DESCRIPTION OF THE CHAIRMAN’S MODIFICATION 

TO THE PROVISIONS OF S. 1321, 

THE “TELEPHONE EXCISE TAX REPEAL ACT OF 2005” 

AND S. 832, 

THE “TAXPAYER PROTECTION AND ASSISTANCE ACT OF 2005” 

Scheduled for Markup 

By the 

SENATE COMMITTEE ON FINANCE 

on June 28, 2006 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

June 28, 2006 

JCX-28-06
 

i 

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. MODIFICATIONS TO THE CHAIRMAN’S MARK....................................................... 2 

A. Modifications to Regulation of Federal Tax Return Preparers 

(item II.C of the Chairman’s Mark).............................................................................. 2 

B. Modification to Regulation of Refund Anticipation Loan Facilitators 

(item II.D of the Chairman’s Mark).............................................................................. 3 

II. IMPROVEMENTS IN TAX ADMINISTRATION AND TAXPAYER 

SAFEGUARDS .................................................................................................................. 4 

A. Waiver of User Fee for Installment Agreements Using Automated Withdrawals ....... 4 

B. Termination of Installment Agreements ....................................................................... 5 

C. Individuals Held Harmless on Improper Levy on Individual Retirement Plan ............ 6 

D. Office of Chief Counsel Review of Offers-In-Compromise......................................... 8 

E. Elimination on Restriction on Offsetting Refunds From Former Residents................. 9 

F. Revisions Relating to Termination of Employment of IRS Employees for 

Misconduct.................................................................................................................. 10 

G. Amend Collection Due Process Procedures for Employment Tax Liabilities............ 11 

H. Extend Time Limit for Contesting IRS Levy ............................................................. 13 

I. Permit the IRS to Require Increased Electronic Filing of Returns Prepared 

by Paid Return Preparers ............................................................................................ 14 

J. Require IRS to Develop Direct Electronic Filing....................................................... 15 

K. Study on Clarifying Recordkeeping Responsibilities................................................. 16 

L. Modification of TIGTA Reporting Requirements ...................................................... 17 

M. Streamline Reporting Process for National Taxpayer Advocate ................................ 18 

N. Whistleblower Reforms .............................................................................................. 19 

O. Allow the Financial Management Service to Retain Transaction Fees from 

Levied Amounts.......................................................................................................... 20 

P. Authorization of Appropriations for Tax Law Enforcement ...................................... 21 

Q. Clarification of Definition of Church Tax Inquiry ..................................................... 22 

R. Notification Requirement for Exempt Entities Not Currently Required to File 

an Annual Information Return.................................................................................... 23 

S. Treat Funds from Indian Tribal Governments as Public Support for Purposes 

of the Public Charity-Private Foundation Classification ............................................ 25 

T. Innocent Spouse.......................................................................................................... 26 

U. Authorization of Appropriations for Tax Law Enforcement Relating to 

Human Trafficking...................................................................................................... 28 

V. Regulation of Payroll Tax Deposit Agents ................................................................. 29 

W. Extension of the Statute of Limitations to File Claims for Refunds Relating 

to Disability Determinations by the Department of Veteran's Affairs........................ 31
 

ii 

III. REFORM OF PENALTIES AND INTEREST ................................................................ 32 

A. Increase Estimated Tax Threshold.............................................................................. 32 

1. Apply one interest rate per estimated tax underpayment period for 

individuals, estates, and trusts............................................................................... 32 

2. Provide that underpayment balances are cumulative............................................ 33 

3. Require 365-day year for all estimated tax interest calculations for 

individuals, estates, and trusts............................................................................... 34 

B. Corporate Estimated Tax ............................................................................................ 35 

C. Increase in Large Corporation Threshold for Estimated Tax Payments..................... 36 

D. Expansion of Interest Netting ..................................................................................... 37 

E. Clarification of Application of Federal Tax Deposit Penalty ..................................... 38 

F. Frivolous Tax Submissions......................................................................................... 39 

G. Understatement of Taxpayer’s Liability by Tax Return Preparers............................. 40 

H. Penalty for Aiding and Abetting the Understatement of Tax Liability ...................... 42 

I. Increase in Criminal Monetary Penalty Limitation for the Underpayment or 

Overpayment of Tax Due to Fraud ............................................................................. 43 

J. Doubling of Certain Penalties, Fines, and Interest on Underpayments Related 

to Certain Offshore Financial Arrangements.............................................................. 45 

K. Increase in Penalty for Bad Checks and Money Orders ............................................. 50 

L. Proposals Relating to Appraisers and Substantial and Gross Overstatement 

of Valuations of Property............................................................................................ 51 

M. Increase the Amounts of Excise Taxes Imposed on Public Charities, Social 

Welfare Organizations, and Private Foundations ....................................................... 55 

N. Penalty for Filing Erroneous Refund Claims.............................................................. 61 

IV. CONFIDENTIALITY AND DISCLOSURE ................................................................... 62 

A. Disclosure to State Officials of Proposed Actions Related to Certain Section 

501(c) Organizations................................................................................................... 62 

B. Collection Activities with Respect to a Joint Return Disclosable to Either 

Spouse Based on Oral Request ................................................................................... 65 

C. Prohibition of Disclosure of Taxpayer Identification Information with Respect 

to Disclosure of Accepted Offers-in-Compromise ..................................................... 66 

D. Compliance By Contractors with Confidentiality Safeguards.................................... 67 

E. Higher Standards for Requests for and Consents to Disclosure ................................. 69 

F. Civil Damage Remedies for Unauthorized Disclosure or Inspection......................... 72 

G. Expanded Disclosure in Emergency Circumstances................................................... 74 

H. Disclosure of Taxpayer Identity for Tax Refund Purposes ........................................ 75 

I. Treatment of Public Records ...................................................................................... 76 

J. Taxpayer Identification Number Matching ................................................................ 78 

K. Form 8300 Disclosures ............................................................................................... 79 

L. Expanded Definition of Return Preparer for Purposes of Sections 6713 and 7216.... 80 

M. Restrict the Use and Disclosure of Taxpayer Information by Return Preparers 

for Nontax Purposes and Offshore Disclosures.......................................................... 82 

V. UNITED STATES TAX COURT MODERNIZATION.................................................. 86 

A. Consolidate Review of Collection Due Process Cases in the Tax Court.................... 86 

B. Confirmation of Tax Court Authority to Apply Equitable Recoupment .................... 88 
 

iii 

C. Extend Authority for Special Trial Judges to Hear and Decide Certain 

Employment Status Cases........................................................................................... 89 

D. Appointment of Tax Court Employees....................................................................... 90 

E. Tax Court Filing Fee................................................................................................... 92 

VI. MISCELLANEOUS ......................................................................................................... 93 

A. Expensing of Broadband Internet Access Expenditures............................................. 93 

B. Exempt Use of Kerosene for Aviation Purposes ........................................................ 96 

C. Declarations on Federal Corporate Income Tax Returns.......................................... 100 

D. Treatment of Professional Employer Organizations as Employers .......................... 101 

E. Require IRS to Promote Estimated Tax Payments Through EFTPS........................ 108 

F. Study of Use of Voluntary Withholding Agreements............................................... 109 

G. Offset of Tax Refunds Against State Court Debts.................................................... 110 

H. Enhancing Tax Court Security.................................................................................. 111 

I. Authorization of Appropriations to Combat the Tax Gap ........................................ 112 

J. Annual Tax Gap Study.............................................................................................. 113 

K. Authorization of Appropriations for Tax Law Enforcement Relating to the 

Hiring and Continued Employment of Undocumented Workers ............................. 114 

L. Repeal of Dollar Limit on Contributions to Qualified Funeral Trusts...................... 115 

M. Permit Administrative Relief for Certain Late Qualified Terminable Interest 

Property Elections..................................................................................................... 116 

N. Exempt Organization Provisions .............................................................................. 117 

1. Disclosure of written determinations.................................................................. 117 

2. Disclosure of internet web site and name under which organization does 

business............................................................................................................... 120 

3. Modification to reporting of capital transactions................................................ 120 

4. Disclosure that Form 990 is publicly available................................................... 121 

5. Expedited review process for certain tax-exemption applications ..................... 121 

6. Extension of declaratory judgment procedures to non-501(c)(3) tax-exempt 

organizations....................................................................................................... 123 

7. Definition of convention or association of churches .......................................... 124 

O. Wireless Telecommunications Property Treated as Qualified Technological 

 Equipment................................................................................................................. 126 

P. Simplification Through Elimination of Inoperative Provisions................................ 128 

VII. REVENUE OFFSET PROVISIONS.............................................................................. 129 

A. Economic Substance Doctrine .................................................................................. 129 

1. Clarification of the economic substance doctrine............................................... 129 

2. Penalty for understatements attributable to transactions lacking economic 

substance, etc. ..................................................................................................... 136 

B. Tax Treatment of Certain Inverted Corporate Entities ............................................. 143 
 

1 

INTRODUCTION 

The Senate Committee on Finance has scheduled a markup of S. 1321, the “Telephone 

Excise Tax Repeal Act of 2005” and S. 832, the “Taxpayer Protection and Assistance Act of 

2005” for June 28, 2006. This document,1

 prepared by the staff of the Joint Committee on 

Taxation, provides a description of the Chairman’s modification to the provisions of S. 1321 and 

S. 832.2

 1

 This document may be cited as follows: Joint Committee on Taxation, Description of the 

Chairman’s Modification to the Provisions of S. 1321, The “Telephone Excise Tax Repeal Act of 2005” 

and S. 832, the “Taxpayer Protection and Assistance Act of 2005” (JCX-28-06), June 28, 2006. 

2

 The provisions of the Chairman’s mark of S. 1321 and S. 832 are described in Joint Committee 

on Taxation, Description of the Chairman’s Mark of S. 1321, the “Telephone Excise Tax Repeal Act of 

2005” and S. 832, the “Taxpayer Protection and Assistance Act of 2005” (JCX-25-06), June 26, 2006. 
 

2

I. MODIFICATIONS TO THE CHAIRMAN’S MARK 

A. Modifications to Regulation of Federal Tax Return Preparers 

(item II.C of the Chairman’s Mark) 

The modification requires the Secretary to accept the credentials of State licensing or 

registration programs for compensated preparers in lieu of testing by the Office of Professional 

Responsibility, to the extent that such State licensing or registration programs are comparable to 

the eligibility requirements established by the Secretary. In addition, the Office of Professional 

Responsibility shall coordinate with the appropriate State in order to collect information 

regarding practitioners that have been disciplined or suspended under State or local rules. 

The modification also imposes a monetary penalty on any person preparing Federal tax 

returns and other tax submissions for compensation who has failed to meet the eligibility or 

renewal requirements for compensated preparers or who has otherwise been suspended from 

practice by the Office of Professional Responsibility. The penalty amount is equal to $1,000 for 

each tax return or other tax submission (e.g., an application for offer-in-compromise) prepared 

during the period such person was not authorized to practice before the Treasury. This penalty 

shall be in addition to other penalties that may be imposed under the Code, such as the penalty 

for failure to furnish an identifying number on a tax return. 

The modification increases the penalties under section 6695 from $50 per return to the 

greater of $500 per return or $1,000. The modification also eliminates the $25,000 annual cap 

on such penalties. 

The modification prohibits any practitioner authorized to practice before the Treasury 

from providing insurance to cover professional fees and other expenses incurred in responding to 

or defending a tax audit. 

The modification requires jurats, signed under penalty of perjury, to be included on any 

form that can or must be submitted to the IRS separate from the taxpayer’s signed tax return 

(e.g., reportable transaction disclosure statements and offer-in-compromise applications). Paid 

preparer information, if applicable, is also required on such forms under the modification. 
 

3

B. Modification to Regulation of Refund Anticipation Loan Facilitators 

(item II.D of the Chairman’s Mark) 

The modification requires the Secretary to terminate the Debt Indicator program 

announced in Internal Revenue Service Notice 99-58.
 

4 

II. IMPROVEMENTS IN TAX ADMINISTRATION 

AND TAXPAYER SAFEGUARDS 

A. Waiver of User Fee for Installment Agreements 

Using Automated Withdrawals 

Present Law

The Code authorizes the IRS to enter into written agreements with any taxpayer under 

which the taxpayer is allowed to pay taxes owed, as well as interest and penalties, in installment 

payments if the IRS determines that doing so will facilitate collection of the amounts owed.3 An 

installment agreement does not reduce the amount of taxes, interest, or penalties owed. 

Generally, during the period installment payments are being made, other IRS enforcement 

actions (such as levies or seizures) with respect to the taxes included in that agreement are held 

in abeyance. 

The IRS charges a user fee if a request for an installment agreement is approved. 

Description of Proposal

The proposal waives the user fee for installment agreements in which the parties agree to 

the use of automated installment payments (such as automated debits from a bank account). 

Effective Date

The proposal applies to agreements entered into on or after the date which is 180 days 

after the date of enactment.

 3

 Sec. 6159. 
 

5 

B. Termination of Installment Agreements 

Present Law

The Code authorizes the IRS to enter into written agreements with any taxpayer under 

which the taxpayer is allowed to pay taxes owed, as well as interest and penalties, in installment 

payments, if the IRS determines that doing so will facilitate collection of the amounts owed.4 An 

installment agreement does not reduce the amount of taxes, interest, or penalties owed. 

Generally, during the period installment payments are being made, other IRS enforcement 

actions (such as levies or seizures) with respect to the taxes included in that agreement are held 

in abeyance. 

Under present law, the IRS is permitted to terminate an installment agreement only if: 

(1) the taxpayer fails to pay an installment at the time the payment is due; (2) the taxpayer fails 

to pay any other tax liability at the time when such liability is due; (3) the taxpayer fails to 

provide a financial condition update as required by the IRS; (4) the taxpayer provides inadequate 

or incomplete information when applying for an installment agreement; (5) the taxpayer’s 

financial condition has significantly changed; or (6) the collection of the tax is in jeopardy.5

Description of Proposal

The proposal grants the IRS authority to terminate an installment agreement when a 

taxpayer fails to timely make a required Federal tax deposit or fails to timely file a tax return 

(including extensions). Under the proposal, the IRS may terminate an installment agreement 

even if the taxpayer remains current with payments under the installment agreement. 

Effective Date

The proposal is effective for failures occurring on or after the date of enactment. 

 4

 Sec. 6159. 

5

 Sec. 6159(b)(2), (3), and (4). 
 

6

C. Individuals Held Harmless on Improper Levy 

on Individual Retirement Plan 

Present Law

Distributions from an individual retirement arrangement (“IRA”) made on account of an 

IRS levy are includible in the gross income of the individual under the rules applicable to the 

IRA subject to the levy. Thus, in the case of a traditional IRA, the amount distributed as a result 

of a levy is includible in gross income except to the extent such amount represents a return of 

nondeductible contributions (i.e., basis). In the case of a Roth IRA, earnings on a distribution are 

excludable from gross income if the distribution is made: (1) after the five-taxable year period 

beginning with the first taxable year for which the individual made a contribution to a Roth IRA; 

and (2) after attainment of age 591⁄2 or on account of certain other circumstances. Amounts 

withdrawn from an IRA due to a levy are not subject to the 10-percent early withdrawal tax, 

regardless of whether the amount is includible in income. 

Present law provides rules under which the IRS returns amounts subject to an incorrect 

levy. For example, amounts withdrawn from an IRA pursuant to a levy are returned to the 

individual owning the IRA in the case of a wrongful levy or if the levy was not in accordance 

with IRS administrative procedures. In the case of a wrongful levy, the IRS is required to pay 

interest on the amount returned to the individual at the overpayment rate. The IRS is not 

required to pay interest if the levy was not in accordance with IRS administrative procedures. 

Present law does not provide special rules to allow an individual to recontribute to an 

IRA amounts withdrawn from an IRA pursuant to a levy and later returned to the individual by 

the IRS (or interest thereon). Thus, if an individual wishes to contribute such returned amounts 

to an IRA, the contribution is subject to the normally applicable rules for IRA contributions. 

Description of Proposal

Under the proposal, an individual is able to recontribute to an IRA amounts withdrawn 

pursuant to a levy and returned by the IRS (and any interest thereon) within 60 days of receipt by 

the individual, without regard to the normally applicable limits on IRA contributions and 

rollovers. The proposal applies to levied amounts returned to the individual because the levy 

(1) was wrongful or (2) is determined to be premature or otherwise not in accordance with 

administrative procedures. The contribution has to be made to the same type of IRA from which 

the amounts were withdrawn. 

Under the proposal, the IRS is required to pay interest on amounts returned to the 

individual at the overpayment rate in the case of a levy that is determined to be premature or 

otherwise not in accordance with administrative procedures (as well as in the case of a wrongful 

levy under present law). Interest paid by the IRS on the amount returned to the individual and 

contributed to the IRA is treated as part of the distribution made from the IRA on account of the 

levy and is not includible in gross income. In addition, any tax attributable to an amount 

distributed from an IRA by reason of a levy is abated if the amount is recontributed to an IRA 

pursuant to the provision. 
 

7

Effective Date

The proposal is effective for levied amounts (and interest thereon) returned to individuals 

after December 31, 2005. 
 

8

D. Office of Chief Counsel Review of Offers-In-Compromise 

Present Law

The IRS has the authority to settle a tax debt pursuant to an offer-in-compromise. IRS 

regulations provide that such offers can be accepted if the taxpayer is unable to pay the full 

amount of the tax liability and it is doubtful that the tax, interest, and penalties can be collected 

or there is doubt as to the validity of the actual tax liability. Offers to compromise tax liabilities 

of $50,000 or more can only be accepted if the reasons for the acceptance are documented in 

detail and supported by a written opinion from the IRS Chief Counsel.6

Description of Proposal

The proposal repeals the requirement that offers to compromise liabilities of $50,000 or 

more must be supported by a written opinion from the IRS Chief Counsel. Under the proposal, 

written opinions must only be provided if the Secretary determines that an opinion from the IRS 

Chief Counsel is required with respect to a compromise. 

Effective Date

The proposal applies to offers-in-compromise submitted or pending on or after the date of 

enactment.

 6

 Sec. 7122. 
 

9

E. Elimination on Restriction on Offsetting Refunds 

From Former Residents 

Present Law

Overpayments of Federal tax may be used to pay past-due child support and debts owed 

to Federal agencies, without the consent of the taxpayer.7 Overpayments of Federal tax may also 

be used to pay specified past-due, legally enforceable State income tax debts, provided that the 

person making the Federal tax overpayment has shown on the Federal tax return for the taxable 

year of the overpayment an address that is within the State seeking the tax offset. 

Description of Proposal

The proposal eliminates the requirement that a person making a Federal tax overpayment 

show on the Federal tax return for the taxable year of the overpayment an address that is within 

the State seeking the tax offset. Accordingly, States may seek to offset refunds from residents of 

their own State as well as any other State to collect specified past-due, legally enforceable State 

income tax debts. 

Effective Date

The proposal is effective on the date of enactment. 

 7

 Sec. 6402. 
 

10

F. Revisions Relating to Termination of Employment 

of IRS Employees for Misconduct 

Present Law

Section 1203 of the IRS Restructuring and Reform Act of 19988

 requires the IRS to 

terminate the employment of an employee for certain proven violations committed by the 

employee in connection with the performance of official duties. The violations include: (1) 

willful failure to obtain the required approval signatures on documents authorizing the seizure of 

a taxpayer’s home, personal belongings, or business assets; (2) providing a false statement under 

oath material to a matter involving a taxpayer; (3) with respect to a taxpayer, taxpayer 

representative, or other IRS employee, the violation of any right under the U.S. Constitution, or 

any civil right established under Titles VI or VII of the Civil Rights Act of 1964, Title IX of the 

Educational Amendments of 1972, the Age Discrimination in Employment Act of 1967, the Age 

Discrimination Act of 1975, sections 501 or 504 of the Rehabilitation Act of 1973 and Title I of 

the Americans with Disabilities Act of 1990; (4) falsifying or destroying documents to conceal 

mistakes made by any employee with respect to a matter involving a taxpayer or a taxpayer 

representative; (5) assault or battery on a taxpayer or other IRS employee, but only if there is a 

criminal conviction or a final judgment by a court in a civil case, with respect to the assault or 

battery; (6) violations of the Internal Revenue Code, Treasury Regulations, or policies of the IRS 

(including the Internal Revenue Manual) for the purpose of retaliating or harassing a taxpayer or 

other IRS employee; (7) willful misuse of section 6103 for the purpose of concealing data from a 

Congressional inquiry; (8) willful failure to file any tax return required under the Code on or 

before the due date (including extensions) unless failure is due to reasonable cause; (9) willful 

understatement of Federal tax liability, unless such understatement is due to reasonable cause; 

and (10) threatening to audit a taxpayer for the purpose of extracting personal gain or benefit. 

Section 1203 also provides non-delegable authority to the Commissioner to determine 

that mitigating factors exist, that, in the Commissioner’s sole discretion, mitigate against 

terminating the employee’s employment. The Commissioner, in his sole discretion, may 

establish a procedure to determine whether an individual should be referred for such a 

determination by the Commissioner. 

Description of Proposal

The proposal removes two items from the list of violations. These two items are: (1) the 

late filing of tax returns claiming an overpayment; and (2) employee versus employee assault or 

battery. The proposal also places the provisions of section 1203 in the Internal Revenue Code. 

The proposal also adds unauthorized inspection of returns and return information to the list of 

violations requiring termination. 

Effective Date

The proposal is effective on the date of enactment.

 8

 Pub. L. No. 105-206. 
 

11 

G. Amend Collection Due Process Procedures for 

Employment Tax Liabilities 

Present Law

Levy is the IRS’s administrative authority to seize a taxpayer’s property to pay the 

taxpayer’s tax liability. The IRS is entitled to seize a taxpayer’s property by levy if a Federal tax 

lien has attached to such property. A Federal tax lien arises automatically where (1) a tax 

assessment has been made, (2) the taxpayer has been given notice of the assessment stating the 

amount and demanding payment, and (3) the taxpayer has failed to pay the amount assessed 

within 10 days after the notice and demand. 

In general, the IRS is required to notify taxpayers that they have a right to a fair and 

impartial collection due process (“CDP”) hearing before levy may be made on any property or 

right to property.9

 Similar rules apply with respect to notices of tax liens, although the right to a 

hearing arises only on the filing of a notice.10 The CDP hearing is held by an impartial officer 

from the IRS Office of Appeals, who is required to issue a determination with respect to the 

issues raised by the taxpayer at the hearing. The taxpayer is entitled to appeal that determination 

to a court. Under present law, taxpayers are not entitled to a pre-levy CDP hearing if a levy is 

issued to collect a Federal tax liability from a State tax refund or if collection of the Federal tax 

is in jeopardy. However, levies related to State tax refunds or jeopardy determinations are 

subject to post-levy review through the CDP hearing process. 

Employment taxes generally consist of the taxes under the Federal Insurance 

Contributions Act (“FICA”), the tax under the Federal Unemployment Tax Act (“FUTA”), and 

the requirement that employers withhold income taxes from wages paid to employees (“income 

tax withholding”).11 Income tax withholding rates vary depending on the amount of wages paid, 

the length of the payroll period, and the number of withholding allowances claimed by the 

employee. 

Description of Proposal

Under the proposal, levies issued to collect Federal employment taxes are excepted from 

the pre-levy CDP hearing requirement. Thus, under the proposal, taxpayers have no right to a 

CDP hearing before a levy is issued to collect employment taxes. As with the present-law 

procedures applicable to levies issued to collect a Federal tax liability from State tax refunds, the 

taxpayer is provided an opportunity for a hearing within a reasonable period of time after the 

levy. Collection by levy is permitted to continue during the CDP proceedings. 

 9

 Sec. 6330(a). 

10 Sec. 6320. 

11 Secs. 3101-3128 (FICA), 3301-3311 (FUTA), and 3401-3404 (income tax withholding). 

FICA taxes consist of an employer share and an employee share, which the employer withholds from 

employees’ wages. 
 

12 

Effective Date

The proposal is effective for levies issued on or after January 1, 2007.
 

13

H. Extend Time Limit for Contesting IRS Levy 

Present Law

The IRS is authorized to return property that has been wrongfully levied upon.12 In 

general, monetary proceeds from the sale of levied property may be returned within nine months 

of the date of the levy. 

Generally, any person (other than the person against whom is assessed the tax out of 

which such levy arose) who claims an interest in levied property and that such property was 

wrongfully levied upon may bring a civil action for wrongful levy in a district court of the 

United States.13 Generally, an action for wrongful levy must be brought within nine months 

from the date of levy.14

Description of Proposal

The proposal extends from nine months to two years the period for returning the 

monetary proceeds from the sale of property that has been wrongfully levied upon. 

The proposal also extends from nine months to two years the period for bringing a civil 

action for wrongful levy. 

Effective Date

The proposal is effective with respect to: (1) levies made after the date of enactment; and 

(2) levies made on or before the date of enactment provided that the nine-month period has not 

expired as of the date of enactment. 

 12 Sec. 6343. 

13 Sec. 7426. 

14 Sec. 6532. 
 

14

I. Permit the IRS to Require Increased Electronic Filing of Returns 

Prepared by Paid Return Preparers 

Present Law

The Code authorizes the IRS to issue regulations specifying which returns must be filed 

electronically.15 There are several limitations on this authority. First, it can only apply to 

persons required to file at least 250 returns during the year.16 Second, the IRS is prohibited from 

requiring that income tax returns of individuals, estates, and trusts be submitted in any format 

other than paper (although these returns may be filed electronically by choice). 

Description of Proposal

The proposal permits the IRS to expand the scope of returns that are prepared by paid 

return preparers and that are required to be filed electronically by removing the present-law 

restrictions relating to the types of tax returns required to be filed electronically and by lowering 

the number of returns that trigger the requirement to file electronically to five. The Committee 

expects the IRS to expand the types of forms and schedules that may be filed electronically to 

permit full implementation of this proposal. 

The proposal also imposes a monetary penalty on any person required to file a return 

electronically that fails to do so. The penalty is equal to the greater of $100 times the number of 

returns not filed electronically as required or $1,000. 

Effective Date

The proposal is effective on the date of enactment.

 15 Sec. 6011(e). 

16 Partnerships with more than 100 partners are required to file electronically. 
 

15

J. Require IRS to Develop Direct Electronic Filing 

Present Law

The IRS has entered into cooperative relationships with commercial return preparation 

services to provide free electronic filing services to eligible low-income or elderly taxpayers. 

This program is called “Free File.” Presently, the IRS does not permit taxpayers to file their tax 

returns electronically without the use of an intermediary. 

Description of Proposal

The proposal requires the Secretary to establish the “Direct e-file Program.” The Direct 

e-file Program is a program that provides individual taxpayers with the ability to electronically 

file their Federal income tax returns through the IRS website without the use of an intermediary 

or with the use of an intermediary with which the IRS contracts to provide free universal access. 

The proposal requires the Secretary to implement the Direct e-file Program for filings for taxable 

years beginning after the date which is not later than three year after the date of enactment. 

Under the proposal, the IRS may develop its own electronic filing products in order to implement 

the Direct e-file Program. 

Under the proposal, the Secretary is required to report to Congress every six months 

regarding the status of the implementation of the Direct e-file Program. In addition, the 

Secretary, in consultation with the National Taxpayer Advocate, is required to report to Congress 

annually on taxpayer usage of the Direct e-file Program. 

The proposal also instructs the IRS to ensure that participating Free File companies do 

not advertise, market, or offer to sell products or services that are not directly related to the 

preparation of a tax return to any taxpayer utilizing Free File. The proposal also requires the IRS 

to establish procedures to encourage companies participating in the Free File Alliance to provide 

for accessible services for the blind. 

The proposal requires the Secretary to provide a report to Congress on the feasibility of 

ensuring that the members of the Free File Alliance that have contracted separately with a State 

to provide free State preparation and filing also be required to provide free electronic filing and 

preparation for that State directly through the IRS Free File website. As part of that report, the 

IRS also should provide the most optimal way of alerting taxpayers on the IRS Free File website 

of those companies that will provide them with free State preparation and filing. 

Effective Date

The proposal is effective on the date of enactment.
 

16

K. Study on Clarifying Recordkeeping Responsibilities 

Present Law

Every person liable for Federal tax must keep records, provide statements, make returns, 

and comply with rules and regulations, as prescribed by the Secretary.17 In general, taxpayers 

are required to keep records for as long as the statute of limitations may be open. 

Description of Proposal

The proposal requires the Secretary of the Treasury to study: 

• The scope of the records required to be maintained by taxpayers; 

• The utility of requiring taxpayers to maintain all records indefinitely; 

• The effects of the necessity to upgrade technological storage for outdated records; 

• The number of negotiated records retention agreements requested by taxpayers 

and the number entered into by the IRS; and 

• Proposals regarding taxpayer recordkeeping. 

The Secretary is required to submit a report of the study to the Congress not later than 

one year after the date of enactment. 

Effective Date

The proposal is effective on the date of enactment.

 17 Sec. 6001. 
 

17

L. Modification of TIGTA Reporting Requirements 

Present Law

The Treasury Inspector General for Tax Administration (“TIGTA”) conducts audits and 

reviews of IRS operations. TIGTA also is statutorily required to report to the Congress (both 

annually and semi-annually) on a number of specific issues. 

Description of Proposal

The proposal repeals the statutory requirement that TIGTA issue the following reports: 

• IRS compliance with the restrictions18 on directly contacting taxpayers who have 

indicated that they prefer that their representatives be contacted. 

• IRS compliance with the requirements relating to disclosure of collection 

information with respect to joint returns. 

• IRS compliance with the fair debt collection provisions of the Code. 

In addition, the proposal requires that all reports currently required to be made annually 

must be provided semi-annually. 

Effective Date

The proposal is effective on the date of enactment.

 18 Sec. 7521. 
 

18 

M. Streamline Reporting Process for National Taxpayer Advocate 

Present Law

The Code requires the National Taxpayer Advocate to produce two reports for the 

Congress each year. The first, due by June 30, reports on the objectives for the office; the 

second, due by December 31, reports on the activities of the office and contains detailed data and 

recommendations in specified areas. 

Description of Proposal

The proposal combines the two reports the National Taxpayer Advocate must produce 

under present law into one, due by December 31. The proposal also provides that the National 

Taxpayer Advocate, in his or her sole discretion, may report to the Congress at any time on any 

significant issues affecting taxpayer rights. 

Effective Date

The proposal combining the reports is effective for reports in 2007 and thereafter. The 

proposal authorizing reports on significant issues affecting taxpayer rights is effective on the date 

of enactment. 
 

19 

N. Whistleblower Reforms 

Present Law

The Code authorizes the IRS to pay such sums as deemed necessary for: “(1) detecting 

underpayments of tax; and (2) detecting and bringing to trial and punishment persons guilty of 

violating the Internal Revenue laws or conniving at the same.”19 Amounts are paid based on a 

percentage of tax, fines, and penalties (but not interest) actually collected based on the 

information provided. For specific information that caused the investigation and resulted in 

recovery, the IRS administratively has set the reward in an amount not to exceed 15 percent of 

the amounts recovered. For information, although not specific, that nonetheless caused the 

investigation and was of value in the determination of tax liabilities, the reward is not to exceed 

10 percent of the amount recovered. For information that caused the investigation, but had no 

direct relationship to the determination of tax liabilities, the reward is not to exceed one percent 

of the amount recovered. The reward ceiling is $10 million (for payments made after November 

7, 2002), and the reward floor is $100. No reward will be paid if the recovery was so small as to 

call for payment of less than $100 under the above formulas. Both the ceiling and percentages 

can be increased with a special agreement. The Code permits the IRS to disclose return 

information pursuant to a contract for tax administration services.20

Description of Proposal

The proposal reforms the reward program for individuals who provide information 

regarding violations of the tax laws to the Secretary. Generally, the proposal establishes a 

reward floor of 15 percent of the collected proceeds (including penalties, interest, additions to tax 

and additional amounts) if the IRS moves forward with an administrative or judicial action based 

on information brought to the IRS’s attention by an individual. The proposal caps the available 

reward at 30 percent of the collected proceeds. The proposal permits awards of lesser amounts 

(but no less than 10 percent) if the action was based principally on allegations (other than 

information provided by the individual) resulting from a judicial or administrative hearing, 

government report, hearing, audit, investigation, or from the news media. 

The proposal creates a Whistleblower Office within the IRS to administer the reward 

program. The Whistleblower Office may seek assistance from the individual providing 

information or from his or her legal representative, and may reimburse the costs incurred by any 

legal representative out of the amount of the reward. To the extent the disclosure of returns or 

return information is required to render such assistance, the disclosure must be pursuant to an 

IRS tax administration contract. 

