Homage to information returns.

If, however, the issuance of third-party information returns is considered too intrusive in nature and thus not politically tenable, there is at least one viable alternative. As a stand-alone alternative (or as a complement to the information return reporting proposal outlined above), Congress should require taxpayers on their income tax returns (Form 1040s) to answer affirmatively the following yes-or-no question:

During the course of the prior calendar year, did you make gifts to or

receive gifts from another taxpayer that exceeded X dollars (i.e., the

annual gift tax exclusion) and that did not qualify for the medical

and educational payment exclusions? (45)

In responding to this yes-or-no question, a taxpayer who made or received a gift and did not want to report it would be required to affirmatively lie. Given the greater psychological discomfort that people typically experience when lying (which constitutes an act of commission) as compared to not filing a return (which constitutes an act of omission), (46) a question of this sort may induce taxpayers to fulfill their gift tax return filing obligations. (47)

3. Service Recipients

Under current law, recipients of paid-for services must issue information returns (i.e., Form 1099-MISC) to individual service providers if the aggregate value of such services for any calendar year exceeds $600. (48) This same requirement does not apply if the service provider in question is a corporate entity. (49) On its face, this appears to be a silly distinction.

Consider the plights of individual A and individual B. Both perform lawn maintenance services. A conducts business in his or her individual name, and B conducts business under the name of B, Inc. Assuming A and B have the same propensity to understate their incomes, it makes logical sense that service recipients--whether they be A's or B's clients--would each be independently obligated to issue information returns to A and B, Inc.

Congress could easily extend information reporting to include corporate service providers. To make this change, Congress would have to amend Code section 6041A and require third-party information reporting for applicable payments to include corporations. (50) While this change should prove to be a nonevent for those corporations that are law-abiding, for those corporate entities that are not being forthright in their income reporting practices, this minor legislative change could result in near instantaneous compliance. In addition, requiring service recipients (e.g., an office complex that requires janitorial services) to issue such annual information returns to corporate service providers (e.g., Apex Cleaning, Inc.) appears to be a burden that could be absorbed at a fairly inconsequential cost. That is, along with instructing their accountants to issue Form 1099s to their noncorporate service providers, at minimal cost for such a ministerial task, service recipients would require that corporate service providers be issued these information returns as well.

4. Real Estate Reporting

In the context of real estate ownership, there are two areas of potential taxpayer noncompliance that are in need of more direct oversight. One pertains to the residential interest deduction and the other pertains to the real estate tax deduction.

With respect to the residential interest deduction, the Code allows taxpayers to deduct so-called qualified interest payments. (51) Qualified interest payments generally include interest on (1) debt to acquire, construct, or substantially improve a principal or second residence (up to $1,000,000) and (2) home equity debt (up to $100,000). (52) Notwithstanding the apparent simplicity of this deductibility rule, the Service, in practice, has a hard time monitoring its compliance. This is because a Form 1098 (issued by the interest recipient) reports only how much interest a real estate owner annually pays. (53) There is nothing on the form itself, however, that delineates whether the interest payment is acquisition/improvement debt or, alternatively, a refinancing (and, if so, by how much the refinancing exceeds the initial acquisition/improvement debt).

To supply taxpayers with guidance and the Service with oversight ability, Congress should require that all lenders be responsible for specifying two additional pieces of critical information. The first would be whether the loan in question involves a financing or refinancing situation. In order to fulfill this requirement, the lender could check in a box to demarcate the loan's status on the Form 1098. (54) The second requirement, applicable only to refinancing, would be to provide the amount being refinanced which exceeds the balance of the existing outstanding loan amount. Once again, on the face of the Form 1098, the lender could supply this number on a newly provided box. (55)

Were the Form 1098 modified in the manner suggested, taxpayers would be on effective notice that different tax treatments apply to initial financing versus refinancing. In addition, receipt of this information would enable Service staff to more easily determine whether submitted tax returns required an audit due to a real estate interest deductibility issue. Like any other information return requirement, there is no doubt that this one would entail more work on the part of the lender. The amount of the additional work, on balance, is miniscule relative to the numerous benefits that such additional work would produce (see analysis below).

Under the real estate tax deduction, the Code permits taxpayers to deduct real estate taxes they pay. (56) Such taxes are only deductible if they are based on the property's assessed value and the intended use of such revenue proceeds is to maintain general municipality infrastructure and services. No deduction, however, is permitted if such real estate taxes are assessed specifically either to secure local benefits of a kind that tend to increase the value of the property assessed (e.g., assessments for streets, sidewalks, water mains, and sewer lines) or for targeted services (e.g., garbage removal). (57)

With respect to real estate tax payments (whatever their nature), the Code does not require recipient municipalities to issue information returns. (58) The absence of an information return issuance requirement leaves taxpayers void of guidance. With only canceled checks made payable to the municipality in question, many taxpayers mistakenly think that whatever payments they make are deductible because there is no breakdown regarding the portion of the payment that is permitted to be deducted and the portion that is nondeductible. Municipalities are typically silent conspirators in the process as they are too often guilty of not providing taxpayers a breakdown of deductible and nondeductible real estate taxes. (59)

To ameliorate the problem, a relatively simple solution is evident. Congress should require that municipalities issue information returns with a breakdown of those taxes that are deductible and those that are not. (60) This requirement would enable taxpayers to more easily prepare their tax returns and would give the federal government oversight ability to monitor taxpayer compliance. Because municipalities currently have no information return issuance responsibility, Congress may consider offsetting some of the start-up expenses initially associated with the imposition of this requirement.

Aside from the recommendations this analysis has set forth above, there are a myriad of other reporting recommendations that Congress should seriously consider (for example, requiring that auction brokers issue information returns). (61) This analysis has chosen to elaborate only on those recommendations listed above because under a cost-benefit analysis (see below), the adoption of these reforms seems the most easily justified. Other reporting recommendations require additional analysis and, notwithstanding their merit, might be perceived by the business community as unduly onerous. (62) Congress should therefore immediately institute the requirements listed above while studying other recommendations. If the latter recommendations merit adoption, they should be instituted sometime in the near future.

III. COST-BENEFIT ANALYSIS ASSOCIATED WITH INFORMATION RETURN ISSUANCE

Part II enumerated those situations in which information return issuance holds at least some promise of helping close the tax gap. Before instituting these proposed reforms, Congress should carefully weigh the projected benefits against the projected costs of information return issuance.

A major benefit of expanding information return issuance would be the generation of additional revenue. No one disputes the positive correlation between information return issuance and revenue generation: in the absence of information return issuance, taxpayers often mistakenly or purposefully misreport their income and deductions in their favor. Information returns curtail this practice. (63) Were Congress to pass, for example, the START Act (i.e., proposed legislation that requires mutual fund companies and brokerage firms to identify and track the tax basis clients have in their investments), both the Government Accountability Office and Service estimate that anywhere from $11 billion to $17 billion annually would be generated. (64) Passage of other proposed information return legislation offers the promise of generating even more revenue. (65)