Issues Covered in this Section:
The Large & Mid-Size Business Subgroup (the LMSB Subgroup) consists of tax professionals from large banks, brokers, insurance companies and accounting firms. During 2007, the LMSB Subgroup met multiple times with members of the IRS LMSB Operating Division and Chief Counsel's office to discuss tax withholding and reporting matters of concern to large payers.
Many of the issues raised by the LMSB Subgroup may take years to resolve due to the need for IRS budget support or changes to Treasury regulations. This Report addresses issues that have been resolved in 2007 or that the LMSB Subgroup is actively pursuing into 2008.
The LMSB Subgroup continued to focus on Electronic Tax Administration (ETA) within the IRS by carrying forward items from the 2005 and 2006 IRPAC Public Reports. These recommendations could enhance data security as the IRS currently transmits large amounts of taxpayer data to financial institutions by U.S. mail and facsimiles. The LMSB Subgroup emphasized to the IRS that taxpayer records - some on magnetic tape and some in letters - are regularly lost in the mail and the IRS does not have a mechanism for tracking mail containing this sensitive information. This reality raises major data security concerns. As the National Taxpayer Advocate mentioned in her 2006 Annual Report to Congress, “[t]he privacy of tax return information is fundamental to tax administration.” (Volume 1 page 500). The IRS can mitigate data security exposures by following earlier IRPAC recommendations to move toward electronic data transmission.
During 2007, we met with Bert DuMars, the Director of Electronic Tax Administration (ETA), to discuss the carry over items from the 2005 and 2006 reports and to be briefed on ETA projects related to information reporting. We also met later in 2007 with David Williams, the successor to Mr. DuMars as Director of Electronic Tax Administration, and with Frank Montero, the Senior Manager for IRS Electronic Tax Administration (responsible for the enhancements to the FIRE system that were deployed January 3, 2007).
The IRS identified the following developments for the year:
- In 2007 ETA addressed IRPAC's request to expand access to the Transcript Delivery System for the Reporting Agent Project.
- The IRS Enterprise Computing Center at Martinsburg (ECC) will transmit B Notices and Penalty Notices on CD-ROM. [The IRS did complete some of this effort by transmitting CD-ROMs in September 2007 for the 2005 year Penalty Notices.]
- The IRS is working on a pilot program to provide C Notices electronically and anticipates that this program will go into effect in 2007.
- The IRPAC-endorsed Information Reporting Clearing House Project is dormant.
IRPAC is encouraged by the programs undertaken by the IRS Electronic Tax Administration. We asked for enhancements in 2007 and earlier years and we anticipate delivery in 2007 of at least two enhancements that will assist with taxpayer data security and will support information return preparers in more efficiently complying with their filing requirements. In calendar year 2007, we expect access to the on-line transcript delivery system will be expanded to payers and withholding agents that were previously prohibited from accessing the system. This will eliminate transcripts provided by facsimile transmission. Also in late 2007 the Martinsburg ECC is expected to send B Notices and 972CG Penalty Notices via CD-ROMs. [As noted above, the IRS did use CD-ROMs to transmit year 2005 Penalty Notices in September 2007.] While the CD-ROM delivery medium is advancement from cartridges and paper, we recommend that the notices be made available for electronic retrieval from the FIRE system by authorized payers. Until the IRS moves to secure electronic delivery of the transcripts and the B Notices and Penalty Notices, unencrypted taxpayer data will continue to float through the facsimile and the mail systems with the potential for misuse if the Notices are lost or stolen prior to being delivered to payers.
The IRS has not addressed the 2005 IRPAC issue requesting electronic C Notices. As with the 2007 enhancements described above, unencrypted taxpayer data will continue to float through the mail system until the IRS moves to an electronic delivery method for C Notices. The pilot program for B Notices on CD-ROM will not include C Notices.
We further recommend development and a continued aggressive position by ETA in the development of the Information Reporting Clearing House. As stated in the 2005 IRPAC Report, we recommend that delivery of information returns to the Clearing House will eventually comply with the electronic delivery requirements and eliminate the need for payers to mail 1099/1098s to payees. With more than one billion information returns each year, this development would represent a major enhancement of data security. We acknowledge that the IRS considers the Clearing House matter dormant.
