oversight

Tax Administration: Information Is Not Available to Determine Whether $5 Billion in Liberty Zone Tax Benefits Will Be Realized

Published by the Government Accountability Office on 2003-09-30.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to Congressional Requesters




September 2003
                 TAX
                 ADMINISTRATION
                 Information Is Not
                 Available to
                 Determine Whether
                 $5 Billion in Liberty
                 Zone Tax Benefits
                 Will Be Realized




GAO-03-1102 

                                                September 2003


                                                TAX ADMINISTRATION

                                                Information Is Not Available to Determine
Highlights of GAO-03-1102, a report to the      Whether $5 Billion in Liberty Zone Tax
Honorable Charles B. Rangel, Ranking
Minority Member, Committee on Ways              Benefits Will Be Realized
and Means, House of Representatives,
and the Honorable Carolyn B. Maloney,
House of Representatives




The President pledged a minimum                 For one of the seven Liberty Zone tax benefits, the business employee credit,
of $20 billion in assistance to New             IRS is collecting but not planning to report some information about use—the
York for response and recovery                  number of taxpayers claiming the credit and the amount of credit claimed—
efforts after the September 11,                 nor is it planning to use this information to report the revenue loss
2001, terrorist attacks. This                   associated with that benefit. IRS is not planning to collect or report
includes tax benefits, commonly
referred to as the Liberty Zone tax
                                                information about the use of the other six benefits or the revenue loss
benefits, that the Joint Committee              associated with those benefits. According to IRS officials, the agency
on Taxation (JCT) estimated would               followed its usual procedures in determining whether to collect information
reduce federal tax revenues by                  about benefit use and revenue loss. IRS officials said they would collect and
about $5 billion. The actual                    report these data if (1) it would help the agency administer the tax laws or
amount of benefits realized,                    (2) IRS was legislatively mandated to do so.
however, will depend on the extent
to which taxpayers and the city and             IRS would need to make several changes if it were to collect more
state of New York take advantage                information on the use of the benefits and the associated revenue loss, and
of them.                                        this information would not be complete or lead to a verifiable measure of the
                                                reduction in federal tax revenues due to the benefits. IRS would need to
GAO was asked to determine
                                                change forms, processing procedures, and computer programming, which
•	   the extent to which the Internal           would add to taxpayer burden and IRS’s workload. IRS officials were unable
     Revenue Service (IRS) is                   to estimate the costs involved in accomplishing these actions or the number
     collecting and reporting                   of staff needed to do so. The officials said that the earliest they could make
     information about the number               these changes would be for tax year 2004 returns. As a result, IRS would not
     of taxpayers using each of the             have information for two of the years that the benefits were in effect, which
     seven Liberty Zone tax benefits            is significant because most of the benefits expire by the end of 2006. In
     and the revenue loss                       addition, if IRS were to collect data on the use of the Liberty Zone benefits, it
     associated with those benefits             would be able to make an estimate, but could not produce a verifiable
     and                                        measure, of the revenue loss due to the benefits because, for example, IRS
•	   if IRS is not collecting and               would have to make assumptions about how taxpayers would have behaved
     reporting this information,
     what steps it would need to
                                                in the absence of the benefits.
     take and what resources would              New York Liberty Zone
     be needed to do so.

GAO is making no
recommendations in this report.
The Commissioner of Internal
Revenue was provided a draft of
this report for his review and
comment. The IRS Director of Tax
Administration Coordination
agreed with the contents of the
report.


www.gao.gov/cgi-bin/getrpt?GAO-03-1102.

To view the full product, including the scope
and methodology, click on the link above.
For more information, contact Michael
Brostek at (202) 512-9110 or
brostekm@gao.gov.
Contents 



Letter                                                                                                   1
              Results in Brief                                                                          2
              Background                                                                                3
              IRS Generally Not Planning to Collect or Report Information about
                the Use of Liberty Zone Tax Benefits or Reductions in
                Taxpayers’ Tax Liabilities                                                              4
              Several Changes Needed If IRS Were to Collect and Report More
                Information about the Liberty Zone Tax Benefits and Estimate
                Revenue Losses                                                                          6
              Agency Comments                                                                           9

Appendix I    Objectives, Scope, and Methodology                                                        11



Appendix II   Summary of the Liberty Zone Tax Benefits                                                  12



Table
              Table 1: Example of Recalculation of Taxable Income                                       8




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              Page i                                           GAO-03-1102 Liberty Zone Tax Benefits
United States General Accounting Office
Washington, DC 20548




                                   September 30, 2003

                                   The Honorable Charles B. Rangel
                                   Ranking Minority Member
                                   Committee on Ways and Means
                                   House of Representatives

                                   The Honorable Carolyn B. Maloney
                                   House of Representatives

