In order to achieve a more rational tax code, the tax legislative process should be methodical, thoughtful, and include sufficient time for thorough contemplation of the likely impact of proposed legislation. A model tax legislative process should approach tax law changes with sufficient time for public debate, deliberations, and input from taxpayers and the IRS.
When Congress considers legislation early in the legislative process, and allows ample opportunity for public comment, it can better understand the policy, economic, and administrative effects of proposals. Congress should seek to ensure that all interested parties have a forum to discuss the impact of these proposals. In particular, Treasury should be invited to provide its comments on the policy and economic impact of the proposals, and the IRS should be invited to discuss the administrability of the legislation. While Treasury speaks for the Administration on tax policy issues, the IRS should be the voice of tax administration. As such, Congress must hear from the tax administrator so that it can consider potential implementation problems prior to enactment of tax legislation.
As the voice of tax administration, the IRS should be able to submit legislative recommendations to improve tax administration directly to Congress. In addition, the IRS should work with the tax writing committees to ensure that they have sufficient information to prepare a Tax Complexity Analysis for each legislative proposal. In this regard, the IRS should explain the impact of proposals on forms, instructions, publications, and regulatory guidance. Moreover, the IRS should share its knowledge as to the impact on taxpayer record keeping and compliance burdens, as well as how it will integrate the proposals with its existing examination and collection activities. The IRS also should identify any other foreseeable administrative problems and technology and resource needs resulting from proposed legislation. Finally, the IRS should develop procedures (e.g., a database of its expert employees) to ensure that the right people are involved in the legislative process. While personnel from the National Office may be helpful, a revenue agent from the field may be more appropriate.
Because Congress must consider the impact of its actions on taxpayers, the private sector must have a role in the tax legislative process. The tax writing committees should actively encourage participation of taxpayers and their representatives through hearings and public comment periods. A mechanism enabling the private sector to volunteer its comments to the tax writing committees or the Joint Committee on Taxation should be established whereby the list of the private sector comments is included as part of the committee and conference reports and a listing of such submissions should be distributed to each member of the tax writing committees. The staff of the tax writing committees should make the private sector comments available to any member of Congress. Private sector comments should be available to all Members of Congress, as well as the public.
Tax Complexity Analysis
The Tax Complexity Analysis increases the prominence of tax complexity early in the drafting process, when its consideration is more likely to affect the substance of legislation. Ideally, a Tax Complexity Analysis should be prepared by the sponsor of the legislation. When the President submits legislative recommendations to the Congress, these recommendations also should be accompanied by a Tax Complexity Analysis. The analysis should be prepared before proposals are scored for revenue and distributional impact so as to help guide the estimators as they make assumptions as to the impact of proposals on economic behavior.
Compliance Burden Estimates
The Tax Complexity Analysis should focus on a formal process to be established for informing Congress of the potential magnitude of taxpayer and IRS compliance burdens resulting from proposed legislation. When a House, Senate or conference committee reports any bill that includes a revenue provision, the report could include the compliance cost estimates. Similarly, any amendment to a revenue bill could be subject to a point of order unless a compliance cost estimate was provided at the time of its consideration and compliance estimates should be required for conference reports or floor amendments.
Burden estimates, for example, might require specific cost estimates for each tax provision that is estimated to either increase or decrease federal revenues by $100 million. The $100 million threshold could be indexed for subsequent inflation. A qualitative assessment of compliance costs could also be presented when the estimated Federal revenue effect of a provision is less than $100 million in any fiscal year. The analysis should contemplate including cost estimates for such provisions where costs are disproportionate to the change in revenues. For example, offsetting revenue effects within the same provision may result in a net revenue impact that is close to neutral. In this instance, the revenue effect of one part of the provision before netting could exceed $100 million for one class of taxpayers.
