Article summary. Congress has enacted another major tax bill. While the objective was to “reform” and restructure the IRS in response to an outpouring of taxpayer complaints during days of congressional hearings, Congress also took the occasion to clarify some recent tax changes and strengthen taxpayer rights. This article reviews 40 changes of most relevance to church leaders.

On July 2, 1998, President Clinton signed into law the Internal Revenue Service Restructuring and Reform Act of 1998. This comprehensive legislation was designed to “restructure” the IRS to make it more responsive to taxpayers. But it does much more. It provides taxpayers with many new benefits and protections. This feature article will review those provisions of most significance to churches and ministers.

1. Sale of a home owned and occupied for less than two years. Under current law, a taxpayer is able to exclude up to $250,000 ($500,000 if married filing jointly) of gain on the sale of a principal residence. To be eligible, the taxpayer must have owned the home and used it as a principal residence for at least two of the five years prior to the sale. A taxpayer who fails to meet this test because of a change in place of employment, health, or unforeseen circumstances, can exclude a fraction of the gain corresponding to the fraction of two years that he or she owned and occupied the home as a principal residence.

The new law contains a big break for taxpayers. It allows taxpayers who own and occupy their home for less than two years to claim a partial exclusion based on the fraction of $250,000 ($500,000 if married filing jointly), not the fraction of the gain, corresponding to the fraction of two years that they owned and occupied the home as their principal residence.

This provision is effective retroactive to sales occurring after May 6, 1997.

The new law also provides that if a married couple filing a joint return does not qualify for the $500,000 maximum exclusion, the amount of the maximum exclusion that may be claimed by the couple is the sum of each spouse’s maximum exclusion determined on a separate basis. This provision is effective retroactive to sales occurring after May 6, 1997.

2. Roth IRAs. Beginning in 1998 taxpayers can make annual nondeductible contributions of up to $2,000 to a “Roth IRA”. Distributions from such IRAs are not taxed if they are made after a five year “holding period,” and are made as a result of the taxpayer attaining age 59 and 1/2 or older, death, disability, or purchase of a first home. Earnings on Roth IRAs accumulate tax—free. Eligibility for Roth IRAs is phased out for single taxpayers with adjusted gross income of $95,000 to $110,000, and for married taxpayers filing jointly with adjusted gross income of $150,000 to $160,000. A regular IRA may be rolled over to a Roth IRA. Only taxpayers with adjusted gross income of less than $100,000 are eligible for this provision. If you roll over your regular IRA into a Roth IRA prior to 1999, the amount that would have been included in taxable income had the funds been withdrawn (any gain or income in excess of annual contributions) are included in your taxable income over a four—year period. The ten percent penalty on early withdrawals from an IRA does not apply.

The new tax law modifies Roth IRAs in the following ways:

• Four—year income “spread” is elective. Under prior law, taxpayers who rolled over a regular IRA into a Roth IRA in 1998 were required to report as taxable income over a four—year period the amount that would have been included in taxable income had the funds been withdrawn. Generally, this refers to the “gain” in the IRA over and above annual contributions. The new law gives taxpayers the option of “spreading” this income over four years, or reporting it all in 1998. If no election is made, it is assumed that the taxpayer has elected to spread income over four years. In the previous example, Rev. D has the election in 1998 to report the entire gain on the conversion IRA ($25,000) as taxable income in that year instead of spreading it out over four years.

• Death during four—year spread. What happens if a taxpayer who has elected to spread income over a four—year period dies before the end of the four years? Under the new law any amounts remaining to be included in income as a result of a 1998 “conversion” of a regular IRA into a Roth IRA are included in income on the taxpayer’s final tax return. But if a surviving spouse is the sole beneficiary of the Roth IRA, the spouse may include the remaining amounts in his or her income over the remainder of the 4—year period.

• Distributions before the end of the four—year “spread”. Taxpayers who convert a regular IRA into a Roth IRA pay tax on the gain or income they have earned on their IRA, but they are exempt from the 10—percent “early withdrawal” tax that normally applies to withdrawals from an IRA prior to age 59 and 1/2. The new law prevents taxpayers from receiving premature distributions (before the end of the 5—year holding period) from their Roth IRA while avoiding payment of the “early withdrawal” 10—percent tax. If amounts in a Roth IRA that was converted from a regular IRA are withdrawn within the 5—year holding period beginning with the year of the conversion, then, to the extent attributable to amounts that were includible in income due to the conversion, the amount withdrawn will be subject to the 10—percent early withdrawal tax.

• Corrections. In order to assist individuals who erroneously convert regular IRAs into Roth IRAs or for anyreason want to change the nature of an IRA contribution, contributions to an IRA may be transferred in a “trustee—to—trustee” transfer from any IRA to another IRA by the due date for the taxpayer’s return for the year of the contribution. Any such transferred contributions are treated as if contributed to the new IRA. Trustee—to—trustee transfers include transfers between IRA trustees as well as IRA custodians, apply to transfers from and to IRA accounts and annuities, and apply to transfers between IRA accounts and annuities with the same trustee or custodian.

• Maximum IRA contributions. The new law clarifies that an individual may contribute up to $2,000 a year to all of his or her IRAs.

