties;

• The fact that some penalties are disproportionate both in amount and severity;

• The fact that some penalties are overbroad, deter remedial and other good conduct, and punish innocent conduct;

• The trend toward strict liability;

• An erosion of basic procedural due process;

• Inconsistencies between penalty standards and the role of tax professionals;

• The increase in automated assessment of penalties that can lead to unwarranted assessments;

• The need for better coordination and oversight of penalty administration;

• The bias in favor of asserting penalties;

• The need to improve internal IRS guidance and training; and

• The need for the IRS to increase its efforts to educate taxpayers and tax professionals.

We provided our comments with an eye toward improving overall tax policy and administration. To that end, we strongly encourage an inclusive and transparent framework for approaching this difficult task, similar to the collaborative efforts culminating in IMPACT. We have urged Congress, Treasury and the Internal Revenue Service to work with taxpayers, practitioners, professional organizations and other stakeholders in developing a systematic and thoughtful approach to civil tax penalty reform and penalty administration.

* * * * * * *

Thank you again for the opportunity to appear before you today. We believe the AICPA is uniquely situated to be a constructive resource as you move forward. I would be happy to respond to any questions you may have.

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