[WPRT 107-2]
[From the U.S. Government Publishing Office]



107th Congress                                                    WMCP:
 1st Session                COMMITTEE PRINT                       107-2
_______________________________________________________________________

                                     


                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS

                     U.S. HOUSE OF REPRESENTATIVES

                               __________
 
                            WRITTEN COMMENTS
                                   on
                            TAXPAYER RIGHTS


                                     
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13

                                     

                             APRIL 2, 2001

         Printed for the use of the Committee on Ways and Means

            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402




                      COMMITTEE ON WAYS AND MEANS

                   BILL THOMAS, California, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida           FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut        ROBERT T. MATSUI, California
AMO HOUGHTON, New York               WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California             SANDER M. LEVIN, Michigan
JIM McCRERY, Louisiana               BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan                  JIM McDERMOTT, Washington
JIM RAMSTAD, Minnesota               GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa                     JOHN LEWIS, Georgia
SAM JOHNSON, Texas                   RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington            MICHAEL R. McNULTY, New York
MAC COLLINS, Georgia                 WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio                    JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania           XAVIER BECERRA, California
WES WATKINS, Oklahoma                KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona               LLOYD DOGGETT, Texas
JERRY WELLER, Illinois               EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin

                     Allison Giles, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JERRY WELLER, Illinois               MICHAEL R. McNULTY, New York
KENNY C. HULSHOF, Missouri           JOHN LEWIS, Georgia
SCOTT McINNIS, Colorado              KAREN L. THURMAN, Florida
MARK FOLEY, Florida                  EARL POMEROY, North Dakota
SAM JOHNSON, Texas
JENNIFER DUNN, Washington


Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.


                            C O N T E N T S

                               __________
                                                                   Page
Advisory of Monday, March 19, 2001, announcing request for 
  written comments on taxpayer rights............................     1

                                 ______

KPMG LLP, Mark H. Ely, and Harry L. Gutman, letter...............     3
Nilles, Kathleen M., Gardner, Carton & Douglas, statement........    10
Pearson, Wendy S., Pearson, Merriam & Kovach, P.S., Seattle, WA, 
  statement......................................................    15
      

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE

March 19, 2001

No. OV-2

                     Houghton Announces Hearing on

                              Request for

                  Written Comments on Taxpayer Rights

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee is requesting written public comments for the record from 
all parties interested on penalty and interest provisions in the 
Internal Revenue Code (I.R.C.), taxpayer privacy concerns, and other 
taxpayer rights.
      

BACKGROUND:

Penalties and Interest

      
    In 1988 and 1989, the Subcommittee held a series of hearings on the 
penalty and interest provisions in the I.R.C. The hearings culminated 
in an overhaul of the penalty and interest regimes with the enactment 
of the Improved Penalty Administration and Compliance Tax Act, included 
in the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239).
      
    In the IRS Restructuring and Reform Act of 1998 (P.L. 105-206), 
Congress directed the U.S. Department of the Treasury and the Joint 
Committee on Taxation to conduct studies to examine whether the current 
penalty and interest provisions: (1) encourage voluntary compliance, 
(2) operate fairly, (3) are effective deterrents to undesired behavior, 
and (4) are designed in a manner that promotes efficient and effective 
administration of the provisions by the Internal Revenue Service.
      
    The Joint Committee on Taxation completed and released its study, 
Study of Present-Law Penalty and Interest Provisions as Required by 
Section 3801 of the Internal Revenue Service Restructuring and Reform 
Act of 1998 (Including Provisions Relating to Corporate Tax Shelters) 
(JCS-3-99), on July 22, 1999. The Treasury Department completed its 
report, Penalty and Interest Provisions of the Internal Revenue Code, 
on October 25, 1999. The Subcommittee requested written comments on 
November 15, 1999, on the penalty and interest provisions of the I.R.C. 
and held a hearing on January 27, 2000.
      

Taxpayer Privacy

      
    In the IRS Restructuring and Reform Act of 1998, Congress directed 
the Treasury Department and the Joint Committee on Taxation to examine: 
(1) the present protections for taxpayer privacy, (2) any need for 
third parties to use tax return information, (3) whether voluntary 
compliance could be achieved by allowing the public to know who is 
required, but does not, file tax returns, (4) the interrelationship of 
the taxpayer confidentiality provisions in the I.R.C. and other Federal 
privacy laws including, the Freedom of Information Act, 5 U.S.C. 
section 552, and (5) the impact of taxpayer privacy of sharing tax 
return information for enforcement of State and local tax laws.
      
    The Joint Committee on Taxation completed and released its study, 
Study of Present-Law Taxpayer Confidentiality and Disclosure Provisions 
as Required by Section 3802 of the Internal Revenue Service 
Restructuring and Reform Act of 1998 (JCS-1-00, Vols. I, II, and III) 
on January 28, 2000. The Treasury Department completed its report, 
Report to Congress on the Scope and Use of Taxpayer Confidentiality and 
Disclosure Provisions, in October 2000.
      
    On April 5, 2000, the Committee on Ways and Means marked up and 
favorably reported H.R. 4163, the ``Taxpayer Bill of Rights 2000,'' 
which addressed several of the issues included in the studies by the 
Joint Committee on Taxation and the Treasury Department. The House 
passed the bill by a vote of 421-0 on April 11, 2000.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written statement 
for the printed record should submit six (6) single-spaced copies of 
their statement, along with an IBM compatible 3.5-inch diskette in 
WordPerfect or MS Word format, with their name, address, and comments 
date noted on label, by the close of business, Monday, April 2, 2001, 
to Allison Giles, Chief of Staff, Committee on Ways and Means, U.S. 
House of Representatives, 1102 Longworth House Office Building, 
Washington, D.C. 20515.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect or 
MS Word format, typed in single space and may not exceed a total of 10 
pages including attachments. Witnesses are advised that the Committee 
will rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.
      
    Note: All Committee advisories and news releases are 
available on the World Wide Web at `HTTP://WWW.HOUSE.GOV/
WAYS__MEANS/'.
      

                                

      

      

                                                   KPMG LLP
                                       Washington, DC 20036
                                                      April 2, 2001

The Honorable Amo Houghton
Chairman
Subcommittee on Oversight
Committee on Ways and Means
U.S. House of Representatives
1102 Longworth House Office Building
Washington, DC 20515

Re: COMMENTS ON PENALTY AND INTEREST PROVISIONS OF THE INTERNAL REVENUE 
                    CODE

    Dear Mr. Chairman:

    We are writing in response to your request for comments on the 
penalty and interest provisions of the Internal Revenue Code (the 
``Code''). We strongly support continued examination of the penalty and 
interest provisions of the Code, as well as legislation that will 
encourage voluntary compliance, fairness, deter undesired behavior, and 
promote efficient and effective administration.
    Section 3801 of the IRS Restructuring and Reform Act of 1998 
required the Joint Committee on Taxation and the Secretary of the 
Treasury to conduct separate studies on the administration and 
implementation of the interest and penalty provisions. Pursuant to this 
study, comments were sought on the penalty and interest provisions of 
the Code. In response to this request, we submitted a number of 
recommendations to improve the fairness and efficacy of the penalty and 
interest regime. Progress has been made on the penalty and interest 
provisions. We believe however, that there is room for further reform 
of the penalty and interest provisions. Therefore, we respectfully 
submit these recommendations to you in order to support the continued 
initiative to improve the fairness and efficacy of the penalty and 
interest regime for all taxpayers.
    We believe that significant improvements should be made both to the 
structure of the penalty and interest provisions and to the ways in 
which they are administered. While some taxpayers may factor penalties 
and interest into the calculation when choosing not to comply with tax 
filing or payment requirements, we believe that, in most instances, the 
cause of noncompliance is due to the complexity of the law, or the 
result of unique events and circumstances. The cost of penalties 
imposed by the Internal Revenue Service (the ``IRS'' or ``Service''), 
as well as the cost of responding to proposed penalty assessments as a 
result of examinations or through IRS notices, is staggering.
    We believe that assessing penalties on taxpayers who have a good 
history of compliance is counterproductive. Assessing penalties against 
these taxpayers often contributes to the perception that the system is 
unfair and may not be conducive to encouraging voluntary compliance. 
Taxpayers with good track records generally should not systemically be 
subjected to penalty assessments.
    The complexity inherent in calculating interest, particularly in 
large scale multi-year examinations, almost always results in errors by 
taxpayers and the IRS. Taxpayers and the government may be losing 
thousands of dollars (or more) due to such errors. Interest 
calculations must be simplified.