The information provided should allow Congress to better understand not only aggregate costs, but also the cost per taxpayer and the Federal costs per dollar of revenue raised. The presentation format could include fiscal year revenue effect, number of taxpayers affected, taxpayer compliance costs, and IRS administrative costs. The costs to be considered should be the direct costs that taxpayers or the IRS would spend to comply with the proposed changes. Any costs that the taxpayer is already bearing under the current system of taxation would not need to be counted again. Such estimates already apply to the IRS when new regulations are proposed or finalized, and the IRS already must estimate its own staffing requirements when implementing new legislation and provide estimates for tax forms showing the time required to maintain records, learn about the operation of the law, and complete the tax forms. While compliance estimating may require additional Joint Committee on Taxation staff and space, the Commission believes that this cost is inconsequential when compared with the enormous burden imposed upon taxpayers today.
As technology has changed and the United States is able to transform to a more paperless society, the IRS must be given the tools to adapt through the ability to enter into cooperative agreements for tax administration. The ability of the IRS to enter into tax administration agreements with state taxing authorities would reduce the burden on the public as well as on tax agencies, improve the efficiency of tax administration at all levels by better utilizing available resources, and increase the collection of delinquent federal and state taxes. Also, the IRS could increase the availability of walk-in assistance through shared federal and state facilities. Significant improvement in the level of taxpayer service already has been seen in Idaho where shared state and federal facilities have been implemented.
The following list is a compendium of simplification proposals that have been advanced by various stakeholder groups and academics, including the American Bar Association, the American Institute of Certified Public Accountants, and the Tax Executives Institute. In addition, the list includes a number of proposals announced by Treasury on April 14, 1997, and April 23, 1997. All of these provisions will affect tax policy, progressivity, and revenues to varying degrees, but could be used by the tax writing committees so that the frustrations of millions of taxpayers can be ameliorated. Accordingly, these simplification proposals are forwarded, without endorsement, to the Committee on Ways and Means and the Committee on Finance.
Avoid hidden tax rates
One of the more perverse creations of the Tax Reform Act of 1986 was the phase-out. The "bubble," which was a phase-out of the fifteen percent rate bracket, subjected taxpayers with less taxable income to higher marginal rates than taxpayers with higher taxable income. The "bubble" was replaced in 1990 with phase-outs of itemized deductions and phase-outs of personal exemptions. While phase-outs are intended to increase progressivity by increasing the tax burden of higher income taxpayers, they create a range of marginal rates that can apply to taxpayers with identical economic income. Rather than using phase-outs, which can be complicated to apply and serve as disguised rate increases, Congress could establish rate schedules that reflect actual economics.
In its quest to target benefits narrowly and prevent specific abuses, Congress often writes new definitions when existing definitions could be used instead. The resulting complexity caused by these overlapping definitions tends to generate additional taxpayer frustration. For example, the Internal Revenue Code currently defines "dependent" at least five different ways—for purposes of determining filing status, calculating the "kiddie tax," qualifying for the earned income tax credit and dependent care credit, and determining personal exemptions. In addition, recent proposals for a nonrefundable child credit would establish yet another definition. While all of these programs have somewhat differing goals, Congress could provide significant simplification for most individuals and the IRS by harmonizing the definitions.
A second example of overlapping definitions can be found in the various versions of ownership attribution rules scattered throughout the Internal Revenue Code. In each instance, the purpose of the attribution rules is to identify whether ownership is deemed to exist due to the presumed relationship between the actual owner and the taxpayer. Congress could provide significant simplification for many businesses and the IRS by establishing one set of ownership attribution rules that would identify ownership based on family relationships, entity relationships, and ownership of options.
Many provisions, including standard deductions, personal exemptions, and income brackets, are indexed for inflation. However, these provisions are not adjusted consistently because the law requires different reference years and rounding conventions. Congress first enacted indexing because the failure to index for inflation results in tax increases each year. Nevertheless, more consistency will lead to less complexity.
A significant source of complexity and taxpayer frustration is the regular expiration (and sometimes, retroactive reenactment) of temporary provisions of the Internal Revenue Code. For example, the exclusion from gross income for certain employer provided educational assistance under section 127 of the Internal Revenue Code has been extended nine times since its enactment in 1978. When section 127 expired and then was extended retroactively in 1996, Congress narrowed the provision by eliminating the preference for graduate education; at the time of writing this report, the provision has expired yet again. Even though temporary provisions often are reenacted, their temporary nature creates unnecessary uncertainty and complexity for taxpayers and the IRS.
