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Report-Penalty-Interest-Provisions-1999.Pdf TABLE OF CONTENTS INTRODUCTION 1 EXECUTIVE SUMMARY 2 I. Scope of Study 11 A. Legislative Mandate 11 B. Solicitation of Public Comments 11 C. Methodology of Study 12 D. General Policy Considerations 16 II. Overview of Major Penalty and Interest Provisions 18 A. Penalties 19 1. 1954 19 2. 1955-1974 21 3. 1975-1988 22 4. 1989 25 5. 1990 to the present 28 B. Interest 32 III. Criteria For Evaluation of Penalties and Interest 35 A. Penalties 35 B. Interest 40 C. Burden 45 IV. Data on Taxes, Penalties and Interest 46 A. Tax, Penalty and Interest Revenue 48 B. Penalties Assessed 51 C. Penalties Assessed and Abated 52 D. Penalties and Interest Written Off 54 E. Risk Profiles of Delinquent Taxpayers 57 v V. Analysis of Specific Penalty Provisions 59 A. Failure to File Penalty 59 1. Present-law penalty 61 2. Historical background 63 3. Comparison with state law failure to file penalties 63 4. Analysis 63 B. Failure to Pay Penalty 68 1. Present-law penalty 68 2. Historical background 71 3. Comparison with state law failure to pay penalties 71 4. Analysis 72 C. Penalties for Failure to Pay Estimated Tax 75 1. Estimated tax payment rules 75 a. Individuals 75 b. Corporations 77 2. Additions to Tax for Failure to Pay Estimated Tax 78 a. Individuals 78 b. Corporations 79 3. Historical background 80 a. Individuals 80 b. Corporations 80 4. Analysis 81 D. Deposit Penalties 89 1. Present-law penalty 90 2. Historical background 92 3. Analysis 92 vi E. Accuracy-Related and Preparer Penalties 97 1. Present-law penalties 98 a. Accuracy-related penalties 98 b. Preparer penalties 101 2. Historical background 104 3. Analysis 105 VI. Interest Provisions 112 A. Present-law interest provisions 112 1. Underpayment interest 113 2. Overpayment interest 113 3. Interest rates 115 4. Interest equalization 116 B. Analysis 120 VII. Abatements of Penalties and Interest 125 A. Penalties 125 B. Interest 128 1. Present law 128 2. Historical background 132 3. Analysis 133 VIII. Other Penalties 137 A. Frivolous Return Penalty 137 B. Penalties Relating to Employee Plans/ Benefits 138 1. Present law 138 2. Analysis 139 vii Tables 1 through 6 - Tax, Penalty and Interest Payments 143 Appendix A - Principal Additions to Tax and Civil Tax Penalties 149 Appendix B - Sample of State Law Penalty and Interest Provisions 163 viii INTRODUCTION This study was conducted by the Treasury Department with respect to the penalty and interest provisions of the Internal Revenue Code of 1986,1 pursuant to section 3801 of the IRS Restructuring and Reform Act of 1998 (“RRA 1998”).2 The first part of this report contains an executive summary, setting forth the Treasury Department’s key recommendations with respect to the penalty and interest provisions of the Code. The executive summary is followed by the text of the report. The text delineates (1) the scope of the study; (2) the historical context of the present-law penalty and interest provisions; (3) the criteria relevant to evaluation of the penalty and interest provisions; (4) data on taxes, penalties and interest; (5) analysis and recommendations with respect to specific penalty and interest provisions; and (6) analysis and recommendations with respect to penalty and interest abatement provisions. Attached as appendices are (1) a compendium of the penalty and interest provisions of the Code (Appendix A); and (2) a summary of state income tax penalty and interest provisions for a sample of states (Appendix B). 1 Unless otherwise specified, references in this report to the “Code” refer to the Internal Revenue Code of 1986, as amended. 2 Pub. L. No. 105-206, 112 Stat. 782 (1998). 1 EXECUTIVE SUMMARY I. Purpose Section 3801 of the IRS Restructuring and Reform Act of 1998 (“RRA 1998”) directs the Secretary of the Treasury to undertake a study of the penalty and interest provisions of the Code. The study is to review the administration and implementation of those provisions and make any legislative and administrative recommendations deemed appropriate to simplify penalty or interest administration and reduce taxpayer burden. The Treasury Department, in consultation with the IRS and interested parties, has conducted its study and this report presents its analysis and recommendations. II. Legislative Recommendations Difficult balances must be struck to achieve a fair and effective system of sanctions involving different taxpayers and diverse causes for noncompliance. The overarching objectives are to foster and maintain a high degree of voluntary compliance, encourage taxpayers to promptly resolve noncompliance problems with the IRS, and impose a system of sanctions that is sufficient to discourage intentional noncompliance without imposing undue burden and complexity on taxpayers whose noncompliance is due to other factors. The penalty and interest regime also cannot be evaluated in isolation; it is one important facet of a complex