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"harming compliant taxpayers because they pay their correct tax liability while others do not. This disparate treatment of similarly situated taxpayers undermines respect for the fairness of the tax system.

Imposing withholding on nonwage payments would increase compliance and facilitate IRS collection activities by filtering regular tax payments from large numbers of taxpayers through significantly fewer collection points. In general, the more payments to which withholding applies, the greater improvement in compliance. However, withholding requirements also impose burdens on payors. The proposal attempts to balance the goal of greater compliance with concerns regarding administrative burdens by imposing withholding only on payments made by Federal, State and most local governments, as well as agencies of these entities. Because the payments of such entities represent a significant part of the economy, 20 the proposal may be expected to appreciably improve compliance, while not burdening private sector payors. To avoid imposing a burden on small entities, local governments with less than $100 million of annual expenditures are not subject to the proposal.

26

Although the proposal imposes new administrative requirements on some payors, in many cases the affected parties will already have procedures in place that can be modified to accommodate the additional requirements. For example, present law imposes information reporting requirements on governmental entities. Arguably, the proposal will require only the expansion of existing information reporting procedures to satisfy the broader withholding requirement, not the creation of wholly new procedures, in such cases. Similarly, certain Federal payments to vendors of goods or services are subject to continuous levy authority under present law." Thus, Federal agencies have existing procedures for deducting and remitting taxes from payments to businesses and individuals that may be tailored to the requirements of the proposal.

27

The proposal imposes a flat rate of three percent on all payments, other than the excluded payments discussed above, regardless of whether the payment is made for goods or services. The advantages of a flat rate of withholding are that it is simple, easy to verify, and applicable to all payees. A disadvantage of this approach, however, is that it is likely to cause either overwithholding or underwithholding for some payees. For example, sellers of goods and materials are more likely to have overwithholding and, thus, bear more of the burden of a flat rate because of the lower profit margin on such sales relative to sales of services. Similar proposals have recommended a higher rate of withholding on payments for the provision of

25 National Taxpayer Advocate, 2003 Annual Report to Congress, Publication 2104 (Rev. 12-2003), p. 265; see also National Taxpayer Advocate, 2004 Annual Report to Congress, Publication 2104 (Rev. 12-2004), at 484.

26 The combined payments for goods and services by Federal, State, and local governments represent between six and seven percent of gross domestic product in any year, with approximately one-third of this amount attributable to purchases of goods and services by the Federal government. See Bureau of Economic Analysis, U.S. Department of Commerce, National Income and Product Accounts Tables, Tables 1.1.5 and 3.10.5 (December 22, 2004).

27 Sec. 6331(h).

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personal services (where no or minimal goods are provided) than on payments for the provision of goods only or a mix of goods and services." A variable rate proposal would add additional complexity, which would have to be weighed against the benefits to be derived from a variable rate system. In addition, the rate under the proposal is set low enough not to necessitate a second rate. The conservative three-percent rate under the proposal will limit instances of overwithholding.

The proposal also addresses inefficiencies in the current Federal levy program. Under present law, the Federal government has broad authority to levy Federal payments made to vendors of goods and services, up to 100 percent of certain Federal payments.29 Although a levy program should provide an efficient and effective method of collecting unpaid taxes, the Federal government's levy authority has not proven fully effective.30 IRS resource constraints have limited the number of cases referred to the levy program and Federal agencies have not systematically imposed levies on cases that have been referred. Because withholding, unlike a levy, is required and relatively simple, the proposal will provide a more effective means of promoting compliance than the current levy program, which requires numerous administrative steps to collect unpaid taxes.

31

Imposing withholding more broadly on non-wage payments throughout the economy could be expected to generate additional positive effects on compliance and IRS collection efforts. 32 However, broader withholding requirements would also involve additional administrative burdens on the private sector and on both payors and payees.

The proposal is estimated to raise approximately $6.4 billion over the fiscal years 2006 through 2014. There is a significant revenue effect in fiscal year 2007 that is largely attributable to accelerating tax receipts as a result of the withholding requirement. However, the proposal also has a significant revenue effect over the estimating period that is directly related to the expected improvement in tax compliance.

