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Strategic Subgroup for Legislative Proposals (2007 IRPAC Report)

Issues Covered in this Section:

A.  Basis Reporting on Security Sales

B.  Merchant Payment Card Reimbursement Reporting

C.  Requiring Tax Identification Numbers (TIN) From Contractors

D.  Require Information Reporting on Payments to Corporations

I. INTRODUCTION

It has never been more apparent that Information Reporting is a powerful tool that improves compliance and can help reduce the Tax Gap.  The Administration's Fiscal Year 2008 Revenue Proposals, released in February 2007, contain seven significant information reporting proposals designed to raise revenue by improving voluntary compliance.  These proposals, if enacted, will significantly increase information reporting responsibilities for a wide variety of taxpayers, as well as for the Service.  The expanded Information Reporting proposals are:

1. Require basis reporting on security sales
2. Require information reporting on merchant payment card reimbursements
3. Require a certified Taxpayer Identification Number from contractors
4. Require information reporting on payments to corporations
5. Expand broker information reporting
6. Require increased information reporting for certain government payments for property and services; and
7. Increase information return penalties.

The level of complexity associated with each proposal varies.  Some proposals such as increased information return penalties are relatively straightforward and easy to implement.  On the other hand, some of the proposals such as Basis Reporting on Security Sales involve creating entirely new information reporting regimes which will involve extensive guidance from Treasury and the IRS, and a close partnership between government and industry to assure an effective implementation and a smooth transition.

In response to the anticipated need for guidance and cooperation, IRPAC formed a Strategic Subgroup (the Strategic Subgroup for Legislative Proposals) to study these proposals.  The Subgroup is comprised of members from each of the four IRPAC subcommittees (LMSB, SBSE, W & I, and TEGE), thus assuring representation from a broad spectrum of stakeholders.
 
In April 2007, IRPAC met with Michael Desmond (Tax Legislative Counsel, Office of Tax Policy, U.S. Treasury Department).  Mr. Desmond was kind enough to share his perspective on what the Information Reporting proposals contained and how vital these initiatives are to the Administration’s goal of increasing voluntary compliance to narrow the Tax Gap.  In turn, IRPAC had an opportunity to present its concerns regarding the importance of developing a comprehensive strategy for implementing these initiatives.  IRPAC looks forward to more of these discussions and hopes to have ongoing working sessions with the appropriate staff at Treasury and the IRS as detailed guidance is developed.

IRPAC began addressing the proposals in 2007, as described herein.

II. ISSUES AND RECOMMENDATIONS

A. Basis Reporting on Securities Sales

Background

Brokers and other financial institutions are currently required to report proceeds from sales of securities on Form 1099-B.  The Administration’s Fiscal Year 2008 Revenue Proposals include a provision to expand information reporting requirements when securities are sold.  Under the proposal, brokers and other financial institutions would be required to report the adjusted basis of securities sold, as well as holding period and gain or loss on the sale (collectively referred to as basis reporting). 

Basis reporting represents a significant departure from current industry practices for securities firms and other institutions that currently report sales of securities on Form 1099-B.  These firms will have to make considerable modifications to their computer systems and business practices in order to furnish accurate and timely basis reporting information.  The IRS will have to alter or issue new 1099s to accommodate basis reporting information and its computerized matching systems will require modifications in order to utilize basis reporting information in a manner consistent with sound tax administration.

Recommendation

IRPAC recommends that Treasury and the IRS develop a comprehensive strategy for implementing basis reporting in concert with various stakeholders, including the securities and mutual fund industries, as well as return preparers.  This strategy should include the following components:

  • Due to the lead time needed to modify systems and business practices, basis reporting should be required only after a reasonable amount of time has lapsed after Treasury and the IRS issue guidance by way of Treasury regulations, IRS forms, or other authoritative pronouncements.
  • Leaders from Treasury and the IRS should continue substantive meetings with the Senate Finance Committee and industry representatives to coordinate legislation, regulatory guidance and the development of IRS forms to accommodate basis reporting.
  • Treasury should allow a reasonable transition period during which penalties would not be imposed on brokers and other financial institutions that make good faith efforts to transform their business practices and systems to comply with new basis reporting requirements.
  • Treasury and the IRS should consider the comments made by various trade organizations, such as the Securities Industry and Financial Markets Association (SIFMA), the Investment Company Institute (ICI), the American Bankers Association (ABA) and other key industry organizations.  These trade organizations are well-positioned to provide sound technical and practical advice since their members (securities brokers, mutual fund companies, et. al.) will be responsible for generating and reporting the majority of basis information returns under the proposed regime.

