[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
2006 TAX RETURN FILING SEASON AND
THE IRS BUDGET FOR FISCAL YEAR 2007
=======================================================================
HEARING
before the
SUBCOMMITTEE ON OVERSIGHT
of the
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
APRIL 6, 2006
__________
Serial No. 109-72
__________
Printed for the use of the Committee on Ways and Means
U.S. GOVERNMENT PRINTING OFFICE
30-443 WASHINGTON : 2006
_____________________________________________________________________________
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
E. CLAY SHAW, JR., Florida CHARLES B. RANGEL, New York
NANCY L. JOHNSON, Connecticut FORTNEY PETE STARK, California
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM MCCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM MCDERMOTT, Washington
JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
PHIL ENGLISH, Pennsylvania WILLIAM J. JEFFERSON, Louisiana
J.D. HAYWORTH, Arizona JOHN S. TANNER, Tennessee
JERRY WELLER, Illinois XAVIER BECERRA, California
KENNY C. HULSHOF, Missouri LLOYD DOGGETT, Texas
RON LEWIS, Kentucky EARL POMEROY, North Dakota
MARK FOLEY, Florida STEPHANIE TUBBS JONES, Ohio
KEVIN BRADY, Texas MIKE THOMPSON, California
THOMAS M. REYNOLDS, New York JOHN B. LARSON, Connecticut
PAUL RYAN, Wisconsin RAHM EMANUEL, Illinois
ERIC CANTOR, Virginia
JOHN LINDER, Georgia
BOB BEAUPREZ, Colorado
MELISSA A. HART, Pennsylvania
CHRIS CHOCOLA, Indiana
DEVIN NUNES, California
Allison H. Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
______
SUBCOMMITTEE ON OVERSIGHT
JIM RAMSTAD, Minnesota, Chairman
ERIC CANTOR, Virginia JOHN LEWIS, Georgia
BOB BEAUPREZ, Colorado EARL POMEROY, North Dakota
JOHN LINDER, Georgia MICHAEL R. MCNULTY, New York
E. CLAY SHAW, JR., Florida JOHN S. TANNER, Tennessee
SAM JOHNSON, Texas CHARLES B. RANGEL, New York
DEVIN NUNES, California
J.D. HAYWORTH, Arizona
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
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C O N T E N T S
__________
Page
Advisory of March 30, 2006 announcing the hearing................ 2
WITNESSES
Internal Revenue Service, Hon. Mark Everson, Commissioner........ 6
______
U.S. Department of the Treasury, Hon. J. Russell George, Treasury
Inspector General for Tax Administration....................... 37
Internal Revenue Service Oversight Board, Hon. Raymond T. Wagner,
Chairman....................................................... 46
Free File Alliance, Hon. Timothy D. Hugo......................... 64
U.S. Government Accountability Office, James R. White, Director,
Tax Issues..................................................... 67
______
American Bar Association, Dennis B. Drapkin...................... 98
American Institute for Certified Public Accountants, Thomas J.
Purcell........................................................ 102
National Association of Enrolled Agents, Francis X. Degen........ 110
SUBMISSIONS FOR THE RECORD
National Society of Accountants, statement....................... 121
Scorse, Gerald, New York, NY, statement.......................... 124
2006 TAX RETURN FILING SEASON AND
THE IRS BUDGET FOR FISCAL YEAR 2007
----------
THURSDAY, APRIL 6, 2006
U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, DC.
The Subcommittee met, pursuant to notice, at 10:02 a.m., in
room 1100, Longworth House Office Building, Hon. Jim Ramstad
(Chairman of the Subcommittee) presiding.
[The advisory announcing the hearing follows:]
ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT
CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
March 30, 2006
OV-6
Ramstad Announces Hearing on
2006 Tax Return Filing Season and the
IRS Budget for Fiscal Year 2007
Congressman Jim Ramstad (R-MN), Chairman, Subcommittee on Oversight
of the Committee on Ways and Means, today announced that the
Subcommittee will hold a hearing on the 2006 tax return filing season,
the Internal Revenue Service (IRS) budget for fiscal year 2007, and
other issues in tax administration. The hearing will take place on
Thursday, April 6, 2006, in the main Committee hearing room, 1100
Longworth House Office Building, beginning at 10:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only.
Witnesses will include IRS Commissioner Mark Everson and
representatives of the U.S. Government Accountability Office, the
Treasury Inspector General for Tax Administration, the IRS Oversight
Board, and several tax practitioner groups.
BACKGROUND:
This year's tax return filing season runs from January 1st to April
17th, and during this time, the IRS expects to receive over 130 million
tax returns, over half of which will be filed electronically. The IRS
anticipates issuing more than $200 billion in refunds to approximately
105 million taxpayers during this period. Seeking assistance from the
IRS in preparing their returns, Americans will contact the Service via
telephone more than 25 million times and will make almost 120 million
visits to the IRS website, which is one of the busiest in the world
during the filing season.
To carry out these and other tax administration duties next year,
the Administration has requested $10.6 billion to fund IRS operations
for fiscal year 2007, a 0.2-percent increase over the amount enacted
last year. This amount will be supplemented by $135 million in new user
fees that the IRS expects to collect by providing individualized
services to taxpayers. This level of funding will support nearly
100,000 employees who will collect nearly $2 trillion in revenue.
In addition to examining IRS performance during the filing season
and the proposed budget for next year, the hearing will also provide
the opportunity to review a number of significant tax administration
issues that have recently arisen. For example, last year the IRS
renegotiated the agreement with the Free File Alliance, a consortium of
tax preparation software companies that provide free software to some
taxpayers through the IRS website. The hearing will review the effects
of the new agreement. Another issue that has recently arisen is
proposed IRS regulations governing the use of taxpayer information by
tax return preparers. The hearing will allow Members of the
Subcommittee the opportunity to inquire about these proposed
regulations and their potential effects on taxpayer privacy.
In announcing the hearing, Chairman Ramstad stated, ``By collecting
$2 trillion in revenue, the IRS fulfills a vital mission for the
Federal Government, and the IRS must pursue its enforcement obligations
aggressively. However, the IRS impacts the lives of all Americans, and
it is important that the IRS respects taxpayers' rights and provides
top-rate service in a time of budgetary constraints. I look forward to
hearing from Commissioner Everson and the other witnesses as they
discuss how the IRS is carrying out these responsibilities this year.''
FOCUS OF THE HEARING:
The hearing will focus on the 2006 tax return filing season, the
IRS budget for fiscal year 2007, and current tax administration issues
facing the IRS.
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Chairman RAMSTAD. The hearing will come to order. Welcome
to our three distinguished panels. Welcome to all our guests.
Commissioner, good to see you again. In a little more than a
week we will reach the culmination of the annual tax return
filing season, as we all know. This is a time of the year when
Americans are reminded of the tax burden they face, and the
mind-numbing complexity of the Tax Code. This is also the time
of the year that brings millions of Americans into contact with
the Internal Revenue Service (IRS). I know everyone there
around the country is working overtime these days. 105 million
taxpayers will receive refunds from the IRS. Taxpayers will
place 25 million calls to the IRS, and they will make 120
million visits to the IRS website, truly mind-numbing numbers.
With all of this interaction, it is important that the IRS
provide high-quality service to taxpayers even in the face of
budgetary constraints. It is just as important that the Service
vigorously enforce the law to ensure that all taxpayers pay
their fair share. We know this is a delicate balancing act, but
it is essential to maintaining high levels of voluntary
compliance with our tax laws.
I have been following the filing season closely, and I have
some concerns that I will explore in detail at this hearing,
that indeed, all of us on this Subcommittee will explore at
this hearing.
First I want to ask about the Free File Alliance. Four
years ago, the IRS entered into an agreement with a group of
tax preparation software companies. The purpose of the
agreement was to encourage more taxpayers to file their tax
returns electronically. Under the agreement, the Government
promised not to develop its own preparation software as the
quid pro quo. In return, the companies, known as the Free File
Alliance, would provide free preparation software to the
American public for the taxpayers.
For the first 3 years under the agreement, this program was
successful, and it grew in popularity with taxpayers. Its use,
in fact, increased by 26 percent 2 years ago, and 46 percent
last year. The popularity of Free File was due in large part to
the fact that last year many of the participating companies
decided to offer free Federal preparation to all taxpayers,
regardless of their income level.
However, several months ago, the IRS renegotiated this
agreement, and included for the first time a cap on the number
of taxpayers who can be served by the Free File Alliance. This
is the first filing season in which the new agreement has been
in place, and as you can see from the graph, use of the Free
File Alliance is down over 21 percent, like I said, in just one
year.
We will explore today more about this agreement that seems
to prevent many taxpayers from receiving free return
preparation services, and apparently discourages taxpayers from
electronic filing. We will also, today, talk more about the
agreement that keeps companies from offering free tax
preparation services to taxpayers through the IRS website. We
are going to explore this with the various panels here today,
and they know the Commissioner has some concerns he wants to
express as well, because this 21-percent decline in the use of
the program in this year alone is certainly concerning to all
of us on the Subcommittee.
In fact, as I expressed on the record, I had some concerns
about this agreement at the time it was signed, but I wanted to
see if it would work, but now that the numbers are in and we
see a dramatic drop-off in the public's use of Free File, I
think we need to seriously look at whether this agreement
should be renegotiated.
We are going to also look at a number of issues facing the
IRS, as we routinely do at these yearly oversight hearings, the
one during the filing season. For example, a number of Members
have expressed concerns about how tax preparers handle their
clients' taxpayer information. Last December the IRS proposed a
new rule that expanded some of the ways that return preparers
can use taxpayer information. This rule has been criticized by
a number of people, including me, but what really concerns me
is current law. Current law allows return preparers to share
taxpayers' private information with any third party as long as
they have taxpayers' consent.
I fear that many taxpayers may not give meaningful consent,
and that many taxpayers will find their private information is
being sold to third parties. This is a real privacy issue that
I know concerns a number of Members.
I am interested in hearing the views of the witnesses as to
whether Congress should consider changes to current law to
provide greater protection to taxpayer information.
I certainly look forward to the Commissioner's testimony as
well as the other two distinguished panels here today on these
important matters.
I am now pleased to recognize my good friend, the
distinguished ranking Member, Mr. Lewis.
Mr. LEWIS OF GEORGIA. Thank you very much, Mr. Chairman.
Again, this year the Subcommittee is holding an oversight
review to examine how the current tax return filing season is
progressing and the adequacy of the administration's proposed
IRS budget for the coming year. Mr. Chairman, I want to thank
you for conducting this annual hearing on the IRS.
More than 130 million tax returns will be filed during the
2006 tax return filing season. This year, the filing season
ends a little later than usual, on April 17th, since April 15th
is a Saturday. Reports indicate that the tax return filing
season is progressing smoothly.
The administration has proposed, for fiscal year 2007, an
IRS budget of about $10.6 billion. It is important that the IRS
be adequately funded and have a balanced approach to
administering our tax laws.
I welcome today's hearing witnesses, and look forward to
each of your testimonies. Importantly, I want to commend you,
Mr. Commissioner, I want to commend you for all of your good
work, and all of the IRS employees nationwide for their good
work, and their hard work to see that our tax laws are
enforced, and that we get the revenue that is due the
government.
Thank you, Mr. Chairman.
Chairman RAMSTAD. I thank the ranking Member, and I
certainly concur in his sentiments. Nobody has a tougher job in
Washington, except maybe the President, than you do,
Commissioner, and you are doing a tough job very well, and all
of the people that work for you are to be commended as well.
We look forward to your testimony, and, please, proceed.
STATEMENT OF THE HONORABLE MARK W. EVERSON, COMMISSIONER,
INTERNAL REVENUE SERVICE
Mr. EVERSON. Thank you for those kind words. Mr. Chairman,
Mr. Lewis, Mr. Shaw, I am pleased to be here today to testify
on the 2007 budget request for the IRS. I will also provide you
with an update on the tax filing season currently under way.
Let me comment first on the tax gap. As you know, the tax
gap is the difference between the amount that taxpayers should
pay for a given year and the amount that they actually pay on a
timely basis. The tax gap represents in dollar terms the annual
amount of noncompliance with our tax laws. We have refined our
research, and now estimate that for the year 2001, the overall
growth tax gap for all types of tax was approximately $345
billion, or a noncompliance rate of 16.3 percent. Our estimate
of the net tax gap, or what remains after enforcement and other
late payments, is $290 billion. Our 2007 budget will help us
reduce the tax gap.
Before discussing this budget though, I want to thank you
for your support for last year's budget. We are using the
moneys that Congress provided to continue our progress in
building a balanced program of service and enforcement. The
2007 budget would sustain this progress. Our request is for
$10.6 billion in direct appropriations, supplemented by $135
million in incremental user fee revenue, to represent a total
operational level of $10.7 billion, or 1.4 percent more than
this year's 2006 budget.
Let me touch briefly on IRS efforts in our three areas of
strategic focus: service, enforcement and modernization, and
then make brief comments on certain legislative proposals
accompanying the 2007 budget which we believe will help close
the tax gap.
We seek to improve service to taxpayers. We also enforce
the law against those who do not comply. As you know, our
working equation at the IRS is ``service plus enforcement
equals compliance.'' We strive to pursue a balanced and fair
approach for all taxpayers.
First, services. We are enjoying a successful filing
season. Electronic filing is up by almost 3 percent from last
year, reflecting a strong increase in the use of tax software
on home computers, partially offset by the effect of the
elimination of our telephone filing program, and as you have
pointed out, Mr. Chairman, somewhat lower returns received via
the Free File Alliance. Our phone level of service is better
than last year, as is the accuracy of our answers to tax law
questions.
We are also seeing continued strong growth in our community
based volunteer tax preparation program. The VITA sites are an
increasingly important part of our efforts, and in fact, last
year, the IRS was recognized by the Points of Light Foundation
for its successful efforts. This was the first time any
government agency has ever been so recognized. Previous
recipients were March of Dimes, Mothers Against Drunk Driving,
organizations like that, no other government agency.
As to enforcement, the fiscal year 2005 results demonstrate
that we have restored the credibility of our enforcement
programs. Individual audits were up 20 percent from 2004 to 1.2
million. That is 97 percent up since 2000. High-income audits
were also up, and have now increased 120 percent since 2000.
Corporate audits, which had bottomed out in 2003, have
recovered now by over 50 percent. Collections are more robust.
Last year we had 2.7 million levies against 200,000 in 2000.
All told, enforcement revenues increased from $43.1 billion in
2004 to $47.3 billion last year. Concerning 2006, we expect
continued progress in enforcement, although I would say, not as
dramatic as some of the double-digit increases I have just
indicated. We are bringing on new personnel with the moneys you
provided, but it will take some time before they get fully up
to speed.
As for the modernization of our computer systems, we have
realized a number of achievements. In particular, I would note
the progress of our taxpayer master file update, the CADE
system. Last year CADE posted 1.4 million returns. Thus far
this year we have already processed 5 million returns through
CADE.
Before taking your questions, let me make one additional
point. As I indicated, we refined our estimates of the tax gap.
We will be using this information to update our audit models
and selection procedures and to calibrate our resource
allocation within our business units. The research also clearly
indicates that where there is third-party reporting, there is
better compliance. In this regard I would draw to your
attention a number of proposals that accompany the President's
2007 budget request. These proposals aim to address
administrative and reporting issues. The most important of
these is a proposal to mandate reporting to the IRS of gross
receipts by credit card issuers for their business customers.
I believe the five legislative proposals that accompany the
funding request can make a significant contribution to reducing
the tax gap. I hope they will enjoy your support.
Finally, I would indicate that I remain a strong advocate
of tax reform and simplification.
Thank you.
[The prepared statement of Commissioner Everson follows:]
Statement of The Honorable Mark W. Everson, Commissioner,
Internal Revenue Service
Introduction
Chairman Ramstad, Ranking Member Lewis and members of the
Subcommittee, I thank you for the opportunity to testify today on the
2006 Income Tax Filing Season. I would also like to update you on both
the FY 2007 budget request for the Internal Revenue Service as well our
latest numbers of the tax gap.
2006 Filing Season
We expect to process almost 135 million individual tax returns in
2006, and we anticipate a continued growth in the number of those that
are e-filed. In the 2005 filing season, over 50 percent of all income
tax returns were e-filed.
We fully expect to exceed that number this year. As of April 1st,
we have received nearly 54 million tax returns filed through e-file, an
increase of over 3 percent compared to the same period last year.
This increase in e-filing is being driven by people using their
home computers. The total number of self-prepared returns that are e-
filed are up by 16.9 percent compared to this time a year ago. Almost
15 million returns have been e-filed by people from the comfort of
their own home, up from just over 12 million for the same period a year
ago. Fully, 28 percent of all electronically filed returns have been
done on home computers. This is up 3 percentage points over this time
frame last year.
Overall, 67 percent of the nearly 80 million returns filed thru
April 1, have been e-filed, over a 3 percent increase compared to the
same period in the 2005 filing season.
Encouraging e-filing is good for both the taxpayer and for the IRS.
Taxpayers who use e-file can generally have their tax refund deposited
directly into their bank account in two weeks or less. That is about
half the time it takes us to process a paper return. For the IRS, the
error rate for returns e-filed is less than for paper returns.
Most people are choosing to have their tax refunds directly
deposited into their bank than ever before. So far this year, we have
directly deposited more than 44 million refunds, or 69 percent of all
refunds issued this tax filing season. This is up from 65 percent for
the same period in 2005.
People are also visiting our web site, IRS.gov in record numbers.
The IRS has recorded almost 90 million visits to our web site, up from
84 million for the same period a year ago. This is a 6.43 percent
increase.
The millions of taxpayers that have visited IRS.gov have benefited
from many of the updates that we have made for this filing season. We
have made it easier for taxpayers to get answers to many of their tax
questions. The web site:
Allows a taxpayer to determine whether he or she
qualifies for the Earned Income Tax Credit (EITC);
Assists the taxpayer in determining whether he or she is
subject to the Alternative Minimum Tax (AMT);
Allows more than 70 percent of taxpayers the option to
actually file their tax returns at no cost through the FreeFile
program;
Assists hurricane victims with information on many of the
changes in the tax laws that are designed to help them along with a
toll free number for victims to get their questions answered; and
Allows a taxpayers who are expecting refunds to track its
progress via the ``Where's My Refund?'' feature on the site.
As of April 1, we have received almost 80 million returns, a very
slight decline over the same period as last year. We have issued 66.7
million refunds this year for a total of $154.3 billion. The average
refund this year is $2,314, $104 more than last year. In addition, more
than 17 million taxpayers have tracked their refund on IRS.gov, up
almost 18 percent over last year.
At the present time we have been able to mitigate much of the
impact of retaining 15 hours of service on our toll free lines. Our
planning assumptions called for reducing toll-free operating hours from
15 hours to 12 hours while still maintaining the same service level for
our customers. When this change was not implemented, the expected
savings were restored and used to increase overtime. In addition,
resources from answering paper correspondence were diverted to
telephones. To date, these strategies have produced positive results.
In addition to these personnel actions, we have not yet experienced
some of the workload increases that were anticipated as a result of the
hurricane disasters. Overall, this filing season through March 25th, we
have actually received about one million fewer telephone calls that
last year (24.6 million in 2006 vs. 25.6 million in 2005). As a result,
our Customer Service Representative (CSR) Level of Service (percent of
calls answered) is slightly above last year (84.19% in 2006 vs. 82.60%
in 2005). Additionally, we have received over 204,000 fewer pieces of
correspondence than last year. However, because we deployed Adjustments
staff to the telephones, paper inventories are 110.6.9% of last year
(870,987 in 2006 vs. 787,491 in 2005). The number of cases that are
overage has also increased significantly (44,915 in 2006 vs. 32,578 in
2005).
While it is still too early to tell if the expected hurricane
disaster calls will materialize, if they do not we are guardedly
optimistic that we will be able to maintain these service levels for
the remainder of the filing season.
As of March 18th, our Taxpayer Assistance Centers (TACs) are
reporting a 12.6 percent decline in face to face contacts this filing
season as compared to last year. We believe that the decline in visits
to our TACs as well as the reduction in the number of calls is largely
attributable to taxpayers increasing their use of IRS.gov and other
electronic means to get their questions answered and obtain tax forms.
The use of other alternatives, such as volunteer return assistance
at Volunteer Income Tax Assistance (VITA) sites and Tax Counseling for
the Elderly sites (TCEs), has steadily increased while the numbers of
TAC contacts have decreased. In FY 2005 over 2.1 million returns were
prepared by volunteers. As of March 25th, volunteer return preparation
is up 6.5 percent above last year's level. Volunteer e-filing is also
up, by 4.5 percent over the same period in the last tax filing season.
This is reflective of continuing growth in existing community
coalitions and partnerships.
Free File
I recognize there have been some questions raised as to the renewal
of our Free File agreement. Allow me to update you on the both the
background of Free File and the new agreement.
Free File's roots can be found in the President's FY 2002
Management Agenda. It contained five Government-wide initiatives, one
of which was to expand electronic government. The overarching goal was
to ``champion citizen-centered electronic government that will result
in major improvements in the federal government's value to the
citizen.''
Subsequently, in November 2001, OMB's Quicksilver Task Force
established 24 e-government initiatives as part of the President's
Management Agenda. These initiatives were designed to improve
government-to-government, government-to-business, and government-to-
citizen electronic capabilities.
One initiative instructed the IRS to provide free online tax return
preparation and filing services to taxpayers. In accordance with this
OMB directive, the IRS began working in partnership with the tax
software industry to develop a solution. Two principles guided its
development: no one should be forced to pay extra to file his or her
return and the IRS should not get into the software business.
The IRS believes that private industry, given its established
expertise and experience in the field of electronic tax preparation,
has a proven track record in providing the best technology and services
available. Rather than entering the tax software business, IRS'
partnership with private industry: (1) provides taxpayers with high
quality services by using the existing private sector expertise; (2)
maximizes consumer choice; (3) promotes competition within the
marketplace; and (4) meets these objectives at the least cost to
taxpayers.
On October 30, 2002, the IRS and the Free File Alliance, LLC,
signed an agreement that created a public-private partnership to
provide free services to the majority of taxpayers.
The Free File Alliance, LLC, is a private-sector consortium of tax
preparation software companies. The original agreement was for three
years with a series of two year renewal options. The primary candidates
for Free File were those taxpayers who prepare their own taxes and
still file paper returns.
While membership in the Alliance may change from time to time, all
members must meet certain IRS standards. Specifically, we must approve
each member's proprietary tax preparation software. In addition, each
member must obtain third party privacy and security certification.
Finally, all Alliance members must adhere to all Federal laws regarding
taxpayer privacy.
Each Free File Alliance member was allowed to set taxpayer
eligibility requirements for its program. Generally, eligibility was
based on such factors as age, adjusted gross income, state residency,
eligibility to file a Form 1040EZ or for the Earned Income Tax Credit.
But, as a whole, under the original agreement, the Alliance was
required to provide free services to at least 60 percent or 78 million
of the nation's individual taxpayers. In addition, all active armed
forces, federal reservist and National Guard personnel were eligible to
free file through a separate program operated by the military.
While the IRS did not support or endorse any Free File Alliance
company or product offered, it did provide a listing of the Alliance
members via the Free File web page, which is hosted on IRS.gov.
Companies were allowed to offer ancillary services to taxpayers for a
fee, but the taxpayer was under no obligation to purchase any of those
services as a condition of getting their Federal tax return prepared
free of charge.
The intent of the Free File program was to reduce the burden on
individual taxpayers, make tax preparation easier and expand the
benefits of electronic filing to a majority of Americans. In the 2003
filing season, 2.8 million taxpayers took advantage of Free File. This
number rose to 3.4 million in 2004. In 2005, the number increased to
over 5 million.
The 2005 number may be a bit of an aberration in that many of the
companies in the Alliance opted to lift qualification restrictions on
taxpayers thus allowing any taxpayer, regardless of income, to utilize
Free File. This started as some companies sought a competitive
advantage by expanding their base and ended with many of the companies'
offering free return preparation services to anyone.
While this was good for taxpayers in general, it posed a serious
threat to the survival of the Alliance and was a prime topic of
discussion when the contract was up for renewal at the end of last
year. Many of the companies could not continue in the Free File
Alliance unless it returned to offering the free service to low and
moderate income individuals. The loss of these companies would have
jeopardized the continued existence of the Alliance.
As we prepared for negotiations to extend the Free File agreement
in 2005, the IRS took the position that Free File should be available
to as many taxpayers as possible. The Alliance's position was that Free
File should only be available to low and moderate income taxpayers.
As is the case in most negotiations, we compromised and agreed that
Free File would be offered to 70 percent of taxpayers, or anyone with
an AGI of $50,000 or less in 2005. This covers approximately 93 million
of the 133 million taxpayers expected to file. This is an improvement
over our earlier agreement which only guaranteed coverage of 60 percent
or availability to 78 million taxpayers. The active armed forces,
federal reservist and National Guard personnel continue to be eligible
to free file under their own program.
In 2006, three Free File Alliance members are offering state filing
for free. Seven members are offering to file F4868, Extension of Time
to File Individual return. As of the end of February, 653 extension
forms had been filed. In addition, there are two companies offering
free packages in Spanish.
While the number of taxpayers taking advantage of Free File in 2006
will likely be less than in 2005, we are unable at this time to fully
explain the decline. Certainly the fact that it is not available to
everyone is one factor, but there likely are other factors as well.
A year ago, the Free File program was benefited greatly by a major
article on the front page of USA Today. Immediately following that
article, there was a tremendous surge of positive publicity as well as
a surge in Free File usage by taxpayers. We have not been the
beneficiary of similar publicity this year and to the extent we have
received coverage much of it has focused on the taxpayers that Free
File does not cover.
One of the major concerns that many critics of the Free File
program have had has been the ability of the Alliance members to use
Free File to market other services to taxpayers. These include the
filing of state tax refunds and the offering of refund anticipation
loans (RALs). We make it clear to taxpayers that the IRS does not
endorse any of these products or services nor is the completion of
their tax return at no cost conditioned on the purchase of any product
or service.
We generally do not know what, if any, fee services taxpayers
actually use from the Free File vendors. The one service that we do
have data on is refund anticipation loans (RALs). RALs are designed to
provide the taxpayer an immediate refund in the form of a consumer
loan. Often the costs incurred with the RAL are disproportionate to the
amount of the refund, especially considering that a taxpayer that files
electronically will get the refund from the IRS in about two weeks.
Unfortunately, it is often low income taxpayers, the ones that can
least afford it, which choose RALs.
What we are seeing from our Free File data thus far in this regard
is encouraging. Only 0.6 percent of the taxpayers utilizing Free File
have utilized a RAL. In fact, half of the Free File vendors do not even
offer refund anticipation loans.
This 0.6 percent RAL participation for Free File is the lowest of
any of our electronic filing groups. Other online filers have a 0.8
percent participation rate. The rate for online returns done by paid
tax preparers is the highest. Approximately 20 percent of the preparer
returns submitted electronically include a RAL.
Now, I would like to talk about the President's FY 2007 proposed
budget for the IRS.
President's FY 2007 Budget Maintains the Balance between Taxpayer
Service and Enforcement
Our total budget request for FY 2007 is $10.6 billion in direct
appropriations supplemented by $135 million in new user fee revenue,
for a total operating level of $10.7 billion. This request represents a
total increase of 1.4 percent from the FY 2006 enacted level. The FY
2007 Budget sustains the enforcement funding increase provided in FY
2006 to improve tax compliance. More importantly, the budget maintains
the balance between service and enforcement.
The IRS' taxpayer service and enforcement activities are funded
from the three appropriations: Processing, Assistance and Management
(PAM); Tax Law Enforcement (TLE); and Information Systems (IS). The
total FY 2007 Budget request for these three operating accounts is
$10.4 billion supplemented by the $135 million in new user fee revenue,
for a total operating level of $10.5 billion, or 1.8 percent increase
over the FY 2006 enacted level.
The $135 million in new user fees revenue will be generated from
several increased and new user fees earned from special or non-routine
services provided to taxpayers by the IRS. These would include such
services as providing private letter rulings for interpretations of tax
law and applications for exempt status. The largest portion of the
anticipated increase in fees will come from new and restructured
installment agreements ($66.7 million). Another $47.1 million is
expected from letter rulings and determinations. The remainder will
come from technical training and enrolled agent fee increases.
These increased fees were designed to more fully reflect the cost
of providing these services as required by OMB Circular A-25. Every two
years the fees are re-examined to see whether they reflect the full
cost.
The budget includes an additional $137 million, a 2 percent
increase for enforcement to fund the pay raise and other cost
adjustments needed to maintain the FY 2006 enforcement initiative
increase. Similar to last year, the President's Budget proposes to fund
this enforcement increase through an adjustment to the discretionary
cap, which in effect would increase the amount of funding dedicated to
tax enforcement from $6.82 billion in FY 2006 to $6.96 billion in FY
2007. The IRS will continue to focus its enforcement resources on
efforts designed to increase compliance and reduce the tax gap. We will
continue our examination of tax-exempt entities used to violate federal
income tax law and tax strategies involving international elements for
both corporations and high income individuals.
I would remind the Subcommittee that in FY 2005 we brought in a
record of $47.3 billion in enforcement revenue, an increase of $4.2
billion from the previous year. In FY 2006, we expect that total to
increase to $48.1 billion, a 42 percent increase from FY 2001.
We have done a lot of work at the IRS regarding our return on
investment (ROI) for the enforcement dollars we are spending. Based on
that work, we estimate that when we receive the full productive
benefits of the FY 2006 increase, the ROI for additional enforcement
resources will be 4:1. Stated another way, we estimate that each dollar
invested in enforcement will return four dollars in additional
enforcement revenue, although this should not be interpreted as a fixed
ratio.
This estimated ``return'' is based on the amount of additional tax
collected and attributes the revenue to the enforcement occupations
that originated each case. For each type of IRS enforcement employee,
the associated amount of additional tax collections is estimated based
on an extensive data base, covering the most recent 11 years of
collection experience.
This analysis does not include the indirect effect of increased
enforcement activities in deterring taxpayers considering engaging in
non-compliant behavior. Econometric estimates of the indirect effects
indicate that they may be 10 times the size of the direct effects, or
larger.
The $3.58 billion for taxpayer service, including the $135 million
from new user fee revenue, will maintain our commitment to provide
high-quality taxpayer services through improvements to information
technology and other targeted efficiencies such as those resulting from
increased electronic filing.
The Business Systems Modernization appropriations account funds the
IRS' costs to develop and deploy our critical, major information
systems. The requested level for BSM is $167.3 million, a 15.1 percent
reduction from the FY 2006 level. This is discussed later in the
testimony.
Lastly, the Health Insurance Tax Credit appropriation (HITCA)
remains a separate account that funds the administration of a
refundable tax credit. The FY 2007 request for HITCA is $14.9 million,
a 25.8 percent reduction from the FY 2006 enacted level.
FY 2007 Detailed Budget Summary
Our FY 2007 Budget request of $10.7 billion, which is offset by the
$135 million in new user fee revenue, primarily funds costs to maintain
the IRS' current levels of service and enforcement ($272.2 million) and
an initiative to consolidate the Philadelphia Campus ($20.9 million).
This request also includes several program savings and efficiencies
that reflect the IRS' aggressive efforts to identify and deploy
technology improvements that will benefit both taxpayer service and
enforcement programs. Collectively, these cost savings total $116.1
million:
E-File Savings -$6,760,000/-174 FTE: This savings results
from increased electronic filing (e-file) and a reduction in Individual
Master File paper returns. Estimated e-file savings are based on the
projected reduction in the number of paper returns processed each year,
offset by the cost of processing e-filed returns.
Improvement Project Savings -$8,215,000/-135 FTE: This
savings results from operational improvements generated by the Contact
Recording, Queuing Management (Q-Matic), Correspondence Imaging
Systems, and End-to-End Publishing improvement projects already in
progress.
Competitive Sourcing Savings -$17,000,000/-242 FTE (The
-242-FTE is a revised figure which corrects an error included in the FY
2007 President's budget request for the IRS). These savings reflect
efficiencies and savings that will be achieved through the IRS'
competitive sourcing efforts resulting from six different projects in
various phases of implementation.
Program Efficiencies -$84,121,000/-873 FTE: (-873 FTE is
a revised figure, which corrects an error included in the FY 2007
President's Budget request for the IRS) These savings reflect Service-
wide efficiencies resulting from the elimination of duplicative
overhead in internal support functions, increased productivity through
improved workload selection, and distribution techniques, automation of
certain taxpayer assistance functions, and deployment of the FY 2006
enforcement hires to full time examiner positions. These efficiency
savings can be realized with no adverse impact on taxpayer service and
enforcement operations.
Of the $84 million in efficiency savings, approximately $24 million
of this reduction reflects savings from renegotiated information
systems and telecommunication contracts. Another $38 million of these
savings are based on enhanced productivity and efficiency of the IRS'
enforcement programs achieved by consolidating, reducing, and
redirecting some of the overhead resources, as well as reengineering of
processes and improved workload selection techniques in examination and
collection. Some examples of these improvements include:
Increased efficiency of LMSB examination process to
improve identification of risks and issues to enable earlier issue
resolution, reduce audit cycle time, and increase inventory turnover;
Conversion of enforcement trainees hired in 2006 to
examiner positions, allowing veteran examiners (working as trainers) to
resume exam work;
Re-engineering of workload selection techniques to
resolve simple cases quickly, and concentrate resources on the most
egregious cases;
Maintenance of audit coverage for large organizations
through improved data collection techniques. Reduction of time required
to complete compliance checks to place returns with agents more
quickly; and
Improved investigative efficiencies, enhanced managerial
oversight, streamlined business processes, and improved technological
capability to process electronic data and evidence.
The remaining $22 million of these savings results from
efficiencies to taxpayer services, including the judicious distribution
of workload and the automation of certain taxpayer assistance
functions, such as the centralized monitoring of case inventories. For
example, approximately $12 million of these efficiencies in taxpayer
service are based on improvements such as:
Deployment of the use of the Individual Taxpayer
Identification Number Real Time System (ITIN RTS). The ITIN RTS will
save time and resources for both the Service and taxpayers, through
automation of the process of providing an Individual Taxpayer
Identification Number (ITIN) to taxpayers ineligible for a Social
Security Number but required to provide identifying information on tax
returns.
Reductions in printing and postage costs due to
efficiencies to the current processes for notices, and
Expanding the use of automated reference tools, such as
operator scripts, to improve telephone operations.
In addition to the program savings and increases for taxpayer
service and enforcement, the FY 2007 Budget includes a $5.5 million
reduction to the Health Insurance Tax Credit Administration (HICTA)
Program. This funding adjustment for HITCA reflects the program's
effort to align fiscal year costs with contract year expenditures.
IRS Modernization
The requested level for BSM of $167.3 million, a decrease of $29.7
million, will continue the support for Customer Account Data Engine
(CADE), Filing and Payment Compliance (F&PC) and the Modernized e-File
(MeF) project along with some of the needed investments to upgrade our
modernized infrastructure.
After several years of cost, schedule, and performance problems,
the BSM program has demonstrated a markedly improved performance in the
past two years in delivering projects and releases on time, on budget,
and meeting or exceeding expectations. Taxpayers are now realizing the
benefits of our enhanced BSM program management capabilities. In FY
2006 and continuing in FY 2007, we are revising our modernization
strategy to emphasize the release of projects to deliver business value
sooner at a lower risk. We will concentrate on delivering releases of
the major tax administration projects, along with infrastructure
initiatives that support all modernization projects, and continuing our
improvements to program management operations. These projects and
initiatives address core IRS strategic priorities: taxpayer service,
enforcement, and modernization.
As part of our continuing effort to improve taxpayer service, we
plan to expand services provided and the number of taxpayers served by
Modernized E-File (MeF). MeF uses the latest secure Internet technology
and speeds turnaround time for tax return submissions, equating to
significant reductions in burden and time for corporate and tax-exempt
taxpayers.