                           PENALTY PROVISIONS

I. General Comments
A. Encouraging Voluntary Compliance
    In general, the penalty provisions of the Code should encourage 
voluntary compliance by taxpayers. We do not believe that it is in the 
best interest of tax administration to enact penalties to raise revenue 
or to punish a taxpayer arbitrarily. For the most part, taxpayers 
understand that basic failures to comply with the Code--e.g., failure 
to file an income tax return or to pay tax in a timely manner--will 
result in the imposition of penalties and interest, and taxpayers will 
try to comply with the law to avoid those adverse consequences. It 
should be noted, however, that frequently the events or circumstances 
that create late filing, late deposits, or late payments, for example, 
are unique events in the life of a taxpayer or business. Too heavy a 
sanction for an inadvertent failure to comply, especially when the 
burden of compliance is heavy, may have the unintended effect of 
undermining faith in the fairness of the system and discouraging future 
compliance.
    Sections 6038A and 6038C provide examples of penalty provisions 
that do notencourage voluntary compliance. Sections 6038A and 6038C 
impose reporting requirements on foreign-owned corporations. Under 
these provisions, certain transactions with related parties must be 
reported on Form 5472. The penalties imposed for failure to comply with 
these reporting requirements are substantial--an initial penalty of 
$10,000 per form and an additional $10,000 for each month (or fraction 
thereof) if the reporting requirements are not met more than 90 days 
after the Service sends notice to the corporation. The penalty can be 
avoided if the corporation can show, to the satisfaction of the 
Secretary, that there was reasonable cause for failing to provide the 
required information, but it is unclear whether the reasonable cause 
exception would apply, for instance, in cases where the taxpayer did 
not know that the Form 5472 was required. These penalty rules would 
more likely encourage voluntary compliance (and comport with basic 
notions of fairness) if the penalties did not apply as long as the 
taxpayer corrected the error before the error was discovered by the 
IRS. This could be achieved by enacting in the foreign reporting 
context a one time rule similar to the ``qualified amended return 
rule'' in effect for purposes of the accuracy-related penalty. See Reg. 
Sec. 1.6664-2(c)(3) (if an error is discovered and corrected before the 
IRS contacts the taxpayer, no accuracy-related penalty can be imposed). 
A similar qualified amended return rule should be enacted for 
transactions required to be reported on Forms 5471.
B. Enacting Substantially Uniform Penalty Provisions
    We appreciate that the inordinate complexity of the tax law and its 
administration preclude perfectly consistent application of penalty and 
interest provisions to all taxpayers. Nevertheless, we respectfully 
request that greater effort be directed to enacting laws that promote 
uniform treatment of taxpayers and encourages voluntary compliance. 
Unfortunately, we are aware of numerous instances in which taxpayers 
with similar fact patterns have received completely different penalty 
treatment by the Service.
    The section 6651(a)(2) and (3) failure to pay penalty leads to 
particularly unfair results. For example, this penalty is imposed when 
an individual taxpayer files a timely return but fails to pay the full 
amount of the tax shown on the return. The failure to pay penalty is 
not imposed, however, when the taxpayer files a Form 4868 and pays at 
least 90 percent of the tax due. The individual taxpayer who files 
timely and the taxpayer who files an extension will only be treated 
equally if there is a 10 percent safe harbor for the failure to pay 
penalty. The safe harbor should apply until the extension date (i.e., 
August 15). Thus, if an individual taxpayer files a timely return, pays 
at least 90 percent of the tax due on April 15, and pays the remaining 
10 percent by August 15, no failure to pay penalty should be imposed. 
In order to treat individual taxpayers uniformly, the statute should be 
amended in order that the penalty not attach until after August 15. A 
similar rule applies to corporate taxpayers (see Reg. Sec. 301.6651-
1(c)(3), (4)). As noted more fully below, however, we believe that the 
failure to pay penalty no longer serves its intended purpose and should 
be repealed.
II. Specific Recommendations
A. Expansion of Reasonable Cause and Good Faith Exception
    We recommend the enactment of statutes that provide a reasonable 
cause and good faith exception to all penalties. The reasonable cause 
and good faith exception to various penalties (such as the section 
6664(c) exception to the section 6662 and 6663 accuracy-related and 
fraud penalties) is one source of the Commissioner's authority to waive 
or not enforce penalties. There are some penalties, however, that do 
not have a reasonable cause and good faith exception. For example, 
there is no reasonable cause exception for estimated tax penalties 
imposed under section 6654 (with the exception of newly retired or 
disabled individuals) and section 6655. Another example is section 
7519, which imposes extremely harsh penalties with no reasonable cause 
exception. We recommend the enactment of statutes that provide a 
reasonable cause and good faith exception to all penalties.
    We also believe that the penalty provisions should be amended to 
recognize that taxpayers be afforded greater protection from penalties 
in the situations in which there is an absence of guidance on how a 
particular tax provision applies. For example, we would recommend that 
either reliance on well-reasoned treatises (or other publications), or 
the Service's failure to provide guidance on a tax law provision, 
should be taken into account in determining whether the taxpayer 
qualifies for the reasonable cause exception to the accuracy-related 
penalty.
B. Enactment of an Objective Reasonable Cause Standard
    We do not believe that the penalty provisions are generally 
designed in a manner that promotes efficient and effective 
administration by the Service. In addition to a subjective ``reasonable 
cause'' standard to abate penalties, there should be enacted an 
objective standard (i.e., one or more ``safe harbors'') for determining 
whether the penalty should apply in the first instance. Given the 
significant number of penalties that are abated under current law, 
objective standards should narrow the group of taxpayers to which a 
given penalty applies in a manner that corresponds to how the 
particular penalty has been administered historically. The subjective 
standard could be used as a supplementary measure to ensure that each 
penalty is being administered equitably and fairly. This two-pronged 
approach may very well result in more judicious initial application of 
penalties, which would be far preferable to the current process of 
proposing or assessing penalties and then abating a large number of 
them when protests are received.
            1. Waiver for First-Time Offenders
    We recommend enactment of a safe-harbor provision for first-time 
offenders as an exception to all the penalty provisions of the Code. In 
certain cases, rather than the Service assessing a penalty and then 
abating it if the taxpayer protests, we recommend enactment of a 
provision that requires educational notices be used for first-time 
offenders. If a taxpayer did not know of, and could not have easily 
learned of, an obligation, a penalty should not be imposed on that 
taxpayer for the first year in which the obligation arose. Any penalty 
waiver provision enacted should take into consideration a taxpayer's 
compliance history. Current law provides little relief for first-time 
offenders. For example, section 6656(c) provides an exception from the 
penalty for failure to deposit employment taxes for first-time 
offenders. Likewise, Reg. Sec. 301.6724-1(a) also provides a waiver of 
the penalty for failure to comply with certain information reporting 
requirements for first-time offenders. We believe that this concept 
should be expanded to all penalty provisions to ensure that the penalty 
provisions are fair for innocent first-time offenders.
    In the case of a first-time offense, we recommend requiring that 
the Service inform the taxpayer of the amount of the penalty if the 
penalty had been assessed. Any notice issued to a taxpayer should 
contain information on what steps the taxpayer should take in the 
future to avoid the penalty. A subsequent delinquency would result in a 
penalty (unless special facts and circumstances in the subsequent year 
justified reasonable cause relief).
    One recent example that we encountered was the assertion of a late 
filing penalty on a foreign based taxpayer who inherited property and 
income from a person within the United States. The taxpayer was 
initially given poor advice, but once he learned that he had a filing 
requirement, he took prompt corrective action without IRS intervention. 
The IRS Service Center refused the request for abatement of the late 
filing penalty. While the taxpayer subsequently prevailed at Appeals, 
the additional cost to do so was high.
            2. Waiver in Interest of Tax Administration
    We recommend adding a specific Code section that would allow the 
Commissioner or National Taxpayer Advocate to waive or abate any 
penalty or addition to tax if it is in the interest of tax 
administration. Currently, Department of the Treasury Order No. 150-10 
gives the Commissioner broad authority in the administration of the tax 
law. This Treasury Order can be used to waive penalties. The waivers of 
the estimated tax penalty noted in News Releases IR 88-39 (waiver of 
estimated tax penalties for farmers who did not receive information 
returns from Department of Agriculture by Feb. 15, 1988) and IR 88-62 
(automatic IRS waiver of estimated tax penalties on retirement income 
for 1987) are examples of the Commissioner's broad authority. We 
believe that in certain circumstances the Commissioner's or the 
National Taxpayer Advocate's waiver or abatement of a penalty may be in 
the best interest of tax administration.
            3. Waiver for Use of Payroll Service Provider
    We think the efficient administration of the penalty provisions 
could be greatly enhanced by modifying the rules relating to payroll 
service providers. Companies hire payroll service providers to help 
comply with the filing and deposit requirements related to payroll 
taxes. Payroll service providers are responsible forthe timely payment 
of billions of dollars in withholding taxes to the U.S. Treasury on a 
daily basis. Despite this contribution, the IRS frequently fails to 
recognize the unique role such companies play. In view of the 
assistance payroll service providers provide to taxpayers and the 
Treasury, consideration should be given to legislation that would 
provide that the use of a competent payroll services company 
presumptively qualifies for reasonable cause (or ``safe harbor'') 
relief from penalties. The presumption could be rebutted by proof of 
action by the taxpayer that was inconsistent with reasonable cause and 
good faith.
C. Expansion of Required Content-Penalty Notices
    We recommend that section 6751 be amended to require that penalty 
notices include the rationale for imposing the penalty and an analysis 
of how it applies to the particular taxpayer. Section 6751, added by 
section 3306(a) of the IRS Restructuring and Reform Act of 1998, 
requires that penalty notices identify the type of penalty and how it 
was computed. Current communications from the Service do not provide 
adequate explanations of penalties and interest. For example, a 30-day 
letter involving the accuracy-related penalty typically contains 
boilerplate language announcing that ``[s]ince all or part of the 
underpayment of tax'' for the relevant tax year is attributable to 
``one or more of'' the accuracy-related penalties for negligence or 
disregard of rules or regulations, a substantial understatement of 
income tax, or a valuation misstatement, a 20% ``addition to the tax is 
charged as provided by section 6662(a) of the Internal Revenue Code.'' 
It sets forth no rationale or analysis justifying the penalty and, 
indeed, does not even tell the taxpayer which component of the 
accuracy-related penalty is at issue. We do not believe that Congress 
intended in enacting section 6751 for taxpayers to receive so little 
helpful information in penalty notices.
    Although the enactment of section 6751 is a move in the correct 
direction, section 6751 would not (unless amended) require including 
the rationale for imposing the penalty and an analysis of how the 
penalty applies to the particular taxpayer under the particular 
circumstances. Section 6751 should be amended to require that 30-day 
letters inform taxpayers of their options--e.g., of explaining how to 
obtain relief from penalties on reasonable cause grounds--as well as of 
informing taxpayers of what they did incorrectly and of how to avoid 
the penalty in the future. Under the current system, a taxpayer may 
have to hire a tax practitioner to understand how to obtain a waiver of 
the penalty and how to avoid the penalty in subsequent tax periods. 
Voluntary compliance would be greatly enhanced if taxpayers were better 
apprised of their rights and responsibilities.
D. Conversion of Certain Penalty Provisions to Interest Provisions
    We recommend the conversion of certain penalty provisions of the 
Code to interest provisions. We believe that where a penalty provision 
is essentially a fee for the use of money, such provision should be 
accurately classified as interest. For example, the individual and 
corporate estimated tax penalties should be replaced with interest 
charge provisions. The conversion of both estimated tax penalties into 
interest charges more closely conforms the titles and descriptions of 
those provisions to their effect. The penalties are essentially a fee 
for the use of money that is compensatory in nature.
E. Repeal of Failure to Pay Penalty
    We recommend repeal of the failure to pay penalty under section 
6651(a)(2) and (3). Although, in the past, some taxpayers would 
generate overpayments and underpayments to take advantage of 
disparities between commercial borrowing rates and the section 6621 
rates, it has been our experience that this is no longer a significant 
issue. In response to the interest rate disparity that existed before 
1986, Congress enacted the failure to pay penalty. The purpose of this 
penalty was to compensate the government for the fact that the interest 
rates on underpayments were substantially less than the commercial 
rates. When the interest rates were so structured, taxpayers were 
``encouraged'' to put off paying their taxes for as long as possible. 
The interest rates, however, are now tied to the market interest rates 
and the original purpose for this penalty has disappeared. The 
government is now adequately compensated for the use of its money. 
Because the failure to pay penalty has outlasted its usefulness, we 
respectfully request its repeal.
F. Staying Collection Proceedings
    We recommend legislation which provides that collection efforts be 
stayed pending completion of the administrative and/or judicial 
proceeding. For example, in some situations the Service attempts to 
collect the trust fund penalty imposed under section 6672 while the 
penalty is being contested administratively or judicially. It would 
ease the burden on taxpayers if the Code provided that collection 
efforts be stayed pending completion of these proceeding.
G. Establishment of National Office Level Oversight
    In order to promote uniformity and fairness, taxpayers generally 
should be subject to a similar penalty regime. Although it would be 
reasonable to have penalties administered by each of the four operating 
units of the Service's reorganized structure, safeguards must be 
instituted to ensure that each such unit administers the penalties in a 
manner that is consistent with the way each other unit administers the 
penalties. In view of the potential for dissimilar treatment, we 
recommend legislation establishing a National Office level function to 
oversee the administration of penalties and to ensure that it is 
uniform and fair.

