IRS Gets Tools In New Law
It’s not often that a corporate tax bill gets the kind of limelight that the American Jobs Creation Act of 2004 has received.
Much of the law’s notoriety stems from its sheer size–it runs more than 600 pages–and provisions that critics in and out of Congress contend will result in special-interest tax cuts for specific businesses and favor companies doing business overseas.
But interspersed among the sections dealing with businesses are several provisions that will directly affect individual taxpayers.
Proponents of the Jobs Creation Act, which President Bush signed into law on Oct. 22, say its effect on the federal government’s tax revenue should essentially be a push because new tax breaks will be offset by the elimination of others and by tighter restrictions on tax shelters and other various loopholes. But tax law experts say it will take time for both businesses and individuals to appreciate the full impact of the act, given its scope and the work still ahead for the Internal Revenue Service in developing rules to implement many of its provisions.
It even will take time to assess whether the act resolves the problem that set Congress to work on the law in the first place. Legislators acted after the World Trade Organization authorized the European Union to impose sanctions that added 12 percent to the cost of American goods exported to the lucrative EU market. The WTO permitted sanctions following its ruling in 2002 that certain U.S. export subsidies were illegal. But it will be a few years before those tax breaks are fully eliminated, and EU officials are expected to take their time to decide whether to lift their tariffs.
Meanwhile, individual taxpayers soon will feel the impact of the Jobs Creation Act. Here are some key provisions likely to affect them:
Tax Shelters. The law gives the IRS some new weapons for its ongoing campaign to restrict tax shelters.
Estimates from Congress and independent groups indicate that these restrictions could be the largest source of new tax income under the act. While some tax shelter restrictions primarily will affect companies and even local government bodies, many are aimed at individual taxpayers.
Under the act, for instance, taxpayers who don’t disclose transactions with the primary purpose of avoiding taxes will face substantial penalties. The act also bolsters penalties against transactions that don’t meet the test for permissible tax shelters. Promoters of illegal tax shelters also will face stiffer penalties.
Private Tax Collectors. The act also gives the IRS another weapon against individuals who default on their taxes by allowing it to enter into “qualified tax collection contracts” with private parties.
The act authorizes the IRS to enlist private parties to “locate and contact any taxpayer specified by the Secretary … to request full payment from such taxpayer [and] to obtain financial information specified by the Secretary with respect to such taxpayer.” The act allows the IRS to pay private collectors up to 25 percent of what they collect from delinquent taxpayers. The act also provides that the federal government may not be sued for the unlawful acts of these private tax collectors.
The congressional Joint Committee on Taxation estimates that private tax collections could produce some $1.4 billion in revenue for the government over the next 10 years, but some experts aren’t so sure.
“I think proponents overstate the revenue that the provision would generate,” says Paul L. Caron, a professor at the University of Cincinnati College of Law.
“But more fundamentally, I think private collection threatens taxpayer privacy and opens up the collection process to abuse by overzealous private contractors,” he says. “If private debt collectors are paid purely on the basis of a percentage of the taxes they collect, this will encourage strong-arming taxpayers. I would rather improve any deficiencies in the IRS collections processes and let them collect the taxes as they have done for over 90 years.”
Sales Tax Deductions. The Internal Revenue Code allows individual taxpayers to deduct amounts they pay in state and local income taxes. But individuals living in states without income taxes could not take advantage of the deduction. Now, the Jobs Creation Act will allow individuals to deduct either state and local income taxes or state and local general sales taxes.
“Under the new provision, taxpayers who itemize their deductions will have the option of either deducting the sales and use taxes they pay in lieu of deducting what they pay in state income taxes,” says Samuel L. Braunstein, a tax attorney in Fairfield, Conn., who serves on the council of the ABA Section of Taxation. “If they cannot verify the actual amounts they expend in sales and use taxes, they will be entitled to deduct amounts determined by the IRS and provided in tables to be developed for that purpose.”
The downside, however, says Braunstein, is that “the overall effect will be minimal due to the interrelationship of itemized deductions with the Alternative Minimum Tax, which will probably eliminate any positive effects to the individual taxpayers.” (Braunstein is a co-author of an annual tax law feature published every November in the ABA Journal.)
Charitable Deductions. Provisions in the Jobs Creation Act may make the tax deductions from donating such items as automobiles, boats and even small airplanes to charities a little less attractive for taxpayers. Previously, donors were allowed to deduct the fair market value of such items, which in some cases gave rise to grandiose estimates of their actual worth. Under the new law, a donor may deduct only the amount of the charity’s gross proceeds from reselling the vehicle or other item if the claimed value of the item is more than $500.
Attorney Fees. Incorporated into the tax bill is the Civil Rights Tax Relief Act. It relieves plaintiffs who settle or win court awards under an array of federal and state civil rights statutes from having to pay taxes on the attorney fee portion of their awards. Actions covered by the provision include cases alleging discrimination on the basis of race, sex or age. The provision also applies to actions for housing discrimination, wage-and-hour issues, ERISA benefits and whistleblower laws.
The deduction for attorney fees will apply regardless of whether plaintiffs itemize their taxes.
Previously, a prevailing plaintiff was taxed on the entire amount of his or her award, including the portion that was paid in legal fees. Because the attorney also paid tax on that amount, it was considered a form of “double taxation.” Proponents of the new provision also claimed the prior law could lead to inequitable results in cases where a prevailing plaintiff who obtained injunctive relief or a small award ended up worse off financially after paying taxes on a large attorney fee.
“The result under the IRS’ and some courts’ interpretations of the tax law was that successful plaintiffs were taxed on the sometimes large portions of their awards or settlements that went directly to their attorneys,” says attorney Russell R. Young of Chicago. Young represented the respondent in oral arguments before the U.S. Supreme Court on Nov. 1 in IRS v. Banks, one of two cases before the justices this term on taxation of attorney fees.
“In some cases, attorney fees were so large relative to the actual damages awarded that the plaintiff could be worse off after taxes for having brought and prevailed in an employment discrimination lawsuit,” says Young. “Such a result undermines civil rights statutes and makes discrimination cases more difficult for employers to settle.” But some tax law experts say Congress didn’t go far enough in redressing inequities from taxing attorney fees.
The Civil Rights Tax Relief Act “is a good idea but terrible execution,” says Caron. “The rule should exclude attorney fees in all cases, not just civil rights cases.”
The ABA supported the Civil Rights Tax Relief Act. It also pressed for passage of two other measures relating to legal awards, but Congress didn’t include either of them in the Jobs Creation Act. One measure would have exempted emotional distress damages from income taxes, according to Richard T. Seymour of Washington, D.C., a council member for the ABA Section of Labor and Employment Law.
The other provision would have allowed plaintiffs to average awards of back pay over a period of years to lighten the tax burden in any single year.
“I’m pleased with what’s in the American Jobs Creation Act,” says Seymour, “but we are going to continue to try to get the other elements enacted into legislation.”