and interactive system of tax collection mechanisms. The study also addresses the important distinction between penalties as sanctions and interest as compensation for the use of money, a distinction that presents difficult analytical issues and administrative considerations. Treasury also was mindful that the behavioral impact of significant changes in the penalty and interest regime cannot be predicted with precision and believes that caution is appropriate in making recommendations for change. Accordingly, Treasury makes the following legislative recommendations with respect to the penalty and interest provisions of the Code:3 3 Proposed effective dates are not provided with these recommendations, and would be contingent on IRS implementation and other considerations. 2 Penalties for Failure to File Returns and Failure to Pay Treasury recommends that the failure to file and failure to pay penalties be restructured to eliminate the frontloading of the failure to file penalty and to impose a higher failure to pay penalty than under current law. The frontloading of the failure to file penalty under current law in the first five months of a filing delinquency does not provide a continuing incentive to correct filing failures and imposes additional financial burden on taxpayers whose filing lapse may be coupled with payment difficulties so as to impede compliance. The filing obligation is of paramount importance to the tax system, but imposition of a severe penalty in the first five months of a filing delinquency appears incongruent with the availability of automatic extensions of time to file. Treasury proposes, accordingly, that the failure to file penalty be restructured to impose a lower penalty rate over a longer period of time, up to the current-law maximum amount. The current-law higher penalty for fraudulent failures to file, however, would be maintained. This proposal would maintain a failure to file penalty to encourage timely filing, but not impose as significant a financial burden as under current law for a filing lapse of short duration, while providing a continuing incentive for delinquent filers to correct a filing lapse of longer duration. The failure to pay penalty should provide appropriate incentives to taxpayers to correct a payment delinquency and, if necessary, arrange for payment under various payment programs that the IRS makes available. A taxpayer who fails to make such arrangements in a timely manner should be subject to a higher penalty rate than that provided under current law. Treasury proposes, accordingly, that the failure to pay penalty be restructured to accomplish these purposes by imposing a penalty at the current rate of 0.5 percent per month for the first six months of a payment delinquency. The penalty rate would be raised to one percent per month for continuing payment delinquencies after the sixth month to provide an additional incentive to pay an outstanding tax liability. As under current law, the maximum penalty would be 25 percent. These penalty rates would be reduced if taxpayers make, and adhere to, arrangements with the IRS for payment. The failure to pay penalty would not be coordinated, as under current 3 law, with the failure to file penalty to recognize that each form of delinquency is a separate act of noncompliance. More specifically, these recommendations would: (1) Restructure the failure to file penalty to impose a penalty of 0.5 percent per month of the net amount due for the first six months of a delinquency in filing tax returns, which penalty rate will be increased to one percent per month thereafter, up to a maximum 25 percent. This restructured penalty would eliminate the current-law frontloading of the penalty into the first five months of a filing delinquency, providing a continuing incentive for delinquent filers to correct their filing delinquency over longer periods of time. The maximum penalty of 25 percent is the same as under current law. As under current law, fraudulent failures to file would be penalized at a higher penalty rate of 15 percent per month, up to a maximum of 75 percent. (2) Restructure the failure to pay penalty to impose a penalty of 0.5 percent per month of the net amount due for the first six months of a payment delinquency, which rate would be increased to one percent per month thereafter, up to a maximum 25 percent. The penalty rate would be decreased from 0.5 percent to 0.25 percent per month if the taxpayer, within six months, enters into a payment arrangement with the IRS to which the taxpayer adheres. Likewise, the one- percent penalty rate would be reduced to 0.5 percent if the taxpayer, after the lapse of six months, enters into a payment arrangement with the IRS to which the taxpayer adheres. Treasury also recommends that consideration be given to charging a fee, in the nature of a service charge, for late filing of “refund due” or “zero balance” returns.
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