Benefits to Payers
Providing enhanced electronic delivery and electronic access to tax information will support the payers' interests in data security and will reduce payers' costs, improve taxpayer compliance and enhance processing efficiency.
Benefits to IRS
Providing payers with enhanced electronic delivery and electronic access to tax information will support the IRS interests in data security and will reduce IRS costs in preparation of paper transcripts and recreation of lost paper lists such as C Notices and B Notices.
Benefits to Taxpayers
Taxpayer privacy and information security are greatly improved by better protection for transmitted taxpayer data. This is a point supported by the National Taxpayer Advocate in her 2006 Annual Report to Congress.
Securities brokerage firms and other nominees are required to report amounts of $10 or more that are deemed paid on Clean Renewable Energy Bonds (CREBs) and Gulf Tax Credit Bonds (Gulf Bonds) on Form 1099-INT. The amounts are treated as paid on credit allowance dates (March 15, June 15, September 15, December 15, and the last day on which the bond is outstanding). The reporting is mandated pursuant to IRC Section 6049(d)(8), and the Secretary is authorized to prescribe regulations necessary or appropriate to facilitate this reporting.
To compute the amount that must be reported on Form 1099-INT, nominees need to know if a bond is a CREB or a Gulf Bond. Since CREBs and Gulf Bonds may be indistinguishable from other bonds with similar terms and features, nominees will have to examine information provided by issuers (such as prospectuses and other offering material) to determine if a bond is a CREB or a Gulf Bond. In practice, this manual process of identifying CREBs and Gulf Bonds is impractical and is not feasible since a list of CREB/Gulf Bond issuers is not available to the public.
Thus, securities brokerage firms and other nominees responsible for Form 1099 reporting often do not have sufficient information from issuers of CREBs and Gulf Bonds to prepare Form 1099-INT.
The IRS should facilitate the flow of information from issuers of CREBs and Gulf Bonds to nominees. IRPAC recommends the following:
- The IRS should require that CREB and Gulf Bond issuers provide their Committee of Uniform Security Identification Procedures’ numbers (CUSIP) to the IRS.
- The IRS should publish a list of CUSIPs for CREBs and Gulf Bonds on the IRS web site for public use.
Nominees need to identify CREBs and Gulf Bonds in order to accurately include the amount deemed paid on Form 1099-INT. Until the Form 8038 is changed, it is difficult to identify information specific to tax credit bonds such as CREBs, Qualified Zone Academy Bonds (QZAB), and Gulf Bonds. In the subgroup’s opinion, the information the IRS receives from issuers of CREBs and Gulf Bonds should be passed along to nominees so they can identify CREBs and Gulf Bonds, and prepare and file accurate Forms 1099-INT.
The IRS and the Treasury Department have regulatory authority under the specific delegation in Section 6049(d)(8). That authority should be exercised to create a feasible information reporting system. If the IRS published the list of CUSIPs, nominees would have sufficient information to prepare accurate Forms 1099-INT.
Benefit to Payers
The list of CUSIPs will allow for the identification of CREBs and Gulf Bonds, and thereby enable nominees to provide accurate reporting to the IRS and taxpayers.
Benefit to IRS
The IRS would receive accurate and complete information returns on a timely basis.
Benefit to Taxpayers
Taxpayers would receive accurate information which is needed for their tax returns.
Until recent discussions with IRPAC, the IRS was unaware of the difficulties in reporting Forms 1099 for CREBs; therefore, there is no comprehensive information available for use in Form 1099 reporting on those securities. In the Notice published in March soliciting applications for the second round (based on 12/22/2006 legislation), the IRS asked the issuers for a voluntary disclosure authorization to release the name of the bond issuer and the amount of the allocation of authority to issue bonds. The authorization did not include disclosure of information concerning bonds’ CUSIP numbers to be issued. The allocation information will be publicly available.
The IRS has been advised that it cannot release bond information such as CUSIP numbers and issuer names without consent of the issuer. Accordingly, the IRS is considering asking issuers to voluntarily authorize a release of bond information such as CUSIP numbers when filing the Form 8038. Addition of such a disclosure release to a form that is required to be filed with the IRS has not been discussed with IRS Counsel. Another Form 8038 specifically for tax credit bonds is under consideration.