                                   The President pledged a minimum of $20 billion in assistance to New York
                                   for response and recovery efforts after the terrorist attacks of
                                   September 11, 2001. The $20 billion includes about $15 billion of
                                   congressionally appropriated funds, primarily administered by the
                                   Department of Housing and Urban Development, Department of
                                   Transportation, and Federal Emergency Management Agency (FEMA), for
                                   different types of assistance.1 The remaining assistance came in the form
                                   of tax benefits, which the Joint Committee on Taxation (JCT) estimated
                                   would reduce federal revenues by about $5 billion. These tax benefits are
                                   commonly referred to as the Liberty Zone tax benefits.2 Because of your
                                   interest in whether the $5 billion in tax benefits will be realized, you asked
                                   us to determine the extent to which the Internal Revenue Service (IRS) is
                                   collecting and reporting information about the number of taxpayers using
                                   each of the seven Liberty Zone tax benefits and the revenue loss
                                   associated with those benefits. In addition, if IRS is not collecting and
                                   reporting this information, you asked us to determine what steps it would
                                   need to take and what resources would be needed to do so.

                                   To address these objectives, we interviewed IRS and city and state of New
                                   York officials and analyzed information they provided, as well as JCT data,
                                   about the use and revenue effects of the Liberty Zone tax benefits. We also
                                   discussed the steps IRS would need to take to collect information on the


                                   1
                                    In March 2003, FEMA became a part of the Department of Homeland Security. Also, a
                                   small portion of the funds are administered by other agencies such as the Small Business
                                   Administration and the Department of Labor. We will report additional information about
                                   the total benefits provided to New York later this year.
                                   2
                                    The New York Liberty Zone is the area located on or south of Canal Street, East Broadway
                                   (east of its intersection with Canal Street), or Grand Street (east of its intersection with
                                   East Broadway) in the Borough of Manhattan in the city of New York.



                                   Page 1                                            GAO-03-1102 Liberty Zone Tax Benefits
                   use and revenue effects of the benefits and the resources it would need to
                   do so. For the purposes of this report, we defined use as the number of
                   taxpayers who claimed each benefit and the amount each claimed.
                   However, the amount that taxpayers claim on their returns is not the same
                   as the reduction in tax liabilities due to using the benefits. Because some
                   of the Liberty Zone tax benefits substitute for less generous deductions or
                   credits to which taxpayers would otherwise be entitled, the net reduction
                   in taxpayers’ tax liabilities (and net reduction in federal revenues) can
                   only be determined by comparing taxpayers’ tax liabilities with the
                   benefits in place to their tax liabilities when only the alternate deductions
                   and credits are available.3 Our scope and methodology are discussed in
                   greater detail in appendix I.


                   For one of the seven Liberty Zone tax benefits, the business employee
Results in Brief   credit, IRS is collecting but not planning to report some information about
                   use—the number of taxpayers claiming the credit and the amount of credit
                   claimed—nor is it planning to use this information to report on the
                   revenue loss associated with that benefit. IRS is not planning to collect or
                   report information about the use of the other six benefits or the revenue
                   loss associated with those benefits. IRS can collect information on the use
                   of the business employee credit because it developed a new form to
                   administer this credit. However, IRS currently cannot collect information
                   on the remaining six Liberty Zone benefits because it is using existing
                   forms to administer them, and taxpayers do not report these six benefits
                   as separate items on their returns. According to IRS officials, the agency
                   followed its usual procedures in determining whether to collect
                   information about benefit use and revenue loss. IRS officials said they
                   would collect and report these data if (1) it would help the agency
                   administer the tax laws or (2) IRS was legislatively mandated to do so.

                   IRS would need to make several changes if it were to collect more
                   information on the use of the benefits and the associated revenue loss, and
                   this information would not be complete or lead to a verifiable measure of
                   the reduction in federal tax revenues due to the benefits. IRS would need
                   to change forms, processing procedures, and computer programming,


                   3
                    JCT’s $5 billion estimate of the reduction in federal tax revenues is not exactly the same
                   as the economic value of the benefits to taxpayers. For example, the JCT estimate, which
                   covers a 10-year time frame, does not completely reflect the fact that taxpayers who claim
                   the expensing deduction today would receive smaller deductions in the future than they
                   otherwise could have claimed.




                   Page 2                                             GAO-03-1102 Liberty Zone Tax Benefits
                  which would add to taxpayer burden and IRS’s workload. For example,
                  changing the form that taxpayers use to claim depreciation so that they
                  report separately the amount of depreciation due to the special Liberty
                  Zone depreciation allowance would result in increased taxpayer burden.
                  IRS’s workload would also increase because, among other things, it would
                  be processing additional information on depreciation. IRS officials were
                  unable to estimate the costs involved in accomplishing these actions or the
                  number of staff needed to do so. They said that the earliest they could
                  make these changes would be for tax year 2004 returns. As a result, IRS
                  would not have information for two of the years that the benefits were in
                  effect, which is significant because most of the benefits expire by the end
                  of 2006. In addition, if IRS were to collect data on the use of the Liberty
                  Zone benefits, it would be able to make an estimate, but could not produce
                  a verifiable measure, of the revenue loss due to the benefits because, for
                  example, IRS would have to make assumptions about how taxpayers
                  would have behaved in the absence of the benefits.