Discussion

The basis reporting proposal presents a variety of significant challenges to the IRS, to the firms that will generate basis information returns and to taxpayers and their preparers who must use the new basis information when preparing tax returns.  Although many brokerage firms, mutual fund companies and other financial institutions provide basis information for securities sold, the information is currently provided as a courtesy for informational purposes only, and on a best-efforts basis.  Computing and reporting the adjusted basis of securities sold according to all concepts and possible adjustments under the Internal Revenue Code (the “Code”) is precedent setting and a significant departure from current practice.

During 2007, IRPAC interviewed several representatives responsible for basis reporting at large and small financial institutions and reviewed comments made by SIFMA, ICI, ABA, the American Institute of Certified Public Accountants, the American Bar Association, and the U.S. Government Accountability Office.  Based on the information provided by these organizations and financial institutions, the major impediments to accurate and timely basis information reporting fall into the following five categories:

  • Basis Calculation Methods – Taxpayers are permitted to use various methods to compute their basis (e.g., average cost, specific identification and first-in first-out (FIFO)). If taxpayers are allowed to dictate the basis computation method a reporting institution is to apply, financial institutions will have to build or modify their existing systems to capture and store the basis calculation method chosen by each taxpayer.  In addition, the average cost method for mutual fund shares presents an especially challenging issue.  Unlike the FIFO or specific identification method, average cost is calculated using the basis of all shares in an account (even shares acquired prior to the effective date of the proposed legislation).  Since financial institutions have never been required to maintain basis information for shares acquired prior to the effective date of the proposed legislation, they may not possess information sufficient to compute basis under the average cost method.  Special consideration must be given to account for the retroactive aspect of computations under the average cost method.
  • Transfers of Securities – Securities are often transferred from one financial institution to another.  Transfers between financial institutions occur for a variety of reasons, such as when a taxpayer decides to move his or her account to a new firm, or when firms merge or change service providers.  Securities can also be transferred between taxpayers and financial institutions.  When transfers of this nature occur, the organization responsible for reporting the sale may not possess sufficient transactional data.  Although the legislative proposals do account for the need to transfer adjusted basis information when securities are transferred among financial institutions and taxpayers, the development effort to accommodate the transfer of information in an automated and efficient manner will be significant.  Financial institutions will not only have to modify their own record-keeping systems, but the industry utilities that serve these organizations must also modify their systems.  In addition, these modifications must be coordinated among industry participants so that each firm can transfer and receive information in a similar manner.  It is critical that the development and modification of these transfer systems be pursued in a coordinated manner and in concert with a well-developed legislative and regulatory basis information reporting strategy.
  • Scope of Securities Subject to Basis Reporting – The type of securities subject to basis reporting will determine the size of the development effort needed to comply with a new basis reporting requirement.  Brokers and other financial institutions are currently required to report the sale of a security on Form 1099-B to the extent the security sale is subject to Code Section 6045 or the corresponding Treasury regulations.  If basis reporting is required for securities not currently subject to Section 6045 reporting, industry participants will need more time to modify their information reporting systems and business practices to comply.  In addition, computing adjusted basis information for certain securities that are defined in Section 6045 may not be practical.   For example, although proceeds from sales of partnership interests are reportable on a Form 1099-B, it is not practical for financial institutions to compute and report the adjusted basis of partnership interests.  Basis in a partnership interest is adjusted to reflect the partner’s pro rata share of income, expense and distributions.  Financial institutions only record the purchase of a partnership interest and distributions. Adjusted basis information is already provided by the partnerships directly to IRS and each partner on Form K-1, which is due by March 15 and is often furnished long after the January 31 deadline for 1099 reporting. 
  • Information Not Available or Received Late – Certain information that affects adjusted basis of securities sold is often not available until after 1099s are issued.  Basis adjustments due to wash sales, certain “load charges” under Section 852(f), and post year-end reclassifications of corporate distributions are examples of information that is often not available at the point in time when 1099s are created.  In addition, determination of adjusted basis often depends on events and conditions that are extrinsic to a taxpayer’s account at the reporting financial institution.  For example, a taxpayer’s choice of accounting method to amortize bond premium may not be known to the reporting financial institution.  In some cases, activities by the taxpayer that occur away from the financial institution could impact adjusted basis, such as the purchase of a substantially identical security at another institution within 30 days of a sale at the reporting institution.  In this case, the wash sale rules are triggered and the loss on the sale must be capitalized into the basis of the securities acquired (Code Section 1091).  In these instances, the reporting financial institutions are unable to observe the information needed to compute basis.  Special consideration needs to be given to information that is not available, arrives late, or that is unobservable.
  • Matching Information Returns (1099s) to Taxpayer Reported Gains and Losses (1040 Schedule D) – Basis reporting will enable the IRS to expand its computerized matching system to identify situations where individuals are underreporting their capital gains and losses.  In light of the substantial impediments to reporting adjusted basis pursuant to all principles and provisions under the Code, there is a reasonable likelihood that excessive mismatches will occur.   To the extent that a mismatch is legitimate, an IRS inquiry into the matter could create an unnecessary burden on the taxpayers and the IRS officials responsible for administering the matching program.  Consideration needs to be given to the application of the matching program and design of tax forms (particularly Form 1040 Schedule D) to avoid unnecessary communications between IRS and taxpayers due to invalid mismatches.