                          INTEREST PROVISIONS

I. Enactment of Single Statutory Interest Rate
    We strongly support enactment of a single statutory rate of 
interest on corporate tax underpayments and overpayments. Under current 
law, a higher rate of statutory interest is imposed on corporate tax 
underpayments than on corporate tax overpayments. Charging a higher 
interest rate on corporate tax underpayments is equivalent to 
subjecting corporate taxpayers to a penalty equal to the interest 
differential. There is no policy basis for assessing a different figure 
for the time value of money depending upon whether the debtor is the 
federal government or a corporate enterprise. Imposing a single rate of 
interest on overpayments and underpayments would eliminate this 
unjustified differential.
    Imposition of a single statutory rate of interest on overpayments 
and underpayments also has the advantage of being easier to administer 
than the current global interest netting rule. The global interest 
netting rule often requires a taxpayer to produce complex calculations 
to demonstrate periods of overlap and the amounts of overpayments and 
underpayments eligible for netting. Imposing a single rate of interest, 
by contrast, would generally have the effect of accomplishing 
``interest netting'' automatically.
    Finally, imposing a single rate of interest has the advantage of 
rendering moot several difficult interpretive questions raised by the 
global interest netting rule enacted by the IRS Restructuring and 
Reform Act of 1998. The global interest netting rule generally provides 
that a taxpayer is entitled to a net interest rate of zero for 
equivalent tax overpayments and underpayments during applicable periods 
of overlap. Questions have been raised as to whether the global 
interest netting rule applies where one taxpayer has an underpayment 
and a related taxpayer has an overpayment. As explained by the Joint 
Committee:

          The zero net interest rate only applies where interest is 
        payable by and allowable to the same taxpayer. The zero net 
        interest rate does not apply where interest is payable by one 
        taxpayer and allowable to a related taxpayer. However, if the 
        related taxpayers joined in a consolidated return for the 
        underpayment and overpayment years, they are presumably treated 
        as a single taxpayer and may apply the zero net interest rate.
          [However,] [c]ertain taxpayers are prevented by the Code from 
        joining in a consolidated return even though one taxpayer is 
        the wholly owned subsidiary of the other . . .

    JCT Interest and Penalty Study, JCS-3-99, July 22, 1999, p. 95. If 
the tax law imposed a single statutory rate of interest on tax 
overpayments and tax underpayments, the difficult interpretive 
questions raised where interest is owed by one taxpayer and interest is 
payable to a related taxpayer would be eliminated.
    Imposition of a single statutory rate of interest would not 
however, resolve a situation in which a taxpayer has an outstanding 
overpayment and underpayment during an overlapping period and interest 
is either not allowable on the underpayment or not payable on the 
overpayment.
II. Interest Netting Rule
A. Expansion of Global Interest Netting Rule
    We recommend legislation that would expand the global interest 
netting rule to apply during certain legislative grace periods when 
there are overlapping overpayments and underpayments, regardless of the 
fact that, under the Code, interest is not paid. For instance, the Code 
provides that if the IRS processes a request for a refund within 45 
days no interest may be paid on the overpayment. Interest only runs if 
the overpayment is not refunded within the 45-day grace period. 
Likewise, interest is not imposed on an ``addition to tax'' if it is 
paid within 21 business days of the date the IRS issues a ``notice and 
demand''--or request for payment (10 business days if the amount of the 
penalty is at least $100,000). Despite these legislative grace periods, 
in each case there is still an outstanding tax overpayment or 
underpayment, and under ``use of money'' principles, interest should be 
accruing. We recommend that the global interest netting rule be 
expanded to apply during these grace periods. This approach would take 
account of the mutuality of indebtedness between the taxpayer and the 
government during the period of overlapping overpayments and 
underpayments.
B. Clarification of Periods of Limitations
    We recommend legislation clarifying the transition rule to section 
3301(c) of the IRS Restructuring and Reform Act of 1998 (the enacting 
legislation to section 6621(d)) to provide that only one period of 
limitation needs to be open on July 22, 1998 in order to qualify for 
global interest netting. We believe such an approach is consistent with 
Congress' mandate that ``the most comprehensive interest netting 
procedures that are consistent with sound administrative practice'' be 
adopted. We believe that this interpretation is in accordance with the 
remedial purpose of section 6621(d).
    Section 3301(c) of the IRS Restructuring and Reform Act of 1998 is 
subject to differing interpretations. The Service interprets section 
3301(c) as requiring that both periods of limitations be open as of 
July 22, 1998. This interpretation does not reflect what we believe to 
be the ``comprehensive netting procedures'' envisioned by Congress. See 
S. Rep. No. 105-174, at 62 (1998). We think that IRS's requirement that 
both periods of limitations be open as of July 22, 1998, is an 
unnecessarily narrow interpretation of section 3301(c). Section 6621(d) 
applies to interest periods beginning before July 22, 1998, ``[s]ubject 
to any applicable statute of limitation not having expired with regard 
to either a tax underpayment or a tax overpayment. . . .'' We believe 
the legislative history strongly supports the view that Congress 
intended that only one period of limitation need be open. The 
Conference Report states that the zero net rate of interest would apply 
retroactively if ``the statute of limitations has not expired with 
respect to either the underpayment or overpayment. . . .'' H.R. Conf. 
Rep. No. 105-599, at 74 (1998).
    Furthermore, requiring only one period of limitation to be open 
would be consistent with the application of the netting rules for 
interest periods beginning after July 22, 1998. See Rev. Proc. 2000-26, 
2000-24 I.R.B. 1257. The following example illustrates this point:

