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  1. 1. A Loophole of Its Own: How the IRS Defies Congress With User Fees by John Myrick Perhaps inspired by reviewing the tax returns of some of this country’s inexplicably profitable busi- nesses, the IRS has gotten into the entrepreneurial spirit. It has started charging user fees for its services — and at exorbitant prices (up to $218,600 per trans- action). But wait, what services could the IRS charge for? Isn’t its business to determine how much money the government wants from you and then to take it? Yes. But a questionable product isn’t a problem when you’ve got motivated customers. The advantage the IRS has over some other government user fee experiences — such as na- tional parks that charge for admission — is that its customers generally have no real choice but to use the service. Why would anyone pay a user fee on top of a tax bill if there were an equally good alternative for meeting the requirements of law? User fees have proven to be a nice revenue generator for the IRS, and they have increased substantially over the past 10 years. There is no reason to expect that trend to reverse. The IRS needs money because Congress won’t give it enough, and the IRS has the full authority to charge user fees and spend the revenue however it wants, with very few strings attached. There’s no incentive for it to do otherwise — except perhaps new legislation or rebukes from the courts, both of which may be coming soon — so for now, all signs point to fees growing rather than diminishing. A. Exploding User Fees Congress has been loudly and enthusiastically tightening the purse strings on the IRS since Repub- licans regained a majority in the House. In fiscal 2010 Congress appropriated $12.15 billion for the IRS. That fell to $10.95 billion in fiscal 2015 and rebounded slightly to $11.2 billion in fiscal 2016.1 Somewhat quietly, in response to the reduced appropriations, the IRS has increased its user fee revenue by 35 percent from its fiscal 2010 level ($290 million) to $391 million in fiscal 2015.2 In fiscal 2016 the IRS expects to collect about $422 million.3 Spending of that user fee revenue has been even more feverish — the IRS plans to spend $509 million in fiscal 2016. Yes, that’s more than it expects to collect. Before 2011, when user fees were mainly reserved to pay for unexpected expenses like the flooding of the IRS building that occurred in 2006, the IRS had built up a reserve in fee revenue. The carryover balance reached a high of $327 mil- lion at the end of fiscal 2011. Since then the IRS has been eating into its fund, and the balance is pro- jected to fall to $93 million by the end of fiscal 2016. The IRS has had the authority to charge user fees since the 1950s; however, at that time, all fees col- lected were simply deposited into the Treasury Gen- eral Fund — the same place taxes typically go — which meant they provided no extra financial ben- efit to the agency. In 1995 Congress passed a law allowing the IRS to keep in its own Miscellaneous Retained Fees Fund up to $119 million of the fee revenue, which by and large it could spend however it chose.4 In 2005 Congress removed the cap, autho- rizing the IRS to keep all fees first imposed after September 30, 1994 — including portions of fees that have been increased since that date.5 As shown in the figure above, the 2005 removal of the fee limit started an upward trend in collec- tions. 1 Taxpayer Advocate Service (TAS), ‘‘National Taxpayer Ad- vocate Annual Report to Congress, 2015’’ (Dec. 31, 2015). 2 William Hoffman, ‘‘Taxpayer Advocate Warns of Class System for Taxpayers,’’ Tax Notes, Jan. 11, 2016, p. 143. 3 Government Accountability Office, ‘‘IRS Could Improve Presentation of Budget Data in Its Congressional Justification,’’ GAO-16-695 (July 2016). 4 P.L. 103-329. See GAO-16-695, supra note 3. 5 P.L. 109-115. John Myrick John Myrick is the deputy editor of Tax Notes. His column takes a second look at some of the more unique, provocative, and noteworthy stories covered by Tax Analysts reporters. In this column, Myrick describes how the IRS is gen- erating revenue through user fees to make up for re- duced appropriations from Congress. tax notes™ GRIST FOR THE MILL TAX NOTES, October 3, 2016 111 For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  2. 2. The most dramatic recent fee increase is in the prefiling agreement (PFA) program. The IRS has increased the cost of a PFA request from $50,000 (its 2014 level) to $218,600 for requests submitted be- ginning in 2017.6 Before 2007 the price of a request ranged from $1,000 to $10,000, depending on the taxpayer’s assets.7 The cost of a traditional letter ruling has more than doubled over the past five years.8 At the beginning of 2012, the cost was $14,000.9 That fee is now $28,300.10 The fee for requests for competent authority assistance in which the taxpayer asks for discretion- ary limitation on benefits relief has increased from $27,500 (its 2015 level) to $37,000 for requests filed on or after September 30, 2016.11 The fee to request an advance pricing agreement increased from $50,000 to $60,000.12 According to an IRS spokesperson, that price will continue to rise. The IRS traditionally charged about 50 percent of the cost of providing the APA service, but by 2020 the IRS plans to increase the fee to 100 percent of the cost.13 B. How Fees Are Made The primary, general authority for user fees comes from the Independent Offices Appropria- tions Act of 1952 (IOAA).14 The IOAA authorizes federal agencies to charge fees when they provide any ‘‘service or thing of value.’’ Under the statute, the fees must be fair and based on the costs to the government, the value of the service or thing to the recipient, the public policy or interest served, and other relevant facts. Federal policy — as set forth by the Office of Management and Budget in Circular A-25 — is for agencies to set user fees at the full cost of the service provided, which includes the direct and indirect costs of personnel, overhead, and collection. How- ever, agencies can ask the OMB for a waiver to charge less than full cost.15 Some IRS user fees derive from specific statutes rather than the IOAA. The statutes usually also provide guidance on how the fees should be deter- mined. Those statutes include section 7528, which authorizes fees for letter rulings and determination letters, and section 6103(p), which authorizes charges for the reproduction of returns and the 6 Rev. Proc. 2016-30, 2016-21 IRB 981; and Andrew Velarde, ‘‘Budget Squeeze Means More Increases in User Fees,’’ Tax Notes, May 16, 2016, p. 883. 