Information reporting has been a fixture of federal taxation for almost 90 years. That longevity notwithstanding, Wall Street has never liked the practice. Over the years, brokers have resisted every attempt to bolster the reporting regime for securities and commodities transactions.
And why wouldn't they? Information reporting is a thankless, often burdensome responsibility. No one likes extra work, and before the modern era of computerization, information returns required lots of extra work.
In the face of that foot-dragging, lawmakers have been resolute; since 1917, they have endowed tax authorities with broad statutory authority to compel information returns from brokers and securities dealers. But tax officials have been reluctant to exercise that authority. For more than 40 years, they left this powerful weapon in the holster.
In the Beginning
When Congress enacted the modern income tax in 1913, lawmakers provided for the withholding of tax payments at the source. This administrative innovation -- based on the Civil War income tax and its withholding for government employees -- proved unpopular, both among taxpayers and affected businesses. In 1916 Treasury Secretary William G. McAdoo suggested Congress abandon the idea, and in 1917 legislators replaced it with a broad new system of information reporting.1
Under the new reporting regime, companies were required to report most of their payments to individuals. "The 'information at source' provision will provide the government with many complete returns," predicted The Washington Post in 1918. "In accordance with this every individual firm or corporation is required to file with the commissioner of internal revenue a true and accurate report of payments made in salary, wages, interest, commissions, rentals, etc., of $800 or more during the year 1917, together with the names and addresses of persons to whom such payments were made."2
To facilitate the reports, the Bureau of Internal Revenue (BIR) introduced Form 1099. The Wall Street Journal took a dim view of this paperwork innovation:
This is regarded as the most important blank form in the whole process of collecting income tax. It will involve an almost endless amount of labor on the part of many thousands of employers throughout the country, who will be asked to fill out a blank for every employee who earns $800 or over. Owing to complicated methods of compensation where day wages, commissions, bonuses, time checks and various other arrangements are employed a great deal of bookkeeping will be required in order to comply with the law.
Officials justified the paperwork by stressing the need to ensure tax compliance. Information reports were a vital and potent weapon in the battle against tax evasion, they declared. "The man who thinks to evade the tax, officials declare, is making a serious error and when discovered will be subjected to heavy penalties," The Washington Post reported ominously.3
Many business leaders resented their new reporting responsibilities, but brokers were particularly unhappy. Confusion surrounded the vague but sweeping legislative language concerning brokers' returns. Under section 27 of the Income Tax Act, as amended by the 1917 revenue law, the commissioner of internal revenue was authorized:
at his discretion to require every taxpayer doing business as a broker on any exchange, or board of trade, or other similar place of business, to render a correct return duly verified under oath, showing the names of customers for whom such taxpayer had transacted any business with such details as to the profits, losses, or other information, which he may require as to each of such customers, as will enable him to determine whether all income tax due on profits, or gains of such customer, or customers, has been paid.4
Wall Street fretted endlessly about the meaning of the mandate. Many brokers worried that BIR officials would require detailed reports for every transaction. Other, more sanguine observers hoped officials could be satisfied with an annual statement of aggregate gain or loss. "In fact, it is asserted that, for the active trader, no other course would be feasible," reported The Wall Street Journal in March 1918, "inasmuch as the submission of details of individual transactions would require laborious bookkeeping processes and result in a voluminous mass of data swamping the revenue offices."5
Ultimately, BIR officials agreed with that assessment and declined to require information reports from brokerage firms. But the threat of more detailed information returns loomed over Wall Street. William H. Edwards, collector of internal revenue for the Second District of New York, advised brokers in 1918 to remain diligent in their recordkeeping: "I would, therefore, suggest, or rather advise, every broker to keep a correct and itemized book account of all of his several transactions or trading on behalf of clients, so as not to be embarrassed in the event the Commissioner should call for this statement."6
Over the next decade, Treasury officials continued to wield their statutory authority with notable restraint. Aware that business would object to any sweeping reporting regime, BIR officials asked for the minimum. For instance, they waited until 1924 to ask publicly held companies for detailed information on dividends paid to shareholders. And even then they made it a one-time request, not an annual mandate. In a hearing on revenue reform, Sen. Andrieus Jones asked whether those reports might be profitably required every year. A.W. Gregg, special assistant to Treasury Secretary Andrew Mellon, responded with solicitude for business interests.
Gregg: Well, it is a decided burden, Senator, on a corporation with fifty or sixty thousand stockholders to make those returns, as many as four times a year, giving the name of each shareholder, his address, and the amount of dividends paid to him during the year.