Return free filing
Congress should consider whether it is appropriate to continue to place the burden of calculating taxes each year on the American taxpayer, or whether it should shift this responsibility and burden to the government, which could be facilitated by offering a return free system. At least thirty-six countries maintain alternative filing systems, including several of the United States largest trading partners. Most of these countries employ a final withholding system, in which individuals do not file returns because their employers withhold the total amount due through the payroll system. Two countries, Denmark and Sweden, have gone further, establishing tax reconciliation systems in which the tax agency calculates individuals’ tax returns on the basis of information reporting, and sends bills or refunds to taxpayers each year during the filing season.
In an October 1996 report, the GAO estimated that as many as 51 million individuals would not have to prepare any tax returns at all if the IRS were able to establish a tax reconciliation system. The basic concept is for the IRS to produce an account statement for individuals on the basis of income reported on information returns and information on filing status and dependents. The IRS would mail the account statements to taxpayers, indicating their balance. Taxpayers then would review their statements, notify the IRS if they agreed, or submit a return indicating corrections. The GAO estimated that this approach would save taxpayers at least 155 million hours annually preparing their returns, as well as millions of dollars of fees paid to tax return preparers, and would reduce IRS return processing and compliance costs. To implement such a system, however, the IRS would need to receive accurate information returns electronically and substantially improve its information technology capabilities. Moreover, to expand the pool of eligible individuals, Congress would have to take steps to simplify the tax code, particularly by harmonizing the overlapping definitions of "dependent."
Individual Tax Simplification
Establish a family allowance
The proposal would consolidate the present law standard deduction, personal exemption, dependent care credit, earned income tax credit, and the proposed child credit into one "family allowance," the amount of which generally would equal the sum of the benefits provided through programs that it would replace. The proposal would retain the additional standard deductions for elderly and blind taxpayers. The allowance, which would be indexed for inflation, would not be phased out. By consolidating five programs into one allowance, and by eliminating the phase-out thereof, this proposal could eliminate much of the complexity that most working individuals face each tax season. Instead of determining eligibility under various programs, taxpayers would determine the amount of their allowance from tables indicating amounts for single and married filers with and without dependents. Taxpayers electing to itemize their deductions would be entitled to a reduced family allowance. Finally, the proposal would simplify the definition of dependent to include a child (natural, adopted, or foster) or grandchild if under age 19 (or 24 if full-time students), if the child resides with the taxpayer for more than one half of the year, or as any other person currently qualifying as a dependent under the support test of section 151 of the Internal Revenue Code.
Simplify itemized deductions
The proposal would replace current itemized deductions with a reduced family allowance for individuals taking deductions for qualifying mortgage interest, charitable contributions, and state and local taxes. These three remaining deductions would be allowed on the Form 1040, thereby eliminating the Schedule A. Moreover, by extending the availability of the three remaining deductions to all individuals and eliminating the phase-out of certain itemized deductions, the proposal creates greater equity in the tax law.
Simplify the earned income tax credit
The earned income tax credit (EITC), which was established in 1975 as a means of incenting workforce participation by individuals below the poverty line, has been difficult to administer for the IRS. A recently released study of the EITC indicates that its high overpayment rate is due, in part, to the complexity of the credit. A number of proposals have been advanced to simplify the EITC and reduce its overpayment rate. For example, on April 23, 1997, Treasury announced a package of eight proposals to improve the operation of the EITC. In addition, the American Tax Policy Institute sponsored a study of the EITC in 1993, which suggested alternative designs for the program in addition to improvements in the current design. Congress and the President should work together to simplify the EITC, maintain its high participation rate, and reduce its overpayment rate to below ten percent.
Simplify the kiddie tax
The proposal would remove the linkage to parents’ and siblings’ taxable income for purposes of calculating the kiddie tax, and instead subject the unearned income of children under the age of fourteen to the fiduciary income tax rates. In addition, the proposal would expand the election for parents to include their children’s income on their return, with appropriate changes to avoid problems that may be encountered when matching with information returns.