As of March 25th, MeF had processed nearly 240,000 Form 1120 and
1120S corporate returns. This compares to 95,000 at this point a year
ago. In addition, there have been another 335,000 requests for
extensions as opposed to 46,000 at this point in 2005. In recent
regulations, the IRS has mandated the nation's largest corporations and
tax exempt organizations file electronically in 2006 through the use of
MeF.
Finally, we will continue to expand the use of the Customer Account
Data Engine (CADE). CADE will ultimately replace our antiquated Master
File system, which is the repository of taxpayer information. CADE
allows faster refunds, improved taxpayer service, faster issue
detection, more timely account settlement, and a robust foundation for
integrated and flexible modernized systems. CADE posted more than 1.4
million returns and generated more than $427 million in refunds in
2005. In 2006, CADE has already posted 5.2 million returns and
generated over $2.5 billion in refunds from electronic filers alone. We
anticipate to processing an additional 1.5 to 2 million returns during
this filing season. In the 2007 filing season, we expect that number to
rise 33 million. CADE serves as the single authoritative repository for
account and return data for those returns.
Private Collection Agencies (PCA)
The American Jobs Creation Act of 2004 created section 6306 of the
Internal Revenue Code, which allows the IRS to use private contractors
to collect delinquent taxes in instances where the amount owed is not
in dispute. It is important to understand that these PCAs will be
assigned cases where the tax balance is not in dispute and will not be
performing audits or assessing penalties, or taking enforced collection
actions of any kind. They will only be used in instances where what is
owed has been determined but the taxpayer has not paid.
On March 9th, we announced the award of contracts to 3 PCAs. It is
our expectation that these firms will begin work as soon as issues are
resolved regarding the two protests to these awards. If cases are
placed in FY 2006, as allowed by statute, the IRS will retain 25
percent of any posted revenue receipts from this program which we will
use to supplement our existing budget (for collection related
activities). We anticipate an even greater return for FY 2007 since
case placements are expected to increase.
The Tax Group
To understand the need for full funding of IRS's proposed FY 2007
budget, one also needs to understand the nature of the tax gap. The tax
gap is the difference between the amount of tax imposed on taxpayers
for a given year and the amount that is paid voluntarily and timely.
The tax gap represents, in dollar terms, the annual amount of
noncompliance with our tax laws.
It is the need to reduce that gap that drives much of what we do.
This is true not only from a revenue standpoint, but also from a
taxpayer fairness perspective. Our tax system is largely based on
voluntary compliance and that compliance is enhanced if taxpayers
believe that everyone is paying their fair share.
A year ago, we released preliminary estimates of the tax gap based
on data derived from a National Research Program (NRP) study done on
individual income tax returns from Tax Year 2001. This was the first
comprehensive update of our tax gap estimate since 1988. We have now
revised those estimates and I would like to summarize them for you.
Our latest numbers show that there is an overall gross tax gap of
approximately $345 billion, leading to a noncompliance rate of 16.3
percent. Both of these numbers are in the upper end of the range of
estimates provided last spring. Our estimate of the corresponding net
tax gap, or what is remaining after enforcement and other late
payments, is $290 billion, also in the upper end of the earlier range.
Noncompliance takes three forms: not filing required returns on
time; not reporting one's full tax liability even when the return is
filed on time; and not paying by the due date the full amount of tax
reported on a timely return. We have separate tax gap estimates for
each of these three types of noncompliance.
Underreporting constitutes nearly 82 percent of the gross tax gap,
up slightly from our earlier estimates. Nonfiling constitutes 8.6
percent and underpayment 9.6 percent of the gross tax gap.
Individual income tax accounts for 46 percent of all tax receipts.
However, individual income tax underreporting is approximately $197
billion. This constitutes about 56 percent of the overall tax gap.
As in previous compliance studies, the NRP data suggest that well
over half ($109 billion) of the individual underreporting gap came from
understated net business income (unreported receipts and overstated
expenses). Approximately 28 percent ($56 billion) came from
underreported non-business income, such as wages, tips, interest,
dividends, and capital gains. The remaining $32 billion came from
overstated reductions of income (i.e. statutory adjustments,
deductions, and exemptions), and from overstated tax credits.
The corresponding estimate of the self-employment tax
underreporting gap is $39 billion, which accounts for about 11 percent
of the overall tax gap. Self employment tax is underreported primarily
because self-employment income is underreported for income tax
purposes. Taking individual income tax and self employment tax
together, then, we see that individual underreporting constitutes about
two-thirds of the overall tax gap.
Increasing Compliance through Service and Enforcement
It is important to understand that the complexity of our current
tax system is a significant reason for the tax gap. It is easy for even
sophisticated taxpayers to make honest mistakes. We must achieve
fundamental reform and simplification of the tax law in order to
achieve significant reductions in the tax gap.
Until we have fundamental tax reform, there are some changes in the
law that will improve compliance and provide us with additional tools
that we can use to go after those taxpayers unwilling to pay their fair
share. Later in my testimony, I will discuss five specific legislative
proposals that are offered as part of the FY 2007 budget and designed
to reduce the tax gap.
IRS is committed to assisting taxpayers in both understanding the
tax law and remitting the proper amount of tax. We are continuing to do
this by maintaining the balance between service and enforcement that is
so critical to tax administration.
Service
I have already talked about IRS.gov and how it can answer many
taxpayer questions on issues ranging from the Earned Income Tax Credit
(EITC) to the Alternative Minimum Tax (AMT) to refund tracking. On a
recent day, our site ranked third in overall hits according to Yahoo's
Buzz Index. The American Customer Satisfaction Index has ranked our
site well ahead of the government benchmark in the areas of content,
functionality, navigation, privacy, satisfaction and in many other
areas. Thus far this year, visits to our site are up 6.43 percent over
the same period a year ago.
This success has been recognized by others. In 2004, IRS.gov won
the Keynote Performance Award as the most reliable Federal web site for
performance and availability. It won the 2005 Government Computer News
agency award for innovation and is a finalist for the 2005
Excellence.gov Award in recognition of being an outstanding Federal
interactive web site.
We believe the internet has become our primary vehicle for
delivering service information to taxpayers. Please note that I said
primary and not exclusive. We recognize that we will likely always have
a percentage of taxpayers that we need to serve through either direct
personal service or over the telephone, but we hope to continually
drive that number down, while at the same time improving the levels of
service and taxpayer satisfaction. This will not only save us time and
resources, but also will provide a valuable service to taxpayers. They
can get answers to their questions at their home, at their convenience,
rather than visiting a walk-in site.
We continue to get good marks on various customer service surveys.
Our toll free telephone service customer satisfaction rating is 94
percent. In FY 2005, the IRS' customer assistance call centers answered
59.1 million calls. We achieved an 82.6 percent toll-free-telephone CSR
level of service, exceeding our FY 2005 target of 82 percent. We also
improved our toll free tax law accuracy rate to 89 percent, an increase
from 80 percent in FY 2004. While this is the highest yearly rate ever,
we continue to strive to improve. This filing season through February,
the tax law accuracy rate is 90.2 percent.
We provided and staffed toll-free FEMA phone assistance lines for
hurricane victims and answered approximately 950,000 calls. The IRS
also implemented numerous tax law changes to help the victims of
hurricanes Katrina, Rita and Wilma, businesses located in the disaster
areas, and individuals donating to charities to support the victims.
We continue to leverage community partnerships to provide free tax
return preparation assistance through successful programs such as
Volunteer Income Tax Assistance (VITA) and Tax Counseling for the
Elderly (TCE). In 2005, 62,000 trained volunteers at 14,000 locations
across the country prepared more than 2.1 million tax returns, an 80
percent increase since 2001. We expect the number of customers served
this year to exceed 2.2 million.
I personally have had the opportunity to visit several VITA sites
and I remain impressed by the diligence, the competence, and the
commitment of the thousands of volunteers that make this program work.
For small businesses, we simplified the employment tax filing
process for more than 950,000 small companies by allowing them to file
their employment tax return annually, rather than quarterly. Our office
of Taxpayer Burden Reduction led a collaborative effort to redesign the
Form 1041 Schedule K-1, which among other things, is used to report
income, deductions, and credits from trusts and estates to
beneficiaries.
We are also making progress on our Taxpayer Assistance Blueprint
(TAB). This is an ambitious, agency-wide, five-year taxpayer services
plan aimed at improving IRS services.
Over the past five years we have taken significant steps to
understand the needs and preferences of individual taxpayers, our
primary customers, and their representatives. Many studies, such as the
Multilingual Initiative, the EITC outreach, and partnerships with
organizations such as AARP and the National Community Tax Coalition
have focused on understanding key demographic and behavioral
differences in our customers. Before now, those initiatives have not
been integrated to form a complete picture of customer needs.
The TAB project will pull the pieces of the puzzle together and
develop a complete picture of our customer base. Through a systematic
data collection and analysis process, a dynamic plan (or Blueprint)
will be developed to meet our short and long term business needs as it
relates to taxpayer assistance and address concerns expressed by
Congress and other oversight bodies.
In short, TAB will help us better understand our customers--their
characteristics, how they access our services, what services they use
and prefer, and if our services truly meet their needs.
We are nearing completion of the first phase of the TAB project. In
Phase 1, we are conducting research and surveying taxpayers,
stakeholders, and IRS employees to form a preliminary assessment of
taxpayer needs, preferences, and demands. We will complete that phase
by mid-April. In Phase 2, we will perform extensive primary research
with taxpayers to refine our assessment and conclude by creating an IRS
blueprint for taxpayer service delivery. We will complete this phase in
October 2006.
Enforcement
The IRS made significant progress towards achieving its enforcement
related goals in FY 2005. We achieved increases in every major area of
enforcement. We have:
Audited nearly 220,000 high income taxpayers in 2005,
more than double the number audited in 2000.
Increased audits for individuals to 1.2 million, 20
percent more than 2004 and almost double the level five years earlier.
Audited nearly 5,000 businesses with assets over $250
million, an increase of 11 percent. In addition, we audited one out of
every five companies with assets of $10 million. Finally, audits of
businesses with less than $10 million in assets rose 145 percent from
2004.
Increased enforcement revenue from audits of corporations
and individuals to $17.7 billion in 2005, compared to $10.7 billion in
2003.
Increased overall collections from heightened enforcement
efforts by 10 percent, from $43.1 billion in 2004 to $47.3 billion in
2005.
Generated more than $4.7 billion in revenue through two
prominent settlement initiatives aimed at reducing examination and
litigation expenses while deterring the use of abusive tax shelters.
Increased collection closure cases by 12 percent and
dollars collected by 14 percent over 2004.
Increased convictions to 2,151 (from 1,926 in 2002)
through increased productivity.
Combating abusive tax shelters remains a high priority in FY 2006.
Last October we announced a global settlement initiative that covered
21 listed and non-listed transactions. They include a wide range of
transactions involving funds used for employee benefits, charitable
remainder trusts, offsetting foreign currency contracts, debt
straddles, lease strips, and certain abusive conservation easements.
Taxpayers had until January 23,2006 to file an election to take
part in the global settlement program. Under the terms of the
settlement, taxpayers will generally be required to pay 100 percent of
taxes owed, interest and, depending on the transaction, either a
quarter or half the accuracy-related penalty the IRS will otherwise
seek.
We have been pleased by the response to this initiative, and we
believe the response was buoyed by provisions in the Gulf Opportunity
Zone Act of 2005 that modified the rules for calculating interest on
tax deficiencies of individual taxpayers who participated in certain
abusive tax shelters, increasing the incentives for individuals to come
forward as part of this program.
In addition, our Large and Mid-Sized Business Division (LMSB) has
issued more than 500 administrative summonses as part of our attack on
shelter promoters, and we have approximately 200 active promoter
examinations under way. Entities being looked at include banks,
accounting firms, law firms and brokerage houses. We want to make it
clear that taxpayers who take aggressive return positions relying on
the ``audit lottery'' and the chance they will not be examined have
made a really bad decision.
In addition, we are continuing to focus on improper uses of certain
tax exempt bonds and trusts, questionable transfer-pricing practices,
offshore accounts, and charitable donations of intangible assets.
Another enforcement priority is to assure that attorneys,
accountants, and other tax practitioners adhere to professional
standards and follow the law. Our system of tax administration depends
upon the integrity of practitioners. The vast majority of practitioners
are conscientious and honest, but even the honest tax professionals
suffered from the sad and steep erosion of ethics in recent years by
being subjected to untoward competitive pressures.
We have done quite a bit to restore faith in the work of tax
professionals. We have strengthened regulations governing the standards
of tax practice to discourage the manufacturing of bogus legal opinions
on the validity of tax shelters. New Treasury Department regulations
took effect last June that revise Circular 230 governing tax
practitioner behavior. The new regulations establish standards for
written tax advice prepared by practitioners.
Further, additional revisions to Circular 230 were recently
proposed to make disciplinary proceedings more transparent so that
practitioners may learn the types of behavior IRS is likely to
challenge under the Circular.
The IRS has made noncompliance by tax exempt and governmental
entities and misuse of the tax exempt status of such entities by third
parties for tax avoidance purposes another major enforcement priority.
For example, earlier this year, we concluded that more than 30 credit
counseling firms, accounting for more than 40 percent of the industry's
revenues, are not entitled to tax exempt status. The proposed
revocations of the tax exempt status of these entities are the
culmination of more than two years of work covering more than 60 credit
counseling organizations.
These organizations were granted tax exempt status originally
because they were supposed to be educating and assisting people who
have credit or cash flow problems. Unfortunately, too many of these
organizations instead operate for the benefit of insiders or are
improperly in league with profit making companies. We want to make sure
that money donated to charities goes for the purpose intended and not
into the pockets of individuals associated with the charitable
organization.
In 2006, our Tax Exempt/Government Entities (TE/GE) division will
continue to focus on key areas where organizations are abusing their
exempt status or where others are using them for unintended purposes.
Three of the areas in which we anticipate renewed enforcement include
political intervention, compensation and abusive transactions.
Regarding political intervention by entities claiming tax exempt
status, in 2006 we will be finishing up contacts with 130 organizations
suspected of political intervention in the 2004 election. Almost half
of these are churches. Thus far we have completed 82 examinations and
have concluded that nearly three-quarters of the non-profits examined,
including churches, engaged in some level of prohibited activity. Most
of these exams concerned one-time, isolated occurrences of prohibited
campaign activity, which the IRS addressed through written advisories
to the organizations. In three cases involving non-churches, the
prohibited activity was egregious enough to warrant the IRS proposing
the revocation of the organization's tax-exempt status.
We have also issued a fact sheet designed to offer guidance to non-
profits on what is and is not permissible activity for tax-exempt
organizations. In addition, we have taken steps to ensure that all
referrals regarding campaign activity that the IRS receives from the
public, as well as activity the IRS itself uncovers, are reviewed
expeditiously, and treated consistently and fairly.
Excessive compensation of executives also will be a main focus of
our enforcement efforts. There are indications that tax-exempt
organizations have allowed key executives too great a voice in
determining their own compensation or otherwise have not used due
diligence in setting compensation levels. We have contacted almost 2000
Section 501(c)(3) organizations, including about 400 private
foundations regarding this issue. In addition, we are exploring
compensation to tax-exempt hospital executives.
In the FY 2006 budget, our enforcement resources increased by $442
million (post-rescission). I know it is important to you, and it is
equally important to us, to show a return on that investment.
Of the total $442 million in increased funding, $180 million funds
the pay and non-pay inflationary costs to maintain the $6.4 billion
devoted to enforcement. The remaining $262 million funds direct costs
for enhanced enforcement hiring, including staff for the Counsel and
Appeals organizations, and associated indirect costs for these hires.
We will focus these resources on:
Increased coverage of high-risk compliance problems to
address the largest portion of the tax gap--the underreporting of tax--
across all major compliance programs;
Complex high-risk issues in abusive tax avoidance
transactions, promoter activities, corporate fraud and aggressive
transactions, resulting in increased corporate and high income audit
coverage;
Efforts aimed at reversing the erosion of individual tax
compliance and support of the strategy to implement a balanced
compliance program;
Return preparer fraud identified through enhanced
operations of the Fraud Detection Centers located on IRS campuses;
Improved ability to identify compliance risks and
significantly expanded coverage of tax-exempt communities;
Safeguarding compliant customers from unscrupulous
promoters through earlier detection of abusive schemes and heightened
efforts to prevent their proliferation; and
Increased vigilance to ensure the assets of tax-exempt
organizations are put to their intended tax-preferred purpose and not
misdirected to fund terrorism or for private gain, including enhanced
processing of questionable exemption applications and increased
technical support to the examination process.
Legislative Proposals
IRS understands that the complexity of the current tax system is a
significant reason for the tax gap. It is easy for even sophisticated
taxpayers to make honest mistakes. We must achieve fundamental reform
and simplification of the tax law in order to achieve significant
reductions in the tax gap.
Until we have fundamental tax reform, however, there are some
changes in the law that will improve compliance, without imposing a
significant burden on taxpayers, and provide us with additional tools
that we can use to go after those taxpayers unwilling to pay their fair
share.
The President's FY 2007 proposed budget includes five legislative
recommendations, the enactment of which is critical to closing the tax
gap. Collectively, these five changes should generate $3.6 billion over
the next ten years. Allow me to address each proposal individually.
The first and perhaps most important proposal would increase
reporting on payment card transactions. Our tax gap study shows clearly
that increased information reporting and backup withholding are highly
effective means of improving compliance with tax laws. More than 150
million wage earners already have their information reported directly
by their employer to the IRS and the non-compliance rate for this group
is less than 1 percent. All of these wage earners are also subject to
mandatory withholding of taxes.
Payment cards (including credit cards and debit cards) are a
growing form of payment in retail business transactions. The failure of
some merchants to accurately report their gross income, including
income derived from payment card transactions, accounts for a
significant portion of the tax gap and creates a significant
competitive advantage for those businesses that underreport.
Specifically, the Administration proposes that the Treasury
Secretary be given the authority to promulgate regulations requiring
annual reporting of the aggregate reimbursement payments made to
merchants in a calendar year, and to require backup withholding by
payment card companies in the event that a merchant payee fails to
provide a valid taxpayer identification number.
Because reimbursement information is already provided to merchants,
requiring this information to be reported to the IRS on an aggregate
annual basis will impose minimal burden on payment card companies and
no burden on the affected merchants. In addition, implementing a backup
withholding system for payment card reimbursements to businesses would
lead to material improvements in the compliance rates of these
taxpayers without imposing a significant burden on the card companies.
Finally, the IRS will be able to use payment card reporting information
to better focus its resources and relieve the burden that existing
audits place on businesses that accurately report their gross income.
The second legislative proposal would clarify when employee leasing
companies can be held liable for their clients' Federal employment
taxes. Employee leasing is the practice of contracting with an outside
business to handle certain administrative, personnel, and payroll
matters for a taxpayer's employees. Typically, these firms prepare and
file employment tax returns for their clients using the leasing
company's name and employer identification number, often taking the
position that the leasing company is the statutory or common law
employer of the clients' workers.
Non-compliance with the Federal employment tax reporting and
withholding requirements is a significant part of the tax gap. Under
present law, there is uncertainty as to whether the employee leasing
company or its client is liable for unpaid Federal employment taxes
arising with respect to wages paid to the client's workers. Thus, when
an employee leasing company files employment tax returns using its own
name and employer identification number, but fails to pay some or all
of the taxes due, or when no returns are filed with respect to the
wages paid by a company that uses an employee leasing company, there
can be uncertainty as to how the Federal employment taxes are assessed
and collected.
The Administration's proposal would set forth standards for holding
employee leasing companies jointly and severally liable with their
clients for Federal employment taxes. The proposal would also allow
employee leasing companies to qualify to be solely liable if they met
certain specified standards.
Our third proposal would amend collection due process procedures
for employment tax liabilities. Currently, we are authorized to take
various collection actions including issuing Federal tax levies to
collect past-due taxes. Before a tax levy can be issued, however, the
IRS generally must provide the taxpayer with notice and an opportunity
for an administrative collection due process (CDP) hearing, and for
judicial review.
Frequently, an employer who fails to satisfy its Federal tax
liabilities for one period will also fail to satisfy them for later
periods, resulting in a ``pyramiding'' of unpaid taxes. Some employers
who request a CDP hearing or judicial review for one tax period will
continue to accrue, or pyramid, their employment tax liabilities during
the CDP proceedings. Liabilities for the subsequent periods cannot be
collected by levy until the employer has been given notice and
opportunity for a hearing and judicial review for each period. The
existing CDP framework compounds the pyramiding problem by depriving
the government of enforced collection as a tool to encourage employers
to satisfy their current Federal employment tax obligations.
Our proposal would allow the levy to be imposed prior to a CDP
hearing in a fashion similar to current law provisions for levies
issued to collect a federal tax liability from a state tax refund.
Taxpayers would have the right to a CDP hearing with respect to
employment tax liabilities within a reasonable time after the levy.
Taxpayers would also continue to have access to existing pre-collection
administrative appeal rights other than CDP.
The fourth proposal would require increased information reporting
and backup withholding for certain government payments for property and
services. It should be noted that present law requires information
reporting for the provision of services and direct sales, but does not
for provisions of goods. This proposal will extend information
reporting, with some exceptions, to the purchase of goods by federal,
state, and local governments.
Our proposal would authorize the Treasury Secretary to promulgate
regulations requiring information reporting and backup withholding on
non-wage payments by Federal, state and local governments to procure
property and services. Certain payments would, of course, be exempt.
These include payments of interest, payments for real property,
payments to tax exempt entities or foreign governments,
intergovernmental payments, and payments made pursuant to a classified
or confidential contract.
The final legislative proposal would expand the signature
requirement and penalty provisions applicable to paid tax return
preparers. Under current law a paid tax return preparer is required to
sign and include his/her taxpayer identification number (TIN) on an
income tax return and related documents that he/she prepares for
compensation. Paid return preparers, however, are not required to sign
and include their TINs on non-income tax returns, such as employment
tax returns, excise tax returns, and estate and gift tax returns, and
tax return related documents filed with the IRS. The Administration's
proposal would expand preparer identification and penalty provisions to
non-income tax returns and tax return-related documents prepared for
compensation. Further, it would impose penalties for preparing tax
return related documents that contain false, incomplete, or misleading
information or certain frivolous positions that delay collection.
These five legislative changes strategically target areas where (1)
research reveals the existence of significant compliance problems, (2)
improvements will burden taxpayers as little as possible, and (3) the
changes support the Administration's broader focus on identifying
legislative and administrative changes to reduce the tax gap.
In addition to these specific legislative proposals, we will study
the distinction between independent contractors and employees under
current law. The improper classification of employees as independent
contractors is a significant problem and substantial contributor to the
tax gap.
Conclusions
Mr. Chairman, Members of the Subcommittee, I would like to
emphasize the following points:
E-Filing continues to grow. Over 50 million people have
already e-filed their return, 67 percent of all returns filed.
Taxpayers who are e-filing from their home computers show
the greatest increase in e-filing, up almost 17 percent from a year
ago.
Hits to IRS' web site, IRS.gov are almost 90 million, up
6.43 percent over last year.
Returns filed by VITA and TCE sites are up 6.5 percent
over a year ago.
In addition, the best way to reduce the tax gap and continue the
progress made last year in both service and enforcement is the adoption
of the President's proposed budget for FY 2007, particularly the $137
million for enforcement that is part of a program integrity cap
adjustment, and enactment of the five legislative proposals.
Thank you, Mr. Chairman and I will be happy to respond to any
questions.
Chairman RAMSTAD. Thank you very much, Commissioner. I
certainly appreciate your testimony. I have a couple questions,
and I can applaud the significant progress that you have made
in a number of important areas that you highlighted today.
I want to, as I said in my opening statement, ask a couple
questions about the Free File agreement. I know in your written
testimony you stated that the new Free File agreement is an
improvement over the original agreement because the original
agreement guaranteed coverage of only 60 percent of taxpayers.
That is a direct quote. However, I am somewhat puzzled because
with this new agreement we have the cap on the number of
taxpayers that can be covered under Free File, and it seems to
me, based on the statistics we have seen, that the effect of
the cap is that more than 40 million Americans who could use
Free File last year cannot do so this year. Isn't that a major
concern?
Mr. EVERSON. If you will indulge me, let me try to talk
about this through the passage of time here, because as you
indicate, we think this is a very important and good program.
We had the initial three-year term, and that lapsed after last
filing season, so then we have renegotiated with this new deal,
as you indicated.
I think that the overall tradeoff that was always in the
spirit of the first negotiation was that the government would
not get into the preparation of tax returns or providing
software that is actually being provided by industry. That was
sort of the quid pro quo, if you will, of the agreement.
What happened here was that, I think as the volumes grew--
and as you indicated, Mr. Chairman, they grew rapidly, and last
year they exceeded 5 million, and there were no caps. Some of
the players--I guess it was about 17 or 18 firms--they let it
go all the way up. We were interested in a couple of things,
and we wanted to make sure, as we renegotiated this, that we
got as high a cap as possible on the income, because they
indicated to us they wanted to put in a cap to keep it to
middle-income and lower-income people. We were also interested
in getting protection on Refund Anticipation Loans (RALs). The
RALs--as you know, we do not favor RALs. We think that they are
predatory and that they are bad for taxpayers. They are not a
real big deal in connection with the Free File Alliance, but
what we did do was we were anxious to get more protections in
terms of clear, up-front indication, ``do you want to be given
information or not on these kinds of products?`` So, that was a
goal that we had.
We were working in what I would call a difficult
negotiation because the parties on the other side, they wanted
to limit this as much as they could. Then you should know that
both sides of this issue are present in Congress, and in a
voice vote in the Senate appropriations process last fall, in
October, an amendment was agreed to that said--and this was
right in the last hours of negotiation--``The Internal Revenue
Service shall provide taxpayers with free individual tax
electronic preparation and filing services only through the
Free File program, and the Internal Revenue Service's Taxpayer
Assistance Center's tax counseling for the elderly, and VITA
sites.'' The effect of that was to say all of our leverage,
which was that the government 1 day might provide these
services for free to taxpayers, was effectively removed. Now,
thankfully, the House didn't follow that. It dropped out in the
Conference Report.
So, I think that we did our best to negotiate the best deal
we could, but corporate interests intruded at a delicate moment
in a negotiation, and limited what we got. We had a proposal on
the table which would have increased that. Our threshold is
about $50,000. That is a 70 percent level. We would have gotten
a higher level we think had this maybe not have happened, but
we got the protection on the RAL, so overall, I am disappointed
that the volumes have gone down. There has been a lot less
publicity on it. Last year, USA Today really trumped it up. I
am hopeful that it will recover over the life of the program.
Going to your point, should we renegotiate it? I want to
get out of this year's filing season, see where we stand, also
understand where the Congress is, because Senators Grassley and
Baucus, in a hearing earlier this week, were talking about more
like the government ought to get into this. On the other hand,
I got a question last week from Members that were saying the
Government should never get into this, so I am not quite sure
where the Congress is on this issue, sir.
Chairman RAMSTAD. I appreciate that explanation. I think
there are some flaws or problems that you obviously have agreed
to look at, some results that are hard to understand, quite
frankly. I just don't understand why the IRS should prohibit
companies willing to offer free services to all taxpayers from
doing so on the IRS website. I know that one member of the
Alliance, to be more specific, offers free Federal preparation
software to all taxpayers on its own website and through
advertisements on the Internet. The same company can offer free
preparation software on the IRS website, as you know, only to
taxpayers making less than $50,000. It just seems to me that
the IRS shouldn't prohibit companies willing to offer free
services to all taxpayers from doing so on the IRS website. I
just don't understand that distinction.
Mr. EVERSON. I haven't thought of that particular point,
but I guess that I would express some concern about trumpeting
any commercial product on our website, even if an element of it
is being offered for free, because obviously, the private
entity is doing that for ultimately some commercial benefit. It
is part of their program to----
Chairman RAMSTAD. Only to taxpayers with income under
$50,000.
Mr. EVERSON. Right.
Chairman RAMSTAD. It seems to people what is good for the
goose is good for the gander.
Mr. EVERSON. Yes, I understand what you are saying, but I
haven't thought----
Chairman RAMSTAD. There is inconsistency, and I trust you
will certainly look at that in terms of renegotiating.
Mr. EVERSON. Yes.
Chairman RAMSTAD. Of course, the bottom line here, if you
look at the aggregate, as we talked about, use of Free File
again, as the graph depicted, is down over 21 percent this
year.
Mr. EVERSON. Yes.
Chairman RAMSTAD. Obviously, having a negative impact on
electronic filing overall. It seems to me that can only be
construed as a negative result of the agreement. Is it your
plan or your desire to renegotiate the agreement?
Mr. EVERSON. I haven't reached a conclusion on that at this
stage. There are two factors. One, I want to see how we do
through the whole filing season, and one of the things we were
able to do here also is get a little more data. I think we will
have better data on who participated in the Free File exercise
through some of the stuff that was renegotiated. That is a good
thing. We will know more. We will have to assess it, and then
again, I do want to work with the Congress and understand,
because I think there are two different views on this.
Many people say the government shouldn't get into this.
Others seem to be saying the government ought to provide the
software. That gets to this issue too, sir.
Chairman RAMSTAD. At the very least you are----
Mr. EVERSON. We will sit back and----
Chairman RAMSTAD. You will consider renegotiating.
Mr. EVERSON. Of course. At the end of this filing season we
will take a good hard look at what happened and why and talk
with all the involved parties, yes, sir.
Chairman RAMSTAD. I want to now defer to the ranking
Member, to recognize the ranking Member. I assume that either
the ranking Member or other colleagues will broach the new
regulations relating to the handling of taxpayer information by
tax return preparers.
Mr. EVERSON. I hope not.
Chairman RAMSTAD. There are some serious privacy concerns I
know my friend from my Arizona has, and so I am going to now
yield to the distinguished ranking Member, Mr. Lewis.
Mr. LEWIS OF GEORGIA. Thank you very much, Mr. Chairman.
Again, Mr. Commissioner, I thank you for being here this
morning. I just want to ask one question. Have the tax laws
become more complex or simpler during the past 10 years?
Mr. EVERSON. Is this a trick question?
[Laughter.]
Mr. LEWIS OF GEORGIA. No, Mr. Commissioner. I would never
attempt to trick you, Mr. Commissioner.
Mr. EVERSON. No, of course, they get more complex all the
time. I got this question yesterday at Small Business, and it
is nothing new under this Congress or this administration, it
is a steady march toward complexity that exists in our system.
You look at something like the American Jobs Creation Act (JOBS
Act) (P.L. 108-357), numerous provisions that we had to respond
to extremely rapidly. One that is--like just the manufacturing,
the benefit for manufacturing activities entails a lot of
complexity in terms of regulation writing and everything else.
So, absolutely, we are not doing tax compliance any favor here,
sir, as we write more and more laws. I would say there are two
reasons for that, one, the inherent complexity, and two,
stability. Obviously, to the degree to which there is stability
in a system, people or businesses can better understand over
time what their obligations are.
Mr. LEWIS OF GEORGIA. Thank you, sir.
Thank you, Mr. Chairman.
Chairman RAMSTAD. Thank you, Mr. Lewis.
The distinguished gentleman from Florida, Mr. Shaw.
Mr. SHAW. Thank you, Mr. Chairman.
I would like to follow up on Congressman Lewis's question
because I think it was at the tail end of your remarks where
you talked about simplification. Would simplification promote
compliance?
Mr. EVERSON. I don't think there is any question to that,
sir. I believe that complexity obscures understanding, and the
people who want to be compliant have a harder time. Look at
something as important as the Earned Income Tax Credit (EITC),
where there is a lot of complexity about whether a child
qualifies. There are something like seven different educational
credits. It is a morass for people to try and understand that
system, let alone when you get into the corporate area. So, the
compliant taxpayer has difficulty. I would say the unscrupulous
taxpayer takes advantage of the complexity, trying to tier
transactions or make it harder for us to detect what the
reality is. So, the good guys suffer and the government suffers
as well, from a compliance point of view.
I am not suggesting, again, that there aren't valid public
policy reasons for what you do up here.
Mr. SHAW. I think maybe we need some help there too, as to
your last point. Where are some areas that you would look to
for simplification? I know now that most of your tax preparers
couldn't possibly file many of the returns that they have today
without computers.
Mr. EVERSON. Yes.
Mr. SHAW. It used to be I would sit down at probably the
dining room table or somewhere in the house, and go through it,
usually on the morning of April 15, and pencil out my tax
return, and then run to the post office by midnight. That is
impossible now with the Alternative Minimum Tax (AMT) and all
of these things, because if you try to do it by hand, you are
probably going to end up with some errors in the return itself.
Where are some areas that you would look to for simplification?
Where should this Committee go to search out areas of
simplification? I would like for you to include in your answer
your thoughts with regard to the AMT.
Mr. EVERSON. That was where I was going to start, because
this whole concept of going through a return, and then getting
to the end, and then we sort of pull the rug out from
underneath the taxpayer, ``Aha, that's not your real tax. It's
over here on a separate schedule.'' That is hard to understand.
It undoubtedly makes people mad, and in the end, they may throw
up their hands and say, ``Geez, why bother with all this?``
So, I think the AMT, whatever you think about it from a
policy point of view, it hurts compliance because of that
dynamic that I just talked about.
Mr. SHAW. I wish we could score it that way.
Mr. EVERSON. Yes, I don't know if you can. I would get rid
of that, obviously, and then I would focus on these credits
that I have mentioned, the multitude of credits is one area
that is problematical. I think that the incredible complexity
on the corporate side of the ledger is also an area that is
damaging or corrosive to the system, if you will.
Mr. SHAW. Mr. Chairman, I would say here there is a fertile
ground for you to spend the next couple of years in going
through the tax code and looking over where we might do better
and where we might be able to solve some of these problems to
report back to the full Committee.
Thank you, sir, Commissioner, appreciate your being here.
Thank you, Mr. Chairman. I yield back.
Chairman RAMSTAD. Thank you, Mr. Shaw.
The distinguished gentleman from North Dakota, Mr. Pomeroy.
Mr. POMEROY. So, much to ask, so little time. Mr. Chairman,
we may need another panel round, if that would be all right.
Mr. Chairman, you were following a particularly interesting
line of discussion relative to the $50,000 limit. I think we
will start right there.
Commissioner, I like you. I think that from a management
perspective you have done a terrific job, and yet there are
some things about the IRS that just make me shake my head. You
are telling me that because one appropriations Members of
Congress wrote a letter to you during negotiations with this
Free File Alliance, you felt--of course, the appropriations
Member writing basically the talking points of a couple of
stakeholders that very much wanted to have the Free File limit,
not for all taxpayers but limited to the $50,000 level, that
based on that single letter from one Member of the
Appropriations Committee----
Mr. EVERSON. No, sir.
Mr. POMEROY. You felt like----
Mr. EVERSON. No, no. Perhaps I wasn't clear. What happened
was, when we were in the final days of negotiation, in a voice
vote on an appropriations bill, the Senate passed the language
that I read. The Senate passed it, and it was part of the
massive--it didn't go through the authorizing Committees. This
is a fundamental change to our tax administration system that
bypassed any discussion with either Finance or Ways and Means.
Mr. POMEROY. It wasn't adopted by the House.
Mr. EVERSON. In the end it was not adopted by the House. It
came out in the conference. It was not a letter, a single
letter, no, sir.
Mr. POMEROY. A voice vote in the Senate Approps that in the
end didn't----
Mr. EVERSON. A voice vote when the Appropriations bill was
on the floor, yes, sir.
Mr. POMEROY. So, the Senate has their version, the House
has their version. They are reconciled in Conference Committee.
This was not one of those items that was specifically in the
legislation coming out of----
Mr. EVERSON. In the end, we were in the latter days of the
negotiation last fall, and there was the Senate language that
came out of the Appropriations Committee, and then when that
came to the floor, that amendment that I read to you was added
to that. So, it was in the pending legislation on the Senate
side.
