The National Taxpayer Advocate in her Fiscal Year 2022 report to Congress[13] recognized the importance of international information return (IIR) penalties in fostering voluntary tax compliance. However, the IRS’ systemic assessment of these penalties often produces excessively large penalties disproportionate to any underlying income tax liability. The IRS assesses IIR penalties on returns it considers to be filed late, but more than 55 percent of systemically assessed IRC §§ 6038 and 6038A penalties are abated because the returns were timely because reasonable cause relief was granted, or in situations where the failure-to-file penalty on the related Form 1120 or Form 1065 filing is abated under the First Time Abatement (FTA) provisions or the return has no tax due. Taxpayers and the IRS expend significant time, energy, and money addressing penalties that the IRS should not have assessed. Thus, these systemic assessments are ineffective in promoting taxpayer compliance and do not promote equity and fairness.

Because the penalties are immediately assessed, taxpayers’ recourse is to rely on IRS discretion to grant a reasonable cause abatement of the penalties, request a Collection Due Process proceeding, or pay the assessed penalty and file suit in district court or the Court of Federal Claims seeking a refund. One means of proactively addressing this disadvantage to taxpayers is to send preassessment correspondence, giving potentially impacted taxpayers the opportunity to explain why the IRS should not assess the penalty. This approach would educate taxpayers and minimize the inefficient and burdensome practice of first assessing and then abating these penalties. Further, it would contribute to tax equity by placing the IRS in a better position to distinguish between good-faith mistakes and intentional tax noncompliance.

The Taxpayer Advocate recommended that the IRS send taxpayers a proposed penalty notice to allow them to provide mitigating evidence such as reasonable cause; if timely filed, proof of timely filing; or application of the FTA administrative relief. The Taxpayer Advocate also recommended that the IRS provide taxpayers 60 days to respond to proposed penalty notices and give IRS employees time to review and consider reasonable cause relief, FTA relief, or the issue of timeliness. Finally, the Taxpayer Advocate continues to call for the IRS to reinstitute a penalty-free voluntary disclosure program, similar to the former FAQ 18 of the 2012 Offshore Voluntary Disclosure Program, in which taxpayers will be encouraged to come forward, file delinquent information returns, and be compliant for future years. Specifically address those taxpayers who do not have other tax liabilities besides penalties associated with the missing IIRs, are not under examination, and have not been contacted for the delinquent IIRs.

Nina Olson, the former Taxpayer Advocate, stated that of the current $441 billion gross tax gap estimate by IRS, some portion of the underreporting gap is attributable to errors made as a result of tax law complexity (unknowing noncompliance) and others are attributable to procedural complexity and barriers – for example, where taxpayers are eligible for a deduction or credit but cannot navigate the bureaucracy on their own and cannot afford representation, so they just give up (functional or characteristic noncompliance).[14] She stated that studies estimating the amount of unreported income by the highest-income taxpayers, and proposals to reduce the underreporting component of the tax gap by increased information reporting, along with the Commissioner’s guestimate that the annual tax gap could be as much as $1 trillion, have led policymakers, commentators, and the media to equate the tax gap with tax evasion. She cautioned that the ubiquitous usage of this phrase actually dilutes its meaning and impact because it allows very different types of noncompliance attributable to very different causes to be lumped together. She found that “framing noncompliance as tax evasion not only undermines compliance among the currently compliant, who will begin to feel naïve for complying, but it creates an environment in which tax agency personnel can feel justified in undermining if not outright ignoring taxpayer rights and protections.”

Nina Olson pointed out the IRS’ heavy emphasis on data-matching and rule-based systems, instead of pattern/network recognition algorithms that include feedback loops.[15] The IRS underutilizes financial account data it receives pursuant to FATCA because it cannot match much of it to existing returns. She also uncovered that many IRS systems have high false-positive and abatement rates. The National Taxpayer Advocate has reported that during the 2020 filing season, the IRS “refund fraud filters” selected 3.2 million returns of which approximately 66 percent were false positives. She concluded that the IRS requires a culture shift about how it approaches data and that the IRS must proactively use data to assist taxpayers, avoiding labeling taxpayer returns as “potentially fraudulent” before the IRS has conclusive evidence of fraud because most taxpayer error is not fraud. Regarding the Biden administration’s proposed changes to GILTI, the following three aspects are most impactful: The U.S. shareholder’s entire net CFC tested income will be subject to U.S. tax. The qualified business asset investment (QBAI) exemption that allows 10 percent of the adjusted basis of QBAI to be exempt from GILTI would be repealed.

The IRC section 250 deduction of 50 percent of the global minimum tax inclusion would be reduced to 25 percent, thereby generally increasing the U.S. effective tax rate under the global minimum tax to 21 percent under the proposed U.S. corporate income tax rate of 28 percent. The “global averaging” method for calculating a U.S. shareholder’s global minimum tax would be replaced with a “jurisdiction-by-jurisdiction” calculation. Under the new standard, a U.S. shareholder’s global minimum tax inclusion and, by extension, residual U.S. tax on such inclusion, would be determined separately for each foreign jurisdiction in which its CFCs have operations. As a result, a separate foreign tax credit limitation would be required for each foreign jurisdiction. A similar jurisdiction-by-jurisdiction approach would also apply with respect to a U.S. taxpayer’s foreign branch income. These changes mean that foreign taxes paid to higher-taxed jurisdictions will no longer reduce the residual U.S. tax paid on income earned in lower-taxed foreign jurisdictions.

The Biden proposal would repeal the Base Erosion and Anti-Abuse Tax (BEAT), replacing it with a new rule disallowing deductions to domestic corporations or branches by reference to the low-taxed income of entities that are members of the same financial reporting group (including a member that is the common foreign parent, in the case of a foreign-parented controlled group). Specifically, under the Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) rule, a deduction (whether related or unrelated party deductions) would be disallowed to a domestic corporation or branch, in whole or in part, by reference to all gross payments that are made (or deemed made) to low-taxed members, which is any financial reporting group member whose income is subject to (or deemed subject to) an effective tax rate that is below a designated minimum tax rate. The proposal to repeal BEAT and replace with SHIELD would be effective from 2023.

Written By William Byrnes