Tax Policy:

Options for Civil Penalty Reform

GGD-89-81: Published: Sep 6, 1989. Publicly Released: Oct 11, 1989.

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Pursuant to a congressional request, GAO analyzed changes to the civil penalty provisions of the Internal Revenue Code proposed in a congressional bill and an Internal Revenue Service (IRS) report, focusing on whether the economic value of the penalty, its potential coverage, and its assessment criteria could effectively motivate taxpayer compliance and deter noncompliance.

GAO found that: (1) both the legislation and IRS report recommended changes to restructure and better rationalize the existing penalty system; (2) the existing penalty system was not time-sensitive, since it penalized late filers by the same amount regardless of when they submitted their returns; (3) although both the legislation and IRS report proposed a new compliance incentive to encourage more prompt information return filing, eliminating the penalty for underreporting taxable income on information returns could weaken the compliance effort; (4) although both proposals made penalty provisions more consistent and better coordinated penalties to avoid overly harsh assessments against taxpayers, they needed to provide for more equitable treatment of similarly situated taxpayers; and (5) the federal tax deposit penalty may not effectively promote compliance because of complex program regulations.

Matters for Congressional Consideration

  1. Status: Closed - Not Implemented

    Comments: The penalty reform adopted did not address this issue. No further action is anticipated in the foreseeable future.

    Matter: To support the statutory requirement that all taxpayers timely file a tax return, Congress should establish a time-sensitive failure-to-file penalty that would be assessed against all delinquent taxpayers regardless of whether or not they had a tax liability, unless the failure is due to reasonable cause.

  2. Status: Closed - Not Implemented

    Comments: The GAO position was rejected. Congress does not intend to take any action.

    Matter: Congress should retain an underreporting penalty similar to the existing presumptive negligence penalty, but that would be subject to abatement for reasonable cause. With regard to penalty rates, Congress should consider setting higher rates than the House bill or reducing the threshold of understated tax liability that would trigger the substantial understatement penalty to at least partly restore the economic value of the penalties.

  3. Status: Closed - Implemented

    Comments: The statute revision reflected the majority of GAO recommendations.

    Matter: To bolster taxpayer confidence in the fairness and equity of these penalties, Congress should add the following changes: (1) eliminating stacking of the accuracy/conduct penalties; (2) targeting the application of the negligence penalty; (3) establishing reasonable cause as the abatement/waiver criterion, except for fraud; and (4) statutorily defining substantial authority.

  4. Status: Closed - Implemented

    Comments: The statutory revision increased penalty amounts.

    Matter: Congress should increase the monetary value of return preparer penalties to improve their economic deterrent value and use a two-tier penalty, with the first tier consisting of negligence and the second tier consisting of willful understatement or intentional disregard.

  5. Status: Closed - Not Implemented

    Comments: A statute of limitation was set, but the GAO position remains valid.

    Matter: Congress should not establish a statute of limitations, as in the case of fraud.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: Congress rejected all but a single abatement criterion.

    Recommendation: To simplify administration, IRS should treat all types of information returns consistently. Within that context, all caps should be eliminated, there should be a single abatement criterion, magnetic media filing thresholds should be set administratively, and only returns exceeding thresholds should be penalized.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Closed - Not Implemented

    Comments: Congress rejected the GAO position on dates.

    Recommendation: Making information return penalties time-sensitive is a good idea; however, IRS should administratively set the penalty dates. Further, to promote voluntary correction of returns, penalties should not be assessed against payors who voluntarily correct their returns.

    Agency Affected: Department of the Treasury: Internal Revenue Service


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