Notice 2006-97, issued November 13, 2006 provides interim guidance for the tax treatment of excess inclusion income (EII) of a real estate investment trust (REIT) that is either a taxable mortgage pool (TMP) or has a qualified REIT subsidiary that is a TMP.
Notice 2006-97 describes the tax reporting and withholding obligations of REITs, pass-through entities, regulated investment companies (RICs) and other brokers and nominees that hold REITs or RICs that have Ell.
Certain tax information reporting and withholding provisions of Notice 2006-97 are either not workable, or are unduly burdensome and outweigh any benefit to tax system administration. For example, with respect to the tax reporting and withholding obligations of nominees:
- The Notice requires that nominees inform beneficial owners that are not disqualified organizations of the amount and character of their Ell. However, the Notice does not set forth any guidelines or requirements as to how or when the information must be reported.
- The Notice requires that nominees pay the tax imposed by Section 860E(e)(6) on excess inclusion income of beneficial owners that are disqualified organizations. There is no feasible way for nominees to identify whether an account is owned by a disqualified organization. Since nominees were never required to identify whether an account is a disqualified organization, their systems do not contain the special coding to identify a disqualified organization.
- The Notice requires that nominees apply withholding tax provisions to the Ell portion of payments made to foreign persons without regard to any treaty exemption or reduction in tax rates. In order for such a withholding system to function, nominees need to know how much of a REIT's or RIC's dividends are Ell. Furthermore, this information must be provided contemporaneously with the dividend payment. In order for contemporaneous notification to occur, the chain of financial intermediaries responsible for processing dividends for REITs and RICs must modify their computer systems to receive and transmit information regarding Ell. Notice 2006-97 is effective upon issuance, and does not provide the necessary lead time for industry participants to modify their systems.
Each of the requirements is associated with operational and logistical burdens. Industry participants need a reasonable period of time to design and implement changes to their computer systems and business practices in order to comply with the terms of this Notice.
IRPAC recommends the following:
- The IRS should provide a reasonable amount of time (a transition period) for industry participants to modify their computer systems and business practices to comply with the terms of Notice 2006-97.
- The IRS should not impose penalties on industry participants that make good faith efforts to comply with the terms of this Notice during the transition period.
IRPAC also urges the IRS to consider the comments made by the Investment Company Institute (ICI) and the National Association of Real Estate Investment Trusts (NAREIT) in their letters of December 29, 2006 and January 30, 2007, respectively.
NAREIT offers an attractive solution for administering the tax on Ell from REITs. They suggest treating a REIT similar to a Real Estate Mortgage Investment Conduit (REMIC) for purposes of calculating and allocating excess inclusion income. Under their proposal, equity interests in a REIT would be comprised of two components: a regular interest and a non-economic residual interest. Their proposal further states that all Ell of the REIT would be allocated to the non-economic residual interest.
NAREIT's proposal is appealing from a tax information reporting standpoint because it concentrates Ell in the REIT's non-economic residual interests. Ownership of the non-economic residual interests could be limited based on suitability or other standards, and thus limit the number of taxpayers subject to Ell.
The tax information reporting and withholding requirements in Notice 2006-97 create significant burdens for issuers of REITs, RICs, pass-through entities and brokers and other nominees. These burdens outweigh the purported benefits to the tax administration system.
The IRS should delay implementation and enforcement of Notice 2006-97 for a reasonable period of time after a practical information reporting regime is developed.
The IRS should consider alternative solutions presented by NAREIT in their letter of January 30, 2007 to the IRS.
Benefit to Payers
Payers will have time to design and implement tax reporting and withholding systems and business practices. Once efficient tax reporting and withholding systems are in place, nominees will be able to generate accurate tax-reporting, and withhold the correct amount of tax.
Benefit to IRS
IRS will receive accurate tax information reporting, and the correct amount of tax will be collected via withholding.
Benefit to Taxpayers
Taxpayers will receive accurate tax information for preparation of their tax returns.
IRS Chief Counsel is considering these recommendations.
The Tax Relief and Health Care Act of 2006 added section 163(h)(3)(E) to the Internal Revenue Code of 1986. This provision allows individual taxpayers to deduct mortgage insurance premiums in certain limited circumstances, for mortgage insurance contracts issued during 2007 and for premiums allocatable to 2007 only. Section 6050H(h) requires information reporting on Form 1098 for mortgage insurance premiums received from an individual.