Relief for sale of principal residence
The proposal would establish an exclusion of up to $500,000 of gain from the sale of a principal residence in lieu of the current law rollover provision and one-time exclusion for taxpayers over the age of 55. By establishing a $500,000 exclusion, this proposal eliminates the necessity for most homeowners to maintain records on the basis of their principal residence and continues the legislative goal of encouraging home ownership.
De minimis exception to passive loss limitation
The proposal would permit individuals to deduct losses from passive activities to the extent that they do not exceed $1000. By eliminating unduly burdensome computational and record keeping requirements for individuals with de minimis amounts of passive losses, the proposal provides simplification for many individuals.
Optional self-employment tax contributions
The proposal would allow all individuals to elect to increase their self-employment income for purposes of obtaining Social Security Insurance coverage. By extending the availability of the current rule to taxpayers other than farmers, the proposal creates greater fairness in the tax law.
Simplify mileage allowances
The proposal would replace existing mileage allowances with a business and a nonbusiness mileage allowance schedule. By consolidating mileage allowances, this proposal would simplify tax calculations for many individuals.
Simplify interest expense deductibility
The proposal would replace the deductions for investment interest and home equity indebtedness interest with a deduction for personal interest on obligations up to an aggregate value of $100,000. By eliminating the tracing requirement currently imposed on investment interest, the proposal vastly simplifies the personal interest deduction.
Business Tax Simplification
Allow certain businesses to elect independent contractor classification
The proposal would allow certain businesses to elect to treat service providers as employees or independent contractors. Businesses electing independent contractor treatment would be required to withhold on payments to covered individuals. The Secretary would be required to establish tables for withholding, which would reflect amounts required for income and self-employment taxes. By providing an election, the proposal allows many businesses to avoid the uncertainty of the present law definition. Moreover, by establishing a withholding regime, the proposal could eliminate the need for many service providers to file estimated tax returns.
Establish straight-line depreciation
The proposal would require the use of the straight-line method for calculating depreciation, and would provide for shorter recovery periods. By eliminating the numerous methods permitted under current law, this proposal simplifies record keeping and tax preparation for millions of businesses. Moreover, use of the straight-line method broadens the tax base, eliminating many of the concerns underlying the present law alternative minimum tax.
Harmonize attribution rules
The proposal would replace all existing ownership attribution rules with one set of rules to cover family attribution, entity attribution, and option attribution. By eliminating the existing overlapping definitions, the proposal simplifies many calculations for millions of taxpayers.
Simplify hedging rules
The proposal would codify the existing hedging regulations and establish additional categories of ordinary assets to ensure that business property is treated as ordinary property. By eliminating the uncertainty created by the Supreme Court’s decision in Arkansas Best, the proposal would modernize the hedging rules to reflect current business practices.
Repeal collapsible corporation rules
The proposal would repeal section 341 of the Internal Revenue Code, which recharacterizes the gain recognized upon the sale or liquidation of stock in a collapsible corporation as ordinary income. Because the statutory purpose of this statute was rendered obsolete by the complete repeal of the General Utilities doctrine in the Tax Reform Act of 1986, elimination of these complex rules will simplify tax planning for closely held businesses.
Simplify like-kind exchanges
The proposal would replace the existing like-kind exchange rules with an exclusion for gain on the disposition of business or investment property if the taxpayer uses the proceeds to obtain replacement property that is similar or related in service or use. By eliminating the necessity to locate a third party, the proposal provides taxpayers with greater flexibility and eliminates unnecessary complexity, uncertainty, and transactional costs.
Simplify personal holding company rules for consolidated groups
The proposal would repeal the requirement of section 542(b)(2) of the Internal Revenue Code that imposes separate company income testing on each member of a consolidated group. This proposal furthers general principles of consolidation and equalizes the tax treatment of all corporations subject to the personal holding company tax.
Modify look-back method for long-term contracts
The proposal would allow taxpayers to elect not to apply the look-back method with respect to long-term contracts if for each prior contract year, taxable income computed using estimates was within 10 percent of actual taxable income.