Now, I learned, to my peril, last year, that things that I
was told would come out of conference, in conference, and then
didn't, particularly on the Senate side and some of the
language that we are living with now, that I had better take
pretty seriously anything that is in a bill on either side of
the appropriations process.
Mr. POMEROY. I will tell you something, I think that your
principal responsibility is to the taxpayers of this Nation,
and if you come into your job wondering what kind of mood is
Congress in today, you are going to have a miserable, miserable
job. I think you need to administer the tax laws of this
country in a way that benefits the taxpayers, and if Congress
legislates something, you follow it, but you don't have old
Floyd watching legislative debate with Senator Hucklestuffel
said this and such. Forget that. So to suggest to us that this
kind of intramural discussion ought to force the Agency to
knuckle under to this collusive, rotten limit advanced by the
Alliance, is ridiculous.
Mr. EVERSON. I am talking about at the margin, sir. We are
talking about a couple percentage points in terms of
eligibility. We got to 70 percent, so we protected the middle
income and the lower income people, and we had----
Mr. POMEROY. Wait a minute. The $50,000 cap protects middle
income people? We have just now defined middle income as
$50,000 as below?
Mr. EVERSON. I think it covers 70 percent of the taxpayers,
so----
Mr. POMEROY. I represent a lot of folks, North Dakota is
not a high income State.
Mr. EVERSON. I understand.
Mr. POMEROY. There are a lot of people who are making
$55,000 in joint income today who would be really thrilled to
know they have just been promoted to the upper class. That is,
in my opinion, completely insufficient. It shows to me--and I
am going to pursue this in future panels--that there is way too
much influence by this--basically, the Alliance, they are
supposed to be helping this effort. We are not supposed to be
running this effort for the benefit of the Alliance, and I kind
of think things got a little askew here, and I think the
$50,000 cap--as long as you are so attentive to legislative
intent, let me tell you, this legislator thinks a $50,000 cap
is absurd.
Mr. EVERSON. Okay. I understand your view. I wanted to see
higher. There is only so much we can do to impose an agreement
between two parties that is being freely negotiated, but I
appreciate your interest and the espousal of that side, because
that side was silent at that point in time in the Congressional
debate.
Mr. POMEROY. Sorry to hear that.
Chairman RAMSTAD. Thank you, Mr. Pomeroy.
The distinguished gentleman from Georgia, Mr. Linder.
Mr. LINDER. Thank you, Mr. Chairman.
Good morning.
Mr. EVERSON. Morning.
Mr. LINDER. Nice to have you here.
How much do you charge e-filers for filing electronically?
Mr. EVERSON. We don't make a charge.
Mr. LINDER. Who does make the charge? Because people have
been telling me that it cost them $30 to file electronically.
Would that be the tax preparer?
Mr. EVERSON. That would be the entity that is processing
them.
Mr. LINDER. Why do you want to have the gross receipts from
credit cards information?
Mr. EVERSON. If you will indulge me, I have a couple of
charts that I will show you on this. If you look at the tax
gap--let's go to the overall tax gap map. It is kind of hard to
see here, but the total tax gap of $345 billion, over 80
percent of that comes from under reporting. That is this center
area. The biggest piece of the under reporting is off that blue
column down on the left, which is individual under reporting,
which is about $200 billion.
If you go to the next chart, this chart shows you, sir,
that the noncompliance rate on wages where there is third-party
reporting and withholding is only 1 percent. 150 million
Americans are used to getting 235 million W-2s each year. We
get that information. People report accurately.
If you go all the way to the right here, so there is only
about $10 or $11 billion in that tax gap is in that area, where
you get third-party reporting withholding.
Mr. LINDER. I am sure you are going to come to the credit
card issue pretty soon.
Mr. EVERSON. Yes. When you come all the way to the right
here where you get no reporting at all, the noncompliance rate
is more like 50 percent. This is particularly relating to
Schedule C income--and this is important because over the
years, since 1978, the percentage of people filing Schedule C
returns, saying they have a business, has increased by 175
percent, instead of the normal--that is the red line there. The
normal filer, that has just gone up by 50 percent. That is
where we have no income verification.
So, what we wanted to craft--and I got some tough questions
from Chairman Manzullo yesterday on this because it affects the
small businesses--we wanted to craft the least burdensome way
to making sure we got the information on the revenues. We feel
by having the credit card issuers report to us once a year the
gross receipts, we will get that information, but without the
small businesses themselves having to do more reporting.
Mr. LINDER. Is your under reporting including what you
think is in the underground economy that doesn't report at all?
Mr. EVERSON. In this proposal it wouldn't get to that
because we are talking only about the credit cards, and when
you are talking about strictly the cash, obviously, that would
fall outside of that. That is an even more difficult element.
Mr. LINDER. That is 2 to 3 trillion dollars a year.
Mr. EVERSON. 2 or 3 trillion, you are saying?
Mr. LINDER. Yes.
Mr. EVERSON. I don't have an exact number on that.
Mr. LINDER. Your under reporting doesn't even consider an
estimate of the underground economy?
Mr. EVERSON. We don't have--we have not captured in this
$345 billion all of the underground economy, no, sir.
Mr. LINDER. How much do you think is in the offshore
financial centers in dollar denominated deposits?
Mr. EVERSON. I don't have an exact answer. You are saying
how much cash is sitting offshore? I don't have an answer for
that. We have been pretty clear that we are very concerned
about, in the corporate domain in particular, about the
increasing difficulty of understanding the international
transactions and the complexity entailing from globalization.
Mr. LINDER. Would you believe $10 trillion?
Mr. EVERSON. That is entirely possible. We have, as you
know, the big trade deficits that are generating hundreds of
billions of dollars each year, so, yes.
Mr. LINDER. What percentage of the revenues you receive
from income comes from corporations?
Mr. EVERSON. From corporations, it is down--I don't have
the exact number with me--but I think it is about 15, 16
percent or something like that.
Mr. LINDER. About 11.
Mr. EVERSON. 11 percent.
Mr. LINDER. 11. What do you think it was in 1950?
Mr. EVERSON. It was much higher. I know it was 20 or 30
percent, something like that.
Mr. LINDER. 23. Is that because they are getting better at
it or because it is too complex?
Mr. EVERSON. I think that those are a variety of policy
choices that the Congress has taken in terms of what it has
done, and it also changes the economic activity. If you go back
to that map that I showed you a minute ago, we have estimated
the corporate tax gap for the larger corporations at $25
billion. I believe that is probably understated. We did not
update the research on that. It may be understated by half, but
it doesn't change the way I would propose allocating our
resources.
If you look at the coverage rates we do, sir, we are
already auditing each year the biggest companies, 44 percent of
those businesses each year. So, the hard thing here, I would
say, if I could be clear, the hard thing here goes back to this
question of simplification. It is the structure of
international transactions, the complexity of the Code. It
would be a lot easier for us to get after more of the corporate
money if we had some help on simplification.
Mr. LINDER. Do you actually believe corporations pay taxes?
Mr. EVERSON. Well, they pay----
Mr. LINDER. They collect them.
Mr. EVERSON. If you are asking me to defend corporate
practices, I have spoken to this, and I have said that there
are two different incentives. There is an incentive to increase
book earnings that is taking place for the public companies,
and to decrease taxable earnings and maximize cash. I am very
concerned about that, and that dynamic. They have extremely
good help in the sense of very talented attorneys and
accountants.
Mr. LINDER. They all used to work here.
Mr. EVERSON. Yes, and who operate on a global basis. We do
not operate on a global basis. We have worked to sort of
increase our relationships with Inland Revenue, and everybody
else, and we have projects where we now have an entity--be
happy to have you come down and visit it--the Joint
International Tax Shelter Information Center, with the United
Kingdom, Canada, Australia, where we are sharing case
information with each of those countries so that we can do
better, because one thing I am very concerned about is tax
arbitrage, not strictly illegal, but you need to look at this
because increasingly a business will structure a transaction so
it comports with one set of laws on one side, and got no tax on
our side, and then you got no tax on the United Kingdom side
either, because it is debt here or equity there. It is an area
we need to look at.
Mr. LINDER. Thank you, Mr. Chairman.
Chairman RAMSTAD. Thank you, Mr. Linder.
The distinguished gentleman from Arizona, Mr. Hayworth.
Mr. HAYWORTH. Let me thank the distinguished Chairman for
the recognition, and we thank our very distinguished guest.
Commissioner, thank you for coming back by, and we appreciate
the time you spend in front of these Committees.
As you might expect, given the nature of our constitutional
office, we spend a lot of time talking to constituents. So it
was when all of us were home recently, we read with great
interest of proposed new regulations from the IRS relating to
the handling of taxpayer information by tax return preparers.
Commissioner, I must tell you, at the various townhalls that I
conducted across the width and breadth of the Fifth
Congressional District of Arizona, there was genuine concern
about privacy protection.
One of the proposed regulations would allow preparers to
use taxpayer information to solicit taxpayers for financial
services offered by unrelated third parties. I will tell you
that I am hearing from my constituents, and they are not vague
on this at all. They are very concerned at what seems to be an
unnecessary and unwise expansion for current rules and
regulations. Can you tell me why you think this change is
important?
Mr. EVERSON. Absolutely. It comes back to some of the
remarks that the Chairman made in the opening statement. This
area, the regulations in this area have been in effect since
1974. Under the law, a taxpayer could always have that
information shared with others if there was consent by the
taxpayer. We felt that--what had happened was there had been a
change over the years, these standards were too general. They
didn't recognize what had evolved with the Internet,
outsourcing the preparation of hundreds of thousands of returns
in India and places like that. There was a lot of concern that
came from this body, in part, the outsourcing of the returns.
As we look at this, we said, ``Geez, we need to tighten up
in this area.'' We think we have tightened up in this area.
What our proposal seeks to do is to make some pretty clear
standards and improve the consent process, if you will. It even
goes so far as to have a type size that has to be there so that
it is not in some little paragraph at the end of something you
are signing when you are under pressure to get a return
finished.
As I look at this--and there have been a lot of comments on
both sides of this--I think that we are tightening this up. I
think this is a classic kind of Washington story, where the
purest in the consumer protection group who would have no
information shared, they have been vocal and they have caused
the concerns--given light to the concerns that you are hearing
about, but the folks who really oppose this regulation the
most, which are the corporate interests, they have been silent,
relatively silent. They are writing to us and commenting
officially, but they have been silent in the public space
because they would like the proposal to die.
The comments I have gotten from corporations, I will read
you one from a letter from a lawyer. ``It requires a nearly
impenetrable morass of language to see anything.''
If we stand down on this, this would basically be the H&R
Block Relief Act, because right now, the big players, they can
sit down with you when you are getting your return prepared and
they say, ``Geez, you ought to be in an Individual Retirement
Account (IRA). We can put you in an IRA.'' Yet your fellow back
in Arizona, who has a little three-man operation, who
understands your situation, he cannot say, ``Geez, First Bank
and Trust down the street has got a product that would save you
money here.'' What we are trying to do is level the
playingfield so that you, as the taxpayer, knowingly consent if
you want to use your information for anything other than just
filing your return. That is what we are trying to do here.
Let me make one final point if I could. I know I have gone
on. There is talk, as the Chairman said, about changing the
statute. What I would point out here is, the basic question is,
whose information is this? I do think that the civil
libertarians, some of whom are talking about this, I think they
would jump down my throat if I said that you as a citizen
couldn't make a decision to share something with Jim Ramstad as
a citizen. All we are trying to do here is make sure that if
that happens, that there are clear rules of the road and that
it is done knowingly. That is what we are trying to do, sir.
Mr. HAYWORTH. Mr. Chairman, I would ask your indulgence. I
see the time has expired, but I just feel it is important to
pursue this line of questioning.
Chairman RAMSTAD. Proceed.
Mr. HAYWORTH. You offered the hypothetical of the small
operations and the financial services offered down the block.
It has been my experience, and I think the experience of
virtually every taxpaying American, that there is already a
deluge of investment and financial opportunities marketed to
consumers, and I just wonder how you really believe this helps
consumers. Now, you have talked about some of the dynamics
within the tax preparation field, but how does it benefit
consumers to set up this pipeline, because even in your answer
you acknowledge that for so many people who go to different
preparers, let's say, on the morning of the 15th, trying to get
things postmarked by midnight, ``Yes, sure, let me sign, let me
sign, let me sign.'' Caveat emptor, of course, is a doctrine
that has served us well. I suppose it is caveat taxpayer, but
even with the type change, what is the benefit to consumers to
see this information shared for yet more financial information
showing up at their doorstep?
Mr. EVERSON. I think there is a benefit in some instances.
Obviously, you do have to weigh--and the Congress can weigh, as
the Chairman indicated, a change in the statute to say that you
want to draw a hard wall on this. You can weigh those two
competing interests, because, obviously, privacy--we are very
concerned about privacy of information. I have been doing some
TV work on phishing. We are getting increasing phishing
exercised. You know what that is, when somebody does a scam to
try and get information. It is a big issue.
What we were trying to do here is work with the current law
in the context of all the changes that have taken place. We
just had a hearing on this this week, where we get people to
come in. We are going to digest all the comments, and we may
make some refinements in this, but we welcome a dialog with the
Congress, because you are right, there is a case to be made to
say, ``No, you can't do this if you are a tax preparer.'' That
case can be made, I agree with you. However, there are other
benefits that can occur, because some people do, sir, turn to
their tax advisor as their real trusted financial advisor. They
may not have a broker or something like that.
Mr. HAYWORTH. I will just finish up. I thank you for being
indulgent with the time.
Commissioner, it also seems that advice is one area, but
solicitation is something all together different.
Mr. EVERSON. I agree with that.
Mr. HAYWORTH. Given our constitutional charge, Mr.
Chairman, I have prepared information. Let me be fair about
this. I think, for example, one of the proposed regulations
that says that a taxpayer would be provided with information if
his or her return was outsourced overseas, I welcome that.
However, Mr. Chairman, it is incumbent upon us in the Congress
to make sure that this wall of privacy exists, and I have
prepared legislation to that effect for us to fulfill our
constitutional obligations, mindful and thankful, as we always
are, for our friends in the IRS handling things from the
administrative angle. It is important for constitutional
officers to weigh in on behalf of the people to make sure that
the wall of privacy exists, as the Commissioner pointed out,
for phishing, ``ph'' phishing, if you will, on the Internet
with e-mail and a variety of other concerns. So I welcome the
Commissioner's response and look forward to working with the
Chairman on legislation.
Mr. EVERSON. If I could, Mr. Chairman, I think that is a
very fair characterization. This is worthy of a public debate,
I would suggest, sir.
Chairman RAMSTAD. The Chair thanks the gentleman from
Arizona for his questioning.
Commissioner, each of the five Members presently on the
dais, has at least one more question that they would like to
ask. Does your schedule so permit?
Mr. EVERSON. I am okay until I think about 11:30 or so.
Chairman RAMSTAD. We will try to be as concise as possible,
and we will certainly have you out of here at 11:30, at which
time we are also expecting a round of votes, so that will
coincide with the vote schedule.
Let me just ask you one question. I want to broach a
subject that has not been talked about today, and that is the
authorization that Congress gave Treasury to enter into private
debt collection of delinquent taxes owed the Federal
government, with the obvious purpose being to shrink an
incredible inventory of potentially uncollectible Federal tax
debt.
A number of us were strong supporters of my predecessor's
bill, former Chairman Amo Houghton, who authored the bill to
provide for private debt collection, because we believe that
this authority given the Treasury Department, the IRS, has a
potential to raise literally hundreds of millions of dollars
for the Federal government. These are for delinquent taxes that
aren't being paid and aren't going to be paid for the most
part.
You recently said it would cost more to hire private debt
collectors than to hire additional IRS employees to do the same
work. I am not sure I understand that because we went through
that, if you look at the legislative history, and given the
various percentages charged by the debt collectors, it seems to
me not entirely accurate to make that claim. Maybe you could
explain. Maybe it is taken out of context.
Mr. EVERSON. I think what I have said is I do believe that
if we had infinite resources at the IRS, we could do this work
as cheaply or more cheaply than the private sector. As you
know, we do the President's Competitive Sourcing Initiative and
we look at different things all the time, different projects,
and more often than not, the government wins because it doesn't
have to make a profit. So, I believe you could do this more
cheaply internally.
The reason I support this is because we have limited
resources, as we have all indicated, in terms of appropriated
funds. This extends our reach on a segment of the debt that we
want to get after. We are working to provide all the
appropriate privacy protections on this. We have just awarded
contracts in the first tranche to three. There has been a
protest that has been lodged. That runs for 100 days, so that
will run till the end of June with GAO, and we are hopeful that
will be resolved, and then we will get after this, and that it
will prove successful.
I didn't mean to imply that this is a bad deal for the
Government. It is not a bad deal. Mr. Rothman, in
Appropriations, was trying to get me to say I was wasteful. I
don't believe this is wasteful. I think this is an intelligent
thing that we have done, and we will do a good job of it.
Chairman RAMSTAD. I certainly appreciate that
clarification, and that is what I assumed you would say, and
that has been your position certainly, because given the
limited resources with which you are operating, it seems to me
that without private debt collection, this debt is sure to go
uncollected. So, I appreciate it.
So, when then, given the 100-day period you mentioned
pursuant to the protest, when can we expect that private debt
collection firms will begin collecting taxes owed the Federal
government?
Mr. EVERSON. Later this fiscal year is our hope that we
will finally get after it. We are ready to go. We are taking
some steps that we can do now in terms of some background
checks and some of the potential individuals who will be doing
the work. We have worked very carefully to develop models for
the training, and again, I want to reassure the Committee
that--it goes back to this privacy issue--we are very sensitive
to that and the private debt collectors, and they are already
being used in the vast majority of States, and they are being
used by the Federal Government for education loans and things
like that. We are going to make sure that the standards are
pretty rigorously enforced.
Chairman RAMSTAD. As you alluded, a number of critics of
this authority are still raising concerns about the private
debt collection program, and maybe you could just outline very
briefly the safeguards that the IRS has instituted, the
safeguards which you alluded to to protect taxpayer privacy and
taxpayer rights.
Mr. EVERSON. I think it really comes down to two areas. It
comes down to within a parameter that they have to have the
same standards that we do in terms of they can't share
information. It comes down to training, and we have been
working on developing good training models on this, and then it
will have very rigorous contract performance monitoring where
our people are in and able to monitor what is happening.
Obviously, particularly, as we ramp this up, I am acutely
aware, sir, that as we ramp this up, we are only going to get
one swing at bat on this and we have to do it right. I meet
monthly with our team that includes training people, technical
people on the use of the systems because one of the issues here
is we have to make sure that the people who are making the
calls have the same data. If we are talking to Mr. Pomeroy and
he has sent a payment in 3 weeks ago, but the private
contractor doesn't have that reflected, that is not going to be
good. So, there is a system element here too.
Chairman RAMSTAD. I don't think you will get any
disagreement from this panel that it has to be done right, that
there is only one, as you put it, crack at the bat. I think
those parameters you spelled out will result in getting it
right, in administering this in a fair manner, one that
protects taxpayer rights, taxpayer privacy, and one, at the
same time, an effort that at the same time will yield good
results for the Federal Treasury.
Mr. EVERSON. Yes. If I can make one final point on this. I
know that Mr. George, who is the Inspector General--you will be
hearing from him later--he has made this one of his personal
areas of concern, so we are going to get--as has the Taxpayer
Advocate--we are going to get a lot of help, sort of if anybody
sees anything going awry here, very quickly we will see it and
respond.
Chairman RAMSTAD. Thank you again, Commissioner.
The Chair now recognizes the distinguished gentleman from
North Dakota, Mr. Pomeroy, for a second question.
Mr. POMEROY. Thank you.
I have three quick items. First one, you and I have talked
about the tax treatment of conservation reserve payment for
retired farmers.
Mr. EVERSON. Yes.
Mr. POMEROY. The self-employment applied, the question that
exists on that.
Mr. EVERSON. Yes.
Mr. POMEROY. We had worked to get this as a work item to
get resolution from the Service. Where is that?
Mr. EVERSON. It has been in the guidance plan, I guess,
this year. It was in last year. I think it got squeezed out
because of that JOBS Act and all the things that happened
there, but I checked on this, having been reliably informed you
might ask about it. Our guidance here ends June 30th. I am
confident we are going to get this resolved. Now, I am not sure
you are going to get the answer that necessarily some of your
folks would be interested in, but I think we will get this done
by June 30th with the guidance plan.
Mr. POMEROY. Well, you are going to have favorable
resolution.
Mr. EVERSON. I know, I know.
Mr. POMEROY. The next issue. You never see the day where
you have in the U.S. Post Office, a little private vendor in
the corner, ``Get your payday loan here.'' You just never have
that. The Federal Government is not going to sponsor what I
believe is private enterprise engaged in such shoddy, predatory
lending with usurious rates charged by those that might
participate.
Yet the Consumer Law Center and the Consumer Federation of
America tell us that the effective annualized rate of an RAL,
based on a 10-day loan period, and then annualized--or an
average refund size of $2,150. An annualized rate for that loan
is 178 percent, and that loan gets even worse if the refund--if
someone's taking out an anticipation loan on a smaller refund.
Mr. EVERSON. Right.
Mr. POMEROY. I am anxious about minimum standards that
these Free File partners of ours need to have. In my opinion,
when we refer taxpayers to them from the IRS website for Free
File, and then they are just free to market this stuff that
does not involve sufficient minimum quality standards, I
believe, I think it is very much like the payday loan guy
sitting in the corner of a post office. So, I have encouraged
you in the past to look at minimum quality, minimum standards
for the products that our Free File Alliance partners might be
selling, so that it is appropriate. Has that gone forward?
Mr. EVERSON. Let me make a general comment. First of all, I
don't like these RALs. I particularly don't like the fact that
some of the preparers keep an interest in the paper. I think
the banks want that because they feel that they get a more
reliable indication that the loan will be repaid. Yet I am
concerned about the inherent conflict there. It gets back to
sort of this privacy issue, and what are we allowing preparers
to do.
Mr. POMEROY. Right.
Mr. EVERSON. Your concern is one that we had that we
addressed in this negotiation that the Chairman was talking
about earlier and that you were mentioning. In actual fact, my
understanding, sir, is that the percentage of Free File
participants who actually get the RALs is de minimis. It is
less than 1 percent, in contrast to a much higher number for
folks who walk into a preparer and someone says, ``By the way,
do you want your money this afternoon?``
Mr. POMEROY. Yes, but we don't sponsor those.
Mr. EVERSON. So, what we did though was we put in some
additional standards, and I think to be very clear, up front,
when you come on, do you want to be solicited or not for this
kind of a product? That's the change we put in to be absolutely
clear that you do, if you want to go down that road. Then if
you say no, I believe you cannot then--there is no other pop-up
that takes place.
Mr. POMEROY. Right. I do encourage--I think the Service has
a continuing obligation to make sure our private partners are
only offering acceptable quality products to the taxpayers.
The final issue really relates to something that
Congressman Hayworth was asking about, privacy, and privacy in
the context of this taxpayer information. Congress is embroiled
in an immigration debate, and I am wondering if the Service is
involved in discussions with any segment of Congress or the
Treasury Department regarding use of taxpayer data for
immigration enforcement? I would be terribly alarmed if there
were discussions along that line proceeding.
Mr. EVERSON. Mr. Pomeroy, I think this did come up, and
there was a hearing in this room some 4 or 6 weeks ago that
involved the U.S. Department Homeland Security (DHS) and Social
Security, and myself. It was part of the Subcommittee on Social
Security, and some of the Members here, Mr. Hayworth in
particular, were present.
What I have said on this issue is that I do not oppose the
sharing of that information. I understand the great stakes that
our Nation has in having a strong immigration, an effective
immigration system.
What I have said, however, is that against that public
good--and there is no doubt if DHS had the information, they
would be better able to enforce workplace rules. We must
understand, though, that a price will be paid in our tax
administration system if we go down that path, because right
now my job is to make sure we get our share of the money
whether you are working----
Mr. POMEROY. Not to recount. I think your view is very
interesting. I am cognizant of my time being up. I just want to
know, so we know the state of play here, are discussions
proceeding regarding the use of taxpayer data?
Mr. EVERSON. That is in the administration proposal. That
is in the administrative proposal that is being discussed on
the Senate side, is my understanding. One of the principal
areas is that, yes, you are strengthening the--stopping
employers from hiring people, and if there is a no-match here,
yes, they want that information, they do, sir.
Mr. POMEROY. So, we are going to use taxpayer data for
immigration enforcement, under discussion.
Mr. EVERSON. That is under discussion, and I have given the
caveat that from my point of view, this would hurt tax
administration, but I am saying if we do effective immigration
reform. I am a former Immigration and Naturalization Services
(INS) deputy, as you may recall. That is a big problem. We have
to fix that.
Mr. POMEROY. Thank you.
Chairman RAMSTAD. The Chair recognizes Mr. Shaw.
Mr. SHAW. Thank you, Mr. Chairman. I would like to proceed
with the sharing of data problem, but going off in a different
direction. You could, in my opinion--and correct me if my
opinion is all wrong--if we were to simply provide that the
EITC is paid on Social Security wages, and then you were to get
information from Social Security as to whose account has gotten
credit for Social Security and how much that is, wouldn't that
almost eliminate any need to audit the EITC? I noticed on the
figures that you had up a while ago it is like 2.39 percent of
your effort is toward that.
Mr. EVERSON. Right.
Mr. SHAW. I would think that when you start auditing that,
you are really talking to a lot of people who have no records
or anything else, which probably makes it very difficult and
probably you are spinning your wheels a lot.
Mr. EVERSON. I think part of this may be income issues, but
it is also who qualifies or not, and there is a lot of
complexity as indicated before on the qualifying child and
other issues like that. Let me try and frame this issue for
you, sir. The EITC, we dispense about $40 billion a year to 22
million claimants. The cost that we have to run that program,
which is a back end program--it is the largest means tested
benefit program--is about $165 million. It has a very high
error rate, which has been a concern. In contrast, if you look
at food stamps, which has, instead of a 25 or 30 percent error
rate, a 6 percent error rate, they dispense $30 billion a year,
but they have a $3 billion administrative budget that is paid
for or used by the States.
So, what we have here is an honors system. You claim the
credit, and at the back end the IRS looks at it, which is
totally different than any other benefits program where there
is an up-front verification process. That is why the audit rate
is a little bit higher than for some other areas.
Mr. SHAW. I think up to a certain level, the more income
you produce or show, the better deal you get on the EITC. As I
view the IRS, you are not really geared up to catching people
for over reporting income, you are geared to catching them for
under reporting income. So, it would appear to me that if we
were to simply say that the EITC is to be based upon Social
Security--we can talk about dependents and all of that stuff
too--but Social Security wages, and then you had a direct link
to what has been paid in, so that if somebody is trying to
claim the EITC on wages that they didn't pay that Social
Security was not paid on, but that wouldn't qualify. It would
seem that that would simplify your system and make it very easy
to back away from even having to do any audits in that regard.
Mr. EVERSON. It is an interesting idea on the revenue side.
As you indicate, you are absolutely right, there is a sweet
spot at something like $14,000 or $15,000 dollars where the
credit maxes out and then starts to come down until--I think it
drops off entirely in the mid 30s.
Mr. SHAW. This would also I think--and of course, another
hot-button subject, which Mr. Pomeroy was talking about, is
what about the wages paid of Social Security wages or wages
that are paid where there is withholding on illegal immigrants.
That is a whole different subject to get into, and I am not
going to prolong the hearing to get involved in that, but that
would also be an area that you could probably stop payment on a
lot of those things and being able to save the American
taxpayer some money.
Thank you, and I yield back.
Chairman RAMSTAD. The gentleman from Arizona, Mr. Hayworth.
Mr. HAYWORTH. Mr. Chairman, mindful of the time and the
indulgence of the Commissioner, I will yield to my friend from
California if that is okay.
Mr. NUNES. Thank you, Mr. Hayworth, appreciate that.
Welcome Commissioner. I just want to talk briefly about the
501(c)(3)s, and recently the IRS conducted a study where out of
the 82 examinations that you did, 59 had engaged in prohibited
political activity. I assume you are familiar with that report.
Mr. EVERSON. Yes, sir.
Mr. NUNES. Which I commend you for conducting that report.
I think it is important. I have two letters here that are dated
March 1st from the IRS to Greenpeace, to their 501(c)(4) and
the Greenpeace Fund, which is a 501(c)(3), in which in the
letter you say that they continue to qualify for exemption from
Federal income tax despite the fact that it clearly outlines
the political activity that was a violation of Federal law. It
looks to me like from what they were doing, it is Enron-type
accounting, where they were moving money from one account to
another, and then never repaying the loan.
With all the political activity that is going around this
place now, I guess I wonder when are you actually going to
enforce the law on some of these 501(c)(3)s, and stop them from
engaging in this political activity?
Mr. EVERSON. Let me make several points here. First of all,
I will not comment on a particular matter. As this Committee is
well aware, I can't do that.
Mr. NUNES. I understand.
Mr. EVERSON. As a general comment, we were very concerned
in the 2004 cycle about increasing indications of political
intervention in 501(c)(3)s. We very much ramped up our effort
on that. We established a small group of experts, all career
people, and they went through a very detailed process of
deciding which matters to look at. That was reviewed
independently by the Inspector General. There is no politics in
any of this. As you indicate, our conclusions were that it did
substantiate political intervention. At the extreme end, we
have proposed the revocation of the tax exempt status for three
of those organizations, and in fact, one of the revocations has
been finalized.
Most of the problems we have seen were one-time problems,
where we issue an advisory, and the organization agrees to
stand down on that practice. A lot of this involves education
of the organization and making sure they understand the rules
of the road.
So, we are doing two things for this 2006 cycle. We have
issued a lot of increased guidance, a lot of sort of scenarios,
what is okay, what is not okay, and we are going to have that
same group--we are going to augment it as we need to--to work
very quickly to address problems that we see.
More broadly speaking, if I could comment upon the
regulatory scheme here. Congress does need to look--and I have
indicated this in my testimony on tax exempts generally--at the
sanctions, because all too often in this area, or in the area
of noncompliance generally by exempt organizations, we are
really faced with two choices, the imposition of a de minimis
tax--in this case, 10 percent of the cost of the activity,
which can be quite de minimis--or lifting the tax exemption,
which may not, on the other hand, be in the public good because
of the many good things the organization is doing. Something in
the middle that has got a little more pain to it, I think would
make our jobs easier, sir.
Mr. NUNES. I think that is a very good point, because you
can understand. My concern is that if you look at this
activity, clearly these groups are sophisticated at what they
are doing, especially in the case--I know you don't want to
comment on it--but these are sophisticated groups that are very
good at what they do, and perhaps you are right, that this
Committee, Mr. Chairman, should look more into these
501(c)(3)s, into not only the political activities they are
doing, but the possible penalties that the IRS is able to
enforce. I think that is a very good point. Thank you for being
here once again, Commissioner.
I yield back the balance of my time.
Chairman RAMSTAD. Thank you, Mr. Nunes.
Thank you very much, Commissioner, for your testimony
today. I think some very important issues have been covered,
and I appreciate the ongoing dialog, and look forward to
working with you. Thank you again.
Mr. EVERSON. Thank you, sir.
Chairman RAMSTAD. The Chair now would ask the second panel
to take seats so we can begin. The second panel, while they are
coming forward, comprises the Hon. Russell George, Treasury
Inspector General for Tax Administration (TIGTA); the Hon.
Raymond T. Wagner, Chairman of the IRS Oversight Board; the
Hon. Timothy Hugo, Executive Director of the Free File
Alliance; and Director James R. White, Director of Tax Issues
at the Government Accountability Office (GAO).
We will begin as soon as we get the dais rearranged. We
will begin with you, Inspector General George, please. Take
your time. I don't mean to rush you at all, Inspector General.
STATEMENT OF THE HONORABLE J. RUSSELL GEORGE, TREASURY
INSPECTOR GENERAL FOR TAX ADMINISTRATION, U.S. DEPARTMENT OF
THE TREASURY
Mr. GEORGE. Thank you, Mr. Chairman. Chairman Ramstad,
Members of the Subcommittee, thank you for the opportunity to
testify.
The IRS' planning for the 2006 season was unusually
difficult due to the tax law changes enacted in response to
Hurricanes Katrina and Rita. However, to date, my office has
not identified any significant processing problems resulting
from that. In fact, our review of the IRS' preparation for the
2006 filing season has determined that the IRS accurately
updated its tax products and computer programming to
incorporate tax law and other changes.
As of March 24, 2006, the IRS has received more than 73
million returns. Of those, the IRS has seen an increase in
electronically filed returns of 2.6 percent, and a decrease in
paper returns of 6.5 percent compared to the same period in
2005. Over the past several years the IRS has seen a steady
growth in electronic filing of income tax returns. In 2005 the
number of electronically filed returns increased to 51 percent
of the total individual income tax returns received. While the
IRS will not meet its Congressionally mandated goal of having
80 percent of all tax returns electronically filed by 2007, it
does expect to see continued growth in electronic filing,
albeit at a diminished rate.
Although electronic filing continues to increase overall,
there are indications that taxpayers are shifting between the
various types of electronically filed returns, and in some
segments the numbers of electronically filed returns is
actually decreasing. Returns filed electronically are generated
from three basic sources: paid preparers who submit their
clients' tax returns, taxpayers who purchase tax preparation
software, and filed their own return via the Internet from
their personal computers, and taxpayers who take advantage of
free electronic filing programs, such as the Free File program,
or in past years, the TeleFile program.
The IRS Restructuring and Reform Act 1998 (P.L. 105-206)
required the IRS to work with the private sector to increase
electronic filing. In 2003, the Free File program was launched
featuring private sector partners that allowed qualifying
taxpayers to prepare and file their taxes online at no cost.
This was made possible through a public-private partnership
consisting of a consortium of tax software companies, known
collectively as the Free File Alliance.
According to statistics provided by the Alliance, almost
2.8 million taxpayers used the program in its first year. In
subsequent years, use of the program increased significantly to
just over 5 million taxpayers in 2005. Following the 2005
filing season, the IRS and the Alliance amended their agreement
which resulted in a significant change in the focus of the
program. While the new agreement comported with the original
goal of increasing the number of taxpayers who electronically
filed their returns, it effectively changed the intent of the
program to focus on assisting lover income and underserved
taxpayers.
The agreement limits the program's availability to 70
percent, approximately 93 million taxpayers for the 2005 tax
year this limit equates to an adjusted gross incomes, as was
discussed by the Commissioner, of $50,000 or less. The net
impact of that during the 2006 filing season, approximately 40
million taxpayers are not being offered free filing services
through the program. This change, as was discussed, has support
from Congress. With the 2005 budget, the House Committee on
Appropriations restated the proposition that the Alliance is
foremost intended to provide electronic tax return preparation
and electronic filing services at no cost to the working poor
and underserved taxpayers. This stems in part from the
different objectives of the IRS and Alliance members.
One of the IRS' principal purposes for establishing the
program was to increase electronic filing. Alliance members,
however, incur a cost to provide these services. According to
the Alliance members my office interviewed, their primary goal
is to keep the Federal Government from entering the tax
preparation business. Furthermore, Alliance members we spoke to
acknowledge that participants in the program are afforded the
opportunity to market additional services to taxpayers.
Overall, my office has found that the increase in
electronic filing this season appears to be the result of a
greater number of taxpayers paying for online filing services.
As of March 18, 2006, paid online filing was up 25 percent.
Free online filing, however, fell 21 percent. There are two
possible explanations for this disparity. Taxpayers who filed
electronically through a practitioner last year may have
decided to purchase software and file online this year, or
taxpayers who filed through the Free File program last year and
who were disqualified from participating this year, purchased
software to file online.