          Example 1: Q Corp. had an underpayment from the 1994 tax year 
        that ran from March 15, 1995, until July 1, 1999 (the date on 
        which it was paid), and an overpayment from the 1997 tax year 
        that runs from March 15, 1998, until March 12, 2002 (the date 
        on which the refund was issued). The overlapping period of 
        underpayment and overpayment is March 15, 1998, through July 1, 
        1999. Because the 1997 return was not ``under consideration'' 
        on December 31, 1999, Q Corp. did not take steps to protect its 
        right to interest netting, if any such steps are required. It 
        appears that the IRS is proposing that, on these facts, no 
        netting of Q Corp.'s 1994 underpayment and 1997 overpayment be 
        done for the period from March 15, 1998, to July 22, 1998--even 
        though netting will be required for interest periods beginning 
        after July 22, 1998. Therefore, in this example, the IRS will 
        only net the overpayment and underpayment for interest accrued 
        between July 22, 1998, and July 1, 1999. Because there is no 
        requirement that both statutes of limitation be open for 
        interest periods beginning after July 22, 1998, we expect that 
        the IRS will net the interest in this case, even though only 
        one period of limitation will be open.

    In Example 1, the period of limitation for the 1994 underpayment 
interest would have expired before March 12, 2002; however, the IRS 
would still be required to net for interest periods beginning after 
July 22, 1998. We do not believe it is logical to make the netting rule 
dependent on when an examination concluded, especially when the IRS has 
sole control over when an examination begins. It should be made clear 
that IRS is required to net the overlapping overpayments and 
underpayments for interest periods beginning before July 22, 1998, just 
as they are required to do for interest periods beginning after July 
22, 1998.
    Application of the zero net rate of interest will not run afoul of 
the general statutes of limitations on claims for refund, even when 
only one of the limitations periods is open. Section 6621(d) requires 
only that a zero net rate be applied; it does not mandate the manner in 
which this is done. As long as one of the periods of limitation is 
open, the interest rate on the overpayment or underpayment for that 
period can be adjusted to effectuate the zero net rate. The following 
example illustrates this point:

          Example 2: T Corp. had a deficiency of $3,000,000 in income 
        tax for the 1988 tax year. That deficiency was timely assessed 
        on March 15, 1992. T Corp. paid the assessment of tax and 
        interest on April 1, 1992. Assume that the deficiency interest 
        accrued between March 15, 1989, and April 1, 1992, at a rate of 
        9 percent.
          T Corp.'s 1989 tax year has been the subject of litigation in 
        the Tax Court. On September 10, 1998, the Tax Court entered a 
        decision determining that T Corp. did not have a deficiency for 
        the 1989 year and that T Corp., instead, had an overpayment of 
        $2,000,000 for that year. As a result, the IRS owes T Corp. 
        interest on the overpayment from March 15, 1990, through the 
        date of payment. Assume that overpayment interest accrued at a 
        rate of 8 percent during this period.
          The overlapping period of underpayment and overpayment runs 
        from March 15, 1990 (the date the 1989 return was filed), to 
        April 1, 1992 (the date T Corp. paid the 1988 deficiency). 
        During the overlapping period, T Corp. paid interest at the 
        rate of 9 percent. The overlapping amount of underpayment and 
        overpayment is $2,000,000. If the IRS refunds the overpayment 
        using the 8 percent interest rate, the net rate of interest on 
        the overlapping amount will be 1 percent. The period of 
        limitation for the 1988 year has expired so, based upon current 
        IRS interpretation, T Corp. cannot seek a refund of the 
        interest rate differential--i.e., 1% of $2,000,000, accruing 
        between March 15, 1990, and April 1, 1992.
          Even though the underpayment year was closed on July 22, 
        1998, the interest rate on the overpayment during the 
        overlapping period can be adjusted to take into account the 
        deficiency interest paid by T Corp. The IRS can adjust the 
        interest rate on the overpayment to 9 percent (the underpayment 
        rate) during the overlapping period to effectuate the zero net 
        rate of interest.

    Moreover, clarifying that only one year must be open is entirely 
consistent with the tax law as applied in other areas. As a general 
proposition, both taxpayers and the IRS can consider, and even make, 
adjustments to closed years in order to determine the correct tax 
treatment in an open year. As long as no assessment or refund is being 
made, the applicable statute of limitations is not being violated. See, 
e.g., Commissioner v. Van Bergh, 209 F.2d 23 (2d Cir. 1954); Jones v. 
Commissioner, 75 T.C. 391 (1978). See also Rev. Ruls. 56-285, 69-543, 
82-49, 81-87, 81-88; PLR 9504032. This is also the approach authorized 
by section 6214(b) when adjustments in years not before the Tax Court 
are taken into account in order to reach the correct result for the 
years at issue. See Odend'hal v. Commissioner, 80 T.C. 588, 618 (1983); 
Russello v. Commissioner, T.C. Memo. 1989-391 (For purposes of 
determining eligibility for income averaging, the court could look at 
the correct amount of income in the base period years even though 
assessment of a deficiency or refund of an overpayment would be barred 
by the statute of limitations). See also Field Service Advice dated 12/
29/98 (Tax Analysts Doc. No. 1999-16631) (``Although the Tax Court is 
without authority to determine a deficiency or overpayment for [the 
closed year], it can consider such facts from [that year] as may be 
necessary to correctly redetermine the taxpayer's tax liability for a 
year with respect to which a deficiency has been determined and is 
properly before the court. I.R.C. section 6214(b).'').
    Because the net rate of zero can be effected by either adjusting 
the interest rate in the underpayment or overpayment year--as long as 
one statute is open--the taxpayer should be able to benefit from the 
netting provisions. It appears that clearly Congress intended that in 
drafting this statute, the interest netting rules be applied as broadly 
as possible. Therefore, we recommend clarification of the law to 
require that only one period of limitation--that of the underpayment 
year or the overpayment year--have been open on July 22, 1998.
III. Expansion of Notice Requirement
    We believe that section 6631 should be amended to require that all 
bills for interest required to be paid--for both individuals and 
corporations--include the Code section under which the interest is 
imposed, a computation of the interest, and an explanation of how the 
interest charge is determined, including the base on which the interest 
is applied, the applicable interest rate, and the period during which 
the interest has accrued. The notice should also include the 
overlapping overpayment and underpayment periods during which the 
Service is applying the net zero rate of interest.
    We believe there are solid reasons to require this interest 
information. For example, the Service's administration of the current 
interest provisions does not always appear to be efficient and 
effective. The service centers, appeals offices, and district counsel 
are sometimes taking inconsistent approaches to interest computations. 
We think this problem may be somewhat alleviated for individuals after 
December 31, 2000, when the Service will be required to provide 
individual taxpayers with notices containing both the Code section 
under which interest is imposed and a computation of the interest. See 
section 6631 (added by section 3308(a) of the IRS Restructuring and 
Reform Act of 1998). The Code currently does not guarantee adequate 
notice to taxpayers other than individuals. We recommend amending 
section 6631 in order to apply to all taxpayers.
IV. Interest Abatement on Account of Equity and Good Conscience
    We recommend amending section 6404 to allow the Service to abate 
interest in situations that do not necessarily involve a ministerial or 
managerial act, but that warrant abatement on grounds of equity and 
good conscience. The ``ministerial'' and ``managerial'' requirements 
are unnecessarily limiting, vague, and do not focus on the equities of 
the case. In addition, we recommend modifying the Commissioner's 
abatement authority to include the abatement of interest on all taxes, 
such as employment taxes. Section 6404(e) only allows the abatement of 
interest on taxes subject to the deficiency procedures. Because 
employment and other taxes are not subject to the deficiency 
procedures, interest on those taxes is not subject to abatement. See 
Woodral v. Commissioner, 112 T. C. 19 (1999). There can be situations, 
however, when interest on employment taxes should be abated because of 
unreasonable errors or delays by the Service. Section 6404(e) could be 
easily modified to account for these situations.
    We recommend enactment of a statute that requires abatement of 
interest in situations where delays in IRS decisions or case actions 
have contributed to large interest assessments in relation to the tax 
owed.
    We recommend amendment to the net worth requirements for Tax Court 
review of the Service's failure to abate interest. In certain cases the 
net worth requirements bar relief, resulting in inequity.
V. Clarification of Code Provisions' Status as Penalty or Tax for 
        Interest Purposes
    Section 6601(e)(2) sets forth the general rules for imposing 
interest on penalties and additions to tax. It is not clear, however, 
whether and when penalties other than those imposed by chapter 68 are 
subject to interest--e.g., the penalties imposed by sections 5761, 
6038A, 6038C, and 7261-7273. It is also unclear how interest accrues on 
certain ``taxes''--e.g., the tax imposed by section 4979 on excess 
contributions to a retirement plan. We recommend that these issues be 
clarified in a manner that encourages compliance (i.e., that does not 
unnecessarily ``stack'' sanctions).
    Certain interest rules act primarily as penalties and their 
application may result in the impermissible stacking of penalties. For 
example, the ``hot interest'' provision in section 6621(c) on large 
corporate underpayments compensates the government for the use of its 
money and effectively penalizes the taxpayer an additional two percent. 
In addition, before 1990, section 6621(c) imposed a 120 percent 
interest rate on tax-motivated transactions. This section was repealed 
for returns due after 1989, but the higher interest rate continues to 
apply to tax-motivated transactions that occurred in earlier years. Not 
only does this provision act as a hidden penalty, but it also results 
in the dissimilar treatment of similarly situated taxpayers.
    Accordingly, we strongly recommend that all rules regarding 
interest should be based upon use of money principles as opposed to 
raising revenue or to the imposition of a penalty.
            Respectfully submitted,
                                        Mark H. Ely
                                 National Partner-in-Charge
                                 Tax Controversy Technical Services