3. Traditional IRAs. The new tax law modifies traditional IRAs in a couple of important ways:

• Spouses who are not active participants in an employer—sponsored retirement plan. Under present law, if a married individual (filing a joint return) is an active participant in an employer—sponsored retirement plan, the $2,000 IRA deduction limit is phased out over the following levels of adjusted gross income (“AGI”):

Taxable years beginning in: Phase—out range

1997 $40,000-$50,000

1998 $50,000-$60,000

1999 $51,000-$61,000

2000 $52,000-$62,000

2001 $53,000-$63,000

2002 $54,000-$64,000

2003 $60,000-$70,000

2004 $65,000-$75,000

2005 $70,000-$80,000

2006 $75,000-$85,000

2007 $80,000-$100,000

The new tax law confirms that an individual is not considered an active participant in an employer—sponsored retirement plan merely because his or her spouse is an active participant. For example, assume that Rev. J is eligible for a church—sponsored retirement plan, but his wife who is employed by a secular business is not. Rev. J’s wife is not an “active participant” in such a plan because her husband is. Rev. J’s phase—out range is described in the above table. His wife’s phase—out range is between $150,000 and $160,000 of adjusted gross income.

This provision is effective for tax years beginning after 1997.

l”Hardship” distributions. Under current law, the 10—percent “early withdrawal” tax does not apply to distributions from an IRA if the distribution is for first—time homebuyer expenses (subject to a $10,000 life—time cap), or for higher education expenses. These exceptions do not apply to distributions from employer—sponsored retirement plans. A distribution from an employer—sponsored retirement plan that is an “eligible rollover distribution” may be rolled over to an IRA. An eligible rollover distribution that is not transferred directly to another retirement plan or an IRA is subject to 20—percent withholding on the distribution. Participants in employer—sponsored retirement plans, including section 403(b) tax—sheltered annuities, have been able to avoid the early withdrawal tax by rolling over “hardship distributions” to an IRA and then withdrawing the funds from the IRA. The new law modifies the rules relating to the ability to roll over hardship distributions from employer—sponsored retirement plans (including section 403(b) annuities) in order to prevent such avoidance of the 10—percent early withdrawal tax. The law provides that distributions from employer—sponsored retirement plans made on account of hardship of the employee are not eligible rollover distributions. However, the new law further clarifies that such distributions will not be subject to the 20—percent withholding rule applicable to eligible rollover distributions.

This provision is effective for tax years beginning after 1998.

4. Capital gains-elimination of 18—month holding period. The Taxpayer Relief Act of 1997 provided lower capital gains rates for individuals. Generally, the 1997 Act reduced the maximum rate on the net capital gain from 28 percent to 20 percent and reduced the 15—percent rate to 10 percent. However, to qualify for these reduced rates, a taxpayer had to hold an asset for more than 18 months prior to sale. This was a major change in the law, since in the past lower capital gains rates were available if an asset had been held for only one year. Beginning in 2001, lower rates of 18 and 8 percent will apply to the gain from certain property held more than five years. The IRS Restructuring and Reform Act of 1998 reduces the 18—month holding period to qualify for the reduced capital gains rates to one year.

This provision takes effect for any tax year beginning after 1997.

5. Education IRAs. Taxpayers were given an important break for education expenses under a law enacted by Congress in 1997-they can contribute up to $500 each year to an “education IRA.” Here is how it works. A taxpayer establishes an education IRA and designates a “beneficiary” (usually, the taxpayer’s child). The taxpayer contributes up to $500 each year into the account, up until the beneficiary’s 18th birthday. Earnings on an education IRA generally accumulate tax—free-provided they are distributed for the post—secondary educational expenses of the beneficiary. Expenses for elementary and secondary school expenses do not qualify. Any balance remaining in an education IRA when a beneficiary attains 30 years of age must be distributed, and the earnings portion of such a distribution will be included in the beneficiary’s taxable income and subject to an additional ten percent penalty tax because the distribution was not for educational purposes.

The IRS Restructuring and Reform Act of 1998 provides that any balance remaining in an education IRA will be deemed to be distributed within 30 days after the date that the designated beneficiary reaches age 30 (or, if earlier, within 30 days of the date that the beneficiary dies). The Act further clarifies that, in the event of the death of the designated beneficiary, the balance remaining in an education IRA may be distributed (without imposition of the additional 10—percent tax) to a contingent beneficiary or to the estate of the deceased designated beneficiary. If any member of the family of the deceased beneficiary becomes the new designated beneficiary of an education IRA, then no tax will be imposed on such redesignation and the account will continue to be treated as an education IRA. However, the new beneficiary must be under 30 years of age for the “rollover,” or change of beneficiary, to be nontaxable.

The new law clarifies that, in order for taxpayers to establish an education IRA, the designated beneficiary must be a life—in—being.

The new law also provides that if any qualified higher education expenses are considered in determining the amount of a distribution from an education IRA that is nontaxable, then no business expense deduction will be allowed with respect to those same education expenses.

These provisions are effective for tax years beginning after 1997.

6. Meals provided for the convenience of the employer. Current law specifies that the value of meals furnished to an employee by his employer is excluded from the employee’s gross income if the meals are furnished on the business premises of the employer and they are furnished for the convenience of the employer. Under what circumstances meals provided on an employer’s premises meet this test has proven to be a difficult question. The IRS Restructuring and Reform Act attempts to provide some clarification by providing that all meals furnished to employees on an employer’s premises are for the convenience of the employer if the meals furnished to at least half of the employees are for the convenience of the employer. Generally, meals are for the convenience of the employer if the employer has a “noncompensatory” business reason for furnishing the meals (for example, there are few if any restaurants nearby, and the employer would have to provide employees with longer lunch breaks if they were not furnished meals at work).