Another factor that may have contributed to the decline of
free online filing is the elimination of the IRS' TeleFile
program. The IRS and the Alliance had hoped that many of the
3.3 million taxpayers who TeleFiled in 2005, would migrate to
the Free File program. However, we have found that many former
TeleFilers have instead opted to file paper returns.
In addition, I am concerned that the Free File program may
not be accessible to all who were eligible for it. Many low-
income families do not have Internet access. Although the IRS
Free File Internet site allows taxpayers to determine whether
they qualify, finding the best software package to meet their
needs may be difficult for less savvy computer users.
I must point out that in preparation for today's hearing, I
called the IRS' 800 number yesterday, which is, as you know,
designed to assist taxpayers in preparing their tax returns.
The many automated options provided did not contain information
on how to access Free File materials. When I reached an IRS
assistor, she did not mention the program to me at all.
Instead, I had to suggest to her that there was an opportunity
to file my taxes online free of charge. Once I made that
statement to her, I was directed to the IRS website for
information regarding the program.
Overall, I am concerned that changes in the Free File
program agreement, along with the elimination of the Tele-File
program, have contributed to a significant slowing of the
growth in electronic filing, which will defer the efficiency
gains the IRS hoped to achieve this year.
Before proceeding with any reduction in customer services,
whether related to tax preparation and filing options, or walk-
in and toll free telephone assistance, the IRS needs to better
understand the impact of such changes on taxpayers.
Mr. Chairman, Members of the Committee, thank you for
allowing me to share my views. I would be pleased to answer any
questions you may have at the appropriate time.
[The prepared statement of Mr. George follows:]
Statement of The Honorable J. Russell George, Treasury Inspector
General for Tax Administration, U.S. Department of the Treasury
Chairman Ramstad, Ranking Member Lewis, and Members of the
Subcommittee, I thank you for the opportunity to testify today on the
Internal Revenue Service's (IRS) 2006 Filing Season and the 2007 budget
proposal. I will discuss the challenges facing the IRS during the 2006
Filing Season, its longer term goal of increasing the number of
taxpayers who file electronically, and its ability to provide quality
taxpayer service.
The 2006 Filing Season
During the 2006 Filing Season, the IRS expects to process an
estimated 135 million individual returns. One of the major challenges
for the IRS each filing season is the implementation of tax law
changes. Changes to tax law have a major impact on how the IRS conducts
its activities, the resources it requires, and how quickly it can meet
its strategic goals. Congress generally makes changes to tax law each
year, and before each filing season begins, the IRS must identify tax
law changes, revise various tax forms, instructions, and publications,
and reprogram its computer system to ensure returns are accurately
processed.
So far, TIGTA has not identified any significant problems with the
IRS' processing of individual tax returns during the 2006 Filing
Season. As of March 24, 2006, the IRS has received over 73.4 million
returns. Of those, 50.3 million were filed electronically (an increase
of 2.6 percent from this time last year), and 23.1 million were filed
on paper (a decrease of 6.5 percent from 2005). Additionally, $144.5
billion in refunds have been timely issued. Of this amount, $113.4
billion were directly deposited to taxpayer bank accounts, an increase
of 4 percent compared to last year.
Planning for the 2006 Filing Season was unusually difficult for the
IRS because of many tax law changes enacted late last year in response
to unprecedented natural disasters. Disaster relief provisions were
enacted into law for taxpayers affected by Hurricanes Katrina, Rita,
and Wilma, and were intended to provide relief to over11 million
taxpayers who lived in the affected areas of the Gulf Coast, as well as
to others who may have been adversely impacted by these storms.
This year, TIGTA is reviewing 28 new tax law provisions and also
closely monitoring the implementation of changes intended to assist
taxpayers adversely affected by the 2005 hurricanes. New tax law
provisions were included in the Katrina Emergency Tax Relief Act of
2005,\1\ the Gulf Opportunity Zone Act of 2005,\2\ and in provisions in
the Working Families Tax Relief Act of 2004 \3\ and the American Jobs
Creation Act of 2004,\4\ all of which became effective in 2005. The
latest legislation, the Gulf Opportunity Zone Act of 2005, was signed
into law on December 21, 2005.
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\1\ Pub. L. No. 109-73, 119 Stat. 2016 (to be codified in scattered
sections of 26 U.S.C.).
\2\ Pub. L. No. 109-135, 199 Stat. 2577 (2005).
\3\ Pub. L. No. 108-311, 118 Stat. 1166 (2004).
\4\ Pub. L. No. 108-357, 118 Stat. 1418 (2004).
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TIGTA reviewed the IRS' preparation for the 2006 Filing Season and
determined that the IRS accurately updated its tax products and
computer programming to incorporate the tax law changes effective in
2005. TIGTA reviewed 42 tax forms, publications, and instructions that
required updating, and determined that they were accurately updated.
The IRS also accurately updated its computer programming and returns
processing programs for the new tax law provisions and other
adjustments or changes.\5\ TIGTA will continue to monitor the IRS'
processing of income tax returns during the 2006 Filing Season and will
report its results later this year.
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\5\ Discussion Draft Report Tax Products and Computer Programs for
Individual Income Tax Returns Were Accurately Updated for the 2006
Filing Season (Audit # 200640015)
---------------------------------------------------------------------------
Electronic Filing
The IRS has seen a steady growth in electronic filing (e-file) of
income tax returns over the past several years. In Calendar Year 2002,
35.9 percent of the 130.3 million individual income tax returns
received by the IRS were e-filed. Last year, the percentage of e-filed
returns increased to 51.7 percent of the total individual income tax
returns received. The number of e-filed returns increased 46.2 percent
over the three-year span. While the IRS will not meet its goal of
having 80 percent of all tax returns e-filed by 2007, it does expect to
see continued growth in electronic filing, although at a somewhat
diminished growth rate from year to year. For example, the IRS expects
the e-file percentage to reach 54.1 percent this year, 57.7 percent in
2007, and 60.6 percent in 2008.
Although e-filing continues to increase overall, TIGTA notes some
indications that taxpayers are shifting between the various types of e-
filed returns, and some segments of e-filed returns are starting to
show a decrease in the numbers filed. E-filed returns are generated
from three basic sources--paid preparers who transmit their clients'
tax returns, taxpayers who purchase tax-preparation software and file
their own returns via the Internet from their personal computers, and
taxpayers who take advantage of free e-filing options, such as the Free
File Program, or in years past, via the TeleFile Program.
Overall, as of mid-March of this year, e-filing has increased 2.6
percent compared to the same period in 2005, although this is
significantly less than the 6 percent increase the IRS expected. While
the number of taxpayers e-filing from their home computers is up 16.6
percent this Filing Season, the number of taxpayers taking advantage of
free online filing is down 21 percent below last year. I am concerned
that more taxpayers are not using the free e-filing services offered by
the IRS, and I will discuss some issues related to the Free File and
TeleFile Programs in the following sections of this testimony.
Free File Program
Background
In February 2002, President Bush established an agenda to improve
management of the Federal Government. One of his agenda items is E-
Government. E-Government is an integral part of the President's
Management Agenda to make it easier for citizens and businesses to
interact with the government, save taxpayer dollars and streamline
citizen-to-government transactions. In response to the President's E-
Government initiative, the Office of Management and Budget (OMB)
developed the EZ Tax Filing Initiative. EZ Tax Filing was intended to
make it easier for citizens to file taxes in a Web-enabled environment.
Citizens would no longer have to pay for basic, automated tax
preparation. The goal of this initiative was to increase the number of
citizens who filed their tax returns electronically.
The IRS Restructuring and Reform Act of 1998 (RRA 98) \6\
established a goal for the IRS of having 80 percent of Federal tax and
information returns filed electronically by 2007. It also required the
IRS to work with private industry to increase electronic filing. In
response to this requirement, in 2003 the Department of the Treasury
(Treasury), OMB and the IRS launched the Free File Program featuring
private-sector partners that allow qualifying taxpayers to prepare and
file their taxes online for free. The Treasury, OMB and IRS made this
possible through a public-private partnership with a consortium of tax
software companies, the Free File Alliance, LLC (Alliance).
---------------------------------------------------------------------------
\6\ Pub. L. No. 105-206, 112 Stat. 685 (codified as amended in
scattered sections of 2 U.S.C., 5 U.S.C. app., 16 U.S.C., 19 U.S.C., 22
U.S.C., 23 U.S.C., 26 U.S.C., 31 U.S.C., 38 U.S.C., and 49 U.S.C.).
---------------------------------------------------------------------------
The Free File Program provides taxpayers with access to free online
tax preparation and e-filing services made possible through a
partnership agreement between the IRS and the tax software industry.
Eligible taxpayers may prepare and e-file their Federal income tax
returns using commercial online software provided by Alliance members.
After the IRS and Alliance entered into a Free File Agreement, the Free
File Program debuted in January 2003. According to statistics provided
by the Alliance, more than 2.79 million taxpayers used the program in
its first year. In subsequent years, use of the Free File Program
increased significantly, to about 3.51 million taxpayers in 2004, and
5.12 million taxpayers in 2005.
The Amended Free File Alliance Agreement and Its Potential Impact on
Electronic Filing
After the 2005 Filing Season, the IRS and the Alliance amended
their agreement to continue the Free File Program through October 2009.
With the amended agreement, the overall focus of the Free File Program
changed significantly. While the amended agreement still contributes to
the original goal of increasing the number of citizens who
electronically file their tax returns, new limits effectively changed
the intent of the Free File Program. The original intent of the program
was to provide free tax preparation and electronic filing services to
all taxpayers. The revised intent is to assist lower income and
underserved taxpayers.
The original 2002 agreement between the IRS and the Alliance
established a minimum number of taxpayers who should be served by the
Free File Program and was more in line with the intent of the EZ Tax
Filing Initiative. There is, however, some support in Congress for the
shift in the program's focus to lower income and underserved taxpayers.
For example, according to the House Appropriations Committee Report
accompanying the IRS' FY 2005 Budget Appropriations, the Committee
reaffirmed its position that the Alliance is first and foremost
intended to provide electronic Federal tax return preparation and e-
filing services at no cost to the working poor and other disadvantaged
and underserved taxpayers.
As part of the amended agreement, new limits were set for
participation in the Free File Program. The new limits stem, in part,
from the differing objectives of the IRS and the Alliance members. One
of the IRS' principal purposes for establishing the program was to add
another avenue for electronic filing with the intent of increasing
electronic filing overall. However, Alliance members are businesses
that incur a cost to provide free services. According to
representatives of Alliance member companies that TIGTA interviewed,\7\
their primary goal is to keep the Federal Government from entering the
tax preparation business. A secondary benefit of their participation in
the program is the opportunity to market their other products for free.
Taxpayers opting to use these services provide additional revenues to
Alliance members.
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\7\ TIGTA interviewed a sample of 6 of the 20 Alliance member
companies.
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Per the initial agreement, a minimum of 60 percent of all taxpayers
(approximately 78 million) were eligible for the Free File Program.
Last year, the Alliance opened the program up to almost 130 million
taxpayers. However, only 5.12 million taxpayers took advantage of it.
The amended agreement now limits the program's availability to 70
percent of taxpayers (approximately 93 million). For Tax Year 2005,
this limitation equates to an Adjusted Gross Income (AGI) of $50,000 or
less. The maximum AGI to achieve the 70 percent limit, however, may
vary from year to year. The net impact of this new limit is that during
the 2006 Filing Season approximately 40 million taxpayers will no
longer be offered free filing services through the program.
As mentioned earlier, online filing on home computers is up 16.6
percent this Filing Season. This increase, however, appears to be the
result of additional taxpayers paying for online filing services. As of
March 18, 2006, paid online filing is up 33.8 percent while free online
filing is down 21 percent. Two possible explanations for the growth in
online filing from home computers and the decline in free online filing
are: 1) taxpayers who filed electronically through a practitioner last
year may have decided to purchase software and file online this year;
and 2) taxpayers who filed through the program last year do not qualify
this year, and they purchased software to file online.
Another factor that appears to have contributed to the decline in
free online filing is elimination of the IRS' TeleFile Program. The IRS
and the Alliance had hoped that many of the 3.3 million taxpayers who
used TeleFile in 2005 would migrate to the Free File Program. However,
current Filing Season statistics indicate that many former TeleFilers
are no longer electronically filing and instead are filing their
returns on paper.
Positive Provisions of the New Free File Alliance Agreement
Although the changes in the amended Free File Agreement limit the
number of taxpayers offered free tax preparation and filing services,
several other changes enhance the quality of the program. Under the
amended agreement, Alliance members must adhere to more stringent
disclosure on the nature, costs, and alternative methods of receiving
refunds faster. In addition, not all taxpayers will be offered a Refund
Anticipation Loan (RAL). There is some controversy over RALs because of
the high fees and rates sometimes associated with those loans. Starting
in 2006, the agreement guarantees that some taxpayers using the Free
File Program will have the option to prepare and file their tax return
without being offered a RAL. The decision of whether or not to accept
an RAL lies with the taxpayer; however, these new provisions make the
choice more clear. If taxpayers choose to apply for an RAL, all terms
of the loans must be fully disclosed.
The amended agreement also increased security requirements and
added performance measures for the individual Alliance members.
Alliance members must have third party security assessments to ensure
that taxpayer information is adequately protected. Also, performance
standards require a 60 percent acceptance rate \8\ for providers who e-
file returns through the program. This acceptance rate will be
gradually increased in future years.
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\8\ The percentage of returns an individual provider must transmit
to the IRS error free.
---------------------------------------------------------------------------
Under the amended agreement, Alliance members also agreed for the
first time to provide the IRS with an indicator that identifies those
taxpayers who use the Free File Program. Prior to the amendment, the
IRS had no way to independently determine how many taxpayers
participated in the program, or which taxpayers were using it.
Previously, individual Alliance members reported data on participation
in the program, and the IRS lacked a method to monitor participation.
This significantly hampered the IRS' ability to evaluate the program's
success or the effects of changes to the program.
Difficulties Using the Free File Program
Although the Free File Program offers some taxpayers the option to
prepare and file their tax return for free, the program may not be
accessible to all who are eligible for it and it is not necessarily
easy to use. The Free File Internet site easily allows taxpayers to
determine whether they qualify for the program, but finding the best
software provider for their needs is time consuming and may be
difficult for less savvy computer users.
Taxpayers must access the Free File Program through the IRS'
Internet site at IRS.gov. The Internet site clearly identifies the
basic requirements for participation in the program and provides a tool
that guides taxpayers to free filing providers. This tool presents
taxpayers with a number of providers from which to choose based on some
basic information that taxpayers provide. Although this tool guides
taxpayers to the providers they qualify to use, the tool does not
assist taxpayers with determining which of those providers best meets
their needs.
Taxpayers must access each provider's Internet site to determine
the services offered and must then compare the services offered and
select the provider that is the best for them. Additionally, each
Alliance member company sets taxpayer eligibility requirements for its
own program. These requirements may differ from company to company.
Generally, eligibility is based on such factors such as age, adjusted
gross income, State residency, military status or eligibility for the
Earned Income Tax Credit.
Although the Free File Program is currently focused on low-income
taxpayers, many of these taxpayers do not have access to the tools to
use it. For example, taxpayers who speak limited English have not been
provided access to all the filing options offered. Only two providers
offer services in Spanish and neither of them offer free electronic
filing of Form 4868, Automatic Extension of Time to File.
The Free File Program also requires taxpayers to have access to a
computer and the Internet. Taxpayers who have access to the necessary
technology must also be savvy enough to navigate the IRS' and the
Alliance members' Internet sites. The focus of the program on lower
income taxpayers may be at odds with their ability to participate in
it. In her 2004 Report to the Congress, the National Taxpayer Advocate
wrote that in 2001 approximately 50 percent of low income families \9\
used a computer and only 38 percent had access to the Internet.
Furthermore, access to a computer or the Internet does not necessarily
indicate that a person has the ability to navigate the Internet or use
tax preparation software.\10\
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\9\ Income of less than $25,000.
\10\ National Taxpayer Advocate 2004 Annual Report to the Congress,
Volume 1 December 2004.
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The IRS offers free assistance to taxpayers with tax preparation
and filing through its Taxpayer Assistance Centers, Voluntary Income
Tax Assistance, and Tax-Aide Programs as well as through the Free File
Program. Similar to the Free File Program, taxpayers must meet certain
requirements in order to receive assistance from those other programs.
The Free File Program, however, is the only free filing option that
taxpayers may use from their homes. Taxpayers must bring their tax
documentation to an assistance site to take advantage of the other free
tax preparation and filing services.
The addition of the RAL provisions, increased security, and added
performance measures to the agreement are important means to further
promote public confidence in the Free File Program. Adding the
electronic indicator to returns filed through the program will provide
the IRS with information to measure the program's success. However,
limiting the scope of the program to 70 percent of taxpayers has
impacted the use of the program. Based on the statistics Alliance
members provided in previous years, the new limits in the amendment to
the agreement appear to be substantially reducing participation in the
program. Furthermore, the AGI limit also keeps the program from
achieving the full intent of the EZ Tax Filing Initiative, which never
specified any such limits for access to free, basic, automated tax
preparation and electronic filing. Not yet known, however, is whether
the IRS' ability to better understand who is using and who is not using
the program will help the IRS better market the program and expand its
usage despite the new limits. The answer to that question may
ultimately have a significant effect on the overall growth rate of
electronic filing.
Elimination of the TeleFile Program
As mentioned earlier in my statement, one factor that appears to
have negatively impacted the Free File Programgrowth of e-filing this
year is the elimination of the TeleFile Program. The IRS discontinued
this program for individual taxpayers in August 2005. The TeleFile
Program allowed taxpayers with the simplest tax returns \11\ to file
their returns by telephone. The pilot TeleFile Program was launched on
a limited basis in 1992, and the program became available nationally in
1997. The RRA 98 included the expectation that the IRS would continue
to offer and improve TeleFile, and make a similar program available on
the Internet.
---------------------------------------------------------------------------
\11\ Forms 1040EZ.
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Despite its initial success, use of the TeleFile Program began to
decrease in 1999. According to IRS electronic filing statistics as of
April 17, 2005, approximately 3.3 million filers used TeleFile in 2005,
a 12.7 percent decline from the previous year. Until the IRS eliminated
the TeleFile Program last year, participation in the program had
declined every year since 1999 when 5.2 million filers used it.
Declining use was one factor the IRS considered when deciding
whether or not to end the TeleFile Program. Other contributing factors
included the increasing cost of maintaining an aging TeleFile system,
declining and discontinued State TeleFile programs, and the growing use
of other electronic filing alternatives, such as the Free File Program.
According to the IRS, taxpayers who previously used TeleFile may
continue to file electronically using one of the following five
methods:
1. Tax preparers;
2. Personal computers with Internet access and tax preparation
software;
3. IRS' Free File Program;
4. Free tax assistance sites, such as the Voluntary Income Tax
Assistance and Tax-Aide Programs; and
5. IRS Taxpayer Assistance Centers.
However, two of the five alternatives require the taxpayer to pay
for tax preparation and filing services that were previously free, and
two other options require taxpayers to have access to computers and the
Internet. Consequently, in many cases, the most cost-effective avenue
for the taxpayer is to file a paper tax return. According to initial
IRS statistics, a significant number of former TeleFile users are
reverting to filing paper returns this year. As of March 17, 2006, the
number of paper Form 1040EZ returns filed has increased 22 percent
compared to this time last year (4.5 million in 2006 compared to 3.7
million in 2005), and there has been a corresponding decrease in
electronically filed Forms 1040EZ (5.8 million in 2006 vs. 7.3 million
in 2005).
TIGTA will further evaluate the impact of the elimination of the
TeleFile Program on taxpayers and the IRS' efforts to increase
electronic filing, and will report the results later this year.
Providing Quality Taxpayer Service Operations for the 2006 Filing
Season
Providing quality customer service to the taxpayer is not only a
primary goal of the IRS, but it is also one of its major management
challenges. The Commissioner has frequently stated that service
combined with enforcement will result in compliance. Quality taxpayer
service includes helping the taxpaying public understand their tax
obligations while making it easier to participate in the tax system.
Since the passage of the RRA 98, the IRS' focus on customer service
has led to many improvements. One of the goals of the IRS is to improve
taxpayer service by improving service options, facilitating
participation in the tax system by all sectors of the public, and
simplifying the tax process. Every year, the IRS helps millions of
taxpayers understand their tax obligations by answering questions on
its toll-free telephone lines or in person at local offices, making
information available on its web site, and responding to
correspondence.
Over the past seven years, the IRS has made commendable strides in
customer service. However, I am concerned that the IRS does not
sufficiently ensure that it uses adequate and reliable data for making
decisions that impact customer service operations. Recent decisions to
close Taxpayer Assistance Centers (TAC) and reduce the hours of
operation for toll-free telephone service were based primarily on input
from IRS functional areas and considered other factors that included
internal priorities, resource demands, and shifts in the IRS' customer
service perspective. However, data were not obtained from taxpayers who
use these services to determine the impact of removing or reducing
them.
After the IRS' closure announcement, Congress enacted legislation
to delay the closure of any TACs.\12\ The IRS is prohibited from using
funds provided in the Fiscal Year 2006 budget appropriation to reduce
any taxpayer service function or program until TIGTA completes a study
detailing the effect of the IRS' plans to reduce services relating to
taxpayer compliance and taxpayer assistance.
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\12\ Transportation, Treasury, Housing and Urban Development, the
Judiciary, the District of Columbia, and Independent Agencies
Appropriations Act, 2006, Pub. L. No. 109-115, 119 Stat. 2396 (2005).
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IRS.gov
IRS.gov continues to be one of the most visited Web sites in the
world, especially during filing seasons. As of the week ending March
18, 2006, the IRS is reporting a 5.7 percent increase in the number of
visits to IRS.gov over the same period last filing season. The IRS now
provides practitioners with online tools to provide better service to
their customers, such as electronic account resolution, transcript
delivery, and disclosure authorization. As of the week ending March 18,
2006, the IRS is also reporting a 17.9 percent increase in taxpayers
obtaining their refund information online via ``Where's My Refund.''
Toll-Free Operations
The 2006 Filing Season has presented unique challenges for the IRS
toll-free operations. The IRS had also planned to reduce the hours of
its toll-free telephone operation in Fiscal Year 2006. The IRS has
about 400 fewer full-time equivalents for toll-free telephone
operations than it had in Fiscal Year 2005 because of plans to reduce
operating hours from 15 to 12 hours per day. Congress, the Taxpayer
Advocate and the National Treasury Employees Union have expressed
concerns about the IRS reducing operating hours for the toll-free
telephone lines. A new law enacted in November 2005 requires the IRS to
consult with stakeholder organizations, including TIGTA, regarding any
proposed or planned efforts to terminate or significantly reduce any
taxpayer service activity.\13\ Congress recently further defined a
reduction of taxpayer service to include limiting available hours of
telephone taxpayer assistance on a daily, weekly, and monthly basis
below the levels in existence during the month of October 2005. TIGTA
is currently assessing the IRS' plans to reduce operating hours and
will report its results later this year.
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\13\ The Transportation, Treasury, Housing and Urban Development,
the Judiciary, the District of Columbia, and Independent Agencies
Appropriations Act, Pub. L. No. 109-115, 119 Stat. 2396 (2006).
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As of March 18, 2006, assistor level of service has not been
negatively impacted, with an IRS reported level of service rate of 84.3
percent. In addition, about 8 percent fewer assistor calls are being
answered but the number of taxpayers who hang-up prior to reaching an
IRS assistor is up 8.5 percent. The average speed of answer is about 60
percent of the time planned so those taxpayers who are calling and
talking with an assistor are not experiencing longer wait times.
In planning for Fiscal Year 2006, IRS management expected fewer
calls program-wide, even after taking into consideration taxpayers
affected by Hurricanes Katrina and Rita. IRS management believed that
most taxpayers needing disaster relief assistance obtained it during
the latter part of 2005. Prior to the start of the filing season, TIGTA
brought to IRS management's attention our concern that more taxpayers
than expected could call the help line with questions due to the
effects of Hurricanes Katrina and Rita.
After we shared our concern, IRS management raised the estimated
volume of services to these telephone lines by about 78,000 services,
from approximately 27,000 to about 105,000 from January through June
2006, a 365.1 percent increase over the total Fiscal Year 2005 services
provided on those telephone lines. For the 2006 Filing Season it
appears that the calls to these telephone lines are higher than
anticipated. For example, the IRS had planned 59,081 services for one
of its applications devoted to assisting disaster victims; however,
through March 16, 2006, the IRS has already provided 106,141 services.
Taxpayer Assistance Centers
The TACs are walk-in sites where taxpayers can receive answers to
both account and tax law questions, as well as receive assistance
preparing their returns. The IRS has acknowledged that staffing would
be a challenge during the 2006 Filing Season since not all TACs would
be fully staffed and not all TACs will provide standard services or
standard hours of operation (from 8:30 a.m. to 4:30 p.m., Monday
through Friday). As of December 1, 2005, the IRS identified 47 TACs
with critical staffing shortages (a critical vacancy is one that must
be filled to ensure that a TAC remains open).
The IRS took actions to minimize the impact of the staffing
shortages. As of January 31, 2006, the IRS had hired additional
frontline technical employees, recalled intermittent employees back to
work, detailed former TAC employees from their current positions in
other IRS functions back to the TACs, and made plans to have some
employees travel between TACs to ensure that all TACs remain open
daily. The IRS' decision to focus more resources on compliance
activities, however, has further limited resources available for the
TAC Program. As a result, the IRS has limited some assistance services
and not all TACs are open during standard operating hours. As of the
week ending March 11, 2006, the IRS is reporting a 12.8 percent
reduction in TAC contacts with taxpayers.
Although the IRS publicized when TAC operating hours are limited,
it did not publicize when TACs limit their services. When notified by
TIGTA, the IRS implemented changes and standardized the list of
services offered at each TAC. Furthermore, the IRS modified its
Internet site, IRS.gov, to indicate when TACs would provide limited
services.
While planning for the 2006 Filing Season, the IRS considered the
impact of Hurricanes Katrina and Rita. Specifically, the IRS accounted
for all employees affected by the hurricanes and located alternate
office space in affected areas. All TACs in impacted areas are open and
operational for the 2006 Filing Season. The IRS also added services to
help lessen taxpayer burden, including tax return preparation for
taxpayers affected by the hurricanes regardless of the income
guidelines. Additionally, the scope of tax law topics in which
assistors are trained was expanded to provide assistance to taxpayers
with questions about casualty losses. Furthermore, the IRS will treat
taxpayers affected by Hurricanes Katrina and Rita as meeting extreme
hardship criteria. That designation allows affected taxpayers to
request and immediately receive transcripts of prior year tax returns
instead of having to order them and wait for delivery.
TIGTA is currently in the process of making anonymous visits to
TACs to determine if taxpayers are receiving quality service, including
correct answers to their questions. TIGTA will also visit additional
TACs to ask tax law questions specifically related to the Katrina
Emergency Tax Relief Act of 2005. IRS assistors should have been
trained to answer these questions. TIGTA's preliminary observations are
that assistors sometimes inappropriately refer taxpayers to
publications to conduct their own research, or respond to tax law
questions without following required procedures such as using the
publication method guide that requires them to ask probing questions.
Volunteer Income Tax Assistance (VITA) Program
The VITA Program plays an increasingly important role in IRS'
efforts to improve taxpayer service and facilitate participation in the
tax system. The VITA Program provides no-cost Federal tax return
preparation and electronic filing to underserved taxpayer segments,
including low income, elderly, disabled, and limited-English-proficient
taxpayers. These taxpayers are frequently involved in complex family
situations that make it difficult to correctly understand and apply tax
law.
TIGTA is currently in the process of visiting VITA sites to
determine if taxpayers are receiving quality service, including the
accurate preparation of their individual income tax returns. TIGTA
developed scenarios that are designed to present volunteers with a wide
range of tax law topics that taxpayers may need assistance with when
preparing their tax returns. These scenarios include the
characteristics (e.g., income level, credits claimed, etc.) of tax
returns typically prepared by the VITA Program volunteers based on an
analysis of the Tax Year 2004 VITA-prepared tax returns. TIGTA's
preliminary observations are that volunteer sites do not always use the
tools and information available when preparing returns.
Conclusions
To date, TIGTA has not identified any significant processing
problems during the 2006 Filing Season. Furthermore, the IRS has taken
a number of actions to ensure that taxpayers impacted by Hurricanes
Katrina and Rita are able to obtain disaster relief assistance. TIGTA
will continue monitoring the IRS' administration of the disaster relief
provisions to ensure that impacted taxpayers are receiving the relief
to which they are entitled.
While the 2006 Filing Season appears to be progressing without
major problems, I am concerned that changes in the Free File Agreement
as well as the elimination of Telefile Program may have contributed to
a significant slowing of the growth in electronic filing this year.
This slowed growth comes at a time when the IRS is still far from
reaching Congress' goal of 80 percent electronic filing by 2007. Slower
growth in electronic filing will defer the efficiency gains for the IRS
that result from electronic filing.
Reducing customer services, such as TAC closures, the elimination
of the TeleFile Program, and a reduction in toll-free hours of
operation, to gain resource efficiencies must be carefully considered
before any further decisions are made. TIGTA continues to be concerned
that the IRS does not ensure that it has adequate and reliable data
prior to making decisions that impact customer service operations.
Before proceeding with these efforts, the IRS needs to better
understand the impact of such changes on taxpayers as well as
taxpayers' abilities to obtain these services through alternative
means.
I hope my discussion of some of these 2006 Filing Season issues
will assist you with your oversight of the IRS' filing season
operations. Mr. Chairman and Members of the Subcommittee, thank you for
allowing me to share my views. I would be pleased to answer any
questions you may have at this time.
Chairman RAMSTAD. Thank you, Mr. George. The Chair would
now recognize the Honorable Raymond T. Wagner. Chairman Wagner?
STATEMENT OF THE HONORABLE RAYMOND T. WAGNER, JR., CHAIRMAN,
INTERNAL REVENUE SERVICE OVERSIGHT BOARD
Mr. WAGNER. Thank you, Mr. Chairman, Members of the
Committee. Thank you for this opportunity to present the
Oversight Board's recommendations for the IRS fiscal year 2007
budget. I have submitted a written statement with more details,
and I respectfully ask this Committee to make that statement a
part of this hearing record.
Chairman RAMSTAD. So ordered.
Mr. WAGNER. The Oversight Board recommends an fiscal year
2007 IRS budget of $11.31 billion, an increase of $732 million
over the enacted fiscal year 2006 budget. This compares to the
President's budget request of $10.59 billion in direct
appropriations. The two budgets share some essential elements.
Both reflect the same adjustments for inflation of $272
million. Both show a savings in reinvestment of $122 million,
and both are supplemented by $135 million in increased user
fees to achieve a higher operating level.
The Board recognizes the theme of the fiscal austerity in
all components of the President's budget, and we highly respect
what the administration is doing. That said, the Board's
statutory responsibility is to speak to a budget which will
ensure that the IRS can carry out its mission and its annual
and long-term strategic plans.
Mr. Chairman, we believe that effective tax administration
and reducing the tax cap requires a comprehensive multi-faceted
long-term plan with organizational commitment and action on
many fronts, from a simpler tax code and more complete income
reporting, to more effective enforcement and service that
improve taxpayer compliance.
We recommend program increases of $705 million in four
program areas. The Board recommends $44 million for more
taxpayers services, $368 million for more enforcement, $105
million for management and infrastructure, $189 million for
business systems modernization (BSM).
Let me summarize the Board's recommendations. In the area
of customer service, the Oversight Board seeks to restore
levels to the fiscal year 2003--2004 levels of performance.
During that period the telephone level of service on the main
toll free line was 87 percent. Since then there has been a
modest erosion in that measure with a 2007 level of service
target of 82 percent. The Board also recommends an additional
$368 million for enforcement. Of that, $308 million would
provide for additional resources to combat egregious
noncompliance, especially among small business and self-
employed taxpayers. We would also add resources to curtail
noncompliance and abusive schemes, nonfilers in corporate
employment taxes and EITC payment fraud.
The Board also calls for $60 million to provide up-to-date
research on taxpayer compliance and the sources of
noncompliance, which could then therefore be used to influence
strategic planning in their resource allocation decisions.
To this end, the Board recommends that the IRS make the
National Research Program permanent, perform compliance
research annually, and produce solid up-to-date tax gap
estimates for all taxpayer segments. We also need solid
research on customer service needs and how customer service
affects compliance.
I want to emphasize that taxpayers want more service and
enforcement from the IRS. The Board surveys of taxpayer
attitudes in 2004 and in 2005 indicate that approximately two-
thirds of taxpayers support additional IRS funding for both
service and enforcement. Time does not permit me to describe
our recommendation for infrastructure and management fully, but
I would like to highlight one specific recommendation, the need
to restore leadership, development training to fiscal year 2003
levels. The lack of leadership training capacity at the IRS is
especially critical during a period in which approximately 50
percent of the IRS managers are eligible for retirement.
It is also critical to discuss BSM. Despite productivity
improvements in recent years, the IRS is still forced to rely
upon a 40-year-old information system. No modern financial
institution in the private sector could survive under these
conditions, and eliminating these limitations are key to making
the IRS as efficient and as effective as a modern financial
institution. The Board recommends that BSM move forward at an
accelerated pace.
Another very important topic to taxpayers is the ability to
electronically file their tax returns, as we have heard much
discussion about so far today. Electronic filing of individual
tax returns so far this filing season is growing at a mere 2.6
percent compared to the previous year. Although the filing
season is far from over, this growth rate is below the historic
growth rate. The Board has recommended in its 2005 electronic
filing report to Congress to extend the Congressionally
mandated goal of 80 percent of all returns file electronically
from 2007 until 2011. The 2007 goal has become unrealistic, as
we have heard, and will not be met. Extending the goal to 2011
will not only clarify Congressional intent that the goal is
important, but by setting a realistic date, it will restore the
goal's ability to influence key policy decisions and affect
electronic filing.
Mr. Chairman, this concludes my oral statement, and I would
be pleased to answer your questions. Thank you, sir.
[The prepared statement of Mr. Wagner follows:]
Statement of The Honorable Raymond T. Wagner, Chairman,
Internal Revenue Service Oversight Board
INTRODUCTION AND OVERVIEW
Mr. Chairman, thank you for this opportunity to present the
Oversight Board's views on the Administration's FY2007 IRS budget
request. I will explain in my testimony why the Board believes its
proposed budget is needed to meet the needs of the country and of
taxpayers. In developing these recommendations, the Board has applied
its own judgment but has also drawn on the collective wisdom of others
in the tax administration community, including the IRS, Government
Accountability Office (GAO), the Treasury Inspector General for Tax
Administration (TIGTA), National Taxpayer Advocate, and Congress.
In fulfilling its responsibilities, the Board must ensure that the
IRS' budget and the related performance expectations contained in the
performance budget support the annual and long-ranges plans of the IRS,
support the IRS mission, are consistent with the IRS goals, objectives
and strategies and ensure the proper alignment of IRS strategies and
plans. In addition to my statement today, the Board is developing a
formal report in which it will explain why it has recommended this
budget for the IRS.
Now is a fiscally challenging time for our nation. Defense and
homeland security needs coupled with rebuilding efforts along the
hurricane-ravaged Gulf Coast have placed an enormous strain on the
federal budget.
In addition to our fiscal challenges, taxpayers are expected to
comply with an increasingly complex tax code which places heavy burdens
on honest taxpayers who wish to comply and offers untold opportunities
for mischief by those who do not.
Against this backdrop, it is imperative that government work better
and smarter and get the most out of every taxpayer dollar. But there is
also a drain on the Treasury that undermines our country's tax revenues
and threatens the integrity of our tax administration system--the tax
gap.