                  The Commissioner of Internal Revenue was provided a draft of this report
                  for his review and comment. The IRS Director of Tax Administration
                  Coordination agreed with the contents of the report.


                  To assist New York in recovering from the September 11, 2001, terrorist
Background        attacks, Congress passed Public Law 107-147, the Job Creation and
                  Worker Assistance Act of 2002. The act was signed into law on March 9,
                  2002, and created seven tax benefits that focus on the New York Liberty
                  Zone. The Liberty Zone tax benefits include

             •	  treating employees in the Liberty Zone as a targeted group for purposes of
                 the work opportunity tax credit (WOTC), which IRS refers to as the
                 business employee credit;
             • a special depreciation allowance;
             • an increase in section 179 expensing;
             • special treatment of leasehold improvement property;
             • 	 an extension of the replacement period for involuntarily converted
                 property;
             • authority to issue tax-exempt private activity bonds; and
             • authority to issue advance refunding bonds.

                  An explanation of each benefit, an example of how it can be used, and the
                  period each benefit is in effect are included in appendix II.




                  Page 3                                   GAO-03-1102 Liberty Zone Tax Benefits
                         Under the Congressional Budget Act of 1974 as amended, JCT provides
                         estimates of the revenue consequences of tax legislation. In March 2002,
                         JCT estimated that the New York Liberty Zone tax benefits would reduce
                         federal revenues by $5.029 billion over the period 2002 through 2012.4


                         For one of the seven Liberty Zone tax benefits, the business employee
IRS Generally Not        credit, IRS is collecting but not planning to report some information about
Planning to Collect or   use—the number of taxpayers claiming the credit and the amount of credit
                         claimed—nor is it planning to use this information to report on how the
Report Information       benefit has reduced taxpayers’ tax liabilities. IRS is not planning to collect
about the Use of         or report information about the use of the other six benefits or how using
                         these benefits has reduced taxpayers’ tax liabilities.
Liberty Zone Tax
Benefits or              IRS collects information on how many taxpayers use the business
Reductions in            employee credit and the amount of the credit claimed on Form 8884 (New
                         York Liberty Zone Business Employee Credit). Submission processing
Taxpayers’ Tax           officials in the Small Business/Self-Employed (SB/SE) Division began
Liabilities              entering information from this form into IRS’s computer system in January
                         2003. Some taxpayers claiming the business employee credit may have
                         their returns processed by the Wage and Investment (W&I) Division,
                         which is not planning to enter information from the form into the
                         computer system. However, IRS officials said that the bulk of the
                         taxpayers who would claim this credit would submit their returns to the
                         SB/SE Division.

                         IRS can collect information on the use of the business employee credit
                         because it developed a new form to administer this credit. Although the
                         business employee credit was included in the WOTC provisions, IRS
                         officials said they needed to track business employee credits separately
                         because the business employee credit can be used to offset any alternative
                         minimum taxes owed but the general WOTC provisions cannot.5 IRS
                         currently cannot collect information on the remaining six Liberty Zone
                         benefits because it is using existing forms to administer them, and



                         4
                          Joint Committee on Taxation, Estimated Revenue Effects of the “Job Creation and
                         Worker Assistance Act of 2002” Fiscal Years 2002-2012 (Washington, D.C.: Mar. 6, 2002),
                         2.
                         5
                          The alternative minimum tax is a separate tax computation required of some taxpayers
                         whose taxable incomes exceed certain thresholds and who otherwise would owe little or
                         no taxes because they are claiming certain special deductions and credits.




                         Page 4                                          GAO-03-1102 Liberty Zone Tax Benefits
taxpayers do not report these six benefits as separate items on their
returns. For example, taxpayers add the amount of depreciation they are
allowed under the Liberty Zone special depreciation allowance benefit to
other depreciation expenses and report their total depreciation expenses
on their returns. Since taxpayers do not report their use of six of the seven
benefits separately on their returns, IRS cannot report on how extensively
these six benefits were used.

IRS officials said that although they are collecting information on the
amount of business employee credits claimed by taxpayers, they are not
planning on reporting information on the extent to which the benefit
reduced taxpayers’ tax liabilities. For the other six benefits, IRS officials
said that without information about use, they cannot collect or report on
the extent to which the benefits reduced taxpayers’ tax liabilities.6

According to IRS officials, the agency followed its usual procedures in
determining the type of information to collect about the Liberty Zone tax
benefits. They added that IRS would collect and report information that
would help it to administer the tax laws or if it was legislatively mandated
to collect or report information. IRS officials said they do not need
information about the use of the Liberty Zone tax benefits or the resulting
reductions in taxpayers’ tax liabilities in order to administer the tax laws.
For example, IRS officials said that they do not need information on each
specific benefit claimed to properly target their enforcement efforts.
Instead, they target their enforcement efforts based on taxpayers claiming
various credits, deductions, and so forth that fall outside of expected
amounts. In addition, IRS officials noted that the agency has not been
legislatively mandated to collect or report information on the benefits.