The Code specifies that ministers may not claim an exclusion for meals or lodging furnished for the convenience of an employer in computing their self—employment tax liability. IRC 1402(a)(8).

7. Donations of computer equipment. In computing taxable income, a taxpayer who itemizes deductions generally is allowed to deduct the fair market value of property contributed to a charitable organization. However, in the case of a charitable contribution of inventory, short—term capital gain property, and certain other gifts, the amount of the deduction is limited to the taxpayer’s basis (cost) in the property. The Taxpayer Relief Act of 1997 provided that certain contributions of computers by corporations to educational institutions for use by elementary and secondary school children qualify for an increased deduction. Under this special rule, the amount of the increased deduction generally is equal to the donor’s basis in the donated property plus one—half of the amount of ordinary income that would have been realized if the property had been sold. However, the increased deduction cannot exceed twice the basis of the donated property. To qualify for the increased deduction, the contribution must satisfy various requirements. This special provision expires after the year 2000.

The IRS Restructuring and Reform Act of 1998 clarifies that the increased charitable contribution deduction applies regardless of whether the recipient is an educational organization or some other tax—exempt charitable entity.

This provision is effective as of August 5, 1997.

8. IRS structure and functions. The main focus of the IRS Restructuring and Reform Act of 1998 is to make the IRS more responsive to taxpayers and less vulnerable to abuse. Here are some of the ways the new law accomplishes this objective:

• IRS reorganization plan. During extensive public hearings, Congress found that a key reason for taxpayer frustration with the IRS is the lack of attention to taxpayer needs. At a minimum, taxpayers should be able to receive from the IRS the same level of service expected from the private sector. For example, taxpayer inquiries should be answered promptly and accurately; taxpayers should be able to obtain timely resolutions of problems and information regarding activity on their accounts; and taxpayers should be treated fairly and courteously at all times. In order to make the IRS more “customer” oriented, the IRS is being reorganized. The old 3—tier geographic structure (including a National Office, Regional Offices, and District Offices) is being replaced by a structure that focuses on four groups of taxpayers with similar needs-individual taxpayers, small businesses, large businesses, and the tax—exempt sector. Under this structure, each unit will be charged with end—to—end responsibility for serving its group of taxpayers.

• IRS mission statement. The current “mission statement” of the IRS begins by declaring that the purpose of the IRS is “to collect the proper amount of tax revenue at the least cost.” The new law requires the IRS to revise its mission statement to provide greater emphasis on serving the public and meeting the needs of taxpayers.

• IRS oversight board. The new law provides for the establishment within the Treasury Department of the “Internal Revenue Service Oversight Board”. The general responsibilities of the new Board are to “oversee the IRS in the administration, management, conduct, direction, and supervision of the execution and application of the internal revenue laws.” The Board will be composed of nine members, six of whom must be from the private sector.

9. Study of tax law complexity. Congress noted “a clear connection between the complexity of the Internal Revenue Code and the difficulty of tax law administration and taxpayer frustration.” It further noted that “complexity and frequent changes in the tax laws create burdens for both the IRS and taxpayers. Failure to address complexity may ultimately reduce voluntary compliance.” As a result, the new law requires the congressional Joint Committee on Taxation to provide an analysis of complexity concerns raised by tax provisions of widespread application to individuals and small businesses. The analysis is to include: (1) an estimate of the number and type of taxpayers affected; and (2) if applicable, the income level of affected individual taxpayers.

In addition, the complexity analysis should include, if possible, the following: (1) the extent to which existing tax forms would require revision and whether a new form or forms would be required; (2) whether and to what extent taxpayers would be required to keep additional records; (3) the estimated cost to taxpayers to comply with the provision; (4) the extent to which enactment of the provision would require the IRS to develop or modify regulations and other official guidance; (5) whether and to what extent the provision can be expected to lead to disputes between taxpayers and the IRS; and (6) how the IRS can be expected to respond to the provision (including the impact on internal training, whether the Internal Revenue Manual would require revision, whether the change would require reprogramming of computers, and the extent to which the IRS would be required to divert or redirect resources in response to the provision).

This provision is effective with respect to legislation considered on or after January 1, 1999.

10. Disclosure of income tax returns. The confidentiality of personal income tax returns has become a growing issue in recent years. In 1997 alone, the number of “federal income tax return disclosures” exceeded 3.2 billion! That works out to an average of 32 “disclosures” for the year for each individual tax return. The Act as originally worded would have required the IRS to place “plain English” notices on all tax forms informing taxpayers of the many different ways in which tax return information is disclosed by the IRS. However, a House—Senate conference committee dropped this provision on the ground that language in the current instruction booklets to the main tax forms provides sufficient “notice” to taxpayers. Even though the proposal for more effective disclosure to taxpayers of the nonconfidentiality of their tax returns did not pass, it has raised the issue. More and more taxpayers will now be aware of how common it is for the IRS to disclose personal tax information to others. This in turn will affect the inaccurate public perception that personal tax return data is confidential.

11. Removal of the “scarlet letter.” For many years, the IRS has placed a special code letter (“P”) in its computer systems and tax files to identify tax “protestors”. This letter has been associated with several tax protestor schemes, including the following: (1) contributions to “mail order” or other “sham” churches; (2) “constitutional” exemptions from tax; (3) reducing taxes because of the declining value of the dollar; and (4) reliance on the gold standard. While such schemes have been universally rejected by the courts, many in Congress felt that it was wrong to stigmatize a person for life as a tax protestor. After all, some of these persons eventually abandon their tax protestor position, and why should they continue to be stigmatized with the letter “P”? The new law forbids the IRS to use this designation any more.

