GAO Report on I.R.C. Penalties

The GAO issue a report in August on tax compliance and the efficacy of the penalty provisions of the Code, entitled Tax Compliance: Inflation has Significantly Decreased the Real Value of Some Penalties.  GAO undertook the study to assess whether the failure to index civil tax penalties for inflation undercut the effectiveness of the penalties.  The many different penalty provisions in the Code utilize a range of mechanisms--some are a percentage of the tax liability, others are a fixed dollar or a fixed maximum or minimum amount that is not adjusted for inflation.  Using IRS data on civil penalties and interviews with IRS employees and tax practitioners, the GAO assessed to what extent adjusting penalties for inflation would impact amounts assessed and collected and the nature of the administrative burden to be expected from making the adjustments.

Its conclusions were straightforward.  Adjusting penalties for inflation could yield tens of millions annually in additional IRS collections (estimated at $38 milion to $61 million per year from 2000 to 2005) without a very heavy administrative burden, whereas failure to adjust could result in weakening deterrent effect of the penalty provisions. 

A few interesting snippets of facts and thought from the report are noted herein.

1. About 99% of the increased collections would be attributable to four areas (some of which have penalties that were set decades ago):  failure to file tax return; failure to file correct information return; failure to file partnership returns and; various penalties on returns by exempt organizations and trusts.
2. In 1990 Congress passed a law requiring most civil penalties to be adjusted for inflation to maintain their deterrent effect, but there were a few exceptions:  the Internal Revenue Code penalties, the Social Security Act penalties, the Tariff Act of 1930, and the Occupational Safety and Health Act of 1970.
3. Of the penalties that are collected, approximately 85% of penalties are collected in the three years following assessment.
4. The penalty for failure to file a partnership return was set at $50 in 1979, and has a real value of only $18 today.
5. Not adjusting penalties for inflation results in inconsistent treatment of similarly situated taxpayers, as the fine decreases in value over time.
6. If the cost to impose penalties stays constant while the penalty amount declines in value, penalties may become disfavored as a means to enforce compliance.

Apparently, Congress is attentively reading GAO reports.  BNA reported today that Senator Baucus  said he intended to work on legislation to deal with this problem.