7 Rev. Proc. 2005-12, 2005-1 C.B. 311; and Amy S. Elliott, ‘‘Prefiling Agreements Get More Expensive Under New Proce- dures,’’ Tax Notes, May 9, 2016, p. 730. 8 Elliott, ‘‘Letter Ruling Fees Have More Than Doubled in 4 Years,’’ Tax Notes, Mar. 30, 2015, p. 1585. 9 Rev. Proc. 2012-1, 2012-1 IRB 1. 10 Rev. Proc. 2016-1, 2016-1 IRB 1. 11 Rev. Proc. 2015-40, 2015-35 IRB 236; and Kristen A. Parillo, ‘‘Final APA, Competent Authority Guidance Increases User Fees,’’ Tax Notes, Aug. 17, 2015, p. 729. 12 Rev. Proc. 2015-41, 2015-35 IRB 263. 13 Parillo, supra note 11. 14 Codified as 31 U.S.C. section 9701. 15 TAS, supra note 1, at 15. IRS User Fee Revenue 1995: Congress allowed IRS to keep some user fees 2006: Congress removed limit on fees IRS could keep 2010: IRS user fee collection continues to rise as Congress cuts IRS appropriation$400 $200 MillionsofDollars Fiscal 1995 Fiscal 1997 Fiscal 1999 Fiscal 2001 Fiscal 2003 Fiscal 2005 Fiscal 2007 Fiscal 2009 Fiscal 2011 Fiscal 2013 Fiscal 2015 Installment Agreements TE/GE — Rulings, etc. Income Verification Other Preparer Registration $202 million $61 million $50 million $40 million $37 million Source: TAS, “National Taxpayer Advocate Annual Report to Congress, 2015: Most Serious Problem.” COMMENTARY / GRIST FOR THE MILL 112 TAX NOTES, October 3, 2016 For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  3. 3. disclosure of return information, such as the income verification express service (IVES). Mortgage lend- ers and other financial entities use IVES transcripts to verify the income of loan applicants. Although the fee is only $2, it generates a lot of revenue. In 2012, when the fee was $2.25, it was the second largest contributor to IRS fee revenue, generating $40 million, or 14 percent of total fees collected. Despite the government’s full cost directive in Circular A-25, until recently, the IRS chose to set many of its user fees at a level below estimated cost to make the services more broadly available to taxpayers.16 Since the congressional budget cuts began in 2010, however, the IRS has been increasing many fees to full cost unless there is a compelling reason not to, such as when the services are pro- vided to low-income taxpayers. The resulting steep increases have led some practitioners to push back and call for more trans- parency regarding how government expenses are calculated — or to ask courts to declare the fees invalid. The IRS does not fully disclose to the public what factors it considers in setting fees.17 In a November 2011 report by the Government Accountability Of- fice, the GAO said that at least ‘‘for the IRS’s smaller user fee programs, we found that data or assump- tions used in cost estimates were not always well documented or understood by officials.’’18 The Tax- payer Advocate Service (TAS) has also called for increased transparency, asking the IRS to ‘‘publish its user fee analysis and address any comments from internal and external stakeholders before adopting or increasing a fee.’’19 The IRS usually reviews its user fees every two years, but it does not publish those review docu- ments.20 As described by the GAO report, the fee review process involves the IRS CFO’s office work- ing with business divisions and program offices to develop cost estimates for particular services and thereby establish fees.21 In 2014, with the impetus to find new user fees and increase existing ones, the IRS added an extra, out-of-cycle fee review.22 The Internal Revenue Manual lists the factors the IRS looks for in deciding whether to impose new fees for services or activities: 1. the user fee activity must be voluntary and requested by the taxpayer; 2. the benefit must be ‘‘identifiable’’ to a spe- cific taxpayer; 3. the cost of administering the fee cannot be a substantial amount of the fee; and 4. the fee’s effect on low-income taxpayers must be considered.23 We may soon get some insight into the fee-setting process. The National Association of Enrolled Agents (NAEA) has made a Freedom of Informa- tion Act request regarding the calculation of the fee for the exam that prospective enrolled agents must take, after the IRS increased it from $11 to $99.24 At the hearing on the request, Robert Kerr, senior director of government relations at the NAEA, described his concern as follows: The increasing cost is $88 per part. IRS antici- pates 20,000 parts administered per year. The total increase in revenue to the Agency is $1.76 million annually. So let’s generously assume that the background check increase of $270,000 is simply passed-on fees from elsewhere. That leaves nearly $1.5 million in revenue or roughly 15 additional full-time equivalent em- ployees. We can’t imagine that IRS requires an office the size of NAEA’s entire staff to meet the three increased costs and the five costs that were omitted from the initial cost estimate. We would like to know what IRS is doing with a rough equivalent of 15 GS-12 and GS-13 staff, and we do not. We are not alone, however. No one outside the Agency knows. And we’re not even sure who inside the Agency knows.25 C. The Ghost of Congress Past With Congress’s recent attempts to squeeze the IRS, it seems odd that lawmakers would have given the agency the freedom to raise its own revenue. Of course, the landmark fee legislation came in 1952, with the enactment of the IOAA, and in 2005, when Congress authorized the IRS to keep and spend all new fees imposed beginning in October 1994. Be- cause the IRS can generally choose how it wants to spend its retained fee revenue — it does not have to get congressional approval on how to use those 16 Velarde, supra note 6. 17 TAS, supra note 1, at 21. 18 GAO, ‘‘User Fees: Additional Guidance and Documenta- tion Could Further Strengthen IRS’s Biennial Review of Fees,’’ GAO-12-193, at 17 (Nov. 2011). 19 Id. at 14. 20 Internal Revenue Manual section 21 GAO-12-193, supra note 18, at 17. 22 TAS, supra note 1, at 17. 23 IRM section 24 REG-134122-15. By the way, there’s a user fee for submit- ting FOIA requests. 5 U.S.C. section 552(a)(4)(A). 25 Transcript of public hearing on REG-134122-15, at 3 (Feb. 25, 2016). See Hoffman, ‘‘NAEA Requests OMB Exception to Exam User Fee,’’ Tax Notes, Feb. 29, 2016, p. 987. TAX NOTES, October 3, 2016 113 COMMENTARY / GRIST FOR THE MILL For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  4. 