Compliance/Enforcement

The administration proposes improvements to achieve greater compliance through many of the same means as proposed in FY 2010. For example, proposals to improve business compliance include mandatory e-filing requirements and enhanced penalties. The administration is also asking for more than $12.5 billion for IRS operations in FY 2011 that, among other expenditures, reflects almost a $300 million increase allocated to IRS enforcement programs.

Information Return Penalties

The president proposes significant increases in information return penalties:

• The first-tier penalty would rise from $15 to $30 and the calendar year maximum penalty would increase from $75,000 to $250,000;
• The second-tier penalty would double from $30 to $60 and the calendar year maximum penalty would rise from $150,000 to $500,000; and
• The third-tier penalty would increase from $50 to $100 and the calendar year maximum would jump from $250,000 to $1.5 million.

Additionally, the minimum penalty for each failure due to intentional disregard would rise from $100 to $250. The proposed hikes to the information return penalties would be effective for returns required to be filed after December 31, 2011.

IMPACT: Penalties would be reduced for qualified small filers (whose average gross receipts do not exceed $5 million). The calendar year maximum first-tier penalty for qualified small filers would be $75,000; the calendar year maximum second-tier penalty would be $200,000; and the calendar-year maximum third-tier penalty would be $500,000.

Electronic Filing

The president proposes, as he did in FY 2010, to require all taxpayers that file Schedule M-3 (Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More) to file their returns electronically. For taxpayers not required to file a Schedule M-3, such as exempt organizations, the president proposes giving the IRS authority to reduce the current threshold for electronic filing from 250 or more returns during the calendar year. The proposal would be effective for tax years ending after December 31, 2010.

Additionally, the president proposes to create an assessable penalty for failure to file electronically where e-filing is mandatory for the corporation or exempt organization. The penalty would be $25,000 for a corporation. Exempt organizations would be liable for a $5,000 penalty. The penalty regime would be effective for returns required to be filed electronically after December 31, 2011.

COMMENT: The 2009 Worker Act requires paid tax return preparers of more than 10 individual federal income tax returns per year to electronically file those returns effective with all returns filed after December 31, 2010.

Employment Taxes

The FY 2011 budget establish standards for holding employee leasing companies, also referred to as professional employer organizations, jointly and severally liable with their clients for federal employment taxes. The president also called for establishing standards for holding employee leasing companies solely liable for employment taxes if certain requirements are met. The proposal would be effective for employment tax returns required to be filed with respect to wages paid after December 31, 2010.

IMPACT: The IRS has identified employment taxes as a lucrative “tax gap” area in which to harvest heretofore untapped revenue. The IRS Small Business/ Self-Employed (SB/SE) Division recently has begun randomly identifying over 1,000 cases for examination under its National Research Program (NRP) related to employment tax issues. That data will help form the selection criteria for more extensive employment tax audits.

FUTA Surtax

The Federal Unemployment Tax Act imposes a 6.2 federal payroll percent tax on the $7,000 wage base. The rate reflects a 5.4 percent credit for state unemployment taxes, a permanent tax rate of 0.6 percent, and a temporary surtax rate of 0.2 percent. The temporary surtax has applied since 1976 and been extended several times, most recently through June 30, 2011. The administration proposes to make the surtax permanent. This will support the continued solvency of federal unemployment trust funds.

Worker Classification

The president proposes to increase certainty with respect to worker classification (employee or independent contractor) by authorizing the IRS to issue generally applicable guidance on the proper classification of workers under common law standards. Moreover, the proposal would reform section 530 of the Revenue Act of 1978 and allow the IRS to require prospective reclassification of workers who are misclassified. The proposal would be effective on enactment. However, prospective reclassification would not be effective until the first calendar year beginning at least one year after the date of enactment.

Independent contractors receiving payments totaling $600 or more in a calendar year from a service recipient would be permitted to require the service recipient to withhold for federal tax purposes a flat-rate percentage of their gross payments. The contractor would select the flat-rate percentage.

IMPACT: The proposal directs the IRS to focus its guidance on industries and jobs where there has been a history of misclassification. Misclassification reportedly will be one of the issues that will be scrutinized within SB/SE’s recently launched employment tax audit program.

Criminal Restitution

Under existing law, court-ordered restitution in criminal tax cases cannot be assessed as a tax. The president proposes, as he did for FY 2010, to allow the IRS to treat court-ordered criminal restitution as tax debt so that collection is easier.

Failure to File

The president proposes to make repeated, willful failures to file a tax return a felony. This treatment would apply to any person who willfully fails to file returns in any three years within any five consecutive years if the aggregated tax liability for the period is at least $50,000.

Bad Check Penalty

The FY 2011 budget clarifies that the bad check penalty applies to electronic checks and other payment forms. The bad check penalty is two percent of the amount of the bad check or money order. If the bad check or money order is for less than $1,250, however, the penalty is the lesser of $25 or the amount of the check or money order.

Statute of Limitations

The president proposes to create an additional exception to the general three-year limitations period for assessments of federal tax liability resulting from adjustments to state or local tax liabilities. The statute of limitations would be extended to the greater of (1) one year from the date the taxpayer first files an amended return with the IRS reflecting adjustments to the state or local tax return or (2) two years from the date the IRS first receives information from the state or local revenue agency under an information sharing agreement.

Offers-in-Compromise

Current law requires taxpayers making lump sum offers-in-compromise (OIC) to provide a nonrefundable payment of 20 percent of the lump sum with the initial offer. If the OIC involves periodic payments, taxpayers must make a nonrefundable payment of the first installment with their initial offer. The president proposes to eliminate the requirement that an initial OIC include a nonrefundable payment of any portion of the taxpayer’s offer.

IMPACT: The nonrefundable payment requirements have been criticized as reducing access to the program for many taxpayers, who often cannot afford the upfront down payment.

IRS Levy Authority For Vendor Payments

The president proposes to expand the levy authority of the IRS in instances where the government purchases or leases goods or services. Current law allows the IRS to levy 100 percent of the payment owed to a federal contractor with unpaid federal tax liabilities for “goods or services sold or leased.” Under the president’s proposal, the IRS would be authorized to issue levies against 100 percent of payments for real estate or other property not specifically considered a good or service. The proposal would be effective for payments made after the date of enactment.

Post-levy due process. The president also proposes to allow the IRS to reduce government payments owed to a contractor prior to a Collection Due Process (CDP) hearing for unpaid employment tax liabilities of the contractor. The proposal would be effective for levies issued after December 31, 2010.

IMPACT: These contractor proposals are in line with the administration’s January 22 memorandum announcing a multiagency initiative to prevent taxpayers delinquent in filing or paying federal income taxes from receiving approvals for bids on government contracts.

Out-of-State Residents

The IRS may offset federal tax refunds to collect delinquent state income tax obligations if the taxpayer resides in the state collecting the tax. The president proposes allowing the IRS to offset federal tax refunds to collect delinquent state income tax obligations wherever the taxpayer resides. The proposal would be effective on the date of enactment.

Source: CCH, a Wolters Kluwer business