Index the accumulated earnings credit
The proposal would increase the accumulated earnings credit to reflect current dollars, and index the limit prospectively. By adjusting the limit for inflation, the proposal furthers equity and eliminates the potential for annual tax increases that do not reflect economic reality.
Estate and Gift Simplification
Gift return exclusion
The proposal would repeal the requirement of filing a gift tax return for charitable gifts that are deductible under section 2522 of the Internal Revenue Code. Because these gifts are deductible, no gift tax arises on covered transfers to charity. By eliminating the requirement of filing a gift tax return for transfers that do not give rise to the gift tax, the proposal simplifies the tax treatment of charitable giving.
Repeal of throwback rules for domestic trusts
The proposal would repeal the throwback rules applicable to domestic trusts. Changes made to the fiduciary income tax brackets by the Tax Reform Act of 1986 largely eliminated the potential abuses targeted by these rules. By eliminating the application of these obsolete provisions to domestic trusts, the proposal eliminates the complex tax calculations and record keeping burdens imposed on trust fiduciaries and beneficiaries.
Unified credit portability
The proposal would allow the surviving spouse to utilize the unused unified credit and generation skipping transfer exemption of the first-to-die spouse. By eliminating the necessity of using lifetime hedging gifts and trusts, this proposal ensures that married persons can utilize the maximum exemptions permitted by law without incurring extensive estate planning costs.
Repeal special rule applicable to charitable lead annuity trusts
The proposal would repeal section 2642(e) of the Internal Revenue Code, which imposes special rules on charitable lead annuity trusts for purposes of calculating the generation skipping transfer tax. By revoking a rule that rarely, if ever, applies, this proposal eliminates unnecessary complexity and simplifies the tax treatment of charitable giving.
Repeal use of Crummey powers
The proposal would amend Chapter 12 of the Internal Revenue Code to repeal the use of Crummey powers, which treat certain transfers in trust as completed gifts of present interests if the beneficiary is provided a period (typically 30 days) during which to demand outright possession of the property transferred in trust. By eliminating the use of complicated trusts and the application of a rule that rarely is used, the proposal would simplify tax planning for many individuals.
Repeal special rule for transfer of appreciated property in trust
The proposal would repeal section 644 of the Internal Revenue Code, which is intended to prevent the use of trusts to avoid tax on capital gain at high marginal rates. Changes made to the fiduciary income tax brackets by the Tax Reform Act of 1986 largely eliminated the potential abuses targeted by these rules. By eliminating this obsolete provision, this proposal simplifies the computation of fiduciary tax returns.
Simplify treatment of direct skips that are nontaxable gifts
The proposal would repeal section 2642(c) of the Internal Revenue Code, which disallows the $10,000 annual exclusion for generation skipping transfer tax purposes for certain transfers in trust. The current provision discourages direct skips in trust, but does not apply to direct skips of cash. By simplifying the treatment of these nontaxable gifts, this proposal eliminates unnecessary complexity and provides taxpayers with flexibility to provide the gifts outright or in trust.
Clarify treatment of certain disclaimers
The proposal would clarify that transfer-type disclaimers qualifying under section 2518(c)(3) of the Internal Revenue Code are treated the same as all other qualified disclaimers for income and gift tax purposes. Because current law is silent as to the treatment of these disclaimers, this proposal provides greater certainty to affected beneficiaries.
Simplify treatment of certain short-term OID obligations
The proposal would conform the treatment of short-term original issue discount obligations held by nonresident aliens for income and estate tax purposes. By exempting the income from these obligations from the estates of nonresident aliens, this proposal eliminates a trap for unwary investors who die while holding these obligations.
Emphasize compliance over penalties
This proposal would exempt employers who discover and correct inadvertent violations of plan qualification requirements from penalties for those violations, if the correction is not made in response to an IRS notice of examination. By encouraging employers to maintain and monitor qualified plans and eliminating penalties for employers that correct their own errors, this proposal facilitates greater compliance.
Facilitate communication with plan participants
The proposal would allow employers to deliver participant notices, other forms of plan communication, and plan transactions by electronic or other means, provided that any participant may obtain a paper copy upon request. The Secretary would be authorized to promulgate regulations to ensure privacy and security of such communications.