12. Payment of taxes. The new law allows taxpayers to pay their taxes with checks payable to the “United States Treasury” instead of the IRS. The idea here is to reinforce the fact that the IRS merely collects taxes on behalf of the federal government.

13. Electronic filing. Each year the IRS publishes a list of forms and schedules that may be electronically filed. During the 1997 tax filing season, the IRS received approximately 20 million individual income tax returns electronically. Under the new law, the stated policy of Congress is to promote “paperless” filing of tax returns, with a long—range goal of providing for the filing of at least 80 percent of all tax returns in electronic form by the year 2007.

14. Due date for certain information returns. Employers are required to file an “information return” (Form W—3) by February 28 of each year reporting the amount of employee wages paid during the previous year. In addition, employers are required to file Form 1096 by February 28 of each year reporting the amount of nonemployee compensation paid during the previous year (to persons who received $600 or more). Under present law, the due date for filing information returns with the IRS is the same whether such returns are filed on paper, on magnetic media, or electronically. The new law provides an incentive to filers of information returns to use electronic filing by extending the due date for filing such returns from February 28 to March 31 of the year following the calendar year to which the return relates.

This provision applies to information returns required to be filed after December 31, 1999.

The new law also requires the Treasury Department to issue a study evaluating the merits and disadvantages, if any, of extending the deadline for providing taxpayers with copies of information returns from January 31 to February 15 (Forms W—2 would still be required to be furnished by January 31).

15. Electronic signatures. Federal tax law requires that tax forms be signed. The IRS will not accept an electronically filed return unless it has also received a Form 8453, which is a paper form that contains signature information on the filer. Obviously, this requirement greatly reduces the convenience and efficiency of electronic filing. The new law requires the IRS to develop procedures that would eliminate the need to file a paper form (Form 8453) relating to signature information. Until the procedures are in place, the provision authorizes the IRS to provide for alternative methods of signing all returns and other documents. An alternative method of signature would be treated identically, for both civil and criminal purposes, as a signature on a paper form.

16. Filing dates for electronically filed returns. Generally, a return is considered timely filed when it is received by the IRS on or before the due date of the return. If the return is mailed by registered mail, the dated registration statement is evidence of delivery. But what about electronically filed returns? When are they filed? The new law requires the IRS to develop rules for determining when electronic returns are deemed filed.

17. Access to account information. Under current law, taxpayers who file their returns electronically cannot review their accounts electronically. The new law requires the IRS to develop procedures under which taxpayers filing returns electronically can review their accounts electronically not later than December 31, 2006-if all necessary privacy safeguards are in place by that date.

18. Civil damages against the IRS for negligence. Under current law, a taxpayer may sue the government for up to $1 million because of an IRS agent’s reckless or intentional disregard of federal tax law in the course of any tax collection activity. The new law allows taxpayers to sue the government for up to $100,000 in civil damages caused by an IRS agent’s negligent disregard of the law. The law clarifies that taxpayers cannot seek civil damages for negligence or reckless or intentional disregard of the law unless they first exhaust their administrative remedies within the IRS.

This provision is effective immediately.

19. Limitation on financial status audits. The IRS selects returns to be audited in a number of ways, including “financial status” audits. Under such an arrangement, IRS agents look for discrepancies between taxpayers’ reported income and their “standard of living.” If the standard of living seems excessive in light of reported income, then several financial questions can be raised in an effort to find unreported income. This technique has been criticized because of the potential for abuse. The new law prohibits the IRS from using financial status or economic reality examination techniques to determine the existence of unreported income of any taxpayer unless the IRS has independent and reasonable proof that there is a likelihood of unreported income.

This provision is effective immediately.

20. Explanation of taxpayers’ rights in interviews with the IRS. Prior to (or at) audit interviews, the IRS must explain to taxpayers the audit process and taxpayers’ rights under that process. In addition, the IRS must explain the collection process and taxpayers’ rights under that process. If a taxpayer clearly states during an interview with the IRS that he or she wishes to consult with a “representative,” the interview must be suspended to allow the taxpayer a reasonable opportunity to consult with the representative. The new law requires that the IRS rewrite Publication 1 (“Your Rights as a Taxpayer”) to more clearly inform taxpayers of their rights (1) to be represented by a representative and (2) if the taxpayer is so represented, that the interview may not proceed without the presence of the representative unless the taxpayer consents.

21. Disclosure of IRS top—secret audit formula. Disclosure of criteria for examination selection. Under current law, the IRS selects returns to be audited in a number of ways, such as through a computerized classification system (the discriminant function (“DIF”) system). The DIF system accounts for about one—third of all audits, but the IRS has refused to disclose any of the details of this system to taxpayers. The new law requires the IRS to add to Publication 1 (“Your Rights as a Taxpayer”) “a statement which sets forth in simple and nontechnical terms the criteria and procedures for selecting taxpayers for examination.” The statement must specify the general procedures used by the IRS, including the extent to which taxpayers are selected for examination on the basis of information in the media or from informants.

The addition to Publication 1 would have to be made not later than 180 days after the date of enactment of the new law.