The IRS recently disclosed that the nation's annual tax gap--the
difference between what is owed and what is collected annually--stands
at $345 billion, and some experts believe it could be even more. The
Board considers the existence of such a large tax gap to be an affront
to honest taxpayers, and is pleased with the attention that Congress
has focused on the tax gap in the last year, especially with the
release of the IRS' latest tax gap estimates. The Board, along with
many other members of the tax administration community, believe that
reducing the tax gap requires a comprehensive, multi-faceted plan with
action on many fronts--from a simpler tax code and more complete income
reporting to better enforcement and quality customer service.
Such an approach needs to be more thoughtful and comprehensive that
merely increasing IRS resources and expecting that the gap will shrink.
However, increased IRS resources are certainly a part of the solution.
A successful strategy will encompass several separate but interrelated
approaches that will reinforce each other to produce the desired
result. In the Board's opinion, a number of actions that can be taken
will require additional IRS resources.
The Oversight Board recommends an integrated set of strategies to
close the tax gap: (1) tax code simplification; (2) improved
information reporting and enforcement tools related to the cash
economy; (3) improved customer service to make taxpayers aware of their
obligations and modern technology to ease their burdens; (4) greater
focus on research; (5) more productive partnerships between the IRS and
tax professionals; and (6) and more emphasis on personal integrity.
There can be no doubt that in the last five years the agency has
achieved significant progress in all dimensions of its mission.
Customer service has rebounded from the lows of the 1990s and through
targeted investments and greater management focus, IRS enforcement has
also turned the corner.
This across-the-board improved performance has not gone unnoticed--
especially among taxpayers. According to the 2005 American Customer
Service Index, overall satisfaction among individual tax filers with
the Internal Revenue Service remains stable at 64 percent; it is even
higher among e-filers. The IRS Oversight Board 2005 Annual Survey also
found that American taxpayer support for overall compliance reached an
all-time high. However, the IRS's job is far from complete and it must
close the tax gap while achieving balance in other parts of its
critical mission.
The Board recommends budget increases in four IRS program areas in
FY2007: customer service, enforcement, Business Systems Modernization,
and infrastructure and management tools.
To achieve balance and ultimately compliance, the Board recommends
two modest investments in customer service to ensure that there is no
slippage in hard won gains. For example, the toll-fee telephone level
of service is slightly down and wait times have increased compared to
FY2004. The Board proposes restoring customer service to FY2003/4
levels and investing in telephone infrastructure. It is far less
expensive to prevent or solve a problem early on than let it grow.
The Board proposes a modest increase in resources for virtually all
IRS enforcement activities. This is money well-spent and there is a
growing recognition of the positive return on money invested in the
IRS. The Board strongly believes that the enforcement increase includes
a significant investment in research to better understand enforcement
and customer service needs and the impact of customer service on
voluntary compliance. The Board's recommended budget puts the IRS on
track to make the National Research Program (NRP) permanent and produce
annual tax gap estimates. The Board further recommends that the IRS
consider developing a long-term strategic plan for research.
Business Systems Modernization is also a priority and the Board
advocates a larger investment in information technology to improve IRS
productivity and reduce taxpayer burden. Despite productivity
improvements in recent years, the IRS is still hampered in its efforts
to modernize because of its reliance on a forty-year-old information
system for its central recording-keeping functions, which limit the IRS
to weekly updates of its central taxpayer records. No modern financial
institution in the private sector could survive under these conditions
and eliminating these limitations is key to making the IRS an efficient
and effective modern financial institution.
Last, the Board recommends a number of management increases that
will help the IRS cope with unfunded mandates, implement BSM projects,
and restore leadership training to FY2003 levels, which has become
especially critical during a period in which over 50 percent of IRS
managers are eligible to retire.
Overall, the Oversight Board proposes a budget that is good for the
country, good for taxpayers, and allows the IRS to achieve its
strategic goals and objectives in an efficient and effective manner. It
calls for $11.3 billion funding for FY2007, a 6.9 percent increase over
last year's appropriation.
The Board has also voiced concern that two items in the
Administration's proposed FY2007 budget for the IRS pose significant
risks. First, the budget proposes $84 million in savings from program
efficiencies. The Oversight Board believes there is a risk that these
reductions will decrease performance. Second, last December the IRS
announced that it would dramatically raise fees for certain services
and the President's budget assumes that the IRS will receive an
additional $135 million in fee revenue. Although the IRS has expressed
confidence it would receive this amount in additional fees based on its
estimates, there is still some risk whether the estimated fee revenue
can be achieved. In addition, external stakeholders have expressed
concern that the additional fees could have an unintended negative
impact on taxpayer compliance.
In conclusion, the Board believes that it has constructed a
fiscally responsible and realistic budget for the IRS that meets
national needs and priorities. It would help shrink the tax gap while
providing taxpayers with a level of service they rightly deserve and
need. It would speed the modernization of the IRS' antiquated
technology and give it the research tools to better understand current
and developing trends. Most importantly, it would maintain that
delicate but critical balance between enforcement and customer service
that America's taxpayers have said time and again they want, and which
has been validated through the Board's Taxpayer Attitude Survey. The
IRS is now solidly on the right track and is making progress, but we
must give it the resources to do its job. It is the right investment
for this and future generations of taxpayers.
Recommended IRS Oversight Budget in Brief
The IRS Oversight Board recommends an FY2007 IRS budget of $11.31
billion, an increase of $732 million over the enacted FY2006 budget.\1\
This recommendation compares to the President's budget request for the
IRS of $10.59 billion in direct appropriations. The two budgets share
the following characteristics:
Both reflect the same adjustments for inflation, $272
million
Both show a savings and reinvestment of $121.6 million
Both are supplemented by $135 million in increased user
fees to achieve a higher operating level
The Board's budget, however, proposes program increases of $705
million compared to a proposed program decrease of nearly $9 million in
the President's budget, as shown in the table below.
Comprison of Board and President's Program Increases
(all dollars in thousands)
------------------------------------------------------------------------
Oversight Board President's
Function Recommendation Request
------------------------------------------------------------------------
Taxpayer Service $ 43,637 $ 0
------------------------------------------------------------------------
Enforcement $367,768 $ 0
------------------------------------------------------------------------
Infrastructure and Mgt $104,715 $20,900
Modernization
------------------------------------------------------------------------
Business Systems Modernization $188,600 ($29,700)
------------------------------------------------------------------------
Total Program Increases $704,720 ($ 8,800)
(Decreases)
------------------------------------------------------------------------
Recommended initiatives for enforcement, customer service,
infrastructure and management and Business Systems Modernization can be
found in the individual sections of this statement and Appendices 2
through 5.
IRS Performance from FY2001 to FT2005
The agency, which had become synonymous with poor customer service
in the late 1990s, has demonstrated a remarkable performance
improvement in the last five years. Toll-free telephone level of
service has steadily increased from 56 percent in FY2001 to a high of
87 percent in FY2004. (In FY2005, there was a slight three percent drop
which the IRS attributes to reduced funding for taxpayer services.)
Toll-free tax law accuracy also rose from 82 percent in FY2003 to an
impressive 88 percent in FY2005.
Perhaps the most important and notable gain recorded over the past
five years is the percent of individuals filing electronically--31
percent in FY2001 to 51 percent in FY2005.\2\ And although it will miss
the 2007 deadline, the IRS is making steady progress in closing in on
the 80 percent e-file goal established by the IRS Restructuring and
Reform Act of 1998.
Through targeted investments and greater management focus, IRS
enforcement has also turned the corner. Enforcement revenue rebounded
from $33.8 billion in FY2001 to $44.1 billion in FY2005. Audit rates
also steadily increased. For high-income individuals they rose from
0.79 percent in FY2001 to 1.61 percent in FY2005. Over the same time
period, corporate and small business audits increased respectively from
13.5 percent to 16.9 percent and 0.88 percent to 1.32 percent.
Taxpayers Respond to Better Performance but Problems Remain
This across-the-board improved performance has not gone unnoticed--
especially among taxpayers. According to the 2005 American Customer
Service Index, overall satisfaction among individual tax filers with
the IRS remains stable at 64 percent. However, the number is much
higher among e-filers who had an ACSI score of 77 percent.\3\ By way of
comparison, the IRS received a 51 percent score in 1998. Taxpayer
attitudes have also improved. Since 2002, the IRS Oversight Board has
conducted an annual survey to gain a deeper understanding of taxpayers'
attitudes. Of great concern was the growing number of individuals who
thought it acceptable to cheat on their taxes.
In 2003, twelve percent of respondents thought it acceptable to
cheat a ``little here and there'' on their taxes, and five percent
would cheat as much as possible. However, two years later those numbers
have dropped to seven and three percent respectively and public support
for tax compliance is at an all-time high. Moreover, the 2005 survey
found that 82 percent of respondents say that their own personal
integrity has the greatest influence on whether or not they report and
pay their taxes honestly--double the number who cite any other factor.
Significantly, the survey also found two out of three surveyed
expressed continued support for additional funding for both IRS
assistance and enforcement.\4\ America's taxpayers want a balanced tax
administration system.
However, as welcome as the news may be, it cannot disguise the hard
fact that the tax gap has remained unacceptably high. In testimony
before the Senate Budget Committee, Comptroller General David Walker
stated that the $345 billion tax gap estimated by the IRS could indeed
be greater: ``IRS has concerns with the certainty of the overall tax
gap estimate in part because some areas of the estimate rely on old
data and IRS has no estimates for other areas of the tax gap. For
example, IRS used data from the 1970s and 1980s to estimate
underreporting of corporate income taxes and employer-withheld
employment taxes.'' \5\
The tax gap is more that an abstract number. According to National
Taxpayer Advocate Nina Olson, it hurts taxpayers in a very concrete
way:
The collective failure by certain taxpayers to pay their taxes
imposes greater burdens on other taxpayers. The IRS receives
approximately 130 million individual income tax returns each year.
Given the size of the net tax gap, the average tax return includes a
``surtax'' of about $2,000 to make up for tax revenues lost to
noncompliance. The tax gap may also impose significant costs on
businesses in the form of unfair competition by noncompliant
competitors who can pass along a portion of their tax ``savings'' to
customers by charging lower prices.
Most importantly, the tax gap can erode the level of confidence
that taxpayers have in the government, thereby reducing federal revenue
and increasing the need for more examination and collection actions.
The tax gap, then, can produce a vicious cycle of increased
noncompliance and increased enforcement.\6\
The IRS Oversight Board believes that its FY2007 IRS budget
recommendations are part of the solution to reversing this corrosive
trend.
Budget Environment Should Not Discourage Investment
The IRS does not operate in a vacuum and the Oversight Board
recognizes that the current budget environment stresses fiscal
restraint and austerity. However, at the same time, we should not throw
up our hands in defeat and say we can do no more to improve tax
administration. We should look at the larger picture.
Unlike other government agencies, there is a positive return on
money invested in the IRS. Senate Budget Committee Chairman Judd Gregg
agrees. He observed at a recent hearing on the tax gap, ``We've got to
talk to the CBO about scoring on that [investing in IRS enforcement],
clearly there's a return on that money.'' \7\
The Board would welcome such a change but also recognizes that this
is a problem that has plagued the IRS for decades. Former IRS
Commissioner Charles O. Rossotti wrote:
When I talked to business friends about my job at the IRS, they
were always surprised when I said that the most intractable part of
job, by far, was dealing with the IRS budget. The reaction was usually,
``Why should that be a problem? If you need a little money to bring in
a lot of money, why wouldn't you be able to get it? \8\
Indeed, this lack of recognition of a direct return on investment
has left many puzzled. In his April 14, 2004 column, Washington Post
financial writer Al Crenshaw wondered why the Administration and
Congress ``aren't falling over themselves to give the IRS more money.
Tax Enforcement pays for itself many times over, and it would be a good
way to cut the deficit.'' \9\
In its FY2007 budget recommendation, the Board calls for increases
in enforcement that would result in a real return on investment,
ranging from three to six dollars on every dollar spent, resulting in
$730 million revenue by FY2009 on a $242 million investment.
The Oversight Board urges Congress to adopt the Board's budget
recommendations and invest in more effective tax administration.
SIX STRATEGIES TO REDUCE THE TAX GAP
The Board considers the existence of such a large tax gap to be an
affront to honest taxpayers, and is pleased with the attention that
Congress has focused on the tax gap in the last year, especially with
the release of IRS latest tax gap estimates. The Board, along with many
other members of the tax administration community, believe that
reducing the tax gap requires a comprehensive, multi-faceted plan with
action on many fronts--from a simpler tax code and more complete income
reporting to better enforcement and quality customer service.
Such an approach needs to be more thoughtful and comprehensive than
merely increasing IRS resources and expecting that the gap will shrink.
That being said, however, increased IRS resources are a part of the
solution. A successful strategy will encompass several separate but
interrelated approaches that will reinforce each other to produce the
desired result. In the Board's opinion, a number of actions that can be
taken will require additional IRS resources.
The Board supports six strategies that it believes would constitute
an over-arching plan to reduce the tax gap. This information is
presented here only to provide some additional background to understand
the Board's FY2007 budget recommendations, so that these
recommendations can be understood in the context of an overall approach
where the individual elements reinforce each other.
The first is a simplified tax code. Our complex and ever changing
tax code not only confounds honest taxpayers who want to comply with
their obligations under the law, but provides ample opportunity for
those who exploit its complexity to cheat. The President's Advisory
Panel on Federal Tax Reform observed:
Since the last major reform effort in 1986, there have been more
than 14,000 changes to the tax code, many adding special provisions and
targeted tax benefits, some of which expire after only a few years.
These myriad changes decrease the stability, consistency, and
transparency of our current tax system while making it drastically more
complicated, unfair, and economically wasteful. Today, our tax system
falls well short of the expectations of Americans that revenues needed
for government should be raised in a manner that is simple, efficient,
and fair.\10\
Second, the Oversight Board recommends improved information
reporting and enforcement tools to address large areas of the tax gap
related to what has been called the cash economy. Although the Board is
prohibited by statute from endorsing any specific proposal, we note
that in its FY2007 budget submission for the IRS, the Administration
makes five legislative recommendations to close the tax gap that
include: (1) increasing information reporting on payment card
transactions; and (2) expanding information reporting to certain
payments made by federal, state and local governments to procure
property and services. They certainly merit congressional discussion
and consideration.
The National Taxpayer Advocate also recommended in her 2005 Annual
Report to Congress that the IRS create a cash economy program office,
similar to the Earned Income Tax Credit program office. The Board is
pleased that the IRS Small Business/Self-Employed Operating Division
Commissioner has agreed to establish a task force on the cash economy
that will seek to determine the feasibility of this and other
recommendations.
In testimony before the Senate Budget Committee, the National
Taxpayer Advocate further recommended that to address the tax gap ``we
should begin by identifying various categories of transactions that
currently are not subject to information reporting and determine, on a
case-by-case basis, whether the benefits of requiring reporting
outweigh the burdens such a requirement would impose.'' \11\ The Board
supports such analysis.
Third, the Board believes that the IRS must improve customer
service to make taxpayers aware of their legal obligations and ease
taxpayer burden through modernization. Indeed, not all non-compliance
is willful; a significant amount of is due to the complexity of the tax
laws that results in errors. IRS Commissioner Mark Everson recently
testified:
[T]he tax gap does not arise solely from tax evasion or cheating.
It includes a significant amount of noncompliance due to the complexity
of the tax laws that results in errors of ignorance, confusion, and
carelessness. This distinction is important, though, at this point, we
do not have sufficiently good data to help us know how much arises from
willfulness as opposed to innocent mistakes. This is an area where we
expect future research to improve our understanding.\12\
Fourth, there should be a much greater emphasis and focus on
research so the IRS can more effectively target areas of major non-
compliance. It bears mentioning that a lack of research in the 1990s
contributed in part to the IRS' failure to detect the emergence and
subsequent epidemic of illegal tax avoidance schemes. The Board
recommends an additional $60 million in funding for research. The IRS
needs to know much more about non-compliance than it currently does to
mount a successful campaign against the tax gap.
Fifth, the Board urges a more productive partnership between IRS
and the tax administration community. At the Board's 2006 open meeting,
the AICPA supported the IRS' efforts to partner with professional
organizations in the area of pro bono tax assistance, noting that such
a synergy provides the IRS with the opportunity to leverage precious
resources and increase customer service at the same time. The Board
would add that such a partnership also contributes directly to
compliance.
Sixth, there must be more emphasis on personal integrity in making
tax decisions. The Board has found that the vast majority of taxpayers
state that their personal integrity is a very import factor in
influencing their tax compliance. In the Board's most recent Taxpayer
Attitude Survey, 82 percent of taxpayers cite personal integrity as the
principal factor for reporting and paying their taxes honestly.
Commissioner Everson also testified at the Senate Budget Committee tax
gap hearing:
[A]nother enforcement priority is to assure that attorneys,
accountants, and other tax practitioners adhere to professional
standards and follow the law. Our system of tax administration depends
upon the integrity of practitioners. The vast majority of practitioners
are conscientious and honest, but even the honest tax professionals
suffered from the sad and steep erosion of ethics in recent years by
being subjected to untoward competitive pressures.\13\
Our tax administration system should challenge taxpayers to be
conscious of the need for integrity when making tax decisions.
The Oversight Board recognizes that no single initiative or program
will solve the tax gap--a multi-faceted effort must be taken to shrink
it. The plan must be more comprehensive than just applying additional
resources to do more of what is being done today. Indeed as
Commissioner Everson told the Senate Budget Committee, a combination of
appropriate funding, legislative changes, new enforcement tools, tax
simplification and auditing and taxpayer service improvements, will
allow the IRS to collect an additional $50-100 billion.\14\ The $705
million in additional funding recommended by Board to help in this
effort is dwarfed in comparison to this estimate of new revenues
collected.
COMPARING THE PRESIDENT'S AND BOARD'S FY2007 BUDGET RECOMMENDATIONS
The size of the tax gap should be a clarion call for our nation to
examine the tax administration system and invest time, energy, and
resources to making it better.
This is not the time to stand still but to move forward in a
comprehensive and unified way to build on what has already been
accomplished and give America's taxpayers a better, more efficient and
fair system in return--what the President's tax reform panel suggested.
The Oversight Board's FY2007 budget recommendations focus on the IRS
resources needed to move forward in FY2007, but much more needs to be
done.
To this end, the Board recommends additional investments in better
service, enforcement, infrastructure and management, and BSM in the
following amounts:
Taxpayer Service $ 43,637
Enforcement $367,768
Infrastructure and Management $104,715
BSM $188,600
Additionally, the Oversight Board has identified two areas of
significant risk in the IRS' FY2007 budget request. First, the IRS
budget justification includes $84.1 million in savings coming from
program efficiencies. The Board is concerned that the IRS may not be
able to achieve these efficiencies without decreasing performance.
Second, the proposed IRS budget for FY2007 in direct appropriations
is supplemented by $135 million in increased user fees. The IRS
announced last December that it would charge taxpayers for receiving
advance assurance from the IRS about the tax consequences of certain
transactions. For example, the fee for IRS Chief Counsel private letter
rulings will increase from $7,000 to $10,000.\15\
The Oversight Board believes that there is risk in assuming that
this revenue stream will be available without a proven record of
collecting fees at this level, especially since the IRS could not
present the Board with FY2006 data to confirm the realism of the
proposed FY2007 revenue stream. The Board recommends that Congress
evaluate actual FY2006 fee collection data to evaluate the validity of
the proposed FY2007 revenue expected from increased fees.
The Board is also concerned about the negative impact these fees
might have on taxpayer compliance. Testifying at the Board's annual
public meeting, the AICPA was also apprehensive that these increases
will result in a substantial reduction in general taxpayer use of
critical IRS programs:
These programs for the most part encourage taxpayers to seek
advance assurance from the IRS that the tax consequences of their
proposed actions will be treated consistently by both the taxpayer and
the IRS. Actions by the IRS that discourage use of programs, such as
private letter ruling requests, could result in greater compliance
costs for taxpayers and enforcement costs for the IRS.\16\
Customer Service: What Is ``Good Enough?''
Good customer service leads to fully informed and satisfied
taxpayers who understand their tax obligations and experience few
problems in interacting with the IRS. Clearly, there is a linkage
between customer service and compliance. Speaking at the Board's 2006
open meeting, Diana Leyden, Associate Clinical Professor of Law,
University of Connecticut School of Law Tax Clinic said:
Customer service at the Internal Revenue Service has a direct
impact on voluntary compliance and ultimately on the tax gap. For
example: (1) making it easier for taxpayers to get their returns
prepared free of charge and quickly encourages taxpayers to become
compliant; (2) providing face-to-face interaction with IRS employees
helps taxpayers get advice in `real time' and usually reduces the time
for resolution of problems.\17\
At the April 14, 2005 Senate Finance Committee hearing on closing
the tax gap, Ranking Member Max Baucus similarly observed:
The IRS cannot close the tax gap simply by increasing enforcement.
Issuing more liens. Conducting more seizures. Levying more bank
accounts. We do need targeted, appropriate enforcement. If, however,
the IRS lets taxpayer service slide--if the IRS diminishes the access
and accuracy of taxpayer service--including the essential need for
face-to-face taxpayer service--then we fail to help taxpayers comply
with the law on the front end. Ensuring up front quality is more
efficient than back end enforcement.\18\
However, efforts to provide quality customer service are hindered
by the fact that there is no consensus among the tax administration
community on desired customer service standards of performance, which
makes informed decision-making about desired levels of service very
difficult. Achieving such a consensus among the executive and
legislative branches and external stakeholder organizations would allow
customer service requirements to influence budget decisions rather than
having budget decisions set service levels.
The drive for improved customer service is further aggravated by
the lack of data on the impact that service levels have on taxpayer
compliance. Such data could be used to make a stronger case to policy
makers about the importance of customer services. We should not retreat
from the high customer service levels previously achieved during
FY2003/2004. Two initiatives contained in the Board's budget are
designed to prevent such a reduction.
First, although significant progress has been made during the past
five years, toll-free telephone level of service is slightly down from
FY2004 and call wait-time on hold has increased. To restore the level
of service, the Oversight Board proposes an initiative to restore the
toll-free telephone service to FY2003/2004 levels. Although the cost is
$35 million, the Board believes that this level of service should be
provided to taxpayers. The potential impact of lower service is that
taxpayers will not get the assistance they need, hurting compliance,
and creating a need for additional enforcement. As Senator Baucus
rightly observed, preventing problems is more cost-effective than the
price of future corrections, such as collection.
Second, the Board also recommends an $8.7 million investment in
telephone infrastructure to expand services to callers and provide
telephone representatives with a more state-of-the-art call center
environment. The IRS predicts this investment would result in lower
queue times across the enterprise for all applications and would
counter a negative trend in telephone service. (Wait time on hold for
taxpayers has been increasing in the last three years. It has gone from
158 seconds in FY2004 to 258 seconds in FY2005, and the FY2006 target
is 300 seconds.)
Enforcement Must Continue to Improve; More Research Needed
As noted earlier in this report, the IRS has boosted its
enforcement activity, and enforcement revenue has increased during the
last two years. The IRS is working smarter and it needs to continue to
improve and build on this important trend.
However, it should be noted that despite these positive results, it
is difficult to evaluate the impact that increased enforcement activity
has had on overall taxpayer compliance.
Absent this information, the Oversight Board still believes that
one important element of the campaign to reduce the tax gap should be
increasing IRS enforcement resources, especially since the application
of additional resources has a positive return on investment. The Board
recommends a modest increase in enforcement resources in virtually all
IRS enforcement activities, including:
1. Combat Egregious Non-Compliance and Prevent Tax Gap Growth
(+$136 million) Add 748 FTEs to enhance coverage of high-risk
compliance areas and address the tax gap associated with small business
and self-employed taxpayers.
2. Intensify Tax Enforcement (+$28 million) Add 86 FTEs to curtail
non-compliance in abusive schemes, corporate fraud, non-filers,
employment tax and Bank Secrecy Act
3. Attack Fraudulent Payments (+$27 million) Add 62 FTEs to
address fraudulent payments made through the EITC program.
The IRS must also do a better job of identifying where non-
compliance is occurring. For example, IRS data indicates impressive
results on abusive, high-profile tax shelters, such as Son-of-BOSS.
However, the most recent research indicates that a majority of the tax
gap is the result of underreporting of income in areas where there is
little third-party reporting.
According to the IRS' National Research Program, half ($109
billion) of the individual underreporting gap came from understated net
business income (unreported receipts and overstated expenses).
Approximately 28 percent ($56 billion) came from underreported non-
business income, such as wages, tips, interest, dividends, and capital
gains. The remaining $32 billion came from overstated subtractions from
income (i.e. statutory adjustments, deductions, and exemptions), and
from overstated tax credits.
Given this situation, the Oversight Board believes that special
attention should be placed on the National Research Program and
additional research be conducted on customer service and its relation
to compliance. Indeed, the National Taxpayer Advocate ``recommends that
the IRS undertake a research-driven needs-assessment, from the
taxpayers' perspective, to help identify what services taxpayers need
and want and how best to deliver them.'' \19\ These efforts are
necessary to improve tax administration to the point where the effects
of IRS activities on taxpayer compliance can be better understood. To
this end, the Board proposes two research initiatives: (1) Improve Tax
Gap Estimates (+$46 million); and (2) Additional Customer Service
Research (+$15 million).
The first of these two initiatives, Improve Tax Gap Estimates, will
establish permanent staffing for the NRP program and put the IRS on a
path to conducting research annually. The Oversight Board recommends
that the NRP be made a permanent program. The NRP is now reporting
estimates of the tax gap based on 2001 tax returns. Prior estimates
were based on extrapolations of 1988 data. It is time to progress from
``catching up'' to making current research the normal and preferred way
of doing business.
The Board also proposes that the IRS consider developing a long-
range strategic plan for research that goes beyond the current 2009 end
date for the IRS Strategic Plan, and covers approximately a decade. In
such a plan, the IRS should describe how it will bring its research on
all taxpayer segments up to date, and perform a limited sample every
year so that its research on all segments will be as current as
possible.
The Board believes the availability of up-to-date research data
will allow the IRS to more effectively focus its service and
enforcement programs on areas that have the greatest impact on taxpayer
compliance, and use the changes in taxpayer compliance rates as
feedback to evaluate the effectiveness of IRS' service and enforcement
program on actual taxpayer compliance. Achieving such a capability will
be a vast improvement over the current situation in which the lack of
data makes it virtually impossible to evaluate the effectiveness of IRS
activity on taxpayer compliance and make informed decisions.
The second research initiative recommended by the Board is to add
$15 million to begin research on the impact of customer service on
voluntary compliance and the service needs of taxpayers. The need for
such research is also consistent with recommendations made by Treasury
Inspector General for Tax Administration and the National Taxpayer
Advocate in testimony last year to the Senate Appropriations Committee
on the closing of a number of Taxpayer Assistance Centers. (The
committee has also requested TIGTA to evaluate the connection between
service and compliance in its study of TAC closings, but TIGTA was
unable to find much existing research.)
However, the IRS has told the Oversight Board that it could extend
and update research efforts in two major areas: evaluating the service
needs of taxpayers and estimating the effect of customer service on
taxpayer compliance. Additional resources in FY2007 would be used to
further evaluate the service needs of taxpayers and to scope and design
the data gathering and analysis capability to estimate the effect of
customer service on taxpayer compliance.
A modest initial effort should include identifying promising areas
of research and determining data needs. If the initial efforts are
promising, this could be expanded in future years. Due to the long-term
nature of these studies, resources should be provided on a multi-year
basis.
Modernizing Infrastructure and Management
The Oversight Board is pleased that the IRS is developing an IRS
Infrastructure Roadmap. It is a detailed plan for replacing the
agency's aging IT equipment in an orderly and cost-effective manner.
Rather than replacing outdated equipment on a one-for-one basis, the
roadmap will identify and prioritize opportunities to consolidate
equipment, retire redundant and low-demand infrastructure components,
and replace old equipment with new technology that is cheaper to
maintain and use. Because the IRS fully anticipates that the
Infrastructure Roadmap will identify new strategies for IT
infrastructure delivery that will mitigate the cost of replacing old IT
equipment while assuring a sound IRS IT infrastructure, the Board is
deferring any recommendations on modernizing IT infrastructure until
FY2008.
The Oversight Board does recommend funding infrastructure and
management initiatives that will assist the IRS to cope with unfunded
mandates, implement BSM projects, and restore its capacity for
leadership development training to FY2003 levels:
1. Fund Business Unit IT Solutions (Non-Major Investments)
2. Implement e-Travel
3. Fund HR Connect
4. Consolidate Philadelphia Campus (included in the President's
budget)
5. Restoration of Leadership Development Training to FY2003 levels
(Board-initiated)
The Board notes that a lack of leadership training capacity at the
IRS is especially critical during a period in which approximately 50
percent of IRS managers are eligible for retirement. The Board
recommends a consistent budget base to allow planning for these
anticipated leadership development training needs.
The requested funds would enable the IRS to: (1) eliminate the
backlog of untrained leaders at all levels by the end of FY2007; (2)
ensure enough capacity to train new managers upon selection in all
Business Units; (3) improve and expand readiness programs to provide a
cadre of manager candidates to step up to management positions; (4)
revise the management curriculum to incorporate more e-learning and
promote continuous learning; and (5) evaluate the effectiveness and
impact of the leadership development training program.
Funding Leadership Development Training at FY2003 levels will also
assist in meeting the objectives of the President's Management Agenda,
which in turn will improve performance and the IRS' objectives of
enhanced employee engagement, employee satisfaction and customer
satisfaction.
Business Systems Modernization
The Board is pleased that the IRS' once-troubled BSM program
experienced better performance in FY2005. In a recent report submitted
to Congress on the BSM FY 2006 expenditure plan, the Government
Accountability Office offered these positive comments:
IRS has made further progress in implementing BSM--Future BSM
project deliveries face significant risks and issues which IRS is
addressing--.IRS has made additional progress in addressing high-
priority BSM program improvement initiatives. [They] appear to be an
effective means of assessing, prioritizing, and addressing BSM issues
and challenges--In response to our prior recommendations, IRS reports
having efforts under way to develop a new Modernization Vision and
Strategy to address a new modernization roadmap.\20\
GAO also had some criticism of the IRS and BSM, but improved
management focus over the past few years has helped the BSM program
deliver within cost and budget targets important technology projects
that will generate greater efficiencies throughout the agency and real
world benefits for taxpayers.
The first taxpayers have already been moved to a modernized data
base known as the Customer Account Data Engine (CADE) and corporate
taxpayers are now able to file their income tax returns with the IRS
electronically using the Modernized e-File system. Indeed, CADE will
process more than 30 million returns in 2007 and will process 70
million by 2009. Daily updates by CADE will allow taxpayers to receive
their refund in just a few days.
Future BSM deliverables are also critical to improved customer
service and enforcement. The IRS does not yet offer products and
services familiar to customers of many financial institutions, such as
daily updating of accounts, electronic access by customers to account
records, and a full range of electronic transactions. However, with the
help of modern technology, the IRS can close this gap.
If the IRS can continue to demonstrate improvement, it would seem
desirable and logical to increase BSM's pace and program funding in
FY2007, especially as BSM funding levels were severely reduced in the
last several years: from $388 million in FY2004 to $203 million in
FY2005, and a requested $199 million in FY2006. In addition to the
base, the Board would fund:
1. Web-based Self-service (+$24 million)
2. Filing and Payment Compliance (+$30 million)
3. Modernized e-Filing (+$70 million)
4. Customer Account Date Engine (+$25 million)
5. Core Infrastructure (+$18 million)
6. Architecture, Integration, and Management (+$13 million)
7. Management Reserve (+$9 million)
Therefore, the Board recommends that the BSM program move forward
at an accelerated pace. Not only will this allow the IRS to operate
more efficiently and effectively, it will strengthen the agency's
efforts to enforce the tax law and improve customer service. Despite
productivity improvements in recent years, the IRS is still hampered in
its efforts to modernize because of its reliance on a forty-year-old
information system for its central recording-keeping functions, which
limit the IRS to weekly updates of its central taxpayer records. No
modern financial institution in the private sector could survive under
these conditions, and eliminating these limitations is key to making
the IRS an efficient and effective modern financial institution.
We would like to make one last point on modernization. Both GAO and
TIGTA have reported on the cost overruns and delays the BSM program has
experienced. However, one cost you will not hear about is the
significant cost to the taxpayers of delaying the benefits of a
modernized IRS.
Professor Joel Slemrod of the University of Michigan testified to
the President's Advisory Panel on Federal Tax Reform that individual
taxpayers spend approximately $85 billion a year complying with the tax
code.\21\ If a modernized IRS makes taxpayers only five percent more
efficient, that would still save taxpayers over $4 billion a year.
Electronic Filing
Another topic that is important to millions of taxpayers is the
ability to electronically file their tax returns. Electronic filing of
individual tax returns so far this filing season is growing at a 2.6
percent rate compared to the previous year. Although the filing season
is far from over, this growth rate is below the historical growth rate
and seems to be influenced by the following two factors:
The loss of approximately 2.6 million TeleFile returns
Fewer returns received through the Free File Alliance,
which is not offering free tax preparation and electronic filing for
taxpayers with income in excess of $50,000 this year. Last year this
capability was offered to all taxpayers.
The Board had reported in its 2005 Electronic Filing report to
Congress that although the e-filing goal had had very positive impacts
on the IRS and taxpayers, the IRS will not meet its congressionally-
mandated goal of 80 percent of all returns filed electronically by
2007, and that other groups, such as the Electronic Tax Administration
Advisory Council (ETAAC) have made similar observations. In this
report, the Board recommended that Congress extend the goal to 2011,
and performed an analysis to demonstrate the revised goal was
realistic.
The Board is concerned that the 2007 goal is becoming so widely
perceived as unrealistic that it is losing its potency. Extending the
goal to 2011, as recommended by the Board, will not only clarify
congressional intent that the goal is important, but by setting a
realistic date it will restore the goal's ability to influence key
policy decisions that affect electronic filing.
CONCLUSION
The IRS Oversight Board believes that it has constructed a fiscally
responsible and realistic budget for the IRS that meets national needs
and priorities. It would help shrink the tax gap while providing
taxpayers with a level of service they rightly deserve and need. It
would speed the modernization of the IRS' antiquated technology and
give it the research tools to better understand current and developing
trends. Most importantly, it would maintain that delicate but critical
balance between enforcement and customer service that America's
taxpayers have said time and again they want. The IRS is now solidly on
the right track and is making progress but we must give it the
resources to do its job. It is an investment we must make for this and
future generations of taxpayers.
______
Appendices:
1. Comparison of the Administration's IRS FY2007 Budget Request
and IRS Oversight Board Recommendation
2. Recommended FY2007 Program Increases: Enforcement
3. Recommended FY2007 Program Increases: Taxpayer Service
4. Recommended FY2007 Program Increases: Infrastructure and
Management Modernization
5. Recommended FY2007 Program Increases: Business Systems
Modernization
6. Explanation for Difference in IRS Oversight Board Budget in the
Administration's FY2007 Budget Request and this Recommendation
Appendix 1:
Comparison of the Administration's IRS FY2007 Budget Request and IRS
Oversight Board Recommendations
(all dollars in thousands)
------------------------------------------------------------------------
Board's President's
Final Board Budget budget Budget Difference
------------------------------------------------------------------------
FY2006 Enacted budget (with 1% $10,573,70 $10,573,706 $0
rescission) 6
------------------------------------------------------------------------
FY2007 Maintaining Current .......... ............. ............
Levels (MCLs) Adjustments
(includes HITCA)
------------------------------------------------------------------------
Labor Annualization $61,994 $61,994 $0
------------------------------------------------------------------------
Labor MCL (2.7 %) $149,819 $149,819 $0
------------------------------------------------------------------------
Non-Labor MCL (1.5 %) $60,418 $60,418 $0
------------------------------------------------------------------------
Total MCL Adjustments $272,231 $272,231 $0
------------------------------------------------------------------------
Base Reinvestment .......... ............. ............