Simplify top-heavy rules
The proposal would amend section 416(c)(2) of the Internal Revenue Code to allow top-heavy plans to satisfy the minimum contribution requirement by providing a matching contribution in an amount equal to employee contributions, up to four percent of the participant’s compensation.
Repeal prohibition on certain qualified plan loans
The proposal would allow sole proprietors, partners, and S corporation shareholders to take loans from a qualified plan subject to the same rules applicable to other plan participants. By providing parity among all plan participants, this proposal encourages individuals to save for retirement without fear of plan disqualification or imposition of the 10 percent excise tax on prohibited transactions.
Design-based safe harbor for minimum distributions
The proposal would establish a design-based safe harbor for minimum distributions, allowing taxpayers to elect to receive annual distributions equal to 10 percent of the account balance on the required beginning date. By simplifying the calculation of minimum distribution amounts, this proposal minimizes the possibility of incurring harsh penalties or plan disqualification.
Repeal application of nondiscrimination rules to governmental plans
The proposal would amend sections 401 and 403 of the Internal Revenue Code to repeal the application of various nondiscrimination rules to governmental plans. Since 1977 these rules have not been applied to governmental plans by the IRS because these plans have broad, almost universal coverage. Moreover, application of these rules to governmental plans could be unduly burdensome on state and local governments.
Simplify post death distributions
The proposal would eliminate the distinction between distributions that begin before or after the death of a participant in a qualified retirement plan. By repealing unnecessarily complex rules, this proposal provides a consistent and simplified approach to post death distributions, minimizing the potential for imposition of harsh penalties or plan disqualification.
The proposal would eliminate the prohibition of incorporated entities from partnership treatment and would allow subchapter S corporations to convert to partnership status without recognizing gain. An S corporation could convert without recognizing gain if it does not have accumulated C corporation earnings and profits or C corporation built-in gain, or if it elects to recognize gain on the conversion. By allowing corporations to elect partnership treatment, the proposal minimizes the impact of the tax law on choice of entity. Moreover, the election allows taxpayers to avail themselves of the more flexible partnership rules without paying the transaction costs of a conversion from subchapter S.
The proposal would define the terms "general partner" and "limited partner," using a material participation standard to distinguish between the two terms. By defining these terms, which are used to determine income and payroll tax liability, as well as passive loss limitations, the proposal provides certainty for taxpayers engaged in business through limited liability companies, limited liability partnerships, and other state law entities classified as partnerships for federal tax purposes whose owners are not denominated as general or limited partners under local law.
Simplified rules for electing large partnerships
The proposal would establish special rules for partnerships with more than 250 partners, or partnerships with more than 100 partners upon election by the partners, including simplified pass-through of partnership items, computations at the partnership level, and adjustment of items at the partnership level. In addition, the proposal would require large partnerships to furnish Schedules K-1 to their partners before the earlier of (1) three and one-half months following the close of the partnership’s taxable year, or (2) two and one-half months following the close of the calendar year in which the partnership’s taxable year ends.
Clarify the definition of liability
The proposal would codify the definition of "liability," as it was defined in temporary regulations issued in 1988. Because the term "liability" is central to many operative provisions of subchapter K, the proposal eliminates uncertainty for many partnerships.
Repeal excise tax on transfers to foreign partnerships
The proposal would repeal the excise tax imposed by section 1491 of the Internal Revenue Code and replace it with deemed royalty rules similar to section 367 of the Internal Revenue Code (which applies to transfers of appreciated property to foreign corporations). By replacing the excise tax with an income tax, the proposal eliminates the harshness of present law without compromising the flexibility of taxpayers to enter into cross-border transactions.
Simplify partnership allocation rules
The proposal would provide that allocations attributable to nonrecourse liabilities must be paid in accordance with the partners’ interest in the partnership. By simplifying the partnership allocation rules, and ensuring that allocations of partnership items reflect the economic substance of the partnership relationship, the proposal eliminates unnecessary complexity for many partnerships.