22. Confidentiality privilege extended to some non—attorney tax professionals. Communications made between an attorney and client are “privileged,” meaning that neither party can be compelled to disclose in court the substance of their confidential conversations. For the privilege to apply, the client must have been meeting with the attorney for legal advice. The IRS also recognizes the attorney—client privilege in tax proceedings. However, no equivalent privilege is provided for communications between taxpayers and other professionals authorized to practice before the IRS, such as CPAs or enrolled agents.

The new law recognizes a new privilege of confidentiality for communications between taxpayers and individuals who are authorized to practice before the IRS. Enrolled agents and CPAs are the tax professionals contemplated by the new law. For the privilege to apply, the professional must be acting within the scope of his or her profession when the communication occurs. Further, the privilege will not apply to criminal proceedings before the IRS.

The purpose of the new privilege is to allow taxpayers to consult with other qualified tax advisors in the same manner they currently may consult with attorneys.

The provision would be effective on the date of enactment.

23. IRS employee contacts. The IRS sends many different notices to taxpayers. Many of these notices do not contain the name and telephone number of an IRS employee the taxpayer can call with questions. This failure has led to untold frustration. The new law addresses this problem by requiring that all IRS notices and correspondence contain a name and telephone number of an IRS employee whom the taxpayer may call. In addition, to the extent practicable and where it is advantageous to the taxpayer, the IRS should assign one employee to handle a matter with respect to a taxpayer until that matter is resolved.

This provision is effective 60 days after the date of the law’s enactment.

24. IRS telephone hotline. The new law requires that all IRS telephone helplines provide an option for any taxpayer to speak with a “live person” in addition to hearing recorded messages.

25. IRS local office telephone numbers. Have you ever experienced the frustration of being unable to find the telephone number for your local IRS office in the telephone directory? Millions have. The new law addresses this problem by requiring each IRS office to list its office telephone number and address in the telephone directory.

26. Approval of IRS levies. Under current law, IRS agents can impose liens, levies or seizures to collect taxes, without a supervisor’s approval (except for the seizure of a taxpayer’s home). The new law requires the IRS to implement an approval process under which any lien, levy or seizure would be approved by a supervisor, who would review the taxpayer’s information, verify that a balance is due, and affirm that a lien, levy or seizure is appropriate under the circumstances. Circumstances to be considered include the amount due and the value of the asset. Failure to follow such procedures should result in disciplinary action against the supervisor or agent.

This provision applies to all future tax collection actions.

27. Changes in levy exemption amounts. Under current law, the IRS can “levy” on all non—exempt property of a taxpayer. This means that the IRS can seize and sell a taxpayer’s property to satisfy an unpaid tax bill. But some property is exempt from this process. Examples include up to $2,500 in value of fuel, provisions, furniture, and personal effects in the taxpayer’s household, and up to $1,250 in value of books and tools necessary for the trade, business or profession of the taxpayer. The new law increases the value of personal effects exempt from levy to $6,250 and the value of books and tools exempt from levy to $3,125. These amounts are indexed for inflation.

This provision is effective for all future collection actions.

28. Waiver of early withdrawal tax for IRS levies on employer—sponsored retirement plans or IRAs. Under current law, a distribution of benefits from any employer—sponsored retirement plan or an IRA generally is includible in gross income in the year it is distributed, except to the extent the amount distributed represents the employee’s after—tax contributions. Distributions from qualified plans and IRAs prior to attainment of age 59 and 1/2 that are includible in income generally are subject to a 10—percent early withdrawal tax, unless an exception applies.

Under current law, the IRS is authorized to levy on all non—exempt property of the taxpayer. Benefits under employer—sponsored retirement plans (including section 403(b) plans) and IRAs are not exempt from levy by the IRS. Distributions from employer—sponsored retirement plans or IRAs made on account of an IRS levy are includible in the gross income of the individual, except to the extent the amount distributed represents after—tax contributions. In addition, the amount includible in income is subject to the 10—percent early withdrawal tax, unless an exception applies.

Congress concluded that the imposition of the 10—percent early withdrawal tax on amounts distributed from employer—sponsored retirement plans or IRAs on account of an IRS levy may impose significant hardships on taxpayers. As a result, the new law provides an exception from the 10—percent early withdrawal tax for amounts withdrawn from any employer—sponsored retirement plan or an IRA that are subject to a levy by the IRS. The exception applies only if the plan or IRA is levied. It does not apply, for example, if the taxpayer withdraws funds to pay taxes in the absence of a levy, or to release a levy on other property.

This provision is effective for future withdrawals.

29. Seizure of personal residences. Under current law, the IRS may seize the property of a taxpayer who neglects or refuses to pay any tax within 10 days after notice and demand. The IRS may not levy on the personal residence of the taxpayer unless (1) the District Director (or the assistant District Director) personally approves in writing, or (2) in cases of jeopardy. There are no special rules for property that is used as a residence by parties other than the taxpayer.

Congress was concerned that seizure of the taxpayer’s principal residence is particularly disruptive for the taxpayer as well as the taxpayer’s family. The seizure of any residence is disruptive to the occupants, and is not justified in the case of a small deficiency. As a result, the new law prohibits the IRS from seizing real property that is used as a residence (by the taxpayer or another person) to satisfy an unpaid liability of $5,000 or less, including penalties and interest.

The new law further requires the IRS to exhaust all other payment options before seizing the taxpayer’s principal residence.

This provision is effective immediately.

