GAO Wants Inflation-Adjusted Bite in Tax Penalties

Accountability investigators say Congress could increase the deterrent for late-filing companies and other abusers, while boosting revenues.
Marie LeoneSeptember 24, 2007

Companies that file tardy tax returns – or don’t file at all – could face larger penalties than in the past if Congress pays heed to a new study from the Government Accountability Office. The study shows that by adjusting civil tax penalties for inflation, the Internal Revenue Service could both increase the deterrent on corporate tax abuses, and bolster revenue from annual penalty-related assessments.

In 2005 alone, for example, the IRS would have collected an extra $60.3 million had penalty levels tracked inflation. What’s more, the agency would have added $302 million dollars to government coffers over six years if penalties had been adjusted during the 2000 to 2005 time period.

But the hit to revenues isn’t the main reason for the GAO’s interest in the penalty system. Investigators point out that inflation has reduced the intended bit of some penalties on companies, making them far less a deterrent than they should be. For instance, in 1982 the IRS set a $100 minimum fine for failure to file a tax return — an amount that in equivalent dollars today equals about $47. Adjusting the penalty for inflation, 2007 fines would start at $214.

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The GAO did not break down the total potential penalty revenue into business and individual taxpayer accounts. But Michael Brostek, GAO director, tax issues, told that changes to the system would affect both groups.

In fact, GAO is recommending that Congress push ahead with the change, suggesting that lawmakers require the IRS to periodically adjust penalty amounts for inflation. In August 2007, the inflation rate was 1.97 percent, down from 2.08 percent in January.

GAO, the investigative arm of Congress, identifies four main civil violations that account for most potential penalty revenue: failure to file tax returns; failure to file correct information; various penalties on returns by exempt organizations and trusts; and failure to file partnership returns. The penalties for these four violations would have accounted for 99 percent of the estimated $60.2 million in additional penalties collected in 2004 if penalties tracked inflaction, says GAO, adding that 2004 was the year that would have brought in the largest amount of fines had the system been adjusted.

Failure-to-file violations would have accounted for $37.9 million of the 2004 total. Failure to file correct information, which has a penalty that was adjusted last in 1989, would have accounted for $18.3 million. Meanwhile the penalty for tax exempt entities, which was adjusted in 1996, would have pulled in an addition $3.1 million. Failure to file partnership returns, which penalties were last set in 1979, would have added $900,000 to the U.S. Treasury.

Making a change to the penalty system would not be much of a strain for the IRS or tax practitioners, according to the report. IRS officials from all but one affected unit said that the updates to databases and documents “would not be significant,” with some adding that “changes would be most burdensome initially and easier to carry out with each subsequent update.”

The relatively small Office of Penalties, which is responsible for coordinating the changes among multiple IRS divisions, said the adjustments might be “considerable” depending on the number of penalties that had to be reworked.