Jones: It is nothing in the world but copying from the books, is it?
Gregg: That is true: It is clerical work, but it is quite a burden at that.
Jones: You say it is quite a burden. Define that to some extent.
Gregg: Well, when we put it into effect two months ago we got such a storm of protest as to the work involved that we had to postpone the requirement for the submission of those returns.7
The exchange was illuminating, casting light on the delicate balance that tax officials tried to strike between public needs and private burdens. Business groups, meanwhile, managed to keep their recalcitrance out of the headlines, at least most of the time. Nonetheless, their reluctance was a powerful check on the nascent reporting regime. It would take a sea change in American politics to loosen that constraint.
A New Deal for Information Returns
In the first year of Franklin Roosevelt's presidency, the nation was captivated by Ferdinand Pecora's spectacular investigation of Wall Street. As chief investigator for the Senate Banking Committee, he grilled leaders of the securities industry on their sweetheart deals and dubious trading strategies. His most glorious moment came in the late spring of 1933, when he roasted J.P. Morgan Jr. for failing to pay income taxes during the darkest years of the early 1930s.
Morgan and his partners paid no income taxes because they had no taxable income. Having suffered huge losses in the stock market, they took refuge in the liberal loss allowances then permitted by the tax laws. Experts acknowledged the legitimacy of the deductions, but ordinary Americans were less forgiving. Wall Street suffered a blow to its prestige, and hostile lawmakers made the most of their newfound moral advantage.8
Congress quickly imposed new limits on the deductibility of capital losses. Meanwhile, Treasury officials introduced a campaign against bogus loss deductions. In October 1933 the department made headlines with a splashy announcement that some 300 agents were hard at work scouring the returns of more than 1,000 taxpayers for dubious deductions. "The Federal Government, which in the past has concentrated its investigations of income tax dodgers on racketeers, turned yesterday to traders in the stock market," reported The New York Times. All the attention came as a rude surprise to Wall Street.9
Authority for the new Treasury investigation was already on the books. The BIR had never relinquished its sweeping authority to compel information returns. Although Andrew Mellon had been reluctant to exercise that power, Roosevelt's new Treasury secretary was more than willing to antagonize brokers. And Wall Street, still reeling from the crash and its attendant scandals, was in no position to complain.
The Treasury promulgated new regulations, requiring brokers to report their clients' names and addresses, as well as annual totals for both purchases and sales. All brokers in stock, bond, or commodities transactions were expected to submit a report for every customer trading more than $25,000 in calendar year 1933 and every subsequent year.10
"This is the first time detailed information concerning private transactions of brokers' clients has been requested," observed The Washington Post.11 Initially, the BIR asked for information on all trades executed from 1929 to 1933. BIR Commissioner Guy Helvering insisted that the new reports, while sweeping in scale and scope, would not place an undue burden on brokers. The BIR had cooperated with Wall Street to develop a workable plan, he told reporters -- one that would place "the least possible burden" on brokers and their clients.12
Many observers were not so optimistic. "The new check-up will entail an enormous amount of clerical work and considerable expense for brokerage firms," noted The New York Times. "Many of the firms have more than 5,000 customers, who account for a trading volume of millions of shares annually." Brokers, meanwhile, complained that new labor codes required under the National Recovery Act would require overtime for brokerage employees rushing to meet the new reporting deadline. (As it happened, the brokers asked for and received an extension of time to file the new reports.)13
In fact, BIR officials tussled with brokerage firms over various details, with the latter seeking to streamline the reporting process. The Association of Stock Exchange Firms, for instance, asked that brokers be allowed to report all credits and debits on a given account, not just the details of particular transactions. That approach would have simplified the bookkeeping burden, freeing brokers of the need to remove entries for dividends received, interest charges, and other extraneous data, according to Frank R. Hope, president of the brokers' group. But Helvering denied the request, insisting that it would distort the clarity of the reports and diminish their utility.14
Ultimately, brokers were in no position to resist the new initiative, their stock having reached an all-time low in the market of public opinion. Treasury and the BIR got what they wanted from the industry, and Treasury Secretary Henry Morgenthau Jr. was pleased with the results. In early 1935, he reported to Congress that disallowed loss deductions had produced $25 million in new taxes assessed against traders. "Returns of information required to be filed by brokers formed the basis for these investigations," he pointed out.15
Morgenthau's new reporting regime survived the 1930s, but World War II brought new leniency to the Roosevelt Treasury. In 1943 the BIR waived the requirement for information reports on trading transactions. And although authority to compel the reports remained on the books, tax officials let it lie dormant for the next 40 years.16
A New Era for Information Reports
In 1982 Wall Street and Washington locked horns over withholding for dividend and interest payments. Vociferous opposition from the private sector managed to derail the withholding plan, despite support from Ronald Reagan's Treasury Department. The brouhaha all but eclipsed a more modest but still important reform: revival of Treasury's long-neglected authority to compel information returns on capital transactions.