------------------------------------------------------------------------
Increase Returns processing $12,237 $12,237 $0
efficiencies
------------------------------------------------------------------------
Program Cost Savings .......... ............. ............
------------------------------------------------------------------------
E-file savings ($6,760) ($6,760) $0
------------------------------------------------------------------------
Improvement project savings ($8,215) ($8,215) $0
------------------------------------------------------------------------
Competitive sourcing savings ($17,000) ($17,000) $0
------------------------------------------------------------------------
Program efficiencies ($84,121) ($84,121) $0
------------------------------------------------------------------------
HITCA program efficiency ($5,500) ($5,500) $0
------------------------------------------------------------------------
Total Savings and ($121,596) ($121,596) $0
Reinvestments
------------------------------------------------------------------------
Transfer Out to TIGTA ($941) ($941) $0
------------------------------------------------------------------------
Total, FY2007 Current $10,735,63 $10,735,637 $0
Service Level 7
------------------------------------------------------------------------
Program Increases .......... ............. ............
------------------------------------------------------------------------
Tax Administration Operations .......... ............. ............
------------------------------------------------------------------------
Taxpayer Service $43,637 $0 $43,637
------------------------------------------------------------------------
Enforcement $367,768 $0 $367,768
------------------------------------------------------------------------
Infrastructure and Mgt $104,715 $20,900 $83,815
Modernization
------------------------------------------------------------------------
Business Systems $188,600 ($29,700) $218,300
Modernization
------------------------------------------------------------------------
Total, Program Increases $704,720 ($8,800) $713,520
Above FY2006 Current Service
Level
------------------------------------------------------------------------
Total, FY2007 Operating $11,440,35 $10,726,837 $713,520
Level 7
------------------------------------------------------------------------
Fee Adjustment ($135,000) ($135,000) ............
------------------------------------------------------------------------
FY2007 Budget Appropriation $11,305,35 $10,591,837 $713,520
Request 7
------------------------------------------------------------------------
Growth Over FY2006 Enacted $731,651 $18,131 $713,520
Budget
------------------------------------------------------------------------
Percent Growth 6.9% 0.2% ............
------------------------------------------------------------------------
Appendix 2:
Recommended FY2007 Program Increases: Enforcement
(In $/thousands)
------------------------------------------------------------------------
Enforcement- Service-
Enforcement Program Increases Total Related Related
------------------------------------------------------------------------
Combat Egregious Non-Compliance
and Prevent Tax Gap Growth
This initiative provides an $135,518 $132,696 $2,822
increase of 748 FTE and $135.5
million to enhance coverage of
high-risk compliance areas as
well as address the tax gap
associated with small business
and self-employed taxpayers.
------------------------------------------------------------------------
Increase Individual Taxpayer
Filing and Payment Compliance
The initiative provides 84 FTE $7,773 $6,968 $805
(87 positions) and $8 million
to support the IRS' enforcement
presence through contracts with
Private Collection Agencies
(PCAs) for Qualified Tax
Collection Contracts.
------------------------------------------------------------------------
Detect and Deter Non-Compliant
Enterprise Structures
This initiative provides an $37,008 $37,008 ...........
increase of 200 FTE (400
positions) and $37 million to
increase the coverage of the
flow-through population,
including examination of
controlling enterprise
entities, that are posing
significant compliance risks.
------------------------------------------------------------------------
Increase Individual Taxpayer
Reporting Compliance
This initiative provides an $10,821 $8,808 $2,013
increase of 100 FTE (125
positions) and $10.8 million to
enable the Automated
Underreporter (AUR) program to
address reporting compliance in
a program that is effective,
efficient, less labor intensive
and less costly.
------------------------------------------------------------------------
Enhance Enforcement in the Tax-
Exempt and Governmental Sectors
This initiative requests an $12,941 $12,941 ...........
additional 69 FTE (138
positions) and $12,940,668 to
improve detection of compliance
risks, accelerate enforcement
actions, and balance the
pursuit of critical enforcement
initiatives while maintaining
adequate coverage of the exempt
community.
------------------------------------------------------------------------
Intensify Tax Enforcement
This initiative requests an $27,570 $27,570 ...........
increase of 86 FTE (172
positions) and $27.6 million to
curtail non-compliance in the
following areas: abusive
schemes, corporate fraud, non-
filers, employment tax and Bank
Secrecy Act (BSA).
------------------------------------------------------------------------
Recommended FY2007 Program Increases: Enforcement--Continued
(In $/thousands)
------------------------------------------------------------------------
Enforcement- Service-
Enforcement Program Increases Total Related Related
------------------------------------------------------------------------
Attack Fraudulent Payments
This initiative, which provides $26,998 $26,837 $161
an increase of 62 FTE (123
positions) and $27 million,
relates directly to the
President's Management Agenda
Program Initiative
``Eliminating Improper
Payments,'' and also supports
the IRS' strategies for
addressing erroneous payments
and non-compliance involving
Earned Income Tax Credits
(EITC).
------------------------------------------------------------------------
Improve Compliance With the Bank
Secrecy and PATRIOT Acts
This initiative provides an $25,858 $25,858 ...........
increase of 124 FTE (248
positions) and $25.9 million to
improve the Bank Secrecy Act
(BSA) compliance program.
------------------------------------------------------------------------
Strengthen Regulatory Compliance
This initiative provides an $6,616 $6,376 $241
increase of 38 FTE (76
positions) and $6.6 million to
strengthen regulatory
compliance activities to deter
fraud, abuse, and terrorist
financing in the tax exempt and
governmental entities
community.
------------------------------------------------------------------------
Improve Enforcement of Circular
230
This initiative provides an $4,104 $4,104 ...........
increase of 8 FTE (16
positions) and $4.1 million to
detect and address tax
practitioner misconduct. The
IRS, Treasury, and Congress are
placing increased emphasis on
practitioner misconduct by
providing new statutory and
regulatory tools to address
abusive behavior.
------------------------------------------------------------------------
Improve Tax Gap Estimates,
Measurement and Detection of
Non-Compliance
Supports 268 FTE (536 positions) $45,942 $45,942 ...........
and $45.9 million to fund and
support ongoing Reporting
Compliance Studies through the
National Research Program.
------------------------------------------------------------------------
Study EITC Compliance
This initiative provides an $6,822 $6,822 ...........
increase of 49 FTE (65
positions) and $6.8 million to
develop estimates of Earned
Income Tax Credit compliance.
------------------------------------------------------------------------
Recommended FY2007 Program Increases: Enforcement--Continued
(In $/thousands)
------------------------------------------------------------------------
Enforcement- Service-
Enforcement Program Increases Total Related Related
------------------------------------------------------------------------
Improve Compliance Through Data-
Driven Workload Identification
This initiative provides an $4,796 ............... $4,796
increase of 67.5 FTE (90
positions) and $4.8 million to
develop and test decision
analytical tools and models for
improved identification of high-
risk filers.
------------------------------------------------------------------------
Customer Service Research Begin $15,000 $15,000 ...........
research on the impact of
customer service on voluntary
compliance and the service
needs of taxpayers.
------------------------------------------------------------------------
Subtotal Enforcement $367,768 $356,931 $10,837
------------------------------------------------------------------------
Appendix 3:
Recommended FY2007 Program Increases: Taxpayer Service
(In $/thousands)
------------------------------------------------------------------------
Taxpayer Service Program Enforcement- Service-
Increases Total Related Related
------------------------------------------------------------------------
Increase Accounts Management
Efficiencies
Provides funding to improve the $8,657 ............... $8,657
telephone infrastructure, e.g.,
Compliance Services and
Accounts Management call
centers, by expanding services
to customers and providing
telephone representatives with
a more state-of-the-art center
environment and providing
taxpayers with improved service
through multiple access
channels. Enterprise queuing
will eliminate the queuing of
calls at the local level and be
queued at the enterprise level,
reducing taxpayer wait times.
------------------------------------------------------------------------
Restore Customer Service to
FY2004 levels
Supports 450 FTE from W&I to $34,980 ............... $34,980
restore telephone level of
service back to 87.3 percent
achieved in FY2004 rather than
the current 82 percent target.
Improves TE/GE service measures
for EP and EO determination
timeliness, CAS toll-free level
of service, correspondence
timeliness measures to FY2004
levels.
------------------------------------------------------------------------
Subtotal: Taxpayer Service $43,647 ............... $43,647
------------------------------------------------------------------------
Appendix 4:
Recommended FY2007 Program Increases: Infrastructure and Management
Modernization
(In $/thousands)
------------------------------------------------------------------------
Infrastructure and Mgt Enforcement- Service-
Modernization Program Increases Total Related Related
------------------------------------------------------------------------
Expand IT Security--Personal
Identity Verification
This initiative requests an $20,000 $12,576 $7,424
increase of $20 million to
ensure IRS' compliance with
Homeland Security Policy
Directive--12 (HSPD-12) and
Federal Information Processing
Standards-201 (FIPS-201).
------------------------------------------------------------------------
Close Financial Management
Material Weaknesses--Custodial
Detail Data Base
This initiative provides $4.7 $4,743 $2,982 $1,761
million to develop the CFO
Custodial Detail Data Base
(CDDB) which will establish the
foundation for building an IRS-
modernized custodial financial
management system.
------------------------------------------------------------------------
Fund Modernization Information
Systems (Major Investments) O&M
This initiative will result in $15,000 $9,432 $5,568
modernized information systems
to improve enforcement
activities.
------------------------------------------------------------------------
Fund Business Unit IT Solutions
(Non-Major Investments) O&M
This initiative provides an $9,972 $7,121 $2,851
increase of $15 million for the
successful transition of
Business Systems Modernization
(BSM) projects to the Current
Production Environment (CPE),
funding their operations and
maintenance as they move to
full production.
------------------------------------------------------------------------
Implement e-Travel
Treasury has mandated that IRS $10,000 $6,288 $3,712
must implement eTravel by
October 1, 2006.
------------------------------------------------------------------------
Fund HR Connect
The initiative requests $11.9 $11,900 $7,482 $4,418
million in FY 2007 to fully
fund the additional Operations
and Maintenance cost associated
with the HR Connect system that
the IRS has implemented and is
billed through the Treasury's
Working Capital Fund.
------------------------------------------------------------------------
Consolidate Philadelphia Campus $20,900 $14,215 $6,685
------------------------------------------------------------------------
Restoration of Leadership
Training to FY2003 levels
The requested funds would enable $12,200 $7,564 $4,636
the IRS to: (1) eliminate the
backlog of untrained leaders at
all levels by the end of
FY2007; (2) ensure enough
capacity to train new managers
upon selection in all Business
Units; (3) improve and expand
readiness programs to provide a
cadre of manager candidates to
step in to management
positions; (4) revise the
management curriculum to
incorporate more e-learning and
promote continuous learning;
and (5) evaluate the
effectiveness and impact of the
leadership training program.
------------------------------------------------------------------------
Subtotal Modernization $104,715 $67,660 $37,055
------------------------------------------------------------------------
Appendix 5:
Recommended FY2007 Program Increases: Business Systems Modernization
(In $/thousands)
------------------------------------------------------------------------
Business Systems Modernization Program
Increases Total
------------------------------------------------------------------------
Web-based Self Service
Identify and design initial set of internet $24,200
self-service applications.
------------------------------------------------------------------------
Filing & Payment Compliance (F&PC)
Completes delivery of full capability needed to $30,000
support Private Collection Agencies.
------------------------------------------------------------------------
Modernized e-file (MeF)
Funds development, testing and deployment of $70,200
modernized electronic filing for Form 1040.
------------------------------------------------------------------------
Customer Account Data Engine (CADE)
Process 33 million returns for the FY2007 $25,000
filing season.
------------------------------------------------------------------------
Core Infrastructure Projects
Improve the facilities which allow pre- $17,900
deployment testing and integration of
modernized systems, which help ensure
modernized systems will operate as needed when
they are deployed.
------------------------------------------------------------------------
Architecture, Integration & Management
Ongoing support and improvements to BSM's $12,800
program with planning, engineering, and
management activities.
------------------------------------------------------------------------
Management Reserve $8,500
------------------------------------------------------------------------
Subtotal BSM $188,600
------------------------------------------------------------------------
Explanation for Difference in IRS Oversight Board Budget in the
Administration's FY2007 Budget Request and this Recommendation
After the Board-approved budget is submitted to the Department of
Treasury, it is reviewed and modified by both the Treasury Department
and the Office of Management and Budget (OMB) before being incorporated
into the President's budget. During the first several years of IRS
Oversight Board operation, the Treasury Department would inform the
Oversight Board of changes as the IRS budget progressed through the
formulation process. However, for the past two years, the Treasury
Department has taken the position that although RRA98 provides the
Oversight Board with the responsibility of reviewing and approving the
budget request prepared by the Commissioner and submitted to the
Department of the Treasury, this authority does not include
participating in subsequent budget decision adjustments and formulation
of the President's Budget.
Consequently, changes in IRS requirements that occur after the
Board approves the IRS budget are not provided to the Board, and can
only be considered by the Board when the President's budget is made
available to the public. The Board adjusted its previously approved
budget to account for the following circumstances:
The Board's initial FY2007 budget was based on the FY2006
President's request, not the enacted appropriation, and is adjusted to
use the FY2005 enacted level as the base.
The inflation factors for labor and non-pay inflation
were not known to the Board when it first approved the IRS budget, and
are adjusted to reflect the lower base as well as changes in rates.
The IRS budget submitted to the Board identified
approximately $15 million in savings, which the Board approved. During
subsequent reviews with the Treasury Department and OMB, the IRS
identified an additional $106 million in savings, for a total savings
of $121 million. The Board's budget is adjusted to reflect these
additional savings, despite the Board's assessment that they may
represent some risk.
The IRS budget submitted to the Board did not identify
any fee offsets, which were not yet authorized by Congress. The Board's
budget is adjusted to reflect these offsets.
The budget is adjusted to reflect the development of an
IRS Infrastructure Blueprint to define a cost-effective approach to
meeting IRS infrastructure needs and the elimination of the need to
fund Kansas City growth in FY2007.
Endnotes
\1\ The President's budget includes on pages IRS-127 to IRS-129 of
the Congressional Justification, as required by law, a copy of the
FY2007 IRS budget the Oversight Board approved and submitted to the
Department of the Treasury. The Board's recommended budget, as show on
these pages, is higher than the request shown above; Appendix 6
provides an explanation of the differences.
\2\ Statistics provided to the Oversight Board by the IRS.
\3\ Professor Claes Fornell, ``ACSI Commentary: Federal Government
Scores'', December 15, 2005.
\4\ IRS Oversight Board, 2005 Taxpayer Attitude Survey.
\5\ Comptroller General David Walker, Testimony Before the Senate
Budget Committee, ``Tax Gap: Making Significant Progress in Improving
Tax Compliance Rests on Enhancing Current IRS Techniques and Adopting
New Legislative Actions,'' February 15, 2006, GAO-06-453T.
\6\ Nina E. Olson, National Taxpayer Advocate, Testimony Before
the Senate Subcommittee on Federal Financial Management, Government
Information, and International Security Committee on Homeland Security
and Governmental Affairs, October 26, 2005
\7\ Tax Notes, February 16, 2006
\8\ Charles O. Rossotti, Many Unhappy Returns: One Man's Quest to
Turn Around the Most Unpopular Organization in America, Harvard
University Press, 2005. p. 278.
\9\ Al Crenshaw, ``Letting Cheaters Prosper,'' Washington Post,
April 14, 2004.
\10\ Statement by the Members of the President's Advisory Panel on
Federal Tax Reform, ``America Needs a Better Tax System,'' April 13,
2005.
\11\ National Taxpayer Advocate, ``Testimony Before the Senate
Budget Committee, Causes and Solutions to the Federal Tax Gap,''
February 15, 2006.
\12\ IRS Commissioner Mark Everson, Testimony Before the Senate
Budget Committee, February 15, 2006
\13\ Everson, op.cit.
\14\ Tax Notes, Everson Says IRS Could Collect Up To $100 Billion
More Per Year, February 16, 2006
\15\ IRS Press Release, ``IRS to Raise Some User Fees in 2006,''
IR-2005-144, December 19, 2005.
\16\ AICPA, ``Statement Presented to the IRS Oversight Board,
``Meeting the Customer Service Needs of Taxpayers and the Importance of
Measures'', February 8, 2006.
\17\ Statement of Diana Leyden, Associate Clinical Professor of
Law, University of Connecticut School of Law Tax Clinic Before the IRS
Oversight Board, February 8, 2006.
\18\ Senator Max Baucus, Opening Statement, Senate Finance
Committee, Hearing, April 14, 2005.
\19\ The National Taxpayer Advocate, 2005 Annual Report to
Congress, Executive Summary, p. I-1.
\20\ General Accountability Office, Report to Congress, ``Business
Systems Modernization: Internal Revenue Service's Fiscal Year 2006
Expenditure Plan,'' February 2006, GAO-06-360, pp. 2-3.
\21\ Statement of Professor Joel Slemrod, University of Michigan
Ross School of Business, before the President's Advisory Panel on
Federal Tax Reform, March 3, 2005.
Chairman RAMSTAD. Thank you, Mr. Wagner. Mr. Hugo, please.
STATEMENT OF TIMOTHY HUGO, EXECUTIVE DIRECTOR,
FREE FILE ALLIANCE
Mr. HUGO. Mr. Chairman, thank you for the opportunity to
appear before you today. I am Tim Hugo, and I am the Executive
Director of the Free File Alliance, and I have served in this
position since July of 2005.
The Free File Alliance is a voluntary association of tax
software companies that provides free tax preparation e-file
service under a growing set of rules that govern the IRS Free
File program. Currently, we have 20 members. Member companies
come and go, and we are open to new members each year.
I am very proud of the public-private partnership that the
Alliance and the IRS have created over the life of the program,
now in its fourth year. The Alliance companies have donated
over $14 million free tax returns to U.S. taxpayers. Estimates
are that each return has saved the U.S. taxpayer approximately
$30, and a case can be made that it is even more, but this
would also indicate that the U.S. taxpayers have saved over $42
million, but the savings to the IRS are far greater and are
summarized below.
First, the IRS has been able to avoid the cost the industry
must accept to development software product which changes every
year as Congress makes changes to the Code. Second, the IRS has
avoided the necessity of building computer and telecom
infrastructure to take individual returns from the Alliance.
Alliance companies paid this cost. Third, the IRS saves $7 or
more each time a paper return filer converts to submitting a
return electronically. Fourth, and perhaps most importantly, it
keeps the IRS from accepting the conflicting role of tax
preparer and tax cop. Fifth, the IRS has avoided significant
technological and political risk of a security breach or a
failure of an IRS product. Sixth, the Free File Alliance makes
the IRS and the Alliance member partners, not opponents. If the
IRS were to become a competitor, it would create a very
different and dynamic relationship with industry.
This 2005 renewal of the agreement between the IRS and the
Alliance, after three pioneering years, was the work of the
program's maturity and success, but it required a balance.
Again, this year, we refocused, as has been commented
earlier, we have refocused on the low-income and low and middle
income that serves $93 million--makes eligible $93 million, 70
percent of the taxpayers.
We have a full statement that I would ask be submitted for
the record, and I thank you, sir, and look forward to answering
questions.
[The prepared statement of Mr. Hugo follows:]
Statement of The Honorable Timothy D. Hugo, Executive Director,
Free File Alliance
Good morning, Mr. Chairman, and other distinguished Members of the
Subcommittee.
I am the Executive Director of the Free File Alliance, LLC
(``Alliance''). I have served in that capacity since July of 2005. I am
only part-time on this role. I also serve as an elected Member of the
Virginia General Assembly where I am in my third term.
The Free File Alliance is a voluntary association of tax software
companies that provide free tax preparation and efiling services under
the growing set of rules that govern the IRS Free File Program.
Currently, we have twenty member companies. Member companies can and do
come and go. We are open to new members each year.
I am very proud of the public-private partnership the Alliance and
IRS have created. Over the life of the program, now in its fourth year,
the Alliance companies have donated over 14,000,000 free tax returns to
the U.S. taxpayers. I estimate that each return has saved U.S.
taxpayers approximately $30 and a case can be made for an even greater
number. That would indicate U.S. taxpayers have directly saved over
$42,000,000. But the savings to the IRS are far greater, and can be
summarized as follows.
First, the IRS has been able to avoid the costs industry must
accept to develop a software product--which must be changed each year
as Congress makes its changes in the Code.
Second, the IRS has avoided the necessity of building the computer
and telecommunications infrastructure to take individual returns from
taxpayers--Alliance companies pay these costs.
Third, the IRS saves $7 or more each time a paper return filer
converts to submitting a return electronically.
Fourth, and perhaps most importantly, it keeps the IRS from
accepting the conflicting role of tax preparer and tax cop.
Fifth, the IRS has also avoided significant technological and
political risks of a security breach or failure of an IRS product.
Sixth, the Free File Program makes the IRS and Alliance members
partners, not opponents. If the IRS becomes a competitor, it will
create a very different and dynamic relationship with industry.
The 2005 renewal of the Agreement between the IRS and the Alliance
after three pioneering years was a mark of the program's maturity and
success, but required a balance between conflicting policy goals. The
2005 Agreement continues the same core agreement as was originally
negotiated, but with some interesting changes. The IRS is still not
permitted to take on the role of a tax preparation company.
The Alliance member companies do not always agree on what is good
policy, or what is good for their companies. Within the government
there is also disagreement as to what should be the requirements of
this program, which revealed itself when the IRS and Treasury took
slightly different negotiating positions with the Alliance in 2005,
notwithstanding that they both work for the same President. Important
Members of Congress have urged different policies for the Free File
Program. The 2005 Agreement is a product of all these forces. Let me
tick off what I think are the key elements of the 2005 Agreement.
First, the Alliance member companies have over time voluntarily
agreed to impose standards of conduct on themselves which exceed all
government regulation and requirements. These standards were often
suggested or sought by the IRS. While accepting this challenge, the
Alliance has an appropriate corresponding fear that over time the IRS
or Congress will use the existence of the Free File Program to create a
new regulatory regime that will burden the companies in the Free File
Program, but not companies who do not participate. After years of
experience, it became clear that both the IRS and the Alliance need to
have authority to restrict any Alliance member company that does not
meet the voluntary high standards. Correspondingly, a dispute
resolution mechanism was created in the 2005 Agreement to utilize the
General Services Board of Contract Appeals (``GSBCA'') to arbitrate
with companies who contest IRS determinations that their practices do
not meet the high standards.
Second, and related to the first issue, Alliance members agreed to
restrictions on sale of certain ancillary products, particularly Refund
Anticipations Loans (``RALs''), that exceed those required by law and
regulation.
Third, the IRS and the Alliance agreed to certain measures designed
to refocus the Free File Program on its original intent to service
lower income, disadvantaged and underserved taxpayer populations. How
and why did we do so?
The Alliance companies are currently required to provide free
services to 93 million taxpayers, which is 70% of the U.S. taxpayers.
This is an increase from the 60% of taxpayers the Alliance agreed to
cover in the original Agreement. This binding 70% coverage requirement
will increase in numbers as the taxpayer population increases.
This focus on the poor, lower income, disadvantaged and underserved
was an underpinning of the original Alliance-IRS agreement. It has been
recognized throughout the Program's history. It is contained in many of
the documents that collectively constitute our forming our agreement.
For example, this language is written in the first and only
Supplemental Memorandum of Understanding Between the IRS and Free File
Alliance. A copy of this one page document is appended to my statement.
It also appears as a portion of the Purpose in the Alliance
Operating Agreement (a current version of paragraph 2.6 of that
document is appended to my statement).
It is contained in the Preamble of the Memorandum of Understanding
on Service Standards and Disputes Between the IRS and Free File
Alliance executed in 2005 (``offer online preparation and filing
services to taxpayers least able to afford e-filing tax returns. . .
.'').
It also appears in a letter from Chairman Ernest Istook, then
Chairman of the Transportation, Treasury and Independent Agencies
Appropriations Subcommittee, to the current Treasury Secretary and IRS
Commissioner, and states in part that the program should be focused
upon the ``under served and lower income citizens. . . . There should
be no uncertainty that the Free File Alliance program is not intended
to provide universal free service to all regardless of need. Such an
objective could break the market-based model that enables the donation
of the services at no cost to those who truly need them.''
Some may assert the program should provide Bill Gates and Warren
Buffett, or other wealthy folks, with free returns. But I do not think
a compelling policy case can be made that such high wealth individuals
need such free services. Last year $4 billion in eligible EITC payments
were not paid to U.S. taxpayers who qualify. Those are the people to
whom I want to provide free services to, and potentially transform
their lives.
Fifty-five million people in this country have no bank account.
Let's bring them into some aspect of the modern financial system, even
if they have to do their Free File return at a VITA site or public
library. A very few miles from this hearing room, in Anacostia, on the
aptly named Good Hope Road, Operation HOPE, an African-American focused
financial literacy group, provides 16 internet work stations where
people in the community can and do take advantage of Free File
services. Those are the people I believe we should focus upon.
Both the IRS and the Alliance made their own evaluations of how to
ensure the long term success of the program. Both concluded the 2005
agreement meets a variety of needs. The 2005 Agreement has created a
stable program with well understood rules. Free for everyone may sound
great, but it has consequences, such as creating pressure for sales of
ancillary products. We have tried to appropriately balance policy
concerns, and now we need to see how that balance works out in
practice. If any company wants to give away their product free to
everyone, there is no restriction in their choosing to do so at the
their own web page, or in Union Station, or anywhere else but the Free
File site.
We do not yet know the final volumes of Free File returns in this
tax season. The IRS and Alliance annually cooperate in evaluating each
season, decide what went well, what needs to be fixed, and what
research is needed to better evaluate this season. We need to do so
again, and evaluate how the IRS can help the 93 million eligible
taxpayers generate savings for themselves and the IRS.
The Alliance program remains dynamic. But it cannot be used to
satisfy every policy. Let me give an example. All fifty states have
little IRS-type organizations to collect taxes, and these agencies have
a professional association called the Federation of Tax Administrators
(FTA). Approximately 20 states, led by New York, Michigan and many
others, are working to replicate the success of the Free File model. We
appreciate those states' efforts. The Alliance does not administer
these state Free File programs. But the FTA has in the past focused
their efforts on the other 20 states that have chosen to compete and
create tax software products. FTA took the position that the IRS should
require that the Alliance provide free state tax returns to states that
compete. We do not feel comfortable dealing in an indirect manner with
groups like the FTA. If the FTA wants to talk to us about this program,
we welcome them--but note that the FTA walked out of such talks when
the Free File Program was starting and hence are not fully reaping the
benefits of the program.
CONCLUSION
We appreciate the Subcommittee's interest in the Free File Program,
and look forward to answering your questions.
Chairman RAMSTAD. Thank you, Mr. Hugo. The Chair now
recognizes Mr. White, please.
STATEMENT OF JAMES R. WHITE, DIRECTOR, STRATEGIC ISSUES, U.S.
GOVERNMENT ACCOUNTABILITY OFFICE
Mr. WHITE. Thank you, Mr. Chairman. Mr. Chairman and
Members of the Committee, we are pleased to participate in
today's hearing. I want to cover three topics: the filing
season, IRS' 2007 budget requests, and IRS's new long-term
goals.
First, IRS' filing season performance so far has improved
compared to last year, and this continues a trend of
improvement going back several years. Return processing has
gone smoothly with over 70 percent of refunds now directly
deposited to taxpayers' bank accounts, which is faster, less
costly and more convenient than issuing paper checks. Telephone
assistance continues to improve with the accuracy rate for both
tax law and taxpayer account questions now over 90 percent.
Wait time to get through to the telephone assistor is down from
almost 4 minutes to 3 minutes. IRS' website is heavily used and
highly rated by external reviewers.
Taxpayers continued the recent pattern of using IRS' walk-
in sites less, and volunteer sites run by community based
organizations more.
Perhaps the biggest concern about the filing season is the
slower growth rate of electronic filing that has been
discussed. Electronic filing is up this year, but only by 2
percent compared to last year. E-filing is important because it
reduces the staff needed for labor-intensive processing of
paper returns. Since 1999 IRS reduced staff devoted to paper
processing by about 1,600. According to IRS, the slower growth
of e-filing is due to new income limits in the Free File
program, which reduced the number of taxpayers eligible to file
electronically for free via IRS website and the termination of
the Tele-File program.
Turning to IRS' budget, the 2007 budget request is for $11
billion, a slight decrease after adjusting for inflation. The
decrease is reflected in staffing. IRS is proposing to cut
staffing for service by about 4 percent, and for enforcement by
about 2 percent.
However, IRS is proposing to improve performance for both
service and enforcement. The 2007 budget request sets
performance goals that are higher than or equal to those for
2006. The proposed budget also reduces funding by 15 percent
for BSM, the ongoing effort to replace IRS' aging information
systems. This reduction could impede progress delivering
improvements to taxpayers.
In a tight budget environment, savings and efficiencies can
help agencies fund their programs. For 2007 IRS has identified
$121 million in savings, expected to free up about 1,400 FTEs
for other uses. While commendable, there are opportunities for
additional savings. For example, we were told that IRS' 25 call
sites have underutilized space. Because calls to IRS are routed
through a central call processing center in Atlanta, the 25
call sites could be consolidated without affecting service to
taxpayers.
Another option for gaining efficiencies is to increase
electronic filing by additional mandates. The IRS currently
mandates electronic filing for large corporations, and 12
States mandate electronic filing of individual tax returns by
certain tax preparers.
Now I want to discuss IRS' new long-term goals. The IRS'
budget request sets two long-term goals, increasing the
voluntary compliance rate from 83 percent to 85 percent, and
reducing the percentage of taxpayers who think it is acceptable
to cheat on their taxes to under 9 percent by 2009. However,
the effect of taxpayer service and enforcement on compliance
has never been quantified. Consequently, IRS does not have a
database plan demonstrating how it will achieve the goals, nor
does IRS have a plan to measure compliance by 2009. The
compliance rate has been measured once since 1988. Reducing the
net tax gap of $290 billion and increasing compliance will be a
challenge.
For years, we have listed tax law enforcement as a high-
risk area. Despite IRS' efforts, the tax gap has persisted at a
relatively stable level for decades. Although IRS' enforcement
efforts are vital, reducing the tax gap will require innovative
solutions beyond funding for IRS. These solutions include
increasing the types of income subject to withholding, more
information reporting about income, and simplifying the Tax
Code.
Mr. Chairman, this conclude my statement. I would be happy
to answer any questions.
[The prepared statement of Mr. White follows:]
Statement of James R. White, Director, Tax Issues, U.S. Government
Accountability Office
Mr. Chairman and Members of the Subcommittee:
Since the passage of the Internal Revenue Service (IRS)
Restructuring and Reform Act of 1998 (RRA 98),\1\ IRS has made
noticeable improvements to taxpayer services such as telephone
assistance, and delivered some modernized information systems that,
among other benefits, speed up refunds to taxpayers. Increased funding
financed some of the improvements, but a significant portion has been
financed internally through efficiencies from increased electronic
filing of tax returns and other operational improvements.
---------------------------------------------------------------------------
\1\ Pub. L. No. 105-206 (1998).
---------------------------------------------------------------------------
IRS has also increased revenue collected through its enforcement
programs; however, tax law enforcement continues to be included on our
list of high-risk federal programs.\2\ This is due, in part, to the
persistence of a large tax gap.\3\ IRS estimated the gross tax gap to
be $345 billion for tax year 2001. After late payments by taxpayers and
revenue brought in by IRS's enforcement efforts, the resulting net tax
gap is estimated to be $290 billion.\4\ Even modest progress in
reducing the tax gap would yield significant revenue; each 1 percent
reduction would likely yield nearly $3 billion annually.
---------------------------------------------------------------------------
\2\ GAO, High Risk Series: An Update, GAO-05-207 (Washington, D.C.:
January 2005).
\3\ The tax gap is an estimate of the difference between the taxes
that should have been timely and accurately paid and what was actually
paid. Throughout this statement, references to the tax gap refer to the
gross tax gap unless otherwise noted.
\4\ GAO, Tax Gap: Making Significant Progress in Improving Tax
Compliance Rests on Enhancing Current IRS Techniques and Adopting New
Legislative Actions, GAO-06-453T (Washington, D.C.: Feb. 15, 2006).
---------------------------------------------------------------------------
If its 2007 budget request is a harbinger of longer term funding,
IRS faces an era of tight budgets. Consequently, continued performance
improvements will depend on the extent to which IRS can make more
efficient use of limited resources to provide internal funding for the
improvements. By indicating how resources are allocated to specific
programs and activities within the agency, the budget request is a key
planning tool showing where the agency intends to achieve additional
efficiencies.
The 2007 budget request is also an indication of how IRS intends to
achieve longer term goals. For the first time, IRS lists two agencywide
long-term goals: to increase the compliance rate and reduce the
proportion of taxpayers who think it is acceptable to cheat on their
taxes.\5\ This budget can be viewed as a first step in a series of
annual steps that will determine whether IRS achieves these long-term
goals.
---------------------------------------------------------------------------
\5\ The Congress set one long-term goal for the IRS in RRA 98 for
IRS to have 80 percent of all individual income tax returns filed
electronically by 2007. We and IRS have previously reported that IRS
likely will not meet this goal. Also, IRS's budget describes plans to
establish other agencywide goals, targets for which have not yet been
established and therefore are not listed in the budget request.
---------------------------------------------------------------------------
Our statement discusses IRS's 2006 filing season performance to
date and fiscal year 2007 budget request. To address your request, we
assessed (1) the interim results of IRS's 2006 filing season
performance compared to prior years; (2) IRS's budget request compared
to prior years; and (3) how the budget helps IRS achieve its long-term
goals aimed at reducing the tax gap.
Our assessment of the interim results of IRS's filing season is
based on comparing IRS's performance this year to prior filing seasons,
monitoring various production meetings and production statistics,
reviewing other IRS documents and reports, interviewing IRS and
Treasury Inspector General for Tax Administration (TIGTA) officials and
paid tax practitioners and other external stakeholders, reviewing TIGTA
and other external reports, and reviewing IRS's Web site. Our
assessment of the budget request is based on a comparative analysis of
IRS's fiscal year 2002 (in most cases) through 2007 budget requests,
funding, expenditures, and other documentation and interviews with IRS
officials. We used historical budget and performance data from reports
and budget requests used by the IRS, Department of the Treasury, and
Office of Management and Budget. In past work, we assessed IRS's budget
and performance data. Since the data sources and procedures for
producing this year's budget and performance data have not
significantly changed from prior years, we determined that the data
were sufficiently reliable for the purposes of this statement. The
budget and performance data for fiscal years 2006 and 2007 are subject
to change as IRS revises its estimates. We did not verify IRS's
estimates for enforcement revenue and the tax gap. IRS presents tax gap
information as supplemental information in its financial statements;
that information is not required to be audited. However, we have been
involved in tax gap methodology briefings, and the TIGTA has an ongoing
review of the accuracy of IRS's tax gap estimates. Additionally, our
analysis of IRS's Business Systems Modernization (BSM) program was
based primarily upon the results of our detailed review of IRS's fiscal
year 2006 BSM expenditure plan in a recent report.\6\ We performed our
work in Washington, D.C., and Atlanta, Georgia, from January 2006
through April 2006, in accordance with generally accepted government
auditing standards.
---------------------------------------------------------------------------
\6\ GAO, Business Systems Modernization: Internal Revenue Service's
Fiscal Year 2006 Expenditure Plan, GAO-06-360 (Washington, D.C.: Feb.
21, 2006).