Effective Date

The proposal is effective for information provided on or after the date of enactment.

 19 Sec. 7623. 

20 Sec. 6103(n). 
 

20

O. Allow the Financial Management Service to Retain 

Transaction Fees from Levied Amounts 

Present Law

To facilitate the collection of tax, the IRS can generally levy upon all property and rights 

to property of a taxpayer.21 With respect to specified types of recurring payments, the IRS may 

impose a continuous levy of up to 15 percent of each payment, which generally continues in 

effect until the liability is paid.22 Continuous levies imposed by the IRS on specified Federal 

payments are administered by the Financial Management Service (FMS) of the Department of 

the Treasury. FMS is generally responsible for making most non-defense related Federal 

payments. FMS is required to charge the IRS for the costs of developing and operating this 

continuous levy program. The IRS pays these FMS charges out of its appropriations. 

Description of Proposal

The proposal allows FMS to retain a portion of funds levied under continuous levies as 

payment of FMS charges for the continuous levy program. The amount credited to the 

taxpayer’s account is not, however, reduced by the amount retained by FMS. 

Effective Date

The proposal is effective on the date of enactment. 

 21 Sec. 6331. 

22 Sec. 6331(h). 
 

21

P. Authorization of Appropriations for Tax Law Enforcement 

Present Law

There is no explicit authorization of appropriations to the Internal Revenue Service to be 

used to combat abusive tax avoidance transactions. 

Description of Proposal

The proposal includes an authorization of an additional $300 million to the Internal 

Revenue Service to be used to combat abusive tax avoidance transactions. 

Effective Date

The proposal is effective on the date of enactment. 
 

22

Q. Clarification of Definition of Church Tax Inquiry 

Present Law

Under present law, the IRS may begin a church tax inquiry only if an appropriate highlevel Treasury official reasonably believes, on the basis of the facts and circumstances recorded 

in writing, that an organization (1) may not qualify for tax exemption as a church, (2) may be 

carrying on an unrelated trade or business, or (3) otherwise may be engaged in taxable 

activities.23 A church tax inquiry is defined as any inquiry to a church (other than an 

examination) that serves as a basis for determining whether the organization qualified for tax 

exemption as a church or whether it is carrying on an unrelated trade or business or otherwise is 

engaged in taxable activities. An inquiry is considered to commence when the IRS requests 

information or materials from a church of a type contained in church records, other than routine 

requests for information or inquiries regarding matters that do not primarily concern the tax 

status or liability of the church itself. 

Description of Proposal

The proposal clarifies that present-law church tax inquiry procedures do not apply to 

contacts made by the IRS for the purpose of educating churches with respect to the Federal 

income tax law governing tax-exempt organizations. For example, the IRS does not violate the 

church tax inquiry procedures when written materials are provided to a church or churches for 

the purpose of educating such church or churches with respect to the types of activities that are 

not permissible under section 501(c)(3). 

Effective Date

The proposal is effective on the date of enactment.

 23 Sec. 7611. 
 

23 

R. Notification Requirement for Exempt Entities Not Currently 

Required to File an Annual Information Return 

Present Law

Under present law, the requirement that an exempt organization file an annual 

information return does not apply to several categories of exempt organizations. Organizations 

excepted from the filing requirement include organizations (other than private foundations), the 

gross receipts of which in each taxable year normally are not more than $25,000.24 Also exempt 

from the requirement are churches, their integrated auxiliaries, and conventions or associations 

of churches; the exclusively religious activities of any religious order; section 501(c)(1) 

instrumentalities of the United States; section 501(c)(21) trusts; an interchurch organization of 

local units of a church; certain mission societies; certain church-affiliated elementary and high 

schools; certain State institutions whose income is excluded from gross income under section 

115; certain governmental units and affiliates of governmental units; and other organizations that 

the IRS has relieved from the filing requirement pursuant to its statutory discretionary authority. 

Description of Proposal

The proposal requires organizations that are excused from filing an information return by 

reason of normally having gross receipts below a certain specified amount (generally, under 

$25,000) to furnish to the Secretary annually, in electronic form, the legal name of the 

organization, any name under which the organization operates or does business, the 

organization’s mailing address and Internet web site address (if any), the organization’s taxpayer 

identification number, the name and address of a principal officer, and evidence of the 

organization’s continuing basis for its exemption from the generally applicable information 

return filing requirements. Upon such organization’s termination of existence, the organization 

is required to furnish notice of such termination. 

The proposal provides that if an organization fails to provide the required notice for three 

consecutive years, the organization’s tax-exempt status is revoked. In addition, if an 

organization that is required to file an annual information return under section 6033(a) (Form 

990) fails to file such an information return for three consecutive years, the organization’s taxexempt status is revoked. If an organization fails to meet its filing obligation to the IRS for three 

consecutive years in cases where the organization is subject to the information return filing 

requirement in one or more years during a three-year period and also is subject to the notice 

requirement for one or more years during the same three-year period, the organization’s taxexempt status is revoked. 

 24 Sec. 6033(a)(2); Treas. Reg. sec. 1.6033-2(a)(2)(i); Treas. Reg. sec. 1.6033-2(g)(1). Sec. 

6033(a)(2)(A)(ii) provides a $5,000 annual gross receipts exception from the annual reporting 

requirements for certain exempt organizations. In Announcement 82-88, 1982-25 I.R.B. 23, the IRS 

exercised its discretionary authority under section 6033 to increase the gross receipts exception to 

$25,000, and enlarge the category of exempt organizations that are not required to file Form 990. 
 

24 

A revocation under the proposal is effective from the date that the Secretary determines 

was the last day the organization could have timely filed the third required information return or 

notice. To again be recognized as tax-exempt, the organization must apply to the Secretary for 

recognition of tax-exemption, irrespective of whether the organization was required to make an 

application for recognition of tax-exemption in order to gain tax-exemption originally. 

If, upon application for tax-exempt status after a revocation under the proposal, the 

organization shows to the satisfaction of the Secretary reasonable cause for failing to file the 

required annual notices or returns, the organization’s tax-exempt status may, in the discretion of 

the Secretary, be reinstated retroactive to the date of revocation. An organization may not 

challenge under the Code’s declaratory judgment procedures (section 7428) a revocation of taxexemption made pursuant to the proposal. 

There is no monetary penalty for failure to file the notice under the proposal. The 

proposal requires that the notices be made available to the public under the public disclosure and 

inspection rules generally applicable to exempt organizations. The proposal does not affect an 

organization’s obligation under present law to file required information returns or existing 

penalties for failure to file such returns. 

The Secretary is required to notify every organization that is subject to the notice filing 

requirement of the new filing obligation in a timely manner. Notification by the Secretary shall 

be by mail, in the case of any organization the identity and address of which is included in the 

list of exempt organizations maintained by the Secretary, and by Internet or other means of 

outreach, in the case of any other organization. In addition, the Secretary is required to publicize 

in a timely manner in appropriate forms and instructions and other means of outreach the new 

penalty imposed for consecutive failures to file the information return. 

The Secretary is authorized to publish a list of organizations whose exempt status is 

revoked under the proposal. 

Effective Date

The proposal is effective for notices and returns with respect to annual periods beginning 

after 2006. 
 

25 

S. Treat Funds from Indian Tribal Governments as Public Support for Purposes 

of the Public Charity-Private Foundation Classification 

Present Law

Organizations described in section 501(c)(3) are classified either as public charities or 

private foundations. The public charity classification generally is based on an organization’s 

sources of support. Support from governmental entities is considered as public support in 

determining whether an organization is publicly or privately supported and thus is classified as a 

public charity or a private foundation. Support from an Indian Tribal Government is not treated 

as support from a governmental entity. 

Description of Proposal

The proposal provides that support from an Indian Tribal Government is treated as 

support from a State for purposes of determining whether an organization described in section 

501(c)(3) is classified as a public charity or a private foundation. 

Effective Date

The proposal applies to support received before, on, or after the date of enactment and to 

the determination of the status of any organization with respect to any taxable year beginning 

after the date of enactment. 
 

26 

T. Innocent Spouse 

Present Law

Generally, a husband and wife are liable jointly and individually for the entire tax on a 

joint return. Under certain circumstances, a spouse may be entitled to relief from joint and 

several liability, “innocent spouse relief.” Generally, the spouse must elect the form of innocent 

spouse relief no later than two years after the date the IRS began collection activities against the 

electing spouse. 

There are three types of relief, general innocent spouse relief, relief for spouses no longer 

married or legally separated (separation of liabilities), and equitable relief. 

For general relief, the electing spouse must have 

• Filed a joint return which has an understatement of tax due to the erroneous items of 

the other spouse, 

• Establish that at the time of signing the return the electing spouse did not know or 

have reason to know there was an understatement of tax, and 

• Taking into account all the facts and circumstances, show that it is inequitable to hold 

the electing spouse liable for the deficiency in tax. 

For separation of liabilities relief, the electing spouse 

• Must have filed a joint return and, 

• Either (1) is no longer married to or is legally separated from the spouse with whom 

the return was filed or (2) must not have been a member of the same household with 

the spouse for a 12-month period. 

If an individual fails to qualify under the preceding two options, such individual may still 

be able to obtain equitable relief. To obtain equitable relief, the IRS must determine that taking 

into account all of the facts and circumstances, it is inequitable to hold the electing spouse liable 

for any unpaid tax or any deficiency in tax (or any portion or either). 

In the case of an individual against whom a deficiency has been asserted and elects to 

have the general relief provisions or the separation of liabilities relief provisions apply, such 

individual may petition the Tax Court to review the IRS’s determinations. 

Description of Proposal

The proposal clarifies that the Tax Court has jurisdiction over equitable relief claims, 

even if the individual does not elect to have the general relief or separation of liabilities relief 

provisions apply. The proposal also suspends collection activity during the period a request for 

equitable relief is pending. 
 

27 

Effective Date

The proposal applies to requests for equitable relief with respect to liability for taxes 

which are unpaid on or after the date of enactment. 
 

28

U. Authorization of Appropriations for Tax Law Enforcement 

Relating to Human Trafficking 

Present Law

IRS undercover operations are statutorily exempt from the generally applicable 

restrictions controlling the use of Government funds (which generally provide that all receipts 

must be deposited in the general fund of the Treasury and all expenses be paid out of 

appropriated funds). In general, the Code permits the IRS to use proceeds from an undercover 

operation to pay additional expenses incurred in the undercover operation, through 2006. The 

IRS is required to conduct a detailed financial audit of large undercover operations in which the 

IRS is churning funds and to provide an annual audit report to the Congress on all such large 

undercover operations. 

There is no explicit authorization of appropriations to the Internal Revenue Service to be 

used to combat tax crimes where the underlying income is derived from sex trafficking crimes. 

Description of Proposal

The proposal authorizes the IRS to use $2 million toward the establishment of an office 

in IRS Criminal Investigation to investigate unlawful sex traffickers for violations of tax laws. 

The Committee intends that the office will coordinate closely with the existing task forces in the 

Department of Justice that are focused on sex trafficking offenders. The proposal allows the 

office to use amounts collected from human sex traffickers for violations of tax laws for 

additional enforcement activities. It is the committee’s intent that the IRS will focus on the 

employer/employee relationship in these cases and the resulting failure of the trafficker to file 

information reporting returns required under the existing rules applicable to employers and other 

payors. 

The proposal requires the Secretary to report to Congress within one year of the date of 

enactment on enforcement activities related to tax violations of sex traffickers. 

The proposal also modifies the whistleblower reward provisions so that the victims of 

human trafficking will be eligible to participate in the program. 

Effective Date

The proposal is effective on the date of enactment. 
 

29 

V. Regulation of Payroll Tax Deposit Agents 

Present Law

Taxpayers may choose to fulfill their payroll tax obligations using payroll tax deposit 

agents. In general, these payroll tax deposit agents are not required to register or post bonds with 

the IRS. Persons required to collect and pay over taxes to the IRS who fail to do so are subject to 

penalty. 

Description of Proposal

First, the proposal requires the annual registration of payroll tax deposit agents with the 

IRS. The annual registration fee shall not exceed $100. A payroll tax deposit agent is defined as 

any person which provides payroll processing or tax filing and deposit services to one or more 

employers (other than an employer working on its own behalf) if such person has the contractual 

authority to access such employer’s funds for the purpose of making employment tax deposits. 

A payroll tax deposit agent does not include a person who only transfers such funds (regardless 

of whether they have the right to determine the amount of such transfer) and does not have the 

authority to impound such funds for such purpose. 

Second, the proposal also provides that payroll tax deposit agents must elect either to: (1) 

post a reasonable bond or (2) submit to an annual audit. If the payroll tax deposit agent elects to 

post a bond, then the amount of such bond shall not be less than $50,000 nor more than $500,000 

and shall be determined with respect to each payroll tax deposit agent under regulations. Any 

bond or security shall be in such form and with such surety or sureties as may be prescribed by 

regulations. If the payroll tax deposit agent elects to submit to an annual audit, then the audit 

shall be performed by an independent third party and shall be based on such audit principles as 

the Secretary deems necessary. In all cases the audits shall confirm that: (1) the escrow account 

in which the payroll tax deposit agent holds the employers’ taxes is balanced annually to the total 

of the quarterly reconciliation statements; (2) the escrow account funds are not commingled with 

the agent’s operating funds; (3) no escrow account funds are used to pay the agent’s operating 

expenses; and (4) there is receipt evidence that the agent paid the required taxes for the 

employers to the proper government employment tax authorities. 

Third, the proposal directs the Secretary to require payroll tax deposit agents to disclose 

to each potential and existing client: (1) the client’s continuing liability for payment of all 

Federal and State employment taxes notwithstanding any contractual relationship with a payroll 

tax deposit agent; (2) the mechanisms available to the client to verify the amount and date of 

payment of all tax deposits made by the payroll tax deposit agent on behalf of such client; and 

(3) such information that the Secretary determines necessary or appropriate to assist employers 

in the selection and use of payroll tax deposit agents. These disclosures are required prior to or 

at the time of contracting for payroll services. 

Fourth, the proposal requires payroll tax deposit agents to ensure the direct notification of 

the employer(s) by any Federal or State employment tax authority regarding the nonpayment of 

such employment taxes. 
 

30 

Fifth, the proposal provides penalties (not to exceed $10,000) for unregistered agents 

acting as payroll tax deposit agents with respect to Federal tax deposits for each 90 days of 

noncompliance. 

Sixth, the proposal provides that only persons registered as payroll tax deposit agents 

may: (1) make Federal tax deposits on behalf of an employer; (2) sign and file Federal 

employment tax returns of behalf of a taxpayer; and (3) have access to confidential tax 

information relating to such employer. 

Finally, the proposal clarifies that the penalty for failure to collect and pay over tax 

applies to payroll agents and is not dischargeable in bankruptcy. 

The Secretary is directed to issue such guidance as necessary to carry out these 

provisions. 

Effective Date

Generally the provisions are effective on January 1, 2007. The provision relating to 

penalties for failure to collect and pay over tax is effective for failures occurring after December 

31, 2006.
 

31 

W. Extension of the Statute of Limitations to File Claims for Refunds Relating 

to Disability Determinations by the Department of Veteran’s Affairs 

Present Law

In general, a taxpayer must file a refund claim within three years of the filing of the tax 

return or within two years of the payment of the tax, whichever expires later (if no tax return is 

filed, the two-year limit applies). A refund claim that is not filed within these time periods is 

rejected as untimely. 

Generally, military retirement benefits based on length of service are included in income, 

whereas veterans’ benefits based on a service-connected disability are excluded from income. If 

an individual receives includible retirement benefits and is later retroactively determined to be 

eligible for service-connected disability benefits, the portion of the retirement benefits 

attributable to the disability is retroactively excluded from income. In that case, the individual 

may claim a refund of the tax paid on the retroactively excluded benefits, subject to the statute of 

limitations on filing a refund claim. 

Description of Proposal

The proposal extends the time period for filing refund claims for retired military 

personnel who receive disability determinations from the Department of Veterans Affairs (e.g. 

determinations after the tax return is filed). Specifically, the proposal extends the period for 

filing such a refund claim until one year after the date of the disability determination (if later 

than the time periods allowed under present law). The proposal applies to any taxable year 

which begins 5 years before the date of the determination or thereafter. In the case of a 

determination after December 31, 2000, and on or before the date of enactment, the period for 

filing a refund claim is extended until one year after the date of enactment (if later than the time 

periods allowed under present law). 

Effective Date

The proposal is effective for claims for refunds filed after the date of enactment. 
 

32

III. REFORM OF PENALTIES AND INTEREST 

A. Increase Estimated Tax Threshold 

Present Law

The Federal income tax system is designed to ensure that taxpayers pay taxes throughout 

the year based on their income and deductions. To the extent that tax is not collected through 

withholding, taxpayers are required to make quarterly estimated payments of tax. If an 

individual fails to make the required estimated tax payments under the rules, a penalty is 

imposed under section 6654. The amount of the penalty is determined by applying the 

underpayment interest rate to the amount of the underpayment for the period of the 

underpayment. The amount of the underpayment is the excess of the required payment over the 

amount (if any) of the installment paid on or before the due date of the installment. The period 

of the underpayment runs from the due date of the installment to the earlier of (1) the 15th day of 

the fourth month following the close of the taxable year or (2) the date on which each portion of 

the underpayment is made. The penalty for failure to pay estimated tax is the equivalent of 

interest, which is based on the time value of money. 

Taxpayers are not liable for a penalty for the failure to pay estimated tax when the tax 

shown on the return for the taxable year (or, if no return is filed, the tax), reduced by 

withholding, is less than $1,000. This safe harbor does not apply, however, when a taxpayer has 

paid tax throughout the year solely through estimated tax payments. For such taxpayers, any tax 

shown on the return for the taxable year, net of estimated tax paid, could subject the taxpayer to 

the penalty for failure to pay estimated tax (unless another safe harbor applies). 

Description of Proposal

The threshold for imposing the penalty for failure to pay estimated tax is increased from 

$1,000 to $2,000. 

Effective Date

The proposal is effective for estimated tax payments made for taxable years beginning 

after December 31, 2006. 

1. Apply one interest rate per estimated tax underpayment period for individuals, estates, 

and trusts 

Present Law

The present-law penalty for failure to pay estimated tax is equal to the underpayment 

interest rate multiplied by the number of days the underpayment is outstanding, which is the 

number of days between when the taxpayer should have made the estimated payment and the 

earlier of (1) the 15th day of the fourth month following the close of the taxable year or (2) the 

date on which each portion of the underpayment is made. The interest rate, which equals the 

Federal short-term rate plus three percentage points, is subject to change on the first day of each 

quarter, which is January 1, April 1, July 1, and October 1. 
 

33

If the applicable interest rate change while an underpayment of estimated tax is 

outstanding, then taxpayers are required to make separate calculations for the periods before and 

after the interest rate change. Such calculations generally are needed to cover 15-day periods. 

For example, the July 1 interest rate occurs 15 days after the June 15 payment date (for calendaryear taxpayers). A change in interest rates, which occurs on the first day of each calendar 

quarter, would require the use of different interest rates during one estimated tax underpayment 

period and would increase the number of calculations that a taxpayer must make in calculating a 

penalty for failure to pay estimated tax. 

Description of Proposal

The interest rates applicable to tax underpayments are aligned so that, for any given 

estimated tax underpayment period, only one interest rate applies. The underpayment interest 

rate in effect on the first day of the quarter in which the pertinent estimated payment due date 

arises is the interest rate that applies during an entire underpayment period. 

Effective Date

The proposal is effective for estimated tax payments made for taxable years beginning 

after December 31, 2006. 

2. Provide that underpayment balances are cumulative 

Present Law

Section 6654(b)(1) defines “underpayment” as the amount of an installment due over the 

amount of any installment paid (including withholding) on or before the due date of the 

installment. In determining an underpayment penalty for a calendar year taxpayer, the period of 

underpayment runs for each underpayment from the payment’s due date through the earlier of 

the date on which any portion of the payment is made or the 15th day of the fourth month 

following the close of the taxable year. Underpayment balances are not cumulative and must be 

tracked separately for each estimated tax underpayment period. 

Description of Proposal

The definition of “underpayment” is modified to allow existing underpayment balances 

to be used in underpayment calculations for succeeding estimated payment periods. Under the 

proposal, taxpayers calculate a cumulative underpayment at the end of each underpayment 

period. 

Effective Date

The proposal is effective for estimated tax payments made for taxable years beginning 

after December 31, 2006. 
 

34

3. Require 365-day year for all estimated tax interest calculations for individuals, estates, 

and trusts 

Present Law

Under current IRS procedures, taxpayers with outstanding underpayment balances that 

extend from a leap year through a non-leap year are required to make separate calculations solely 

to account for the different number of days in the two different years. For example, if a taxpayer 

has an underpayment outstanding from September 15, 2008, through January 15, 2009, then the 

taxpayer is required to account for the period from September 15, 2008 through December 31, 

2008, using a 366-day formula.25 The taxpayer then is required to account for the period from 

January 1, 2009, through January 15, 2009, under a 365-day formula. This calculation is 

required regardless of whether the interest rate changes on January 1, 2009. 

Description of Proposal

A 365-day year is used for all individual, estate, and trust estimated tax interest 

calculations. 

Effective Date

The proposal is effective for estimated tax payments made for taxable years beginning 

after December 31, 2006. 

 25 The year 2008 is a leap year, the year 2009 is not. 
 

35

B. Corporate Estimated Tax 

Present Law

In general, corporations are required to make quarterly estimated tax payments of their 

income tax liability.26 An exception to this requirement applies if the amount of tax for the 

taxable year is less than $500. 

Description of Proposal

The proposal increases the threshold amount of tax for requiring corporate estimated tax 

payments to $1,000. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2006.

 26 Sec. 6655. 
 

36

C. Increase in Large Corporation Threshold for Estimated Tax Payments 

Present Law

In general, corporations are required to make quarterly estimated tax payments of their 

income tax liability (sec. 6655). In general, the total of the estimated payments must equal the 

lesser of 100 percent of the current year’s tax or 100 percent of the previous year’s tax. Large 

corporations, however, may not base their estimated payments on the previous year’s tax. A 

large corporation is a corporation with taxable income of $1 million or more for any taxable year 

in the preceding three taxable years. 

Description of Proposal

The proposal increases the $1 million threshold defining large corporations (for purposes 

of quarterly estimated tax) by $50,000 every year beginning after 2006 until it reaches $1.5 

million. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2006. 
 

37

D. Expansion of Interest Netting 

Present Law

A special net interest rate of zero applies to the extent that, for any period, interest is 

payable under subchapter A and allowable under subchapter B on equivalent underpayments and 

overpayments by the same taxpayer. If both the underpayment and overpayment are unsatisfied, 

the interest rate applied to both will be zero. If either the underpayment or overpayment has 

previously been satisfied, the interest rate applicable to the unsatisfied amount will be equal to 

the interest rate applicable to the satisfied amount to the extent that interest was allowable or 

payable on both the underpayment and the overpayment for the same period. 

Interest must be both payable and allowable for interest netting to apply. If interest is not 

payable by the taxpayer with respect to an underpayment of tax, or interest is not allowable to the 

taxpayer on an overpayment of tax, the interest netting rules will not apply. 

For example, on July 1, 2017, a deficiency of $1,500 is determined with respect to a 

taxpayer’s 2014 Federal income tax return, which the taxpayer pays within 21 days. In the 

meantime, the taxpayer has filed returns for 2015 and 2016, showing a refund due to 

overwithholding each year of $1,000. The IRS issues the appropriate refund checks on May 15 

of each year, within 45 days of the due date of the return. Thus, interest is not allowable to the 

taxpayer with respect to either 2015 or 2016. In this case, the taxpayer owes interest on the 

$1,500 year 2014 underpayment from the original due date of the return (April 15, 2015) until 

the underpayment is satisfied. Although there are offsetting periods of overpayment (April 15, 

2016 to May 15, 2016 and April 15, 2017 to May 15, 2017), there is no offsetting period for 

which interest is allowable on an overpayment. 

Description of Proposal

In the case of any taxpayer (whether an individual or corporation or other), the interest 

netting rules with respect to tax underpayments and overpayments are applied without regard to 

the 45-day period in which the Secretary may refund an overpayment of tax without the payment 

of interest under section 6611(e). Solely for the purpose of the interest netting computation, the 

portion of the 45-day period before repayment of the overpayment is considered as a period for 

which overpayment interest was allowable at a zero rate. The proposal does not modify the 

period for which interest is payable or allowable for any other purpose. 

In the example discussed under present law, above, a net interest rate of zero would be 

applied to $1,000 of the taxpayer’s year 2014 underpayment for the periods between the due date 

of the 2015 and 2016 returns and the dates on which the refunds are made. The taxpayer in the 

example would owe interest at the underpayment rate for the periods from April 16, 2015, to 

April 15, 2016; May 16, 2016 to April 15, 2017; and from May 16, 2017 to July 1, 2017. For the 

periods April 15, 2016, to May 15, 2016 and April 15, 2017 to May 15, 2017, a zero net interest 

rate applies. 

Effective Date

The proposal is effective for interest accrued after December 31, 2010. 
 

38

E. Clarification of Application of Federal Tax Deposit Penalty 

Present Law

In many instances, taxpayers are required to make deposits of Federal taxes.27 Failure to 

do so is subject to a penalty.28 The amount of that penalty depends on the length of time that the 

deposit was not made. The penalty is two percent of the underpayment if the failure to deposit is 

for not more than five days, 5 percent for six through 15 days, and 10 percent for more than 15 

days. The IRS applies the 10 percent penalty rate automatically if a deposit is not made in the 

manner required. 

Description of Proposal

The application of the Federal tax deposit penalty is clarified so that the 10 percent 

penalty rate only applies in cases in which the failure to deposit extends for more than 15 days. 

Thus, a taxpayer who makes a deposit on time but not in the manner required is subject to a 

penalty of two percent. 

Effective Date

The proposal is effective on the date of enactment. 

 27 Sec. 6302. 

28 Sec. 6656. 
 

39 

F. Frivolous Tax Submissions 

Present Law

The Code provides that an individual who files a frivolous income tax return is subject to 

a penalty of $500 imposed by the IRS (sec. 6702). The Code also permits the Tax Court29 to 

impose a penalty of up to $25,000 if a taxpayer has instituted or maintained proceedings 

primarily for delay or if the taxpayer’s position in a proceeding is frivolous or groundless (sec. 

6673(a)). 

Description of Proposal

The proposal modifies the penalty on frivolous returns by increasing the amount of the 

penalty to up to $5,000 and by applying it to all taxpayers and to all types of Federal taxes. 

The proposal also modifies present law with respect to certain submissions that raise 

frivolous arguments or that are intended to delay or impede tax administration. The submissions 

to which the proposal applies are requests for a collection due process hearing, installment 

agreements, offers-in-compromise, and taxpayer assistance orders. First, the proposal permits 

the IRS to disregard such requests. Second, the proposal permits the IRS to impose a penalty of 

up to $5,000 for such requests, unless the taxpayer withdraws the request after being given an 

opportunity to do so. 

The proposal requires the IRS to publish a list of positions, arguments, requests, and 

submissions determined to be frivolous for purposes of these provisions. 

Effective Date

The proposal applies to submissions made and issues raised after the date on which the 

Secretary first prescribes the required list of frivolous positions. 

 29 Because in general the Tax Court is the only pre-payment forum available to taxpayers, it 

addresses most of the frivolous, groundless, or dilatory arguments raised in tax cases. 
 

40 

G. Understatement of Taxpayer’s Liability by Tax Return Preparers 

Present Law

An income tax return preparer is defined as any person who prepares for compensation, 

or who employs other people to prepare for compensation, all or a substantial portion of an 

income tax return or claim for refund.30 Under present law, the definition of an income tax 

return preparer does not include a person preparing non-income tax returns, such as estate and 

gift, excise, or employment tax returns. 

Income tax return preparers are required to sign and include their taxpayer identification 

numbers on income tax returns and income return-related documents prepared for compensation. 

Under section 6695, penalties are imposed on any income tax return preparer who, in connection 

with the preparation of an income tax return, fails to (1) furnish a copy of a return or claim for 

refund to the taxpayer, (2) sign the return or claim for refund, (3) furnish his or her identifying 

number, (4) retain a copy of the completed return or a list of the taxpayers for whom a return was 

prepared, (5) file a correct information return, and (6) comply with certain due diligence 

requirements in determining a taxpayer’s eligibility for the earned income credit.31 Generally, 

the penalty is $50 for each failure and the total penalties imposed for any single type of failure 

for any calendar year are limited to $25,000. The penalty for failing to comply with the due 

diligence requirements for determining a taxpayer’s eligibility for the earned income credit is 

$100. An income tax return preparer who endorses or negotiates a check issued to a taxpayer 

(other than the income tax return preparer) is liable for a penalty of $500 with respect to each 

such check. 

An income tax return preparer who prepares a return with respect to which there is an 

understatement of tax that is due to an undisclosed position for which there was not a realistic 

possibility of being sustained on its merits, or a frivolous position, is liable for a first-tier penalty 

of $250, provided the preparer knew or reasonably should have known of the position. For 

purposes of the penalty, an understatement is generally defined as any understatement with 

respect to any tax imposed by subtitle A (i.e., income taxes). An income tax return preparer who 

prepares a return and engages in specified willful or reckless conduct with respect to preparing 

an income tax return is liable for a second-tier penalty of $1,000. 

Description of Proposal

The proposal broadens the scope of the present-law preparer penalties to include 

preparers of estate and gift tax, employment tax, and excise tax returns, and returns of exempt 

organizations. 

The proposal alters the standards of conduct that must be met to avoid imposition of the 

penalties for preparing a return with respect to which there is an understatement of tax. First, the 

 30 Sec. 7701(a)(36)(A). 

31 Sec. 6695. 
 

41 

proposal replaces the realistic possibility standard for undisclosed positions with a requirement 

that there be a reasonable belief that the tax treatment of the position was more likely than not 

the proper treatment. The proposal replaces the not-frivolous standard with the requirement that 

there be a reasonable basis for the tax treatment of the position. 

The proposal also imposes a penalty on a tax return preparer who prepares the portion of 

a claim for refund or credit that is disallowed if there is no reasonable basis for the claimed tax 

treatment of the disallowed portion of such claim for refund or credit. 

The proposal also increases the first-tier penalty from $250 to the greater of $1,000 or 50 

percent of the tax preparer’s fee. The proposal increases the second-tier penalty from $1,000 to 

the greater of $5,000 or 50 percent of the tax preparer’s fee. 

Effective Date

The proposal is effective for tax returns prepared after the date of enactment. 
 

42

H. Penalty for Aiding and Abetting the Understatement of Tax Liability 

Present Law

A penalty is imposed on a person who: (1) aids or assists in, procures, or advises with 

respect to a tax return or other document; (2) knows (or has reason to believe) that such 

document will be used in connection with a material tax matter; and (3) knows that this would 

result in an understatement of tax of another person. In general, the amount of the penalty is 

$1,000. If the document relates to the tax return of a corporation, the amount of the penalty is 

$10,000. 

Description of Proposal

The proposal expands the scope of the aiding and abetting penalty in several ways. First, 

it applies the penalty to aiding or abetting with respect to tax liability reflected in a tax return. 

Second, it applies the penalty separately to each instance of aiding or abetting. Third, it 

increases the amount of the penalty to a maximum of 100 percent of the gross income derived (or 

to be derived) from the aiding or abetting. Fourth, if more than one person is liable for the 

penalty, all such persons are jointly and severally liable for the penalty. Fifth, the penalty, as 

well as amounts paid to settle or avoid the imposition of the penalty, is not deductible for tax 

purposes. 

Effective Date

The proposal is effective for activities occurring after the date of enactment.
 

43 

I. Increase in Criminal Monetary Penalty Limitation for the Underpayment 

or Overpayment of Tax Due to Fraud 

Present Law

Attempt to evade or defeat tax

In general, section 7201 imposes a criminal penalty on persons who willfully attempt to 

evade or defeat any tax imposed by the Code. Upon conviction, the Code provides that the 

penalty is up to $100,000 or imprisonment of not more than five years (or both). In the case of a 

corporation, the Code increases the monetary penalty to a maximum of $500,000. 

Willful failure to file return, supply information, or pay tax

In general, section 7203 imposes a criminal penalty on persons required to make 

estimated tax payments, pay taxes, keep records, or supply information under the Code who 

willfully fail to do so. Upon conviction, the Code provides that the penalty is up to $25,000 or 

imprisonment of not more than one year (or both). In the case of a corporation, the Code 

increases the monetary penalty to a maximum of $100,000. 