                                    Harry L. Gutman
                                          Partner-in-Charge
                            Tax Legislative and Regulatory Services
                                                Washington National Tax

                                


    Statement of Kathleen M. Nilles, Esq., Gardner, Carton & Douglas
    I am a tax lawyer practicing in Washington, D.C. I have been 
involved in federal tax law for the past 16 years. Following law 
school, I worked for five years as a tax associate in private practice. 
Then I served as tax counsel to the Committee on Ways and Means. As Tax 
Counsel, I was responsible for advising the Committee on tax compliance 
issues, including IRS penalties and interest.
    Since leaving Government service in early 1995, I have represented 
a variety of clients as a tax partner in the law firm of Gardner, 
Carton & Douglas. We currently represent the Partnership Defense Fund 
Trust, an organization funded by and formed to defend the interests of 
several hundred individual investors in the partnerships described 
below. This statement is submitted exclusively on the Trust's behalf. 
We do not represent any individual partners in these partnerships.
    In connection with the Oversight Subcommittee's review of the 
penalty and interest provisions in the Internal Revenue Code, I would 
like to bring to the Subcommittee's attention a situation that has 
drastically affected the lives of thousands of taxpayers throughout the 
country. It is the kind of situation that this Committee attempted to 
address in the IRS Restructuring and Reform Act of 1998. To date, 
however, the IRS has failed to incorporate Congressional intent--both 
in its published guidance and in its actual administration of the tax 
law. Thus, I would urge Congress to consider whether stronger 
legislative measures are needed.
The Situation of the Individual Taxpayers Who Invested in Hoyt 
        Partnerships
    From 1977 through 1997, approximately 3,000 individuals and couples 
throughout the United States were induced to invest in one or more of 
over 100 separate partnerships set up by Walter J. Hoyt, a nationally 
recognized cattle breeder. Twenty years later, many of these investors 
are confronting a fate much worse than the mere loss of their original 
investment in these now bankrupt partnerships. Pursuant to a complex 
fraud in which the partnerships' promoter inappropriately allocated a 
limited number of cattle among several partnerships resulting in excess 
deductions, many Hoyt investors have received tax, penalty and interest 
assessments totaling ten to twenty times their original investment. As 
a result of factors beyond their control, these individual investors--
who are largely middle-class wage earners--typically face IRS 
liabilities of $200,000 to $600,000.\1\ The enormity of these 
liabilities has caused great emotional distress and threatened many 
investors' financial and retirement security.
---------------------------------------------------------------------------
    \1\ One reason why the interest portion of these liabilities is so 
large is that the IRS has imposed a penalty form of interest, known as 
``tax-motivated interest,'' for tax years 1983 through 1988.
---------------------------------------------------------------------------
    The Hoyt partnerships, although fraught with fraudulent 
misrepresentations and bookkeeping irregularities, were not a typical 
tax shelter. Mr. Hoyt and his family were nationally recognized cattle 
breeders. In the years 1984 to 1994, Hoyt's cattle operations owned 
between 4,000 and 10,000 head of cattle. The cattle were kept on ten to 
twelve separate ranches owned by the Hoyt partnerships with a combined 
acreage totaling over 500,000 acres, as well as on other leased land. 
The Hoyt investors could not have individually discovered the fraud. 
Indeed, it took IRS auditors and federal prosecutors years to develop 
sufficient evidence to verify their longstanding suspicions.
    For several years after the IRS Criminal Investigation Division 
first began to investigate the Hoyt operations, Walter J. Hoyt was 
allowed to continue to conduct business as usual, to promote more 
partnerships, and to retain his role as the Tax Matters Partner 
(``TMP'') for the approximately 118 separate partnerships he formed and 
promoted. In addition to failing to remove him as TMP, the IRS failed 
to take any of the following possible actions against him:
     The IRS failed to file an injunction against Mr. Hoyt as a 
tax return preparer. See IRC Sec. 7407.
     The IRS failed to file an injunction against Mr. Hoyt as a 
promoter of an abusive tax shelter. See IRC Sec. 7408.
     The IRS failed to disbar Mr. Hoyt from practice before the 
IRS as an ``Enrolled Agent.'' \2\
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    \2\ From the late 1970's until 1997, Mr. Hoyt used his continued 
Enrolled Agent status as proof that he was a legitimate tax advisor. 
The IRS finally removed Mr. Hoyt's Enrolled Agent status in 1997 and as 
TMP in 1999.
---------------------------------------------------------------------------
    An IRS officer, with substantial experience on this case, 
recognized that the investors were ``unwitting victims'' of Walter J. 
Hoyt's fraud. Appeals Officer William McDevitt filed a statement in 
1997 in which he described the taxpayers as ``unwitting victims,'' 
``unsophisticated in tax matters,'' and ``confused by the'' Tax Court's 
1989 decision in Bales v. Commissioner.\3\ The Bales case held that the 
partnerships were bona fide businesses and seemed to confirm most of 
Hoyt's assertions and theories.\4\ Officer McDevitt concluded that 
``proposing penalties against these investors would only be likened to 
pouring salt into their open wounds . . . it would amount to adding 
mere numbers to already uncollectable amounts.''
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    \3\ Statement of Appeals Officer William McDevitt, Appeals 
Supporting Statement (Dec. 23, 1997).
    \4\ In Bales v. Commissioner, T.C. Memo 1989-568, the Tax Court 
found that a Hoyt cattle partnership was not an abusive tax shelter; 
however, the Court also held that certain deductions for expenses in 
excess of the partners' actual investments should be disallowed.
---------------------------------------------------------------------------
    Notwithstanding the Bales decision in October 1989, the IRS 
continued auditing the Hoyt partnerships, disallowing all claimed 
deductions and making adjustments consistent with the position that the 
partnerships constituted abusive tax shelters. In 1993, the IRS and Mr. 
Hoyt as TMP settled the 1981 through 1986 partnership tax years. The 
settlements meant that essentially all claimed deductions and losses 
allocated to the investors from the partnership returns would be 
disallowed, while substantial income that would have accrued to the 
Hoyt family was minimized.
    The individual partners first received notice of their 1981 through 
1986 personal tax liabilities from the settlement (via Form 4549 
computational adjustment notices) beginning in 1998. The 1987 through 
1996 tax years remain unresolved, with the selected dockets for the 
1987 through 1992 tax years having been tried and other dockets 
awaiting trial.
    On May 18, 2000, the Tax Court released its decision entitled 
Durham Farms. In Durham Farms, the Tax Court held that the investors in 
seven Hoyt partnerships are precluded from deducting any cattle-raising 
expenses for 1987 to 1992, because sufficient evidence was not produced 
to establish that the seven Hoyt partnerships owned any cattle. In 
light of this decision, a federal judge has asked the IRS and 
partnership attorneys to work out final settlement. However, several 
hundred cases still are pending in Tax Court.
    In February 2000, a jury in a U.S. District Court found Walter J. 
Hoyt III and two of his co-defendants guilty of mail fraud, money 
laundering and conspiracy. To date, Walter J. Hoyt has not been 
arrested for any tax-related criminal charges.
Recent Congressional Focus on the Hoyt Partnerships
    W. Val Oveson, testifying as the IRS National Taxpayer Advocate at 
a January 27, 2000, Oversight Subcommittee hearing on penalty and 
interest reform, described the Hoyt situation (and others similar to 
it) as follows:

