Homage to information returns.

Keeping cost efficiencies and compliance concerns in mind, Congress should still vastly expand the issuance of information returns. Specifically, Congress should expand information reporting issuance with respect to each of the following transactions and events: (1) tax basis for investments, (2) receipts of gifts, (3) most payments made to service providers, and (4) real estate interest and tax deductions.

1. Tax Basis Reporting for Taxpayers' Investments

Under current law, the Code provides that the net amount realized less adjusted basis determines a taxpayer's gain or loss. (20) The amount realized is a current "fact" and presents no major conceptual or administrative problems. (21) But the same cannot be said about tax basis identification. For reasons relating to complexity, (22) the absence of a substantiation requirement, (23) and the lack of compliance incentives, (24) tax basis identifications have historically proven extraordinarily difficult for taxpayers to make. When confronted with these difficulties, taxpayers must often make estimates; and when they do, they unintentionally or deliberately err in their own favor, costing the government billions of dollars annually. (25)

Third-party information returns can play a pivotal role in addressing this problem. Mutual funds and brokerage firms are ideal candidates to identify and track the tax basis clients have in their investments. This is because these funds and firms handle millions of accounts, and most have an existing system that documents this information. In addition, most of these funds and firms have experts on staff or retain outside counsel to monitor capital changes that affect the tax basis clients have in their investments. (26)

Instituting this reporting requirement would be a boon to taxpayers, the government, and even mutual funds and brokerage firms. Taxpayers would have ready access to critical tax basis information: prior to every April 15 there would likely be far fewer shoeboxes that taxpayers would have to dust off and bring to their accountants. In terms of dollars and cents, taxpayers would no longer have to spend additional money to have their accountants compute the tax basis of their investments. The most identifiable benefit to the government is that it could, over a ten-year scoring period, collect up to an additional quarter of a trillion dollars of revenue. (27) Additionally, the Internal Revenue Service (Service), having put the brakes on tax basis misreporting, could redirect its scarce resources to other areas where taxpayer compliance is lagging. The benefits that would inure to the mutual fund companies and brokerage firms would most likely be evidenced around tax season, when individuals who staff the telephones and offices at these funds and firms would no longer be beset by clients who call or stop by and make tax basis inquiries.

This requirement to report tax basis should also extend to investments made in partnerships and S corporations. Under present law, these pass-through entities are supposed to issue a Form K-1 on an annual basis to each equity holder. (28) On this form, the reporting entity conveys many pieces of significant tax information, such as the investor's gains and losses and, if relevant, his or her capital account. Conspicuously absent from the face of the Form K-1 is the taxpayer's basis in his or her equity interest, commonly referred to as "outside basis." Yet, every year, a taxpayer's outside basis is likely to fluctuate due to gains, losses, distributions, and, in the case of partnerships, liabilities incurred by the entity itself. (29)

Asking equity holders in pass-through entities to keep track of all the relevant basis adjustments (as is currently the case) is a lot to ask both from a legal and mechanical point of view. Moreover, from the perspective of the equity holder, who must inevitably hire the services of a tax professional to conduct this tracking, it is an expensive proposition. In addition, an equity holder's motivation to keep track of outside basis may be low due to the fact that it would have no year-to-year relevance, except in the case of a tax shelter or failing business. (30)

When it comes to oversight of these pass-through entities, tax basis identification deserves a lot more attention. The outside basis of the equity holder should be initially established in the year of acquisition. In the case of an original issue, the entity would report the outside basis to the holder and the Service. In the case of a sale, the buyer would notify the entity of the purchase price and the entity would report the gross sale/purchase price to the Service, the seller, and the buyer. For every year thereafter, it would be sensible for Congress to require that the pass-through entity be obligated to issue a Form K-1 with adjusted outside tax basis information to each partner, member, or S corporation shareholder. By instituting the initial acquisition and ongoing reporting requirements, Congress could reform the current system of haphazard compliance with the pass-through entity regimes. (31)

2. Receipt of Gifts

Current reporting practices require that taxpayers who make gifts to nonspousal beneficiaries in excess of the annual gift tax exclusion (currently $12,000) file a gift tax return (i.e., Form 709 (U.S. Gift (and Generation-Skipping Transfer) Tax Return)). (32) There are virtually no mechanisms in place to ensure that taxpayers will fulfill their gift tax filing obligations. (33) The burden of accurately reporting gifts falls entirely to the taxpayer and, when it comes to self-reporting, it is well known and empirically documented that taxpayers, left to their own devices, often fall short of the required compliance benchmark. (34)

If Congress wants to have taxpayers take their gift tax return obligations seriously, it should consider the fact that third-party information returns have proven pivotal in increasing taxpayer compliance with the income tax. Given this history of success, Congress should consider extending the use of third-party information returns to the administration of the gift tax.

The proposal would operate as follows: (35) whenever a nonspousal donee receives a taxable gift (i.e., a gift that exceeds the gift tax annual exclusion and that does not qualify for medical or tuition exclusions), (36) the donee would have to file an information return. Furthermore, if the donee receives multiple gifts from the same donor the aggregate value of which during any calendar year exceeds the gift tax annual exclusion, the donee would likewise have to file an information return. The proposed information return would delineate the names of the donor and donee, a description of the property gifted (including its tax basis), the date of the gift, and the fair market value of the gifted property. The scope of this reporting obligation would include contributions to irrevocable trusts in which the donor made completed gifts. That is, trustees of such trusts would be obligated to report trust contributions that are subject to gift tax. (37) Bolstered by receipt of these information returns, the Service would be far better situated to check the accuracy of donors' gift tax returns (i.e., Form 709).

Is third-party information return reporting such as suggested in the prior paragraph administratively feasible? There is certainly evidence that this process can work. Indeed, such a requirement is already in place with respect to the receipt of gifts and bequests from foreign individuals as well as distributions made from foreign trusts. Under current law, if a foreign donor makes a sizable gift or bequest (i.e., in excess of $100,000) to a U.S. taxpayer or resident alien, (38) the latter must report the receipt of such gift or bequest on a Form 3520. (39) A similar rule applies to cases in which a foreign trust makes a distribution to a U.S. taxpayer or resident alien. (40) Following the format already established with respect to foreign gifts and bequests, there is no reason why a similar reporting obligation could not be imposed for recipients of gifts made by U.S. taxpayers. (41)

Broadening this third-party reporting requirement to include all gifts--foreign or domestic--would probably be the most effective way to give the gift tax "traction" in the area of taxpayer compliance. Some commentators would likely lament the institution of this third-party reporting requirement. Why? They would argue that this reporting requirement puts recipients in the uncomfortable position of having to "tattle" on donors. Put differently, does Congress really want to have taxpayers' children, the recipient of most taxable gifts, serve as an enforcement arm of the Service?

It should not, however, be psychologically troubling to require the recipients of sizable gifts to report the taxable gifts they receive. Notably, a similar sort of complaint was lodged against a Service research officer who, in the early 1980s, suggested taxpayers claiming their children as dependents provide the children's social security numbers. (42) At the time, there was an anguishing outcry that this requirement was too Big Brother in nature. Congress nevertheless heeded the Service research officer's recommendation, and seven million dependents suddenly vanished from the tax rolls, generating an additional three billion dollars of revenue annually. (43) The envisioned filing requirement is no more intrusive than the disclosure of a dependent's social security number or the litany of detailed information returns taxpayers are already required to provide. (44)