Fraud and false statements

In general, section 7206 imposes a criminal penalty on persons who make fraudulent or 

false statements under the Code. Upon conviction, the Code provides that the penalty is up to 

$100,000 or imprisonment of not more than three years (or both). In the case of a corporation, 

the Code increases the monetary penalty to a maximum of $500,000. 

Uniform sentencing guidelines

Under the uniform sentencing guidelines established by 18 U.S.C. 3571, a defendant 

found guilty of a criminal offense is subject to a maximum fine that is the greatest of: (a) the 

amount specified in the underlying proposal, (b) for a felony32 $250,000 for an individual or 

$500,000 for an organization, or (c) twice the gross gain if a person derives pecuniary gain from 

the offense. This Title 18 proposal applies to all criminal proposals in the United States Code, 

including those in the Internal Revenue Code. For example, for an individual, the maximum fine 

under present law upon conviction of violating section 7206 is $250,000 or, if greater, twice the 

amount of gross gain from the offense. 

 32 Section 7206 provides that the making of fraudulent or false statements is a felony. In 

addition, this offense is a felony pursuant to the classification guidelines of 18 U.S.C. 3559(a)(5). 
 

44 

Description of Proposal

Attempt to evade or defeat tax

The proposal increases the criminal penalty under section 7201 for individuals to 

$500,000 and for corporations to $1,000,000. The proposal increases the maximum prison 

sentence to ten years. 

Willful failure to file return, supply information, or pay tax

The proposal increases the criminal penalty under section 7203 for individuals from 

$25,000 to $50,000 and, in the case of an “aggravated failure to file” (defined as a failure to file a 

return for a period of three or more consecutive taxable years if the aggregated tax liability for 

such period is at least $100,000 or any failure to file a return where the underlying income or 

payment is attributable to activities that are felonies under Federal or State criminal law), 

changes the crime from a misdemeanor to a felony and increases the maximum prison sentence 

to ten years. The proposal clarifies that the aggravated failure to file penalty may be applied in 

addition to other criminal tax penalties. 

Fraud and false statements 

The proposal increases the criminal penalty for making fraudulent or false statements to 

$500,000 for individuals and $1,000,000 for corporations. The proposal increases the maximum 

prison sentence for making fraudulent or false statements to five years. The proposal provides 

that in no event shall the amount of the monetary penalty under the proposal be less than the 

amount of the underpayment or overpayment attributable to fraud. 

Effective Date

The proposal is effective for actions and failures to act occurring after the date of 

enactment. 
 

45 

J. Doubling of Certain Penalties, Fines, and Interest on Underpayments 

Related to Certain Offshore Financial Arrangements 

Present Law

In general 

The Code contains numerous civil penalties, such as the delinquency, accuracy-related, 

fraud, and assessable penalties. These civil penalties are in addition to any interest that may be 

due as a result of an underpayment of tax. If all or any part of a tax is not paid when due, the 

Code imposes interest on the underpayment, which is assessed and collected in the same manner 

as the underlying tax and is subject to the respective statutes of limitations for assessment and 

collection. 

Delinquency penalties

Failure to file

Under present law, a taxpayer who fails to file a tax return on a timely basis is generally 

subject to a penalty equal to five percent of the net amount of tax due for each month that the 

return is not filed, up to a maximum of five months or 25 percent. An exception from the 

penalty applies if the failure is due to reasonable cause. In the case of fraudulent failure to file, 

the penalty is increased to 15 percent of the net amount of tax due for each month that the return 

is not filed, up to a maximum of five months or 75 percent. The net amount of tax due is the 

excess of the amount of the tax required to be shown on the return over the amount of any tax 

paid on or before the due date prescribed for the payment of tax. 

Failure to pay

Taxpayers who fail to pay their taxes are subject to a penalty of 0.5 percent per month on 

the unpaid amount, up to a maximum of 25 percent. If a penalty for failure to file and a penalty 

for failure to pay tax shown on a return both apply for the same month, the amount of the penalty 

for failure to file for such month is reduced by the amount of the penalty for failure to pay tax 

shown on a return. If an income tax return is filed more than 60 days after its due date, then the 

penalty for failure to pay tax shown on a return may not reduce the penalty for failure to file 

below the lesser of $100 or 100 percent of the amount required to be shown on the return. For 

any month in which an installment payment agreement with the IRS is in effect, the rate of the 

penalty is half the usual rate (0.25 percent instead of 0.5 percent), provided that the taxpayer 

filed the tax return in a timely manner (including extensions). 

Failure to make timely deposits of tax

The penalty for the failure to make timely deposits of tax consists of a four-tiered 

structure in which the amount of the penalty varies with the length of time within which the 

taxpayer corrects the failure. A depositor is subject to a penalty equal to two percent of the 

amount of the underpayment if the failure is corrected on or before the date that is five days after 

the prescribed due date. A depositor is subject to a penalty equal to five percent of the amount of 

the underpayment if the failure is corrected after the date that is five days after the prescribed due 
 

46 

date but on or before the date that is 15 days after the prescribed due date. A depositor is subject 

to a penalty equal to 10 percent of the amount of the underpayment if the failure is corrected 

after the date that is 15 days after the due date but on or before the date that is 10 days after the 

date of the first delinquency notice to the taxpayer (under sec. 6303). Finally, a depositor is 

subject to a penalty equal to 15 percent of the amount of the underpayment if the failure is not 

corrected on or before earlier of 10 days after the date of the first delinquency notice to the 

taxpayer and 10 days after the date on which notice and demand for immediate payment of tax is 

given in cases of jeopardy. 

An exception from the penalty applies if the failure is due to reasonable cause. In 

addition, the Secretary may waive the penalty for an inadvertent failure to deposit any tax by 

specified first-time depositors. 

Accuracy-related penalties

In general

The accuracy-related penalties are imposed at a rate of 20 percent of the portion of any 

underpayment that is attributable, in relevant part, to (1) negligence, (2) any substantial 

understatement of income tax, (3) any substantial valuation misstatement, and (4) any reportable 

transaction understatement. The penalty for a substantial valuation misstatement is doubled for 

certain gross valuation misstatements. In the case of a reportable transaction understatement for 

which the transaction is not disclosed, the penalty rate is 30 percent. These penalties are 

coordinated with the fraud penalty. This statutory structure operates to eliminate any stacking of 

the penalties. 

No penalty is to be imposed if it is shown that there was reasonable cause for an 

underpayment and the taxpayer acted in good faith, and in the case of a reportable transaction 

understatement the relevant facts of the transaction have been disclosed, there is or was 

substantial authority for the taxpayer’s treatment of such transaction, and the taxpayer reasonably 

believed that such treatment was more likely than not the proper treatment. 

Negligence or disregard for the rules or regulations

If an underpayment of tax is attributable to negligence, the negligence penalty applies 

only to the portion of the underpayment that is attributable to negligence. Negligence means any 

failure to make a reasonable attempt to comply with the provisions of the Code. Disregard 

includes any careless, reckless, or intentional disregard of the rules or regulations. 

Substantial understatement of income tax

Generally, an understatement is substantial if the understatement exceeds the greater of 

(1) 10 percent of the tax required to be shown on the return for the tax year, or (2) $5,000. In 

determining whether a substantial understatement exists, the amount of the understatement is 

reduced by any portion attributable to an item if (1) the treatment of the item on the return is or 

was supported by substantial authority, or (2) facts relevant to the tax treatment of the item were 

adequately disclosed on the return or on a statement attached to the return. 
 

47 

Substantial valuation misstatement

A penalty applies to the portion of an underpayment that is attributable to a substantial 

valuation misstatement. Generally, a substantial valuation misstatement exists if the value or 

adjusted basis of any property claimed on a return is 200 percent or more of the correct value or 

adjusted basis. The amount of the penalty for a substantial valuation misstatement is 20 percent 

of the amount of the underpayment if the value or adjusted basis claimed is 200 percent or more 

but less than 400 percent of the correct value or adjusted basis. If the value or adjusted basis 

claimed is 400 percent or more of the correct value or adjusted basis, then the overvaluation is a 

gross valuation misstatement. 

Reportable transaction understatement

A penalty applies to any item that is attributable to any listed transaction, or to any 

reportable transaction (other than a listed transaction) if a significant purpose of such reportable 

transaction is tax avoidance or evasion. 

Fraud penalty

The fraud penalty is imposed at a rate of 75 percent of the portion of any underpayment 

that is attributable to fraud. The accuracy-related penalty does not to apply to any portion of an 

underpayment on which the fraud penalty is imposed. 

Assessable penalties

In addition to the penalties described above, the Code imposes a number of additional 

penalties, including, for example, penalties for failure to file (or untimely filing of) information 

returns with respect to foreign trusts, and penalties for failure to disclose any required 

information with respect to a reportable transaction. 

Interest provisions

Taxpayers are required to pay interest to the IRS whenever there is an underpayment of 

tax. An underpayment of tax exists whenever the correct amount of tax is not paid by the last 

date prescribed for the payment of the tax. The last date prescribed for the payment of the 

income tax is the original due date of the return. 

Different interest rates are provided for the payment of interest depending upon the type 

of taxpayer, whether the interest relates to an underpayment or overpayment, and the size of the 

underpayment or overpayment. Interest on underpayments is compounded daily. 

Offshore Voluntary Compliance Initiative

In January 2003, Treasury announced the Offshore Voluntary Compliance Initiative 

(“OVCI”) to encourage the voluntary disclosure of previously unreported income placed by 

taxpayers in offshore accounts and accessed through credit card or other financial arrangements. 

A taxpayer had to comply with various requirements in order to participate in the OVCI, 

including sending a written request to participate in the program by April 15, 2003. This request 
 

48 

had to include information about the taxpayer, the taxpayer’s introduction to the credit card or 

other financial arrangements and the names of parties that promoted the transaction. A taxpayer 

entering into a closing agreement under the OVCI is not liable for the civil fraud penalty, the 

fraudulent failure to file penalty, or the civil information return penalties. Such a taxpayer is 

responsible for back taxes, interest, and certain accuracy-related and delinquency penalties.33

Voluntary disclosure policy

A taxpayer’s timely, voluntary disclosure of a substantial unreported tax liability has long 

been an important factor in deciding whether the taxpayer’s case should ultimately be referred 

for criminal prosecution. The voluntary disclosure must be truthful, timely, and complete. The 

taxpayer must show a willingness to cooperate (as well as actual cooperation) with the IRS in 

determining the correct tax liability. The taxpayer must make good-faith arrangements with the 

IRS to pay in full the tax, interest, and any penalties determined by the IRS to be applicable. A 

voluntary disclosure does not guarantee immunity from prosecution. It creates no substantive or 

procedural rights for taxpayers.34 The IRS treats participation in the OVCI as a voluntary 

disclosure.35

Description of Proposal

The proposal doubles the amounts of civil penalties, interest, and fines related to 

taxpayers’ underpayments of U.S. income tax liability through the direct or indirect use of 

certain offshore financial arrangements. The proposal applies to taxpayers who did not (or do 

not) voluntarily disclose such arrangements through the OVCI or otherwise. Under the proposal, 

the determination of whether any civil penalty is to be applied to such underpayment is made 

without regard to whether a return has been filed, whether there was reasonable cause for such 

underpayment, and whether the taxpayer acted in good faith. 

The proscribed financial arrangements include, but are not limited to, the use of certain 

foreign leasing corporations for providing domestic employee services,36 certain arrangements 

whereby the taxpayer may hold securities trading accounts through offshore banks or other 

financial intermediaries, certain arrangements whereby the taxpayer may access funds through 

the use of offshore credit, debit, or charge cards, and offshore annuities or trusts. 

The Secretary of the Treasury is granted the authority to waive the application of the 

proposal if the use of the offshore financial arrangements is incidental to the transaction and, in 

 33 Rev. Proc. 2003-11, 2003-4 C.B. 311. 

34 Internal Revenue News Release 2002-135, IR-2002-135 (December 11, 2002). 

35 Rev. Proc. 2003-11, 2003-4 C.B. 311. 

36 These arrangements were described and classified as listed transactions in Notice 2003-22, 

2003-1 C.B. 851. 
 

49 

the case of a trade or business, such use is conducted in the ordinary course of the type of trade 

or business in which the taxpayer is engaged. 

Effective Date

The proposal generally is effective with respect to a taxpayer’s open tax years on or after 

the date of enactment.
 

50

K. Increase in Penalty for Bad Checks and Money Orders 

Present Law

The Code37 imposes a penalty for bad checks and money orders on the person who 

tendered it. The penalty is two percent of the amount of the bad check or money order, with a 

minimum penalty of $15 (or, if less, the amount of the check). 

Description of Proposal

The proposal increases the minimum penalty for bad checks and money orders to $25 (or, 

if less, the amount of the check). 

Effective Date

The proposal applies to checks or money orders received after the date of enactment.

 37 Sec. 6657. 
 

51 

L. Proposals Relating to Appraisers and Substantial and Gross 

Overstatement of Valuations of Property 

Present Law

Taxpayer penalties

Present law imposes accuracy-related penalties on a taxpayer in cases involving a 

substantial valuation misstatement or gross valuation misstatement relating to an underpayment 

of income tax.38 For this purpose, a substantial valuation misstatement generally means a value 

claimed that is at least twice (200 percent or more) the amount determined to be the correct 

value, and a gross valuation misstatement generally means a value claimed that is at least four 

times (400 percent or more) the amount determined to be the correct value. 

The penalty is 20 percent of the underpayment of tax resulting from a substantial 

valuation misstatement and rises to 40 percent for a gross valuation misstatement. No penalty is 

imposed unless the portion of the underpayment attributable to the valuation misstatement 

exceeds $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal 

holding company). Under present law, no penalty is imposed with respect to any portion of the 

understatement attributable to any item if (1) the treatment of the item on the return is or was 

supported by substantial authority, or (2) facts relevant to the tax treatment of the item were 

adequately disclosed on the return or on a statement attached to the return and there is a 

reasonable basis for the tax treatment. Special rules apply to tax shelters. 

Present law also imposes an accuracy-related penalty on substantial or gross estate or gift 

tax valuation understatements.39 In general, there is a substantial estate or gift tax 

understatement if the value of any property claimed on any return is 50 percent or less of the 

amount determined to be the correct amount, and a gross estate or gift tax understatement if such 

value is 25 percent or less of the amount determined to be the correct amount. 

In addition, the accuracy-related penalties do not apply if a taxpayer shows there was 

reasonable cause for an underpayment and the taxpayer acted in good faith.40

Penalty for aiding and abetting understatement of tax

A penalty is imposed on a person who: (1) aids or assists in or advises with respect to a 

tax return or other document; (2) knows (or has reason to believe) that such document will be 

used in connection with a material tax matter; and (3) knows that this would result in an 

understatement of tax of another person. In general, the amount of the penalty is $1,000. If the 

document relates to the tax return of a corporation, the amount of the penalty is $10,000. 

 38 Sec. 6662(b)(3) and (h). 

39 Sec. 6662(g) and (h). 

40 Sec. 6664(c). 
 

52 

Qualified appraisals

Present law requires a taxpayer to obtain a qualified appraisal for donated property with a 

value of more than $5,000, and to attach an appraisal summary to the tax return.41 Treasury 

Regulations state that a qualified appraisal means an appraisal document that, among other 

things: (1) relates to an appraisal that is made not earlier than 60 days prior to the date of 

contribution of the appraised property and not later than the due date (including extensions) of 

the return on which a deduction is first claimed under section 170; (2) is prepared, signed, and 

dated by a qualified appraiser; (3) includes (a) a description of the property appraised; (b) the fair 

market value of such property on the date of contribution and the specific basis for the valuation; 

(c) a statement that such appraisal was prepared for income tax purposes; (d) the qualifications of 

the qualified appraiser; and (e) the signature and taxpayer identification number of such 

appraiser; and (4) does not involve an appraisal fee that violates certain prescribed rules.42 

Qualified appraisers

Treasury Regulations define a qualified appraiser as a person who holds himself or 

herself out to the public as an appraiser or performs appraisals on a regular basis, is qualified to 

make appraisals of the type of property being valued (as determined by the appraiser’s 

background, experience, education and membership, if any, in professional appraisal 

associations), is independent, and understands that an intentionally false or fraudulent 

overstatement of the value of the appraised property may subject the appraiser to civil 

penalties.43

Appraiser oversight

The Secretary is authorized to regulate the practice of representatives of persons before 

the Department of the Treasury (“Department”).44 After notice and hearing, the Secretary is 

authorized to suspend or disbar from practice before the Department or the Internal Revenue 

Service (“IRS”) a representative who is incompetent, who is disreputable, who violates the rules 

regulating practice before the Department or the IRS, or who (with intent to defraud) willfully 

and knowingly misleads or threatens the person being represented (or a person who may be 

represented). 

The Secretary also is authorized to bar from appearing before the Department or the IRS, 

for the purpose of offering opinion evidence on the value of property or other assets, any 

individual against whom a civil penalty for aiding and abetting the understatement of tax has 

been assessed. Thus, an appraiser who aids or assists in the preparation or presentation of an 

 41 Sec. 170(f)(11). 

42 Treas. Reg. sec. 1.170A-13(c)(3). 

43 Treas. Reg. sec. 1.170A-13(c)(5)(i). 

44 31 U.S.C. sec. 330. 
 

53 

appraisal will be subject to disciplinary action if the appraiser knows that the appraisal will be 

used in connection with the tax laws and will result in an understatement of the tax liability of 

another person. The Secretary has authority to provide that the appraisals of an appraiser who 

has been disciplined have no probative effect in any administrative proceeding before the 

Department or the IRS. 

Description of Proposal

Taxpayer penalties

The proposal lowers the thresholds for imposing accuracy-related penalties on a taxpayer. 

Under the proposal, a substantial valuation misstatement exists when the claimed value of any 

property is 150 percent or more of the amount determined to be the correct value. A gross 

valuation misstatement occurs when the claimed value of any property is 200 percent or more of 

the amount determined to be the correct value. 

The proposal tightens the thresholds for imposing accuracy-related penalties with respect 

to the estate or gift tax. Under the proposal, a substantial estate or gift tax valuation 

misstatement exists when the claimed value of any property is 65 percent or less of the amount 

determined to be the correct value. A gross estate or gift tax valuation misstatement exists when 

the claimed value of any property is 40 percent or less of the amount determined to be the correct 

value. 

Under the proposal, the reasonable cause exception to the accuracy-related penalty does 

not apply in the case of gross valuation misstatements. 

Appraiser oversight

Appraiser penalties 

The proposal establishes a civil penalty on any person who prepares an appraisal that is to 

be used to support a tax position if such appraisal results in a substantial or gross valuation 

misstatement. The penalty is equal to the greater of $1,000 or 10 percent of the understatement 

of tax resulting from a substantial or gross valuation misstatement, up to a maximum of 125 

percent of the gross income derived from the appraisal. Under the proposal, the penalty does not 

apply if the appraiser establishes that it was “more likely than not” that the appraisal was correct. 

Disciplinary proceeding 

The proposal eliminates the requirement that the Secretary assess against an appraiser the 

civil penalty for aiding and abetting the understatement of tax before such appraiser may be 

subject to disciplinary action. Thus, the Secretary is authorized to discipline appraisers after 

notice and hearing. Disciplinary action may include, but is not limited to, suspending or barring 

an appraiser from: preparing or presenting appraisals on the value of property or other assets to 

the Department or the IRS; appearing before the Department or the IRS for the purpose of 

offering opinion evidence on the value of property or other assets; and providing that the 

appraisals of an appraiser who has been disciplined have no probative effect in any 

administrative proceeding before the Department or the IRS. 
 

54 

Qualified appraisers

The proposal defines a qualified appraiser as an individual who (1) has earned an 

appraisal designation from a recognized professional appraiser organization or has otherwise met 

minimum education and experience requirements to be determined by the IRS in regulations; (2) 

regularly performs appraisals for which he or she receives compensation; (3) can demonstrate 

verifiable education and experience in valuing the type of property for which the appraisal is 

being performed; (4) has not been prohibited from practicing before the IRS by the Secretary at 

any time during the three years preceding the conduct of the appraisal; and (5) is not excluded 

from being a qualified appraiser under applicable Treasury regulations. 

Qualified appraisals

The proposal defines a qualified appraisal as an appraisal of property prepared by a 

qualified appraiser (as defined by the proposal) in accordance with generally accepted appraisal 

standards and any regulations or other guidance prescribed by the Secretary. 

Effective Date

The proposal amending the accuracy-related penalty applies to returns filed after the date 

of enactment. The proposal establishing a civil penalty that may be imposed on any person who 

prepares an appraisal that is to be used to support a tax position if such appraisal results in a 

substantial or gross valuation misstatement applies to appraisals prepared with respect to returns 

or submissions filed after the date of enactment. The proposals relating to appraiser oversight 

apply to appraisals prepared with respect to returns or submissions filed after the date of 

enactment.
 

55 

M. Increase the Amounts of Excise Taxes Imposed on Public Charities, 

Social Welfare Organizations, and Private Foundations 

Present Law

Public charities and social welfare organizations

The Code imposes excise taxes on excess benefit transactions between disqualified 

persons (as defined in section 4958(f)) and charitable organizations (other than private 

foundations) or social welfare organizations (as described in section 501(c)(4)).45 An excess 

benefit transaction generally is a transaction in which an economic benefit is provided by a 

charitable or social welfare organization directly or indirectly to or for the use of a disqualified 

person, if the value of the economic benefit provided exceeds the value of the consideration 

(including the performance of services) received for providing such benefit. 

The excess benefit transaction tax is imposed on the disqualified person and, in certain 

cases, on the organization manager, but is not imposed on the exempt organization. An initial 

tax of 25 percent of the excess benefit amount is imposed on the disqualified person that receives 

the excess benefit. An additional tax on the disqualified person of 200 percent of the excess 

benefit applies if the violation is not corrected. A tax of 10 percent of the excess benefit (not to 

exceed $10,000 with respect to any excess benefit transaction) is imposed on an organization 

manager that knowingly participated in the excess benefit transaction, if the manager’s 

participation was willful and not due to reasonable cause, and if the initial tax was imposed on 

the disqualified person.46 If more than one person is liable for the tax on disqualified persons or 

on management, all such persons are jointly and severally liable for the tax.47

Private foundations

Self-dealing by private foundations

Excise taxes are imposed on acts of self-dealing between a disqualified person (as 

defined in section 4946) and a private foundation.48 In general, self-dealing transactions are any 

direct or indirect: (1) sale or exchange, or leasing, of property between a private foundation and a 

disqualified person; (2) lending of money or other extension of credit between a private 

foundation and a disqualified person; (3) the furnishing of goods, services, or facilities between a 

private foundation and a disqualified person; (4) the payment of compensation (or payment or 

reimbursement of expenses) by a private foundation to a disqualified person; (5) the transfer to, 

 45 Sec. 4958. The excess benefit transaction tax is commonly referred to as “intermediate 

sanctions,” because it imposes penalties generally considered to be less punitive than revocation of the 

organization’s exempt status. 

46 Sec. 4958(d)(2). Taxes imposed may be abated if certain conditions are met. Secs. 4961 and 

4962. 

47 Sec. 4958(d)(1). 

48 Sec. 4941. 
 

56 

or use by or for the benefit of, a disqualified person of the income or assets of the private 

foundation; and (6) certain payments of money or property to a government official.49 Certain 

exceptions apply.50

An initial tax of five percent of the amount involved with respect to an act of self-dealing 

is imposed on any disqualified person (other than a foundation manager acting only as such) who 

participates in the act of self-dealing. If such a tax is imposed, a 2.5-percent tax of the amount 

involved is imposed on a foundation manager who participated in the act of self-dealing knowing 

it was such an act (and such participation was not willful and was due to reasonable cause) up to 

$10,000 per act. Such initial taxes may not be abated.51 Such initial taxes are imposed for each 

year in the taxable period, which begins on the date the act of self-dealing occurs and ends on the 

earliest of the date of mailing of a notice of deficiency for the tax, the date on which the tax is 

assessed, or the date on which correction of the act of self-dealing is completed. A government 

official (as defined in section 4946(c)) is subject to such initial tax only if the official participates 

in the act of self-dealing knowing it is such an act. If the act of self-dealing is not corrected, a 

tax of 200 percent of the amount involved is imposed on the disqualified person and a tax of 50 

percent of the amount involved (up to $10,000 per act) is imposed on a foundation manager who 

refused to agree to correcting the act of self-dealing. Such additional taxes are subject to 

abatement.52

Tax on failure to distribute income

Private nonoperating foundations are required to pay out a minimum amount each year as 

qualifying distributions. In general, a qualifying distribution is an amount paid to accomplish 

one or more of the organization’s exempt purposes, including reasonable and necessary 

administrative expenses.53 Failure to pay out the minimum results in an initial excise tax on the 

foundation of 15 percent of the undistributed amount. An additional tax of 100 percent of the 

undistributed amount applies if an initial tax is imposed and the required distributions have not 

been made by the end of the applicable taxable period.54 A foundation may include as a 

qualifying distribution the salaries, occupancy expenses, travel costs, and other reasonable and 

necessary administrative expenses that the foundation incurs in operating a grant program. A 

qualifying distribution also includes any amount paid to acquire an asset used (or held for use) 

directly in carrying out one or more of the organization’s exempt purposes and certain amounts 

 49 Sec. 4941(d)(1). 

50 See sec. 4941(d)(2). 

51 Sec. 4962(b). 

52 Sec. 4961. 

53 Sec. 4942(g)(1)(A). 

54 Sec. 4942(a) and (b). Taxes imposed may be abated if certain conditions are met. Secs. 4961 

and 4962. 
 

57 

set-aside for exempt purposes.55 Private operating foundations are not subject to the payout 

requirements. 

Tax on excess business holdings

Private foundations are subject to tax on excess business holdings.56 In general, a private 

foundation is permitted to hold 20 percent of the voting stock in a corporation, reduced by the 

amount of voting stock held by all disqualified persons (as defined in section 4946). If it is 

established that no disqualified person has effective control of the corporation, a private 

foundation and disqualified persons together may own up to 35 percent of the voting stock of a 

corporation. A private foundation shall not be treated as having excess business holdings in any 

corporation if it owns (together with certain other related private foundations) not more than two 

percent of the voting stock and not more than two percent in value of all outstanding shares of all 

classes of stock in that corporation. Similar rules apply with respect to holdings in a partnership 

(“profits interest” is substituted for “voting stock” and “capital interest” for “nonvoting stock”) 

and to other unincorporated enterprises (by substituting “beneficial interest” for “voting stock”). 

Private foundations are not permitted to have holdings in a proprietorship. Foundations 

generally have a five-year period to dispose of excess business holdings (acquired other than by 

purchase) without being subject to tax.57 This five-year period may be extended an additional 

five years in limited circumstances.58

The initial tax is equal to five percent of the value of the excess business holdings held 

during the foundation’s applicable taxable year. An additional tax is imposed if an initial tax is 

imposed and at the close of the applicable taxable period, the foundation continues to hold excess 

business holdings. The amount of the additional tax is equal to 200 percent of such holdings. 

Tax on jeopardizing investments

Private foundations and foundation managers are subject to tax on investments that 

jeopardize the foundation’s charitable purpose.59 In general, an initial tax of five percent of the 

amount of the investment applies to the foundation and to foundation managers who participated 

in the making of the investment knowing that it jeopardized the carrying out of the foundation’s 

exempt purposes. The initial tax on foundation managers may not exceed $5,000 per investment. 

If the investment is not removed from jeopardy (e.g., sold or otherwise disposed of), an 

additional tax of 25 percent of the amount of the investment is imposed on the foundation and 

five percent of the amount of the investment on a foundation manager who refused to agree to 

 55 Secs. 4942(g)(1)(B) and 4942(g)(2). In general, an organization is permitted to adjust the 

distributable amount in those cases where distributions during the five preceding years have exceeded the 

payout requirements. Sec. 4942(i). 

56 Sec. 4943. Taxes imposed may be abated if certain conditions are met. Secs. 4961 and 4962. 

57 Sec. 4943(c)(6). 

58 Sec. 4943(c)(7). 

59 Sec. 4944. Taxes imposed may be abated if certain conditions are met. Secs. 4961 and 4962. 
 

58 

removing the investment from jeopardy. The additional tax on foundation managers may not 

exceed $10,000 per investment. An investment, the primary purpose of which is to accomplish a 

charitable purpose and no significant purpose of which is the production of income or the 

appreciation of property, is not considered a jeopardizing investment.60

Tax on taxable expenditures

Certain expenditures of private foundations are subject to tax.61 In general, taxable 

expenditures are expenses: (1) for lobbying; (2) to influence the outcome of a public election or 

carry on a voter registration drive (unless certain requirements are met); (3) as a grant to an 

individual for travel, study, or similar purposes unless made pursuant to procedures approved by 

the Secretary; (4) as a grant to an organization that is not a public charity or exempt operating 

foundation unless the foundation exercises expenditure responsibility62 with respect to the grant; 

or (5) for any non-charitable purpose. For each taxable expenditure, a tax is imposed on the 

foundation of 10 percent of the amount of the expenditure, and an additional tax of 100 percent is 

imposed on the foundation if the expenditure is not corrected. A tax of 2.5 percent of the 

expenditure (up to $5,000) also is imposed on a foundation manager who agrees to making a 

taxable expenditure knowing that it is a taxable expenditure. An additional tax of 50 percent of 

the amount of the expenditure (up to $10,000) is imposed on a foundation manager who refuses 

to agree to correction of such expenditure. 

Lobbying and political activities

Lobbying

Under present law, an organization described in section 501(c)(3) may not engage in 

more than a substantial amount of lobbying. Organizations may make an election to limit their 

lobbying expenditures in accordance with specific rules and excise taxes.63 Organizations not 

making such an election are subject to an excise tax if, as a result of lobbying expenditures 

during a taxable year, the organization is not described in section 501(c)(3).64 The excise tax is 

five percent of the lobbying expenditures for such taxable year. In addition, a tax is imposed on 

an organization manager if the manager agreed to the making of a lobbying expenditure, 

knowing that the expenditure likely would result in the organization not being described in 

 60 Sec. 4944(c). 

61 Sec. 4945. Taxes imposed may be abated if certain conditions are met. Secs. 4961 and 4962. 

62 In general, expenditure responsibility requires that a foundation make all reasonable efforts 

and establish reasonable procedures to ensure that the grant is spent solely for the purpose for which it 

was made, to obtain reports from the grantee on the expenditure of the grant, and to make reports to the 

Secretary regarding such expenditures. Sec. 4945(h). 

63 Secs. 501(h) and 4911. 

64 Sec. 4912. The excise tax does not apply to churches, certain other religious organizations, 

and private foundations. Sec. 4912(c)(2). Private foundations separately are subject to an excise tax for 

certain lobbying expenditures. Sec. 4945(d)(1) 
 

59 

section 501(c)(3), unless such agreement is not willful and is due to reasonable cause. The tax is 

five percent of the amount of any such expenditure. 

Political activities

Organizations described in section 501(c)(3) may not participate or intervene in any 

political campaign on behalf of (or in opposition) to any candidate for public office. This ban on 

political activities by section 501(c)(3) organizations may result in loss of tax exempt status. 

Political expenditures, i.e., amounts paid or incurred by a section 501(c)(3) organization for such 

participation or intervention, also are subject to an excise tax.65 An initial tax of 10 percent of 

the amount of the expenditure is imposed on the organization; and an initial tax of 2.5 percent of 

the expenditure (not to exceed $5,000) is imposed on an organization manager who agrees to the 

making of a political expenditure, knowing that it is a political expenditure if such agreement is 

not willful and is due to reasonable cause. Additional taxes apply to the organization and the 

organization manager if the political expenditure is not corrected. Such additional tax on the 

organization manager may not exceed $10,000. 

Description of Proposal

Self-dealing and excess benefit transaction initial taxes and dollar limitations

For acts of self-dealing other than the payment of compensation by a private foundation 

to a disqualified person, the proposal increases the initial tax on the self-dealer from five percent 

of the amount involved to 10 percent of the amount involved. The proposal increases the initial 

tax on foundation managers from 2.5 percent of the amount involved to five percent of the 

amount involved and increases the dollar limitation on the amount of the initial and additional 

taxes on foundation managers per act of self-dealing from $10,000 per act to $20,000 per act. 

Similarly, the proposal doubles the dollar limitation on organization managers of public charities 

and social welfare organizations for participation in excess benefit transactions from $10,000 per 

transaction to $20,000 per transaction. 