          One of the problems taxpayers are bringing to the Taxpayer 
        Advocate Service with increasing frequency involves TEFRA 
        partnerships determined to be tax shelters. Taxpayers, as early 
        as the 1970's and up through the 1990's, invested in a number 
        of partnerships whose major, if not only, purpose was to 
        shelter income from tax liability.\5\ For a number of reasons, 
        audits of shelter cases can be quite extensive and Tax Court 
        proceedings fairly lengthy. Thus, for taxpayers who do not 
        settle these cases, but await the results of litigation, final 
        resolution can leave them with liabilities dating back 10 years 
        or more with penalty and interest accruals to match.
---------------------------------------------------------------------------
    \5\ Note: Although Mr. Oveson's statement generally describes the 
situation of the Hoyt investors, the Hoyt partnerships do not fit the 
definition of a tax shelter (i.e., an organization whose major or 
exclusive purpose is to shelter income).
---------------------------------------------------------------------------
          The enormity of these liabilities has caused taxpayers to 
        seek assistance from a number of sources, including their 
        Congressional representatives and various functional areas 
        within the Service, including my office, to abate all or part 
        of the accumulated liabilities or to suspend collection action. 
        Some taxpayers have filed for bankruptcy protection. More than 
        most, shelter cases can reflect the burden associated with the 
        past and current penalty and interest structures. Very few 
        taxpayers are prepared to pay or can pay penalty and interest 
        accumulations that may date back to the 1970's.

    Some say that these taxpayers should have known that the results of 
their investments were too good to be true. Nevertheless, I believe we 
should not focus on blame at this point. We need to work to get these 
taxpayers back into full compliance, possibly through installment 
agreements or the expanded offer-in-compromise criteria. I believe that 
tax shelters are an abuse of our system and the investors should be 
penalized. I also concede that the investors owe interest for the time 
they had the use of the government's money. I question, however, 
whether it is the function of the government and our penalty and 
interest regimes to punish these taxpayers to the point that they 
become insolvent and unable to pay even a fraction of these 
liabilities.
    Statement of W. Val Oveson, National Taxpayer Advocate, Internal 
Revenue Service, before the Subcommittee on Oversight, Committee on 
Ways and Means (January 27, 2000) (emphasis added).
    Subcommittee Chairman Houghton highlighted the Hoyt investors' 
situation in his Opening Statement at that same hearing to illustrate 
the heavy burden of compounded interest on tax liabilities that take 
years to resolve:

          I doubt that there is anyone on this panel who hasn't heard 
        more than one heartbreaking story from constituents who find 
        themselves facing crushing back taxes, penalties and interest 
        payments because they were unable to comply with a tax code 
        they have no hope of understanding. Albert Einstein once said 
        that compounded interest is the most powerful force in the 
        universe. Taxpayers whose interest payments far exceed their 
        underlying taxes can well appreciate the truth of his words.
          Just yesterday my staff met with representatives of a group 
        of investors who were defrauded by an enrolled agent. His 
        promotional materials targeted working people, promising them 
        ``quality investments for folks that dream about owning a piece 
        of the country.''
          * * * * *
          Today, nearly all of the investors face back taxes, penalties 
        and interest--going back in some cases to the 1970's--because 
        their deductions were disallowed. One of the investors, Ed Van 
        Scoten, says the IRS is trying to collect about half a million 
        dollars from him. ``Who are they trying to kid?,'' he asks. 
        ``They could never get $500,000 from me if I worked five 
        lifetimes.''
          In some cases individual investors first received notice from 
        the IRS of their 1981-1986 tax liability beginning in early 
        1998. The interest clock was running all this time.
          The unscrupulous will always prey on the unsuspecting, but 
        something is seriously wrong with a penalties and interest 
        regime that adds to the problems faced by the victims of this 
        sort of scam.

    Statement of Congressman Amo Houghton (R-NY), before the Oversight 
Subcommittee of the Committee on Ways and Means (January 27, 2000).
Congressional Mandate To Expand Offer in Compromise Criteria
    Section 7122 of the Internal Revenue Code authorizes the IRS to 
settle tax cases with taxpayers under appropriate circumstances for 
less than the full amount of tax, penalties and interest owed. In the 
IRS Restructuring and Reform Act (``RRA'') of 1998, Congress amended 
Section 7122 and directed the Secretary to prescribe guidelines to 
determine when an offer-in-compromise should be accepted. See Code 
Sec. 7122(c) as added by Section 3462 of the RRA. The legislative 
history of this amendment clearly indicates what members of the tax-
writing committees wanted the IRS to address:
     The Conference Report of the 1998 RRA directs that ``the 
IRS [in formulating these rules] take into account factors such as 
equity, hardship, and public policy where a compromise of an individual 
taxpayer's income tax liability would promote effective tax 
administration.'' H. Conf. Rep. No. 599, 105th Cong., 2d Sess. 289 
(1998) (emphasis added).
     The legislative history also specifies that the IRS should 
utilize this new authority ``to resolve longstanding cases by forgoing 
penalties and interest which have accumulated as a result of delay in 
determining the taxpayer's liability.'' Id.
    Consideration of factors such as equity and public policy 
represents a significant expansion of the traditional grounds for 
settling tax cases. Formerly, offers-in-compromise were limited to two 
situations: (1) doubt as to liability and (2) doubt as to 
collectibility.
IRS Proposed Regulations on Expanded Offer in Compromise Tests
    On July 21, 1999, the IRS issued proposed regulations which clearly 
do not incorporate the Congressional mandate of encouraging offers-in-
compromise in longstanding cases in which penalties and interest have 
accumulated as a result of delay. Instead, the regulations continue the 
traditional focus on economic factors while giving short shrift to 
equity and public policy considerations. Specifically, the regulations 
provide that if there are no grounds for compromise based on doubt as 
to collectability or liability, a compromise may be entered into to 
promote effective tax administration when:

          (i) collection of the liability will create economic 
        hardship; or
          (ii) regardless of a taxpayer's financial circumstances, 
        exceptional circumstances exist such that collection of the 
        full liability will be detrimental to voluntary compliance by 
        taxpayers; and
          (iii) compromise of the liability will not undermine 
        compliance by taxpayers with the tax laws.

Temp. Reg. Sec. 301.7122-1T(b)(4)(i) through (iii).
    The regulations provide specific factors for determining when the 
first and third prongs are satisfied, but no specific factors are 
provided for determining when the second prong--``exceptional 
circumstances''--may be satisfied. Unfortunately, the temporary and 
proposed regulations only offer two examples of cases of ``exceptional 
circumstances:''

          (i) the first involves a taxpayer who suffered a serious 
        illness and was unable to manage his financial affairs during 
        such time; and
          (ii) the second example involves a case where a taxpayer 
        relied on incorrect advice from the IRS in an informal E-mail 
        response concerning the rollover period for an IRA account.

Temp. Reg. Sec. 301.7122-1T(b)(4)(iv)(E) (examples 1 and 2).
    The regulations provide a third example that involves embezzlement 
of payroll withholding taxes. This example could be viewed as 
illustrating equitable considerations in the case of a victimized 
taxpayer. However, the example is classified as a financial hardship 
example because paying the accumulated taxes, penalties and interest 
would cause the taxpayer's business to fail. Temp. Reg. Sec. 301.7122-
1T(b)(4)(iv)(D) (example 4).
    In practice, the IRS continues to view ``exceptional 
circumstances'' with the same narrowly focused lens as it always has. 
In the IRS view, the overriding factor is the taxpayer's ability to pay 
(i.e., financial hardship). This exclusive focus on financial factors 
to the exclusion of equitable considerations is evidenced in a recent 
letter from the IRS Chief Counsel's Office to Representative John M. 
McHugh (R-NY) in response to his inquiry about how the IRS planned to 
deal with Hoyt investor partners who are facing large interest 
accumulations:

          Taxpayers may at any time enter into an offer in compromise 
        with regard to their tax liability. We understand that, in many 
        cases, taxpayers will be unable to pay their liability in full, 
        and an offer in compromise based on doubt as to collectibility 
        will be considered under the established procedures for such a 
        request. There are no special rules for Hoyt Partnership 
        investors . . . .