The IRS should provide guidance on this one-year reporting requirement so that mortgage servicers will be able to comply without undue burden; the IRS should also provide penalty relief for reasonable, good faith compliance.
Industry practice is for mortgage servicers to collect and load escrow funds on an aggregate basis. There is no way to track mortgage insurance separately until the servicer makes a payment to the mortgage insurer. We requested clarification that the phrase "premiums paid or accrued" includes the payment from the servicer to the insurer. With this clarification, mortgage servicers could report the amount paid to the insurers without trying to track when the actual payment is received from the borrower. However, it would also result in a deductible amount being reported to a borrower on the basis of the accrued mortgage insurance payment, even if the borrower is delinquent.
Benefit to Lenders
Lenders would be able to comply with this one-year, 2007 only, reporting requirement in a consistent manner that is reasonable and will utilize information available currently, without necessitating significant system changes. Guidance would provide greater certainty to lenders, and penalty relief would protect lenders in the event that the amount reported on Form 1098 is not exactly equal to the amount deductible under §163.
Benefit to IRS
The IRS would benefit from greater certainty in arriving at the determination of reportable mortgage insurance premiums, as well as improved compliance by lenders.
Benefit to Taxpayers
Taxpayers will be required to determine the appropriate deductible amount of mortgage insurance premiums, regardless of the methodology used by lenders. There are limitations that only the taxpayer would be able to apply. Therefore, the taxpayer should be indifferent to any guidance given to lenders, as long as there is sufficient information available to taxpayers to be able to determine the deductible amount.
IRS Chief Counsel will provide Forms and Publications with legal guidance as necessary to conform the Forms and Publications with this “one-year” change in the law.
Treas. Reg. §§ 1.1441-3(b) and (c) require withholding and reporting on gross payments of interest and/or corporate distributions, regardless of whether the payments constitute a return of capital. The Form 1042-S instructions do not include an income code for return of capital (ROC). Some withholding agents report ROC under Code 50, the "other income" code, but because ROC is not income, this code is not appropriate. Other withholding agents do not report ROC on Form 1042-S.
The Form 1042-S instructions could be revised to add a new income code specifically for ROC. Another option would be to revise Form 1042-S to include a box for nondividend distributions, similar to the Form 1099-DIV, Box 3, nondividend distributions.
Benefit to Payers
Providing an income code for ROC would remove the lack of clarity that currently exists for payers regarding how to report ROC on the Form 1042-S.
Benefit to IRS
By providing a code specifically for ROC, the IRS can ensure that reporting of ROC is completed consistently and accurately by taxpayers.
Benefit to Taxpayers
Providing a separate code for ROC would permit taxpayers to obtain a clearer understanding of the types of income reflected on Form 1042-S.
With the release of the Form 1042-S instructions for 2007, the IRS included a separate income code for ROC. Income code number 37 is the appropriate income code for all reporting of ROC and taxpayers should no longer use code 50 for such reporting.
The Forms W-8 do not provide adequate space for the complete country name on the applicable lines. Many taxpayers have difficulty typing or hand writing the country name in the space provided and the Forms W-8 and corresponding instructions do not permit the use of abbreviated country names in lieu of the full country name. Revenue Agents are invalidating Forms W-8 when clear, commonly recognized and accepted country code abbreviations are being used on the forms.
The IRS should permit taxpayers to use the same country codes specified for use on Form 1042-S (boxes 16 and 18).
Benefit to Payers
Permitting the use of abbreviated country names would insure payers are provided with accurate and legible country information. This would help to avoid confusion and misinformation.
Benefit to IRS
The use of commonly accepted country codes on Form W-8BEN would insure the IRS could obtain accurate information with respect to the correct country and it would avoid problems that arise when the IRS has difficulty reading the information on the form.
Benefit to Taxpayers
Permitting the use of commonly accepted abbreviated country names would insure taxpayers are able to provide accurate and legible country information. This would prevent withholding agents from resoliciting forms when the Form W¬8 is otherwise valid.