28 National Taxpayer Advocate, 2003 Annual Report to Congress, Publication 2104 (Rev. 12-2003), at 265.

29 Sec. 6331(h), as amended by Pub. L. No. 108-357 (2004).

30

U.S. General Accounting Office, Tax Administration: Federal Payment Levy Program Measure, Performance, and Equity Can Be Improved, GAO-03-356 (March 6, 2003).

31 Id.

32 The National Taxpayer Advocate generally recommended withholding by all payors on non-wage payments. National Taxpayer Advocate, 2003 Annual Report to Congress, Publication 2104 (Rev. 12-2003); see also National Taxpayer Advocate, 2004 Annual Report to Congress, Publication 2104 (Rev. 12-2004), at 484.

B. Require Partial Payments with Submission of Offers-in-Compromise

Present Law

In general

The Federal government may compromise any civil or criminal case arising under the internal revenue laws.33 In general, taxpayers initiate this process by making an offer-incompromise, which is an offer by the taxpayer to settle an outstanding tax liability for less than the total amount due. Offers are generally made using Form 656. The IRS currently imposes a user fee of $150 on most offers, payable upon submission of the offer to the IRS. Taxpayers may justify their offers on the basis of doubt as to collectibility or liability or on the basis of effective tax administration. In general, enforcement action is suspended during the period that the IRS evaluates an offer. In some instances, it may take the IRS 12 to 18 months to evaluate an offer.34 Taxpayers are permitted (but not required) to make a deposit with their offer; if the offer is rejected, the deposit is generally returned to the taxpayer. There are two general categories35 of offers-in-compromise.

34

Lump-sum offers

Taxpayers making lump-sum offers propose to make one lump-sum payment of a specified dollar amount in settlement of their outstanding liability.

Periodic payment offers

Taxpayers making periodic payment offers propose to make a series of payments over time (either short-term or long-term) in settlement of their outstanding liability.

Reasons for Change

The offer-in-compromise program is a valuable collection tool; it allows the IRS to collect a portion of an outstanding tax liability in circumstances in which it may not be possible or reasonable to expect collection of the entire liability. In general, submission of an offer indicates that the taxpayer is willing and able to make a partial payment of the taxpayer's liability. Because of the lengthy review process that the IRS undertakes prior to accepting an offer, there may be a substantial period of time before the Government actually collects the amounts the taxpayer is willing to pay. Moreover, experience under present law has shown that in some cases taxpayers do not make offers in good faith (e.g., by concealing information from the IRS). Requiring partial payment with the submission of an offer-in-compromise will

33 Sec. 7122.

34

Olsen v. United States, 326 F. Supp.2d 184 (D. Mass. June 16, 2004).

35 The IRS categorizes payment plans with more specificity, which is generally not significant for purposes of the proposal. See Form 656, Offer-in-Compromise, page 6 of instruction booklet (revised July 2004).

preserve the offer program for those cases in which it is appropriate, and will increase fairness for those taxpayers who pay their taxes in full.

Description of Proposal

In general

The proposal requires that a taxpayer make partial payments to the government while the taxpayer's offer is being considered by the IRS. These payments are retained by the government and applied to the taxpayer's outstanding balance, even if the taxpayer's offer is rejected as inadequate.

Lump-sum offers

The proposal requires that taxpayers make a down payment of 20 percent of the amount of any lump-sum offer-in-compromise with any application for an offer. A lump-sum offer includes single payments as well as payments made in five or fewer installments. For example, if the taxpayer owes the IRS $100,000 and submits an offer-in-compromise of a single payment of $40,000 to settle this liability in full, the taxpayer must make a down payment of $8,000 when the taxpayer submits the offer-in-compromise to the IRS. If the IRS rejects an offer as inadequate and the taxpayer makes a new offer, the taxpayer must make an additional down payment so that the total of the new down payment and the previous down payment equals 20 percent of the new offer. In the previous example, if the IRS rejects that offer, the $8,000 down payment is kept by the IRS and applied to the taxpayer's account. If the taxpayer submits a new offer of $60,000, the taxpayer must make an additional down payment of $4,000 when the taxpayer submits the new offer to the IRS.