30. “Due process” in IRS collection actions. The IRS may collect taxes by “levy” upon a taxpayer’s property (including accrued wages) if the taxpayer neglects or refuses to pay the tax within 10 days after notice and demand that the tax be paid. Notice of the IRS’s intent to collect taxes by levy must be given no less than 30 days before the day of the levy. The notice of levy must describe the procedures that will be used, the administrative appeals available to the taxpayer and the procedures relating to such appeals, the alternatives available to the taxpayer that could prevent levy, and the procedures for redemption of property and release of liens.

Following days of hearings in which taxpayers recounted horror stories of IRS seizures of their property, Congress was convinced that taxpayers are entitled to protections in dealing with the IRS that are similar to those they would have in dealing with any other creditor. Accordingly, the new law establishes formal procedures designed to insure due process where the IRS seeks to collect taxes by levy. As under present law, notice of the intent to levy must be given at least 30 days before property can be seized or salary and wages garnished. During the 30—day notice period, the taxpayer may demand a hearing to take place before an appeals officer who has had no prior involvement in the taxpayer’s case. If the taxpayer demands a hearing within that period, the proposed collection action may not proceed until the hearing has concluded and the appeals officer has issued his or her determination. During the hearing, the IRS is required to verify that all statutory, regulatory, and administrative requirements for the proposed collection action have been met. IRS verifications are expected to include (but not be limited to) showings that (1) the IRS agent recommending the collection action has verified the taxpayer’s liability; (2) the estimated expenses of levy and sale will not exceed the value of the property to be seized; (3) the IRS agent has determined that there is sufficient equity in the property to be seized to yield net proceeds from sale to apply to the unpaid tax liabilities; and (4) with respect to the seizure of the assets of a going business, the IRS agent recommending the collection action has thoroughly considered the facts of the case, including the availability of alternative collection methods, before recommending the collection action.

The taxpayer is allowed to raise any relevant issue at the hearing. Issues eligible to be raised include (but are not limited to): (1) challenges to the underlying liability as to existence or amount; (2) appropriate spousal defenses; (3) challenges to the appropriateness of collection actions; and (4) collection alternatives, which could include the posting of a bond, substitution of other assets, an installment agreement or an offer—in—compromise.

The taxpayer may contest the determination of the appellate officer in Tax Court by filing a petition within 30 days of the date of the determination. The Tax Court is expected to review the appellate officer’s determination for abuse of discretion and also may consider procedural issues, as under present law. The IRS may not take any collection action pursuant to the determination during this 30 day period or while the taxpayer’s contest is pending in Tax Court.

The due process procedures apply to collection actions initiated more than six months after the date of the new law’s enactment.

31. Application of fair debt collection practices. The Fair Debt Collection Practices Act provides a number of rules relating to debt collection practices. Among these are restrictions on communication with the consumer, such as a general prohibition on telephone calls outside the hours of 8:00 a.m. to 9:00 p.m. local time, and prohibitions on harassing or abusing the consumer. In general, these provisions do not apply to the federal government (including the IRS). Congress concluded that the IRS should be at least as considerate to taxpayers as private creditors are required to be with their customers. Accordingly, the new law makes the Fair Debt Collection Practices Act’s restrictions relating to communication with the debtor and the prohibitions on harassing or abusing the debtor applicable to the IRS by incorporating these provisions into the Internal Revenue Code. The restrictions relating to communication with the taxpayer are not intended to hinder the ability of the IRS to respond to taxpayer inquiries (such as answering telephone calls from taxpayers).

This provision is effective immediately.

32. Offers in compromise. The tax code permits the IRS to compromise a taxpayer’s tax liability. An offer—in—compromise is an offer by the taxpayer to settle an unpaid bill for less than the full amount of the assessed balance. There are two bases for making an offer in compromise-doubt as to a tax liability for the amount owed, and doubt as to ability to pay the amount owed. Congress came to the conclusion, following several days of testimony, that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system. Accordingly, Congress concluded that the IRS should make it easier for taxpayers to enter into offer—in—compromise agreements, and should do more to educate the taxpaying public about the availability of such agreements.

The new law modifies the offer in compromise rules in the following ways:

1. National and local schedules of allowances. The IRS must now develop and publish schedules of national and local “allowances” (personal expenses) that will provide taxpayers entering into an offer—in—compromise with adequate means to provide for basic living expenses. The IRS also will be required to consider the facts and circumstances of a particular taxpayer’s case in determining whether the national and local schedules are adequate for that particular taxpayer. If the facts indicate that use of scheduled allowances would be inadequate under the circumstances, the taxpayer would not be limited by the national or local allowances.

2. Low—income taxpayers. The new law prohibits the IRS from rejecting an offer—in—compromise from a low—income taxpayer solely on the basis of the amount of the offer. This provision does not affect the ability of the IRS to reject an offer in compromise made by a taxpayer (other than a low—income taxpayer) because the amount offered is too low. The new law further prohibits the IRS from requesting a financial statement if a taxpayer makes an offer—in—compromise based solely on doubt as to a tax liability.

3. Suspension of levy efforts. The new law prohibits the IRS from collecting a tax liability by levy during any period that a taxpayer’s offer in compromise for that liability is being processed, or during the 30 days following rejection of an offer (and during any period in which an appeal of the rejection of an offer is being considered).

