2. Civil damages with respect to unauthorized collection actions

Present Law

A taxpayer may sue the United States for up to $1 million of civil damages caused by an officer or employee of the IRS who recklessly or intentionally disregards provisions of the Internal Revenue Code or Treasury regulations in connection with the collection of Federal tax with respect to the taxpayer.

Description of Proposal

The proposal would permit (1) up to $100,000 in civil damages caused by an officer or employee of the IRS who negligently disregards provisions of the Internal Revenue Code or Treasury regulations in connection with the collection of Federal tax with respect to the taxpayer, and (2) up to $1 million in civil damages caused by an officer or employee of the IRS who willfully disregards provisions of the Bankruptcy Code relating to automatic stays or discharges. The proposal would also provide that persons other than the taxpayer may sue for civil damages for unauthorized collection actions. No person would be entitled to seek civil damages in a court of law without first exhausting administrative remedies.

Effective Date

The proposal would be effective with respect to actions of officers or employees of the IRS occurring after the date of enactment.

3. Increase in size of cases permitted on small case calendar

Present Law

Taxpayers may choose to contest many tax disputes in the Tax Court. Special small case procedures apply to disputes involving $10,000 or less, if the taxpayer chooses to utilize these procedures (and the Tax Court concurs) (Sec. 7463). The IRS cannot require the taxpayer to use the small case procedures. The Tax Court generally concurs with the taxpayer's request to use the small case procedures, unless it decides that the case involves a tax policy issue that should be heard under the normal procedures. After the case has commenced, the Tax Court may order that the small case procedures should be discontinued only if (1) there is reason to believe that the amount in controversy will exceed $10,000 or (2) justice would require the change in procedure.

Small tax cases are conducted as informally as possible. Neither briefs nor oral arguments are required and strict rules of evidence are not applied. Most taxpayers represent themselves in small tax cases, although they may be represented by anyone admitted to practice before the Tax Court. Decisions in a case conducted under small case procedures are neither precedent for future cases nor reviewable upon appeal by either the government or the taxpayer.

Description of Proposal

The proposal would increase the cap for small case treatment from $10,000 to $50,000.

Effective Date

The proposal would apply to proceedings commenced after the date of enactment.

4. Expand Tax Court jurisdiction to include determination of penalties under section 6672 of the Code

Present Law

In general, employers are required to withhold income taxes (Sec. 3402) and social security taxes (Sec. 3102) from their employee's wages. These withheld taxes constitute a trust in favor of the United States from the time that the employer deducts them from the employee's wages, and the employer is liable to the government for the payment of such taxes (Sec. 7501(a)). Section 6672 subjects all persons considered responsible for the withholding and payment of taxes to a penalty equal to the amount of taxes due where the employer fails to turn over such funds to the government (the "responsible person" penalty, also known as the "100 percent" penalty). Generally, the determination of whether a person is a "responsible person" is a question of the person's status, duty, and authority in the context of the business which has failed to collect and pay over taxes required to be withheld. A responsible person penalty may also be imposed on a payroll lender (Sec. 3505).

The Tax Court has no jurisdiction over the determination of the correctness of the assessment of the responsible person penalty. Accordingly, as the Tax Court is the only pre payment forum for the determination of tax liability, the imposition of the responsible person penalty can only be challenged in a refund suit in the appropriate district court or the U.S. Court of Federal Claims after payment of such penalty. The responsible person penalty is a divisible tax. Thus, unlike a refund suit for income taxes, a responsible person need not pay the full amount of the assessment to invoke the jurisdiction of the district court or the U.S. Court of Federal Claims. Instead, the alleged responsible person may commence a refund suit after payment of the portion of the penalty attributable to one employee for one quarter.

Description of Proposal

The proposal would provide Tax Court jurisdiction over the "responsible person" penalty. Accordingly, the responsible person would not have to make a payment before challenging the imposition of the penalty.

Effective Date

The proposal would apply to penalties imposed after the date of enactment.