4. funds — it has spent the money precisely in areas where Congress is reducing appropriations.26 Congress has asked the IRS to focus on taxpayer services and make cuts in other areas.27 Congress allocates its appropriations to four categories of IRS spending, which the IRS cannot then redistribute. The biggest victims of the reduced funding have been enforcement and operations support. Appro- priations for taxpayer services have actually in- creased slightly from fiscal 2010 ($2.28 billion)28 to fiscal 2016 ($2.41 billion).29 With its user fee revenue, however, the IRS has gone in the opposite direction, shifting its spending away from taxpayer services ($129 million in fiscal 2011 to $45 million in fiscal 2015) and toward operations support ($54 million in fiscal 2011 to $393 million in fiscal 2015).30 Of course, that legal defiance has not gone unno- ticed.31 There have been efforts by Republicans in Congress to eliminate IRS discretion over how it spends its user fee funds and divert the fees back to the Treasury General Fund. The IRS Oversight While Eliminating Spending Act of 2016,32 intro- duced in March by House Ways and Means Com- mittee member Jason Smith, R-Mo., would prohibit the IRS from spending any fee revenue until spe- cifically authorized by an appropriations act.33 But for now, the IRS can continue doing what the law allows, even if lawmakers are not completely happy about it. Granted, when lawmakers set IRS funding levels, they take into account how much the IRS expects to collect in user fees and how it plans to allocate those funds. But other than pre- emptively lowering allocations or enacting new legislation, Congress can’t then control the IRS’s user fee spending. D. Good Service Is Expensive Before Congress decries the IRS too much over the rogue use of fees, lawmakers should consider giving the agency fewer new assignments. Three of the top targets of IRS user fee spending involve the implementation of relatively new legislation. In fiscal 2016, of the $509 million in user fee funds the IRS plans to spend, $204 million will go to imple- menting the Affordable Care Act, $62 million to implementing the Foreign Account Tax Compliance Act, and $30 million to implementing the Achieving a Better Life Experience Act, all of which were enacted after 2009. Of the $1.6 billion the IRS spent implementing the ACA between fiscal 2010 and fiscal 2015, 29 percent of the funds came from user fee revenue.34 One of the interesting revelations of the IRS’s move to a full cost policy for user fees is that it puts a rough price tag on what the IRS believes its services actually cost. Many are pretty pricey — at least from the perspective of your everyday tax- payer. That, in turn, sheds light on the difficult decisions the agency must make in dealing with budget shortfalls. For example, in the letter ruling program, if it legitimately costs the government $28,300 each time it examines a taxpayer issue and writes up a ruling, it’s apparent why the IRS might want to set some limits on taxpayer access to the program. Expensive services that at least theoretically benefit only a small group of taxpayers would seemingly suffer the most in an era of budget cuts, as opposed to more broadly based programs such as general guid- ance and litigation support.35 But many taxpayer issues require an upfront, personalized determination from the IRS. Organi- zations that seek tax-exempt status, for example, must first submit an application to the IRS and get its blessing. If the IRS doesn’t want to expend a lot of resources providing those services, it must come up with an alternative. Many times the answer has been to resort to automatic procedures or to let taxpayers simply check a box and choose their own tax treatment. Regarding the issue of applying for tax-exempt status, the IRS in 2014 developed a streamlined process for organizations that meet specific limits on gross receipts and assets. It made the process easier and cut down on the information those organizations have to provide — and consequently on the analysis the agency has to pay its staff to perform. One result of this streamlined procedure has been a drop in the user fee for the application, from $400 to $275.36 Because the procedure is simpler for 26 The IRS must get approval of its user fee spending plan from Treasury and the OMB. GAO, supra note 3. 27 TAS, supra note 1, at 21. 28 Treasury, ‘‘FY 2011 Budget in Brief,’’ at 65 (Feb. 2010). 29 GAO-16-695, supra note 3. 30 Id. 31 See majority staff report of the House Ways and Means Committee, ‘‘Doing Less With Less: IRS’s Spending Decisions Harm Taxpayers’’ (Apr. 22, 2015) (criticizing the IRS for shifting user fee spending away from customer service and toward other purposes). 32 H.R. 4885. 33 Hoffman, ‘‘Professionals Differ on Bill Restricting IRS User Fees,’’ Tax Notes, Apr. 11, 2016, p. 186. 34 GAO-16-695, supra note 3. 35 Elliott, supra note 8. 36 Rev. Proc. 2016-32, 2016-22 IRB 1019. COMMENTARY / GRIST FOR THE MILL 114 TAX NOTES, October 3, 2016 For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  5. 5. the IRS, it’s faster and less costly to administer, and the agency has been able to clear the backlog in claims.37 However, according to critics, the trade-off has been a reduction in IRS oversight, which increases the possibility that unqualified filers will gain sec- tion 501(c)(3) status. Before the simplified approach was implemented, the approval rate for applicable organizations was 77 percent. Following the change, that rate rose to 95 percent, as of December 2015.38 E. User Fee Shell Game IRS revenue from user fees generally does not fund the services for which they’re charged. For example, the Office of Chief Counsel retains none of the fees for the letter rulings it prepares. Most fees go to either the IRS Miscellaneous Retained Fees Fund or the Treasury General Fund, depending on when the fee was created and which statute autho- rizes it. That discrepancy between which services charge fees and which ones benefit from the revenue undermines a primary argument for allowing fees — that specific government programs have an ascertainable value and can be paid for by the people who choose to use them. Fees that can be used for any purpose look a lot like income from tax revenue, which funds the government’s general checking account. If nothing else, the optics are bad. People don’t pay the barber for the mechanic to fix their car. Why should offer in compromise fees fund the implementation of the ACA? One way to sidestep the discrepancy would be to say that money is fungible. If