These impediments are significant.  Considering the breadth of issues that confront stakeholders, it is not surprising that the effective date of the new basis reporting regime is of paramount concern.  When should basis reporting become mandatory?  Can basis reporting requirements be phased in over time?  Should basis reporting only apply to securities acquired after a certain date?  What should that date be?  Congress and Treasury should respond to these questions and define the effective date of the basis reporting regime in light of the significant lead time that industry participants will need to modify their systems and business practices.

On May 25, 2007 the Senate Finance Committee released a Discussion Draft concerning basis reporting.  IRPAC provided comments on the Discussion Draft on July 11, 2007 (see attached Letter from IRPAC).

Benefit to Payers

Payers will have sufficient lead time to modify their computer systems and business practices to comply with the requirement to report adjusted basis of securities sold.

Benefit to IRS
The IRS will receive accurate and useful basis information from brokers and other financial institutions.

Benefit to Taxpayers
Taxpayers will receive accurate basis information from brokers and other financial institutions, which should ease their compliance burden and encourage voluntary compliance.

IRS Action(s)
Treasury is considering IRPAC’s suggestions.

B. Merchant Payment Card Reimbursement Reporting

Background

The Fiscal Year 2008 Budget includes a proposal to require the Secretary of the Treasury to promulgate regulations to expand information reporting requirements by mandating payment card processors to report gross annual reimbursements to merchants.

Recommendation

IRS should address industry concerns about how such a reporting requirement would be met, whether the benefits of this requirement outweigh the costs, and whether the IRS has the capability to use the information in the manner it has identified.

Discussion

The Administration proposal would require “payment card processors to report gross annual reimbursements to merchants.”  There is a potential for overlap with existing information reporting requirements depending on how the proposal defines “merchant.”  Duplicate reporting of a single transaction would produce inefficiencies and data reporting discrepancies, while the value of the information to the IRS would be diminished.  Backup withholding on merchant transactions would be particularly problematic, and it should not apply.  Backup withholding claims would disrupt the complex relationships in a multi-party payments system, particularly when the parties to a transaction have rights that can be asserted after the transaction is complete.  Merchants do not use tax reporting information (such as TINs and tax addresses) to process payments, and the information that typically flows through the payment system is limited and has a short retention period.  Finally, gift cards and cash-back transactions would present unique reporting difficulties.

The IRS has publicly stated that the information requested in the IRS proposals will not be used for information matching purposes.  The IRS intends to use this merchant information to better target the agency’s audit resources by using the data to determine whether merchants have understated cash receipts.  This would require extensive research by the IRS on the patterns of credit card use by type of transaction, size, and location of merchant.  Because of cash-back transactions, charge-backs, merchant discounts, fees, and accounting rules, gross merchant reimbursements will not necessarily provide accurate information about a merchant’s tax situation.
 
Benefit to Payers

By addressing these industry concerns, the payment card industry would hope to have sufficient time to adapt its systems to comply with a requirement to report reimbursements to merchants without having to redesign entire transaction processing systems at a significant cost.

Benefit to IRS

Before requiring the industry to incur significant costs, it would be helpful to the IRS to determine whether the costs outweigh the benefits and whether the IRS has the capability to use this information for the purposes it has identified.