Failure to distribute income, excess business holdings, jeopardizing investments, and 

taxable expenditures

The proposal doubles the amounts of the initial taxes and the dollar limitations on 

foundation managers with respect to the private foundation excise taxes on the failure to 

distribute income, excess business holdings, jeopardizing investments, and taxable expenditures. 

Specifically, for the failure to distribute income, the initial tax on the foundation is 

increased from 15 percent of the undistributed amount to 30 percent of the undistributed amount. 

 65 Sec. 4955. In the case of an organization which is formed primarily for purposes of promoting 

the candidacy (or prospective candidacy) of an individual for public office, political expenditures also 

include certain other amounts. Sec. 4955(d)(2). 
 

60 

For excess business holdings, the initial tax on excess business holdings is increased from 

five percent of the value of such holdings to 10 percent of such value. 

For jeopardizing investments, the initial tax of five percent of the amount of the 

investment that is imposed on the foundation and on foundation managers is increased to 10 

percent of the amount of the investment. The dollar limitation on the initial tax on foundation 

managers of $5,000 per investment is increased to $10,000 and the dollar limitation on the 

additional tax on foundation managers of $10,000 per investment is increased to $20,000. 

For taxable expenditures, the initial tax on the foundation is increased from 10 percent of 

the amount of the expenditure to 20 percent, the initial tax on the foundation manager is 

increased from 2.5 percent of the amount of the expenditure to five percent, the dollar limitation 

of the initial tax on foundation managers is increased from $5,000 to $10,000, and the dollar 

limitation of the additional tax on foundation managers is increased from $10,000 to $20,000. 

Lobbying and political activities

The proposal increases the rate of tax on lobbying expenditures imposed under section 

4912 on the organization and on the organization manager from five percent to 10 percent of the 

amount of the expenditure. 

For political expenditures, the proposal increases the rate of the initial tax on the 

organization from five percent of the amount of the expenditure to 10 percent. The proposal 

increases the rate of the initial tax on the organization manager from 2.5 percent to five percent. 

In addition, the dollar limitation on the initial tax on organization mangers is increased from 

$5,000 to $10,000, and the dollar limitation on the additional tax on foundation managers is 

increased from $10,000 to $20,000. 

Effective Date

The proposal is effective for taxable years beginning after the date of enactment.
 

61

N. Penalty for Filing Erroneous Refund Claims 

Present Law

Present law imposes accuracy-related penalties on a taxpayer in cases involving a 

substantial valuation misstatement or gross valuation misstatement relating to an underpayment 

of income tax.66 For this purpose, a substantial valuation misstatement generally means a value 

claimed that is at least twice (200 percent or more) the amount determined to be the correct 

value, and a gross valuation misstatement generally means a value claimed that is at least four 

times (400 percent or more) the amount determined to be the correct value. 

The penalty is 20 percent of the underpayment of tax resulting from a substantial 

valuation misstatement and rises to 40 percent for a gross valuation misstatement. No penalty is 

imposed unless the portion of the underpayment attributable to the valuation misstatement 

exceeds $5,000 ($10,000 in the case of a corporation other than an S corporation or a personal 

holding company). Under present law, no penalty is imposed with respect to any portion of the 

understatement attributable to any item if (1) the treatment of the item on the return is or was 

supported by substantial authority, or (2) facts relevant to the tax treatment of the item were 

adequately disclosed on the return or on a statement attached to the return and there is a 

reasonable basis for the tax treatment. Special rules apply to tax shelters. 

Description of Proposal

The proposal imposes a penalty on any taxpayer filing an erroneous claim for refund or 

credit. The penalty is equal to 20 percent of the disallowed portion of the claim for refund or 

credit for which there is no reasonable basis for the claimed tax treatment. 

Effective Date

The proposal is effective for claims for refund or credit filed after the date of enactment 

or for claims for refund or credit submitted prior to the date of enactment that are not withdrawn 

within 30 days after the date of enactment.

 66 Sec. 6662(b)(3) and (h). 
 

62

IV. CONFIDENTIALITY AND DISCLOSURE 

A. Disclosure to State Officials of Proposed Actions Related 

to Certain Section 501(c) Organizations 

Present Law

In the case of organizations that are described in section 501(c)(3) and exempt from tax 

under section 501(a) or that have applied for exemption as an organization so described, present 

law (sec. 6104(c)) requires the Secretary to notify the appropriate State officer of (1) a refusal to 

recognize such organization as an organization described in section 501(c)(3), (2) a revocation of 

a section 501(c)(3) organization’s tax-exempt status, and (3) the mailing of a notice of deficiency 

for any tax imposed under section 507, chapter 41, or chapter 42.67 In addition, at the request of 

such appropriate State officer, the Secretary is required to make available for inspection and 

copying, such returns, filed statements, records, reports, and other information relating to the 

above-described disclosures, as are relevant to any State law determination. An appropriate 

State officer is the State attorney general, State tax officer, or any State official charged with 

overseeing organizations of the type described in section 501(c)(3). 

In general, returns and return information (as such terms are defined in section 6103(b)) 

are confidential and may not be disclosed or inspected unless expressly provided by law.68 

Present law requires the Secretary to keep records of disclosures and requests for inspection69

and requires that persons authorized to receive returns and return information maintain various 

safeguards to protect such information against unauthorized disclosure.70 Willful unauthorized 

disclosure or inspection of returns or return information is subject to a fine and/or 

imprisonment.71 The knowing or negligent unauthorized inspection or disclosure of returns or 

return information gives the taxpayer a right to bring a civil suit.72 Such present-law protections 

against unauthorized disclosure or inspection of returns and return information do not apply to 

the disclosures or inspections, described above, that are authorized by section 6104(c). 

 67 The applicable taxes include the termination tax on private foundations; taxes on public 

charities for certain excess lobbying expenses; taxes on a private foundation’s net investment income, 

self-dealing activities, undistributed income, excess business holdings, investments that jeopardize 

charitable purposes, and taxable expenditures (some of these taxes also apply to certain non-exempt 

trusts); taxes on the political expenditures and excess benefit transactions of section 501(c)(3) 

organizations; and certain taxes on black lung benefit trusts and foreign organizations. 

68 Sec. 6103(a). 

69 Sec. 6103(p)(3). 

70 Sec. 6103(p)(4). 

71 Secs. 7213 and 7213A. 

72 Sec. 7431. 
 

63

Description of Proposal

The proposal provides that upon written request by an appropriate State officer, the 

Secretary may disclose: (1) a notice of proposed refusal to recognize an organization as a section 

501(c)(3) organization; (2) a notice of proposed revocation of tax-exemption of a section 

501(c)(3) organization; (3) the issuance of a proposed deficiency of tax imposed under section 

507, chapter 41, or chapter 42; (4) the names, addresses, and taxpayer identification numbers of 

organizations that have applied for recognition as section 501(c)(3) organizations; and (5) returns 

and return information of organizations with respect to which information has been disclosed 

under (1) through (4) above.73 Disclosure or inspection is permitted for the purpose of, and only 

to the extent necessary in, the administration of State laws regulating section 501(c)(3) 

organizations, such as laws regulating tax-exempt status, charitable trusts, charitable solicitation, 

and fraud. Such disclosure or inspection may be made only to or by an appropriate State officer 

or to an officer or employee of the State who is designated by the appropriate State officer, and 

may not be made by or to a contractor or agent. The Secretary also is permitted to disclose or 

open to inspection the returns and return information of an organization that is recognized as taxexempt under section 501(c)(3), or that has applied for such recognition, to an appropriate State 

officer if the Secretary determines that disclosure or inspection may facilitate the resolution of 

Federal or State issues relating to the tax-exempt status of the organization. For this purpose, 

appropriate State officer means the State attorney general, the State tax officer, and any other 

State official charged with overseeing organizations of the type described in section 501(c)(3). 

In addition, the proposal provides that upon the written request by an appropriate State 

officer, the Secretary may make available for inspection or disclosure returns and return 

information of an organization described in section 501(c)(2) (certain title holding companies), 

501(c)(4) (certain social welfare organizations), 501(c)(6) (certain business leagues and similar 

organizations), 501(c)(7) (certain recreational clubs), 501(c)(8) (certain fraternal organizations), 

501(c)(10) (certain domestic fraternal organizations operating under the lodge system), and 

501(c)(13) (certain cemetery companies). Such returns and return information are available for 

inspection or disclosure only for the purpose of, and to the extent necessary in, the administration 

of State laws regulating the solicitation or administration of the charitable funds or charitable 

assets of such organizations. Such disclosure or inspection may be made only to or by an 

appropriate State officer or to an officer or employee of the State who is designated by the 

appropriate State officer, and may not be made by or to a contractor or agent. For this purpose, 

appropriate State officer means the State attorney general, the State tax officer, and the head of 

an agency designated by the State attorney general as having primary responsibility for 

overseeing the solicitation of funds for charitable purposes of such organizations. 

In addition, the proposal provides that any returns and return information disclosed under 

section 6104(c) may be disclosed in civil administrative and civil judicial proceedings pertaining 

to the enforcement of State laws regulating the applicable tax-exempt organization in a manner 

prescribed by the Secretary. Returns and return information are not to be disclosed under section 

 73 Such returns and return information also may be open to inspection by an appropriate State 

officer. 
 

64

6104(c), or in such an administrative or judicial proceeding, to the extent that the Secretary 

determines that such disclosure would seriously impair Federal tax administration. The proposal 

makes disclosures of returns and return information under section 6104(c) subject to the 

disclosure, recordkeeping, and safeguard provisions of section 6103, including the requirements 

that the Secretary maintain a permanent system of records of requests for disclosure (sec. 

6103(p)(3)), and that the appropriate State officer maintain various safeguards that protect 

against unauthorized disclosure (sec. 6103(p)(4)). The proposal provides that the willful 

unauthorized disclosure of returns or return information described in section 6104(c) is a felony 

subject to a fine of up to $5,000 and/or imprisonment of up to five years (sec. 7213(a)(2)), the 

willful unauthorized inspection of returns or return information described in section 6104(c) is 

subject to a fine of up to $1,000 and/or imprisonment of up to one year (sec. 7213A), and 

provides the taxpayer the right to bring a civil action for damages in the case of knowing or 

negligent unauthorized disclosure or inspection of such information (sec. 7431(a)(2)). 

Effective Date

The proposal is effective on the date of enactment but does not apply to requests made 

before such date.
 

65

B. Collection Activities with Respect to a Joint Return Disclosable 

to Either Spouse Based on Oral Request 

Present Law

Section 6103(e) concerns disclosures to persons with a material interest. Section 

6103(e)(1)(B) requires, upon written request, the IRS to allow the inspection or disclosure of a 

joint return to either of the individuals with respect to whom the return is filed. Section 

6103(e)(7) permits the IRS to disclose return information to the same persons who may have 

access to a return under the other proposals of section 6103(e). Requests for information 

pursuant to section 6103(e)(7) do not have to be in writing. Pursuant to section 6103(e)(7) and 

section 6103(e)(1)(B), either spouse may obtain return information regarding a joint return, 

including collection information without making a written request. 

In response to concerns that former spouses were not able to obtain information regarding 

collection activities relating to a joint return, the Taxpayer Bill of Rights 2 added section 

6103(e)(8).74 When a deficiency is assessed with respect to a joint return and the individuals are 

no longer married or no longer reside in the same household, upon request in writing by either of 

such individuals, the IRS is required to disclose: (1) whether the IRS has attempted to collect 

such deficiency from the other individual; (2) the general nature of such collection activities; and 

(3) the amount collected.75 

The Treasury Inspector General for Tax Administration conducts semiannual reports 

involving a review and certification of whether the Secretary is complying with the requirements 

of disclosing information to an individual filing a joint return on collection activity involving the 

other individual filing the return.76

Description of Proposal

The proposal eliminates the requirement for former spouses to make a written request for 

disclosure of collection activities with respect to a joint return. The proposal also eliminates the 

Treasury Inspector General for Tax Administration’s reporting requirement associated with the 

disclosure of collection activities with respect to a joint return. 

Effective Date

The proposal is effective for requests and reports made after the date of enactment.

 74 “The IRS does not routinely disclose collection information to a former spouse that relates to 

tax liabilities attributable to a joint return that was filed when married.” Joint Committee on Taxation, 

General Explanation of Taxation Legislation Enacted in the 104th Congress (JCS-12-96), December 18, 

1996 at 29. 

75 Sec. 6103(e)(8). 

76 Sec. 7803(d)(1)(B). 
 

66

C. Prohibition of Disclosure of Taxpayer Identification Information with 

Respect to Disclosure of Accepted Offers-in-Compromise 

Present Law

Section 6103 permits the IRS to disclose return information to members of the general 

public to permit inspection of accepted offers in compromise.77 For one year after the date of 

execution, a copy of the Form 7249, “Offer Acceptance Report,” for each accepted offer in 

compromise with respect to any liability for a tax imposed by Title 26 is made available for 

inspection and copying in the location designated by the Compliance Area Director or 

Compliance Services Field Director within the Small Business and Self-Employed Division of 

the taxpayer’s geographic area of residence.78 Currently, this form contains the taxpayer 

identification number of the taxpayer, e.g., the social security number in the case of an individual 

taxpayer, along with the taxpayer’s name and full address. 

Description of Proposal

The proposal prohibits the disclosure of the taxpayer’s taxpayer identification number as 

part of the publicly available summaries of accepted offers-in-compromise. 

Effective Date

The proposal applies to disclosures made after the date of enactment.

 77 Sec. 6103(k)(l). 

78 Treas. Reg. sec. 601.702(d)(8). 
 

67

D. Compliance By Contractors with Confidentiality Safeguards 

Present Law

Section 6103 permits the disclosure of returns and return information to State agencies, as 

well as to other Federal agencies for specified purposes. Section 6103(p)(4) requires, as 

conditions of receiving returns and return information, that State agencies (and others) provide 

safeguards as prescribed by the Secretary of the Treasury by regulation to be necessary or 

appropriate to protect the confidentiality of returns or return information.79 It also requires that 

a report be furnished to the Secretary at such time and containing such information as prescribed 

by the Secretary regarding the procedures established and utilized for ensuring the confidentiality 

of returns and return information.80 After an administrative review, the Secretary may take such 

actions as are necessary to ensure these requirements are met, including the refusal to disclose 

returns and return information.81 

Under present law, employees of a State tax agency may disclose returns and return 

information to contractors for tax administration purposes.82 These disclosures can be made 

only to the extent necessary to procure contractually equipment, other property, or the providing 

of services, related to tax administration.83 

The contractors can make redisclosures of returns and return information to their 

employees as necessary to accomplish the tax administration purposes of the contract, but only to 

contractor personnel whose duties require disclosure.84 Treasury regulations prohibit 

redisclosure to anyone other than contractor personnel without the written approval of the IRS.85 

 79 Sec. 6103(p)(4)(D). 

80 Sec. 6103(p)(4)(E). 

81 Sec. 6103(p)(4) (flush language) and (7); Treas. Reg. sec. 301.6103(p)(7)-1. 

82 Sec. 6103(n) and Treas. Reg. sec. 301.6103(n)-1(a). “Tax administration” includes “the 

administration, management, conduct, direction, and supervision of the execution and application of 

internal revenue laws or related statutes (or equivalent laws and statutes of a State)...” Sec. 6103(b)(4). 

83 Treas. Reg. sec. 301.6013(n)-1(a). Such services include the processing, storage, transmission 

or reproduction of such returns or return information, the programming, maintenance, repair, or testing of 

equipment or other property, or the providing of other services for purposes of tax administration. 

84 Treas. Reg. sec. 301.6103(n)-1(a) and (b). A disclosure is necessary if such procurement or 

the performance of such services cannot otherwise be reasonably, properly, or economically 

accomplished without such disclosure. Treas. Reg. sec. 301.6103(n)-1(b). The regulations limit the 

quantity of information to that needed to perform the contract. 

85 Treas. Reg. sec. 301.6103(n)-1(a). 
 

68

By regulation, all contracts must provide that the contractor will comply with all 

applicable restrictions and conditions for protecting confidentiality prescribed by regulation, 

published rules or procedures, or written communication to the contractor.86 Failure to comply 

with such restrictions or conditions may cause the IRS to terminate or suspend the duties under 

the contract or the disclosures of returns and return information to the contractor.87 In addition, 

the IRS can suspend disclosures to the State tax agency until the IRS determines that the 

conditions are or will be satisfied.88 The IRS may take such other actions as deemed necessary 

to ensure that such conditions or requirements are or will be satisfied.89 

Description of Proposal

The proposal requires that a State, local, or Federal agency conduct on-site reviews every 

three years of all of its contractors or other agents receiving Federal returns and return 

information. If the duration of the contract or agreement is less than one year, a review is 

required at the mid-point of the contract. The purpose of the review is to assess the contractor’s 

efforts to safeguard Federal returns and return information. This review is intended to cover 

secure storage, restricting access, computer security, and other safeguards deemed appropriate by 

the Secretary. Under the proposal, the State, local or Federal agency is required to submit a 

report of its findings to the IRS and certify annually that such contractors and other agents are in 

compliance with the requirements to safeguard the confidentiality of Federal returns and return 

information. The certification is required to include the name and address of each contractor or 

other agent with the agency, the duration of the contract, and a description of the contract or 

agreement with the State, local, or Federal agency. 

The proposal does not apply to contracts for purposes of Federal tax administration. 

This proposal does not alter or affect in any way the right of the IRS to conduct safeguard 

reviews of State, local, or Federal agency contractors or other agents. It also does not affect the 

right of the IRS to initially approve the safeguard language in the contract or agreement and the 

safeguards in place prior to any disclosures made in connection with such contracts or 

agreements. 

Effective Date

The proposal is effective for disclosures made after the date of enactment. The first 

certification is required to be made with respect to the portion of calendar year 2006 following 

the date of enactment.

 86 Treas. Reg. sec. 301.6103(n)-1(d). 

87 Treas. Reg. sec. 301.6103(n)-1(d)(1). 

88 Treas. Reg. sec. 301.6103(n)-1(d)(2). 

89 Treas. Reg. sec. 301.6103(n)-1(d). 
 

69

E. Higher Standards for Requests for and Consents to Disclosure 

Present Law

In general

As a general rule, returns and return information are confidential and cannot be disclosed 

unless authorized by Title 26.90 Under section 6103(c), a taxpayer may designate in a request or 

consent to the disclosure by the IRS of his or her return or return information to a third party. 

Treasury regulations set forth the requirements for such consent.91 The request or consent may 

be written or nonwritten form. The Treasury regulations require that the taxpayer sign and date a 

written consent. At the time the consent is signed and dated by the taxpayer, the written 

document must indicate (1) the taxpayer’s taxpayer identity information; (2) the identity of the 

person to whom disclosure is to be made; (3) the type of return (or specified portion of the 

return) or return information (and the particular data) that is to be disclosed; and (4) the taxable 

year covered by the return or return information. The regulations also require that the consent be 

submitted within 60 days of the date signed and dated, however, at the time of submission, the 

IRS generally is unaware of whether a consent form was completed or dated after the taxpayer 

signs it. Present law does not require that a recipient receiving returns or return information by 

consent maintain the confidentiality of the information received. Under present law, the 

recipient is also free to use the information for purposes other than for which the information was 

solicited from the taxpayer. 

Section 6103(c) consents are often used in connection with mortgage loan applications. 

Mortgage originators qualify loan applicants as meeting or not meeting the requirements for loan 

approval. This process involves the verification and investigation of information and conditions. 

If the loan is granted, the mortgage originator may use its own money to fund the loan. 

Alternatively, another entity, an “investor,” may buy the loan and provide the money. Investors 

typically perform a re-investigation of loans received for funding. Such re-investigations may 

include verification through the IRS of the tax return provided by the taxpayer to the mortgage 

originator. 

Usually the mortgage originator does not know which investor will ultimately fund the 

loan. Thus, at the time of application, the originator asks the borrower/taxpayer to sign a consent 

(Form 4506) designating the originator as the third party to receive the taxpayer’s returns. 

Subsequently, at closing, the investor may request that the originator obtain another Form 4506 

naming the investor as the third party to receive the taxpayer’s return. 

Ostensibly to avoid confusion over why the taxpayer would be authorizing a party other 

than the originator to receive his tax return, the taxpayer may be asked to sign a blank Form 4506 

at closing. In some cases, mortgage originators ask taxpayers not to date the Form 4506. This 

 90 Sec. 6103(a). 

91 Treas. Reg. sec. 301.6103(c)-1. 
 

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allows the form to be submitted to the IRS at a later date, often months or years later, for 

purposes of mortgage resale. 

Criminal penalties

Under section 7206, it is a felony to willfully make and subscribe any document that 

contains or is verified by a written declaration that it is made under penalties of perjury and 

which such person does not believe to be true and correct as to every material matter.92 Upon 

conviction, such person may be fined up to $100,000 ($500,000 in the case of a corporation) or 

imprisoned up to 3 years, or both, together with the costs of prosecution. 

Under section 7213, criminal penalties apply to: (1) willful unauthorized disclosures of 

returns and return information by Federal and State employees and other persons; (2) the offering 

of any item of material value in exchange for a return or return information and the receipt of 

such information pursuant to such an offer; and (3) the unauthorized disclosure of return 

information received by certain shareholders under the material interest proposal of section 6103. 

Under section 7213, a court can impose a fine up to $5,000, up to five years imprisonment, or 

both, together with the costs of prosecution. If the offense is committed by a Federal employee 

or officer, the employee or officer will be discharged from office upon conviction. 

The willful and unauthorized inspection of returns and return information can subject 

Federal and State employees and others to a maximum fine of $1,000, up to a year in prison, or 

both, in addition to the costs of prosecution. If the offense is committed by a Federal employee 

or officer, the employee or officer will be discharged from office upon conviction. 

Civil damage remedies for unauthorized disclosure or inspection

If a Federal employee makes an unauthorized disclosure or inspection, a taxpayer can 

bring suit against the United States in Federal district court. If a person other than a Federal 

employee makes an unauthorized disclosure or inspection, suit may be brought directly against 

such person. No liability results from a disclosure based on a good faith, but erroneous, 

interpretation of section 6103. A disclosure or inspection made at the request of the taxpayer 

will also relieve liability. 

Upon a finding of liability, a taxpayer can recover the greater of $1,000 per act of 

unauthorized disclosure (or inspection), or the sum of actual damages plus, in the case of an 

inspection or disclosure that was willful or the result of gross negligence, punitive damages. 

The taxpayer may also recover the costs of the action and, if found to be a prevailing party, 

reasonable attorney fees. 

The taxpayer has two years from the date of the discovery of the unauthorized inspection 

or disclosure to bring suit. The IRS is required to notify a taxpayer of an unauthorized inspection 

or disclosure as soon as practicable after any person is criminally charged by indictment or 

information for unlawful inspection or disclosure. 

 92 Sec. 7206(1). 
 

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Description of Proposal

The proposal requires the consent form prescribed by the IRS to contain a warning, 

prominently displayed, informing the taxpayer that he or she should not sign the form unless it is 

complete. The proposal requires the consent form to state that if the taxpayer believes there is an 

attempt to coerce him to sign an incomplete or blank form, the taxpayer should report the matter 

to the Treasury Inspector General for Tax Administration. The telephone number and address 

for the Treasury Inspector General for Tax Administration must be included on the form. The 

returns and return information of any taxpayer disclosed to a designee of the taxpayer for a 

purpose specified in writing, electronically, or orally may be disclosed or used by such persons 

only for the purpose of, and to the extent necessary in, accomplishing the purpose for the 

disclosure specified and cannot not be disclosed or used for any other purpose. The proposal 

makes a violation of these requirements, or use or disclosure of information obtained by consent 

for purposes not permitted by section 6103, punishable by a civil penalty. 

The Secretary of the Treasury is required to submit a report to Congress on compliance 

with the designation and certification requirements no later than 18 months after the date of 

enactment. Such report must evaluate (on the basis of random sampling) whether the proposal is 

achieving its purpose, whether requesters and submitters are continuing to evade the purpose of 

the proposal, whether the sanctions are adequate, and whether additional provisions are 

necessary or appropriate to better achieve the purposes of the proposal. 

Any request for or consent to disclose any return or return information under section 

6103(c) made before the date of enactment of the proposal remains in effect until the earlier of 

the date such request or consent is otherwise terminated or the date three years after the date of 

enactment. 

Effective Date

The proposal applies to requests and consents made three months after the date of 

enactment. 
 

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F. Civil Damage Remedies for Unauthorized Disclosure or Inspection 

Present Law

If a Federal employee makes an unauthorized disclosure or inspection, a taxpayer can 

bring suit against the United States in Federal district court. If a person other than a Federal 

employee makes an unauthorized disclosure or inspection, suit may be brought directly against 

such person. No liability results from a disclosure based on a good faith, but erroneous, 

interpretation of section 6103. A disclosure or inspection made at the request of the taxpayer 

will also relieve liability. 

Upon a finding of liability, a taxpayer can recover the greater of $1,000 per act of 

unauthorized disclosure (or inspection), or the sum of actual damages plus, in the case of an 

inspection or disclosure that was willful or the result of gross negligence, punitive damages. 

The taxpayer may also recover the costs of the action and, if found to be a prevailing party, 

reasonable attorney fees. 

The taxpayer has two years from the date of the discovery of the unauthorized inspection 

or disclosure to bring suit. The IRS is required to notify a taxpayer of an unauthorized inspection 

or disclosure as soon as practicable after any person is criminally charged by indictment or 

information for unlawful inspection or disclosure. 

Description of Proposal

The proposal requires the Secretary to notify a taxpayer if the IRS or, upon notice to the 

Secretary by a Federal or State agency, if such Federal or State agency, proposes an 

administrative determination as to disciplinary or adverse action against an employee arising 

from the employee’s unauthorized inspection or disclosure of the taxpayer’s return or return 

information. The proposal requires the notice to include the date of the inspection or disclosure 

and the rights of the taxpayer as a result of such administrative determination. 

Under the proposal, in action for civil damages for unauthorized disclosure or inspection, 

any person who made the inspection or disclosure bears the burden of proving the existence of a 

good faith interpretation of section 6103 to avoid liability. 

 The proposal adds a new exhaustion of administrative remedies requirement. A 

judgment for damages will not be awarded unless the court determines that the plaintiff has 

exhausted the administrative remedies available. The proposal also clarifies that unauthorized 

disclosure or inspection damage claims are payable out of funds appropriated under section 1304 

of title 31 of the United States Code (relating to the United States Judgment Fund). Both 

administrative settlements and settlements of judicial proceedings are paid out of this fund. The 

Secretary of the Treasury will report annually to the Committee on Finance of the Senate and the 

Committee on Ways and Means of the House of Representatives regarding damage claim 

payments made from the United States Judgment Fund. 

As part of its public report on disclosures, the proposal requires the Secretary to furnish 

information regarding the willful unauthorized disclosure and inspection of returns and return 
 

73

information. Such information includes the number, status, and results of: (1) administrative 

investigations, (2) civil lawsuits brought under section 7431 (including the amounts for which 

such lawsuits were settled and the amounts of damages awarded), and (3) criminal prosecutions. 

Effective Date

The proposal is effective: (1) for determinations made after 180 days after the date of 

enactment with respect to the taxpayer notice requirement; (2) for inspections and disclosures 

occurring on and after 180 days after the date of enactment with respect to the proposals relating 

to the exhaustion of administrative remedies and burden of proof; (3) 180 days after the date of 

enactment with respect to the payment authority; and (4) for calendar years ending after 180 days 

after the date of enactment with respect to the reporting requirements.
 

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G. Expanded Disclosure in Emergency Circumstances 

Present Law

Section 6103(i)(3)(B) permits the IRS to disclose return information to the extent 

necessary to apprise Federal or State law enforcement officials of circumstances involving an 

imminent danger of death or physical injury to an individual. Recipients of such information are 

required to adhere to certain recordkeeping, reporting, and safeguard requirements as a condition 

of receiving such information (sec. 6103(p)(4)). Upon completion of use of such information, 

the Code requires the recipient to return the information to the IRS or make the information 

undisclosable and furnish a report to the IRS as to the manner in which the information was 

made undisclosable (“destruction requirements”) (sec. 6103(p)(4)(F)(i)). 

Description of Proposal

The proposal expands present law to permit disclosure of return information to local law 

enforcement authorities to apprise them of circumstances involving imminent danger of death or 

physical injury to an individual. The proposal eliminates the recordkeeping, safeguard and 

destruction requirements for all such disclosures to Federal, State or local law enforcement 

officials. 

Effective Date

The proposal is effective on the date of enactment. 
 

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H. Disclosure of Taxpayer Identity for Tax Refund Purposes 

Present Law

When the IRS is unable to find a taxpayer due a refund, present law provides that the IRS 

may use “the press or other media” to notify the taxpayer of the refund.93 Section 6103(m) 

allows the IRS to give the press taxpayer identity information for this purpose.94 Taxpayer 

identity includes name, mailing address, taxpayer identification number or combination thereof. 

The IRS believes that the current statutory framework of “press and other media” does 

not permit disclosures via the Internet. The legislative history of the present-law proposal does 

not address the meaning of “press and other media.” At the time of the statute’s enactment in 

1976, the press (newspapers and periodicals) and other traditional media were the only means 

available for the IRS to distribute undelivered refund information to the public. Thus, the IRS 

interprets the term “other media” to exclude the Internet. 

Description of Proposal

The proposal allows the IRS to use any means of “mass communication,” including the 

Internet, to notify the taxpayer of an undelivered refund. It limits the amount of return 

information that may be disclosed to a taxpayer’s name, and the city, State, and zip code of the 

taxpayer’s mailing address. 

Effective Date

The proposal is effective upon date of enactment.

 93 Sec. 6103(m)(1). This section provides: 

The Secretary may disclose taxpayer identity information to the press or other media for 

purposes of notifying persons entitled to tax refunds when the Secretary, after reasonable 

effort and lapse of time, has been unable to locate such persons. 

94 Sec. 6103(m)(1), and (b)(6) (definition of “taxpayer identity”). 
 

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I. Treatment of Public Records 

Present Law

Section 6103 provides that “returns and return information shall be confidential and 

except as authorized by this title . . . [none of the identified persons] shall disclose any return or 

return information obtained by him . . .”95 A taxpayer can sue the United States government for 

the unauthorized disclosure and/or inspection of returns and return information.96 Section 6103 

does not expressly address the disclosure of returns and return information made a part of the 

public record. 

Returns and return information become part of the public record in many ways. For 

example, returns and return information introduced in judicial proceedings constitutes publicly 

available court records.97 As another example, notices of Federal tax lien filed with the county 

recorder alert the public of the IRS’s interest in a taxpayer’s property.98

The courts are divided on whether section 6103 applies to publicly disclosed returns and 

return information. Some courts have strictly interpreted section 6103, applying it despite the 

information’s public availability. Other courts have found that returns and return information 

found in the public record loses its confidential status so that a person disclosing it does not 

violate section 6103. Still other courts have looked to the source of the information being 

disclosed. These courts find that section 6103 does not protect returns and return information 

taken directly from a public source, while information taken directly from IRS records remains 

protected. 

Description of Proposal

Under the proposal, the general confidentiality restrictions do not apply to returns and 

return information disclosed: (1) in the course of any judicial or administrative proceeding or 

pursuant to tax administration activities, and (2) properly made part of the public record. In a 

situation in which a third-party is seeking to have the IRS divulge information that would 

otherwise be protected by section 6103, it is expected that the third party seeking the information 

will be required to point to specific information in the public record that appears to duplicate that 

being withheld. For example, if a third party makes a Freedom of Information Act request for a 

record that is contained both in a publicly available court file and also in an IRS administrative 

file, the requester would need to provide to the IRS evidence that the information sought from 

the IRS is also in the court file. 

 95 Sec. 6103(a). 

96 Sec. 7431. 

97 See, e.g., sec. 7461 regarding the publicity of U.S. Tax Court proceedings. 

98 See sec. 6323(f) regarding where to file notices of Federal tax lien. 
 

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Effective Date

The proposal is effective before, on, and after the date of enactment. 
 

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J. Taxpayer Identification Number Matching 

Present Law

A taxpayer identification number (TIN) is an identification number used by the IRS for 

purposes of tax administration. A TIN must be furnished on all returns, statements, or other tax 

related documents.99 The Code imposes information reporting requirements upon payors of 

income. The Code provides that a person (the payor) required to make a return with respect to 

another person (the payee) must ask the payee for the identifying number prescribed for securing 

the proper identification of the payee and include that number in the return.100 Typically, if there 

is an error with the name/TIN combination furnished by the payee, the disclosure of such error to 

the payor is permitted when the reportable payment is already subject to backup withholding.101 

Description of Proposal

The proposal permits the IRS to disclose to any person required to provide a taxpayer 

identifying number to the IRS whether such information matches records maintained by the IRS. 