5. Actions for refund with respect to certain estates which have elected the installment method of payment

Present Law

In general, the U.S. Court of Federal Claims and the U.S. district courts have jurisdiction over suits for the refund of taxes, as long as full payment of the assessed tax liability has been made. Flora v. United States, 357 U.S. 63 (1958), aff'd on reh'g, 362 U.S. 145 (1960). Under Code section 6166, if certain conditions are met, the executor of a decedent's estate may elect to pay the estate tax attributable to certain closely-held businesses over a 14-year period. Courts have held that U.S. district courts and the U.S. Court of Federal Claims do not have jurisdiction over claims for refunds by taxpayers deferring estate tax payments pursuant to section 6166 unless the entire estate tax liability has been paid (i.e., timely payment of the installments due prior to the bringing of an action is not sufficient to invoke jurisdiction). See, e.g., Rocovich v. United States, 933 F.2d 991 (Fed. Cir. 1991), Abruzzo v. United States, 24 Ct. Cl. 668 (1991). Under section 7479, the U.S. Tax Court has limited authority to provide declaratory judgments regarding initial or continuing eligibility for deferral under section 6166.

Description of Proposal

The proposal would grant the U.S. Court of Federal Claims and the U.S. district courts jurisdiction to determine the correct amount of estate tax liability (or refund) in actions brought by taxpayers deferring estate tax payments under section 6166, as long certain conditions are met. In order to qualify for the proposal, (1) the estate must have made an election pursuant to section 6166, (2) the estate must have fully paid each installment of principal and/or interest due (and all non-6166-related estate taxes due) before the date the suit is filed, (3) no portion of the payments due may have been accelerated, (4) there must be no suits for declaratory judgment pursuant to section 7479 pending, and (5) there must be no outstanding deficiency notices against the estate. In general, to the extent that a taxpayer has previously litigated its estate tax liability, the taxpayer would not be able to take advantage of this procedure under principles of res judicata. Taxpayers would not be relieved of the liability to make any installment payments that become due during the pendency of the suit (i.e., failure to make such payments would subject the taxpayer to the existing provisions of section 6166(g)(3)).

The proposal further would provide that once a final judgment has been entered by a district court or the U.S. Court of Federal Claims, the IRS would not be permitted to collect any amount disallowed by the court, and any amounts paid by the taxpayer in excess of the amount the court finds to be currently due and payable would be refunded to the taxpayer, with interest. Lastly, the proposal would provide that the two-year statute of limitations for filing a refund action would be suspended during the pendency of any action brought by a taxpayer pursuant to section 7479 for a declaratory judgment as to an estate's eligibility for section 6166.

Effective Date

The proposal would be effective with respect to claims for refunds filed after the date of enactment.

6. Provide Tax Court jurisdiction to review an adverse IRS determination of a bond issue's tax-exempt status

Present Law

Interest earned on bonds or other debt obligations issued by States or political subdivisions of States generally is excluded from gross income (Sec. 103(a)). However, interest on bonds issued by state and local governments may be taxed when the proceeds of the bond are not used for traditional governmental purposes (Sec. 103(b)). Bonds used for nontraditional governmental purposes include private activity bonds, arbitrage bonds, and bonds that are not issued in registered form.

A prospective issuer of bonds, the interest on which is intended to be excludable from gross income under Code section 103(a), can request a ruling from the IRS that is subject to the declaratory judgment procedures of Code section 7478. Code section 7478 permits the prospective issuer to obtain a declaratory judgment with respect to the tax-exempt status of the bonds. The governmental issuer has no opportunity to litigate the tax-exempt status of the bonds once they are issued.

Description of Proposal

The proposal would extend the declaratory judgment procedures currently applicable to prospective bond issuers to issuers of outstanding bonds.

Effective Date

The proposal would apply to petitions filed after the date of enactment. C. Relief for Innocent Spouses and Persons With Disabilities

1. Innocent spouse relief

Present Law

Relief from liability for tax, interest and penalties is available for "innocent spouses" in certain circumstances. To qualify for such relief, the innocent spouse must establish: (1) that a joint return was made; (2) that an understatement of tax, which exceeds the greater of $500 or a specified percentage of the innocent spouse's adjusted gross income for the preadjustment (most recent) year, is attributable to a grossly erroneous item of the other spouse; (3) that in signing the return, the innocent spouse did not know, and had no reason to know, that there was an understatement of tax; and (4) that taking into account all the facts and circumstances, it is inequitable to hold the innocent spouse liable for the deficiency in tax. The specified percentage of adjusted gross income is 10 percent if adjusted gross income is $20,000 or less. Otherwise, the specified percentage is 25 percent.

