House Ways and Means Committee testimony: interest and penalty provisions of the Internal Revenue Code.

November 9, 1999

On November 5, 1999, Tax Executives Institute submitted the following statement to the Oversight Subcommittee of the House Committee on Ways and Means in connection with a planned November 9 hearing on proposed changes to the interest and penalty provisions of the Internal Revenue Code. The hearing, which was scheduled following the release of separate studies by the staff of the Joint Committee on Taxation and the Department of the Treasury, was postponed owing to the press of other legislative business, but will likely be rescheduled in 2000. The Institute's testimony, which was to have been presented by TEI President Charles W. Shewbridge, III, was prepared under the aegis of the IRS Administrative Affairs Committee, whose chair is Robert J. McDonough, Jr. of Wang Global, Inc. Earlier this year, TEI submitted comments to the Joint Committee staff and the Treasury Department in response to their requests. Those earlier comments are reprinted in the May-June 1999 issue of The Tax Executive.

Good afternoon. I am Charles W. Shewbridge, III, Chief Tax Executive for BellSouth Corporation in Atlanta, Georgia. I appear before you today as the President of Tax Executives Institute, the preeminent group of corporate tax professionals in North America. The Institute is pleased to provide the following comments on the Internal Revenue Code's interest and penalty provisions, with particular focus on the recommendations recently made by the staff of the Joint Committee on Taxation and the Department of the Treasury. See Staff of the Joint Committee on Taxation, 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) (JCS3-99) (July 22, 1999) (hereinafter cited as the "Joint Committee Study"); Office of Tax Policy, U.S. Department of the Treasury, Report to the Congress on Penalty and Interest Provisions of the Internal Revenue Code (October 1999) (hereinafter cited as the "Treasury Report").

1. Background

   Tax Executives Institute was established in 1944 to serve the professional needs of in-house tax practitioners. Today, the Institute has 52 chapters in the United States, Canada, and Europe. Our 5,000 members are accountants, attorneys, and other business professionals who work for the largest 2,800 companies in the United States and Canada; they are responsible for conducting the tax affairs of their companies and ensuring their compliance with the tax laws. TEI members deal with the tax code in all its complexity, as well as with the Internal Revenue Service, on almost a daily a basis. Most of the companies represented by our members are part of the IRS's Coordinated Examination Program, pursuant to which they are audited on an ongoing basis. TEI is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. Our background and experience enable us to bring a unique and, we believe, balanced perspective to the subject of the Internal Revenue Code's interest and penalty provisions.

   TEI has long believed that the Code's interest and penalty provisions are unduly complex and inequitable. The interest provisions can operate in an unfair manner and are difficult to administer, especially when taxpayers have overlapping periods of under- and overpayments. In many cases, the provisions have served as an inappropriate penalty (such as with the estimated tax penalty), rather than as recompense for the time value of money.

   Moreover, the calculation of interest itself -- with its restricted interest provisions and requirements for compounding and netting -- is inordinately difficult and leads to errors by both the government and the taxpayer. Almost every TEI member can recount a protracted tale, if not a horror story, of convoluted, complicated, and ultimately incorrect interest calculations. For good reason, taxpayers doubt the IRS's ability to compute interest accurately, and they frequently incur significant expense in hiring outside consultants to review interest charges -- often without the benefit of a print-out of the IRS calculations. We recognize that much of the cause of the problem lies in the IRS's computer system (which is in the process of being replaced), but we believe the IRS can take immediate steps to assist taxpayers now -- for example, by providing copies of interest calculations.(1)

   Moreover, the unfairness and complexity of the Code's interest rules have been exacerbated by the delay in issuing guidance. For example, the Internal Revenue Service Restructuring and Reform Act of 1998 mandates the use of interest netting when there are overlapping periods of under- and overpayments. A transition rule permits taxpayers to apply the ameliorative rules retroactively, but to avail themselves of this relief, taxpayers must file elections by the end of the year. Even though less than two months remain to qualify for transitional relief, the IRS and Treasury Department have not yet issued guidance on the mechanics of the election (e.g., what information must be included, especially in respect of the level of detail required). The delay in issuing the procedure is regrettable and feeds the perception that the IRS and Treasury continue to resist interest netting notwithstanding Congress's mandate.

   In respect of the Code's penalty provisions, TEI believes that they should be simple, fair, and easy to administer. Unfortunately, we have moved away from this concept in the last decade where penalty has been piled upon penalty to target specific areas such as transfer pricing and corporate tax shelters. Rather than being straightforward, direct, and effective, penalties have become almost as complicated as the underlying provisions they seek to enforce. Dangerously, too, the enactment of new or racheting up of existing penalties deprives the system of proportionality while representing a politically expedient way of raising revenues without increasing "taxes."

   We seem to have lost track of the concept that penalties should be applied only in cases of intentional (or volitional) noncompliance, and not for every error or omission. The current structure does not effectively distinguish between the two, but instead places taxpayers who unintentionally fail to meet some requirement in the same category with those who willfully decide not to comply.

   It is clearly time for an in-depth review of the Code's interest and penalty provisions. TEI commends Chairman Houghton and the Oversight Subcommittee for scheduling this hearing to determine the effectiveness of the current interest and penalty regime and to consider recommendations for reform.(2) The Institute believes that such a comprehensive review of the provisions will invariably lead to the following conclusions (among others):(3)

   * The interest-rate differential should be repealed and the interest charged on under- and overpayments should be equalized.

   * The rate of interest on under- and overpayments should equal the applicable federal rate plus two or three percentage points.

   * The estimated tax penalty should be converted to an interest charge and a safe harbor should be created for all taxpayers.

   * The Internal Revenue Service's ability to abate interest should be expanded.

   * The Code's penalty regime should encourage disclosure by taxpayers. The standards for imposing penalties should be harmonized and consistently applied, and there should be a realization that certainty and fairness of application play a bigger role in encouraging compliance than reflexively increasing penalty rates.

   * The pension-related penalties should be consolidated for enforcement purposes under a single government agency.

   TEI would be pleased to assist the Oversight Subcommittee in effecting these changes.

2. Interest Provisions

   1. Elimination of the Interest-Rate Differential

      Section 6621 of the Code establishes the rate of interest to be paid on over- and underpayments of tax. The rate on overpayments of tax by a corporation is the federal short-term rate plus two percentage points; the underpayment rate is the federal short-term rate plus three percentage points.(4) "Large corporate underpayments" are subject to an interest equal to the federal short-term rate, plus five percentage points (the so-called hot interest provision).(5) Thus, the rate of interest the government charges corporate taxpayers on tax deficiencies is higher than the rate of interest the government...