The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) expanded the information reporting requirements for brokers, instructing Treasury to promulgate regulations requiring information returns that indicated the gross proceeds from securities and commodities transactions. While the withholding controversy got all the headlines, a few observers noted the significance of the innovation. "This means that the I.R.S. will have yet another weapon in its arsenal to attack attempts at tax evasion by those who receive capital gains on Wall Street," observed The New York Times.17 Brokers would not be required to report the profit or loss stemming from a transaction; lawmakers had accepted industry assertions that such tracking was impossible. But the simple report of a sale and its proceeds would at least alert the IRS to the likelihood of a taxable event.18
Senate Finance Committee Chair Robert Dole introduced the expanded reporting requirement as part of a larger package of compliance measures, collectively known as the Taxpayer Compliance Improvement Act of 1982. As originally drafted, the bill would have required Treasury to issue new regulations for brokers' information reports. Firms should be required to report "only such information as would normally be acquired by the broker in the conduct of its business," according to the Joint Committee on Taxation description. If the broker had sufficient information to calculate gain or loss, it would be required to do so. Otherwise it would report just the gross proceeds from a transaction.19
The Securities Industry Association (SIA) objected to the proposal, raising questions about the amount of revenue at stake and complaining about the burden on brokerage firms. "There is no doubt that reporting of capital gains or proceeds of sales would impose an enormous record-keeping burden on the industry," the organization said. Brokers rarely provided customers with capital gains calculations, and then just to a few special clients. "An awareness of the inability of firms to provide this information is evidenced by the proposal to report gross proceeds of sales." Even that latter, more modest reporting requirement would represent a major burden for brokers. Finally, the SIA declared, lawmakers should consider whether the IRS could even handle the flood of new data.20
Citibank offered similar complaints, insisting that most firms lacked adequate data to calculate the profit or loss from a specific transaction. Often, brokers had only half the story, leaving the accuracy of any gain and loss reports open to doubt.21
Despite those complaints, opposition to the new reporting provision was relatively muted. And several witnesses endorsed the idea. John S. Nolan, head of the American Bar Association Section of Taxation, argued that the IRS had long chosen to ignore its statutory authority to compel those reports. "It is my understanding that the Treasury Department is reluctant to prescribe regulations at this late date because of its concern that brokers will strongly oppose the imposition of any type of reporting requirements," he told the Finance Committee.22
As the legislation moved through Congress, the securities industry maintained its opposition to the Dole bill. In a letter to Mark McConaghy, chief of staff of the JCT, SIA spokesperson Edward O'Brien restated industry concern, specifically criticizing any effort to compel gain or loss calculations. "Most financial intermediaries lack the systemic capability, storage capacity, and the key data elements (adjusted basis and date of acquisition) to make the underlying computations for the vast majority of their customers," he wrote.23
During hearings before the House Ways and Means Committee, the SIA took a more moderate stance, embracing the plan for reporting gross proceeds. After restating their arguments against more sweeping reports, SIA officials signed on for the watered-down version of the legislation. Norman M. Epstein, executive vice president for E.F. Hutton & Co., declared that the new approach "would impose far less costs on securities firms, and would leave the responsibility for determining the basis and date of acquisition to the taxpayer." Reports of gross proceeds were more than adequate, he insisted: "What I am saying here in no uncertain terms is that visibility will create efficiency."24
Eventually, Congress approved the gross proceeds requirement. After its enactment, wrangling continued over the coming Treasury regulations. Even Sen. Charles Grassley, R-Iowa, complained that the regulations were stricter than he had intended. "It seems to me that the final regulations are somewhat more complicated and stricter than the intent of the law," he wrote to the Treasury Department.25
Last month National Taxpayer Advocate Nina Olson suggested that lawmakers require brokers to track and report taxpayers' basis in security transactions. (See Doc 2006-556 or 2006 TNT 9- 26.) The proposal seems a natural extension of the 1982 legislation, capitalizing on the last 25 years of technological progress. Many of the complaints long associated with basis tracking ring hollow in the modern information age.