    Letter of Deborah A. Butler, Assistant Chief Counsel (Field 
Service), Internal Revenue Service to The Honorable John M. McHugh 
(June 4, 1999). Thus, although Congress specified in the 1998 RRA that 
the IRS should consider equity and public policy and to resolve 
``longstanding cases'' by foregoing penalties and interest, the IRS has 
shown no inclination whatsoever to provide for significant interest 
abatement based on equitable considerations or exceptional 
circumstances.\6\
---------------------------------------------------------------------------
    \6\ At the Ways and Means Oversight Subcommittee hearing on January 
27, 2000, Treasury Tax Legislative Counsel Joseph Mikout testified: ``. 
. . Treasury's position remains that it is appropriate that situations 
involving abatement of interest be narrowly drawn.''
---------------------------------------------------------------------------
Conclusion
    Where innocent taxpayers are victimized by a tax shelter promoter 
and the process of adjudicating the tax liabilities takes as long as 20 
years, equitable factors are strongly present. The broader issue raised 
by the fraud perpetrated on the Hoyt partnership investors is how such 
equitable considerations should be taken into account in determining 
whether a portion of a taxpayer's total liability (e.g., the interest) 
should be compromised or abated.
    In 1998, Congress determined that interest abatement should be part 
of the new offer-in-compromise procedures in certain situations. As 
noted above, Congress directed the IRS to take into account factors 
like ``equity'' and ``public policy.'' However, two years later, the 
IRS has yet to develop reasonable guidelines to facilitate offers in 
compromise that give proper attention to these factors.
    If the IRS continues to exhibit resistance to Congressional intent, 
Congress may want to revisit the issue in a legislative context. The 
Joint Committee on Taxation staff has recommended that abatement of 
interest be utilized if a ``gross injustice'' would otherwise result if 
interest were to be charged. It is anticipated that such authority 
would be used infrequently. Although I believe that the IRS already has 
the authority to address situations of gross injustice under the 
expanded offer-in-compromise authority of RRA 1998, enactment of a new 
statutory remedy may be necessary.
    Attached hereto is a proposed statutory amendment that would 
clarify Congressional intent with regard to the offer-in-compromise 
criteria that should apply to long-standing cases involving equity.

       PROPOSED STATUTORY AMENDMENT FOR IRS OFFERS-IN-COMPROMISE

Present law
    Section 7122 of the Internal Revenue Code gives the IRS the 
authority to settle cases for less than the full amount of tax, 
penalties and interest owed. In the IRS Restructuring and Reform Act of 
1998 (RRA '98), Congress directed the Secretary to develop guidelines 
for offers-in-compromise incorporating criteria other than the 
traditional grounds for such settlements--doubt as to liability and 
collectibility. The RRA '98 Conference Report specified that the 
factors to be taken into account when considering an offer-in-
compromise include equity, hardship and public policy. The legislative 
history also specified that the IRS should utilize this new authority 
to resolve longstanding cases in which penalties and interest have 
accumulated as a result of delay.
Reason for statutory amendment
    The IRS has expressed uncertainty about the standards that should 
apply with regard to abatement of interest on equitable grounds in the 
offer-in-compromise context. IRS proposed regulations issued in 1999 
failed to provide workable guidelines for IRS field personnel. 
Consequently, Congressional intent is not being effectuated. In 
particular, such intent is not being effectuated in situations where 
penalties and interest have accumulated as a result of delay and 
equitable grounds are present. H.R. 4163, the Taxpayer Bill of Rights 
2000, contains a provision which provides for the abatement of interest 
on equitable grounds if a gross injustice would otherwise result (i.e., 
if interest were to be charged); however, this provision would be 
effective only for interest accruing on or after the date of enactment.
Proposed statutory amendment
    Section 7122 of the Internal Revenue Code should be amended to 
provide the IRS with authority to abate penalties and interest 
accumulated as a result of delay where equitable grounds or exceptional 
circumstances are present. The amendment should also clearly state that 
the IRS may exercise such authority to abate penalties and interest 
notwithstanding the provisions of section 6404.
Effective date
    This amendment applies to proposed offers-in-compromise submitted 
after the date of enactment.

         PROPOSED STATUTORY AMENDMENT FOR OFFERS-IN-COMPROMISE

    Evaluation of Offers--Section 7122 of the Internal Revenue Code of 
1986 (relating to compromises of civil or criminal cases arising under 
the internal revenue laws prior to reference to the Department of 
Justice) is amended by adding at the end of subsection (c) the 
following new subparagraph:

          `(3) Interest and Penalties--Notwithstanding the provisions 
        of section 6404, the Secretary may use his authority under this 
        section to resolve longstanding cases by foregoing penalties 
        and interest, in part or whole, which have accumulated as a 
        result of delay in determining the taxpayer's liability and 
        taking into account equity or other exceptional 
        circumstances.'.

                                


  Statement of Wendy S. Pearson, Esq., Pearson, Merriam & Kovach, P.S.
    I am a tax lawyer and partner in a small law firm in Seattle, 
Washington that specializes in federal tax controversies. Each of the 
attorneys in our firm are former IRS counsel or Department of Justice 
Tax Division counsel. The combined experience of the law partners in 
handling federal tax matters extends more than 50 years.
    Our firm presently represents over 250 individuals who were 
partners and investors in cattle and sheep breeding partnerships 
promoted by Walter J. Hoyt III. Mr. Hoyt was recently convicted for 
fraudulently inducing the investors to purchase interests in the 
partnerships and misrepresenting the number and quality of livestock 
operated by these partnerships. These selfsame partnerships have been 
audited by the Internal Revenue Service for more than 20 separate tax 
years (called the ``Hoyt Project''), with many of the tax years 
remaining unresolved as long as 15 years after the IRS began the audit.
    For purposes of the review of penalty and interest provisions of 
the Internal Revenue Code, we would like to present to the Oversight 
Subcommittee some information and insights about the inequitable impact 
of penalty and interest provision on taxpayers who become unwitting 
victims of a tax shelter promoter. Our colleague, Ms. Kathleen Nilles 
of the law firm Gardner, Carton & Douglas, has suggested to this 
subcommittee that prior Congressional action in the IRS Restructuring 
and Reform Act of 1998 (RRA 98) was intended to ameliorate the impact 
of interest and penalties on individual taxpayers like the Hoyt 
investors, but that the IRS has failed to effectuate such Congressional 
intent. We echo those comments and urge Congress to clarify its intent 
or to consider stronger legislative measures.
    We will not reiterate here the factual background of the Hoyt 
Shelter Project as explained by Ms. Nilles in her comments dated April 
2, 2001. We offer the following additional information to assist the 
subcommittee in its evaluation of the IRS effectuation of legislative 
intent and the adequacy of current tax law to address tax 
administration issues that arise in cases like this.
The Impact of Hoyt's Fraud on Taxpayers
    The following scenarios depict some of the typical investors whom 
we represent. We have submitted offers in compromise (under 26 U.S.C. 
Sec. 7122) for these investors, wherein we have requested interest 
abatement due to the ``longstanding'' nature of the cases and equitable 
consideration of their retirement or medical needs in determining the 
minimum acceptable offer. The IRS has indicated that RRA 98 does not 
serve as a basis for abating interest and that interest will not be 
abated for Hoyt investors under the offer in compromise program, namely 
because the IRS does not believe that it contributed to a delay in the 
resolution of the cases and it does not want to abate interest in tax 
shelter cases. Similarly, the IRS has indicated that the minimum offer 
will be based on the net realizable value of assets and income, without 
consideration of equity and retirement needs. Further, the IRS has 
indicated that pending offers of Hoyt investors will not be processed, 
because each investor is a general partner in a Hoyt partnership with 
pending litigation (i.e., no one can get out until the partnership 
litigation is over).
    The impact of the IRS position and policy on these investor cases 
can be illustrated as follows. You will see that these taxpayers not 
only lose their entire investment to Hoyt's fraud, but they lose their 
entire life savings to pay the tax, penalties and interest attributable 
to Hoyt's fraud.interest attributable to Hoyt's fraud.


------------------------------------------------------------------------

------------------------------------------------------------------------
(1) RETIREMENT/MEDICAL EXAMPLE

Retired Couple: Husband is 67, Wife is 65; Initial Tax Year of
 Investment--1983

------------------------------------------------------------------------
INVESTMENT
  Amounts paid to Hoyt including Tax                          $ 97,228
 Refunds Received
  Tax Refunds Received                                        ($ 67,698)
                                                            ------------
    Net out of pocket loss                                    $ 29,530

TAX LIABILITY
  Tax Only                                                    $ 83,445
  Interest (Including Tax Motivated                           $243,743
 Interest)
  Penalties (87-96)                                           $ 31,639
                                                            ------------
    TOTAL                                                     $358,827

ASSETS/INCOME
  Savings                                                     $ 11,500
  Life Insurance (cash value)                                 $ 17,528
  Burial plots (cash value)                                   $  5,900
  Vehicle Equity                                              $  1,000
  Home Equity (Manufactured home)                             $112,850
  Total Assets                                                $148,798
  Monthly Income (Social Security and                         $  3,150
 Small Pension)
                                                            ============
TRADITIONAL IRS MINIMUM OFFER          PAY                    $153,598
------------------------------------------------------------------------
Total value of all assets PLUS discretionary income () 48
 months.
Assumption for this couple: $100 discretionary income per IRS standards.
------------------------------------------------------------------------

Comments:
    Taxpayers have to liquidate all assets and obtain a loan for equity 
in the home, even though there is no additional income to pay for the 
home loan. Does not allow for any ``extraordinary expenses'' such as 
home repair, home modifications due to illness, additional medical 
costs for serious illness, or the purchase of a new car when vehicles 
need replacement. The wife is very ill with no chances of recovery. A 
T. Rowe Price Retirement Analyzer shows that this couple will run out 
of money in 2012, because they have to obtain a home equity loan to 
cover medical and other living expenses if the IRS takes all of their 
cash assets in the offer. The loan would be necessary to account for 
inflation and for any extraordinary expenses such as increased medical 
costs and home maintenance.
    Accordingly, equity allowances for special medical needs and 
retirement needs are important to these taxpayers.