4. Review of an IRS rejection of an offer—in—compromise. The IRS must implement procedures to review all rejections of taxpayer offers in compromise prior to the rejection being communicated to the taxpayer. The IRS must allow the taxpayer to appeal any rejection of such offer to the IRS Office of Appeals. The IRS must notify taxpayers of their right to have an appeals officer review a rejected offer—in—compromise on the application form for an offer in compromise.

5. Publication of taxpayer’s rights with respect to offers in compromise. The new law requires the IRS to publish guidance on the rights and obligations of taxpayers relating to offers—in—compromise.

6. Liberal acceptance policy. Congress instructed the IRS to “adopt a liberal acceptance policy for offers in compromise to provide an incentive for taxpayers to continue to file tax returns and continue to pay their taxes.”

These provisions are effective for all offers in compromise submitted after the date of the new law’s enactment.

33. Guaranteed availability of installment agreements. The tax code currently authorizes the IRS to enter into written agreements with any taxpayer under which the taxpayer is allowed to pay taxes (plus interest and penalties) in installment payments if the IRS determines that doing so will “facilitate collection of the amounts owed”. An installment agreement does not reduce the amount of taxes, interest, or penalties owed. However, it does provide for a longer period during which payments may be made during which other IRS enforcement actions (such as levies or seizures) are suspended. Many taxpayers can request an installment agreement by filing Form 9465. This form is relatively simple and does not require the submission of detailed financial statements. The IRS in most instances readily approves these requests if the amounts involved are not large (in general, below $10,000) and if the taxpayer has filed tax returns on time in the past. Some taxpayers are required to submit background information to the IRS substantiating their application. If the request for an installment agreement is approved by the IRS, a user fee of $43 is charged. This user fee is in addition to the tax, interest, and penalties that are owed.

Congress has concluded that the ability to make payments of tax liability by installment enhances taxpayer compliance. Further, Congress has concluded that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations.

The new law requires the IRS to enter into an installment agreement, at the taxpayer’s option, if

(1) the liability is $10,000, or less (excluding penalties and interest)

(2) within the previous 5 years, the taxpayer has not failed to file or to pay, nor entered an installment agreement under this provision

(3) when requested by the Secretary, the taxpayer submits financial statements, and the Secretary determines that the taxpayer is unable to pay the tax due in full

(4) the installment agreement provides for full payment of the liability within 3 years, and

(5) the taxpayer agrees to continue to comply with the tax laws and the terms of the agreement for the period (up to 3 years) that the agreement is in place.

This provision is effective immediately.

34. Statute of limitations. The “statute of limitations” which defines the period of time during which the IRS must assess additional taxes is generally three years from the date a return is filed (a return filed before the due date is considered to be filed on the due date). Prior to the expiration of the statute of limitations, both the taxpayer and the IRS may agree in writing to extend the three—year period, using Form 872 or Form 872—A. An extension may be for either a specified period or an indefinite period. The statute of limitations for the collection of tax is generally ten years after assessment. Prior to the expiration of the statute of limitations, both the taxpayer and the IRS may agree in writing to extend the statute, using Form 900.

The new law eliminates the provision of current law that allows the statute of limitations on collections to be extended by agreement between the taxpayer and the IRS. The new law also requires that, on each occasion on which the taxpayer is requested by the IRS to extend the statute of limitations on an assessment of tax, the IRS must notify the taxpayer of the taxpayer’s right to refuse to extend the statute of limitations or to limit the extension to particular issues.

These provisions apply to requests to extend the statute of limitations made after the date of the new law’s enactment, and to all extensions of the statute of limitations on collections that are open 180 days after the date of enactment.

35. Relief for innocent spouses. Under current law, each spouse who signs a joint tax return is fully responsible for the accuracy of the return and for the full tax liability. This is true even though only one spouse may have earned the income which is shown on the return. This is “joint and several” liability. A spouse who wishes to avoid joint liability must file as a “married person filing separately.”

Relief from liability for tax is available for “innocent spouses” in certain limited circumstances. To qualify for such relief, the innocent spouse must establish: (1) that a joint return was made; (2) that an understatement of tax, which exceeds the greater of $500 or a specified percentage of the innocent spouse’s adjusted gross income for the most recent year, is attributable to a grossly erroneous item (items of gross income that are omitted from reported income and claims of deductions or credits having no basis in law) of the other spouse; (3) that in signing the return, the innocent spouse did not know, and had no reason to know, that there was an understatement of tax; and (4) that taking into account all the facts and circumstances, it is inequitable to hold the innocent spouse liable for the deficiency in tax. The specified percentage of adjusted gross income is 10 percent if adjusted gross income is $20,000 or less. Otherwise, the specified percentage is 25 percent.

Congress concluded that that the innocent spouse provisions of present law are inadequate, and that it is inappropriate to limit innocent spouse relief only to the most extreme cases where the understatement is large and the tax position taken is grossly erroneous. It also concluded that partial innocent spouse relief should be considered in appropriate circumstances, and that all taxpayers should have access to the Tax Court in resolving disputes concerning their status as an innocent spouse. Finally, Congress concluded that taxpayers need to be better informed of their right to apply for innocent spouse relief in appropriate cases and that the IRS is the best source of that information.

The new law accomplishes these objectives in the following ways:

1. Relief more easy to obtain. The new law eliminates all of the understatement thresholds and requires only that the understatement of tax be attributable to an erroneous (and not just a grossly erroneous) item of the other spouse.