Certainly the basis proposal is consistent with almost a century of legislative language, if not with the administrative reality surrounding information reports. But does the idea have a chance? Perhaps. It holds the allure of relatively easy revenue. And it promises to simplify the lives of overburdened taxpayers, if not the brokers who cater to them. But perhaps the best reason to give the idea some decent odds? Dole's cosponsor for the 1982 legislation -- including its original suggestion that brokers report basis whenever possible -- was none other than Grassley, current chair of the Senate Finance Committee.
1 Charlotte Twight, "Evolution of Federal Income Tax Withholding: The Machinery of Institutional Change," Cato Journal, Winter 1995, p. 359. The law did not require brokers to withhold taxes on client transactions, but many observers thought it probably did imply a responsibility for information returns. However, Congress did not clearly establish that responsibility until 1917. See "Bearing of the Income Tax on Bankers and Brokers," The Wall Street Journal, Apr. 15, 1913, p. 1.
2 "Helps on Income Tax," The Washington Post, Jan. 20, 1918, p. RE5. During the early years of the modern income tax, Form 1099 was used to report all types of income, including wages and salaries. The modern W-2 did not appear until World War II.
3 Id. The BIR made a habit of issuing those threats, publishing a series of taxpayer information bulletins that stressed its enforcement capabilities. Regularly reprinted in newspapers around the country, the statements often began with the assertion that "the bureau of internal revenue has at its command innumerable sources for checking up delinquents." See, e.g., "1921 Income Tax Law Is Explained," The Washington Post, Jan. 23, 1921, p. 41.
4 "William H. Edwards Further Explains Tax Law," The Wall Street Journal, Mar. 5, 1918, p. 7.
5 "Traders Puzzle Over Income Tax Returns," The Wall Street Journal, Mar. 12, 1918, p. 8.
6 Supra note 4.
7 Revenue Act of 1924: Hearing Before Senate Comm. on Finance, 68th Cong. 15 (1924).
8 For more on the Pecora investigation, see Joseph J. Thorndike, "Historical Perspective: Pecora Hearings Spark Tax Morality, Tax Reform Debate," Tax Notes, Nov. 10, 2003, p. 688.
9 "Income Tax Check in Wall St. Ordered," The New York Times, Oct. 5, 1933, p. 1.
10 "Evasion of Taxes Hit by New Rules," The New York Times, Jan. 21, 1934, p. 6, "Brokers Required to File Reports on Clients' Deals," The Wall Street Journal, Jan. 30, 1935, 1.
11 "U.S. Demands Brokers' Data in Income Quiz," The Washington Post, Oct. 5, 1933. On novelty, see also "Income Tax Check in Wall St. Ordered," The New York Times, Oct. 5, 1933, p. 1.
14 "Brokers' Reports Must Give Totals," The New York Times, Feb. 9, 1934, p. 37 (referring to the revenue acts of 1928 and 1932). Both acts required brokers to report transaction details for their customers when requested by the commissioner.
15 "Treasury Figures on Business Gains," The New York Times, Jan. 8, 1935, p. 2.
16 Joint Comm. on Taxation, 97th Cong., Background on Federal Income Tax Compliance and Description of S. 2198 (Taxpayer Compliance Improvement Act of 1982) 18 (1982). See also "Treasury Waives Regulation for Brokers to File Client Data," The Wall Street Journal, Feb. 5, 1943, p. 43.
17 "Data on Stocks Going to IRS," The New York Times, August 20, 1982, p. 34.
18 Jane Bryant Quinn, "New IRS Form 1099b Takes Aim at Capital Gains Tax Cheaters," The Washington Post, Jan. 30, 1984, p. 63.
19 Supra note 16.
20 Hearing Before Subcomm. on Oversight of the Internal Revenue Service, Senate Comm. on Finance, 97th Cong. 387 (Mar. 22, 1982).
21 Id. at 337.
22 Id. at 256.
23 "Securities Industry Association Critiques Compliance Legislation," Tax Notes, July 12, 1982, p. 157.
24 Tax Compliance Act of 1982 and Related Legislation: Hearing Before the House Comm. on Ways and Means, 97th Cong. 309 (May 18, 1982).
25 "Sen. Grassley Questions Strictness of Final Regulations for Broker Information Reporting," Tax Notes, July 11, 1983, p. 133.
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