Tax Policy:

Deducting Interest on Funds Borrowed to Purchase or Carry Tax-Exempt Bonds

GGD-89-14: Published: Dec 19, 1988. Publicly Released: Dec 19, 1988.

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Jennie S. Stathis
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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.

Recommendations for Executive Action

  1. 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 study the costs and benefits of requiring information reporting for tax-exempt interest income.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. 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.

    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


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