2. Partial relief available. The new law provides that innocent spouse relief may be provided on a partial basis. That is, the spouse may be relieved of liability as an innocent spouse to the extent the liability is attributable to the portion of an understatement of tax which the spouse did not know of and had no reason to know of.

3. Review of denials of relief. The new law specifically provides that the Tax Court has jurisdiction to review any denial (or failure to rule) by the IRS regarding an application for innocent spouse relief.

4. A separate form. The new law requires the IRS to develop a separate form with instructions for taxpayers to use in applying for innocent spouse relief within 180 days from the date of the new law’s enactment. An innocent spouse seeking relief under this provision must claim innocent spouse status with regard to any assessment not later than two years after the date of such assessment.

These provisions are effective for understatements with respect to taxable years beginning after the date of the new law’s enactment.

36. Burden of proof. Under current law, there is a “rebuttable presumption” that any determination of tax liability by the IRS is correct. As a result, taxpayers who challenge IRS determinations have the “burden of proof”. There are a few exception to this rule, in which the IRS has the burden of proof (including fraud and proof of employee status for payroll tax purposes). Congress has concluded that (1) individual and small business taxpayers frequently are at a disadvantage when forced to litigate with the IRS, and that the present “burden of proof” rules contribute to that disadvantage; (2) facts asserted by individual and small business taxpayers who cooperate with the IRS and satisfy relevant recordkeeping and substantiation requirements should be accepted; and (3) shifting the burden of proof to the IRS in such circumstances will create a better balance between the IRS and taxpayers, without encouraging tax avoidance.

The new law addresses these concerns by providing that the IRS will have the burden of proof in any court proceeding with respect to a factual issue if the taxpayer introduces credible evidence relevant to ascertaining the taxpayer’s income tax liability. Four conditions apply:

” The taxpayer must comply with the requirements of the tax code and regulations to substantiate any item.

” The taxpayer must maintain records required by the tax code and regulations.

” The taxpayer must cooperate with reasonable requests by the IRS for meetings, interviews, witnesses, information, and documents (including providing, within a reasonable period of time, access to and inspection of witnesses, information, and documents within the control of the taxpayer, as reasonably requested by the IRS). A necessary element of cooperating with the IRS is that the taxpayer must exhaust his or her administrative remedies (including any appeal rights provided by the IRS). The taxpayer is not required to agree to extend the statute of limitations to be considered to have cooperated. Cooperating also means that the taxpayer must establish the applicability of any privilege.

” Taxpayers (other than individuals) must meet the net worth limitations that apply for awarding attorney’s fees. Corporations, trusts, and partnerships whose net worth exceeds $7 million are not eligible for the benefits of the provision. No net worth limitations apply to individuals.

This provision applies to court proceedings arising in connection with examinations beginning after the date of the new law’s enactment.

37. Suspension of interest and certain penalties if the IRS fails to contact individual taxpayer. Under current law, interest and penalties accrue continuously while taxes are unpaid whether or not the taxpayer is aware there is tax due. In many cases, the interest and penalties eventually exceed the tax liability itself. The new law suspends the accrual of penalties and interest after 18 months if the IRS has not sent the taxpayer a notice of deficiency within 18 months following the date which is the later of (1) the original due date of the return or (2) the date on which the individual taxpayer timely filed the return. The suspension only applies to taxpayers who file a timely tax return. The provision applies only to individuals and does not apply to the “failure to pay” penalty, in the case of fraud, or with respect to criminal penalties. Interest and penalties resume 21 days after the IRS sends a notice and demand for payment to the taxpayer.

This provision is effective immediately.

38. Mitigation of “failure to deposit” penalty. An employer’s deposits of payroll taxes are allocated to the earliest period for which a deposit is due. If an employer misses or makes an insufficient deposit, later deposits will first be applied to satisfy the shortfall for the earlier period. The remainder is then applied to satisfy the obligation for the current period. If the employer is not aware this is taking place, “cascading penalties” may result as payments that would otherwise be sufficient to satisfy current liabilities are applied to satisfy earlier shortfalls.

Congress concluded that the cascading penalty effect is unfair and that employers should be able to designate payments to minimize its effect. As a result, the new law allows employers to designate the period to which each deposit is applied. The designation must be made no later than 90 days after the related IRS penalty notice. The new law also extends the authorization to waive the “failure to deposit” penalty to the first deposit a taxpayer is required to make after the taxpayer is required to change the frequency of the taxpayer’s deposits.

This provision applies to deposits made more than 180 days after the date of the new law’s enactment.

39. Personal delivery of notice of penalty under section 6672. Any person who is required to collect and pay over any tax imposed by the tax code who willfully fails to do so is liable for a penalty equal to the amount of the tax. Before the IRS may assess any such “100—percent penalty,” it must mail a written preliminary notice informing the person of the proposed penalty to that person’s last known address. The mailing of such notice must precede any notice and demand for payment of the penalty by at least 60 days. The statute of limitations on assessments shall not expire before the date 90 days after the date on which the notice was mailed. These restrictions do not apply if the IRS finds the collection of the penalty is in jeopardy.

The imposition of the 100—percent penalty is a serious matter that potentially affects church treasurers and officers. Congress has concluded that permitting personal service of the preliminary notice may afford taxpayers the opportunity to resolve cases involving the 100—percent penalty at an earlier stage. As a result, the new law permits in person delivery, as an alternative to delivery by mail, of a preliminary notice that the IRS intends to assess a 100—percent penalty.

This provision is effective immediately.

© Copyright 1998 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m69 c0598