On June 14, 2007, the IRS posted on its website a draft of the revised Form W¬8BEN and a draft of the revised Form W-8BEN instructions. The proposed effective date for the Form W-8BEN is January 1, 2008. The draft form has removed the phrase "do not abbreviate" from the country section and therefore, country abbreviations may be used on Lines 4, 5 and 9(a). Furthermore, additional space is provided on Line 9(a) to provide the country name under which the tax treaty benefit is being claimed. Although the IRS has not released revised drafts of the other forms in the Form W-8 series, the IRS has indicated the do-not-abbreviate language will be removed from those forms when they are revised. Further, the IRS has indicated that until the other forms in the Form W-8 series are revised, the Examination Division will be advised that use of country name abbreviations will not invalidate the form.
Line 10 of Form W-8BEN is required to be completed when the beneficial owner chooses to make a treaty claim and an additional representation is needed to make a valid tax treaty claim. The representation is in addition to those made on Lines 9(a) through 9(e).
The current instructions to Form W-8BEN are unclear with respect to whether a reverse hybrid entity should complete Line 10 when it chooses to make a tax treaty claim. In general, most income tax treaties do not treat fiscally transparent entities as residents under the tax treaty and therefore, such entities are generally not eligible to make a valid claim for benefits under the treaty. However, other income tax treaties do treat fiscally transparent entities as residents and therefore, do permit such entities to make valid claims for benefits under the tax treaty.
The instructions to Form W-8BEN should be revised to address whether a reverse hybrid entity should complete Line 10 when it is a beneficial owner that chooses to make a treaty claim and therefore, must complete an additional representation.
Benefit to Payers/Taxpayers
Revising the instructions to Form W-8BEN to make clear whether and when reverse hybrid entities should complete Line 10 will help to ensure consistency and accuracy on Form W-8BEN.
Benefit to IRS
Revised instructions to Form W-8BEN will make clear whether and when reverse hybrid entities should complete Line 10, and therefore, will help to insure the IRS is obtaining accurate and complete information from taxpayers. In addition, it will avoid inconsistencies that currently exist depending upon whether a reverse hybrid entity is eligible for treaty benefits as a fiscally transparent entity.
The draft Instructions to Form W-8BEN released June 12, 2007 do not clarify this issue, but the IRS has indicated that the next version of the Form W-8BEN instruction will clarify when a reverse hybrid will need to complete Line 10.
Treas. Reg. § 1.1441-3(c)(2)(i)(C) provides that a corporation may elect not to withhold on a distribution if, based on a reasonable estimate, the distribution is not paid out of earnings and profits. Treas. Reg. § 1.1441-3(c)(2)(ii)(B)(2) provides that if, at the end of the year of distribution, it is determined that the corporation underwithheld and the underwitholding is paid on or before the due date for filing Form 1042, no penalties for failure to withhold and deposit will be imposed.
Notwithstanding the foregoing regulations, the instructions to Form 1042 provide that withholding agents should report their tax liability on Lines 1 through 60. However, the instructions do not provide a mechanism for withholding agents to report subsequently determined underreporting. Thus, if the current instructions are followed and the underwithholding is reported on a timely filed Form 1042, a late deposit penalty notice will be automatically generated.
The instructions to Form 1042 could provide that underwithholding may be reported on Line 63(b) (adjustments), which would prevent the automatic issuance of failure to deposit penalty notices from the IRS.
Benefit to Withholding Agents
Revising the instructions to Form 1042 will clarify to withholding agents how to properly report amounts determined to be underwithheld and would save taxpayers the time and expense of preparing reasonable cause explanations to have penalties abated.
Benefit to IRS
Revised instructions to Form 1042 would prevent the automatic issuance of penalty notices due to permitted underwithholding that is not accurately reflected on Form 1042. This would prevent the IRS from having to address this issue with withholding agents on a case-by-case basis to fix the problem and correct inaccurate accounts, a process that is often time consuming and labor intensive for IRS personnel.
Benefit to Taxpayers
Revised instructions to Form 1042 would allow withholding agents to accurately report underreporting on the form in a manner consistent with the regulations. In addition, withholding agents would avoid the time consuming and costly consequences of receiving inappropriate penalty notices when, in fact, the taxpayer is compliant with IRS regulations.