6
  Bond issuers also receive economic benefits from tax-exempt bonds because they pay
less interest than they would have had to pay on the same amount of bonds that were not
tax exempt. IRS could use forms prepared by bond issuers to collect information about the
two Liberty Zone bond benefits, such as the maturity date and issue prices. Information on
the bonds issued is also available from the city and state of New York.




Page 5                                            GAO-03-1102 Liberty Zone Tax Benefits
                             IRS would need to make several changes if it were to collect more
Several Changes              information on taxpayers’ use of the benefits and their effect on reducing
Needed If IRS Were to        taxpayers’ tax liabilities. IRS would need to change forms used to collect
                             information from taxpayers, change how it processes information from tax
Collect and Report           returns, and revise computer programming, which would add to taxpayer
More Information             burden and IRS’s workload. Even if it were to make these changes, IRS
                             would not have information for two of the years the benefits were
about the Liberty            available. Also, although the additional information would enable IRS to
Zone Tax Benefits and        make an estimate of the revenue loss due to the benefits, it would not be
Estimate Revenue             able to produce a verifiable measure of the loss. To produce the estimate,
                             IRS would have to make assumptions about how taxpayers would have
Losses                       behaved in the absence of the benefits.


Several Changes Needed If    For six of seven of the Liberty Zone tax benefits, IRS would need to revise
IRS Were to Report on Use    forms, tax return processing procedures, and computer programming if it
of Benefits and Reduction    were to collect and report information about the number of taxpayers
                             claiming the benefit and the amount they claimed. It would also need to
in Taxpayers’ Tax            take most of these steps to report on the use of the seventh benefit—the
Liabilities                  business employee credit. According to IRS officials, they would need to
                             make staff available to revise forms, review returns for completeness and
                             accuracy, transcribe the additional data, and write the necessary computer
                             programs for entering and extracting data. They would also need to
                             allocate computer resources to process the additional information
                             collected and prepare reports on the use of the benefits. For example, for
                             the special depreciation allowance benefit, IRS would need to revise

                        •	  Form 4562 (Depreciation and Amortization) so that taxpayers reported the
                            amount of depreciation they claimed specifically due to this benefit,
                        • 	 tax return processing procedures so that processing staff reviewed Form
                            4562 for completeness and accuracy and transcribed information about
                            the special depreciation allowance, and
                        • 	 computer programming so that information about the special depreciation
                            allowance could be entered into IRS’s information systems and extracted
                            in order to prepare reports about the use of the benefit.

                             For the seventh benefit—the business employee credit—taxpayers already
                             separately report the amount of the credit they are claiming, and IRS is
                             already reviewing these forms for accuracy and completeness,
                             transcribing data from them, and entering this information into the
                             agency’s computer system for those returns that are processed by the
                             SB/SE Division. However, computer programming would need to be
                             changed to extract information to prepare reports about benefit use. For



                             Page 6                                   GAO-03-1102 Liberty Zone Tax Benefits
any returns processed by the W&I Division, IRS would also need to revise
W&I processing procedures and computer programming.

Since IRS currently does not have any plans to make these changes,
officials were unable to estimate the costs involved in accomplishing these
actions or the number of staff needed to do so. However, IRS officials
estimated they added one full-time equivalent (FTE) primarily to review
the Form 8884s for completeness and accuracy and for data
transcription—part of the process to collect information about the use of
the business employee credit.7

If IRS collected information about the use of the benefits, IRS could then
develop some information on the reduction in taxpayers’ tax liabilities due
to the benefits. For example, IRS could determine how much lower each
taxpayers’ tax liability is due to the use of the tax benefits, assuming that
taxpayer behavior would be the same whether the benefits existed or not.
Table 1 is an example of such a computation for claiming the Liberty Zone
Section 179 expensing benefit. In this example, a taxpayer with $100,000 in
income bought $40,000 worth of office equipment in 2002 and placed this
equipment in service in the Liberty Zone in 2002. After applying the Liberty
Zone section 179 expensing benefit, taxable income would be $60,000.
Since the equipment has been completely expensed, the taxpayer cannot
claim any further deductions for this equipment. To recalculate the
taxpayer’s taxable income as if the special Liberty Zone expensing benefit
did not exist, IRS could assume that the taxpayer would make the same
investment, even without the Liberty Zone tax benefit, and still claim the
$24,000 section 179 deduction available to all taxpayers in 2002 and any
other available deductions, such as the special depreciation allowance. In
our example, the special depreciation allowance would be worth $4,800,
and the amount otherwise available as a depreciation deduction (regular
depreciation) would be worth $1,600, which would reduce the taxpayer’s
taxable income to $69,600. The total reduction in taxable income would be
$9,600.