---------------------------------------------------------------------------
Our statement makes these key points: IRS has improved its 2006
filing season performance to date in important areas compared to last
year, continuing a recent trend. IRS's returns processing has gone
smoothly and over 70 percent of refunds are now directly deposited to
taxpayers' bank accounts, which is faster, more convenient and less
costly than issuing paper checks. Electronic filing continues to grow,
but at a slower rate. So far this filing season, electronic filing has
grown 2.4 percent compared to 4.3 percent annually for the previous two
years. According to IRS officials, the slower rate of growth is due, in
part, to new income limits in the Free File program, which reduced the
number of taxpayers eligible to file electronically for free via IRS's
Web site, and the termination of the TeleFile program, which eliminated
electronic filing by phone. Telephone assistance has improved this
year, in part, due to lower call volume. The percentage of taxpayers
attempting to reach an IRS telephone assistor and who actually received
service increased 1 percentage point to 84 percent this filing season
and the length of time taxpayers waited to get their calls answered
decreased from 235 seconds to 182 seconds. The accuracy of IRS's
responses to tax law and account questions improved--both are now at 90
percent or more. IRS's Web site is being used more, is performing well
based on third-party evaluations, and has been reconfigured with the
goal of improving taxpayer service. Taxpayers continued the recent
pattern of using IRS's walk-in sites less, and using sites run by
community-based organizations and staffed by volunteers more.
IRS's fiscal year 2007 proposed budget is $11 billion,
which is a small decrease compared to the 2006 enacted level after
adjusting for expected inflation.\7\ For service, the budget proposes
to cut staffing by 4 percent. For enforcing tax laws, the budget
proposes to cut staffing by 2 percent. However, for service and
enforcement, the budget sets performance goals for 2007 that are higher
than or equal to those for 2006. For maintaining and operating IRS's
existing information systems (IS), the 2007 budget request shows an
increase in resources when compared to the 2006 enacted budget.
However, when compared to the level currently assumed for 2006, the
2007 budget request leaves Full-time Equivalents (FTE) \8\ for IS
virtually constant. For the BSM program, which is the ongoing effort to
replace the agency's aging information systems, the budget proposes to
reduce spending by about 15 percent. This reduction could delay
delivery of improved services for taxpayers. As it has in prior years,
IRS's budget request identifies savings--the 2007 budget proposes to
save over $121 million and 1,424 FTEs. However, additional
opportunities exist for savings. One is to increase electronic filing
by additional use of mandates. IRS currently mandates electronic filing
by large corporations and 12 states currently mandate electronic filing
of individual income tax returns by certain tax preparers. Another
opportunity is to consolidate IRS's 25 telephone call sites. IRS
officials told us that the call sites have space that is not used for
850 staff. Call sites could be consolidated without affecting service
to taxpayers. Finally, IRS has long been hampered by a lack of current
and accurate cost information for making resource allocation decisions.
IRS recently implemented components of a cost accounting system, but
needs to continue gathering the cost data needed to make it an
effective planning tool.
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\7\ The Congressional Budget Office is estimating inflation to be
1.8 percent in 2007. Congressional Budget Office, The Budget and
Economic Outlook: Fiscal Years 2007 to 2016. (Washington, D.C.: January
2006).
\8\ According to IRS, a FTE is the equivalent of one person
working full-time for one year with no overtime. A staff year includes
overtime. Therefore, the cost of 1 staff year is equal to the cost of 1
FTE plus overtime.
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IRS's budget request sets two long-term goals: increasing
the rate of voluntary compliance from 83 percent to 85 percent by 2009
and reducing the percentage of taxpayers who think it is acceptable to
cheat on their taxes from 10 percent to 9 percent in 2008. These goals
will be challenging to meet because the tax gap has persisted at a
relatively stable level of 81 to 84 percent for many years. However,
because the effect of taxpayer service and enforcement on compliance
has never been quantified, IRS does not have a data-based plan
demonstrating how it will use its programs to achieve its goals and
reduce the tax gap. Nor does IRS have a plan for measuring compliance
by 2009. Reducing the tax gap will likely require new and innovative
solutions such as simplifying the tax code, increasing income subject
to withholding, and increasing information reporting about income.
IRS's budget request includes several proposals for increasing
compliance that would not require additional resources for IRS. For
example, the Department of the Treasury plans to study, and we have
long supported, clarifying the definition of independent contractors
and requiring additional information reporting on their income, steps
that could increase tax revenue by billions of dollars.
IRS's Filing Season Performance to Date Has Improved in Important
Areas, Continuing a Recent Trend
IRS improved its 2006 filing season performance in important areas
that affect large numbers of taxpayers. This continues a trend of
improvement since at least 2002. Returns processing has gone smoothly
and electronic filing continues to grow, although at a slower rate than
in previous years. Taxpayer assistance has improved in the two most
commonly used services--toll-free telephones and the Internet Web site.
Fewer taxpayers visited IRS's walk-in sites, and more sought assistance
at volunteer-staffed sites.
Return Processing Has Been Smooth and Electronic Filing Continues to
Grow, Although At a Slower Rate Than Previous Years
From January 1 through March 17, 2006, IRS processed about 63
million individual income tax returns, about the same number as the
same period last year. Of those returns, 47 million returns were filed
electronically (up 2.2 percent) and 16 million returns were filed on
paper (down 9.8 percent).
According to IRS data and officials, returns processing has gone
smoothly so far this filing season. IRS issued 56 million refunds, 40
million, or 71 percent, of which were directly deposited, up 3
percentage points over the same period as last year. Direct deposit is
faster, more convenient for taxpayers, and less expensive for IRS than
mailing paper checks.
Because of the volume of tax returns, it is normal for IRS to
experience some processing disruptions, although this year, disruptions
have not been significant. For example, 13 different tax forms were
unavailable for electronic filing until February 1 due to the late
hurricane relief legislation, which caused a minor processing delay for
some returns.
Furthermore, IRS officials said that the new Customer Account Data
Engine (CADE), which is intended eventually to replace IRS's antiquated
Master File system containing taxpayer records, processed 4.3 million
returns and dispersed 3.8 million refunds, so far during the 2006
filing season without disruptions. IRS is reporting that direct deposit
refunds and paper check refunds are being issued within 4 and 6
business days, respectively, after tax returns are posted to CADE,
which is faster than for returns processed by the Master File system.
CADE's growth in future years will directly benefit taxpayers. Not only
can it speed up refunds, but it also updates taxpayer account
information quicker than the Master File system.
Representatives of the taxpayer industry corroborated IRS's view
that the filing season is going smoothly. Groups and organizations that
we talked to included the National Association of Enrolled Agents, the
American Institute of Certified Public Accountants, and others. In
addition, the TIGTA recently testified that thus far it has seen no
significant problems during the filing season.\9\
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\9\ Written statement of Treasury Inspector General for Tax
Administration, J. Russell George, before the Committee on
Appropriations, Subcommittee on Transportation, Treasury and Housing
and Urban Development, the Judiciary, District of Columbia, and
Independent Agencies, U.S. House of Representatives, Hearing on the
Internal Revenue Service's Fiscal Year 2007 Budget, Washington, D.C.,
Mar. 29, 2006.
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The growth of electronic filing is important, because it generates
savings by reducing staff years needed for labor intensive paper
processing. Between fiscal years 1999 and 2006, IRS reduced the number
of staff years devoted to paper and electronic processing by 1,586, or
34 percent as shown in figure 1.
Figure 1: Number of Individual Returns and IRS Staff Years for
Individual Paper and Electronic Processing, Fiscal Years 1999-
2007
[GRAPHIC] [TIFF OMITTED] T0443A.001
\a\ Fiscal years 2006 and 2007 are IRS projections.
Note: Staff years and FTE are units of measurement that are often
used interchangeably. As noted in the figure, staff years for paper
filing are for selected major activities only.
Electronic filing continues to grow but at a slower rate than
previous years. This year's 2.4 percent rate of growth is less than the
average annual rate of growth of 4.3 percent for each of the preceding
2 years. According to IRS officials, the slower growth in electronic
filing this year is due, in part, to changes in the Free File program,
which reduced the number of taxpayers eligible to file electronically
for free this year and to reduced advertising by companies involved in
that program, and the termination of the TeleFile program, which
eliminated the way for taxpayers to file their returns electronically
via telephone.
The Free File program enables taxpayers to file their returns
electronically via IRS's Web site. Through IRS's Web site, taxpayers
can access the Web sites of 20 companies comprising the Free File
Alliance. The alliance is a consortium of tax preparation companies
that agreed to offer free return preparation and electronic filing for
taxpayers that meet certain criteria (see app. 1 for further detail).
In an amended agreement with IRS that took effect this year, the Free
File Alliance set a $50,000 income limitation on taxpayer
participation. This limit was absent last year and reduced the number
of taxpayers eligible to participate in the program. As of March 19,
2006, IRS processed about 2.9 million free file returns, which is a
decrease of 23 percent from the same period last year. This decline is
inconsistent with IRS's projection that it would receive 6 million tax
returns filed through the Free File program, almost a million more
compared to last year.
For 2006, IRS terminated the TeleFile program. IRS expected that
eliminating TeleFile would reduce electronic filing, but justified the
decision because of declining usage and relatively high costs. The
number of taxpayers using the program had been decreasing--from
approximately 5.7 million in 1999 to 3.8 million in 2004. IRS estimated
the cost per tax return submitted through TeleFile, typically Form
1040EZ, to have been $2.63 versus $1.51 for a return filed on paper,
largely due to contractor, telecommunications, and other costs. Given
the limitations of IRS's cost accounting system, the validity of these
figures is unknown. IRS officials stated that the reason for this
year's increase in the number of 1040EZ returns filed on paper is due,
in part, to the elimination of TeleFile. Through March 17, 2006, the
number of 1040EZ returns has increased 18 percent from last year.
Options for increasing electronic filing, in particular mandated
electronic filing, will be discussed in the budget section of this
statement.
Telephone Access and Accuracy Improved, in Part Due to Lower Call
Volume
Taxpayers' ability to access IRS's telephone assistors and the
accuracy of answers provided improved compared to previous years. From
January 1 through March 11, 2006, IRS answered approximately 22 million
phone calls, which is about a 7 percent decline from the same period as
last year.\10\ The call volume has been less than projected by IRS and
less than was assumed when IRS set staffing levels for telephone
assistors for the filing season. IRS officials offered several
explanations for the unexpected decline in call volume. One explanation
is that more taxpayers are using improved tax preparation software,
which reduces their need to call IRS. Another explanation is that more
taxpayers are getting through to a telephone assistor the first time
they call, thus reducing the need for taxpayers to call again.
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\10\ Despite less demand overall, call volume increased from
affected taxpayers in federally-declared disaster areas. IRS maintains
a special services hotline (1-866-562-5227) to provide assistance on
questions related to hurricane relief and combat zone participation.
Between January 1 and March 11, 2006, the hotline received 36,552
calls, an increase of 158 percent over the same period in 2005.
According to IRS officials, the hotline received primarily combat zone
calls in 2005 because there were so few federally-declared disaster
areas. Therefore, IRS officials attribute the 2006 increase to the
three major hurricanes in 2005.
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As shown in table 1, the percentage of taxpayers who attempted to
reach an assistor and actually got through and received service--
referred to as the level of service--was 84 percent so far this filing
season compared to 83 percent over the same period last year--and
greater than its 2006 fiscal year goal of 82 percent. According to IRS
officials, one possible explanation for the improvement in access is
the decline in overall call volume. When call volume decreases,
taxpayers are likely to wait less time to speak with an IRS telephone
assistor. As a result, fewer taxpayers would likely hang up, increasing
the percentage of taxpayers who get through to an assistor.
IRS also reported that, so far this filing season, the average
speed of answer (length of time taxpayers wait to get their calls
answered) is down 53 seconds from the same time last year to 182
seconds, a decrease of about 23 percent, and significantly better than
IRS's 2006 fiscal year goal of 300 seconds. IRS also reported that the
rate at which taxpayers abandoned their calls \11\ to IRS decreased
from 11.5 percent to 8.9 percent compared to the same period last year.
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\11\ IRS divides abandoned calls into two subsets, primary abandons
and secondary abandons. Primary abandons occur when callers hang up
before being put into queue to wait for an available assistor.
Secondary abandons are the number of callers who hang up after being
put into the queue to wait for an assistor. In November 2004, IRS
established a program to help determine where primary abandons occur
within the IRS scripts. According to IRS officials, looking at the
number and percentage of where callers hang up highlights opportunities
where IRS can improve its menu prompt phrasings in a way that would be
more beneficial for callers.
Table 1: IRS Telephone Assistance Performance in the First Weeks of the
Filing Seasons, 2002 through 2006
------------------------------------------------------------------------
Telephone assistance 2002 2003 2004 2005 2006
------------------------------------------------------------------------
Total calls \a\ 34,489 27,905 29,058 23,340 21,616
------------------------------------------------------------------------
Answered by assistors 9,208 9,434 10,116 9,421 8,653
------------------------------------------------------------------------
Answered by automation 25,281 18,471 18,942 13,919 12,963
------------------------------------------------------------------------
Assistor level of service 62% 82% 84% 83% 84%
------------------------------------------------------------------------
Average speed of answer \b\ 227 183 199 235 182
seconds second second second second
s s s s
------------------------------------------------------------------------
Accounts customer accuracy rate 88.3% 87.9% 89.1% 91.7% 92.7%
estimates \c\ +/-.9% +/-.7% +/-.8% +/-.7% +/-.7%
------------------------------------------------------------------------
Tax law customer accuracy rate 83.5% 81.2% 75.8% 87.5% 90.2%
estimates \c\ +/-.7% +/- +/- +/- +/-
1.0% 1.3% 1.0% 1.0%
------------------------------------------------------------------------
Source: IRS.
\a\ Total calls (i.e., calls answered by assistors and automation) and
CSR level of service are based on actual counts from January 1 to
March 16, 2002; March 15, 2003; March 13, 2004; March12, 2005; and
March 11, 2006.
\b\ From January 1 to March 16, 2002; March 15, 2003; March 13, 2004;
March 12, 2005; and March 11, 2006.
\c\ Based on a representative sample estimated at the 90 percent
confidence interval from January through February 2002, 2003, 2004,
2005, and 2006.
Using a statistical sampling process, IRS estimates that the
accuracy of telephone assistors' responses to taxpayers' tax law and
account questions improved compared to last year. IRS estimates its tax
law accuracy rate to be 90.2 percent, an increase of 2.7 percentage
points over the same time period last year, continuing an improvement
since 2004. Additionally, IRS estimates that the accuracy rate to
taxpayers' inquiries about their accounts, to be 92.7 percent this year
compared to 91.7 percent over same period last year, continuing an
improvement since 2003. IRS officials attribute these improvements in
performance to several factors, including better and more timely
performance feedback for telephone assistors, increased assistor
experience, better training, and increased use of the Probe and
Response Guide, a script used by telephone assistors to understand and
respond to tax law questions.
IRS's Web Site Is Being Used More, Is Performing Well, and Has Been
Reconfigured withthe Goal of Improving Taxpayer Service
Use of IRS's Web site has increased so far this filing season
compared to prior years based on the number of visits and downloads.
From January 1 through February 28, IRS's Web site was visited 67
million times by visitors who downloaded 56 million forms and
publications. The number of visits reflects a 7 percent increase over
the same period last year while the number of forms and publications
downloaded has increased by 25 percent.
Further, IRS's Web site is performing well. For example,
we found IRS's Web site to be readily accessible, easy to
navigate, and easy to search,
an independent weekly study by Keynote, a company that
evaluates Web sites, reported that IRS's Web site has repeatedly ranked
second out of 40 government agencies evaluated in terms of average
download time. The same study also reported that IRS has repeatedly
ranked first out of the most commonly accessed government related Web
sites for response time and success rate, and
the American Consumer Satisfaction Index overall customer
satisfaction with IRS's Web site increased from 68 to 72 percent after
IRS reconfigured the site.
IRS reconfigured its Web site for the 2006 filing season. According
to IRS officials, the goal for reconfiguring the Web site was to
improve overall customer service through easier navigation and a more
effective search function. As a result, the number of Web site searches
has decreased by 53 percent, from 76 million during the same period
last year to 36 million this year. Typically, search functions are used
when users fail to find information through links. According to IRS
officials, the decrease in the number of searches indicates that users
are finding the information that they need faster.
IRS also added the following new features to its Web site this
year:
Electronic IRS: The Electronic IRS brand reconfigured the
IRS's Web site and made it easier to locate items, as evidenced by the
decline in searches;
Alternative Minimum Tax (AMT) Assistant: Helps taxpayers
determine if they do not owe AMT; and
Help for Hurricane Victims: A special link that provides
victims of the recent hurricanes information on special tax relief,
assistance and how to get help with tax matters;
IRS's Web site continues to include several important
features in addition to the Free File program;
Where's My Refund, which allows taxpayers to check on the
status of their refunds. As of March 20, 2006, 19.8 million taxpayers
accessed the Where's My Refund feature to check on the status of their
tax refunds. This was a 21 percent increase from the same period last
year; and
Electronic Tax Law Assistance, where taxpayers can ask
IRS general tax law questions via its Web site. From January 1 through
March 20, 2006, IRS received 7,353 emails requesting tax law assistance
(down over 32 percent compared to last year). As of February 28, 2006,
IRS estimated the accuracy rate of IRS's responses to tax law questions
submitted via the Web site, to be 85 percent down from 88 percent in
2005. However, the average number of days that it took IRS to respond
to tax law questions submitted via the Web site improved to 2.4 days,
compared to 4 days in 2005.
Taxpayers Continue Their Recent Pattern of Using IRS's Walk-In Sites
Less and Using Volunteer Sites More, and Information About the
Quality of Service Remains Limited
Fewer taxpayers have used IRS's 400 walk-in sites so far in the
2006 filing season compared to the same period in prior years. Staff at
walk-in sites provide taxpayers with information about their tax
accounts and answer taxpayers' questions within a limited scope of
designated tax law topics, such as those related to income, filing
status, exemptions, deductions, and related credits.\12\ Walk-in site
staffs also provide need-based tax return preparation assistance,
limited to taxpayers meeting certain requirements.\13\ As of March 11,
2006, the total number of contacts at IRS's walk-in sites declined by
approximately 12 percent compared to last year. The decline thus far
this year is consistent with the annual trends in walk-in use shown in
figure 2, including IRS's projection for 2006. The declines in the
number of taxpayers using IRS's walk-in sites, including for tax return
preparation, are also consistent with IRS's strategy to reduce its
costly face-to-face assistance by providing taxpayers with additional
options, such as IRS's toll-free telephone service, Web site, and
numerous volunteer sites. It is unclear, however, whether the declining
volume is an indicator of how well IRS is meeting taxpayers' demand for
face-to-face assistance. For example, IRS does keep track of the number
of taxpayers entering a walk-in site, taking a number to queue for
service, but then leaving the site without receiving service. If a
taxpayer did not take a number, IRS would have no way of counting those
taxpayers.
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\12\ IRS considers some tax law questions to be out of scope
related to businesses and corporations, for example. If staff cannot
answer taxpayer's questions, they are required to refer taxpayers to
IRS's telephone service or Web site.
\13\ Return preparation assistance is limited to taxpayers with
income of $38,000 or less. According to IRS, this limitation
approximates the amount set in the tax code for claiming the Earned
Income Tax Credit. IRS has required appointments for most taxpayers
seeking this assistance since 2003.
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IRS officials said the types of services offered at walk-in sites
remained constant for most sites from 2005 to 2006. For sites in areas
with a high number of natural disaster victims, IRS expanded the types
of assistance provided. For example, IRS eliminated income limits for
taxpayers seeking return preparation assistance.
[GRAPHIC] [TIFF OMITTED] T0443A.002
Figure 2: Assistance Provided at IRS Walk-in Sites and Volunteer
Sites, 2001--2006 Filing Seasons (contacts in millions)
Note: ``Other walk-in contacts'' includes assistance for account
notices, tax law inquiries, forms, and compliance work, but not return
preparation. For the walk-in sites, the time periods covered are
December 31, 2000, through April 28, 2001; December 30, 2001, through
April 27, 2002; December 29, 2002, through April 26, 2003; December 28,
2003, through April 24, 2004; and December 26, 2004, through April 23,
2005. For volunteer sites, the time period covered for 2001 is January
1, 2001, through April 21, 2001; December 30, 2001, through April 27,
2002; December 29, 2002, through April 26, 2003; December 28, 2003,
through April 24, 2004; and December 26, 2004, through April 23, 2005.
\a\ Fiscal years 2006 and 2007 are IRS projections. For walk-in
sites, projections cover the time periods of December 25, 2005 through
April 22, 2006, and December 31, 2006 through April 28, 2007. For
volunteer sites, projections cover the time periods from January 1
through April 30, 2006 and 2007.
In contrast to IRS walk-in sites, the number of taxpayers seeking
return preparation assistance at approximately 14,000 volunteer sites
has increased this year by 5.6 percent, continuing the trend since 2001
(see fig. 2). These sites, often run by community-based organizations
and staffed by volunteers who are trained and certified by IRS, do not
offer the range of services IRS provides at walk-in sites, but instead
focus on preparing tax returns primarily for low-income and elderly
taxpayers and operate chiefly during the filing season. As we have
previously reported,\14\ the shift of taxpayers from walk-in to
volunteer sites is important because it has allowed IRS to transfer
time-consuming services, such as return preparation, from IRS to other
less costly alternatives that can be more convenient for taxpayers.
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\14\ GAO, Tax Administration: IRS Improved Performance in the 2004
Filing Season, but Better Data on the Quality of Some Services Are
Needed, GAO-05-67 (Washington, D.C.: Nov. 15, 2004).
---------------------------------------------------------------------------
IRS has used both walk-in and volunteer sites to provide relief
efforts for federally-designated disaster zones such as in hurricane-
affected areas. IRS developed a Disaster Referral Services Guide and
new training materials for employees to better equip them to address
disaster-related issues. Also, IRS adjusted the type of tax law
questions that it would answer at walk-in sites to include casualty
loss and removed income limitations for disaster victims seeking return
preparation assistance at walk-in sites. Volunteer sites performed
outreach within their network of partners by creating training material
for tax practitioners, and agreeing with two organizations to accept
referrals from IRS of disaster victims needing tax return preparation
assistance.
Concerning the quality of services provided at walk-in and
volunteer sites, IRS continues to lack reliable and comprehensive data
on the quality of the services provided. As in previous years, TIGTA is
conducting an audit on the accuracy of some services provided at walk-
in sites, although the results will not be available until after the
filing season. However, TIGTA has noted problems with the quality of
services provided at IRS walk-in sites in prior reports.\15\ We have
made recommendations for IRS to improve its quality measurement at
walk-in sites.\16\ At volunteer sites, IRS is conducting different
types of reviews to monitor tax return preparation assistance.\17\
According to IRS officials, the results to date show that the quality
of service has improved at volunteer sites compared to previous years,
but they acknowledge that challenges remain in terms of volunteers'
adherence to IRS's procedures and use of IRS materials. As in previous
years, TIGTA will conduct limited quality reviews at volunteer sites.
While the results of those reviews are based on a judgmental sample,
TIGTA has concluded in the past that, while significant improvements
have been made in the oversight of volunteer sites, continued effort is
needed to ensure the accuracy of tax return assistance provided.\18\
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\15\ Treasury Inspector General for Tax Administration,
Coordination and Monitoring Are Needed for Continued Improvement in the
Tax Return Preparation Process at the Taxpayer Assistance Centers,
Reference No. 2004-40-147, (Washington, D.C.: 2005), and Treasury
Inspector General for Tax Administration, Customer Accuracy at Taxpayer
Assistance Centers Showed Little Improvements During the 2005 Filing
Season, Reference No. 2005-40-146, (Washington, D.C.: 2003).
\16\ See GAO-05-67 and GAO-06-51.
\17\ The different types of reviews include site reviews to measure
the administrative aspects of a volunteer site such as readiness. IRS
plans on conducting 825 of these site reviews. IRS also plans on
conducting 2,475 return reviews, approximately 3 during each site
review, which will involve on-site review of the return for accuracy
and discretionary reviews for problem sites not operating in accordance
with the IRS's guidelines.
\18\ Treasury Inspector General for Tax Administration, Significant
Improvements Have Been Made in the Oversight of the Volunteer Income
Tax Assistance Program, but Continued Effort Is Needed to Ensure the
Accuracy of Services Provided, Reference No. 2006-40-004, (Washington,
D.C.: 2005).
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IRS's Budget Proposes Decreases in Staffing and Identifies Savings, but
Opportunities for Additional Savings Exist
IRS's fiscal year 2007 budget request is a small decrease compared
to 2006 enacted levels after adjusting for expected inflation. It
proposes to reduce overall staffing levels, as well as staffing levels
for taxpayer service and enforcement activities, while maintaining or
improving taxpayer service and enforcement. As it has in prior years,
IRS has identified some savings, but additional opportunities exist for
enhancing savings.
IRS's Budget Proposes Decreases in Funding After Adjusting for Expected
Inflation and in Staffing
IRS's proposed fiscal year 2007 budget is $11 billion (a 1.6
percent increase), but after adjusting for expected inflation, it
reflects a slight decrease over last year's enacted budget. The $11
billion includes $417 million from new and existing user fees and
reimbursable agreements with other federal agencies.\19\ The 2007
budget request for IRS's appropriation accounts is shown in table 2
(see app. II for more details).\20\
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\19\ According to IRS, the $417 million estimate is based on
receiving $135 million from increasing existing user fees and
establishing new ones. IRS has committed to distributing the $135
million over its PAM, TLE, and IS accounts, exclusively for taxpayer
service. The remaining user fees will be used as needed by IRS.
\20\ The PAM appropriation account primarily funds functions
related to taxpayer service which includes funding for enforcement; TLE
primarily funds enforcement activities but includes funding for
taxpayer services; IS funds information technology support and
improvements for legacy systems which support both taxpayer services
and enforcement; BSM funds the new modernized business system; and
HITCA administers a refundable tax credit for health insurance for
qualified individuals. We did not review the HITCA account as part of
our work.
Table 2: IRS's Changes in Funding and FTEs for Fiscal Years 2006 through 2007
----------------------------------------------------------------------------------------------------------------
Fiscal year 2007 Fiscal year 2006 Percentage change
requested including new enacted fiscal year 2006-
Dollars in thousands user fee revenue ------------------------- 2007
------------------------- --------------------
Dollars FTEs Dollars FTEs Dollars FTEs
----------------------------------------------------------------------------------------------------------------
Processing, Assistance, and Management $4,159,893 37,126 $4,095,212 38,796 1.58 -4.30
(PAM)
----------------------------------------------------------------------------------------------------------------
Tax Law Enforcement (TLE) 4,764,954 49,479 4,678,498 50,559 1.85 -2.14
----------------------------------------------------------------------------------------------------------------
IS 1,619,834 7,351 1,582,977 7,032 2.33 4.54
----------------------------------------------------------------------------------------------------------------
BSM 167,310 0 197,010 0 -15.08 0.00
----------------------------------------------------------------------------------------------------------------
Health Insurance Tax Credit 14,846 17 20,008 17 -25.80 0.00
Administration (HITCA)
----------------------------------------------------------------------------------------------------------------
Total $10,726,837 93,973 $10,573,706 96,404 1.45 -2.52
----------------------------------------------------------------------------------------------------------------
Existing user fees and reimbursablesa $282,543 1,503 $258,820 1,350 9.17 11.33
----------------------------------------------------------------------------------------------------------------
Total program operating level $11,009,380 95,476 $10,832,526 97,754 1.63 -2.33
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
Notes: For fiscal year 2007, the figures shown for requested FTEs reflect an IRS adjustment and differ slightly
from what IRS reported in its budget request. The Congressional Budget Office projects the inflation rate to
be 1.8 percent in 2007; therefore, IRS's proposed increases are less than the rate of inflation.
\a\ Reimbursables are payments IRS receives for providing services to other federal agencies and states.
The real decrease in the proposed budget can be seen in staffing.
IRS proposes to fund 95,476 FTEs in fiscal year 2007, down over 2
percent from 97,754 FTEs in enacted fiscal year 2006 (see table 5 in
app. II for comparisons in enacted FTE levels for fiscal years 2002
through 2007). Actual FTEs tend to be lower than enacted FTEs, in part,
because of how IRS absorbs unbudgeted costs (see table 6 in app. II for
actual FTEs).
The decrease in FTEs may be greater than shown in IRS's fiscal year
2007 budget request. Every year agencies, including IRS, are expected
to absorb some costs that are not included in their budget requests.
For fiscal year 2007, IRS officials currently anticipate having to
absorb over $117 million in costs, including about $41 million for
homeland security-related controls over physical access to government
facilities. Absorbing such costs reduces the actual number of FTEs that
IRS can support. For example, for fiscal year 2005, the enacted level
of FTEs was 96,435 but the actual level was 94,282.
IRS's Budget Request Proposed to Maintain or Improve Taxpayer Services
with Fewer Resources
IRS is requesting $4.2 billion for PAM, including some user fees,
which is funding primarily spent on providing service to taxpayers.\21\
The amount requested is about a 1.6 percent increase over fiscal year
2006 enacted levels, but is a slight decrease after adjusting for
expected inflation. This funding level translates into reduced
staffing, down over 4 percent from an enacted level of 38,796 FTEs in
fiscal year 2006 to 37,126 proposed FTEs in fiscal year 2007. Since
fiscal year 2002, FTEs devoted to PAM have declined over 15 percent
from an enacted level of 43,866 FTEs.
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\21\ IRS has funding in other appropriation accounts that support
its taxpayer service programs.
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Despite the proposed inflation-adjusted decrease in funding in
2007, IRS is planning to maintain or improve taxpayer services. For
every one of the major taxpayer services listed in the budget, 2007
planned performance goals are higher or equal to 2006 performance
goals. These services include telephone assistance and refund issuance.
IRS's Budget Request Reduces Enforcement Staffing Slightly, While
Increasing Major Enforcement Activities
IRS is requesting $4.8 billion for TLE.\22\] The 2007 budget
request proposes an overall decrease in enforcement FTEs, down over 2
percent to a proposed 49,479 FTEs from last year's enacted level of
50,559 FTEs. For its three main categories of skilled enforcement
staff, IRS is proposing a marginal increase in staffing of 0.2 percent
(see fig. 3). For special agents (those who perform criminal
investigations), the increase is 1.7 percent. For the other two
categories--revenue agents (those who examine complex returns), revenue
officers (those who perform field collection work)--IRS is proposing to
keep the number of staff the same as in 2006.
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\22\ In his recent testimony, the IRS Commissioner said that if the
Congress failed to provide funding outside the program integrity cap
adjustment it could potentially jeopardize past gains. This year, IRS
is seeking $137 million outside the cap.
[GRAPHIC] [TIFF OMITTED] T0443A.003
Figure 3: Revenue Agents, Revenue Officers, and Special Agents,
Fiscal Years 1998--2007
Notes: Numbers for 2006 and 2007 are IRS estimates. IRS
recalculated the figures since GAO reported them last year. GAO is
using the new figures because IRS has validated those figures using its
new cost accounting system.
Despite keeping skilled enforcement staff virtually unchanged, IRS
is proposing to maintain or increase its major enforcement activities.
For all the major enforcement activities listed in the budget, IRS is
establishing goals in 2007 that are higher or equal to 2006 planned
performance goals. Major enforcement activities include individual
taxpayer examinations, collection coverage,\23\ and criminal
investigations completed. IRS officials anticipate increased revenue
collected and other performance improvements as a result of using data
from IRS's most current compliance research effort, known as the
National Research Program (NRP).\24\
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\23\ The number of collection cases closed or otherwise eliminated
compared to the total number of collection cases in inventory.
\24\ NRP replaced the Taxpayer Compliance Measurement Program,
which last measured compliance for individuals for 1988 but was
canceled because of concerns about costs and burdens on taxpayers. GAO,
Tax Administration: New Compliance Research Effort Is on Track, but
Important Work Remains, GAO-02-769 (Washington, D.C.: June 27, 2002)
and Tax Administration: Status of IRS' Efforts to Develop Measures of
Voluntary Compliance, GAO-01-535 (Washington, D.C.: June 18, 2001)
discuss the development of the NRP study.
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Budget for IS Request for Funding Is Up Slightly, and IRS Has Taken
Additional Steps to Improve Budgeting for IS Operations and
Maintenance
IRS is requesting about $1.6 billion for IS in fiscal year 2007,
which is intended to fund information technology (IT) staff and related
costs for activities such as information security and maintenance and
operations of its current tax administration systems. Although the
number of FTEs proposed in 2007 is up when enacted FTEs are considered,
it is virtually the same as the operating level currently assumed in
2006 (see app. II for more details).
In 2002, we reported that the agency did not develop its fiscal
year 2003 IS operations and maintenance budget request in accordance
with the investment management approach used by leading organizations.
We recommended that IRS prepare its future budget requests in
accordance with these best practices.\25\ To address our
recommendation, IRS agreed to take a variety of actions, which it has
made progress in implementing. For example, IRS planned to develop a
capital planning guide to implement processes for capital planning and
investment control, budget formulation and execution, business case
development, and project prioritization. In August 2005, IRS issued the
initial version of its IT Capital Planning and Investment Control
(CPIC) Process Guide, which (1) provides executives with the framework
within which to select, control, evaluate, and maintain the portfolio
of IT investments to best meet IRS business goals and (2) defines the
governance process that integrates the agency's IT investments with the
strategic planning, budgeting, and procurement processes. According to
IRS officials and documentation, the agency formulated its prioritized
fiscal year 2007 IT portfolio and associated budget request, including
operations and maintenance requirements, in accordance with this CPIC
Process Guide. We will continue to monitor the implementation of IRS's
CPIC process as its IT investment management process matures.
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\25\ GAO, Internal Revenue Service: Improving Adequacy of
Information Systems Budget Justification, GAO-02-704 (Washington, D.C.:
June 28, 2002).
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In addition, IRS stated that it planned to develop an activity-
based cost model to plan, project, and report costs for business tasks/
activities funded by the IS budget. During fiscal year 2005, as part of
the first release of the Integrated Financial System (IFS),\26\ IRS
implemented a cost module that is potentially capable of allocating
costs by activity. However, agency officials stated that they needed to
accumulate 3 years of actual costs to have the historical cost data
necessary to provide a basis for meaningful future budget estimates.
Since then, according to the Office of the Chief Financial Officer, IRS
has (1) populated the cost module with all actual fiscal year 2005
expenses; (2) identified the data needed from IFS to support its budget
requests; and (3) developed a system to capture, test, and analyze the
cost data to devise a standard methodology to provide the necessary
data from the cost module. Once the pilot results and recommendations
have been reviewed, an implementation plan will be developed. IRS still
expects to have the requisite 3 years of historical cost data available
in time to support development of the fiscal year 2010 budget request.
Although IRS has made progress in implementing best practices in
developing its IS operations and maintenance budget, until IRS
completes the actions necessary to fully implement the activity--based
cost module, the agency will not be able to ensure that its request is
adequately supported.
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\26\ IFS replaces aspects of IRS's core financial systems and is
ultimately intended to operate as its new accounting system of record.
The first release of this system became fully operational in January
2005.
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IRS's Proposed BSM Budget Reduction Could Impede Future Progress
BSM is a high-risk, highly complex effort that involves developing
and delivering a new set of information systems that are intended to
replace the agency's aging tax processing and business systems. The
program is critical to supporting IRS's taxpayer service and
enforcement goals. For example, BSM includes projects to allow
taxpayers to file and retrieve information electronically and to
provide technology solutions to help reduce the backlog of collections
cases. It also helps IRS considerably in providing the reliable and
timely financial management information needed to account for the
nation's largest revenue stream and better enable the agency to both
determine and justify its resource allocation decisions and budget
requests.
IRS's fiscal year 2007 budget request of $167.3 million for the BSM
program reflects a reduction of about 15 percent (and even greater when
adjusted for expected inflation), or about $30 million, from the
enacted fiscal year 2006 budget of $197 million.