Benefit to Taxpayers

If the payment card industry is forced to redesign transaction processing systems at a significant cost, it is likely that the cost would be passed on to merchants and eventually to consumers.  Addressing industry concerns may help to lessen this burden.

C. Requiring Tax Identification Numbers (TIN) From Contractors

Background

Under current law, trades or businesses must report on IRS Form 1099-MISC any payment of $600 or more made to a non-corporate, non-employee service provider. The tax identification number (TIN) of the service recipient is currently not required to be verified. In addition, income tax withholding is not permitted on such payments which may necessitate the filing of estimated tax payments by such contractors and/or the contractor’s inability to make final tax payment installments by tax filing date. In the interest of reducing the estimated tax filing burden and improving tax collection, the Administration and Treasury have proposed the following:

  • Requiring a contractor receiving payments from a business of $600 or more to provide a Form W-9 certifying the recipient contractor’s TIN.
  • Requiring the payer business to verify the TIN with the IRS, presumably through the IRS TIN matching program.
  • Requiring the payer business to withhold a flat rate percentage of the gross payments as income tax withholding if the contractor fails to provide a valid TIN.
  • Providing an option to contractors receiving $600 or more in payments from a business to require the payer business to withhold a flat percentage rate of their gross payments with the percentage rate being 15%, 25%, 30% or 35%, whichever is selected by the contractor.

It is estimated that the TIN/Withholding proposal would, between 2008 and 2017, generate an $749 million in additional tax revenue. The proposal would be effective for payments made to contractors on or after January 1, 2008. 

IRPAC reviewed the TIN / Withholding proposal, and offers the following recommendations. 

Recommendation

The following recommendations are premised on the Budget proposal as presented including the identified effective date. It is anticipated that additional review and study will be undertaken by IRPAC in 2008. IRPAC recommends:

  • That the proposed effective date of January 1, 2008 be postponed to a date that follows by at least 18 months the date of issuance by Treasury of detailed regulations and guidance. Sufficient lead-time is necessary to allow affected businesses to develop reliable TIN verification procedures and withholding and reporting systems.
  • That the proposed effective date of January 1, 2008 be additionally postponed to a date that follows by at least 6-9 months the issuance by the IRS of the reporting requirements relative to the reporting specifications to be applied, the form to be used, etc. (If the reporting issue and protocol will be incorporated into the regulations referenced above the 18 months is sufficient for both.).
  • That the IRS take into account and address in its regulations the issues raised in the discussion below. 
  • That the dollar threshold for applying the TIN/Withholding requirement be raised to perhaps $2,000 or $5,000 in the interest of minimizing the potentially large burden this new requirement would place on payer businesses. 
  • That further study of the potentially large burden this will place on payer businesses be taken into account before a TIN/ Withholding requirement is imposed to improve tax compliance. 
  • That any reporting or withholding penalties not be applied until after the issuance of final regulations with respect to this proposal. 

Discussion

In reviewing the TIN/ Withholding proposal, the IRPAC had several concerns and concluded that several considerations and circumstances need to be taken into account either prior to or during the development of any guidance or regulations relative to the TIN/ Withholding issue. These include but are not limited to the following:

