ongress adjourned for the year November 13 for a long holiday season. Congress returns in late January but does not settle down to work again until February. Here’s an update on the status of the tax issues we have been following since passage of the Taxpayer Relief Act of 1997. These include Internal Revenue Service restructuring, technical corrections, education individual retirement accounts for elementary and secondary education, and the line-item vetoed tax provisions.

Most of these initiatives passed the House before adjournment and the Senate will turn to them next spring. One possible scenario is that the Senate will combine a variety of items into a single bill and return it to the House for conference. It is very possible that these items will not be resolved until late spring or even next summer.

Budget Surpluses Ahead? First, a few preliminaries. The deficit for fiscal year 1997, which ended September 30, totaled $22.7 billion. It was the lowest deficit since 1974, due largely to greater than anticipated revenues attributed to strong economic growth. In the context of the overall budget, that’s chicken feed. The promise of a balanced budget by 2002 may arrive early if the economy remains as strong as it has been.

This means that next year’s tax debates will include calls for further tax cuts. Leading the list of candidates, at least when you listen to members of Congress, are some sort of marriage penalty relief and increasing or indexing the personal exemption in the alternative minimum tax. Other members want to increase infrastructure spending or pay down the debt.

House Budget Committee Chairman John Kasich, R-Ohio, urges his colleagues to act prudently and balance the budget, while others, led by a group of freshman Republicans, argue for repealing the marriage penalty, cutting capital gains and estate taxes further, cutting income tax rates, or enacting other tax relief proposals. House Transportation and Infrastructure Committee Chairman Bud Shuster, R-Pa., supports increasing spending on the nation’s roads and other infrastructure projects.

The ultimate direction of tax policy next year still is unclear. Experience suggests it will take a while for activity in the next session to rev up, and the various pieces of legislation bouncing around at the moment may be reined into one tax measure before moving forward.

IRS Restructuring -- The House overwhelmingly approved, 426-4, its version of the IRS restructuring bill, along with technical corrections to the Taxpayer Relief Act. The bill approved by the House created a public-private sector board of directors to recommend budgets and strategic plans for the IRS. The board’s purpose is to improve management of the agency by infusing it with private sector standards and approaches to problem solving.

The bill would establish parity of privilege between attorneys and Accountants and other tax professionals in their dealings with the IRS and in Tax Court. The restructuring bill also provides for netting of tax underpayments and overpayments by smoothing the interest differential between them during periods of mutual indebtedness.

The burden of proof in Tax Court would be shifted to the government in cases brought against individuals and small corporations. No change would occur in the District Courts or the Claims Courts because the Ways and Means Committee does not have jurisdiction in those venues. The proposal would help taxpayers in IRS appeals, but the Tax Executives Institute and others have expressed concern that this change could make audits more intrusive and erode compliance.

Senate Finance Committee Chairman Bill Roth, R-Del., supports restructuring the IRS but wants to look at strengthening the oversight board, and making certain enough steps have been taken to protect taxpayer rights. Roth and others particularly want to be sure the bill does not create more problems than it fixes. They also realize that the media paid close attention to the panel’s hearings on taxpayer problems and hope similar attention will be paid if the restructuring debate is put off until 1998, which is an election year.

New IRS Commissioner Takes Charge -- Commissioner Charles Rossotti, who took office November 13, faces tough challenges in the current atmosphere. He must cope with pressures to fix management problems and restructure the IRS at a time of limited funding, and also tackle upgrading the IRS’ antiquated computer systems. It’s unclear that those looking for a quick fix heard Rossotti say at his confirmation hearing that it will take years to fix problems; it’s too soon to tell if there will be any political backlash from this.

Technical Corrections -- The IRS restructuring bill passed by the House also included technical corrections. The most interesting of these (1) fix the capital gains rules to provide, in effect, that a net short-term loss will first offset gains taxed at the highest capital gains rate; (2) prevent avoidance of penalties on early withdrawals from traditional IRAs when rolling over to Roth IRAs; and (3) clarify the residence exclusion rule to provide that if a home is sold before the two-year period expires, the taxpayer may exclude gain up to the fraction of the $250,000 ($500,000 joint) exclusion that is equal to the fraction of the two years the taxpayer owned the house.

The Senate declined to consider a technical corrections bill this year because its leaders wanted the IRS and taxpayers to work with the new law in the 1998 filing season before enacting technical changes. They want to see if additional technical corrections will be identified and to place their stamp on the bill marked up by the Ways and Means Committee.

