In response to a congressional request, GAO reviewed various Internal Revenue Code (IRC) provisions that prohibited deduction of interest expenses associated with borrowing funds to purchase or carry tax-exempt obligations to: (1) determine whether the Internal Revenue Service (IRS) could adequately administer the provisions; (2) quantify potential compliance problems; and (3) evaluate the effects of establishing a total mechanical disallowance rule for corporate taxpayers.

GAO found that IRS could not adequately administer IRC because it could not: (1) verify amounts that individual taxpayers reported for their tax-exempt interest income, since there was no such reporting requirement; (2) determine whether a nonfinancial corporation was subject to the de minimis rule, since it did not require corporations to report separately on the tax form their taxable and tax-exempt assets; (3) evaluate whether large numbers of nonfinancial corporations were properly reporting their circumstances; (4) measure the extent of individual taxpayer compliance with the provision; and (5) has not studied corporate compliance. GAO believes that extending the mechanical disallowance rule to all corporations would aid IRS in administering IRC.

Status Legend:

Review Pending-GAO has not yet assessed implementation status.

Open-Actions to satisfy the intent of the recommendation have not been taken or are being planned, or actions that partially satisfy the intent of the recommendation have been taken.

Closed-implemented-Actions that satisfy the intent of the recommendation have been taken.

Closed-not implemented-While the intent of the recommendation has not been satisfied, time or circumstances have rendered the recommendation invalid.

• Review Pending
• Open
• Closed - implemented
• Closed - not implemented

Recommendations for Executive Action

Recommendation: The Commissioner of Internal Revenue should study the costs and benefits of requiring information reporting for tax-exempt interest income.

Agency Affected: Department of the Treasury: Internal Revenue Service

Status: Closed - Implemented

Comments: IRS TCMP exams will collect some limited information on interest income, but IRS believes it cannot obtain data to do a thorough cost-benefit study.

Recommendation: The Commissioner of Internal Revenue should consider changing Schedule L on the U.S. Corporation Income Tax Return to separately identify tax-exempt securities from other securities.

Agency Affected: Department of the Treasury: Internal Revenue Service

Status: Closed - Implemented

Comments: The tax year 1989 Corporation Tax Form will separately identify tax-exempt securities from U.S. Government securities. Corporate Form 1120, partnership, and 1120-S all changed.