the IRS needs $10x to operate and it receives $8x in congressional appro- priations and $2x in user fees, it doesn’t really matter how the IRS applies the user fee revenue — the funds remain crucial to the overall IRS budget. Thus, if the programs most vulnerable to budget shortfalls are the ones charging fees, those pro- grams benefit from the additional revenue, even if they don’t directly receive it. However, that argument reveals something about what user fees really are — just another source of revenue. In fact, applied in the opposite direction, the argument cuts against the significance of tying user fee revenue to the programs that charge them. In the above example, the IRS receives $8x in appropriations from Congress but needs $10x to fund all services adequately. Suppose it raises an additional $2x through user fees but can spend the funds only on the services that charge them. The IRS still wins because it can apply the remaining $8x to meet its other needs — which should now be only $8x following the application of the fee rev- enue.39 The TAS has even gone as far as to compare the OIC fee to a tax shelter or accounting gimmick. When a taxpayer makes an offer to settle a delin- quent tax debt, the fee is factored into the determi- nation of what the taxpayer can afford to pay. That reduces how much the taxpayer can pay in back taxes, thus shifting some money to the IRS — in the form of a fee — that otherwise would have gone to the treasury.40 Thus, even if we can select specific IRS services that are expensive, are important, and have identi- fiable beneficiaries, the question to answer first is whether the IRS should be allowed to impose fees to raise its own revenue and, next, whether it should have the authority to increase those fees whenever it needs additional funding. Raising revenue through fees should be a policy choice rather than an accident of necessity and forgotten legislation. The same questions of fairness and progressivity should apply to the imposition of fees that (should) apply to other government meth- ods of extracting money from the public. One problem with user fees is that they can be very regressive.41 Most IRS user fee revenue comes from installment agreements,42 which are used by taxpayers who cannot otherwise pay their tax bills in full and are trying to regain compliance. That means taxpayers who have trouble paying their ordinary tax bills are the ones who are in large part charged with filling the IRS user fee pot to fund new mandates from Congress. On the other extreme, fees for services like letter rulings have become so expensive that only rela- tively wealthy taxpayers can afford them. That raises the specter of a government that will provide elite-level service only to those who have the re- sources to pay for the privilege.43 Without going too far into questions of fairness, it’s enough to say that decisions about user fees should be the product of specific analysis and debate, not happenstance. If the IRS continues to press the limits of its authority to create new user 37 Fred Stokeld, ‘‘User Fee for EO Short Form Reduced,’’ Tax Notes, June 6, 2016, p. 1333. 38 Hoffman, ‘‘Taxpayer Advocate Warns of Class System for Taxpayers,’’ Tax Notes, Jan. 11, 2016, p. 143. 39 This assumes that the fee-charging programs are not gen- erating fees that exceed what the services cost. 40 TAS, supra note 1, at 24. 41 GAO, ‘‘Federal User Fees: A Design Guide,’’ GAO-08- 386SP (May 2008). 42 In fiscal 2010, installment agreements accounted for 68 percent of IRS retained fees. GAO-12-193, supra note 18. 43 See Hoffman, supra note 38. TAX NOTES, October 3, 2016 115 COMMENTARY / GRIST FOR THE MILL For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  6. 6. fees and increase the cost of existing ones, it should be because we prefer the IRS to have that revenue- raising power. Note that although I have framed user fees fairly negatively, many people support them as a policy choice and believe they should be more widely applied — probably in conjunction with a reduction in other taxes. One example would be conservative groups that see user fees as a steppingstone toward replacing income taxes with consumption taxes.44 F. Are User Fees a Tax? The above discussion raises the issue of whether fees give the IRS its own administrative tax system. Are fees actually distinct from taxes? For legal purposes, to escape questions of delegating the authority to tax, the answer is supposed to be yes. The harder part is pinning down the reasoning that gets you there. From a taxpayer’s perspective, any time the IRS asks you for money, it’s for either a tax or something related, and the difference isn’t all that relevant. Both add to your overall burden of tax compliance. The government, of course, does care about the distinction. The labeling issue has come up in the courts many times because of the different require- ments and consequences associated with the vari- ous government exactions such as fees, taxes, and penalties. But despite the frequent litigation, defin- ing the terms remains philosophically challenging because the distinctions are a matter of degree and the categories can overlap. Painted with a broad brush, both taxes and fees are exactions the government charges the public to fund its services. The nuance comes in determining who bears the incidence of the charge, how the charge is calculated, and whether taxpayers have a choice in paying it. Here’s one way to distinguish the two: • User fees are charges assessed on specific ben- eficiaries who make a voluntary request for goods or services provided by the federal government above and beyond what is nor- mally provided to the public. The fees are generally based on the cost of the service or good provided, although a fee can exceed that cost. • Taxes arise from the government’s sovereign power to raise revenue and are not necessarily related to any specific benefit. Unlike user fees, taxes are generally imposed to raise revenue to fund benefits for the general public, such as the national defense.45 Those distinctions seem most apt when compar- ing, for example, the $2 user fee for an IVES transcript with the income tax, which is not based on the cost of a specific service but on one’s ability to pay. However, the differences break down if you poke at them. The tax family tree is big and has a lot of branches. An excise tax is different from an income tax, which is different from a VAT, which is different from a tariff. All those taxes also involve