Closing of partnership year with respect to deceased partner
The proposal would close the taxable year of the partnership with respect to a partner whose entire interest terminates, whether by death, liquidation, or otherwise. By aligning the treatment of deceased partners, the proposal provides uniform treatment for partners whose entire interest in a partnership terminates.
Simplification of partnership termination rules
The proposal would modify section 708(b)(1)(B) of the Internal Revenue Code to provide that a partnership terminates only upon the sale or exchange of 50 percent or more of the interests in the partnership, if the interests are sold or exchanged in one transaction, or a series of related transactions. By eliminating the potential for inadvertent terminations of partnerships and incorporating the step transaction doctrine, this proposal ensures that a technical termination of a partnership only results from the coordinated sale or exchange of one half of the interests in the partnership.
Simplification of partnership distribution rules
The proposal would modify the rules relating to distributions of partnership property to require adjustments to partnership basis in remaining partnership property following distributions of partnership property that reduce the partner’s interest. In addition, the proposal would modify the rules relating to distributions of stock to a corporate partner, to require the corporation whose stock was distributed to reduce the basis of its assets if the corporate partner owns 80 percent by vote or value of the stock distributed.
Simplify foreign partnership reporting requirements
The proposal would clarify that a foreign partnership engage in a United States trade or business is required to file a return, require annual information reporting by United States partners of controlled foreign partnerships, and conform the reporting rules and penalties relating to changes in ownership and transfers to foreign partnerships to those applicable to foreign corporations. By rationalizing the reporting requirements of foreign partnerships and eliminating distinctions between requirements applicable to foreign corporations, these proposals simplify administration in this area.
Clarify partnership debt-equity rule
The proposal would clarify that a partnership realizes cancellation of indebtedness income upon the transfer by the partnership of a partnership interest to a creditor in satisfaction of a debt. By providing a rule that mirrors the treatment of corporate stock for debt exchanges, the proposal clarifies the law of partnerships in bankruptcy and provides greater parity among the tax treatment of business entities.
Clarify the statute of limitations for pass-through entities
The proposal would clarify that the individual’s return, not the pass-through entity’s return, starts the running of the statute of limitations. By codifying the rule established by the Supreme Court for S corporations in Bufferd, the proposal provides certainty for partnerships, S corporations, and certain trusts.
Financial Products Simplification
The proposal would repeal section 1504(b)(2) of the Internal Revenue Code, and related provisions, to allow life insurance companies maximum ability to file consolidated returns.
Safe harbor for captive insurance companies
The proposal would establish a safe harbor providing that insurance premiums paid to a wholly-owned subsidiary are deductible provided such premiums, combined with any other premiums paid by related parties, do not exceed 50 percent of the total premiums received by the captive insurer for the taxable year. By providing a safe harbor for determining the nature of captive insurers, this proposal provides much needed certainty and should eliminate costly litigation in this area.
Simplify application of policy interest rates
The proposal would modify section 808(d)(1)(B) of the Internal Revenue Code to require use of the greater of the prevailing State assumed rate or the applicable federal rate for purposes of calculating excess interest. By eliminating inconsistencies in the calculations of policy interest rates, the proposal simplifies taxpayers’ recordkeeping requirements.
Safe harbor permitting RICs to avoid PFIC treatment
The proposal would establish a safe harbor under which regulated investment companies (RICs) would be relieved of the onerous burden of determining whether foreign investments are treated as passive foreign investment companies. If a RIC owns less than 10 percent of the outstanding stock of a foreign company and less than 5 percent of the RIC’s assets are invested in the holding, a RIC would not be required to apply the PFIC rules. By providing this safe harbor, this proposal simplifies the tax treatment of RICs significantly.
Simplify exchange rates used in translating foreign taxes
The proposal would simplify the rules for translating foreign tax payments into dollar amounts by providing for translation using average exchange rates for the taxable year to which the taxes relate. By reducing the amount of time necessary to calculate deemed paid foreign tax credits, this proposal simplifies recordkeeping and administration of these rules.
Simplify foreign tax credit limitation for individuals
The proposal would allow taxpayers with no more than $300 ($600 in the case of joint returns) of creditable foreign taxes, and no foreign source income other than passive income, to claim their foreign tax credit directly on Form 1040 if the income is shown on a payee statement. By eliminating the necessity to complete the complex Form 1116, this proposal simplifies the treatment of passive foreign income that is subject to information reporting.