  • The format for reporting, e.g. whether IRS Form 1009-MISC will be utilized to report payment and withholding or some other form;
  • The timeframe for reporting, e.g. January 31st or February 28th of the following year, the payer businesses’ tax filing date, the payer businesses’ tax filing date plus extensions? How will differences in payer and contractor fiscal years be accommodated?
  • How payer business reporting and contractor recipient reporting is to be reconciled when variances occur: what steps need to be taken and by which party? What will be the reporting correction protocol? 
  • Will electronic reporting to contractors be permitted and if so, under what conditions; the same “consent” provisions as are applied to other electronic reporting?
  • What or how will reporting and withholding take place if the TIN provided is invalid? What number should be used and for what purpose or value is withholding if only a faulty TIN is available? Will some code designating the number as invalid be provided? 
  • How to handle service emergencies where validation of a TIN is not possible and postponing the service delivery by the prospective contractor is not feasible or in the interest of the business or its customers? 
  • What withholding rate percentage will apply when a valid TIN is not provided?  Would the rate be the same as one of the optional rates for voluntary withholding or will some other rate apply?
  • To what extent, if any, will the backup withholding rules as described in Code section 3406 apply?
  • To what extent, if any, will the standard penalties for failure to provide a valid TIN apply?
  • To what extent, if any, will the withholding and reporting provisions be applied to foreign based service providers with no domestic business location?  Would the provisions of Code section 1441 apply?  Would Form 1042-S reporting apply?
  • Currently a vast number of businesses may only have payroll based withholding systems in place and the withholding protocol called for in the proposal would have to be layered on top or interwoven into systems and procedures already in place. In addition, many businesses may have no familiarity or involvement with the IRS TIN matching program. This needs to be considered in applying the effective date.
  • Contractual engagement of vendors often is not centralized within a business but rather scattered across internal or external divisions. New procedures for obtaining TIN information and new internal controls would have to be developed and implemented by affected businesses. This could impede the contracting process and substantially add to the time necessary to execute a contract as departments and divisions would have to either separately develop TIN matching procedures and withholding capabilities or pass a proposed contract through a central department for clearance. Time will be needed to develop the necessary contracting policies and procedures.
  • Businesses would have to develop completely new withholding and reporting systems and allocate new resources to accommodate situations where a TIN is not validated or as also proposed, where a contractor voluntarily requests withholding. This will take time.
  • To what extent, if any, should a payer reverse voluntary tax withholding requested by a service provider who determines, later in their tax year that taxable income will be much below previous estimates (or that they expect to incur a taxable loss)?

Benefit to Payers

There is little benefit for the businesses that would be required to comply with the new TIN/ Withholding requirement as the requirement will impose additional tax, reporting and withholding burdens and requirements on such businesses that do not exist currently.

Benefit to IRS

The benefit to the IRS would largely center on the improvement in tax compliance and the generation of additional tax revenue. As cited in the General Explanations of the Administration’s Fiscal Year 2008 Revenue Proposals an increase of approximately $279 million dollars would be raised by 2017 if the TIN/ Withholding proposal became effective in 2008. Treasury also indicates that it is its belief that the burden of filing estimated taxes and paying self-employment income, if applicable, would be reduced by the availability of voluntary withholding by payer businesses and that by offering the withholding option contractors would be able to more easily and effectively assure that their tax liability can be satisfied.

Benefit to Taxpayers
The benefit to taxpayers is indirect: better tax compliance (and thus higher revenue collected) likely would benefit taxpayers since personal income tax and other tax increases could be avoided if this proposal goes into effect.  This proposal could also improve the sense of fairness and shared burden and tax obligation among all taxpayers and lead to a more compliant attitude.

D. Require Information Reporting on Payments to Corporations

Background

Currently, Form 1099-MISC is required to be filed for payments made to noncorporate service providers.  Congress is now recommending that these filing requirements be expanded to payments made to corporations for services provided.

Recommendation

IRPAC recommends that the Form 1099-MISC filing requirements not be expanded to corporate service providers.

Discussion

  • If the Form 1099-MISC filing requirements were expanded to apply to corporations, there would be significant additional burdens to taxpayers who are paying numerous corporations for services.  The additional costs and recordkeeping requirements would impose large time and monetary burdens on both payers and recipients.  There will also be many problems with taxpayers not distinguishing, or not being able to distinguish between payments for services and payments for products, which will mean a multitude of additional 1099’s issued unnecessarily.
  • Tax preparers for corporate recipients of these 1099s may encounter difficulty in reconciling the 1099 amounts with what the taxpayer has recorded as gross receipts.  If the 1099’s received are greater than the taxpayer recorded amounts, the preparer would have to find out which ones have not been recorded as they may not have been deposited.  If the 1099’s are less than the recorded amounts, the tax preparer would still have to verify that all reported 1099’s are part of the gross receipts.
  • Fiscal year corporate recipients receiving calendar year Form 1099’s would be especially challenged to reconcile to their fiscal year reported amounts.
  • The IRS also would have great difficulty in reconciling these 1099 amounts to what these corporate taxpayers are reporting as gross receipts.  Due to this difficulty, the information reported on these forms would provide little value to the Service, while imposing a large burden on taxpayers.

Benefit to Payers

The payers would not have the additional burdens as listed above.

Benefit to IRS

The Service would benefit by not having to match significant numbers of 1099s which would add little or no value.

Benefit to Taxpayers
Taxpayers and tax preparers would avoid significant expense and time burdens.

Page Last Reviewed or Updated: 23-Apr-2014