different incidence, different manners of collection, and dif- ferent justifications for imposition. When consider- ing the variety within the tax family, distinguishing fees becomes more difficult. According to Justice Stephen G. Breyer, rather than thinking of two wholly separate families, fees and taxes, it is better to consider them as ‘‘a spectrum with a paradigmatic tax at one end and a paradigmatic fee at the other.’’46 But let’s take a look at some of the characteristics mentioned above, shake the branches a bit, and see what comes out. 1. Voluntariness. The IRM cites the voluntary na- ture of an IRS service as a factor in whether to charge a fee: ‘‘The IRS does not charge taxpayers for special services that they do not request.’’47 According to the Tax Foundation, many states have abandoned voluntariness as a factor in distin- guishing between fees and taxes.48 And rightly so. Paying taxes is not something most people do voluntarily — outside a legal mandate to do so — and thus any choice on how to meet those compli- ance burdens will be illusory, at least to some degree. For example, tax return preparers must include a preparer tax identification number on every return and other refund claim they submit to the IRS. To obtain that PTIN, the preparers must pay a fee, first to apply for it and then each ensuing year to renew 44 See Jasper L. Cummings, Jr., ‘‘Meandering From Income to Consumption Taxes Via User Fees,’’ Tax Notes, Aug. 29, 2016, p. 1241. 45 This definition is primarily drawn from GAO-12-193, supra note 18, but it also adds elements from Joseph Henchman, ‘‘How Is the Money Used? Cases Distinguishing Taxes and Fees,’’ State Tax Notes, May 20, 2013, p. 619. Henchman would object to the voluntary requirement of the user fee. To him the distinction comes down to the primary purpose of the exaction: The primary purpose of fees is to recoup the cost of a service, and the primary purpose of taxes is to raise revenue. For a good overview of some other definitions, see Cummings, supra note 44. 46 San Juan Cellular Telephone Co. v. Public Service Commission of Puerto Rico, 967 F.2d 683 (1st Cir. 1992). 47 IRM section 48 Henchman, supra note 45. COMMENTARY / GRIST FOR THE MILL 116 TAX NOTES, October 3, 2016 For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  7. 7. it (although the identifying numbers themselves do not change from year to year). Preparers could choose not to obtain a PTIN, but that would expose them to potential penalties un- der section 6695(c) for failure to provide one — $50 per return and up to $25,000 per year. Further, section 7407 authorizes the government to seek an injunction requiring the preparer to include a PTIN on future returns or to bar the preparer from continuing in that line of work. Thus, assuming the penalty would apply, the true alternatives for the tax return preparer are a $50 fee or a $25,000 penalty. It’s fair to say that that’s not a good choice. Other IRS fees don’t subscribe so fully to the twist-your-arm definition of voluntariness, but they do apply to services that are an important and regular part of practice. For example, the IRS has recently increased the fee for rulings for so-called 9100 relief under reg. section 301.9100, which pro- vides administrative relief for specific missed elec- tions. The process has become so routine — and the alternative so unpalatable — that there is often ‘‘no choice in the matter’’ but to seek it, according to Mark Schneider of Deloitte Tax LLP.49 Also, voluntariness is not the exclusive province of user fees. There are many examples of taxpayer choice regarding the timing and selection of differ- ent tax regimes — from the check-the-box entity rules, to the various rulings blessing specific merg- ers and acquisitions, to the assortment of methods for deferring income and accelerating the recogni- tion of losses. 2. Specific benefit. The IRM says fees should be imposed only when the benefit of the service is ‘‘identifiable to a specific taxpayer.’’ There are two problems with that: (1) sometimes it’s unclear what the benefit actually is to the taxpayer, other than avoiding noncompliance; and (2) often the benefits spill over to other taxpayers. Coming back to PTINs, return preparers are required to include those numbers on returns they submit to the IRS. Thus, obtaining one from the IRS is not so much a benefit as it is a necessity for people in that profession. Before 2010 the IRS provided PTINs for free, and before that preparers simply used their Social Security numbers. PTINs likely help reduce identity theft, compared with the use of SSNs, but it should not be considered a special concession of the government to allow taxpayers to comply with the law without being exposed to unnecessary risks. Services such as PFAs, which allow taxpayers to agree with the IRS in advance about the tax treat- ment of specific transactions, are often an overall better use of resources than the alternative — which involves taxpayers making their best guess about a transaction’s tax treatment and then eventually hashing it out with the IRS in an audit and maybe the courts. Both the PFA and the audit require personalized service from the IRS and end in an agreed-on tax treatment, but only the PFA, despite often being the better alternative, carries a hefty price tag. George A. Hani of Miller & Chevalier Chtd. said: Really [PFAs are] long-term resource savers. [They allow the IRS to] look at something today because it is closer in time to the trans- action, the people, the documents. So [it will] be more efficient in examination of the issue rather than wait three to four years [for it] to come up on audit.50 So what exactly is the specific benefit of PFAs that’s worth charging for? Is it that they provide a shortcut around an otherwise more difficult and expensive audit process? That is a little like charg- ing a fee to allow people to cut the line at the Department of Motor Vehicles. Although PFAs pro- vide a benefit, it’s only because they remedy a problem the government created. The second problem with the specific benefit requirement is that the benefits of some services are not limited to the taxpayers who use them. For example, with letter rulings, although the benefit applies mostly to the taxpayer who can rely on the IRS’s ruling and can plan accordingly, the benefit also spills over to the IRS and to taxpayers more generally. For one thing, although letter rulings may not be relied on as precedent by other taxpayers, they indicate the IRS’s views on how specific mat- ters should be treated, giving the tax community a better chance to plan correctly and avoid audits, which are expensive for both taxpayers and the government. Further, rulings bring to the IRS’s attention some of the issues that are floating around in the transactional market and thereby help the IRS develop broader guidance such as revenue rulings and regulations.51 The related challenge in identifying which spe- cific benefits to charge for is identifying which specific benefits not to charge for. This creates a ‘‘fence’’ problem in that services of similar complex- ity may be expensive for one taxpayer but free or cheap for a different taxpayer. Depending on which pasture you’re in, you could get relatively unfair treatment. 