This will allow a payor to verify the TIN furnished by a payee prior to filing information returns 

for reportable payments on behalf of the payee. Under the proposal, the IRS informs the payor 

whether there is an error with the name/TIN combination furnished by the payee. The 

verification is limited to whether the information provided by the payor matches the records of 

the IRS. The IRS will not disclose correct TINs if an error arises, as it will be the responsibility 

of the payor to obtain the correct TIN from the payee. 

Effective Date

The proposal is effective on the date of enactment.

 99 Sec. 6109(a)(1). 

100 Sec. 6109(a)(3). 

101 Sec. 3406. 
 

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K. Form 8300 Disclosures 

Present Law

Under the Code, any person engaged in a trade or business who receives more than 

$10,000 in cash in one transaction (or in two or more related transactions) is required to report 

the receipt of cash to the IRS and the Financial Crimes Enforcement Network (FinCEN) on Form 

8300 (Report of Cash Payments Over $10,000 Received in a Trade or Business).102 Any Federal 

agency, State or local government agency, or foreign government agency may have access, upon 

written request, to the information contained in returns filed under section 6050I. The Code 

provides that disclosures of information from Form 8300 be made on the same basis and subject 

to the same conditions as apply to disclosures of information filed on Currency Transaction 

Reports under the Bank Secrecy Act.103 This proposal however, cannot be used to obtain 

disclosures for tax administration purposes. The general safeguard requirements of the Code 

apply to such disclosures.104 For example, as a condition of disclosure, requesting agencies must 

file with the IRS a report describing the procedures established and utilized by the agency for 

ensuring the confidentiality of return information. 

Description of Proposal

The proposal repeals the safeguard requirements applicable to the disclosure of returns 

filed reflecting cash receipts of more than $10,000 received in a trade or business. 

Effective Date

The proposal is effective on the date of enactment.

 102 Sec. 6050I and 31 U.S.C. sec. 5331. 

103 31 U.S.C. sec. 5313. 

104 Sec. 6103(p)(4). 
 

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L. Expanded Definition of Return Preparer for Purposes of 

Sections 6713 and 7216 

Present Law

Section 7216 imposes criminal penalties on return preparers of income tax returns who 

knowingly or recklessly make unauthorized disclosures or use information furnished to them in 

connection with the preparation of an income tax return. A violation of section 7216 is 

punishable by a fine of not more than $1,000, one year of imprisonment, or both, together with 

the costs of prosecution. The penalties do not apply to disclosures authorized by the Code or 

made pursuant to an order of a court. The penalties also do not apply to the use of information in 

the preparation of State and local tax returns and declarations of estimated tax of the person to 

whom the information relates. Finally, the penalties do not apply to any disclosure or use 

permitted under the applicable Treasury regulations. 

In addition, tax return preparers are subject to civil penalties under section 6713 for 

disclosure or use of tax return information unless an exception under the rules of section 7216 

applies to the disclosure or use. The civil penalty is $250 for each unauthorized disclosure or 

use, but the total amount imposed on a person for any calendar year cannot exceed $10,000. 

Under present law Treasury regulations, “tax return preparer” means any person: 

• who is engaged in the business of preparing tax returns, 

• who is engaged in the business of providing auxiliary services in connection with the 

preparation of tax returns, 

• who is remunerated for preparing, or assisting in preparing, a tax return for any other 

person, or 

• who, as part of his duties or employment with any person described in (1), (2) or (3) 

above, performs services which assist in the preparation of, or assist in providing 

auxiliary services in connection with the preparation of, a tax return.105

A person is engaged in the business of preparing tax returns if, in the course of his 

business, he holds himself out to taxpayers as a person who prepares tax returns, whether or not 

tax return preparation is his sole business activity and whether or not he charges a fee for such 

services. A person is engaged in the business of providing auxiliary services in connection with 

the preparation of tax returns if, in the course of his business, he holds himself out to tax return 

preparers or taxpayers as a person who performs such auxiliary services, whether or not 

providing auxiliary services is his sole business activity and whether or not he charges a fee for 

such services. For example, a person part or all of whose business is to provide a computerized 

tax return processing service based on tax return information furnished by another person is a tax 

return preparer. 

 105 Treas. Reg. 301.7216-1(b)(2). 
 

81 

A person is not a tax return preparer merely because he leases office space to a tax return 

preparer, furnishes credit to a taxpayer whose tax return is prepared by a tax return preparer, or 

otherwise performs some service which only incidentally relates to the preparation of tax returns. 

Description of Proposal

The proposal expands the return preparer penalties beyond income tax returns to other tax 

returns, including estate and gift tax returns, employment tax, and excise tax returns. 

The proposal modifies the regulatory definition of tax return preparer to include any 

person who assists in preparing tax returns for compensation or holds himself out to tax return 

preparers or taxpayers as a person who assists in preparing tax returns, regardless of whether tax 

return preparation is the person’s sole business activity and regardless of whether the person 

charges a fee for tax return preparation services. The proposal also specifically includes as a tax 

return preparer, a person who develops software that is used to prepare or file a tax return, 

electronic return originators/authorized IRS e-file providers, as well as contractors of the tax 

return preparer performing services in connection with tax return preparation. 

Effective Date

The proposal is effective for returns prepared after the date of enactment. 
 

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M. Restrict the Use and Disclosure of Taxpayer Information by Return 

Preparers for Nontax Purposes and Offshore Disclosures 

Present Law

Section 7216 imposes criminal penalties on return preparers of income tax returns who 

knowingly or recklessly make unauthorized disclosures or use information furnished to them in 

connection with the preparation of an income tax return. The criminal penalties do not apply to 

disclosures authorized by the Code or made pursuant to an order of a court. The penalties also 

do not apply to the use of information in the preparation of State and local tax returns and 

declarations of estimated tax of the person to whom the information relates. Finally, the 

penalties do not apply to any disclosure or use permitted under the applicable Treasury 

regulations. 

The Treasury regulations set forth circumstances under which a tax return preparer may 

disclose or use a taxpayer’s tax return information without first obtaining the taxpayer’s consent 

and those circumstances for which the formal consent of the taxpayer is required. 

Disclosure or use without formal consent of taxpayer

Disclosure or use of information in the case of related taxpayers

Taxpayer consent is not required for the disclosure or use of information in the case of a 

related taxpayers. A tax return preparer may use, in preparing a tax return of a second taxpayer, 

and may disclose to such second taxpayer in the form in which it appears on such return, any tax 

return information which the preparer obtained from a first taxpayer if 

The second taxpayer is related to the first taxpayer, 

• The first taxpayer’s tax interest in such information is not adverse to the second 

taxpayer’s tax interest in such information, and 

• The first taxpayer has not expressly prohibited such disclosure or use. 

One taxpayer is related to another taxpayer if they have any one of the following 

relationships: husband and wife, child and parent, grandchild and grandparent, partner and 

partnership, trust or estate and fiduciary, corporation and shareholder, or members of a controlled 

group of corporations. 

Other permissible disclosures without consent

Consent of the taxpayer also is not required for the following disclosures: 

• Disclosures pursuant to an order of a court or a Federal or State agency. 

• Disclosures for use in revenue investigations or court proceedings. Disclosure for use 

in revenue investigations or court proceedings in connection with investigations of 

the return preparer by the IRS or for use in connection with proceedings involving 

such return preparer before a court or grand jury. 
 

83 

• Certain disclosures by lawyers and accountants to other members or employees of the 

firm.106

• Corporate fiduciaries. A trust company, trust department of a bank or other corporate 

fiduciary which prepares a tax return for a taxpayer to or for who it renders fiduciary, 

investment, or other custodial or management services may (1) disclose or use the tax 

return information in the ordinary course of rendering services to or for the taxpayer 

or (2) with the express or implied consent of the taxpayer, make such information 

available to the taxpayer’s attorney, accountant, or investment advisor. 

• Disclosure to the taxpayer’s fiduciary. If the taxpayer dies, becomes incompetent, 

insolvent or bankrupt, or his assets are placed in conservatorship or receivership after 

furnishing tax return information to a tax return preparer, the tax return preparer may 

disclosure such information to the duly appointed fiduciary of the taxpayer or his 

estate, or to the duly authorized agent of such fiduciary. 

• Disclosure by tax return preparer to tax return processor. A tax return preparer may 

disclose tax return information to another tax return preparer for the purpose of 

having the second tax return preparer transfer that information to and compute the tax 

liability on, a tax return of such taxpayer by means of electronic, mechanical, or other 

form of tax return processing service. 

• Disclosure by one officer, employee or member to another. Transfers of tax return 

information between officers, employees and members of the same firm for the 

purpose of performing services which assist in the preparation of, or assist in 

providing auxiliary services in connection with the preparation of, the tax return of a 

taxpayer by or for whom the information was furnished. 

• Identical information obtained from other sources. No restrictions are placed on 

identical tax return information if obtained other than in connection with the 

preparation of, or providing auxiliary services in connection with the preparation of, a 

tax return. 

• Disclosure or use of information in the preparation or audit of State returns. 

 106 Tax return preparers who are lawyers or accountants may disclose such information to another 

member or employee of the preparer’s firm who may use it to render other legal or accounting services to 

the taxpayer; and may (1) take such return information into account and may act upon it in the course of 

performing legal or accounting services for a client other than the taxpayer or (2) disclose such 

information to another employee or member of the preparer’s law or accounting firm to enable that other 

employee or member to take information into account and act upon it in the course of performing legal or 

accounting services for a client other than the taxpayer when such information is or may be relevant to the 

subject matter of such legal or accounting services for the other client and its consideration by those 

performing the services is necessary for the proper performance by them of such services. However, such 

information may not be disclosed to a person who is not a member or employee of the law or accounting 

firm unless such disclosure is authorized by another provision. 
 

84 

• Retention of records. A tax return preparer may retain tax return information of the 

taxpayer and may use such information in connection with the preparation of other 

returns of the taxpayer or in connection with an audit by the IRS of any tax return. 

• Lists for solicitation of tax return business. A tax return preparer may compile and 

maintain a list of client taxpayer names and addresses for the sole purpose of 

contacting the taxpayers on the list for the purpose of offering tax information or 

additional tax return preparation services to such taxpayers. The compiler of the list 

may not transfer such list except in conjunction with the sale or other disposition of 

the tax return preparation business of such compiler. 

• Disclosures to report a crime. Disclosures to report a commission of a crime to the 

proper Federal, State or local official does not require consent. 

• Disclosure or use of information for quality or peer reviews. Tax return information 

may be disclosed for the purpose of a quality or peer review to the extent necessary to 

accomplish the review. 

• Disclosure of tax return information due to a tax return preparer’s incapacity or death. 

In the event of incapacity or death of a tax return preparer, disclosure of tax return 

information may be made for the purpose of assisting the tax return preparer or his 

legal representative (or the representative of a deceased preparer’s estate) in operating 

the business. 

Disclosure or use requiring the consent of the taxpayer

Use of tax return information by an affiliated group

Present law Treasury regulations allow a tax return preparer to solicit a taxpayer’s 

consent to use tax return information for services or facilities (unrelated to tax preparation) 

currently offered by the tax return preparer or member of the tax return preparer’s affiliated 

group. The consent may not be made later than the time the taxpayer receives his completed tax 

return from the tax return preparer. A tax return preparer may not request a consent again after a 

taxpayer has once before refused to provide such consent. 

The form of the consent is prescribed in the regulations. A separate written consent, 

signed by the taxpayer or his duly authorized agent or fiduciary, must be obtained for each 

separate use or disclosure and must contain: 

• The name of the tax return preparer, 

• The name of the taxpayer, 

• The purpose for which the consent is being furnished, 

• The date on which such consent is signed, 

• A statement that the tax return information may not be disclosed or used by the tax 

return preparer for any purpose other than that stated in the consent, and 

• A statement by the taxpayer, or his agent or fiduciary that he consents to the 

disclosure or use of such information. 
 

85 

Consent to disclose tax return information to any third party

Under the Treasury regulations, if a tax return preparer has obtained from a taxpayer a 

consent in the form described above, the tax return preparer may disclose the tax return 

information of such taxpayer to such third persons as the taxpayer may direct. 

Present law does not require a tax return preparer to obtain the written consent of the 

taxpayer before disclosing such information to another tax return preparer located outside of the 

United States. 

Description of Proposal

The proposal permits disclosure by consent only for tax preparation purposes (regardless 

of whether the disclosure or use is by an affiliate of the tax return preparer or a third party). 

Under the proposal, taxpayer consents to use or disclose tax return information other than for tax 

purposes are not permitted. The proposal also prohibits the sale of taxpayer return information 

except in conjunction with the sale of the taxpayer’s business. The renting of client taxpayer 

lists also is prohibited under the proposal. The proposal does not alter the circumstances under 

which a taxpayer’s return information may be disclosed or used without consent. 

The proposal also requires that a tax return preparer notify a taxpayer and obtain the 

taxpayer’s consent before providing the taxpayer’s tax return information to a person located 

outside of the United States. The proposal directs the Secretary to prescribe a consent form that 

provides, among other information deemed appropriate by the Secretary, a clear statement that 

the taxpayer’s tax return information will be disclosed to a tax return preparer located outside of 

the United States and that Federal tax law may not protect the taxpayer from unauthorized use or 

disclosure by such persons. 

Effective Date

The proposal is effective for disclosures and uses made after the date of enactment.
 

86

V. UNITED STATES TAX COURT MODERNIZATION 

A. Consolidate Review of Collection Due Process Cases in the Tax Court 

Present Law

In general, the Internal Revenue Service (“IRS”) is required to notify taxpayers that they 

have a right to a fair and impartial hearing before levy may be made on any property or right to 

property.107 Similar rules apply with respect to liens.108 The hearing is held by an impartial 

officer from the IRS Office of Appeals, who is required to issue a determination with respect to 

the issues raised by the taxpayer at the hearing. The taxpayer is entitled to appeal that 

determination to a court. The appeal must be brought to the United States Tax Court (the “Tax 

Court”), unless the Tax Court does not have jurisdiction over the underlying tax liability. If that 

is the case, then the appeal must be brought in the district court of the United States.109 If a court 

determines that an appeal was not made to the correct court, the taxpayer has 30 days after such 

determination to file with the correct court. 

The Tax Court is established under Article I of the United States Constitution110 and is a 

court of limited jurisdiction.111 The Tax Court only has the jurisdiction that is expressly 

conferred on it by statute.112 For example, the jurisdiction of the Tax Court includes the 

authority to hear disputes concerning notices of income tax deficiency, certain types of 

declaratory judgment, and worker classification status, among others, but does not include 

jurisdiction over most excise taxes imposed by the Internal Revenue Code. Thus, the Tax Court 

may not have jurisdiction over the underlying tax liability with respect to an appeal of a due 

process hearing relating to a collections matter. As a practical matter, many cases involving 

appeals of a due process hearing (whether within the jurisdiction of the Tax Court or a district 

court) do not involve the underlying tax liability. 

Description of Proposal

The proposal modifies the jurisdiction of the Tax Court by providing that all appeals of 

collection due process determinations are to be made to the United States Tax Court. 

 107 Sec. 6330(a). 

108 Sec. 6320. 

109 Sec. 6330(d). 

110 Sec. 7441. 

111 Sec. 7442. 

112 Sec. 7442. 
 

87

Effective Date

The proposal applies to determinations made by the IRS after the date of enactment.
 

88

B. Confirmation of Tax Court Authority to Apply Equitable Recoupment 

Present Law

Equitable recoupment is a common-law equitable principle that permits the defensive use 

of an otherwise time-barred claim to reduce or defeat an opponent’s claim if both claims arise 

from the same transaction. U.S. District Courts and the U.S. Court of Federal Claims, the two 

Federal tax refund forums, may apply equitable recoupment in deciding tax refund cases.113 In 

Estate of Mueller v. Commissioner,

114 the Court of Appeals for the Sixth Circuit held that the 

United States Tax Court (the “Tax Court”) may not apply the doctrine of equitable recoupment. 

More recently, the Court of Appeals for the Ninth Circuit, in Branson v. Commissioner,

115 held 

that the Tax Court may apply the doctrine of equitable recoupment. 

Description of Proposal

The proposal confirms that the Tax Court may apply the principle of equitable 

recoupment to the same extent that it may be applied in Federal civil tax cases by the U.S. 

District Courts or the U.S. Court of Claims. No implication is intended as to whether the Tax 

Court has the authority to continue to apply other equitable principles in deciding matters over 

which it has jurisdiction. 

Effective Date

The proposal is effective for any action or proceeding in the Tax Court with respect to 

which a decision has not become final as of the date of enactment.

 113 See Stone v. White, 301 U.S. 532 (1937); Bull v. United States, 295 U.S. 247 (1935). 

114 153 F.3d 302 (6th Cir.), cert. den., 525 U.S. 1140 (1999). 

115 264 F.3d 904 (9th Cir.), cert. den., 2002 U.S. LEXIS 1545 (U.S. Mar. 18, 2002). 
 

89

C. Extend Authority for Special Trial Judges to Hear 

and Decide Certain Employment Status Cases 

Present Law

In connection with the audit of any person, if there is an actual controversy involving a 

determination by the IRS as part of an examination that (1) one or more individuals performing 

services for that person are employees of that person or (2) that person is not entitled to relief 

under section 530 of the Revenue Act of 1978, the Tax Court has jurisdiction to determine 

whether the IRS is correct and the proper amount of employment tax under such 

determination.116 Any redetermination by the Tax Court has the force and effect of a decision of 

the Tax Court and is reviewable. 

An election may be made by the taxpayer for small case procedures if the amount of the 

employment taxes in dispute is $50,000 or less for each calendar quarter involved.117 The 

decision entered under the small case procedure is not reviewable in any other court and should 

not be cited as authority. 

The chief judge of the Tax Court may assign proceedings to special trial judges. The 

Code enumerates certain types of proceedings that may be so assigned and may be decided by a 

special trial judge. In addition, the chief judge may designate any other proceeding to be heard 

by a special trial judge.118

Description of Proposal

The proposal clarifies that the chief judge of the Tax Court may assign to special trial 

judges any employment tax cases that are subject to the small case procedure and may authorize 

special trial judges to decide such small tax cases. 

Effective Date

The proposal is effective for any action or proceeding in the Tax Court with respect to 

which a decision has not become final as of the date of enactment.

 116 Sec. 7436. 

117 Sec. 7436(c). 

118 Sec. 7443A. 
 

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D. Appointment of Tax Court Employees 

Present Law

The Tax Court is a legislative court established by the Congress pursuant to Article I of 

the U.S. Constitution (an “Article I” court).119 The Tax Court is authorized to appoint 

employees, subject to the rules applicable to employment with the Executive Branch of the 

Federal Government (generally referred to as “competitive service”), as administered by the 

Office of Personnel Management.120 

Employment with the Federal Executive Branch is governed by certain general statutory 

principles, such as recruitment of qualified individuals, fair and equitable treatment of employees 

and applicants, maintenance of high standards of employee conduct, and protection of employees 

against arbitrary action. The rules for employment in the Federal Executive Branch address 

various aspects of such employment, including: (1) procedures for the appointment of employees 

in the competitive service, including preferences for certain individuals (e.g., veterans); (2) 

compensation, benefits, and leave programs for employees; (3) appraisals of employee 

performance; (4) disciplinary actions; and (5) employee rights, including appeal rights. In 

addition, employees are protected from certain personnel practices (referred to as “prohibited 

personnel practices”), such as discrimination on the basis of race, color, religion, age, sex, 

national origin, political affiliation, marital status, or handicapping condition. 

Description of Proposal

The proposal extends to the Tax Court authority to establish its own personnel 

management system, similar to authority that applies to courts in the Federal Judicial Branch. 

Any personnel management system adopted by the Tax Court must: (1) include the merit system 

principles that govern employment with the Federal Executive Branch; (2) prohibit personnel 

practices that are prohibited in the Federal Executive Branch; and (3) in the case of an individual 

eligible for preference for employment in the Federal Executive Branch, provide preference for 

that individual in a manner and to an extent consistent with preference in the Federal Executive 

Branch. 

The proposal requires the Tax Court to prohibit discrimination on the basis of race, color, 

religion, age, sex, national origin, political affiliation, marital status, or handicapping condition. 

The Tax Court is also required to promulgate procedures for resolving complaints of 

discrimination by employees and applicants for employment. 

The proposal allows the Tax Court to appoint a clerk without regard to the Federal 

Executive Branch rules regarding appointments in the competitive service. Under the proposal, 

the clerk serves at the pleasure of the Tax Court. 

 119 Sec. 7441. 

120 Sec. 7471. 
 

91 

The proposal also allows the Tax Court to appoint other necessary employees without 

regard to the Federal Executive Branch rules regarding appointments in the competitive service. 

Under the proposal, these employees are subject to removal by the Tax Court. 

The proposal allows judges and special trial judges of the Tax Court to appoint law clerks 

and secretaries, in such numbers as the Tax Court may approve, without regard to the Federal 

Executive Branch rules regarding appointments in the competitive service. Under the proposal, a 

law clerk or secretary serves at the pleasure of the appointing judge. 

The proposal exempts law clerks from the sick leave and annual leave provisions 

applicable to employees of the Federal Executive Branch. Any unused sick or annual leave to 

the credit of a law clerk as of the effective date of the proposal remains credited to the individual 

and is available to the individual upon separation from the Federal Government, or upon transfer 

to a position subject to such sick leave and annual leave provisions. 

The proposal allows the Tax Court to fix and adjust the compensation of the clerk and 

other employees without regard to the Federal Executive Branch rules regarding employee 

classifications and pay rates. To the maximum extent feasible, Tax Court employees are to be 

compensated at rates consistent with those of employees holding comparable positions in the 

Federal Judicial Branch. The Tax Court may also establish programs for employee evaluations, 

incentive awards, flexible work schedules, premium pay, and resolution of employee grievances. 

In the case of an individual who is an employee of the Tax Court on the day before the 

effective date of the proposal, the proposal preserves certain rights that the employee is entitled 

to as of that day. The proposal preserves the right to: (1) appeal a reduction in grade or removal; 

(2) appeal an adverse action; (3) appeal a prohibited personnel practice; (4) make an allegation of 

a prohibited personnel practice; or (5) file an employment discrimination appeal. These rights 

are preserved for as long as the individual remains an employee of the Tax Court. 

Under the proposal, a Tax Court employee who completes at least one year of continuous 

service under a nontemporary appointment with the Tax Court acquires competitive service 

status for appointment to any position in the Federal Executive Branch competitive service for 

which the employee possesses the required qualifications. 

The proposal also allows the Tax Court to procure the services of experts and consultants 

in accordance with Federal Executive Branch rules. 

Effective Date

The proposal is effective on the date the Tax Court adopts a personnel management 

system after the date of enactment of the proposal.
 

92

E. Tax Court Filing Fee 

Present Law

The Tax Court is authorized to impose a fee of up to $60 for the filing of any petition for 

the redetermination of a deficiency or for declaratory judgments relating to the status and 

classification of 501(c)(3) organizations, the judicial review of final partnership administrative 

adjustments, and the judicial review of partnership items if an administrative adjustment request 

is not allowed in full.121 The statute does not specifically authorize the Tax Court to impose a 

filing fee for the filing of a petition for review of the IRS’s failure to abate interest or for failure 

to award administrative costs and other areas of jurisdiction for which a petition may be filed. 

The practice of the Tax Court is to impose a $60 filing fee in all cases commenced by petition.122 

Description of Proposal

The proposal provides that the Tax Court is authorized to charge a filing fee of up to $60 

in all cases commenced by the filing of a petition. No negative inference should be drawn as to 

whether the Tax Court has the authority under present law to impose a filing fee for any case 

commenced by the filing of a petition. 

Effective Date

The proposal is effective on the date of enactment. 

 121 Sec. 7451. 

122 See Rule 20(b) of the Tax Court Rules of Practice and Procedure. 
 

93 

VI. MISCELLANEOUS 

A. Expensing of Broadband Internet Access Expenditures 

Present Law

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of 

certain property used in a trade or business or for the production of income. The amount of the 

depreciation deduction allowed with respect to tangible property for a taxable year is determined 

under the modified accelerated cost recovery system (“MACRS”) (sec. 168). Under MACRS, 

different types of property generally are assigned applicable recovery periods and depreciation 

methods. The recovery periods applicable to most tangible personal property (generally tangible 

property other than residential rental property and nonresidential real property) range from 3 to 

25 years. The depreciation methods generally applicable to tangible personal property are the 

200-percent and 150-percent declining balance methods, switching to the straight-line method 

for the taxable year in which the depreciation deduction would be maximized. 

In lieu of depreciation, a taxpayer with a sufficiently small amount of annual investment 

may elect to deduct (or “expense”) such costs (sec. 179). Present law provides that the 

maximum amount a taxpayer may expense, for taxable years beginning in 2003 through 2009, is 

$100,000 of the cost of qualifying property placed in service for the taxable year. The $100,000 

amount is reduced (but not below zero) by the amount by which the cost of qualifying property 

placed in service during the taxable year exceeds $400,000. The $100,000 and $400,000 

amounts are indexed for inflation for taxable years beginning after 2003 and before 2010. In 

general, under section 179, qualifying property is defined as depreciable tangible personal 

property that is purchased for use in the active conduct of a trade or business. Additional section 

179 incentives are provided with respect to a qualified property used by a business in the New 

York Liberty Zone (sec. 1400L(f)), an empowerment zone (sec. 1397A), a renewal community 

(sec. 1400J), or the Gulf Opportunity Zone (section 1400N). Recapture rules generally apply 

with respect to property that ceases to be qualified property. 

Description of Proposal

The proposal provides an election to treat any qualified broadband expenditure paid or 

incurred by the taxpayer as not chargeable to capital account, but rather, as a deduction. The 

deduction is allowed in the first taxable year in which either current generation, or next 

generation, broadband services are provided through qualified equipment to qualified 

subscribers. Expenditures are eligible for this election only for qualified equipment, the original 

use of which commences with the taxpayer. The proposal applies for qualified broadband 

expenditures incurred after June 30, 2006, and before January 1, 2011. 

Current generation broadband services are defined as the transmission of signals at a rate 

of at least 5 million bits per second to the subscriber and at a rate of at least 1 million bits per 

second from the subscriber. Next generation broadband services are defined as the transmission 

of signals at a rate of at least 50 million bits per second to the subscriber and at a rate of at least 

10 million bits per second from the subscriber. 
 

94 

Qualified broadband expenditures means the direct or indirect costs properly taken into 

account for the taxable year for the purchase or installation of qualified equipment (including 

upgrades) and the connection of the equipment to a qualified subscriber. The term does not 

include costs of launching satellite equipment. 

Qualified broadband expenditures include only the portion of the purchase price paid by 

the lessor, in the case of leased equipment, that is attributable to otherwise qualified broadband 

expenditures by the lessee. In the case of property that is originally placed in service by a person 

and that is sold to the taxpayer and leased back to such person by the taxpayer within three 

months after the date that the property was originally placed in service, the property is treated as 

originally placed in service by the taxpayer not earlier than the date that the property is used 

under the leaseback. 

A qualified subscriber, with respect to current generation broadband services, means any 

nonresidential subscriber maintaining a permanent place of business in a rural area or 

underserved area, or any residential subscriber residing in a rural area or underserved area that is 

not a saturated market. A qualified subscriber, with respect to next generation broadband 

services, means any nonresidential subscriber maintaining a permanent place of business in a 

rural area or underserved area, or any residential subscriber. 

For this purpose, a rural area means any census tract not within 10 miles of an 

incorporated or census-designated place with more than 25,000 people and not with in a county 

with overall population density of more than 500 people per square mile. An underserved area 

means a census tract located in an empowerment zone or enterprise community designated under 

section 1391 or the District of Columbia Enterprise Zone, or any census tract the poverty level of 

which is at least 30 percent and the median family income of which does not exceed (1) for a 

tract in a metropolitan statistical area, 70 percent of the greater of the metropolitan area median 

family income or the statewide median family income, and (2) for a tract that is not in a 

metropolitan statistical area, 70 percent of the nonmetropolitan statewide median family income. 

A saturated market, for this purpose, means any census tract in which, as of the date of 

enactment, current generation broadband services have been provided by a single provider to 85 

percent or more of the total potential residential subscribers. The services must be usable at least 

a majority of the time during periods of maximum demand, and usable in a manner substantially 

the same as services provided through equipment not eligible for the deduction under this 

proposal. 

If current, or next, generation broadband services can be provided through qualified 

equipment to both qualified subscribers and to other subscribers, the proposal provides that the 

expenditures with respect to the equipment are allocated among subscribers to determine the 

amount of qualified broad broadband expenditures that may be deducted under the proposal. 

Qualified equipment means equipment that provides current, or next, generation 

broadband services at least a majority of the time during periods of maximum demand to each 

subscriber, and in a manner substantially the same as such services are provided by the provider 

to subscribers through equipment with respect to which no deduction is allowed under the 

provision. Limitations are imposed under the provision on equipment depending on where it 
 

95 

extends, and on certain packet switching equipment, and on certain mulitplexing and 

demultiplexing equipment. 

Effective Date

The proposal applies to expenditures incurred after June 30, 2006, and before January 1, 

2011. 
 

96 

B. Exempt Use of Kerosene for Aviation Purposes 

Present Law

Nontaxable uses of kerosene 

In general, if kerosene on which tax has been imposed is used by any person for a 

nontaxable use, a refund in an amount equal to the amount of tax imposed may be obtained either 

by the purchaser, or in specific cases, the registered ultimate vendor of the kerosene.123 

However, the 0.1 cent per gallon representing the Leaking Underground Storage Tank Trust 

Fund financing rate generally is not refundable, except for exports.124 

A nontaxable use is any use which is exempt from the tax imposed by section 4041(a)(1) 

other than by reason of a prior imposition of tax.125 Nontaxable uses of kerosene include: 

• Use on a farm for farming purposes;126

• Use in foreign trade or trade between the United States and any of its possessions;127

• Use as a fuel in vessels and aircraft owned by the United States or any foreign nation 

and constituting equipment of the armed forces thereof;128

• Exclusive use of a state or local government;129

• Export or shipment to a possession of the United States;130

• Exclusive use of a nonprofit educational organization;131

• Use as a fuel in an aircraft museum for the procurement, care, or exhibition of aircraft 

of the type used for combat or transport in World War II;132 and 

 123 Sec. 6427(l). 

124 Sec. 6430. 

125 Sec. 6427(l)(2). 

126 Sec. 4041(f). 

127 Sec. 4041(g)(1) 

128 Id. 

129 Sec. 4041(g)(2). 

130 Sec. 4041(g)(3). 

131 Sec. 4041(g)(4). 

132 Sec. 4041(h). 
 

97 

• Use as a fuel in (a) helicopters engaged in the exploration for or the development or 

removal of hard minerals, oil, or gas and in timber (including logging) operations if 

the helicopters neither take off from nor land at a facility eligible for Airport Trust 

Fund assistance or otherwise use federal aviation services during flights or (b) any air 

transportation for the purpose of providing emergency medical services (1) by 

helicopter or (2) by a fixed-wing aircraft equipped for and exclusively dedicated on 

that flight to acute care emergency medical services.133

• Off-highway business use. 

Claims for refund of kerosene used in aviation

“Commercial aviation” is the use of an aircraft in a business of transporting persons or 

property for compensation or hire by air, with certain exceptions.134 All other aviation is 

noncommercial aviation. 

For fuel not removed directly into the wing of an airplane, the Safe, Accountable, 

Flexible, Efficient, Transportation Equity Act: A Legacy for Users (“SAFETEA”) changed the 

rate of taxation for aviation-grade kerosene from 21.8 cents per gallon to the general kerosene 

and diesel rate of 24.3 cents per gallon.135 In order to preserve the aviation rate for fuel actually 

used in aviation, the 21.8 cent rate of taxation (or as the case may be, the 4.3 cent commercial 

aviation rate, or the nontaxable use rate) is achieved through a refund when the fuel is sold in 

aviation (a refund of 2.5 cents for taxable noncommercial aviation, 20 cents in the case of 

commercial aviation, and 24.3 cents for nontaxable uses).136 These changes became effective on 

October 1, 2005. 