7
 An FTE consists of one or more employees who collectively work for 1 year. For example,
one full-time employee or two half-time employees equal one FTE.




Page 7                                          GAO-03-1102 Liberty Zone Tax Benefits
                            Table 1: Example of Recalculation of Taxable Income

                                Taxpayer calculation of                         Recalculation of taxable
                                taxable income with Liberty                     income with standard
                                Zone expensing benefit                          deductions
                                Income                             $100,000 Income                             $100,000
                                  Less:                                           Less:
                                     Liberty Zone Section 179        (40,000)        Standard Section 179      (24,000)
                                                                                     Special depreciation        (4,800)
                                                                                     Regular depreciation        (1,600)
                                Taxable income                       $60,000 Taxable income                     $69,600
                            Sources: IRS and GAO.

                            Note: GAO analysis of IRS information.


                            Once all the adjustments to taxable income were made, IRS would then
                            need to apply the appropriate marginal tax rate to arrive at the taxpayer’s
                            recalculated tax liability.


IRS Could Produce           If IRS were to begin collecting information on the number of taxpayers
Estimates but Not a         using the Liberty Zone tax benefits and the amounts they claimed, the
Verifiable Measure of the   information would not be complete. In addition, although the information
                            would enable IRS to make an estimate of the revenue loss due to the
Revenue Loss                benefits, the information would not result in a verifiable measure of the
                            loss. To produce the estimate, IRS would have to make assumptions about
                            how taxpayers would have behaved in the absence of the benefits.

                            IRS said the earliest it would be able to collect information on the number
                            of taxpayers using the benefits and the amounts each claimed would be
                            for tax year 2004 returns, which IRS would not process until calendar year
                            2005. As a result, IRS would not have information for two of the years that
                            the benefits were in effect, which is significant because most of the
                            benefits expire by the end of 2006.8 IRS could not reconstruct information
                            on tax liability for those 2 years because returns already filed would not
                            indicate whether taxpayers used the Liberty Zone benefits and would not
                            show the amount claimed through benefit use. Although IRS could ask for
                            information about past benefit use since taxpayers are instructed to keep
                            tax records for 3 years, this would require taxpayers to provide additional
                            information and increase taxpayer burden. Also, it would be difficult for


                            8
                                Details on the expiration dates for each benefit are given in app. II.




                            Page 8                                                 GAO-03-1102 Liberty Zone Tax Benefits
                    IRS to use current year information to estimate the amount claimed
                    through benefit use retroactively because the pattern of using the benefits
                    could have changed over time.

                    In addition to not being complete, the data that IRS could collect on the
                    number of taxpayers using the Liberty Zone benefits and the amounts each
                    claimed would not be sufficient for actually measuring how much revenue
                    those benefits cost the federal government. The reduction in revenues due
                    to the Liberty Zone tax benefits is equal to the difference between the
                    amount of revenue that the federal government would collect with the
                    benefits in place and the amount it would collect in the absence of those
                    benefits. There are two reasons why revenues would be different with and
                    without the benefits. First, the rules for computing tax liabilities are
                    different in the two cases (as shown in table 1). Second, the behavior of
                    many taxpayers is likely to be different in the two cases. In fact, a primary
                    purpose of the tax benefits is to influence taxpayer behavior. For example,
                    in the case of the Liberty Zone section 179 benefit, some taxpayers who
                    claim this benefit would have made different investment decisions if that
                    particular benefit were not available. In our simplified example shown in
                    table 1, this difference in behavior might be that the taxpayer invested less
                    than $40,000 in office equipment—perhaps even nothing—because the
                    Liberty Zone benefit did not exist. As a consequence, the taxpayer’s
                    taxable income would have been different than the $69,600 shown in table
                    1. Given that IRS cannot know what taxpayers would have done in the
                    absence of the benefits, the best it could do is estimate revenue losses
                    based on assumptions about that alternative behavior.


                    The Commissioner of Internal Revenue was provided a draft of this report
Agency Comments 	   for his review and comment. The IRS Director of Tax Administration
                    Coordination agreed with the contents of the report.


                    As agreed with your offices, unless you publicly announce its contents
                    earlier, we plan no further distribution of this report until 7 days from its
                    date. At that time, we will send copies to the Chairman and Ranking
                    Minority Member of the Senate Committee on Finance; the Chairman of
                    the House Committee on Ways and Means and the Chairman and Ranking
                    Minority Member of its Subcommittee on Oversight; the Secretary of the
                    Treasury; the Commissioner of Internal Revenue; the Director of the Office
                    of Management and Budget; and other interested parties. We will make
                    copies available to others on request. In addition, the report will be
                    available at no charge on the GAO Web site at http://www.gao.gov.