49 Elliott, supra note 8. 50 Velarde, supra note 6. 51 Id. TAX NOTES, October 3, 2016 117 COMMENTARY / GRIST FOR THE MILL For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  8. 8. For example, the IRS has identified several types of questions that qualify for reduced letter ruling fees. Because the IRS views those issues as routine or simple, its attorneys spend less time resolving them, and the rulings therefore cost the government less. However, taxpayers who need the response to an otherwise simple question — but one that is not listed as qualifying for a reduced fee — still have to pay full price. The American Institute of CPAs recently raised that complaint regarding letter rul- ing requests to treat late S elections as timely or to waive inadvertently ineffective S elections or inad- vertent terminations. Those requests are subject to the full $28,300 fee, even though the AICPA believes they are no more complex than many questions that qualify for the reduced rate.52 3. Fees versus excise taxes. Of the various members of the tax family, excise taxes may be the closest relative to user fees. Excise taxes are charges tacked onto the sale of particular goods or services. One rationale for imposing excise taxes is to discourage people from buying specific products — excise taxes on cigarettes are a good example. But the other rationale is to tailor the tax to specific con- sumers — that is, to levy the tax only on those who choose to pay for that service or good, just like with user fees. Sometimes the revenue generated from excise taxes is earmarked for a fund that pays for related government services. There is a federal excise tax imposed on the sale of gasoline — a flat fee of 18.4 cents per gallon. Many consumers don’t notice it because it is built into the price, like a lot of excise taxes. The revenue from the gas tax is earmarked for the Highway Trust Fund, which pays for surface transportation spending, such as building and re- pairing roads and bridges.53 Thus, the tax targets the people who spend a lot of money on gas and who thus presumably also spend a lot of time driving on roads and bridges. That’s the idea. Because of the similarities between excise taxes and user fees, the OMB says they should not both be charged for the same activity. In the words of Circular A-25, ‘‘Excise taxes are another means of charging specific beneficiaries for the Government services they receive. New user charges should not be proposed in cases where an excise tax currently finances the Government services that benefit spe- cific individuals.’’ Excise taxes have been distinguished from fees in terms of their purpose, that is, whether they are charged for revenue (excise taxes) or to recover the cost of a service (user fees), and in how they are calculated — fees should be based on the cost of the service provided, whereas excise taxes should be limited only by what’s politically feasible to impose. But those are thin differences. Using the gas tax to pay for highways is more along the lines of recov- ering costs than is using letter fee revenue to fund the implementation of FATCA and the ACA. And capping fees at the cost of services doesn’t seem to be a big limitation based on the recent fee hikes by the IRS. While government services remain very expensive to provide, setting an upper limit of ‘‘full cost’’ still allows for a broad range of fee pricing. Excise taxes are also generally imposed on goods or services the government might not own or provide. The gas tax, for example, can be collected from transactions between two nongovernment parties. User fees, by nature, must involve the provision of a government good or service. But that difference doesn’t always hold, as indicated by Circular A-25. Sometimes excise taxes and user fees could both apply to the same good or service. In that case, the government must generally pick one or the other. 4. Squelching sin versus recouping cost. Excise taxes are often intended to discourage the use of a particular good or service or to impose an extra cost on those who undertake activities seen as especially dangerous. In that role, they’re sometimes referred to as sin taxes.54 For example, there are excise taxes on the use of tanning beds and on the sale of alcohol, tobacco, firearms, and ammunition. On the campaign trail, Democratic presidential nominee Hillary Clinton expressed her support for an excise tax on soda passed in Philadelphia earlier this year.55 User fees can also be imposed to discourage or regulate use,56 but that generally isn’t the stated reason for charging them, at least for the IRS. Neither the IRM nor Circular A-25 requires the agency, when introducing new fees, to consider how the increased cost might discourage the use of the services. According to the TAS, the IRS some- times estimates the impact of fees on demand for 52 Joseph DiSciullo, ‘‘AICPA Seeks Reduced User Fees for S Corporation Letter Rulings,’’ Tax Notes, May 30, 2016, p. 1203. 53 Stephen K. Cooper and Hoffman, ‘‘Congress Passes High- way Bill With Tax Debt, Passport Offsets,’’ Tax Notes, Dec. 7, 2015, p. 1219. The gas tax revenue is deposited in the Treasury General Fund, and an equivalent amount is then transferred to the Highway Trust Fund. 54 See Joseph J. Thorndike, ‘‘Don’t Believe the Hype: Excise Taxes Are About Revenue,’’ Tax Notes, Jan. 12, 2015, p. 179. 55 Paul C. Barton, ‘‘Does Clinton’s Soda Stance Violate Her Tax Pledge?’’ Tax Notes, May 2, 2016, p. 602. 56 See Clayton P. Gillette and Thomas D. Hopkins, ‘‘Federal User Fees: A Legal and Economic Analysis,’’ 67 B.U. L. Rev. 795 (1987). COMMENTARY / GRIST FOR THE MILL 118 TAX NOTES, October 3, 2016 For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  9. 