Tax Watch: Congress questions the true effect of tax cuts

Pressure is mounting on the Congressional Budget Office to scrap its system for estimating how much legislative proposals would cost the Treasury. The heat emanates from think tanks and congressional Republicans in favor of tax cuts. They argue that in estimating costs, the CBO should consider the economic growth tax cuts stimulate.

CBO director Dan L. Crippen has responded by inviting critics to discuss the pros and cons of their preferred forecasting method, “dynamic scoring.”

Mr. Crippen claims that there is too much disagreement in the economic community about how dynamic scoring should be done, and that publishing an estimate that could be interpreted in a variety of ways would politicize his agency and undermine its credibility.

For example, if Congress responded to a revenue loss with spending restraint, as Republicans tend to assume it does, many tax cuts would have a strong positive effect on economic growth, and their cost likely would be substantially offset, Mr. Crippen acknowledged recently.

However, if Congress responded with tax increases later or by allowing the nation’s debt to grow, the CBO might conclude that the tax cut would have a negative effect on growth, he added.

“We don’t know what the next Congresses and the next two or three presidents are going to do,” Mr. Crippen said. “It’s not a matter of being supply side or not supply side … it is rather a matter of estimation and predicting future government action.”

Calls for dynamic scoring tend to ebb and flow on Capitol Hill, and generally increase when the government is in the red, as those who favor tax cuts search for data suggesting that taxes can be cut without pushing the nation deeper into debt. Dynamic scoring also can be applied to spending proposals.

Many Democrats argue, just as seriously, that government spending can stimulate the economy.

IRS leaves taxpayers forwarding addresses

As the Internal Revenue Service reassigns workloads at its processing centers, some taxpayers may find themselves filing their tax returns at locations different from earlier years’. The IRS continues to redistribute its workload among 10 processing centers – an example, it says, of its commitment to provide better service to taxpayers.

The IRS now is providing the new addresses, to be used for 2002 returns that will be filed during filing season 2003. Taxpayers who file paper returns will use the new center addresses provided on envelopes in the tax package. The complete list of addresses for tax professionals’ use may be found at the agency’s website, irs.gov.

Rules on reporting stock option exercise

If an employee (or former employee) purchases stock through the exercise of a stock option and then sells that stock on the same day through a broker, the broker is not required to report it.

The IRS recently issued that exemption to reporting on Form 1099-B, “Proceeds From Broker and Barter Exchange Transactions,” in IRS Revenue Procedure 2002-50.

To determine whether the employee exercised the option and sold the underlying shares on the same day, the broker may rely on a receipt or written statement provided by the employee or employer showing the date of exercise.

To clarify whether the employer uses the sale price of the shares to calculate the compensation income generated to employees by the option exercise, the broker may rely upon a written statement from the employer certifying that it follows that practice.

Under those circumstances, the rules require the broker to furnish the employee with a statement containing the following information:

* The gross sales price of the shares sold through the broker.

* The commissions or other fees the broker charged on the sale.

* A description of how gain or loss with respect to shares obtained through the option exercise is calculated, and the manner in which such gain or loss should be reported on a federal income tax return.

The description need not be an independent document, but may be part of a document such as a settlement sheet provided to the customer in connection with the sale.

The IRS also recently issued a notice (2002-47) that provided, in part, that until the Department of the Treasury and the IRS issue further guidance on statutory stock options, the IRS will not assess the Federal Insurance Contributions Act or Federal Unemployment Tax Act tax or apply federal tax-withholding obligations upon either the purchase or sale of the stock acquired by an employee in connection with the exercise of the option.

IRS crackdown adds small-time shelters

The IRS once again is modifying the tax shelter rules, while still retaining the pre-existing standards governing tax shelter opinions. This time the changes or clarifications affect the list-maintenance requirement and define those taxpayers considered to be participating in reportable transactions.

The tax shelter regulations require that corporate taxpayers disclose their participation in listed and other reportable transactions.

The IRS only recently discovered that so-called non- corporate taxpayers actually participate in many of those transactions. Accordingly, as part of its program to obtain information about potentially abusive transactions, it now requires any individual, trust, partnership or S corporation that participates in them to disclose listed and other reportable transactions.

To further widen its search – and to obtain information about potentially abusive transactions by that newly broadened group of taxpayers – the IRS is attempting to clarify the term “indirect participation” in a reportable transaction.

Under the proposed rule, a taxpayer will have indirectly participated in a reportable transaction “if the taxpayer knows or has reason to know that the tax benefits claimed from the taxpayer’s transaction are derived from a reportable transaction.”

According to the IRS, some taxpayers have applied the “substantially similar” standard in an overly narrow manner to avoid disclosure. In that case too, the IRS is clarifying that the term “substantially similar” includes any transaction that is expected to obtain the same or similar types of tax benefits and that is either factually similar or based on the same or similar tax strategy.