Simplify rules applicable to dispositions of interests in controlled foreign corporations
The proposal would simplify the treatment of income derived from the disposition of stock in a controlled foreign corporation, including deemed dividend treatment for gains on dispositions of lower-tier controlled foreign corporations, proportional reduction in the taxation of subpart F income in the year of disposition for acquiring United States shareholders, and repeal of the limitation on look-through treatment of certain dividends to United States shareholders out of earnings from periods during which the recipient was not a United States shareholder. By rationalizing these rules, these proposals greatly simplify the operation of controlled foreign corporations.
Tentative carryback adjustments for foreign tax credits
The proposal would extend the application of section 6411 of the Internal Revenue Code, which allows taxpayers to file an application for tentative carryback and refund adjustments, to foreign tax credit carrybacks.
Eliminate PFIC/CFC overlap
The proposal would eliminate the overlap of the passive foreign investment company (PFIC) and controlled foreign corporation (CFC) rules by treating a PFIC that is also a CFC as if it is not a PFIC with respect to its 10 percent United States shareholders. By eliminating the unnecessary and duplicative overlap of these rules, this proposal eliminates complex calculations for taxpayers already subject to the complexity of subpart F.
Simplify foreign tax credit limitation baskets
The proposal would merge all 10-50 corporation foreign tax credit limitation baskets into a single 10-50 basket, except those associated with passive foreign investment companies. By reducing the complexity and compliance burdens of taxpayers owning between 10 and 50 percent of a foreign corporation, this proposal reduces the bias against participation in foreign joint ventures by United States companies through affiliates that are not majority owned.
Repeal high-tax kick out rule
The proposal would repeal section 904(d)(2)(A)(iii)(III) of the Internal Revenue Code, which excludes any high-taxed income from the foreign source passive income basket used to calculate the foreign tax credit. By eliminating a significant source of complexity in the calculation of foreign tax credits, the proposal simplifies the treatment of passive foreign investments.
Regulatory authority for same country exception
The proposal would permit the Secretary to issue regulations under section 954(c)(3)(A) of the Internal Revenue Code, treating certain countries or possessions as a single country for purposes of the same country exception of subpart F. This authority would allow multinational companies to consolidate their operations in covered countries or possessions when such countries or possessions participate in common markets.
Mark-to-market election for PFIC shareholders
The proposal would allow shareholders of passive foreign investment companies with "marketable" stock to avoid application of the interest-charge method by electing to mark their PFIC shares to market annually. By allowing taxpayers who are unable to use the present law current inclusion method, this proposal provides greater flexibility to investors in passive foreign investment companies.
Elimination of uniform capitalization rules applicable to certain foreign corporations
The proposal would eliminate the application of the uniform capitalization rules of section 263A of the Internal Revenue Code to foreign corporations that do not conduct business in the United States. By eliminating the requirement of uniform capitalization inventory adjustments for these corporations, this proposal significantly simplifies the calculation of earnings and profits of foreign subsidiaries.
Repeal of sailing permit requirement
The proposal would repeal the requirement for aliens to obtain a certificate ("sailing permit") from the IRS district director prior to departure from the United States. By replacing a rule that often is ignored by taxpayers and the IRS with a requirement that aliens file a year-to-date tax return within 90 days of their permanent departure from the country, this proposal simplifies the tax treatment of departing aliens.
Simplify application of trading safe harbor
The proposal would repeal section 864(b)(2)(C), which prohibits the use of a principal office within the United States for purposes of qualifying for the securities and commodities safe harbors. Current law has the effect of shifting certain administrative jobs from the United States to foreign tax havens, and generally increases the cost of operating investment funds designed to attract foreign investors, but does not serve to prohibit any tax abuse.
Election to calculate earnings and profits using GAAP
The proposal would allow taxpayers to calculate the earnings and profits of foreign corporations using generally accepted accounting principles (GAAP). This election would allow taxpayers to avoid expensive and time consuming adjustments.