Schmidt Baking -- The revenue offset in the IRS restructuring bill reverses the portion of the Tax Court’s decision in Schmidt Baking that addresses vacation pay. In the Schmidt Baking decision, the Tax Court held that an irrevocable letter of credit securing the employer’s accrued vacation and severance pay liability satisfied the requirement that payment be made within two and a half months of the close of the taxable year and thus took the payment out of the deferred compensation rules that would have delayed the employer’s deduction.

The Schmidt Baking revenue offset also is used in several other pending bills. Often lawmakers use the same offset in two bills. When one is enacted, they have to find a replacement for the offset in the bill that has not been enacted.

Line-Item Veto Provisions -- The President used his line-item veto authority to strike two provisions from the 1997 act. One related to farm product refiners, the other to active financing income of controlled foreign corporations. The active financing legislation is important to financial institutions.

The House Ways and Means Committee chose not to attempt an override of the vetoes, but instead worked out new legislative language that satisfied Treasury’s concerns and reinstates the provisions. The House Budget Committee then objected that these "new tax cuts" had to be paid for. After weeks of wrangling, a sale of the government’s excess supply of the mineral palladium and changes in health insurance reimbursements for state department employees abroad provided the necessary funding and the bill passed the House on a voice vote.

Plans to pass the bill in the Senate failed when the usual end of session tensions brought objections to considering the bill, mainly due to concerns about the farm cooperative language and because Senate leaders wanted to bypass the Finance Committee, which has jurisdiction over the issue. At this point, these objections do not seem to constitute long-term obstacles to the bill.

Internet Tax Freedom -- A bill (S. 442) granting a temporary moratorium on certain taxes relating to the Internet was reported favorably by the Senate Commerce Committee, but additional work must be done because several committees have jurisdiction. This bill would impose a four-year moratorium on any state or other local jurisdiction imposing a tax on access to or use of the Internet or an on-line provider, transmission of data over the net, and transactions through the net. The legislation does not apply to income taxes, business license taxes as based on a physical presence, or sales and use taxes on goods sold via the Internet.

Treaties Ratified -- The Senate resolved lingering problems with real estate investment trusts associated with several treaties and then ratified the tax treaties with Austria, Canada, Ireland, Luxembourg, South Africa, Switzerland, Thailand, and Turkey. The House does not to need to act on treaties, and so they already taken effect.

Expanded Education IRAs -- During conference on the 1997 tax act President Clinton insisted that a proposal to allow education IRAs to be used to pay costs for grades kindergarten through 12 be removed. The President viewed this as tantamount to a school voucher proposal, which he opposes, fearing vouchers undermine the public school system.

Congressional Republicans then started to move an independent bill to expand IRAs for primary and secondary education (known as Coverdell IRAs, after Sen. Paul Coverdell, R-Ga., who introduced the bill). The plan was to send the bill to the President and let him veto it. (Clinton had strongly objected to the bill on the grounds that it could undermine the nation’s public education system.)

The House did its part, passing an education IRA expansion bill (H.R. 2676), 230-198. The Senate twice failed to break a filibuster against the legislation, and so it died for the session. Whether Senate leaders can resurrect the measure next year remains to be seen.

The vacation component of the Schmidt Baking case is used to offset the cost of the proposal to expand education IRAs. The severance pay component of Schmidt Baking is used as the offset in two trade bills: the Caribbean Basin Initiative bill (H.R. 2644) and the fast-track trade bill (H.R. 2621). The CBI parity bill was rejected by the House and the fast-track trade bill was pulled from the schedule in the House due to fears that it would be voted down. The prospects for both bills next year also is uncertain.

Fundamental Tax Reform -- The potentially large political gains that fundamental tax reform presents for politicians continue to tantalize lawmakers, but a method for capturing those gains remains elusive. Considering the striking impact the Senate Finance Committee hearings had on the public and the media, politicians continue to search for ways to take advantage of voters’ anger with the present tax system, and some politicians believe tax reform could be the key. The main problem with this approach is that no constituency for reform presently can be identified.

House Majority Leader Dick Armey, R-Texas, and Rep. Billy Tauzin, R-La., have held town meetings around the nation to determine whether there is enough interest in reform to pursue the issue.

The Clinton administration also says it’s exploring the idea of making the present tax system simpler and fairer. The White House does not want to get whipsawed on tax reform like it did on IRS restructuring, so it is not ruling anything off the political agenda.

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