Thursday, March 5, 2009
Mark Gergen (UC-Berkeley) presents Third Party Opinions as a Tool for Enforcing Tax Law at Northwestern today as part of its Advanced Topics in Taxation Series organized by Tom Brennan and Charlotte Crane. Here is the Conclusion:
Aggressive reporting by taxpayers on items that involve legal or factual uncertainty is an endemic problem in tax law. While aggressive tax shelter opinions have attracted the most attention aggressive valuations backed up by aggressive appraisals probably are a greater problem. We cannot know for sure because it is very difficult for the government to police valuations. Taxpayers have an informational advantage and it is costly for the government to contest a valuation. If a taxpayer is audited, then she can expect to be able to settle on favorable terms. This essay shows that this problem is not solvable by increasing the audit rate, expending more resources to contest aggressive positions, and imposing a penalty that is the inverse of the audit rate when a substantial underpayment is found. Even at fairly high audit rates taxpayers are likely to continue to take aggressive positions when reporting items that involve legal or factual uncertainty because of the asymmetric treatment of overpayments and underpayments. Another solution beckons. This is to require taxpayers to obtain an opinion or appraisal supporting their position, imposing a penalty that is around 1/10th inverse of the audit rate on a taxpayer if there is a substantial underpayment, and requiring the opinion supplier to indemnify the taxpayer for this penalty. This strategy is likely to suppress aggressive reporting if the government also requires taxpayers to report the fee paid for an appraisal and announces a policy of auditing transactions with abnormally high fees. The problem with this strategy is that if applied globally it would significantly increase expenditures on tax compliance, which is a dubious good. But this strategy should be employed to deter tax motivated transactions that themselves are wasteful.