------------------------------------------------------------------------

------------------------------------------------------------------------
(2) INTEREST ABATEMENT EXAMPLE

Widow, 68; Initial Tax Year of Investment--1984

------------------------------------------------------------------------
INVESTMENT
  Amounts paid to Hoyt including Tax                          $ 57,507
 Refunds Received
  Tax Refunds Received                                        ($ 24,310)
                                                            ------------
    Net out of pocket loss                                    $ 33,197

TAX LIABILITY
  Tax Only                                                    $ 63,724
  Interest (Including Tax Motivated                           $143,216
 Interest)
  Penalties (87-96)                                           $ 24,562
                                                            ------------
    TOTAL                                                     $231,502

ASSETS/INCOME
  Retirement Accounts                                         $ 36,000
  Annuities                                                   $ 70,000
  Vehicle Equity                                              $  6,000
  Home Equity                                                 $140,000
  Total Assets                                                $252,000
  Monthly Income (Social Security and                         $  3,100
 Small Pension)
                                                            ============
TRADITIONAL IRS MINIMUM OFFER          PAY                    $231,502
------------------------------------------------------------------------
Total value of all assets PLUS discretionary income () 48
 months.
Assumption for this taxpayer: $100 discretionary income per IRS
 standards.
------------------------------------------------------------------------

Comments:
    Taxpayer will be considered capable of paying the tax liability in 
full. To do this, she must liquidate all assets and obtain a loan for 
equity in the home, even though she has insufficient additional income 
to pay for the home loan. It also does not allow for any 
``extraordinary expenses'' such as home repair, home modifications due 
to illness, additional medical costs for serious illness, or the 
purchase of a new car when vehicle needs replacement. The offer does 
not allow for the retention of assets to subsidize retirement needs 
during her life expectancy.
    Accordingly, interest abatement and consideration of retirement 
needs under equitable provisions is important to this taxpayer.


------------------------------------------------------------------------

------------------------------------------------------------------------
(3) INTEREST ABATEMENT EXAMPLE

Retired Couple: Husband is 72, Wife is 67; Initial Tax Year of
 Investment--1984

------------------------------------------------------------------------
INVESTMENT
  Amounts paid to Hoyt including Tax                          $ 96,184
 Refunds Received
  Tax Refunds Received                                        ($ 69,969)
                                                            ------------
    Net out of pocket loss                                    $ 29,530

TAX LIABILITY
  Tax Only                                                    $160,255
  Interest                                                    $392,361
  (Including Tax Motivated Interest)                          $ 77,453
  Penalties
                                                            ------------
    TOTAL                                                     $630,069

ASSETS/INCOME
  Retirement Accounts                                         $203,319
  Stocks & Money Market                                       $ 12,245
  Cash                                                        $ 20,459
  Vehicles (2) Equity                                         $ 20,000
  Home Equity                                                 $250,500
  Total Assets                                                $506,523
  Monthly Income (Pension & Social                            $  2,830
 Security)
                                                            ============
TRADITIONAL IRS MINIMUM OFFER          PAY                    $520,923
------------------------------------------------------------------------
Total value of all assets PLUS discretionary income () 48
 months.
Assumption for this couple: $300 discretionary income per IRS standards.
------------------------------------------------------------------------

Comments:
    The taxpayers must sell everything and obtain a loan for equity in 
the home. Note, the additional amount due over the value of assets is 
from the present value ($14,400) of discretionary income of $300.00/
month. They have no means of acquiring this additional $14,400.00 to 
satisfy the minimum offer. The minimum offer also does not allow for 
any ``extraordinary expenses'' such as home repair, home modifications 
due to illness, additional medical costs for severe illness, or the 
purchase of a new car when vehicles need replacement.
    Accordingly, interest abatement is important to these taxpayers.


------------------------------------------------------------------------

------------------------------------------------------------------------
(4) RETIREMENT EXAMPLE

Widow, 78; Initial Tax Year of Investment--1984

------------------------------------------------------------------------
INVESTMENT
  Amounts paid to Hoyt including Tax                          $ 67,153
 Refunds Received
  Tax Refunds Received                                        ($ 41,833)
                                                            ------------
    Net out of pocket loss                                    $ 25,320

TAX LIABILITY
  Tax Only                                                    $ 88,908
  Interest (Including Tax Motivated                           $206,724
 Interest)
  Penalties                                                   $ 34,319
                                                            ------------
    TOTAL                                                     $329,951

ASSETS/INCOME
  Retirement Accounts                                         $ 13,000
  Mutual Funds                                                $  2,000
  Vehicle Equity                                              $  3,000
  Home Equity                                                 $ 12,000
  Total Assets                                                $ 30,000
  Monthly Income (Social Security)                            $  2,406
                                                            ============
TRADITIONAL IRS MINIMUM OFFER          PAY                    $ 30,000
------------------------------------------------------------------------
Total value of all assets.
Assumption based on IRS standards: No discretionary income.
------------------------------------------------------------------------

Comments:
    Taxpayer must liquidate all assets and obtain a loan for equity in 
the home, even though she does not have sufficient income to pay for 
the home loan. It does not allow for any ``extraordinary expenses'' 
such as home repair, home modifications due to illness, additional 
medical costs for severe illness, or the purchase of a new car when 
vehicle needs replacement. It does not allow taxpayer to retain any 
assets to support her living needs during her life expectancy.
    Accordingly, consideration of retirement needs under equity 
provisions is important to this taxpayer.
The IRS Handling of the Hoyt Tax Cases Does Not Promote Effective Tax 
        Administration
    Notwithstanding the many shortcomings in the IRS handling of the 
Hoyt Project cases, the current IRS position on the resolution and 
closure of these cases impairs effective tax administration. For the 
majority of Hoyt investors whom we represent, they are unable to pay 
even a fraction of the principal tax liability, let alone the interest 
and penalties thereon. Even if one were to accept the IRS' unwavering 
conviction that these taxpayers deserve to be punished for investing 
inan abusive tax shelter, what end is served by rendering them 
penniless? Similarly, accepting the premise that the interest charged 
on their tax deficiencies is to exact a cost for the use of money \7\ 
in order to encourage proper tax reporting (or deter improper 
reporting), how does the imposition of that charge serve such purposes 
when the government has acknowledged that the taxpayers had no idea 
that they were making improper tax claims because they were being 
defrauded? \8\
---------------------------------------------------------------------------
    \7\ Note, the investors were required to pay Hoyt at least 75% of 
their tax benefits. And in most instances, the investors paid Hoyt all 
of their tax benefits plus additional amounts out of pocket. Thus, Hoyt 
had the use of the government's money for the entire period of time the 
IRS chose not to shut him down.
    \8\ In the recent prosecution of Hoyt, the government made its case 
based on the fact that the investors were unwitting victims. Similarly, 
the IRS Appeals Officer in the Hoyt audits concluded the investors were 
unwitting victims.
---------------------------------------------------------------------------
    More to the point, the interest charges on these cases stem from 
the longstanding nature of the audit and case administration. Clearly, 
no one can disagree that a tax shelter audit project begun in the late 
1970's and ongoing to date is a longstanding case. And, Congress 
recognized in RRA 98 that effective tax administration may be served by 
abating interest in longstanding cases, regardless of fault or reasons 
for the delay in resolution of the cases. I submit that RRA 98 was 
intended to remedy and ameliorate the effect of cumulative interest and 
penalties on precisely taxpayer cases such as this one. And, the IRS 
handling of offers in compromise in these cases illustrates the fact 
that there will be no instance in which the IRS considers the abatement 
of interest to be justified (except as set forth in the interest 
abatement provisions under 26 U.S.C. Sec. 6404(e)). The IRS position is 
inconsistent with RRA 98 and does not promote effective tax 
administration.
    We urge the Subcommittee to adopt the Offer in Compromise reform 
proposals submitted by and through our colleague, Kathleen Nilles, as 
part of the new taxpayer Bill of Rights being considered by the 
Subcommittee for this year.
    Thank you for your consideration of these comments.

                                   -