Currently the instructions to Form 1042 provide that Line 63(b) may only be used by RICs and REITs for adjustments to withholding on dividends. However, Form 1042 instructions for 2007 will clarify that the adjustments line, i.e. Line 63(b), may be used when it is subsequently found that a reasonable estimate of tax due on a corporate distribution was inaccurate, and the estimate resulted in underwithholding.
Treas. Reg. § 1.1442-5(b)(2) provides that partnerships that have not made an actual distribution of income to a foreign partner are required to withhold tax on the foreign partner's distributive share on the earlier of (a) the mailing date of the K-1 or (b) the due date for filing the K-1. However, the instructions to Form 1042 do not clearly indicate which year withholding should be reported - i.e., the year in which the undistributed income is earned, which automatically triggers a failure to deposit penalty notice, or the same year in which the withholding takes place.
Consequently, some taxpayers report the withholding in the year in which the undistributed income was earned, which automatically triggers a failure to deposit penalty notice. Other taxpayers report the withholding in the same year in which the withholding took place.
The instructions to Form 1042 should be revised to make it clear to taxpayers that they should report withholding in the year the withholding was done.
Although revising the instructions to Form 1042 may avoid the issuance of failure to deposit penalty notices to taxpayers, there may be a mismatch between the information on a partner's Schedule K-1 and the Form 1042 for a given tax year. Moreover, if the partnership issues a Schedule K-1 for the income for the year the income was earned and the deposit is made in the subsequent calendar year, it is unclear whether this is reported on the Form 1042 and Form 1042-S of the year the income was earned or the year the deposit was made.
Benefit to Payers/Taxpayer
Withholding agents will obtain clarity around how to properly report withholding on undistributed partnership earnings. In addition, taxpayer will avoid the time consuming and costly consequences of receiving inappropriate penalty notices when, in fact, the taxpayer is compliant with IRS regulations.
Benefit to IRS
As a result of revised instructions, the IRS will receive consistent and accurate reporting of undistributed partnership earnings instead of having to determine how a particular taxpayer treated this item for reporting purposes. In addition, the revised instructions will prevent the automatic issuance of penalty notices. Consequently, the IRS will not have to remedy the issue on a taxpayer-by-taxpayer basis to correct inaccurate accounts, a process that is often time consuming and labor intensive for IRS personnel.
The IRS has advised that Form 1042 instructions for 2007 will clarify that withholding agents should report the withholding on undistributed partnership earnings in the same year in which the withholding takes place. This will result in a mismatch between the information reported on the partner's Schedule K-1 and the information reported on Form 1042. However, it will avoid the automatic generation of failure to deposit penalty notices.
Guidance for substitute Forms W-8 is contained in the Instructions for the Requester of Forms W-8BEN, W-8ECI, W-8EXP, and W-8IMY. The instructions to these forms require that the taxpayer include a statement immediately above the single signature line. For example, on Form W-8BEN, the instructions require the following:
"Additionally, the following statement must be presented in the same manner as in the preceding sentence and must appear immediately above the single signature line: "The Internal Revenue Service does not require your consent to any provision of this document other than the certifications required to establish your status as a non-U.S. person and, if applicable, obtain a reduced rate of withholding."
This language appears to be too broad because the statement applies to all substitute Forms W-8.
The language in the instructions to Forms W-8BEN, W-8ECI, W-8EXP, and W-81MY should be modified to provide that the statement is only required when a substitute Form W-8 contains a single signature line that is used to indicate consent to provisions other than the certifications in the official Form W-8.
Requesters are similarly required to place this statement above the signature line when creating a substitute Form W-9. However, for purposes of Form W-9 the statement is only required when the single signature line relates to the other provisions of the document. In contrast, the statement is required on all substitute Forms W-8, even those that do not contain other provisions.
Benefit to Payers
Payers would benefit from clarity and by having consistency between Forms W-8 and W-9 instructions.
Benefit to IRS
IRS would benefit from having consistent instructions addressing the use of substitute forms.
Benefit to Taxpayers
This proposal supports simplification and efficiency.
The IRS has agreed to address this issue in the Instructions to the Requester of the Form W-8BEN by requiring the statement only when a substitute Form W-8 contains a single signature line that is used to indicate consent to provisions other than the certifications in the official Form W-8.