                    Page 9                                    GAO-03-1102 Liberty Zone Tax Benefits
This report was prepared under the direction of Jonda Van Pelt, Assistant
Director. If you have any questions regarding this report, please contact
her at (415) 904-2186 or vanpeltj@gao.gov or me at (202) 512-9110 or
brostekm@gao.gov. Key contributors to this report were Evan Gilman,
Edward Nannenhorn, Lynne Schoenauer, Shellee Soliday, Anne Stevens,
and James Wozny.




Michael Brostek
Director, Tax Issues




Page 10                                  GAO-03-1102 Liberty Zone Tax Benefits
Appendix I: Objectives, Scope, and
Methodology

              Our first objective was to determine the extent to which the Internal
              Revenue Service (IRS) is collecting and reporting information about the
              use and value of the seven Liberty Zone tax benefits. We defined use as the
              number of taxpayers who claimed each benefit and the amount each
              claimed. In analyzing value, we examined what information IRS could
              provide about reductions in taxpayers’ tax liabilities when they used the
              Liberty Zone tax benefits, and then examined whether this information
              could be used to measure the actual reduction in federal tax revenues. To
              address the first objective, we interviewed IRS officials from Legal
              Counsel, the Wage and Investment (W&I) Division’s and the Small
              Business/Self-Employed (SB/SE) Division’s submission processing groups,
              Statistics of Income (SOI), Forms and Publications, and the Tax Exempt
              Government Entities (TEGE) Division to determine if they were collecting
              and reporting any information about the use of the Liberty Zone tax
              benefits and how the benefits reduced taxpayers’ tax liabilities. We
              analyzed the documents they provided about collecting and reporting on
              the use of the benefits and the reduction in taxpayers’ tax liabilities. We
              also analyzed the data the Joint Committee on Taxation (JCT) provided
              about its estimate of the reduction in federal tax revenues. Finally, we
              interviewed New York city and state officials to determine if they were
              collecting and reporting information on the benefits.

              Our second objective was to determine what steps IRS would need to take
              and the resources it would need to collect and report information on the
              use and value of the Liberty Zone tax benefits if it is not already doing so.
              We used the same definition of use and value as we used for the first
              objective. To address the second objective, we interviewed IRS officials
              from Legal Counsel, the W&I Division’s and the SB/SE Division’s
              submission processing groups, SOI, Forms and Publications, and the
              TEGE Division to determine what steps they would need to take and the
              resources they would need to collect and report information on the use of
              the Liberty Zone tax benefits and the reduction in taxpayers’ tax liabilities
              if they used the benefits. We also analyzed IRS documents related to the
              steps that would need to be taken to collect and report on the use of the
              benefits and on the reduction in taxpayers’ tax liabilities.

              We performed our work from April 2003 through August 2003 in
              accordance with generally accepted government auditing standards.




              Page 11                                   GAO-03-1102 Liberty Zone Tax Benefits
Appendix II: Summary of the Liberty Zone
Tax Benefits


Liberty Zone 

            a
tax benefit        Benefit summary                                                    Example of the benefit          Effective dates 

Business         The work opportunity tax credit (WOTC) was expanded to               An employee works at a          Wages paid or incurred
employee credit	 include a new targeted group for employees who perform               small company located in        for qualified employees
                 substantially all their services for a business in the Liberty       the Liberty Zone from           during calendar years
                 Zone or for a business that relocated from the Liberty Zone          June 1, 2002, to October 31,    2002 and 2003
                 elsewhere within New York City due to the physical                   2002, and receives $3,000
                 destruction or damage of their workplaces by the                     in wages a month. The
                 September 11, 2001, terrorist attacks.                               company can claim a credit
                   The New York Liberty Zone business employee credit                 for 40 percent of the first 

                   allows eligible businesses with an average of 200 or fewer         $6,000 in wages paid 

                   employees to take a maximum credit of 40 percent of the            ($2,400). 

                   first $6,000 in wages paid or incurred for work performed by

                   each qualified employee during calendar years 2002 and 

                   2003. Unlike the other targeted groups under WOTC, the 

                   credit for the new group is available for wages paid to both

                   new hires and existing employees. 