9. services, such as in its biennial reviews, but that analysis is performed only after the fees are im- posed or increased.57 The hope that user fees can help recoup the cost of services must be balanced with the deterrent effect that any fee or tax will have in raising the price for consumers. As discussed previously, the cost of PFAs is undergoing a dramatic increase, from a maximum of $10,000 in 2007 to $218,600 in 2017, even though PFAs are arguably more efficient than the potential alternative of conducting audits after the fact. Ac- cording to the TAS report, the Large Business and International Division opposed the increase in the PFA fee, arguing that it could deter taxpayers from participating in the program, which enhances com- pliance and provides certainty to taxpayers.58 One way to deal with the deterrent effect would be to charge for the disfavored of two alternative paths. Thus, for the PFA, why not charge for the audit instead of the upfront agreement? Audits require the IRS to spend significant resources bat- tling with a single taxpayer to resolve payment disputes. If the IRS believes its limited resources are best spent on efforts that benefit the largest number of taxpayers while incurring the lowest cost, audits should be avoided whenever possible. Charging user fees for audits would fail the ‘‘voluntary’’ requirement in the IRM, but as has been discussed, voluntariness only loosely applies to any compliance efforts that taxpayers undertake. Taxpayers can ‘‘choose’’ not to participate in audits just like return preparers can choose not to obtain a PTIN — their freedom of choice simply comes with a large mandatory bill. Or, less glibly, the taxpayer’s choice could be the decision to forgo a PFA and thus roll the dice on a risky position, which ultimately costs the government — and the taxpayers who fund it — by requiring a lengthy audit and possible battles in court. It remains to be seen whether the price increase will lessen the use of PFAs. Taxpayers who would seek them tend to have the resources to pay large fees. As described by Michael P. Dolan of KPMG LLP, taxpayers might just have to accept the fee: ‘‘The tax director [may have to] scratch his head a couple times in terms of being able to get budget authority to do it, but the financial statement con- sequence and the tax certainty consequence will still be worth it for those major transactions.’’59 However, other fee increases have been followed by reduced participation. From fiscal 2010 through fiscal 2014, the number of private letter rulings released decreased by 30 percent.60 In the year the IRS imposed a fee for the OIC program — a relatively cost-effective method of collecting delin- quent tax debt — submissions fell by over 20 percent among taxpayers at every income level.61 5. Are user fees a tax? User fees may be the ugly cousin no one wants to claim, but it’s hard to make the argument that they don’t belong on the tax family tree. However, that doesn’t mean user fees are inherently wrong. If a court won’t overturn them, government agencies can keep charging them. The question again comes down to policy: Is that how we should raise revenue, or should we increase income taxes or create new taxes, like a VAT? G. Tax Return Preparers Fight Back We may soon find out if a court will overturn one of the IRS’s user fees — the PTIN fee. It’s the subject of a class action lawsuit before the U.S. District Court for the District of Columbia (Steele).62 Accord- ing to T. Keith Fogg of Villanova University School of Law, the case could ‘‘presage challenges to other fees that the IRS charges, though it will be harder to find a class in some of the other fee areas.’’63 The same court in two recent cases has found that the IRS overreached in attempts to regulate return preparers (Loving64 and Ridgely65). The Steele plain- tiffs seek recovery of fees previously paid and a judgment declaring that the IRS lacks the authority to charge a fee for a PTIN or, alternatively, that the amount of the fee is excessive. Since the case is a class action, the stakes are high for the IRS. The suit seeks recovery of fees paid, which the plaintiffs say would exceed $130 million. The plaintiffs estimate that the class in Steele — which has now been certified for both the declara- tory and monetary claims — includes between 700,000 and 1.2 million people.66 The IRS has issued PTINs since 1999, but they were not initially mandatory, and the IRS did not charge for them.67 In 2010 the IRS began to take a 57 TAS, supra note 1, at 18-19. 58 Id. at 19. 59 Elliott, supra note 7. 60 GAO, ‘‘IRS Is Scaling Back Activities and Using Budget Flexibilities to Absorb Funding Cuts,’’ GAO-15-624, at 11 (June 2015). 61 TAS, supra note 1, at 24. 62 Amended Class Action Complaint, Steele v. United States, No. 1:14-cv-01523 (D.D.C. filed Aug. 7, 2015). 63 Nathan J. Richman, ‘‘Class Certified in Challenge to IRS’s PTIN Fee Authority,’’ Tax Notes, Feb. 15, 2016, p. 765. 64 Loving v. IRS, 917 F. Supp.2d 67 (D.D.C. 2013), aff’d, 742 F.3d 1013 (D.C. Cir. 2014). 65 Ridgely v. Lew, 55 F. Supp.3d 89 (D.D.C. 2014). 66 Steele, 2016 U.S. Dist. LEXIS 103784 (D.D.C. 2016). 67 Amended Class Action Complaint, supra note 62, at paras. 9 and 10. TAX NOTES, October 3, 2016 119 COMMENTARY / GRIST FOR THE MILL For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  10. 10. comprehensive look at regulating the tax return preparation industry.68 This involved the require- ments struck down in Loving for competency testing and for continuing education for tax return prepar- ers who were not otherwise certified as profession- als (such as CPAs, attorneys, and enrolled agents). Other changes in 2010 were to make PTINs mandatory and to begin charging a fee for them, for both the initial application and renewal each year.69 The fees at issue in Steele were $64.25 for a new PTIN and $63 for a renewal.70 According to the IRS, the fees are necessary to recover the direct and indirect costs of providing the service. Of the fee, the IRS said $50 was for ‘‘processing’’ the PTIN application and that the rest was paid to a third party to ‘‘administer the PTIN application and renewal process.’’71 The IRS estimated that the fees would cover its $51 million to $77 million in annual costs of the PTIN registration program. That amount includes payments to third-party vendors for processing applications, as well as the IRS-incurred costs of providing registration cards to each registered pre- parer; creating forms, instructions, and other guid- ance; and conducting ‘‘tax compliance and suitability checks’’ of return preparers.72 According to the complaint, the IRS has not performed any suitability checks, does not gener- ally provide registration cards to return preparers, and does not usually charge for the guidance and instructions it provides to taxpayers. Further, the complaint alleges that the IRS or another agency has sold the PTIN database to vendors, who use it to try and sell goods and services to PTIN holders. The statutory authority the IRS relies on for the fee is section 6109 and the general authority of the IOAA. Section 6109 requires tax return preparers to provide an identifying number on any return or claim for refund they prepare, and it authorizes regulations that would enable the IRS to obtain any ‘‘information as may be necessary to assign an identifying number to any person.’’ The IOAA, as discussed above, authorizes agencies to charge a user fee when they provide a ‘‘service or thing of value.’’ The value provided by the PTIN, according to the IRS, is that it gives return preparers ‘‘the ability to prepare tax returns for compensation.’’73 The com- plaint in Steele points out that tax return preparers had been preparing returns for many years without the special power of the PTIN, and it cites Loving and the U.S. Constitution for the proposition that tax return preparers have ‘‘a right to prepare returns for others for compensation.’’ Even though the plaintiffs have succeeded in getting certification of the class in a court with a track record of overturning IRS attempts at regulat- ing tax return preparers, they may still face an uphill battle. Previous challenges to the PTIN fee have failed. The decision in Loving might not affect the validity of the PTIN fee because the IRS justifies the fee under a different statute than the one at issue in Loving. The courts in Brannen74 (which predated Loving) and Buckley75 (which was decided after and discusses Loving) both found that the IRS had the authority to impose the PTIN fee. H. Conclusion The IRS is not doing anything illegal by collect- ing user fees and spending the revenue. However, the spending clearly runs contrary to the express desire of Congress to cut IRS funding, and some lawmakers have introduced a bill to end the user fee workaround. The IRS experience has shown that user fees can be an effective way to raise additional revenue. Fees and excise taxes are a step in the direction of consumption taxes, and at their best, they require the people who benefit from specific government services to be the ones who pay the cost of provid- ing them. But the current setup does not live up to the beneficiary-pays ideal, regardless of its merit. In general, IRS user fees do not fund the specific services for which they are charged but rather fund IRS needs as a whole. That puts the burden of funding the agency on a very small, somewhat arbitrarily selected group of taxpayers. And the recent rate hikes appear to have less to do with determining what specific services should cost than with the IRS’s need to find additional revenue. User fees for IRS services should be used spar- ingly, if at all, and costs should be determined with an eye toward whether they discourage the use of cost-effective and efficient resources. Taxpayers 68 See IRS Publication 4832, Return Preparer Review (Dec. 2009) (discussing the importance of regulating the tax return prepa- ration industry). 69 T.D. 9501 (imposing the fee); T.D. 9503 (setting the rate). 70 The fees have been reduced to $50 for the initial application and for renewal. The IRS said it reduced the PTIN fees because it ‘‘has determined that the full cost of administering the PTIN program going forward has been reduced from $50 to $33 per application or renewal.’’ T.D. 9781. 71 REG-139343-08. 72 T.D. 9527. 73 Steele, 2016 U.S. Dist. LEXIS 103784 at *9 n.5. 74 Brannen v. United States, 682 F.3d 1316 (11th Cir. 2012) (upholding the initial fee). 75 Buckley v. United States, No. 1:13-cv-01701 (N.D. Ga. 2013) (upholding the annual fee). COMMENTARY / GRIST FOR THE MILL 120 TAX NOTES, October 3, 2016 For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.
  11. 11. want to choose the easiest and cheapest way to accomplish what’s required of them — as should the IRS. Compliance with tax law is ‘‘voluntary’’ only in the sense that the government gives you a chance to pay before shaking the money from your pockets. So although the IRS has a monopoly on administer- ing federal tax law, we should think twice about allowing it to charge high fees for taxpayers to do something that — if given a real choice in the matter — they would probably rather skip. IN THE WORKS A look ahead to planned commentary and analy- sis. Will Treasury’s interpretation of the cap on ABLE make it more capable? (Tax Notes) Stephanie Hoffer examines the purpose of section 529A tax-favored savings vehicles and argues that if individuals with qualify- ing disabilities contribute and withdraw money in the same year, those funds should not count toward the annual limit. VAT: Has the time come? (Tax Notes) Jim Leet argues in favor of implementing a VAT and says that doing so would stimulate economic growth and increase wages. DMA v. Brohl — ‘Son of Quill’? (State Tax Notes) David Vistica and Jeremy Sharp contend that the long road traveled by Direct Marketing Association v. Brohl has created two ap- proaches for states seeking to challenge the Quill/Bellas Hess sales and use tax physical presence standard. Test results from Massachusetts’s energy laboratory (State Tax Notes) Patrick Dowdall discusses two legislative developments and a decision by the Su- preme Judicial Court of Massachusetts that have happened in the last six months regard- ing the state’s incentives for renewable en- ergy. U.S. income tax treatment of Australian superannuation funds (Tax Notes International) Roy A. Berg and Marsha-laine Dungog iden- tify areas in which Treasury and the IRS should issue guidance on the treatment of Australian superannuation funds owned by U.S. persons. Mexican service companies come under challenge by the tax administration (Tax Notes International) Manuel Solano, Koen van ’t Hek, and Terri Grosselin discuss a recent Mexican court decision regarding a VAT refund request and the legal status of a service company. TAX NOTES, October 3, 2016 121 COMMENTARY / GRIST FOR THE MILL For more Tax Notes content, please visit (C)TaxAnalysts2016.Allrightsreserved.TaxAnalystsdoesnotclaimcopyrightinanypublicdomainorthirdpartycontent.