Prior to October 1, 2005, if fuel that was previously taxed was used in noncommercial 

aviation for a nontaxable use, generally, the ultimate purchaser of such fuel (other than for the 

exclusive use of a State or local government, or for use on a farm for farming purposes) could 

claim a refund for the tax that was paid. SAFETEA eliminated the ability of a purchaser to file 

for a refund with respect to fuel used in noncommercial aviation. Instead, the registered ultimate 

vendor is the exclusive party entitled to a refund with respect to kerosene used in noncommercial 

aviation.137 An ultimate vendor is the person who sells the kerosene to an ultimate purchaser for 

use in noncommercial aviation. If the fuel was used for a nontaxable use, the vendor may make 

 133 Secs. 4041(l), 4261(f) and (g). 

134 “Commercial aviation” does not include aircraft used for skydiving, small aircraft on 

nonestablished lines or transportation for affiliated group members. 

135 Sec. 11161 of Pub. L. No. 109-59 (2005). 

136 Sec. 6427(l)(5). 

137 Sec. 6427(l)(5)(B) 
 

98 

a claim for 24.3 cents per gallon, otherwise, the vendor is permitted to claim 2.5 cents per gallon 

for kerosene sold for use in noncommercial aviation.138

For commercial aviation, the ultimate purchaser has the option of filing a claim itself, or 

waiving the right to refund to its ultimate vendor if the vendor agrees to file on behalf of the 

purchaser.139 

A separate special rule also applies to kerosene sold to a State or local government, 

regardless of whether the kerosene was sold for aviation or other purposes.140 In general, this 

rule makes the registered ultimate vendor the appropriate party for filing refund claims on behalf 

of a State or local government. Special rules apply for credit card sales.141

Description of Proposal

In general

The proposal allows purchasers that use kerosene for an exempt aviation purpose (other 

than in the case of a State or local government) to make a claim for refund of the tax that was 

paid on such fuel or waive their right to claim a refund to their registered ultimate vendors. As a 

result, under the proposal, crop-dusters, air ambulances, aircraft engaged in foreign trade and 

other exempt users may either make the claim for refund of the 24.3 cents per gallon themselves 

or waive the right to their vendors. 

General noncommercial aviation use (which is entitled to a refund of 2.5-cents per 

gallon) remains an exclusive ultimate vendor rule. The rules for State and local governments 

also are unchanged. 

 138 Sec. 6427(l)(5)(A). Under this provision, of the 24.4 cents of tax imposed on kerosene used 

in taxable noncommercial aviation, the 0.1 cent for the Leaking Underground Storage Tank Trust Fund 

financing rate and 21.8 cents of the tax imposed on kerosene cannot be refunded. The limitations of sec. 

6427(l)(5)(A) on the amount that cannot be refunded do not apply to uses exempt from tax. However, 

sec. 6430 prevents a refund of the Leaking Underground Storage Tank Trust Fund financing rate in all 

cases except export. Sec. 6427(l)(5)(B) requires that all amounts that would have been paid to the 

ultimate purchaser pursuant to sec. 6427(l)(1) are to paid to the ultimate registered vendor, therefore the 

ultimate registered vendor is the only claimant for both nontaxable and taxable use of kerosene in 

noncommercial aviation. 

139 Sec. 6427(l)(4)(B). 

140 Sec. 6427(l)(6). 

141 If certain conditions are met, a registered credit card issuer may make the claim for refund in 

place of the ultimate vendor. If the diesel fuel or kerosene is purchased with a credit card issued to a State 

but the credit card issuer is not registered with the IRS (or does not meet certain other conditions) the 

credit card issuer must collect the amount of the tax and the State is the proper claimant. 
 

99 

Special rule for purchases of kerosene used in aviation on a farm for farming purposes

For kerosene used in aviation on a farm for farming purposes that was purchased after 

December 31, 2004, and before October 1, 2005, the Secretary is to pay to the ultimate purchaser 

(without interest) an amount equal to the aggregate amount of tax imposed on such fuel, reduced 

by any payments made to the ultimate vendor of such fuel. Such claims must be filed within 3 

months of the date of enactment and may not duplicate claims filed under section 6427(l). 

Effective Date

In general

The proposal is effective for kerosene sold after September 30, 2005. For kerosene used 

for an exempt aviation purpose eligible for the waiver rule created by the proposal, the ultimate 

purchaser is treated as having waived the right to payment and as having assigned such right to 

the ultimate vendor if the vendor meets the requirements of subparagraph (A), (B) or (D) of 

section 6416(a)(1). The rule of the preceding sentence applies to kerosene sold after September 

30, 2005, and before the date of enactment. 

Special rule for kerosene used in aviation on a farm for farming purposes

The special rule for kerosene used in aviation on a farm for farming purposes is effective 

on the date of enactment. 
 

100

C. Declarations on Federal Corporate Income Tax Returns 

Present Law

The Code requires142 that the income tax return of a corporation must be signed by either 

the president, the vice-president, the treasurer, the assistant treasurer, the chief accounting 

officer, or any other officer of the corporation authorized by the corporation to sign the return. 

The Code also imposes143 a criminal penalty on any person who willfully signs any tax 

return under penalties of perjury that that person does not believe to be true and correct with 

respect to every material matter at the time of filing. If convicted, the person is guilty of a 

felony; the Code imposes a fine of not more than $100,000144 ($500,000 in the case of a 

corporation) or imprisonment of not more than three years, or both, together with the costs of 

prosecution. 

Description of Proposal

The proposal requires that a corporation’s Federal income tax return include a declaration 

signed under penalties of perjury that the corporation has in place processes and procedures to 

ensure that the return complies with the Code and that the CEO was provided reasonable 

assurance of the accuracy of all material aspects of the return. The proposal does not change 

present law rules as to who is required to sign the return. 

Effective Date

The proposal is effective for Federal tax returns for taxable years ending after the date of 

enactment. 

 142 Sec. 6062. 

143 Sec. 7206. 

144 Pursuant to 18 U.S.C. 3571, the maximum fine for an individual convicted of a felony is 

$250,000. 
 

101 

D. Treatment of Professional Employer Organizations as Employers 

Present Law

In general

Employment taxes generally consist of the taxes under the Federal Insurance 

Contributions Act (“FICA”), the taxes under the Railroad Retirement Tax Act (“RRTA”), the tax 

under the Federal Unemployment Tax Act (“FUTA”), and the requirement that employers 

withhold income taxes from wages paid to employees (“income tax withholding”).145

FICA tax consists of two parts: (1) old age, survivor, and disability insurance (“OASDI”), 

which correlates to the Social Security program that provides monthly benefits after retirement, 

disability, or death; and (2) Medicare hospital insurance (“HI”). The OASDI tax rate is 6.2 

percent on both the employee and employer (for a total rate of 12.4 percent). The OASDI tax 

rate applies to wages up to the OASDI wage base ($94,200 for 2006). The HI tax rate is 1.45 

percent on both the employee and the employer (for a total rate of 2.9 percent). Unlike the 

OASDI tax, the HI tax is not limited to a specific amount of wages, but applies to all wages. 

RRTA taxes consist of tier 1 taxes and tier 2 taxes. Tier 1 taxes parallel the OASDI and 

HI taxes applicable to employers and employees. Tier 2 taxes consist of employer and employee 

taxes on railroad compensation up to the tier 2 wage base. For 2006, the tier 2 employer rate is 

12.6 percent, the employee rate is 4.4 percent, and the tier 2 wage base is $69,900. 

Under FUTA, employers must pay a tax of 6.2 percent of wages up to the FUTA wage 

base of $7,000. An employer may take a credit against its FUTA tax liability for its 

contributions to a State unemployment fund and, in certain cases, an additional credit for 

contributions that would have been required if the employer had been subject to a higher 

contribution rate under State law. For purposes of the credit, contributions means payments 

required by State law to be made by an employer into an unemployment fund, to the extent the 

payments are made by the employer without being deducted or deductible from employees’ 

remuneration. 

Employers are required to withhold income taxes from wages paid to employees. 

Withholding rates vary depending on the amount of wages paid, the length of the payroll period, 

and the number of withholding allowances claimed by the employee. 

Wages paid to employees, and FICA, RRTA, and income taxes withheld from the wages, 

are required to be reported on employment tax returns and on Forms W-2.146

 145 Secs. 3101-3128 (FICA), 3201-3241 (RRTA), 3301-3311 (FUTA), and 3401-3404 (income 

tax withholding). 

146 Secs. 6011 and 6051. 
 

102 

Employment taxes generally apply to all remuneration paid by an employer to an 

employee. However, various exceptions apply to certain types of remuneration or certain types 

of services.147 In addition, as discussed above, certain employment taxes apply only on amounts 

up to a specified wage base. If an employee works for multiple employers during a year, 

separate wage bases generally apply to each employer. However, a single OASDI or FUTA 

wage base applies in certain cases in which an employer (a “successor” employer) takes over the 

business of another employer (the “predecessor” employer) and employs the employees of the 

predecessor employer. 

Responsibility for employment tax compliance

Employment tax responsibility generally rests with the person who is the employer of an 

employee under a common-law test that has been incorporated into Treasury regulations.148 

Under the regulations, an employer-employee relationship generally exists if the person for 

whom services are performed has the right to control and direct the individual who performs the 

services, not only as to the result to be accomplished by the work, but also as to the details and 

means by which that result is accomplished. That is, an employee is subject to the will and 

control of the employer, not only as to what is to be done, but also as to how it is to be done. It is 

not necessary that the employer actually control the manner in which the services are performed, 

rather it is sufficient that the employer have a right to control. Whether the requisite control 

exists is determined on the basis of all the relevant facts and circumstances. The test of whether 

an employer-employee relationship exists often arises in determining whether a worker is an 

employee or an independent contractor. However, the same test applies in determining whether 

a worker is an employee of one person or another.149

In some cases, a person other than the common-law employer (a “third party”) may be 

liable for employment taxes. For example, if wages are paid to an employee by a third party and 

the third party, rather than the employer, has control of the payment of the wages, the third party 

is the statutory employer responsible for complying with applicable employment tax 

requirements.150 In addition, an employer may designate a reporting agent to be responsible for 

 147 See, e.g., secs. 3121(a) and (b), 3231(e), 3306(b) and (c), and 3401(a). 

148 Treas. Reg. secs. 31.3121(d)-1(c)(1), 31.3306(i)-1(a), and 31.3401(c)-1. 

149 Issues relating to the classification of workers as employees or independent contractors are 

discussed in Joint Committee on Taxation, Study of the Overall State of the Federal Tax System and 

Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code of 

1986 (JCS-3-01), April 2001, at Vol. II, Part XV.A, at 539-550. 

150 Sec. 3401(d)(1) (for purposes of income tax withholding, if the employer does not have 

control of the payment of wages, the person having control of the payment of such wages is treated as the 

employer); Otte v. United States, 419 U.S. 43 (1974) (the person who has the control of the payment of 

wages is treated as the employer for purposes of withholding the employee’s share of FICA from wages); 

In re Armadillo Corporation, 561 F.2d 1382 (10th Cir. 1977), and In re The Laub Baking Company v. 

United States, 642 F.2d 196 (6th Cir. 1981) (the person who has control of the payment of wages is the 

employer for purposes of the employer’s share of FICA and FUTA). The mere fact that wages are paid 

by a person other than the employer does not necessarily mean that the payor has control of the payment 
 

103 

FICA tax and income tax withholding compliance,151 including filing employment tax returns 

and issuing Forms W-2 to employees.152 In that case, the reporting agent and the employer are 

jointly and severally liable for compliance.153

Employer credit for FICA tax paid on tips

An employer may take an income tax credit for FICA taxes paid by the employer on 

certain tips received by an employee.154 The tips taken into account for purposes of the credit are 

tips from customers in connection with providing, delivering, or serving food or beverages for 

consumption if customers’ tipping employees delivering or serving food or beverages is 

customary. The amount of such tips taken into account for purposes of the credit is tips that 

(1) are deemed to be paid to the employee by the employer for FICA purposes and (2) exceed the 

amount by which wages (excluding tips) paid to the employee by the employer are less than the 

total amount payable to the employee at the minimum wage rate. 

Reporting by large food and beverage establishments

Certain reporting requirements apply to tips. In the case of a large food or beverage 

establishment, an employer is generally required to report the following information each 

calendar year: (1) the gross receipts of the establishment from the provision of food and 

beverages (other than certain receipts); (2) the aggregate amount of charge receipts (other than 

certain receipts); (3) the aggregate amount of charged tips on the charge receipts; (4) the sum of 

the aggregate amount of tips reported to the employer by employees and certain amounts 

required to be reported by the employer on employees’ Form W-2s; and (5) with respect to each 

employee, the amount of tips allocated to the employee based on the receipts of the 

establishment.155 

User fees

User fees apply to requests to the IRS for ruling letters, opinion letters, determination 

letters, and similar requests.156 The user fees that apply are determined by the IRS and are 

 

of the wages. Rather, control depends on the facts and circumstances. See, e.g., Consolidated Flooring 

Services v. United States, 38 Fed. Cl. 450 (1997), and Winstead v. United States, 109 F. 2d 989 (4th Cir. 

1997). 

151 The designated reporting agent rules do not apply for purposes of FUTA compliance. 

152 Sec. 3504. Form 2678 is used to designate a reporting agent. 

153 For administrative convenience, an employer may also use a payroll service to handle payroll 

and employment tax filings on its behalf, but the employer, not the payroll service, continues to be 

responsible for employment tax compliance. 

154 Sec. 45B. 

155 Sec. 6053(c). 

156 Sec. 7528. 
 

104 

generally required to be determined after taking into account the average time and difficulty 

involved in a request. 

Description of Proposal

Treatment of certified professional employer organization as employer for employment tax 

purposes

Under the proposal, if certain requirements are met, for purposes of employment taxes 

and other obligations under the employment tax rules, a certified professional employer 

organization is treated as the employer of any work site employee performing services for any 

customer of the certified professional employer organization, but only with respect to 

remuneration remitted to the work site employee by the certified professional employer 

organization.157 In addition, no other person is treated as the employer for employment tax 

purposes with respect to remuneration remitted by the certified professional employer 

organization. 

The proposal does not apply in the case of a customer who is related to the certified 

professional employer organization.158 In addition, the proposal does not apply with respect to 

an individual with net earnings from self-employment derived from a customer’s trade or 

business (i.e., a self-employed individual), including a customer who is a sole proprietor or a 

partner of a customer that is a partnership. 

As discussed more fully below, a work site employee is an individual who performs 

services (1) for a customer pursuant to a contract between the customer and the certified 

professional employer organization that meets certain requirements and (2) at a work site that 

meets certain requirements. Thus, if the contract or work site fails to meet these requirements, 

the individual is not a work site employee. However, the proposal applies also in the case of an 

individual (other than a self-employed individual) who is not a work site employee, but who 

performs services under a contract the meets the specified requirements. 

In general, the wage and employment exceptions that would apply if the certified 

professional employer organization were not treated as the employer under the proposal 

generally continue to apply. However, the proposal provides rules under which, on entering into 

a service contract with a customer, a certified professional employer organization is treated as a 

successor employer and the customer is treated as the predecessor employer. Similarly, on 

termination of a service contract, the customer is treated as a successor employer and the 

certified professional employer organization is treated as the predecessor employer. Thus, wages 

 157 Nothing contained in the proposal is to be construed to create any inference with respect to 

the determination of who is an employee or employer (1) for Federal tax purposes (other than the 

purposes set forth in the proposal), or (2) for purposes of any other provision of law. 

158 Whether a customer and a certified professional employer organization are related is 

determined under the rules of section 267(b) or 707(b), but applied by substituting 10 percent for 50 

percent. 
 

105 

paid by the customer and the certified professional employer organization are subject to a single 

OASDI or FUTA wage base. 

A certified professional employer organization is eligible for the FUTA credit with 

respect to payments made to a State unemployment fund with respect to a work site employee by 

the certified professional employer organization or a customer. An additional FUTA credit may 

be claimed by a certified professional employer organization if, under State law, a certified 

professional employer organization is permitted to collect and remit contributions with respect to 

a work site employee to the State unemployment fund. 

The Secretary of the Treasury is directed to prescribe such regulations as may be 

necessary or appropriate to carry out the purposes of the proposal. 

Certified professional employer organization

A certified professional employer organization is a person who applies to be treated as a 

certified professional employer organization and has been certified by the Secretary of the 

Treasury as meeting certain requirements. These requirements are met if the person−

• demonstrates that the person (and any owner, officer, and such other persons as may 

be specified in regulations) meets requirements established by the Secretary with 

respect to tax status, background, experience, business location, and annual financial 

audits; 

• represents that it will satisfy the bond and independent financial review requirements 

(described below) on an ongoing basis; 

• represents that it will satisfy reporting obligations imposed by the Secretary; 

• computes its taxable income using an accrual method of accounting unless the 

Secretary approves another method; 

• agrees to verify the continuing accuracy of any previously provided representations 

and information on a periodic basis as prescribed by the Secretary; and 

• agrees to notify the Secretary in writing of any change that materially affects the 

continuing accuracy of any previously provided representation or information. 

Under the bond requirement, a certified professional employer organization must post a 

bond for the payment of employment taxes in a minimum amount and in a form acceptable to the 

Secretary. The minimum amount is determined for the period April 1 of any calendar year 

through March 31 of the following calendar year and is the greater of (1) five percent of the 

employment taxes for which the certified professional organization is liable under the proposal 

during the preceding calendar year (but not to exceed $1,000,000), or (2) $50,000. 

Under the independent financial review requirements, a certified professional employer 

organization must: (1) have, as of the most recent audit date (i.e., six months after the 

completion of the certified professional employer organization’s fiscal year), caused to be 

prepared and provided to the Secretary an opinion of an independent certified public accountant 

as to whether the certified professional employer organization’s financial statements are 
 

106 

presented fairly in accordance with generally accepted accounting principles; and (2) provide to 

the Secretary, not later than the last day of the second month beginning after the end of each 

calendar quarter, from an independent certified public accountant an assertion regarding Federal 

employment tax payments and an examination level attestation on the assertion. The assertion 

must state that the certified professional employer organization has withheld and made deposits 

of all required FICA, RRTA, and withheld income taxes for the calendar quarter, and the 

attestation must state that the assertion is fairly stated in all material respects. If a certified 

professional employer organization fails to file the required assertion and attestation with respect 

to any calendar quarter, the independent financial review requirements are treated as not satisfied 

for the period beginning on the due date for the attestation. 

For purposes of the bond and independent financial review requirements, all professional 

employer organizations that are members of a controlled group are treated as a single 

organization. The Secretary may suspend or revoke the certification of a person’s certified 

professional employer organization status if the Secretary determines that the person does not 

satisfy the representations or other requirements for certification or fails to satisfy the applicable 

accounting, reporting, payment, or deposit requirements. 

Work site employee

A work site employee is an individual who: (1) performs services for a customer of a 

certified professional employer organization pursuant to a contract between the customer and the 

certified professional employer organization that meets certain requirements (described below); 

and (2) performs services at a work site meeting certain requirements (described below). 

The contract between the customer and the certified professional employer organization 

must be in writing and, with respect to an individual performing services for the customer, must 

provide that the certified professional employer organization will−

• assume responsibility for payment of wages to the individual, without regard to the 

receipt or adequacy of payment from the custom; 

• assume responsibility for reporting, withholding, and paying any employment taxes 

with respect to the individual’s wages, without regard to the receipt or adequacy of 

payment from the customer; 

• assume responsibility for any employee benefits that the contract may require the 

certified professional employer organization to provide, without regard to the receipt 

or adequacy of payment from the customer; 

• assume responsibility for hiring, firing, and recruiting workers in addition to the 

customer’s responsibility for hiring, firing and recruiting workers; 

• maintain employee records relating to the individual; and 

• agree to be treated as a certified professional employer organization for employment 

tax purposes with respect to such individual. 

For purposes of whether an individual is a work site employee, the work site where the 

individual performs services meets the applicable requirements if at least 85 percent of the 
 

107 

individuals performing services for the customer at the work site are subject to one or more 

contracts with the certified professional employer organization that meet the above requirements. 

For this purpose, certain individuals are not taken into account, such as employees who are under 

age 21 or have not completed six months of service. 

Other rules

Employer credit for FICA taxes paid on tips

Under the proposal, if a certified professional employer organization is treated for 

employment tax purposes as the employer of a work site employee, any credit for FICA taxes 

paid on tips of the employee applies to the customer (not to the certified professional employer 

organization) and, for purposes of the credit, the customer is to take into account any 

remuneration or taxes remitted by the certified professional employer organization. 

Reporting by large food and beverage establishments

Under the proposal, if a certified professional employer organization is treated for 

employment tax purposes as the employer of a work site employee, the customer for whom the 

work site employee performs services is the employer for purposes of the reporting required with 

respect to a large food or beverage establishment. The certified professional employer 

organization is required to furnish the customer with any information necessary to complete the 

required reporting. 

User fees

Under the proposal, the user fee charged under the program for certifying a professional 

employer organization may not exceed $500. 

Effective Date

The proposal is effective on January 1 of the first calendar year beginning more than 12 

months after the date of enactment of the proposal. The Secretary of the Treasury is directed to 

establish the certification program for professional employer organizations not later than six 

months before the proposal becomes effective. 
 

108

E. Require IRS to Promote Estimated Tax Payments Through EFTPS 

Present Law

To the extent that tax is not collected through withholding, taxpayers are required to 

make quarterly estimated payments of tax. If an individual fails to make the required estimated 

tax payments under the rules, a penalty is imposed under section 6654. The amount of the 

penalty is determined by applying the underpayment interest rate to the amount of the 

underpayment for the period of the underpayment. 

The Code imposes a penalty on employers who fail to deposit employment taxes within 

the required time and in the proper manner. The Code also requires the IRS to collect at least 94 

percent of these taxes through the Electronic Funds Transfer Payment System (EFTPS).159

Description of Proposal

The proposal requires the Secretary to study increased collection of estimated tax 

payments through the EFTPS. The proposal requires the Secretary to report the results of such 

study within one year of the date of enactment. 

Effective Date

The proposal is effective on the date of enactment. 

 159 Sec. 6302(h). 
 

109

F. Study of Use of Voluntary Withholding Agreements 

Present Law

Employment taxes generally consist of the taxes under the Federal Insurance 

Contributions Act (“FICA”), the tax under the Federal Unemployment Tax Act (“FUTA”), and 

the requirement that employers withhold income taxes from wages paid to employees (“income 

tax withholding”).160 Income tax withholding rates vary depending on the amount of wages 

paid, the length of the payroll period, and the number of withholding allowances claimed by the 

employee. 

Description of Proposal

The proposal requires the Secretary to study the use of voluntary withholding agreements 

between independent contractors and service recipients. The proposal requires the Secretary to 

report the results of such study, including any necessary statutory changes, within one year of the 

date of enactment. 

Effective Date

The proposal is effective on the date of enactment. 

 160 Secs. 3101-3128 (FICA), 3301-3311 (FUTA), and 3401-3404 (income tax withholding). 

FICA taxes consist of an employer share and an employee share, which the employer withholds from 

employees’ wages. 
 

110

G. Offset of Tax Refunds Against State Court Debts 

Present Law

Overpayments of Federal tax may be used to pay past-due child support and debts owed 

to Federal agencies, without the consent of the taxpayer.161 Overpayments of Federal tax may 

also be used to pay specified past-due, legally enforceable State income tax debts, provided that 

the person making the Federal tax overpayment has shown on the Federal tax return for the 

taxable year of the overpayment an address that is within the State seeking the tax offset. 

Description of Proposal

The proposal permits State courts to use overpayments of Federal tax may be used to pay 

past-due court-ordered debts. The State court debts would have lower priority than other debts 

that may be offset under present law. 

Effective Date

The proposal is effective on the date of enactment. 

 161 Sec. 6402. 
 

111

H. Enhancing Tax Court Security 

Present Law

The Tax Court is established under Article I of the United States Constitution162 and is a 

court of limited jurisdiction.163 The U.S. Marshal’s Service does not have responsibility to 

provide security to the Tax Court. 

Description of Proposal

The proposal authorizes additional security for the Tax Court similar to that now 

provided to other Federal courts. The proposal requires the U. S. Marshal’s Service to provide 

security to the Tax Court, including personal protection of the Tax Court judges, court officer, 

witnesses, and other threatened persons. 

Effective Date

The proposal is effective on the date of enactment. 

 162 Sec. 7441. 

163 Sec. 7442. 
 

112 

I. Authorization of Appropriations to Combat the Tax Gap 

Present Law

There is no explicit authorization of appropriations to the Internal Revenue Service to be 

used to combat the tax gap. 

The IRS has promulgated IRS Notice 2006-50 relating to the $13 billion telephone excise 

tax refund program. 

Description of Proposal

Tax gap

The proposal includes an authorization of an additional $732 million dollars to the 

Internal Revenue Service to be used to combat the tax gap, including educational programs 

designed to improve taxpayer compliance. 

Telephone excise tax refund program

The proposal includes an authorization of an additional $49 million dollars to the Internal 

Revenue Service to implement the telephone excise tax refund program under IRS Notice 2006-

50. The authorization is intended to cover such costs as form revisions, taxpayer assistance, 

processing and enforcement. 

Effective Date

The proposals are effective on the date of enactment.
 

113 

J. Annual Tax Gap Study 

Present Law

There is no requirement that the Department of the Treasury produce a study for the taxwriting committees on its activities to close the tax gap. 

Description of Proposal

The proposal requires the Department of the Treasury to submit an annual report to the 

tax-writing committees not later than September 30 of each year on activities the Treasury 

Department is undertaking to close the tax gap. The report should include a comprehensive set 

of strategies to: achieve a simpler tax Code; achieve more complete income reporting; improve 

tax-law enforcement; and improve customer service. The report should also include a detailed 

analysis of the elements of the tax gap, a list of measures designed to reduce the tax gap, goals 

for reducing the tax gap, and timelines to achieve those goals. Finally, the report should include 

specific administrative actions taken to reduce the tax gap and proposed legislative 

recommendations to improve taxpayer compliance. 

Effective Date

The proposal is effective on the date of enactment.
 

114 

K. Authorization of Appropriations for Tax Law Enforcement Relating to the 

Hiring and Continued Employment of Undocumented Workers 

Present Law

IRS undercover operations are statutorily exempt from the generally applicable 

restrictions controlling the use of Government funds (which generally provide that all receipts 

must be deposited in the general fund of the Treasury and all expenses be paid out of 

appropriated funds). In general, the Code permits the IRS to use proceeds from an undercover 

operation to pay additional expenses incurred in the undercover operation, through 2006. The 

IRS is required to conduct a detailed financial audit of large undercover operations in which the 

IRS is churning funds and to provide an annual audit report to the Congress on all such large 

undercover operations. 

There is no explicit authorization of appropriations to the Internal Revenue Service to be 

used to prosecute employers for the violations of tax laws relating to the hiring and continued 

employment of undocumented workers. 

Description of Proposal

The proposal authorizes the IRS to use $2 million toward the establishment of an office 

in IRS Criminal Investigation to prosecute employers for the violations of tax laws relating to the 

hiring and continued employment of undocumented workers. 

Effective Date

The proposal is effective on the date of enactment.
 

115 

L. Repeal of Dollar Limit on Contributions to Qualified Funeral Trusts 

Present Law

A qualified funeral trust is a taxable trust that arises as a result of a contract with a person 

engaged in the trade or business of providing funeral or burial services or property necessary to 

provide such services, and which meets certain other requirements.164 A qualified funeral trust 

must have as its sole purpose holding, investing, and reinvesting funds in the trust, and using 

such funds solely to make payments for the above-described services or property for the benefit 

of the beneficiaries of the trust. A qualified funeral trust may have as beneficiaries only 

individuals with respect to whom the above-described services or property are to be provided at 

death, and the trust may only accept contributions by or for the benefit of such beneficiaries. In 

addition, to qualify, the trust must be one that, but for the making of a required election, would 

be treated under the grantor trust rules as owned by the purchaser of the funeral or burial 

contract. Because a qualified funeral trust is not treated as a grantor trust, the trust (rather than 

the purchaser of the contract) is taxed on income from the trust. 

A trust is not a qualified funeral trust if it accepts aggregate contributions by or for the 

benefit of an individual in excess of a statutory dollar limit, which is $8,500 for 2006 (and which 

periodically is adjusted for inflation). 

Description of Proposal

The proposal repeals the dollar limit on contributions to qualified funeral trusts. 

Effective Date

The proposal is effective for contributions made after December 31, 2006.

 164 Sec. 685(b). 
 

116 

M. Permit Administrative Relief for Certain Late Qualified Terminable 

Interest Property Elections 

Present Law

A 100-percent marital deduction generally is permitted for the value of property 

transferred between spouses. Transfers of “qualified terminable interest property” also are 

eligible for the marital deduction. “Qualified terminable interest property” (or “QTIP”) is 

property: (1) that passes from the decedent, (2) in which the surviving spouse has a “qualifying 

income interest for life,” and (3) with respect to which a timely election has been made. A 

“qualifying income interest for life” exists if: (1) the surviving spouse is entitled to all the 

income from the property (payable annually or at more frequent intervals) or has the right to use 

the property during the spouse’s life, and (2) no person has the power to appoint any part of the 

property to any person other than the surviving spouse. 

A QTIP transfer may occur by way of a lifetime gift (i.e., an inter vivos QTIP transfer) or 

at death. In the event of a QTIP transfer made at a decedent’s death, the QTIP election must be 

made by the decedent’s executor on the estate tax return. In the event of an inter vivos QTIP 

transfer, the QTIP election generally must be made on the gift tax return for the calendar year in 

which the interest is transferred, and the election must be made within the time prescribed for 

filing such return. A QTIP election, once made, is irrevocable. 

The IRS, under certain circumstances, has granted relief for late QTIP elections for estate 

tax purposes by granting an extension of time to make such an election. In the event a taxpayer 

fails to make an inter vivos QTIP election within the prescribed timeframe, the extent of the 

IRS’s authority to grant similar relief is unclear. 

Description of Proposal

The proposal directs the Secretary to issue regulations prescribing the circumstances and 

procedures under which extensions of time will be granted to make an inter vivos QTIP election, 

including elections with respect to transfers that occurred prior to the effective date of the 

proposal. The proposal provides that in determining whether to grant an extension of time, the 

Secretary shall take into account all relevant circumstances, including evidence of intent 

contained in the trust instrument or instrument of transfer and such other factors as the Secretary 

deems relevant. For purposes of determining whether to grant relief, the proposal provides that 

the time specified in the Code for making an inter vivos QTIP election shall be disregarded. 

Effective Date

The proposal applies to requests for relief with respect to transfers made before, on, or 

after the date of enactment.
 

117 

N. Exempt Organization Provisions 

1. Disclosure of written determinations 

Present Law

In general

Three provisions of present law govern the disclosure of information relating to taxexempt organizations. First, section 6103 provides a general rule that tax returns and return 

information generally are not subject to disclosure unless authorized by the Code.165 Second, in 

order to allow the public to scrutinize the activities of tax-exempt organizations, section 6104 

grants an exception to the confidentiality rule of section 6103 for certain categories of taxexempt organization documents and information. Third, section 6110 provides that written 

determinations by the IRS and related background file documents generally are open to public 

inspection in redacted form. Section 6110 does not apply to any matter to which section 6104 

applies.166

Disclosure of applications for recognition of tax exemption and annual information returns 

Under present law, the IRS is required to make approved applications for recognition of 

tax-exempt status (and certain related documents)167 and annual information returns (Form 990 

or Form 990-PF) available for public inspection, except that the IRS is not authorized to disclose 

the names and addresses of contributors (other than contributors to a private foundation). 

The Secretary may withhold disclosure of certain information described in an 

organization’s application for tax-exempt status if disclosure would: (1) divulge a trade secret, 

patent, process, style of work, or apparatus of the organization, and the Secretary determines that 

such disclosure would harm the organization; or (2) that the Secretary determines would harm 

the national defense.168 The organization must apply to the Commissioner for a determination 

that the disclosure would violate one of these criteria. The organization will be given 15 days to 

contest an adverse determination before the information is made available for public 

inspection.169

 165 Sec. 6103(a). 

166 Sec. 6110(l)(1). 

167 Section 6104(a)(1)(A) provides that “any papers submitted in support of” an application for 

tax-exempt status must be available for inspection. Treasury regulations limit the definition of supporting 

documents to papers submitted by the organization. Treas. Reg. sec. 301.6104(a)-1(e). 

168 Sec. 6104(a)(1)(D). 

169 Treas. Reg. sec. 301.6104(a)-5(a)(1). 
 

118 

Disclosure of written determinations

Section 6110 provides that the text of any written determination by the IRS and related 

background file document is open to public inspection.170 The term “written determination” 

means a ruling, determination letter, technical advice memorandum, or Chief Counsel advice. 