The proper forum for contesting the Secretary's denial of innocent spouse relief is determined by whether an underpayment is asserted or the taxpayer is seeking a refund of overpaid taxes. Accordingly, the Tax Court may not have jurisdiction to review all denials of innocent spouse relief.

Description of Proposal

In General

The proposal would modify the innocent spouse provisions to permit a spouse to elect to limit his or her liability for unpaid taxes on a joint return to the spouse's separate liability amount. In the case of a deficiency arising from a joint return, a spouse would be liable only to the extent items giving rise to the deficiency are allocable to the spouse.

The allocation of items would be accomplished without regard to community property laws. The election by a spouse to limit the spouse's liability to the separate liability amount could be made without regard to whether the spouse knew, or had a reason to know, that an item allocable to the other spouse was erroneous.

The separate liability election would apply to all unpaid taxes under subtitle A of the Internal Revenue Code, including the income tax and the self-employment tax. The election could be made at any time not later than 2 years after collection activities begin with respect to the electing spouse.

The Tax Court would have jurisdiction of disputes arising from the separate liability election. For example, a spouse who makes the separate liability election could petition the Tax Court to determine the limits on liability applicable under this proposal. The Tax Court would be authorized to establish rules that would allow the Secretary of the Treasury and the electing spouse to require, with adequate notice, the other spouse to become a party to any proceeding before the Tax Court. The Secretary of the Treasury would be required to develop a separate form with instructions for taxpayers to use in electing to limit liability.

Special rules would apply to prevent the inappropriate use of the proposal. First, relief under the proposal would not be available to the extent of the value of any property that was transferred to the electing spouse by the other spouse if the principal purpose of the transfer was avoidance of tax (including the avoidance of payment of tax). A rebuttable presumption would exist that a transfer is made for tax avoidance purposes if the transfer was made less than one year before the earlier of the date of assessment or notice of deficiency. The rebuttable presumption would not apply to transfers incident to a decree of divorce or separate maintenance. The presumption may be rebutted by a showing that the principal purpose of the transfer was not the avoidance of tax. Second, if the IRS demonstrates that assets were transferred between the spouses in a fraudulent scheme joined in by both spouses to reduce total liability, neither spouse would be eligible to make the election under the proposal (and consequently joint and several liability would apply to both spouses).

Allocations of items

Under the proposal, allocation of items of income and deduction would follow the present law rules determining which spouse is responsible for reporting an item when the spouses use the married, filing separate filing status. The Secretary of the Treasury would be granted authority to prescribe regulations providing simplified methods of allocating items.

In general, apportionment of items of income would follow the source of the income. Wage income would be allocated to the spouse performing the job and receiving the Form W-2. Business and investment income (including any capital gains) would be allocated in the same proportion as the ownership of the business or investment that produces the income. Where ownership of the business or investment is held by both spouses as joint tenants, it is expected that any income would be allocated equally to each spouse, in the absence of clear and convincing evidence supporting a different allocation.

The allocation of business deductions would follow the ownership of the business. Personal deduction items are expected to be allocated equally between spouses, unless the evidence shows that a different allocation is appropriate. For example, a charitable contribution would normally be expected to be allocated equally to both spouses. However, if the wife were to provide evidence that the deduction relates to the contribution of an asset that was the sole property of the husband, any deficiency assessed because it is later determined that the value of the property was overstated would be allocated to the husband.

Items of loss or deduction would be allocated to a spouse only to the extent that income attributable to the spouse was offset by the deduction or loss. Any remainder would be allocated to the other spouse.

Income tax withholding would be allocated to the spouse from whose paycheck the tax was withheld. Estimated tax payments would be allocated to the spouse who made the payments; if the payments were made jointly, the payments would be allocated equally to each spouse, in the absence of evidence supporting a different allocation.

The allocation of items would be accomplished without regard to the community property laws of any jurisdiction.

If, considering all the facts and circumstances, it would be inequitable to hold a spouse responsible for any unpaid tax or deficiency attributable to an item, such item may be equitably reallocated to the other spouse. In cases where the IRS proves fraud, the IRS would have the power to distribute, apportion, or allocate any item between spouses.

