Lawmakers Rush to Close Tax Loophole

Congress is scrambling for ways to close a loophole that has caused the Internal Revenue Service to send disaster-related refund checks to 630,000 procrastinating taxpayers, even though most sustained no disaster damage.

The loophole was created in tax reform laws in the last two years but was widely unknown until The Times revealed Saturday that the IRS has been automatically sending out refunds of interest charges levied on late taxes to any taxpayer who lived in a disaster area since 1996.

The laws authorizing the refunds were originally intended to help people when natural disasters prevented filing taxes on time. Because of the way the laws were worded, however, the IRS sent a refund to anyone who lived in a federally declared disaster area and who was charged interest for paying his or her taxes after the April 15 deadline.

The Joint Tax Committee, the powerful panel that drafts most tax legislation, is looking for ways to plug the loophole before millions more taxpayers discover they can get an interest-free loan from the government, congressional sources said. The committees have been fielding angry calls from constituents and members of Congress since the disaster provision was revealed.

For example, under current law, any resident of Los Angeles County--which was declared a federal disaster area in January because of frost damage to citrus farms in the northern part of the county--could pay taxes late this year and get a refund of the interest.

“I wouldn’t count on [the loophole] being there for long,” one source said.

Rep. Robert T. Matsui (D-Sacramento), a member of the House Ways and Means Committee, sent a letter to Treasury Secretary Robert E. Rubin earlier this week asking him to issue regulations that would limit the refunds to taxpayers who were forced to file late because of a disaster.

Rubin did not return calls for comment.

Some members of Congress criticized the IRS for not requiring taxpayers to prove they were affected by a disaster before it sent out a refund. Others, including Senate Finance Committee Chairman William V. Roth Jr. (R-Del.), said the IRS was simply trying to carry out a law that was designed to rush help where it was most needed.

“When there’s a disaster, you try to help [the victims] as quickly as possible,” Roth said. “If you write all kinds of complexities into the law, then it doesn’t work.”

Roth said he would support closing the loophole only if the solution did not discourage people who needed the tax break from using it.

Other sources, however, say Congress may have to pass a law to fix the glitch. Among the proposals being discussed is a postcard that would be sent to residents of a disaster area requiring them to swear under penalty of perjury that their late payments were due to delays caused by the disaster.

The refunds stem from changes in the Taxpayer Relief Act of 1997 that sought to give a tax break to people who lived in counties declared by the president to be disaster areas. Follow-up legislation in 1998 extended the loophole and granted the refunds to businesses, estates and trusts in addition to individuals.

The IRS, which has been trying to rehabilitate its image with taxpayers and Congress, began shipping out the refunds in December without requiring taxpayers to apply for the money or to prove they had suffered disaster damage. The IRS used ZIP Codes provided by the Federal Emergency Management Agency to identify late-paying taxpayers who lived in disaster areas.

Accountants say they were mystified at first by the checks, which seemed to range from a few dollars to $4,000. Some members of the California Society of Certified Public Accountants, a trade group, questioned the fairness of lumping legitimate disaster victims with people who simply put off paying their taxes.

The actual cost of the refund spree is unknown. The IRS said it does not know how much has been refunded, although it is expected to be far more than the $25 million Congress expected the tax break to cost.

The IRS was also unable to estimate how many refunds went to Californians, though the number is expected to be high. Californians are more likely than the average taxpayer to file extensions, and much of California has been declared a disaster area in recent years.

El Nino storms and floods prompted President Clinton to designate 48 of California’s 58 counties, including much of Northern California, disaster areas in 1997 and 41 California counties, including all of Southern California except Imperial County, disaster areas in 1998. So far this year, the president has declared 18 California counties--including Los Angeles, San Bernardino, Ventura and Santa Barbara--disaster areas.