Closing agreements, which are final and conclusive written agreements entered into by the IRS 

and a taxpayer in order to settle the taxpayer’s tax liability with respect to a taxable year, do not 

constitute written determinations.171

Before releasing any written determination or background file document, the IRS must 

delete identifying details of the person about whom the written determination pertains and 

certain other private information.172

The application of section 6110 to guidance relating to tax-exempt organizations is 

limited to written determinations unrelated to an organization’s tax-exempt status. Section 

6110(l)(1) provides, “this section shall not apply to any matter to which section 6104 applies.” 

The regulations under section 6110 clarify which matters are within the ambit of section 6104 

and, therefore, are not subject to disclosure under section 6110: 

[a]ny application filed with the Internal Revenue Service with respect to the qualification or 

exempt status of an organization . . .; any document issued by the Internal Revenue Service in 

which the qualification or exempt status of an organization is . . . granted, denied or revoked or 

the portion of any document in which technical advice with respect thereto is given to a district 

director; . . . the portion of any document issued by the Internal Revenue Service in which is 

discussed the effect on the qualification or exempt status of an organization . . . of proposed 

transactions by such organization . . . ; and any document issued by the Internal Revenue Service 

in which is discussed the qualification or status of a [private foundation or private operating 

foundation].173

In addition, the regulations under section 6104 provide that some documents relating to 

tax exemption that are not open to public inspection under section 6104(a)(1)(A) are nevertheless 

“within the ambit” of section 6104 for purposes of the disclosure provisions of section 6110.174 

 170 Sec. 6110(a). A background file document includes the request for a written determination, 

any written material submitted by the taxpayer in support of the request, and any communications 

between the IRS and other persons in connection with the written determination received before issuance 

of the written determination. Sec. 6110(b)(2). 

171 Sec. 6103(b)(2)(D); sec. 6110(b)(1)(B). 

172 Sec. 6110(c). 

173 Treas. Reg. sec. 301.6110-1(a). 

174 Treas. Reg. sec. 301.6104(a)-1(i). 
 

119 

The regulation explains that the following documents are, therefore, not available for public 

inspection under either section 6104 or 6110: 

• unfavorable rulings or determination letters issued in response to applications for tax 

exemption; 

• rulings or determination letters revoking or modifying a favorable determination 

letter; 

• technical advice memoranda relating to a disapproved application for tax exemption 

or the revocation or modification of a favorable determination letter; 

• any letter or document filed with or issued by the IRS relating to whether a proposed 

or accomplished transaction is a prohibited transaction under section 503; 

• any letter or document filed with or issued by the IRS relating to an organization’s 

status as a private foundation or private operating foundation, unless the letter or 

document relates to the organization’s application for tax exemption; and 

• any other letter or document filed with or issued by the IRS which, although it relates 

to an organization’s tax exempt status as an organization described in section 501(c), 

does not relate to that organization’s application for tax exemption.175

Under the regulations, such written determinations relating to exempt status issues are not 

released, even in redacted form. Pursuant to a decision of the D.C. Circuit Court of Appeals, 

however, the IRS is required to disclose written determinations relating to denials and 

revocations of exempt status − a decision in which the IRS acquiesced.176

Description of Proposal

The proposal provides that the provisions of section 6110 apply to written determinations 

and related background file documents relating to an organization described in section 501(c) or 

(d) (including any written determination denying an organization exempt status under such 

subsection), or to a political organization described in section 527, that are not required to be 

disclosed by section 6104(a)(1)(A). 

Effective Date

The proposal is effective for written determinations issued after the date of enactment. 

 175 Id.

176 Tax Analysts v. Internal Revenue Service, 350 F.3d 100 (D.C. Cir. 2003); A.O.D. 2004-02. 
 

120 

2. Disclosure of internet web site and name under which organization does business 

Present Law

Most types of tax-exempt organizations are required to file annually an information 

return.177 The Internal Revenue Code does not specifically require an exempt organization to 

furnish on the applicable information return any name under which the organization operates or 

does business, if such name differs from the legal name of the organization, or the organization’s 

Internet web site address, if any.178

Description of Proposal

The proposal requires a tax-exempt organization subject to reporting requirements under 

section 6033(a) to include on its annual return any name under which such organization operates 

or does business, and the Internet web site address (if any) of such organization. 

Effective Date

The proposal applies to returns filed after December 31, 2006. 

3. Modification to reporting of capital transactions 

Present Law

Private foundations are required to file an annual information return (Form 990-PF).179 

Part IV of the Form 990-PF requires that private foundations report detailed information 

regarding the gain or loss from the sale or other disposition of property, including a description 

of the property sold, how it was acquired (purchase or donation), the date acquired, the date sold, 

the gross sales price, the amount of depreciation allowed or allowable, and the cost or other basis 

plus expenses of the sale. Such information generally is required for the IRS to calculate the tax 

on the private foundation’s net investment income. The Form 990-PF is required to be made 

available to the public. 

Description of Proposal

The proposal requires that any information regarding capital gains and losses from the 

sale or disposition of stock or securities that are listed on an established securities market that is 

required to be furnished by private foundations in order to calculate the tax on net investment 

income be furnished also in summary form. 

 177 Sec. 6033(a). 

178 The IRS requires disclosure of an organization’s Internet web site address and business name 

on Forms 990 and 990-EZ but not on Form 990-PF. 

179 Sec. 6033(a). 
 

121 

In addition, information regarding capital gains and losses from the sale or disposition of 

stock or securities that are listed on an established securities market that is required to be filed 

with the IRS but that is not in summary form is not required to be made available to the public by 

the IRS or by the private foundation except by the explicit request of a member of the public to 

the IRS or to the foundation. A member of the public may request disclosure of such 

information from the Secretary, who shall prescribe the manner of making such request and the 

manner of disclosure. A member of the public also may request disclosure of the private 

foundation, which must be made in person or in writing. If the request is made in person, the 

foundation shall provide a copy of the information immediately and, if the request is made in 

writing, the foundation shall provide the information within 30 days. 

The proposal also provides that private foundations are required to state on the furnished 

summary that the more detailed description is available upon request. 

Effective Date

The proposal applies to returns filed after December 31, 2006. 

4. Disclosure that Form 990 is publicly available 

Present Law

Under present law, there is no requirement that the IRS notify the public that the Form 

990 is publicly available. 

Description of Proposal

The proposal requires the IRS to notify the public in appropriate publications and other 

materials of the extent to which Form 990, Form 990-EZ, or Form 990-PF are publicly available. 

Effective Date

The proposal applies to publications or other materials issued or revised after the date of 

enactment. 

5. Expedited review process for certain tax-exemption applications 

Present Law

Most organizations that seek tax-exempt status as a charitable organization are required 

to file an Application for Recognition of Exemption (Form 1023) with the IRS.180 Organizations 

that are not required to file Form 1023 include churches, their integrated auxiliaries, and 

conventions or associations of churches, and any organization (other than a private foundation) 

that normally has gross receipts of $5,000 or less in a taxable year. Organizations that file Form 

 180 Sec. 508(a). 
 

122 

1023 within 15 months of the end of the month of the organization’s formation will, if the 

application is approved, be recognized as tax-exempt from the date of formation. The IRS will 

automatically grant an organization’s request for an additional 12-month extension of the 15-

month period. Otherwise, exemption normally will be recognized as of the date the application 

was received by the IRS. In appropriate circumstances, upon written request, the IRS will 

expedite consideration of applications for tax-exemption. For example, organizations formed to 

provide relief to victims of disasters or other emergencies often receive expedited consideration. 

Description of Proposal

The proposal provides that the Secretary or his delegate shall adopt procedures to 

expedite consideration of applications for exempt status by organizations that are organized and 

operated for the primary purpose of providing social services. To be eligible, the organization 

must: (1) be seeking a contract or grant under a Federal, State, or local program that provides 

funding for social service programs; (2) establish that tax-exempt status is a condition of 

applying for such contract or grant; (3) include a completed copy of the contract or grant 

application with the application for exemption; and (4) meet such other criteria as the Secretary 

may provide. Organizations that meet the eligibility requirements described above (except for 

the requirement that tax-exempt status is a condition of the contract or grant application), and 

that certify that the organization’s average annual gross receipts over the four year period 

preceding the application was not more than $50,000 (or, in the case of an organization in 

existence less than four years, is not expected to be more than $50,000 during the organization’s 

first four years) are entitled to a waiver of any fee for application of tax-exempt status. 

For this purpose, social services is defined as services directed at helping people in need, 

reducing poverty, improving outcomes of low-income children, revitalizing low-income 

communities, and empowering low-income families and low-income individuals to become selfsufficient, including: (1) child care services, protective services for children and adults, services 

for children and adults in foster care, adoption services, services related to the management and 

maintenance of the home, day care services for adults, and services to meet the special needs of 

children, older individuals, and individuals with disabilities (including physical, mental, or 

emotional disabilities); (2) transportation services; (3) job training and related services, and 

employment services; (4) information, referral, and counseling services; (5) the preparation and 

delivery of meals, and services related to soup kitchens or food banks; (6) health support 

services; (7) literacy and mentoring programs; (8) services for the prevention and treatment of 

juvenile delinquency and substance abuse, services for the prevention of crime and the provision 

of assistance to the victims and the families of criminal offenders, and services related to the 

intervention in, and prevention of, domestic violence; and (9) services related to the provision of 

assistance for housing under Federal law. Social services does not include a program having the 

purpose of delivering educational assistance under the Elementary and Secondary Education Act 

of 1965 or under the Higher Education Act of 1965. 

Effective Date

The proposal applies to applications for tax-exempt status filed after December 31, 2006.
 

123 

6. Extension of declaratory judgment procedures to non-501(c)(3) tax-exempt 

organizations 

Present Law

In order for an organization to be granted tax exemption as a charitable entity described 

in section 501(c)(3), it generally must file an application for recognition of exemption with the 

IRS and receive a favorable determination of its status. Similarly, for most organizations, a 

charitable organization’s eligibility to receive tax-deductible contributions is dependent upon its 

receipt of a favorable determination from the IRS. In general, a section 501(c)(3) organization 

can rely on a determination letter or ruling from the IRS regarding its tax-exempt status, unless 

there is a material change in its character, purposes, or methods of operation. In cases in which 

an organization violates one or more of the requirements for tax exemption under section 

501(c)(3), the IRS is authorized to revoke an organization’s tax exemption, notwithstanding an 

earlier favorable determination. 

In situations in which the IRS denies an organization’s application for recognition of 

exemption under section 501(c)(3) or fails to act on such application, or in which the IRS 

informs a section 501(c)(3) organization that it is considering revoking or adversely modifying 

its tax-exempt status, present law authorizes the organization to seek a declaratory judgment 

regarding its tax status (sec. 7428). Section 7428 provides a remedy in the case of a dispute 

involving a determination by the IRS with respect to: (1) the initial qualification or continuing 

qualification of an organization as a charitable organization for tax exemption purposes or for 

charitable contribution deduction purposes; (2) the initial classification or continuing 

classification of an organization as a private foundation; (3) the initial classification or 

continuing classification of an organization as a private operating foundation; or (4) the failure of 

the IRS to make a determination with respect to (1), (2), or (3). A “determination” in this 

context generally means a final decision by the IRS affecting the tax qualification of a charitable 

organization, although it also can include a proposed revocation of an organization’s tax-exempt 

status or public charity classification. Section 7428 vests jurisdiction over controversies 

involving such a determination in the U.S. District Court for the District of Columbia, the U.S. 

Court of Federal Claims, and the U.S. Tax Court. 

Prior to utilizing the declaratory judgment procedure, an organization must have 

exhausted all administrative remedies available to it within the IRS. An organization is deemed 

to have exhausted its administrative remedies at the expiration of 270 days after the date on 

which the request for a determination was made if the organization has taken, in a timely 

manner, all reasonable steps to secure such determination. 

If an organization (other than a section 501(c)(3) organization) files an application for 

recognition of exemption and receives a favorable determination from the IRS, the determination 

of tax-exempt status is usually effective as of the date of formation of the organization if its 

purposes and activities during the period prior to the date of the determination letter were 

consistent with the requirements for exemption. However, if the organization files an application 

for recognition of exemption and later receives an adverse determination from the IRS, the IRS 

may assert that the organization is subject to tax on some or all of its income for open taxable 
 

124 

years. In addition, as with charitable organizations, the IRS may revoke or modify an earlier 

favorable determination regarding an organization’s tax-exempt status. 

Under present law, a non-charity (i.e., an organization not described in section 501(c)(3)) 

may not seek a declaratory judgment with respect to an IRS determination regarding its taxexempt status. The only remedies available to such an organization are to petition the U.S. Tax 

Court for relief following the issuance of a notice of deficiency or to pay any tax owed and sue 

for refund in Federal district court or the U.S. Court of Federal Claims. 

Description of Proposal

The proposal extends declaratory judgment procedures similar to those currently 

available only to charities under section 7428 to other section 501(c) and 501(d) determinations. 

The proposal limits jurisdiction over controversies involving such other determinations to the 

United States Tax Court.181 

Effective Date

The extension of the declaratory judgment procedures to organizations other than section 

501(c)(3) organizations is effective for pleadings filed with respect to determinations (or requests 

for determinations) made after December 31, 2006. 

7. Definition of convention or association of churches 

Present Law

Under present law, an organization that qualifies as a “convention or association of 

churches” (within the meaning of sec. 170(b)(1)(A)(i)) is not required to file an annual return,182

is subject to the church tax inquiry and church tax examination provisions applicable to 

organizations claiming to be a church,183 and is subject to certain other provisions generally 

applicable to churches.184 The Internal Revenue Code does not define the term “convention or 

association of churches.” 

 181 This limitation currently applies to declaratory judgments relating to tax qualification for 

certain employee retirement plans (sec. 7476). 

182 Sec. 6033(a)(2)(A)(i). 

183 Sec. 7611(h)(1)(B). 

184 See, e.g., Sec. 402(g)(8)(B) (limitation on elective deferrals); sec. 403(b)(9)(B) (definition of 

retirement income account); sec. 410(d) (election to have participation, vesting, funding, and certain other 

provisions apply to church plans); sec. 414(e) (definition of church plan); sec. 415(c)(7) (certain 

contributions by church plans); sec. 501(h)(5) (disqualification of certain organizations from making the 

sec. 501(h) election regarding lobbying expenditure limits); sec. 501(m)(3) (definition of commercialtype insurance); sec. 508(c)(1)(A) (exception from requirement to file application seeking recognition of 

exempt status); sec. 512(b)(12) (allowance of up to $1,000 deduction for purposes of determining 
 

125 

Description of Proposal

The proposal provides that an organization that otherwise is a convention or association 

of churches does not fail to so qualify merely because the membership of the organization 

includes individuals as well as churches, or because individuals have voting rights in the 

organization. 

Effective Date

The proposal is effective on the date of enactment. 

 

unrelated business taxable income); sec. 514(b)(3)(E) (definition of debt-financed property); sec. 

3121(w)(3)(A) (election regarding exemption from social security taxes); sec. 3309(b)(1) (application of 

federal unemployment tax provisions to services performed in the employ of certain organizations); sec. 

6043(b)(1) (requirement to file a return upon liquidation or dissolution of the organization); and sec. 

7702(j)(3)(A) (treatment of certain death benefit plans as life insurance). 
 

126 

O. Wireless Telecommunications Property Treated as Qualified 

Technological Equipment 

Present Law

A taxpayer is allowed to recover, through annual depreciation deductions, the cost of 

certain property used in a trade or business or for the production of income. The amount of the 

depreciation deduction allowed with respect to tangible property for a taxable year is determined 

under the modified accelerated cost recovery system (“MACRS”) (sec. 168). Under MACRS, 

different types of property generally are assigned applicable recovery periods and depreciation 

methods. The recovery periods applicable to most tangible personal property (generally tangible 

property other than residential rental property and nonresidential real property) range from 3 to 

25 years. The depreciation methods generally applicable to tangible personal property are the 

200-percent and 150-percent declining balance methods, switching to the straight-line method 

for the taxable year in which the depreciation deduction would be maximized. 

Under MACRS, qualified technological equipment is depreciated over a five-year 

recovery period using the 200-percent declining balance method. Qualified technological 

equipment includes any computer or peripheral equipment, any technology station equipment 

installed on a customer’s premises, and any high technology equipment. 

The recovery periods under MACRS for various asset classes are prescribed by Revenue 

Procedure 87-56.185 Under IRS guidance, assets used to provide cellular telephone service fall 

within asset classes 48.12 (Telephone Central Office Equipment, 10-year recovery period), 

48.121 (Computer-based Telephone Central Office Switching Equipment, 5-year recovery 

period), 48.13 (Telephone Station Equipment, 7 year recovery period), and 48.14 (Telephone 

Distribution Plants, 15 year recovery period).186 Switching, transmission, and reception 

equipment located at either the mobile telephone switching office (MTSO) or cell sites are 

described in asset class 48.12. Computer-based switching equipment located at either the MTSO 

or cell sites is described in asset class 48.121. Transmission and reception assets are qualified 

technology equipment with a 5-year recovery period if they qualify as computer or peripheral 

equipment. 

Description of Proposal

Under the proposal, wireless telecommunications equipment placed in service before 

January 1, 2011, is treated as qualified technological equipment and therefore is eligible for the 

five-year recovery period applicable to such property. Wireless telecommunications equipment 

is defined as equipment used in the transmission, reception, coordination, or switching of 

wireless telecommunications service. Wireless telecommunications equipment does not include 

towers, buildings, T-1 lines, or other cabling that connects cell sites to mobile switching centers. 

 185 1987-2 C.B. 674. 

186 Technical Advice Memorandum 9825003 (Jan. 30, 1998). 
 

127 

For this purpose, wireless telecommunications service includes any commercial mobile 

radio service as defined in title 47 of the Code of Federal Regulations (“CFR”).187

Effective Date

The proposal applies to property placed in service after the date of enactment and before 

January 1, 2011.

 187 Under the CFR, a commercial mobile radio service is “a mobile service that is: (a)(1) 

provided for profit, i.e., with the intent of receiving compensation or monetary gain; (2) an interconnected 

service; and (3) available to the public, or to such classes of eligible users as to be effectively available to 

a substantial portion of the public; or (b) the functional equivalent of such a mobile service described in 

paragraph (a) of this section.” (47 C.F.R. §20.3.) 

Under the CFR, a mobile service is “a radio communication service carried on between mobile 

stations or receivers and land stations, and by mobile stations communicating among themselves, and 

includes: (a) Both one-way and two-way radio communications services; (b) A mobile service which 

provides a regularly interacting group of base, mobile, portable, and associated control and relay stations 

(whether licensed on an individual, cooperative, or multiple basis) for private one-way or two-way land 

mobile radio communications by eligible users over designated areas of operation; and (c) Any service 

for which a license is required in a personal communications service under part 24 of this chapter.” (47 

C.F.R. §20.3.) 
 

128 

P. Simplification Through Elimination of Inoperative Provisions 

Present Law

The Internal Revenue Code of 1986 contains provisions that are no longer used in 

computing current taxes or are little used or of minor importance. These provisions are 

popularly referred to as “deadwood”. 

Description of Proposal

The proposal contains numerous amendments to the Code repealing obsolete provisions. 

The proposal simplifies the Code by deleting “deadwood” without making substantive changes 

in the tax law. 

Effective Date

The proposal takes effect on the date of enactment. 

 
 

129 

VII. REVENUE OFFSET PROVISIONS 

A. Economic Substance Doctrine 

1. Clarification of the economic substance doctrine 

Present Law

In general

The Code provides specific rules regarding the computation of taxable income, including 

the amount, timing, source, and character of items of income, gain, loss and deduction. These 

rules are designed to provide for the computation of taxable income in a manner that provides for 

a degree of specificity to both taxpayers and the government. Taxpayers generally may plan 

their transactions in reliance on these rules to determine the federal income tax consequences 

arising from the transactions. 

In addition to the statutory provisions, courts have developed several doctrines that can 

be applied to deny the tax benefits of tax motivated transactions, notwithstanding that the 

transaction may satisfy the literal requirements of a specific tax provision. The common-law 

doctrines are not entirely distinguishable, and their application to a given set of facts is often 

blurred by the courts and the IRS. Although these doctrines serve an important role in the 

administration of the tax system, invocation of these doctrines can be seen as at odds with an 

objective, “rule-based” system of taxation. Nonetheless, courts have applied the doctrines to 

deny tax benefits arising from certain transactions.188 

A common-law doctrine applied with increasing frequency is the “economic substance” 

doctrine. In general, this doctrine denies tax benefits arising from transactions that do not result 

in a meaningful change to the taxpayer’s economic position other than a purported reduction in 

federal income tax.189

Economic substance doctrine

Courts generally deny claimed tax benefits if the transaction that gives rise to those 

benefits lacks economic substance independent of tax considerations − notwithstanding that the 

purported activity actually occurred. The tax court has described the doctrine as follows: 

“The tax law . . . requires that the intended transactions have economic substance separate and 

distinct from economic benefit achieved solely by tax reduction. The doctrine of economic 

 188 See, e.g., ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), aff’g 73 T.C.M. 

(CCH) 2189 (1997), cert. denied 526 U.S. 1017 (1999). 

189 Closely related doctrines also applied by the courts (sometimes interchangeable with the 

economic substance doctrine) include the “sham transaction doctrine” and the “business purpose 

doctrine”. See, e.g., Knetsch v. United States, 364 U.S. 361 (1960) (denying interest deductions on a 

“sham transaction” whose only purpose was to create the deductions). 
 

130 

substance becomes applicable, and a judicial remedy is warranted, where a taxpayer seeks to 

claim tax benefits, unintended by Congress, by means of transactions that serve no economic 

purpose other than tax savings.”190 

Business purpose doctrine

Another common law doctrine that overlays and is often considered together with (if not 

part and parcel of) the economic substance doctrine is the business purpose doctrine. The 

business purpose test is a subjective inquiry into the motives of the taxpayer − that is, whether 

the taxpayer intended the transaction to serve some useful non-tax purpose. In making this 

determination, some courts have bifurcated a transaction in which independent activities with 

non-tax objectives have been combined with an unrelated item having only tax-avoidance 

objectives in order to disallow the tax benefits of the overall transaction.191 

Application by the courts

Elements of the doctrine

There is a lack of uniformity regarding the proper application of the economic substance 

doctrine.192 Some courts apply a conjunctive test that requires a taxpayer to establish the 

presence of both economic substance (i.e., the objective component) and business purpose (i.e., 

the subjective component) in order for the transaction to survive judicial scrutiny.193 A narrower 

approach used by some courts is to conclude that either a business purpose or economic 

substance is sufficient to respect the transaction).194 A third approach regards economic 

 190 ACM Partnership v. Commissioner, 73 T.C.M. at 2215. 

191 ACM Partnership v. Commissioner, 157 F.3d at 256 n.48. 

192 “The casebooks are glutted with [economic substance] tests. Many such tests proliferate 

because they give the comforting illusion of consistency and precision. They often obscure rather than 

clarify.” Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988). 

193 See, e.g., Pasternak v. Commissioner, 990 F.2d 893, 898 (6th Cir. 1993) (“The threshold 

question is whether the transaction has economic substance. If the answer is yes, the question becomes 

whether the taxpayer was motivated by profit to participate in the transaction.”). 

194 See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d 89, 91-92 (4th Cir. 1985) (“To treat 

a transaction as a sham, the court must find that the taxpayer was motivated by no business purposes other 

than obtaining tax benefits in entering the transaction, and, second, that the transaction has no economic 

substance because no reasonable possibility of a profit exists.”); IES Industries v. United States, 253 F.3d 

350, 358 (8th Cir. 2001) (“In determining whether a transaction is a sham for tax purposes [under the 

Eighth Circuit test], a transaction will be characterized as a sham if it is not motivated by any economic 

purpose out of tax considerations (the business purpose test), and if it is without economic substance 

because no real potential for profit exists (the economic substance test).”). As noted earlier, the economic 

substance doctrine and the sham transaction doctrine are similar and sometimes are applied 

interchangeably. For a more detailed discussion of the sham transaction doctrine, see, e.g., Joint 

Committee on Taxation, Study of Present-Law Penalty and Interest Provisions as Required by Section 
 

131 

substance and business purpose as “simply more precise factors to consider” in determining 

whether a transaction has any practical economic effects other than the creation of tax 

benefits.195

Recently, the Court of Federal Claims questioned the continuing viability of the 

doctrine.196 The court also stated that “the use of the ‘economic substance’ doctrine to trump 

‘mere compliance with the Code’ would violate the separation of powers.”197 

Nontax economic benefits

There also is a lack of uniformity regarding the type of non-tax economic benefit a 

taxpayer must establish in order to satisfy economic substance. Several courts have denied tax 

benefits on the grounds that the subject transactions lacked profit potential.198 In addition, some 

courts have applied the economic substance doctrine to disallow tax benefits in transactions in 

which a taxpayer was exposed to risk and the transaction had a profit potential, but the court 

concluded that the economic risks and profit potential were insignificant when compared to the 

tax benefits.199 Under this analysis, the taxpayer’s profit potential must be more than nominal. 

Conversely, other courts view the application of the economic substance doctrine as requiring an 

objective determination of whether a “reasonable possibility of profit” from the transaction 

existed apart from the tax benefits.200 In these cases, in assessing whether a reasonable 

 

3801 of the Internal Revenue Service Restructuring and Reform Act of 1998 (including Provisions 

Relating to Corporate Tax Shelters) (JCS-3-99) at 182. 

195 See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 247; James v. Commissioner, 899 

F.2d 905, 908 (10th Cir. 1995); Sacks v. Commissioner, 69 F.3d 982, 985 (9th Cir. 1995) (“Instead, the 

consideration of business purpose and economic substance are simply more precise factors to consider . . . 

We have repeatedly and carefully noted that this formulation cannot be used as a ‘rigid two-step 

analysis’.”). 

196 Coltec Industries, Inc. v. United States, 62 Fed. Cl. 716 (2004) (slip opinion at 123-124). The 

court also found, however, that the doctrine was satisfied in that case. Id. at 128. 

197 Id. at 128.

198 See, e.g., Knetsch, 364 U.S. at 361; Goldstein v. Commissioner, 364 F.2d 734 (2d Cir. 1966) 

(holding that an unprofitable, leveraged acquisition of Treasury bills, and accompanying prepaid interest 

deduction, lacked economic substance). 

199 See, e.g., Goldstein v. Commissioner, 364 F.2d at 739-40 (disallowing deduction even though 

taxpayer had a possibility of small gain or loss by owning Treasury bills); Sheldon v. Commissioner, 94 

T.C. 738, 768 (1990) (stating that “potential for gain . . . is infinitesimally nominal and vastly 

insignificant when considered in comparison with the claimed deductions”). 

200 See, e.g., Rice’s Toyota World v. Commissioner, 752 F.2d at 94 (the economic substance 

inquiry requires an objective determination of whether a reasonable possibility of profit from the 

transaction existed apart from tax benefits); Compaq Computer Corp. v. Commissioner, 277 F.3d at 781 
 

132 

possibility of profit exists, it is sufficient if there is a nominal amount of pre-tax profit as 

measured against expected net tax benefits. 

Financial accounting benefits

In determining whether a taxpayer had a valid business purpose for entering into a 

transaction, at least one court has concluded that financial accounting benefits arising from tax 

savings do not qualify as a non-tax business purpose.201 However, based on court decisions that 

recognize the importance of financial accounting treatment, taxpayers have asserted that 

financial accounting benefits arising from tax savings can satisfy the business purpose test.202

Description of Proposal

The proposal clarifies and enhances the application of the economic substance doctrine. 

The proposal provides that, in a case in which a court determines that the economic substance 

doctrine is relevant to a transaction (or a series of transactions), such transaction (or series of 

transactions) has economic substance (and thus satisfies the economic substance doctrine) only if 

the taxpayer establishes that (1) the transaction changes in a meaningful way (apart from Federal 

income tax consequences) the taxpayer’s economic position, and (2) the taxpayer has a 

substantial non-tax purpose for entering into such transaction and the transaction is a reasonable 

means of accomplishing such purpose.203 

The proposal does not change current law standards used by courts in determining when 

to utilize an economic substance analysis.204 Also, the proposal does not alter the court’s ability 

 

(applied the same test, citing Rice’s Toyota World); IES Industries v. United States, 253 F.3d 350, 354 (8th

Cir. 2001). 

201 See, American Electric Power, Inc. v. U.S., 136 F. Supp. 2d 762, 791-92 (S.D. Ohio 2001); 

aff’d 326 F.3d.737 (6th Cir. 2003). 

202 See, e.g., Joint Committee on Taxation, Report of Investigation of Enron Corporation and 

Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations (JSC-3-

03) February, 2003 (“Enron Report”), Volume III at C-93, 289. Enron Corporation relied on Frank Lyon 

Co. v. United States, 435 U.S. 561, 577-78 (1978), and Newman v. Commissioner, 902 F.2d 159, 163 (2d 

Cir. 1990) to argue that financial accounting benefits arising from tax savings constitutes a good business 

purpose. 

203 If the tax benefits are clearly contemplated and expected by the language and purpose of the 

relevant authority, it is not intended that such tax benefits be disallowed if the only reason for such 

disallowance is that the transaction fails the economic substance doctrine as defined in this provision. 

204 See, e.g., Treas. Reg. sec. 1.269-2, stating that characteristic of circumstances in which a 

deduction otherwise allowed will be disallowed are those in which the effect of the deduction, credit, or 

other allowance would be to distort the liability of the particular taxpayer when the essential nature of the 

transaction or situation is examined in the light of the basic purpose or plan which the deduction, credit, 

or other allowance was designed by the Congress to effectuate. 
 

133 

to aggregate, disaggregate or otherwise recharacterize a transaction when applying the 

doctrine.205 The proposal provides a uniform definition of economic substance, but does not 

alter the flexibility of the courts in other respects. 

Conjunctive analysis

The proposal clarifies that the economic substance doctrine involves a conjunctive 

analysis − there must be an objective inquiry regarding the effects of the transaction on the 

taxpayer’s economic position, as well as a subjective inquiry regarding the taxpayer’s motives 

for engaging in the transaction. Under the proposal, a transaction must satisfy both tests − i.e., it 

must change in a meaningful way (apart from Federal income tax consequences) the taxpayer’s 

economic position, and the taxpayer must have a substantial non-tax purpose for entering into 

such transaction (and the transaction is a reasonable means of accomplishing such purpose) − in 

order to satisfy the economic substance doctrine. This clarification eliminates the disparity that 

exists among the circuits regarding the application of the doctrine, and modifies its application in 

those circuits in which either a change in economic position or a non-tax business purpose 

(without having both) is sufficient to satisfy the economic substance doctrine. 

Non-tax business purpose

The proposal provides that a taxpayer’s non-tax purpose for entering into a transaction 

(the second prong in the analysis) must be “substantial,” and that the transaction must be “a 

reasonable means” of accomplishing such purpose. Under this formulation, the non-tax purpose 

for the transaction must bear a reasonable relationship to the taxpayer’s normal business 

operations or investment activities.206 

 205 See, e.g., Minnesota Tea Co. v. Helvering, 302 U.S. 609, 613 (1938) (“A given result at the 

end of a straight path is not made a different result because reached by following a devious path.”). 

206 See, e.g., Treas. Reg. sec. 1.269-2(b) (stating that a distortion of tax liability indicating the 

principal purpose of tax evasion or avoidance might be evidenced by the fact that “the transaction was not 

undertaken for reasons germane to the conduct of the business of the taxpayer”). Similarly, in ACM 

Partnership v. Commissioner, 73 T.C.M. (CCH) 2189 (1997), the court stated: 

Key to [the determination of whether a transaction has economic substance] is that the 

transaction must be rationally related to a useful nontax purpose that is plausible in light 

of the taxpayer’s conduct and useful in light of the taxpayer’s economic situation and 

intentions. Both the utility of the stated purpose and the rationality of the means chosen 

to effectuate it must be evaluated in accordance with commercial practices in the relevant 

industry. A rational relationship between purpose and means ordinarily will not be found 

unless there was a reasonable expectation that the nontax benefits would be at least 

commensurate with the transaction costs. [citations omitted] 

See also Martin McMahon Jr., Economic Substance, Purposive Activity, and Corporate Tax 

Shelters, 94 Tax Notes 1017, 1023 (Feb. 25, 2002) (advocates “confining the most rigorous application of 

business purpose, economic substance, and purposive activity tests to transactions outside the ordinary 

course of the taxpayer’s business − those transactions that do not appear to contribute to any business 
 

134 

In determining whether a taxpayer has a substantial non-tax business purpose, an 

objective of achieving a favorable accounting treatment for financial reporting purposes will not 

be treated as having a substantial non-tax purpose.207 Furthermore, a transaction that is expected 

to increase financial accounting income as a result of generating tax deductions or losses without 

a corresponding financial accounting charge (i.e., a permanent book-tax difference)208 should not 

be considered to have a substantial non-tax purpose unless a substantial non-tax purpose exists 

apart from the financial accounting benefits.209 

By requiring that a transaction be a “reasonable means” of accomplishing its non-tax 

purpose, the proposal reiterates the present-law ability of the courts to bifurcate a transaction in 

which independent activities with non-tax objectives are combined with an unrelated item having 

only tax-avoidance objectives in order to disallow the tax benefits of the overall transaction.210

Profit potential

Under the proposal, a taxpayer may rely on factors other than profit potential to 

demonstrate that a transaction results in a meaningful change in the taxpayer’s economic 

position; the proposal merely sets forth a minimum threshold of profit potential if that test is 

relied on to demonstrate a meaningful change in economic position. If a taxpayer relies on a 

profit potential, however, the present value of the reasonably expected pre-tax profit must be 

 

activity or objective that the taxpayer may have had apart from tax planning but are merely loss 

generators.”); Mark P. Gergen, The Common Knowledge of Tax Abuse, 54 SMU L. Rev. 131, 140 (Winter 

2001) (“The message is that you can pick up tax gold if you find it in the street while going about your 

business, but you cannot go hunting for it.”). 