Special            The special depreciation allowance provides an additional          On December 1, 2002, a          Residential rental
depreciation       deduction for eligible properties. Eligible Liberty Zone           real estate development firm    property and
allowance          properties include new tangible property (e.g., new office         purchases an office building    nonresidential real
                   equipment), used tangible property (e.g., used office              in the New York Liberty         property: Acquired by
                   equipment), and residential rental property (e.g., an              Zone that costs $10 million     purchase after
                   apartment complex) and nonresidential real property (e.g.,         and places it in service on     September 10, 2001,
                   an office building) if it rehabilitates real property damaged or   June 1, 2003. The building      and placed in service
                   replaces real property destroyed or condemned as a result          replaces real property          on or before
                   of the September 11, 2001, terrorist attacks.                      damaged as a result of the      December 31, 2009
                   For property inside the Liberty Zone, the special                  September 11, 2001,             New and used tangible
                   depreciation allowance allows taxpayers to deduct 30               terrorist attacks. Under the    property: Acquired by
                   percent of the adjusted basis of qualified property acquired       provision, the taxpayer is      purchase after
                   by purchase after September 10, 2001, and placed in                allowed an additional first-    September 10, 2001,
                   service on or before December 31, 2006 (December 31,               year depreciation deduction     and placed in service
                   2009, in the case of nonresidential real property and              of 30 percent ($3 million).     on or before
                   residential rental property). For property outside the Liberty                                     December 31, 2006
                   Zone, a special depreciation allowance is available for
                   taxpayers but only with regard to qualified property—such
                   as new tangible property and non-Liberty Zone leasehold
                   improvement property—that is acquired after
                   September 10, 2001, and before September 11, 2004, and
                   is placed in service on or before December 31, 2004.
                   However, recent legislation (the Jobs and Growth Tax
                   Relief Reconciliation Act of 2003, Pub. L. No. 108-27) has
                   increased the deduction to 50 percent for qualified property
                   both within and outside the Liberty Zone that is acquired
                   after May 5, 2003, and placed in service on or before
                   December 31, 2004.




                                             Page 12                                               GAO-03-1102 Liberty Zone Tax Benefits
                                          Appendix II: Summary of the Liberty Zone
                                          Tax Benefits




Liberty Zone 

            a
tax benefit      Benefit summary                                                 Example of the benefit       Effective dates 

Section 179      Taxpayers with a sufficiently small investment in qualified  In 2002, a taxpayer             Effective for section
expensing        section 179 business property in the Liberty Zone can elect  purchases and places in         179 property placed in
                 to deduct rather than capitalize the amount of their         service in his or her Liberty   service after
                 investment and are eligible for an increased amount over     Zone business several           September 10, 2001,
                 other taxpayers. For qualified Liberty Zone property placed  qualified items of equipment    and on or before
                 in service during 2001 and 2002, under section 179           costing a total of $260,000.    December 31, 2006
                 taxpayers could deduct up to $59,000 ($24,000 under the      Because 50 percent of the
                 general provision plus an additional $35,000) of the cost.   cost of the property
                 The investment limit (phase-out range) in the property was   ($130,000) is less than
                 $200,000. For qualified Liberty Zone property placed in      $200,000, the investment
                 service after 2002 and before 2007, taxpayers could deduct   limit, the section 179
                 $60,000 ($25,000 under the general provision plus the        deduction of $59,000 is not
                 additional $35,000) of the cost.                             reduced, and the taxpayer
                 However, recent legislation (Pub. L. No. 108-27) has further can deduct this amount.
                 increased the maximum deduction for qualified Liberty Zone
                 property placed in service after 2002 and before 2006 to
                 $135,000 and has increased the investment limit to
                 $400,000. For 2006, the maximum section 179 deduction
                 allowed for qualified Liberty Zone property returns to
                 $60,000 and the investment limit is $200,000. To calculate
                 the available expensing treatment deduction amount for
                 qualified Liberty Zone property, every dollar for which 50
                 percent of the cost of the property exceeds the investment
                 limit is subtracted from the maximum deduction allowed.
                 Taxpayers outside of the Liberty Zone may also expense
                 qualified property under section 179. However, the
                 maximum deduction for non-Liberty Zone property is
                 $35,000 less than the maximum deduction allowed for
                 Liberty Zone property. The investment limits for Liberty
                 Zone and non-Liberty Zone property are similar. However,
                 in contrast, in calculating the available expensing treatment
                 deduction amount for non-Liberty Zone properties, every
                 dollar invested in the property that exceeds the investment
                 limit is subtracted from the maximum deduction allowed.




                                          Page 13                                            GAO-03-1102 Liberty Zone Tax Benefits
                                           Appendix II: Summary of the Liberty Zone
                                           Tax Benefits




Liberty Zone 

            a
tax benefit      Benefit summary                                                  Example of the benefit          Effective dates 

Leasehold        Qualified Liberty Zone leasehold improvement property can In 2004, a taxpayer buys               Effective for property
improvement      be depreciated over a 5-year period using the straight-line    and places in service             placed in service after
property         method of depreciation. The term “qualified Liberty Zone       $100,000 in additional walls      September 10, 2001,
                 leasehold property” means property as defined in section       for a leased office building in   and on or before 

                 168(k)(3) and may include items such as additional walls       the Liberty Zone. For each        December 31, 2006 

                 and plumbing and electrical improvements made to an            tax year from 2004 through 

                 interior portion of a building that is nonresidential real     2008, the taxpayer can 

                 property. Qualified Liberty Zone leasehold improvements        deduct up to one-fifth of the 

                 must be placed in service in a nonresidential building that is cost of the property. 

                 located in the Liberty Zone after September 10, 2001, and 

                 on or before December 31, 2006. The class life for qualified

                 New York Liberty Zone leasehold improvement property is 9 

                 years for purposes of the alternative depreciation system. 