Periodic payment offers

The proposal requires the taxpayer to comply with the taxpayer's own proposed payment schedule while the offer is being considered. For example, if the taxpayer owes the IRS $100,000 and submits an offer-in-compromise of $500 per month for five years to fully settle this liability, the taxpayer would be required to pay $500 when the taxpayer submits the offer-incompromise as well as $500 each month thereafter for as long as the IRS is considering the offer. If the IRS rejects this offer as inadequate, the taxpayer would stop making payments at that time and enforcement action is permitted. If the taxpayer then submits a higher offer of $600 per month for five years, the taxpayer would be required to pay $600 when the taxpayer submits the offer-in-compromise as well as $600 each month thereafter for as long as the IRS is considering the offer. If the taxpayer does not continue to comply with the taxpayer's own proposed payment schedule for the entire period the offer is being considered, the offer is considered to be withdrawn on the date compliance ceases and immediate enforcement action is permitted.

Rules of general applicability

Offers submitted to the IRS that do not comport with the proposed payment requirements are returned to the taxpayer as unprocessable and immediate enforcement action is permitted. The taxpayer is permitted to specify how these payments are to be applied. These payment requirements are separate from, and do not affect, any user fee imposed by the IRS with respect

to offers-in-compromise. The IRS is authorized to establish parallel rules for complex offers that have both lump-sum and periodic features. If the IRS does not make a decision to reject an offer within two years of its submission, it is considered accepted for all purposes. The ability of the IRS to make jeopardy assessments is unaffected by the proposal.

Effective Date

The proposal is effective for offers-in-compromise submitted to the IRS after 60 days after the date of enactment.

Discussion

An offer-in-compromise is a valuable tool that permits final resolution of disputes over amounts owed to the government. Agreeing on an appropriate offer may, however, be difficult, for several reasons. First, the interests of the taxpayer and the government diverge on the issue of the amount to be paid. Taxpayers prefer to pay as little as possible, whereas the government wants to maximize its receipts of outstanding liabilities. Second, the interests of the taxpayer and the government diverge on the issue of the rapidity of payment. In general, taxpayers prefer to delay payment as long as possible (especially if enforcement actions are held in abeyance), whereas the government has an interest in receiving payment as soon as possible.36 Third, there is also likely to be an imbalance of information. The taxpayer necessarily has complete information on the taxpayer's own financial information, whereas the government has incomplete information (which is often information supplied by the taxpayer). While many taxpayers make an offer in good faith, some are abusing the offer process by concealing information from the government and by making low-ball offers.

The proposal is designed to accelerate receipts to the government while preserving the structure of the offer program. Because the proposal calculates the amount of the partial payment on the basis of the offer that the taxpayer is making, taxpayers should generally be able to comply with payment terms that they themselves propose. This has several implications. First, the proposal should not discourage most taxpayers from making offers that would be comparable to the offers they would make absent the proposal. Second, the proposal should not impede or further strain the efforts of the IRS in evaluating offers. Third, no special rules are necessary with respect to offers from low-income taxpayers.

36 While the government has an interest in receiving payment as soon as possible, it also has an interest in receiving the maximum appropriate amount, and these two interests conflict. Reviewing an offer (to establish that the government is receiving the maximum appropriate amount) generally takes a significant period of time. Most offers are made because of doubt as to collectibility; in other words, the taxpayer asserts that its resources are inadequate to pay the government in full. To evaluate the veracity of the taxpayer's assertions, the IRS must in many instances consider in detail the resources available to the taxpayer. This requires a very factintensive process, which can require significant time to complete. In addition, the evaluation of how those resources should be deployed to satisfy the taxpayer's obligation to the government (as well as the taxpayer's other obligations) requires both time and sound judgment.

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