Tax deficiencies

If a spouse elects separate liability, the liability for deficiencies determined after a joint return is filed would be allocated to the spouse whose item gives rise to the deficiency. For example, if a deficiency is assessed after an IRS audit that relates to the husband's income that he failed to report on the return, the entire deficiency would be allocated to the husband. If the wife elects separate liability, she would owe none of the deficiency. It would be the sole responsibility of the husband who failed to report the income.

If the deficiency relates to the items of both spouses, the separate liability for the deficiency will be allocated between the spouses in the same proportion as the items giving rise to the deficiency are allocated. If the deficiency arises as a result of an item of deduction or credit, the amount of the deficiency allocated to the spouse to whom the item of deduction or credit is allocated would be limited to the amount of income or tax allocated to such spouse that was offset by the deduction or credit. The remainder of the liability would be allocated to the other spouse to reflect the fact that income or tax allocated to that spouse was originally offset by a portion of the disallowed deduction or credit.

For example, a married couple files a joint return with wage income of $100,000 allocable to the wife and $30,000 of self employment income allocable to the husband. On examination, a $20,000 deduction allocated to the husband is disallowed, resulting in a deficiency of $5,600. Under the proposal, the liability is allocated in proportion to the items giving rise to the deficiency. Since the only item giving rise to the deficiency is allocable to the husband, and because he reported sufficient income to offset the item of deduction, the entire deficiency is allocated to the husband and the wife has no liability with regard to the deficiency, regardless of the ability of the IRS to collect the deficiency from the husband.

If the joint return had shown only $15,000 (instead of $30,000) of self employment income for the husband, the income offset limitation rule discussed above would apply. In this case, the disallowed $20,000 deduction entirely offsets the $15,000 of income of the husband, and $5,000 remains. This remaining $5,000 of the disallowed deduction offsets income of the wife. The liability for the deficiency is therefore divided in proportion to the amount of income offset for each spouse. In this example, the husband would be liable for 3/4 of the deficiency ($4,200), and the wife would be liable for the remaining 1/4 ($1,400).

Tax shown on a return, but not paid

The separate liability election would also be applicable in situations where the tax shown on a joint return is not paid with the return. In this case, the amount determined under the separate liability election would equal the electing spouse's liability on a separate return.

The separate liability election could not be used to create a refund, or to direct a refund to a particular spouse.

Effective Date

The proposal would apply to any liability for tax arising after the date of enactment and any liability for tax arising on or before such date, but remaining unpaid as of such date.

2. Reports on collection activity against spouses

Present Law

If a tax deficiency with respect to a joint return is assessed, and the individuals filing the joint return are no longer married or no longer reside in the same household, the IRS must disclose in writing (in response to the written request of one of the individuals) whether the IRS has attempted to collect the deficiency from the other individual, the general nature of the collection activities, and the amount collected, if any.

Description of Proposal

The Treasury Inspector General would be required to certify annually that the IRS has implemented and is following procedures insuring that properly requested disclosures regarding amounts collected from former or estranged spouses are being provided.

Effective Date

The certification would be made annually, beginning in 1999.

3. Suspension of statute of limitations on filing refund claims during periods of disability

Present Law

In general, a taxpayer must file a refund claim within three years of the filing of the return or within two years of the payment of the tax, whichever period expires later (if no return is filed, the two-year limit applies) (Sec. 6511(a)). A refund claim that is not filed within these time periods is rejected as untimely.

There is no explicit statutory rule providing for equitable tolling of the statute of limitations. The U.S. Supreme Court has held that Congress did not intend the equitable tolling doctrine to apply to the statutory limitations of section 6511 on the filing of tax refund claims.

Description of Proposal

The proposal would permit equitable tolling of the statute of limitations for refund claims of an individual taxpayer during any period of the individual's life in which he or she is unable to manage his or her financial affairs by reason of a medically determinable physical or mental impairment that can be expected to result in death or to last for a continuous period of not less than 12 months. Tolling would not apply during periods in which the taxpayer's spouse or another person is authorized to act on the taxpayer's behalf in financial matters.

Effective Date

The proposal would apply to periods of disability before, on, or after the date of enactment but would not apply to any claim for refund or credit which (without regard to the proposed provision) is barred by the statute of limitations as of January 1, 1998.