                 Taxpayers can also depreciate leasehold improvements 

                 outside of the Liberty Zone. These taxpayers can 

                 depreciate an addition or improvement to leased 

                 nonresidential real property using the straight-line method 

                 of depreciation over 39 years. Qualified leasehold 

                 improvement properties outside the Liberty Zone can qualify 

                 for both the 39-year depreciation deduction and the special 

                 depreciation allowance. However, leasehold improvements 

                 inside the Liberty Zone do not qualify for the special 

                 depreciation allowance. 

Replacement      A taxpayer may elect not to recognize gain with respect to       A taxpayer held a truck for     Effective for involuntary 

period for       property that is involuntarily converted if the taxpayer         productive use in a Liberty     conversions in the 

involuntarily    acquires qualified replacement property within an applicable     Zone business, but it was       Liberty Zone occurring 

converted        period. The replacement period for property that was             destroyed in the                on or after 

property         involuntarily converted in the Liberty Zone as a result of the   September 11, 2001,             September 11, 2001, 

                 September 11, 2001, terrorist attacks is 5 years after the       terrorist attacks. Several      as a result of the
                 end of the taxable year in which a gain is realized provided     years ago, the taxpayer paid    terrorist attacks on that
                 that substantially all of the use of the replacement property    $50,000 for the truck and,      date
                 is in New York City. The involuntarily converted Liberty         over time, depreciated the
                 Zone property can be replaced with any tangible property         basis in the truck to
                 held for productive use in a trade or business because           $30,000. If the insurance
                 taxpayers in presidentially declared disaster areas such as      company paid $35,000 in
                 the Liberty Zone can use any tangible, productive use            reimbursement for the truck
                 property to replace property that was involuntarily              and the taxpayer used the
                 converted.                                                       $35,000 to purchase
                 Outside of the Liberty Zone, the replacement period for          replacement property of any
                 involuntarily converted property is 2 years (3 years if the      type that is held for
                 converted property is real property held for the productive      productive use in a trade or
                 use in a trade or business or for investment), and the           business within 5 years after
                 converted property must be replaced with replacement             the close of the tax year of
                 property that is similar in service or use.                      payment by the insurance
                                                                                  company, the taxpayer
                                                                                  would not recognize a gain.




                                           Page 14                                             GAO-03-1102 Liberty Zone Tax Benefits
                                                     Appendix II: Summary of the Liberty Zone
                                                     Tax Benefits




 Liberty Zone 

             a
 tax benefit               Benefit summary                                                    Example of the benefit          Effective dates 

 Private activity          An aggregate of $8 billion of tax-exempt private activity          The Mayor of New York City      Effective for bonds
 bonds 	                   bonds, called qualified New York Liberty bonds, are                designates $120 million of      issued after March 9,
                           authorized to finance the acquisition, construction,               qualified New York Liberty      2002 (the date of
                           reconstruction, and renovation of certain property that is         bonds to finance the            enactment of the Job
                           primarily located in the Liberty Zone. Qualified New York          construction of an office       Creation and Worker
                           Liberty bonds must finance nonresidential real property,           building in the Liberty Zone.   Assistance Act of
                           residential rental property, or public utility property and must                                   2002), and on or before
                           also satisfy certain other requirements. The Mayor of New                                          December 31, 2004
                           York City and the Governor of New York State may each
                           designate up to $4 billion in qualified New York Liberty
                           bonds.
 Advance          An aggregate of $9 billion of advance refunding bonds may                   The Governor of New York        Effective for advance
 refunding bonds	 be issued to pay principal, interest, or redemption price on                State designates $70 million    refunding bonds issued
                  certain prior issues of bonds issued for facilities located in              of advance refunding bonds      after March 9, 2002,
                  New York City (and certain water facilities located outside of              to refinance bonds that         and on or before
                  New York City). Under this benefit, certain qualified bonds,                financed the construction of    December 31, 2004
                  which were outstanding on September 11, 2001, and had                       hospital facilities in New
                  exhausted existing advance refunding authority before                       York City.
                  September 12, 2001, are eligible for one additional advance
                  refunding. The Mayor of New York City and the Governor of
                  New York State may each designate up to $4.5 billion in
                  advance refunding bonds.
Sources: Public Law 107-147, IRS, and GAO.
                                                     a
                                                     The Liberty Zone tax benefits were enacted as part of the Job Creation and Worker Assistance Act of
                                                     2002, Pub. L. No. 107-147.




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                                                     Page 15                                               GAO-03-1102 Liberty Zone Tax Benefits
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