207 However, if the tax benefits are clearly contemplated and expected by the language and 

purpose of the relevant authority, such tax benefits should not be disallowed solely because the 

transaction results in a favorable accounting treatment. An example is the repealed foreign sales 

corporation rules. 

208 This includes tax deductions or losses that are anticipated to be recognized in a period 

subsequent to the period the financial accounting benefit is recognized. For example, FAS 109 in some 

cases permits the recognition of financial accounting benefits prior to the period in which the tax benefits 

are recognized for income tax purposes. 

209 Claiming that a financial accounting benefit constitutes a substantial non-tax purpose fails to 

consider the origin of the accounting benefit (i.e., reduction of taxes) and significantly diminishes the 

purpose for having a substantial non-tax purpose requirement. See, e.g., American Electric Power, Inc. v. 

U.S., 136 F. Supp. 2d 762, 791-92 (S.D. Ohio, 2001), aff’d 326 F.3d.737 (6th Cir. 2003) (“AEP’s 

intended use of the cash flows generated by the [corporate-owned life insurance] plan is irrelevant to the 

subjective prong of the economic substance analysis. If a legitimate business purpose for the use of the 

tax savings ‘were sufficient to breathe substance into a transaction whose only purpose was to reduce 

taxes, [then] every sham tax-shelter device might succeed,’”) (citing Winn-Dixie v. Commissioner, 113 

T.C. 254, 287 (1999)). 

210 See, e.g., ACM Partnership v. Commissioner, 157 F.3d at 256 n.48. 
 

135 

substantial in relation to the present value of the expected net tax benefits that would be allowed 

if the transaction were respected.211 Moreover, the profit potential must exceed a risk-free rate of 

return. In addition, in determining pre-tax profit, fees and other transaction expenses and foreign 

taxes are treated as expenses. 

In applying the profit potential test to a lessor of tangible property, depreciation, 

applicable tax credits (such as the rehabilitation tax credit and the low income housing tax 

credit), and any other deduction as provided in guidance by the Secretary are not taken into 

account in measuring tax benefits. 

Transactions with tax-indifferent parties

The proposal also provides special rules for transactions with tax-indifferent parties. For 

this purpose, a tax-indifferent party means any person or entity not subject to Federal income tax, 

or any person to whom an item would have no substantial impact on its income tax liability. 

Under these rules, the form of a financing transaction will not be respected if the present value of 

the tax deductions to be claimed is substantially in excess of the present value of the anticipated 

economic returns to the lender. Also, the form of a transaction with a tax-indifferent party will 

not be respected if it results in an allocation of income or gain to the tax-indifferent party in 

excess of the tax-indifferent party’s economic gain or income or if the transaction results in the 

shifting of basis on account of overstating the income or gain of the tax-indifferent party. 

Other rules

The Secretary may prescribe regulations which provide (1) exemptions from the 

application of the proposal, and (2) other rules as may be necessary or appropriate to carry out 

the purposes of the proposal. 

No inference is intended as to the proper application of the economic substance doctrine 

under present law. In addition, except with respect to the economic substance doctrine, the bill 

shall not be construed as altering or supplanting any other common law doctrine (including the 

sham transaction doctrine), and the Senate amendment shall be construed as being additive to 

any such other doctrine. 

Effective Date

The proposal applies to transactions entered into after the date of enactment.

 211 Thus, a “reasonable possibility of profit” will not be sufficient to establish that a transaction 

has economic substance. 
 

136 

2. Penalty for understatements attributable to transactions lacking economic substance, 

etc. 

Present Law

General accuracy-related penalty

An accuracy-related penalty under section 6662 applies to the portion of any 

underpayment that is attributable to (1) negligence, (2) any substantial understatement of income 

tax, (3) any substantial valuation misstatement, (4) any substantial overstatement of pension 

liabilities, or (5) any substantial estate or gift tax valuation understatement. If the correct income 

tax liability exceeds that reported by the taxpayer by the greater of 10 percent of the correct tax 

or $5,000 (or, in the case of corporations, by the lesser of (a) 10 percent of the correct tax (or 

$10,000 if greater) or (b) $10 million), then a substantial understatement exists and a penalty 

may be imposed equal to 20 percent of the underpayment of tax attributable to the 

understatement.212 Except in the case of tax shelters,213 the amount of any understatement is 

reduced by any portion attributable to an item if (1) the treatment of the item is supported by 

substantial authority, or (2) facts relevant to the tax treatment of the item were adequately 

disclosed and there was a reasonable basis for its tax treatment. The Treasury Secretary may 

prescribe a list of positions which the Secretary believes do not meet the requirements for 

substantial authority under this provision. 

The section 6662 penalty generally is abated (even with respect to tax shelters) in cases in 

which the taxpayer can demonstrate that there was “reasonable cause” for the underpayment and 

that the taxpayer acted in good faith.214 The relevant regulations provide that reasonable cause 

exists where the taxpayer “reasonably relies in good faith on an opinion based on a professional 

tax advisor’s analysis of the pertinent facts and authorities [that] . . . unambiguously concludes 

that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld 

if challenged” by the IRS.215

Listed transactions and reportable avoidance transactions

In general 

A separate accuracy-related penalty under section 6662A applies to “listed transactions” 

and to other “reportable transactions” with a significant tax avoidance purpose (hereinafter 

 212 Sec. 6662. 

213 A tax shelter is defined for this purpose as a partnership or other entity, an investment plan or 

arrangement, or any other plan or arrangement if a significant purpose of such partnership, other entity, 

plan, or arrangement is the avoidance or evasion of Federal income tax. Sec. 6662(d)(2)(C). 

214 Sec. 6664(c). 

215 Treas. Reg. sec. 1.6662-4(g)(4)(i)(B); Treas. Reg. sec. 1.6664-4(c). 
 

137 

referred to as a “reportable avoidance transaction”). The penalty rate and defenses available to 

avoid the penalty vary depending on whether the transaction was adequately disclosed. 

Both listed transactions and reportable transactions are allowed to be described by the 

Treasury department under section 6707A(c), which imposes a penalty for failure adequately to 

report such transactions under section 6011. A reportable transaction is defined as one that the 

Treasury Secretary determines is required to be disclosed because it is determined to have a 

potential for tax avoidance or evasion.216 A listed transaction is defined as a reportable 

transaction which is the same as, or substantially similar to, a transaction specifically identified 

by the Secretary as a tax avoidance transaction for purposes of the reporting disclosure 

requirements.217 

Disclosed transactions

In general, a 20-percent accuracy-related penalty is imposed on any understatement 

attributable to an adequately disclosed listed transaction or reportable avoidance transaction.218 

The only exception to the penalty is if the taxpayer satisfies a more stringent reasonable cause 

and good faith exception (hereinafter referred to as the “strengthened reasonable cause 

exception”), which is described below. The strengthened reasonable cause exception is available 

only if the relevant facts affecting the tax treatment are adequately disclosed, there is or was 

substantial authority for the claimed tax treatment, and the taxpayer reasonably believed that the 

claimed tax treatment was more likely than not the proper treatment. 

Undisclosed transactions

If the taxpayer does not adequately disclose the transaction, the strengthened reasonable 

cause exception is not available (i.e., a strict-liability penalty generally applies), and the taxpayer 

is subject to an increased penalty equal to 30 percent of the understatement.219 However, a 

taxpayer will be treated as having adequately disclosed a transaction for this purpose if the IRS 

Commissioner has separately rescinded the separate penalty under section 6707A for failure to 

disclose a reportable transaction.220 The IRS Commissioner is authorized to do this only if the 

failure does not relate to a listed transaction and only if rescinding the penalty would promote 

compliance and effective tax administration.221 

 216 Sec. 6707A(c)(1). 

217 Sec. 6707A(c)(2). 

218 Sec. 6662A(a). 

219 Sec. 6662A(c). 

220 Sec. 6664(d). 

221 Sec. 6707A(d). 
 

138 

A public entity that is required to pay a penalty for an undisclosed listed or reportable 

transaction must disclose the imposition of the penalty in reports to the SEC for such periods as 

the Secretary shall specify. The disclosure to the SEC applies without regard to whether the 

taxpayer determines the amount of the penalty to be material to the reports in which the penalty 

must appear; and any failure to disclose such penalty in the reports is treated as a failure to 

disclose a listed transaction. A taxpayer must disclose a penalty in reports to the SEC once the 

taxpayer has exhausted its administrative and judicial remedies with respect to the penalty (or if 

earlier, when paid).222 

Determination of the understatement amount

The penalty is applied to the amount of any understatement attributable to the listed or 

reportable avoidance transaction without regard to other items on the tax return. For purposes of 

this provision, the amount of the understatement is determined as the sum of: (1) the product of 

the highest corporate or individual tax rate (as appropriate) and the increase in taxable income 

resulting from the difference between the taxpayer’s treatment of the item and the proper 

treatment of the item (without regard to other items on the tax return);223 and (2) the amount of 

any decrease in the aggregate amount of credits which results from a difference between the 

taxpayer’s treatment of an item and the proper tax treatment of such item. 

Except as provided in regulations, a taxpayer’s treatment of an item shall not take into 

account any amendment or supplement to a return if the amendment or supplement is filed after 

the earlier of when the taxpayer is first contacted regarding an examination of the return or such 

other date as specified by the Secretary.224

Strengthened reasonable cause exception

A penalty is not imposed under the provision with respect to any portion of an 

understatement if it is shown that there was reasonable cause for such portion and the taxpayer 

acted in good faith. Such a showing requires: (1) adequate disclosure of the facts affecting the 

transaction in accordance with the regulations under section 6011;225 (2) that there is or was 

substantial authority for such treatment; and (3) that the taxpayer reasonably believed that such 

treatment was more likely than not the proper treatment. For this purpose, a taxpayer will be 

treated as having a reasonable belief with respect to the tax treatment of an item only if such 

 222 Sec. 6707A(e). 

223 For this purpose, any reduction in the excess of deductions allowed for the taxable year over 

gross income for such year, and any reduction in the amount of capital losses which would (without 

regard to section 1211) be allowed for such year, shall be treated as an increase in taxable income. Sec. 

6662A(b). 

224 Sec. 6662A(e)(3). 

225 See the previous discussion regarding the penalty for failing to disclose a reportable 

transaction. 
 

139 

belief: (1) is based on the facts and law that exist at the time the tax return (that includes the 

item) is filed; and (2) relates solely to the taxpayer’s chances of success on the merits and does 

not take into account the possibility that (a) a return will not be audited, (b) the treatment will not 

be raised on audit, or (c) the treatment will be resolved through settlement if raised. 226 

A taxpayer may (but is not required to) rely on an opinion of a tax advisor in establishing 

its reasonable belief with respect to the tax treatment of the item. However, a taxpayer may not 

rely on an opinion of a tax advisor for this purpose if the opinion (1) is provided by a 

“disqualified tax advisor” or (2) is a “disqualified opinion.” 

Disqualified tax advisor

A disqualified tax advisor is any advisor who: (1) is a material advisor227 and who 

participates in the organization, management, promotion or sale of the transaction or is related 

(within the meaning of section 267(b) or 707(b)(1)) to any person who so participates; (2) is 

compensated directly or indirectly228 by a material advisor with respect to the transaction; (3) has 

a fee arrangement with respect to the transaction that is contingent on all or part of the intended 

tax benefits from the transaction being sustained; or (4) as determined under regulations 

prescribed by the Secretary, has a disqualifying financial interest with respect to the transaction. 

A material advisor is considered as participating in the “organization” of a transaction if 

the advisor performs acts relating to the development of the transaction. This may include, for 

example, preparing documents: (1) establishing a structure used in connection with the 

transaction (such as a partnership agreement); (2) describing the transaction (such as an offering 

memorandum or other statement describing the transaction); or (3) relating to the registration of 

the transaction with any federal, state or local government body.229 Participation in the 

 226 Sec. 6664(d). 

227 The term “material advisor” means any person who provides any material aid, assistance, or 

advice with respect to organizing, managing, promoting, selling, implementing, or carrying out any 

reportable transaction, and who derives gross income in excess of $50,000 in the case of a reportable 

transaction substantially all of the tax benefits from which are provided to natural persons ($250,000 in 

any other case). Sec. 6111(b)(1). 

228 This situation could arise, for example, when an advisor has an arrangement or understanding 

(oral or written) with an organizer, manager, or promoter of a reportable transaction that such party will 

recommend or refer potential participants to the advisor for an opinion regarding the tax treatment of the 

transaction. 

229 An advisor should not be treated as participating in the organization of a transaction if the 

advisor’s only involvement with respect to the organization of the transaction is the rendering of an 

opinion regarding the tax consequences of such transaction. However, such an advisor may be a 

“disqualified tax advisor” with respect to the transaction if the advisor participates in the management, 

promotion or sale of the transaction (or if the advisor is compensated by a material advisor, has a fee 

arrangement that is contingent on the tax benefits of the transaction, or as determined by the Secretary, 

has a continuing financial interest with respect to the transaction). 
 

140 

“management” of a transaction means involvement in the decision-making process regarding any 

business activity with respect to the transaction. Participation in the “promotion or sale” of a 

transaction means involvement in the marketing or solicitation of the transaction to others. Thus, 

an advisor who provides information about the transaction to a potential participant is involved 

in the promotion or sale of a transaction, as is any advisor who recommends the transaction to a 

potential participant. 

Disqualified opinion

An opinion may not be relied upon if the opinion: (1) is based on unreasonable factual or 

legal assumptions (including assumptions as to future events); (2) unreasonably relies upon 

representations, statements, finding or agreements of the taxpayer or any other person; (3) does 

not identify and consider all relevant facts; or (4) fails to meet any other requirement prescribed 

by the Secretary. 

Coordination with other penalties

To the extent a penalty on an understatement is imposed under section 6662A, that same 

amount of understatement is not also subject to the accuracy-related penalty under section 

6662(a) or to the valuation misstatement penalties under section 6662(e) or 6662(h). However, 

such amount of understatement is included for purposes of determining whether any 

understatement (as defined in sec. 6662(d)(2)) is a substantial understatement as defined under 

section 6662(d)(1) and for purposes of identifying an underpayment under the section 6663 fraud 

penalty. 

The penalty imposed under section 6662A does not apply to any portion of an 

understatement to which a fraud penalty is applied under section 6663. 

Description of Proposal

The proposal imposes a penalty for an understatement attributable to any transaction that 

lacks economic substance (referred to in the statute as a “non-economic substance transaction 

understatement”).230 The penalty rate is 40 percent (reduced to 20 percent if the taxpayer 

adequately discloses the relevant facts in accordance with regulations prescribed under section 

6011). No exceptions (including the reasonable cause or rescission rules) to the penalty are 

available (i.e., the penalty is a strict-liability penalty). 

A “non-economic substance transaction” means any transaction if (1) the transaction 

lacks economic substance (as defined in the earlier proposal regarding the economic substance 

doctrine),231 (2) the transaction was not respected under the rules relating to transactions with 

 230 Thus, unlike the present-law accuracy-related penalty under section 6662A (which applies 

only to listed and reportable avoidance transactions), the new penalty under the proposal applies to any 

transaction that lacks economic substance. 

231 The proposal generally provides that in any case in which a court determines that the 

economic substance doctrine is relevant, a transaction has economic substance only if: (1) the transaction 
 

141 

tax-indifferent parties (as described in the immediately preceding proposal regarding the 

economic substance doctrine),232 or (3) any similar rule of law. For this purpose, a similar rule 

of law would include, for example, an understatement attributable to a transaction that is 

determined to be a sham transaction. 

For purposes of the proposal, the calculation of an “understatement” is made in the same 

manner as in the present law provision relating to accuracy-related penalties for listed and 

reportable avoidance transactions (sec. 6662A). Thus, the amount of the understatement under 

the proposal would be determined as the sum of (1) the product of the highest corporate or 

individual tax rate (as appropriate) and the increase in taxable income resulting from the 

difference between the taxpayer’s treatment of the item and the proper treatment of the item 

(without regard to other items on the tax return), 233 and (2) the amount of any decrease in the 

aggregate amount of credits which results from a difference between the taxpayer’s treatment of 

an item and the proper tax treatment of such item. In essence, the penalty will apply to the 

amount of any understatement attributable solely to a non-economic substance transaction. 

As in the case of the understatement penalty for reportable and listed transactions under 

present law section 6662A(e)(3), except as provided in regulations, the taxpayer’s treatment of 

an item will not take into account any amendment or supplement to a return if the amendment or 

supplement is filed after the earlier of the date the taxpayer is first contacted regarding an 

examination of such return or such other date as specified by the Secretary. 

As in the case of the understatement penalty for undisclosed reportable transactions under 

present law section 6707A, a public entity that is required to pay a penalty under the provision 

(but in this case, regardless of whether the transaction was disclosed) must disclose the 

imposition of the penalty in reports to the SEC for such periods as the Secretary shall specify. 

The disclosure to the SEC applies without regard to whether the taxpayer determines the amount 

of the penalty to be material to the reports in which the penalty must appear, and any failure to 

disclose such penalty in the reports is treated as a failure to disclose a listed transaction. A 

taxpayer must disclose a penalty in reports to the SEC once the taxpayer has exhausted its 

administrative and judicial remedies with respect to the penalty (or if earlier, when paid). 

 

changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, 

and (2) the taxpayer has a substantial non-tax purpose for entering into such transaction and the 

transaction is a reasonable means of accomplishing such purpose. Specific other rules also apply. See 

“Description of Proposal” for the immediately preceding provision, “Clarification of the economic 

substance doctrine.” 

232 The proposal provides that the form of a transaction that involves a tax-indifferent party will 

not be respected in certain circumstances. 

233 For this purpose, any reduction in the excess of deductions allowed for the taxable year over 

gross income for such year, and any reduction in the amount of capital losses that would (without regard 

to section 1211) be allowed for such year, would be treated as an increase in taxable income. 
 

142 

Regardless of whether the transaction was disclosed, once a penalty under the proposal 

has been included in the first letter of proposed deficiency which allows the taxpayer an 

opportunity for administrative review in the IRS Office of Appeals, the penalty cannot be 

compromised for purposes of a settlement without approval of the Commissioner personally. 

Furthermore, the IRS is required to keep records summarizing the application of this penalty and 

providing a description of each penalty compromised under the proposal and the reasons for the 

compromise. 

Any understatement on which a penalty is imposed under the provision will not be 

subject to the accuracy-related penalty under section 6662 or under 6662A (accuracy-related 

penalties for listed and reportable avoidance transactions). However, an understatement under 

the Senate amendment is taken into account for purposes of determining whether any 

understatement (as defined in sec. 6662(d)(2)) is a substantial understatement as defined under 

section 6662(d)(1). The penalty imposed under the proposal will not apply to any portion of an 

understatement to which a fraud penalty is applied under section 6663. 

Effective Date

The proposal applies to transactions entered into after the date of enactment. 
 

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B. Tax Treatment of Certain Inverted Corporate Entities 

Present Law

Determination of corporate residence

The U.S. tax treatment of a multinational corporate group depends significantly on 

whether the parent corporation of the group is domestic or foreign. For purposes of U.S. tax law, 

a corporation is treated as domestic if it is incorporated under the law of the United States or of 

any State. Other corporations (i.e., those incorporated under the laws of foreign countries) 

generally are treated as foreign. 

U.S. taxation of domestic corporations

The United States employs a “worldwide” tax system, under which domestic corporations 

generally are taxed on all income, whether derived in the United States or abroad. In order to 

mitigate the double taxation that may arise from taxing the foreign-source income of a domestic 

corporation, a foreign tax credit for income taxes paid to foreign countries is provided to reduce 

or eliminate the U.S. tax owed on such income, subject to certain limitations. 

Income earned by a domestic parent corporation from foreign operations conducted by 

foreign corporate subsidiaries generally is subject to U.S. tax when the income is distributed as a 

dividend to the domestic corporation. Until such repatriation, the U.S. tax on such income 

generally is deferred, and U.S. tax is imposed on such income when repatriated. However, 

certain anti-deferral regimes may cause the domestic parent corporation to be taxed on a current 

basis in the United States with respect to certain categories of passive or highly mobile income 

earned by its foreign subsidiaries, regardless of whether the income has been distributed as a 

dividend to the domestic parent corporation. The main anti-deferral regimes in this context are 

the controlled foreign corporation rules of subpart F (secs. 951-964) and the passive foreign 

investment company rules (secs. 1291-1298). A foreign tax credit is generally available to 

offset, in whole or in part, the U.S. tax owed on this foreign-source income, whether such 

income is repatriated as an actual dividend or included under one of the anti-deferral regimes. 

U.S. taxation of foreign corporations

The United States taxes foreign corporations only on income that has a sufficient nexus to 

the United States. Thus, a foreign corporation is generally subject to U.S. tax only on income 

that is “effectively connected” with the conduct of a trade or business in the United States. Such 

“effectively connected income” generally is taxed in the same manner and at the same rates as 

the income of a U.S. corporation. An applicable tax treaty may limit the imposition of U.S. tax 

on business operations of a foreign corporation to cases in which the business is conducted 

through a “permanent establishment” in the United States. 

In addition, foreign corporations generally are subject to a gross-basis U.S. tax at a flat 

30-percent rate on the receipt of interest, dividends, rents, royalties, and certain similar types of 

income derived from U.S. sources, subject to certain exceptions. The tax generally is collected 

by means of withholding by the person making the payment. This tax may be reduced or 

eliminated under an applicable tax treaty. 
 

144 

U.S. tax treatment of inversion transactions prior to the American Jobs Creation Act of 

2004

Prior to the American Jobs Creation Act of 2004 (“AJCA”), a U.S. corporation could 

reincorporate in a foreign jurisdiction and thereby replace the U.S. parent corporation of a 

multinational corporate group with a foreign parent corporation. These transactions were 

commonly referred to as inversion transactions. Inversion transactions could take many different 

forms, including stock inversions, asset inversions, and various combinations of and variations 

on the two. Most of the known transactions were stock inversions. In one example of a stock 

inversion, a U.S. corporation forms a foreign corporation, which in turn forms a domestic merger 

subsidiary. The domestic merger subsidiary then merges into the U.S. corporation, with the U.S. 

corporation surviving, now as a subsidiary of the new foreign corporation. The U.S. 

corporation’s shareholders receive shares of the foreign corporation and are treated as having 

exchanged their U.S. corporation shares for the foreign corporation shares. An asset inversion 

could be used to reach a similar result, but through a direct merger of the top-tier U.S. 

corporation into a new foreign corporation, among other possible forms. An inversion 

transaction could be accompanied or followed by further restructuring of the corporate group. 

For example, in the case of a stock inversion, in order to remove income from foreign operations 

from the U.S. taxing jurisdiction, the U.S. corporation could transfer some or all of its foreign 

subsidiaries directly to the new foreign parent corporation or other related foreign corporations. 

In addition to removing foreign operations from U.S. taxing jurisdiction, the corporate 

group could seek to derive further advantage from the inverted structure by reducing U.S. tax on 

U.S.-source income through various earnings stripping or other transactions. This could include 

earnings stripping through payment by a U.S. corporation of deductible amounts such as interest, 

royalties, rents, or management service fees to the new foreign parent or other foreign affiliates. 

In this respect, the post-inversion structure could enable the group to employ the same taxreduction strategies that are available to other multinational corporate groups with foreign 

parents and U.S. subsidiaries, subject to the same limitations (e.g., secs. 163(j) and 482). 

Inversion transactions could give rise to immediate U.S. tax consequences at the 

shareholder and/or the corporate level, depending on the type of inversion. In stock inversions, 

the U.S. shareholders generally recognized gain (but not loss) under section 367(a), based on the 

difference between the fair market value of the foreign corporation shares received and the 

adjusted basis of the domestic corporation stock exchanged. To the extent that a corporation’s 

share value had declined, and/or it had many foreign or tax-exempt shareholders, the impact of 

this section 367(a) “toll charge” was reduced. The transfer of foreign subsidiaries or other assets 

to the foreign parent corporation also could give rise to U.S. tax consequences at the corporate 

level (e.g., gain recognition and earnings and profits inclusions under secs. 1001, 311(b), 304, 

367, 1248 or other provisions). The tax on any income recognized as a result of these 

restructurings could be reduced or eliminated through the use of net operating losses, foreign tax 

credits, and other tax attributes. 

In asset inversions, the U.S. corporation generally recognized gain (but not loss) under 

section 367(a) as though it had sold all of its assets, but the shareholders generally did not 

recognize gain or loss, assuming the transaction met the requirements of a reorganization under 

section 368. 
 

145 

U.S. tax treatment of inversion transactions under AJCA

In general

AJCA added new section 7874 to the Code, which defines two different types of 

corporate inversion transactions and establishes a different set of consequences for each type. 

Certain partnership transactions also are covered. 

Transactions involving at least 80 percent identity of stock ownership

The first type of inversion is a transaction in which, pursuant to a plan234 or a series of 

related transactions: (1) a U.S. corporation becomes a subsidiary of a foreign-incorporated entity 

or otherwise transfers substantially all of its properties to such an entity in a transaction 

completed after March 4, 2003; (2) the former shareholders of the U.S. corporation hold (by 

reason of holding stock in the U.S. corporation) 80 percent or more (by vote or value) of the 

stock of the foreign-incorporated entity after the transaction; and (3) the foreign-incorporated 

entity, considered together with all companies connected to it by a chain of greater than 50 

percent ownership (i.e., the “expanded affiliated group”), does not have substantial business 

activities in the entity’s country of incorporation, compared to the total worldwide business 

activities of the expanded affiliated group. The provision denies the intended tax benefits of this 

type of inversion (“80-percent inversion”) by deeming the top-tier foreign corporation to be a 

domestic corporation for all purposes of the Code.235 

In determining whether a transaction meets the definition of an inversion under the 

provision, stock held by members of the expanded affiliated group that includes the foreign 

incorporated entity is disregarded. For example, if the former top-tier U.S. corporation receives 

stock of the foreign incorporated entity (e.g., so-called “hook” stock), the stock would not be 

considered in determining whether the transaction meets the definition. Similarly, if a U.S. 

parent corporation converts an existing wholly owned U.S. subsidiary into a new wholly owned 

controlled foreign corporation, the stock of the new foreign corporation would be disregarded, 

with the result that the transaction would not meet the definition of an inversion under the 

provision. Stock sold in a public offering related to the transaction also is disregarded for these 

purposes. 

Transfers of properties or liabilities as part of a plan a principal purpose of which is to 

avoid the purposes of the provision are disregarded. In addition, the Treasury Secretary is to 

provide regulations to carry out the provision, including regulations to prevent the avoidance of 

the purposes of the provision, including avoidance through the use of related persons, passthrough or other noncorporate entities, or other intermediaries, and through transactions designed 

 234 Acquisitions with respect to a domestic corporation or partnership are deemed to be “pursuant 

to a plan” if they occur within the four-year period beginning on the date which is two years before the 

ownership threshold under the provision is met with respect to such corporation or partnership. 

235 Since the top-tier foreign corporation is treated for all purposes of the Code as domestic, the 

shareholder-level “toll charge” of sec. 367(a) does not apply to these inversion transactions. 
 

146 

to qualify or disqualify a person as a related person or a member of an expanded affiliated group. 

Similarly, the Treasury Secretary has the authority to treat certain non-stock instruments as 

stock, and certain stock as not stock, where necessary to carry out the purposes of the provision. 

Transactions involving at least 60 percent but less than 80 percent identity of stock

ownership

The second type of inversion is a transaction that would meet the definition of an 

inversion transaction described above, except that the 80-percent ownership threshold is not met. 

In such a case, if at least a 60-percent ownership threshold is met, then a second set of rules 

applies to the inversion. Under these rules, the inversion transaction is respected (i.e., the foreign 

corporation is treated as foreign), but any applicable corporate-level “toll charges” for 

establishing the inverted structure are not offset by tax attributes such as net operating losses or 

foreign tax credits. Specifically, any applicable corporate-level income or gain required to be 

recognized under sections 304, 311(b), 367, 1001, 1248, or any other provision with respect to 

the transfer of controlled foreign corporation stock or the transfer or license of other assets by a 

U.S. corporation as part of the inversion transaction or after such transaction to a related foreign 

person is taxable, without offset by any tax attributes (e.g., net operating losses or foreign tax 

credits). This rule does not apply to certain transfers of inventory and similar property. These 

measures generally apply for a 10-year period following the inversion transaction. 

Other rules

Under section 7874, inversion transactions include certain partnership transactions. 

Specifically, the provision applies to transactions in which a foreign-incorporated entity acquires 

substantially all of the properties constituting a trade or business of a domestic partnership, if 

after the acquisition at least 60 percent (or 80 percent, as the case may be) of the stock of the 

entity is held by former partners of the partnership (by reason of holding their partnership 

interests), provided that the other terms of the basic definition are met. For purposes of applying 

this test, all partnerships that are under common control within the meaning of section 482 are 

treated as one partnership, except as provided otherwise in regulations. In addition, the modified 

“toll charge” rules apply at the partner level. 

A transaction otherwise meeting the definition of an inversion transaction is not treated as 

an inversion transaction if, on or before March 4, 2003, the foreign-incorporated entity had 

acquired directly or indirectly more than half of the properties held directly or indirectly by the 

domestic corporation, or more than half of the properties constituting the partnership trade or 

business, as the case may be. 

Description of Proposal

The proposal extends the 80-percent inversion regime of section 7874 to certain other 80-

percent inversions. The proposal applies the rules of section 7874(b), relating to 80-percent 

inversions, to transactions completed after March 20, 2002 (as opposed to March 4, 2003 under 

present law), in the manner described below. A transaction otherwise meeting the definition of 

an inversion transaction under the proposal is not treated as an inversion transaction if, on or 

before March 20, 2002 (as opposed to March 4, 2003 under present law), the foreign-
 

147 

incorporated entity had acquired directly or indirectly more than half the properties held directly 

or indirectly by the domestic corporation, or more than half the properties constituting the 

partnership trade or business, as the case may be. 

Under the proposal, the inverted foreign-incorporated entity that engaged in the 

transaction described above is deemed to have transferred all its assets and liabilities to a 

domestic corporation in a transaction that is generally treated as a nontaxable inbound 

reorganization (“repatriation”). The repatriation is deemed to occur at the end of the last day of 

the foreign-incorporated entity’s taxable year that began in 2005. The basis of the assets of the 

foreign-incorporated entity generally remains the same in the hands of the domestic corporation, 

subject to any special adjustments for importing built-in losses (e.g., sec. 362(e)). Shareholders 

of the domestic corporation inherit the respective bases of their shares of the foreignincorporated entity. 

On the day of the repatriation, the earnings and profits of the inverted foreignincorporated entity transfer over to the domestic corporation. The transfer of such earnings and 

profits is not a deemed dividend and does not result in a tax upon the domestic corporation or its 

shareholders. However, shareholders may be subject to tax on distributions of such earnings and 

profits. 

Beginning on the day after the repatriation, the inverted foreign-incorporated entity is 

treated for all tax purposes as a domestic corporation. Thus, any income earned by the inverted 

foreign-incorporated entity after the date of repatriation is deemed to be earned by a domestic 

corporation, and therefore, is fully taxable at U.S. corporate income tax rates. As a further 

consequence of the repatriation of the inverted foreign-incorporated entity, foreign subsidiaries 

become controlled foreign corporations, subject to the rules of subpart F. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005.