Since our testimony before this subcommittee on last year's budget
request, IRS has made further progress in implementing BSM, although
some key projects did not meet short-term cost and schedule
commitments. During 2005 and the beginning of 2006, IRS deployed
additional releases of several modernized systems that have delivered
benefits to taxpayers and the agency, including CADE, e-Services (a new
Web portal and electronic services for tax practitioners), and
Modernized e-File (a new electronic filing system). While three BSM
project releases were delivered within the cost and/or schedule
commitments presented in the fiscal year 2005 expenditure plan, others
experienced cost increases or schedule delays. For example, two IFS and
Modernized e-File project releases experienced cost increases of 93
percent \27\ and 29 percent, respectively. As we have previously
reported,\28\ the BSM program has had a history of cost increases and
schedule delays that have been due, at least in part, to deficiencies
in various management controls and capabilities that have not yet been
fully corrected. IRS is in the process of implementing our prior
recommendations to correct these deficiencies.
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\27\ IRS recently reported that it plans to redirect about $5
million of unobligated funding from the IFS project to program
management reserve, which would reduce this cost overrun.
\28\ For example, see GAO, Business Systems Modernization: Internal
Revenue Service's Fiscal Year 2005 Expenditure Plan, GAO-05-774
(Washington, D.C.: July 22, 2005).
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IRS has identified significant risks and issues that confront
future planned system deliveries. For example, according to IRS,
schedule delays and contention for key resources between multiple
releases of CADE necessitated the deferral of some functionality. The
deferral of these requirements may negatively impact the cost and
schedule for two important releases, which are planned to be deployed
later this year. The agency, however, recognizes the potential impact
of these project risks on its ability to deliver planned functionality
within cost and schedule estimates, and to its credit, has developed
mitigation strategies to address them. IRS has also made additional
progress in addressing high-priority BSM program improvement
initiatives during the past year, including initiatives related to
shifting the role of systems integrator from the prime contractor to
IRS. IRS's program improvement process appears to be an effective means
of assessing, prioritizing, and addressing BSM issues and challenges.
However, much more work remains for the agency to fully address these
issues and challenges.
In addition, in response to our prior recommendation, IRS is
developing a new Modernization Vision and Strategy to address BSM
program changes and provide a modernization roadmap. According to the
Associate Chief Information Officer for BSM, the agency's new strategy
focuses on promoting investments that provide value in smaller,
incremental releases that are delivered more frequently, with the goal
of increasing business value. IRS is currently finalizing a high-level
vision and strategy as well as a more detailed 5-year plan for the BSM
program. We believe these actions represent sound steps toward
addressing our prior recommendation to fully revisit the vision and
strategy and develop a new set of long-term goals, strategies, and
plans consistent with the budgetary outlook and with IRS's management
capabilities.
While the requested fiscal year 2007 BSM budget will allow IRS to
continue the development and deployment of the CADE, Modernized e-File,
and Filing and Payment Compliance (F&PC) \29\ projects, the proposed
reduced funding level would likely affect the agency's ability to
deliver the functionality planned for the fiscal year and could result
in project delays and/or scope reductions. This could, in turn, impact
the long-term pace and cost of modernizing tax systems and of
ultimately improving taxpayer service and strengthening enforcement.
For example, according to IRS documents, the agency had planned to
spend $85 million in fiscal year 2007 to develop and deploy additional
CADE releases that would enable the system to process up to 50 million
individual tax returns by the 2008 filing season and issue associated
refunds faster. However, with a proposed budget of $58.5 million--over
30 percent less than anticipated--IRS would likely have to scale back
its planned near-term work on this project. In addition, the reductions
to the planned budgets for the Modernized e-File and F&PC projects may
also result in IRS having to redefine the scope and/or reassess
schedule commitments for future project releases.
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\29\ F&PC is a series of projects expected to provide support for
detecting, scoring, and working nonfiler (filing compliance) and
delinquency (payment compliance) cases. The first phase of F&PC is
Private Debt Collection, which will use advanced software to analyze
tax collection cases and divide them into the complex cases requiring
IRS involvement and the less complex (balance due) cases that can be
handled by private collection agencies.
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The proposed BSM budget reduction would also significantly reduce
the amount allotted to program management reserve by about 82 percent
(from $13 million in fiscal year 2006 to $2.3 million in fiscal year
2007). If BSM projects have future cost overruns that cannot be covered
by the depleted reserve, this reduction could result in increased
budget requests in future years or delays in planned future activities.
While the BSM program still faces challenges, IRS has recently made
progress in delivering benefits and addressing project and program-
level risks and issues. Reducing BSM funds at a time when benefits to
taxpayers and the agency are being delivered could adversely impact the
momentum gained from recent progress and result in delays in the
delivery of future benefits. However, until IRS addresses our prior
recommendation by clearly defining its future goals for the BSM program
as well as the impact of various funding scenarios on meeting these
goals in its new Modernization Vision and Strategy, the long-term
impact of the proposed budget reduction is unclear.
IRS's Budget Request Identified Some Savings, but Opprotunities Exist
for Enhancing Savings
In its 2007 budget request, IRS identified savings as it has done
in prior years and plans to redirect some of those savings to front-
line taxpayer service and enforcement activities. IRS is proposing to
save over $121 million and 1,424 FTEs by, for example, automating the
process of providing an individual taxpayer identification number to
those taxpayers ineligible for a Social Security number and improving
data collection techniques and work processes for enforcement
activities through increased financial reporting requirements and
scanning and imaging techniques.
IRS's history of realizing savings proposed in past budget requests
provides some confidence that the agency will be able to achieve
savings in fiscal year 2007. For example, IRS reported it realized 88
percent of the anticipated dollar savings and 86 percent of the
anticipated staff savings identified in the fiscal year 2004 budget
request. IRS also reported exceeding the savings targets in the fiscal
year 2005 budget request (see app. III).
In addition to the areas identified by IRS in its budget request,
there may be additional opportunities for efficiency gains.
Increasing electronic filing: In an era of tight budgets,
continued growth in electronic filing may be necessary to help fund
future performance improvements. One proposal for continuing to
increase electronic filing is additional use of electronic filing
mandates. Currently, IRS mandates electronic filing for large
corporations. The 2007 budget request proposes a legislative change
that would expand its authority to require electronic filing for
businesses. Moreover, 12 states now mandate electronic filing for
certain classes of tax practitioners (see app. IV for more information
on state mandates). As we have reported,\30\ although there are costs
and burdens likely to be associated with electronic filing mandates for
paid tax preparers and taxpayers, state mandates have generated
significant increases in electronic filing. IRS has an electronic
filing strategy, which the agency is updating.
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\30\ GAO-06-51.
Changing the menu of taxpayer services: IRS currently
lacks a comprehensive strategy explaining how its various taxpayer
services (including its telephone, walk-in, volunteer, and Web site
assistance) will collectively meet taxpayer needs. In response to a
Congressional directive,\31\ IRS is developing such a strategy. The
strategy is important because some taxpayers may not be well served by
the current service offerings. IRS's attempts to reduce some taxpayer
services, namely reducing the hours of telephone operations and closing
some walk-in sites, have met with resistance from the Congress.
Although congressional directives to study the impact of IRS's actions
exist,\32\ we still believe there may be opportunities to adjust IRS's
menu of services to reduce costs, without affecting IRS's ability to
meet taxpayers' needs.
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\31\ In the H.R. Conf. Rep. No. 109-307 (2005), the Congress
directed the IRS, in conjunction with the IRS Oversight Board and the
National Taxpayer Advocate, to develop a 5-year plan for taxpayer
service activities and report to the House and Senate Committees on
Appropriations by April 14, 2006.
\32\ In Pub. L. No. 109-115, 205, (Nov. 30, 2005), the Congress
directed the IRS not to reduce taxpayer services as the IRS proposed in
fiscal year 2006 until TIGTA completed a study on the impact of such
reductions on taxpayer compliance and services. Further, IRS was
directed, to consult with stakeholder organizations, including, but not
limited to, the IRS Oversight Board, National Taxpayer Advocate, TIGTA
and Internal Revenue employees with respect to any efforts by the IRS
to terminate or reduce significantly any taxpayer service activity.
Pub. L. No. 109-148, 5021 (Dec. 30, 2005) extends above provisions to
include any reduction in available hours of telephone taxpayer
assistance below the levels in existence during the month of October
2005.
Consolidating telephone call sites: IRS operates 25 call
sites throughout the country. Consistent with earlier plans, IRS closed
two of its smallest call sites--Chicago and Houston--in March 2006, to
realize savings in its toll-free telephone operations. Also, IRS has
gained efficiencies from using a centralized call router located in
Atlanta. As a result, there are currently more than 850 workstations
that are not being used; consequently, IRS may have the potential to
close several additional call sites. Consolidations would not affect
telephone service and would be invisible from the taxpayer's
perspective.
Accurate Cost Information Would Help IRS Make Resource Allocation
Decisions, and Help Provide Some Information About the Return
on Investment for its Programs
Managing a federal agency as large and complex as IRS requires
managers to constantly weigh the relative costs and benefits of
different approaches to achieving the goals mandated by the Congress.
Management is constantly called upon to make important long-term
strategic as well as daily operational decisions about how to make the
most effective use of the limited resources at its disposal. As
constraints on available resources increase, these decisions become
correspondingly more challenging and important. In order to rise to
this challenge, management needs to have current and accurate
information upon which to base its decisions, and to enable it to
monitor the effectiveness of actions taken over time so that
appropriate adjustments can be made as conditions change.
In its ongoing effort to make such increasingly difficult resource
allocation decisions and defend those decisions before the Congress,
IRS has long been hampered by a lack of current and accurate
information concerning the costs of the various options being
considered. Instead, management often has relied on a combination of
the limited existing cost information; the results of special analysis
initiated to establish the full cost of a specific, narrowly defined
task or item; and estimates based on the best judgment of experienced
staff. This has impaired IRS's ability to properly decide which, if
any, of the options at hand are worth the cost relative to the expected
benefits. For example, accurate and timely cost information may help
IRS consider changes in the menu of taxpayer services that it provides
by identifying and assessing the relative costs, benefits, and risks of
specific projects. Without reliable cost information, IRS's ability to
make such difficult choices in an informed manner is seriously
impaired. The lack of reliable cost information also means that IRS
cannot prepare cost-based performance measures to assist in measuring
the effectiveness of its programs over time.
Further, IRS does not have the capability to develop reliable
information on the return on investment for each category of taxpayer
service and enforcement. IRS lacks reliable information on both the
return from services (the additional revenue collected by helping
taxpayers understand their tax obligations) and the investment or cost
of the services. While developing return on investment information is
difficult, the cost component of that equation may be the least complex
to develop. Having such cost information is a building block for
developing return on investment estimates. For its enforcement
programs, IRS has developed a rough measure of return on investment in
terms of tax revenue that is directly assessed from uncovering
noncompliance. Continuing to develop return on investment measures
could help officials make more informed decisions about allocating
resources.\33\ The new NRP data, for example, are to be used to better
identify which tax returns to examine so that fewer compliant taxpayers
are burdened by unnecessary audits and IRS can increase the amount of
noncompliance that is addressed through its enforcement activities.
Even without return on investment information, cost information can
help IRS determine if, for example, IRS should change the menu of
services provided.
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\33\ Developing such measures is difficult because of incomplete
information on all the costs and all the tax revenue ultimately
collected from specific enforcement efforts, as well as incomplete
information on the indirect tax revenues generated when current
enforcement actions prompt voluntary compliance improvements in the
future.
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As discussed in the BSM section, in fiscal year 2005, IRS
implemented a cost accounting module as part of IFS. However, while
this module has much potential and has begun accumulating cost
information, IRS has not yet determined what the full range of its cost
information needs are or how best to tailor the capabilities of this
module to serve those needs. Also, IRS does not have an integrated
workload management system which would provide the cost module with
detailed allocation of personnel cost information.\34\ In addition, as
noted in developing its IS budget, because it generally takes several
years of historical cost information to support meaningful estimates
and projections, IRS cannot yet rely on IFS as a significant planning
tool. It will likely require several years, implementation of
additional components of IFS, and integration of IFS with IRS's tax
administration activities before the full potential of IFS's cost
accounting module will be realized. Furthermore, IRS's fiscal year 2007
BSM budget request does not include funding for additional releases of
IFS. In the interim, IRS decision making will continue to be hampered
by inadequate underlying cost information.
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\34\ IRS had planned to develop a workload management system, but
has postponed this project indefinitely, due to budget constraints.
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IRS Sets Long-Term Goals, but Lacks a Data-Based Plan for Achieving the
Goals, and Addressing the Tax Gap Requires Solutions Beyond
Funding and Staffing for IRS
For the first time, IRS's budget request sets long-term goals aimed
at reducing the tax gap, although IRS does not have a data-based plan
for achieving the goals. However, because of its persistence, reducing
the tax gap requires solutions which go beyond funding and staffing for
IRS.
IRS's Budget Proposes Long-Term Goals, but Lacks a Data-Based Plan for
Achieving Them
IRS established two agencywide, long-term performance goals, as
shown in table 3. IRS plans to improve voluntary compliance from 83
percent in 2005 to 85 percent by 2009, and reduce the number of
taxpayers who think it is acceptable to cheat on their taxes from 10
percent in 2005 to less than 9 percent in 2010. According to IRS, these
are the first in a series of quantitative goals that will link to its
three strategic goals--improve taxpayer service, enhance tax law
enforcement, and modernize IRS through technology and processes.
Table 3: IRS Agencywide Goals for Fiscal years 2004 through 2010
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fiscalyear 2004 Fiscalyear 2005 Fiscalyear 2006 Fiscalyear 2007 Fiscalyear 2008 Fiscalyear 2009 Fiscalyear 2010
Performance level actual actual planned planned planned planned planned
performance performance performance performance performance performance performance
--------------------------------------------------------------------------------------------------------------------------------------------------------
Improve voluntary compliance..... N/A 83.0% N/A N/A N/A 85.0% N/A
--------------------------------------------------------------------------------------------------------------------------------------------------------
Reduce the percentage of 12.0% 10.0% 10.0% 10.0% 9.0% <9.0% <9.0%
taxpayers who think it is
acceptable to cheat on their
taxes.
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Source: IRS.
These goals will be challenging to meet, because for three decades,
IRS has consistently reported a persistent, relatively stable tax gap.
Although IRS has made a number of changes in its methodologies for
measuring the tax gap, which makes comparisons difficult, regardless of
methodology used, the voluntary compliance rate that underpins the gap
has tended to range from around 81 percent to around 84 percent.
Because of a lack of quantitative estimates of how changes to its
service and enforcement programs affect compliance, IRS is unable to
show in a data-based plan how it will use those programs to reach the
two long-term goals shown in table 3. If IRS could quantify the impact
of its service and enforcement programs on the compliance rate or
attitudes towards cheating, it could use the information to show the
kinds of changes to the programs needed to achieve the long-term goals
and how best to direct resources towards achieving those goals.
Unfortunately, quantifying the impact of IRS's service and enforcement
programs on compliance or cheating is very challenging. The type of
data needed to make such a link does not currently exist, and may not
be easy to collect.
Lacking such quantitative estimates, IRS must take a more
qualitative approach in its plans for increasing compliance, which
would likely also involve changing attitudes towards cheating. IRS's
overall approach to reducing the tax gap consists of improving service
to taxpayers and enhancing enforcement of the tax laws. We recently
reported that IRS has taken a number of steps that may improve its
ability to reduce the tax gap.\35\ Favorable trends in staffing of IRS
enforcement personnel; examinations performed through correspondence,
as opposed to more complex face-to-face examinations; and the use of
some enforcement sanctions such as liens and levies are encouraging.
Also, IRS has made progress with respect to abusive tax shelters
through a number of initiatives and recent settlement offers that have
resulted in billions of dollars in collected taxes, interest, and
penalties. Finally, IRS has continually improved taxpayer service by
increasing, for example, the accuracy of responses to tax law
questions.
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\35\ GAO-06-453T.
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The effect of this overall approach and the 2007 budget proposal
will have on voluntary compliance has not been quantified by IRS.
Therefore, the Congress will have to rely on the IRS Commissioner for
qualitative explanations, of why, in his judgment, IRS's mix of
taxpayer service and enforcement and overall approach for reducing the
tax gap, including the 2007 budget proposal, will be sufficient to
start IRS on a path towards achieving its long-term goals. More
specifically, such explanations could include a clear statement of
which service and enforcement programs have priorities for expansion
because they are expected to contribute the most to increasing the
compliance rate and the evidence that supports that judgment.
In addition, IRS lacks a plan for measuring progress towards one
goal--improving voluntary compliance. IRS plans to measure progress
towards the second goal--reducing the percentage of taxpayers who think
it is acceptable to cheat--via the IRS Oversight Board's annual
Taxpayer Attitude Survey.
Nevertheless, IRS recently estimated voluntary compliance as part
of the NRP study, which reviewed the compliance of a random sample of
individual taxpayers and used those results to estimate compliance for
the population of all taxpayers. The study took several years to plan
and execute. In addition to providing an estimate of the compliance
rate, the study's results will be used to better target IRS's audits of
potentially non-compliant taxpayers. Better targeting reduces the
burden on taxpayers because IRS is better able to avoid auditing
compliant taxpayers.
At this time, however, IRS has not made plans to repeat the study
in time to measure compliance by 2009. Furthermore, doing compliance
studies once every few years does not give IRS or others information
about what is happening in the intervening years. Annual estimating of
the compliance rate could provide information that would enable IRS
management to adjust plans as necessary to help achieve the goal in
2009. One option that would not increase the cost of estimating
compliance would be to use a rolling sample. IRS Oversight Board
officials and we agree that instead of sampling, for example, once
every 5 years, one-fifth of the sample could be collected every year.
The total sample could include 5 years worth of data--with each passing
year the oldest year would be dropped from the sample and the latest
year added. The availability of current research data would allow IRS
to more effectively focus its service and compliance efforts.
Addressing the Tax Gap Requires Solutions Beyond Funding and Staffing
for IRS
For years, we have reported that tax law enforcement is a high-risk
area, in part because of the size of the gross estimated tax gap, which
IRS most recently estimated to be $345 billion for tax year 2001. IRS
estimated it would recover around $55 billion through late payments and
enforcement revenue, resulting in a net tax gap of around $290
billion.\36\ Reducing the tax gap would yield significant revenue and
even modest progress, such as a 1 percent reduction, would likely yield
nearly $3 billion annually. In recent years, IRS reported increases in
enforcement revenue--revenue brought in as a result of IRS taking
enforcement action. Between fiscal years 2003 and 2005, IRS reported
that enforcement revenue grew from $37.6 billion to $47.3 billion, with
a level of $48.1 billion estimated for 2006. However, the voluntary
compliance rate has persisted at a relatively stable level.
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\36\ GAO-06-453T.
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We have reported that significant reductions in the tax gap will
likely require exploring new and innovative solutions.\37\ Such
solutions that may not require significant additional IRS resources,
but are nonetheless difficult to achieve, include
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\37\ GAO-06-453T.
simplifying the tax code to make it easier for
individuals and businesses to understand and comply with their tax
obligations;
increasing tax withholding for income currently not
subject to withholding;
improving information reporting; and
leveraging technology to improve IRS's capacity to
receive and process tax returns.
IRS's 2007 budget request includes five new legislative proposals
to address some of these solutions to reduce the tax gap, along with a
proposal to study independent contractor compliance that would not
require additional resources. In recent testimony, the IRS Commissioner
stated that the amount of enforcement revenue IRS expects from the
legislative proposals will be $3.6 billion over the next 10 years
(about 0.1 percent of the tax gap). However, the proposals should also
increase revenue voluntarily paid without any IRS enforcement actions.
The amount of that revenue is uncertain. The IRS Commissioner
recognizes the implications of the tax gap and states in the budget
that addressing it is a top priority. Although IRS's 2007 budget
request does not propose allocating IRS resources to new initiatives to
reduce the tax gap, according to IRS officials, they plan to continue
initiatives identified in prior budgets. For example, IRS has two
ongoing BSM projects--F&PC and Modernized e-File--which, according to
IRS's Associate Chief Information Officer for BSM, could help reduce
the tax gap. F&PC is expected to increase IRS's capacity to resolve the
growing backlog of delinquent taxpayer cases and increase collections,
while Modernized e-File is expected to help make it easier for IRS to
process tax returns, look for irregularities, and track down unpaid
taxes.
The budget request states that the administration will study the
standards used to distinguish between employees and independent
contractors for purposes of paying and withholding income taxes. We
have long supported efforts aimed at improving independent contractor
compliance.\38\ Past IRS data have shown that independent contractors
report 97 percent of the income that is reported on information returns
to IRS, while contractors that do not receive these information returns
report only 83 percent of income. We have also identified other options
for improving information reporting by independent contractors,
including increasing penalties for failing to file required information
returns, lowering the $600 threshold for requiring such returns, and
requiring businesses to separately report on their tax returns the
total amount of payments to independent contractors.\39\ We previously
reported that clarifying the definition of independent contractors and
extending reporting requirements for those contractors could possibly
increase tax revenue by billions of dollars.\40\
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\38\ GAO, Tax Administration: Approaches for Improving Independent
Contractor Compliance, GAO/GGD-92-108 (Washington, D.C.: July 23,
1992).
\39\ GAO-06-453T.
\40\ GAO, Opportunities for Congressional Oversight and Improved
Use of Taxpayer Funds, GAO-04-659 (Washington, D.C.: May 7, 2004).
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Two of the legislative proposals call for more information
reporting on payment card transactions from certain businesses and on
payments by federal, state, and local governments to businesses.
Information reporting has been shown to significantly reduce
noncompliance. Although information reporting is highly effective in
encouraging compliance, such reporting imposes costs and burdens on the
businesses that implement it. However, information reporting is a way
to significantly increase voluntary compliance without increasing IRS's
budget.
Mr. Chairman, this completes my prepared statement. I would be
happy to respond to any questions you or other members of the
subcommittee my have at this time.
Contacts and Acknowledgments
For further information regarding this testimony, please contact
James R. White, Director, Strategic Issues.or David A. Powner,
Director, Information Technology Management Issues. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this statement. Individuals making key
contributions to this testimony include Joanna Stamatiades, Assistant
Director; Amanda Arhontas; Paula Braun; Terry Draver; Paul Foderaro;
Chuck Fox; Tim Hopkins; Kathryn Horan; Hillary Loeffler; Sabine Paul;
Cheryl Peterson; Neil Pinney; Steve Sebastian; Tina Younger.
______
Appendix I: Differences Between the 2002 and 2005 Free File Agreements
In 2002, Internal Revenue Service (IRS) entered into a 3-year
agreement with the Free File Alliance, a consortium of 20 tax
preparation companies to provide free electronic filing to taxpayers
who access any of the companies via a link on IRS's Web site. The 2002
Free File Agreement stated that as part of the agreement, IRS would not
compete with the Consortium in providing free, online tax return
preparation and filing services to taxpayers. IRS and the Consortium
amended the agreement in 2005. Key differences between the two
agreements are: the new income limitation of $50,000 and new language
in the amendment that states the Alliance members must disclose early
on if state tax return services are available, and if so, whether a fee
will be charged for such services; and provide the necessary support to
accomplish a customer satisfaction survey. It also added language
pertaining to the marketing and offering of Refund Anticipation Loans
(RALs) \41\ whereby:
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\41\ Refund Anticipation Loans are very short-term loans issued
while taxpayers wait for their refunds.
No offer of free return preparation and filing of an
electronic return in the free file program shall be conditioned on the
purchase of a RAL; and
RALs will be offered with clear language indicating, for
example, that RALs are loans, not a faster way of receiving an IRS
refund; must be repaid even if the IRS does not issue a full refund;
are short-term loans interest rates may be higher and customers may
wish to consider using other forms of credit; and may be offered but
not promoted.
IRS tests each Consortium member's software to ensure it is in
accordance with the Free File provisions, including those cited
previously, before allowing a link to IRS's Web site. In addition, IRS
officials monitor complaints about the Free File program received via
IRS.gov, including allegations regarding false, deceptive, or
misleading information or advertising. While IRS does not track the
number of complaints it receives, according to IRS officials, most of
the complaints received thus far were a result of the taxpayer either
not carefully reading or following instructions, or incorrectly
entering information. GAO conducted limited testing of the Free File
program and found that the Consortium members were complying with the
terms outlined in the amended Free File agreement pertaining to RALs.
The amended Free File agreement contains provisions that enable IRS
to monitor taxpayer participation beginning in the 2006 filing season,
unlike prior years where Free File Alliance members self-reported
filing figures. IRS also tracks the number of free file users who are
accepting any financial products, such as RALs. As of March 16, IRS
reported that 163,000 Free File returns accepted financial products.
This represents 5.6 percent of all returns filed through the Free File
program.
The number of taxpayers using free file to electronically file
their individual income tax returns has increased steadily from 2.8
million in 2003, to 3.5 million in 2004, to 5.1 million in 2005. The
substantial growth between 2004 and 2005 was due to, in part, several
Consortium members offering free filing to all taxpayers through the
free file program regardless of their income in 2005. However,
according to IRS officials, the lack of income limitation created
conflict among Consortium members as it put pressure on all Alliance
members to offer free service, which may not have been economically
feasible for some, threatening competition if members were to drop out
of the Alliance.
IRS projected that 6.1 million taxpayers would use free file in
2006. However, this projection may be optimistic, because between
January 1 and March 19, IRS has reported receiving only 2.9 million
free file returns compared to 3.8 million during the same period last
year, a decline of 23 percent. According to IRS officials, contributing
factors to this decline are, in part, due to decreased press attention
and advertising by the participating companies and the income
limitation. The income limitation provides coverage to 70 percent of
the nation's taxpayers, or more than 92 million people. This coverage
includes taxpayers with an adjusted gross income of $50,000 or less.
______
Appendix II: Comparison of IRS's Actual and Enacted Funding and Full-
Time Equivalents, Fiscal Years 2002 through 2007
For fiscal year 2007, the Internal Revenue Service (IRS) has
requested $10.7 billion in its appropriation accounts. This request
consists of $10.6 billion in direct appropriations and $135 million in
revenue from new user fees, which IRS will commit to taxpayer service
activities in its Processing, Assistance, and Management (PAM), Tax Law
Enforcement (TLE), and Information System (IS) accounts. In addition,
IRS is projecting to collect and use $282 million from existing user
fees and reimbursable agreements with states and other federal
agencies. This brings IRS's proposed fiscal year 2007 budget to
approximately $11 billion (a 1.6 percent increase over fiscal year
2006). After adjusting for expected inflation, IRS's $11 billion budget
request reflects a slight decrease from last year's enacted budget.
IRS's enacted budgets for its appropriation accounts from fiscal
years 2002 through 2007 are shown in table 4. IRS's enacted budget has
increased almost 8 percent since fiscal year 2002. By far, the biggest
percentage increase has been TLE--almost 21 percent--and is reflective
the shift in resources devoted to TLE from PAM during this period. The
biggest percentage decrease was in the Business Systems Modernization
(BSM) program, down almost 58 percent.
Table 4: IRS's Funding for Fiscal Years 2002 through 2007
----------------------------------------------------------------------------------------------------------------
Fiscal year Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal year
2007 year 2006 year 2005 year 2004 year 2003 year 2002 2002--2007
---------------------------------------------------------------------------------
Dollars in thousands Requested
including Percentage
new user Enacted Enacted Enacted Enacted Enacted change
fees
----------------------------------------------------------------------------------------------------------------
PAM $4,159,893 $4,095,21 $4,056,85 $4,009,20 $3,930,06 $3,982,97 4.44
2 7 5 4 1
----------------------------------------------------------------------------------------------------------------
TLE 4,764,954 4,678,49 4,363,53 4,171,24 3,849,88 3,940,74 20.92
9 9 4 4 1
----------------------------------------------------------------------------------------------------------------
IS 1,619,834 1,582,97 1,577,76 1,581,57 1,621,83 1,620,90 -0.07
7 8 5 4 5
----------------------------------------------------------------------------------------------------------------
BSM 167,310 197,010 203,360 387,699 363,621 391,593 -57.27
----------------------------------------------------------------------------------------------------------------
HITCA 14,846 20,008 34,562 34,794 69,545 NA NA
----------------------------------------------------------------------------------------------------------------
Total appropriations requested $10,726,837 $10,573,7 $10,236,0 $10,184,5 $9,834,94 $9,936,21 7.96
06 87 17 8 0
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
Notes: Numbers may not add due to rounding. Fiscal year 2007 includes $135 million in new user fee revenue
distributed in PAM, TLE, and IS accounts. Without user fees, IRS is requesting $4,045,122 for PAM, $4,762,327
for TLE, and $1,602,232 for IS.
Tables 5 and 6 show IRS's enacted and actual Full-time Equivalents
(FTEs) for fiscal years 2002 through 2007. Overall, actual FTEs tend to
be lower than enacted FTEs due in part to the way IRS funds its
unbudgeted requirements. When both enacted and actual FTEs are
considered, FTEs for PAM have steadily decreased and, for the most
part, FTEs for TLE have increased since fiscal year 2002. However,
steady trends are not apparent when comparing enacted and actual FTEs
in IRS's IS account. For example, when enacted FTEs are considered, IS
staffing appears to fluctuate up and down between fiscal years 2002
through 2007; yet, when actual FTEs are considered, IS staffing
decreased from fiscal year 2002 through 2005 and increased from fiscal
years 2005 to 2006. IRS officials attribute these fluctuations in FTEs
to reorganizations and other factors.
Tables 5 and 6 also show significant differences in percentage
changes between enacted and actual FTEs in some of IRS's appropriations
accounts from fiscal years 2006 to 2007. The enacted level of FTEs is
the number IRS projected it could support given the level of funding
the Congress enacted. According to IRS officials, enacted levels tend
to be overstated compared to actual FTEs for several reasons. First,
IRS, like most federal agencies, does not receive its budgets when
expected and cannot fill all positions. Also, as the costs of
maintaining current FTE levels increase annually, IRS is not able to
realize all of the FTEs it projects to fund with the appropriations the
Congress enacts.
Table 5: IRS's Enacted FTEs for Fiscal Years 2002 through 2007
----------------------------------------------------------------------------------------------------------------
Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal Fiscal
year 2007 year year year year year year 2006-- year 2002--
------------ 2006 2005 2004 2003 2002 2007 2007
----------------------------------------------------------------------
Requested Percentage Percentage
Enacted Enacted Enacted Enacted Enacted change change
----------------------------------------------------------------------------------------------------------------
PAM 37,126 38,796 39,901 42,332 43,452 43,774 -4.30 -15.19
----------------------------------------------------------------------------------------------------------------
TLE 49,479 50,559 49,132 49,147 47,478 48,628 -2.14 1.75
----------------------------------------------------------------------------------------------------------------
IS 7,351 7,032 7,385 7,559 7,445 7,499 4.54 -1.97
----------------------------------------------------------------------------------------------------------------
BSM 0 0 0 0 0 NA 0.00 NA
----------------------------------------------------------------------------------------------------------------
HITCA 17 17 17 17 6 NA 0.00 NA
----------------------------------------------------------------------------------------------------------------
Total 93,973 96,404 96,435 99,055 98,381 99,901 -2.52 -5.93
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
Notes: Fiscal year 2007 requested FTEs reflect an adjustment after the budget was printed. Also, we are not
reporting FTEs for user fees and reimbursable as shown in an earlier section of this statement, because we
were unable to obtain this information for all years in time for this statement.
Table 6: IRS's Actual FTEs from Fiscal Years 2002 through 2007
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Fiscal Fiscal Fiscal Fiscal
Fiscal Requested Fiscal Operating Fiscal Actual Fiscal Actual year Actual year Actual year 2006-- Percentage year 2002--
year 2007 year 2006 Level year 2005 year 2004 2003 2002 2007 change 2007
-------------------------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------
PAM 37,126 38,308 38,710 41,436 43,452 44,191 -3.09 -15.99
----------------------------------------------------------------------------------------------------------------------------------
TLE 49,479 49,721 48,544 47,704 47,478 48,238 -0.49 2.57
----------------------------------------------------------------------------------------------------------------------------------
IS 7,351 7,340 7,015 7,279 7,445 7,773 0.15 -5.43
----------------------------------------------------------------------------------------------------------------------------------
BSM 0 0 0 0 0 NA 0.00 NA
----------------------------------------------------------------------------------------------------------------------------------
HITCA 17 17 13 12 6 NA 0.00 NA
----------------------------------------------------------------------------------------------------------------------------------
Total 93,973 95,386 94,282 96,431 98,381 100,202 -1.48 -6.22
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
Notes: Fiscal year 2007 requested FTEs reflect an adjustment after the budget was printed. Also, we are not reporting FTEs for user fees and reimbursable as shown in an earlier section of this
statement, because we were unable to obtain this information for all years in time for this statement.
In its fiscal year 2006 budget request, IRS showed its budget
distributed by taxpayer services and enforcement, including IS funding
for those areas, because the agency's current appropriation accounts
are not divided clearly between taxpayer service and enforcement. As
table 7 shows, funding for enforcement increased 15 percent between
fiscal years 2004 and 2007 to $6.96 billion, while funding for taxpayer
service declined over 3 percent to almost $3.6 billion.
Table 7: IRS's Funding for Taxpayer Service and Enforcement for Fiscal Years 2004 through 2007
----------------------------------------------------------------------------------------------------------------
Percentage
Dollars in Millions Fiscal year Fiscal year Fiscal year Fiscal year change 2004-
2007 requested 2006 enacted 2005 enacted 2004 enacted 2007
----------------------------------------------------------------------------------------------------------------
Taxpayer Service $3,583 $3,533 $3,606 $3,710 -3.4
Enforcement $6,961 $6,824 $6,392 $6,052 15.0
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
Note: IRS's taxpayer service and enforcement programs are funded through its PAM, TLE, and IS accounts.
______
Appendix III: IRS's Estimated and Actual Savings and Reinvestments
In its 2007 budget request, the Internal Revenue Service (IRS) is
proposing to save over $121 million and 1,424 Full-time Equivalents
(FTEs) and reinvest over $12 million and 11 FTEs. Based on IRS's
ability to achieve prior year savings and reinvestments as shown in
table 8, we have a basis to believe that IRS will achieve most, if not
all, of these savings. For example, IRS reported it realized 88 percent
of its anticipated budget savings and 86 percent of its anticipated
staff savings for savings identified in its fiscal year 2004 budget
request, and IRS reported exceeding savings targets in fiscal year
2005.
Table 8: IRS's Estimated and Actual Savings and Reinvestments for Fiscal years 2004 through 2007
----------------------------------------------------------------------------------------------------------------
Fiscal year 2004 Fiscal year 2005 Fiscal year 2006 Fiscal year 2007
actual actual estimate estimate
Dollars in Thousands ---------------------------------------------------------------------------------
Dollars FTEs Dollars FTEs Dollars FTEs Dollars FTEs
----------------------------------------------------------------------------------------------------------------
Savings\a\ .......... ....... .......... ....... .......... ....... ......... ......
----------------------------------------------------------------------------------------------------------------
Budgeted $160,872 1,993 $110,841 1,442 $230,096 2,230 $121,596 1,424
----------------------------------------------------------------------------------------------------------------
Actual $141,142 1,711 $127,239 1,628 $226,908 2,230 NA NA
----------------------------------------------------------------------------------------------------------------
Percentage realized 88 86 115 113 99 100 NA NA
between Budgeted and
Actual\b\.
----------------------------------------------------------------------------------------------------------------
Reinvestments\a\ .......... ....... .......... ....... .......... ....... ......... ......
----------------------------------------------------------------------------------------------------------------
Budgeted $141,419 602 $66,343 359 $95,893 805 $12,237 11
----------------------------------------------------------------------------------------------------------------
Actual $118,330 313 $96,481 958 $92,030 805 NA NA
----------------------------------------------------------------------------------------------------------------
Percentage realized 84 52 145 267 96 100 NA NA
between Budgeted and
Actual\b\.
----------------------------------------------------------------------------------------------------------------
Source: GAO analysis of IRS data.
Note: Fiscal year 2007 FTE savings reflect an adjustment after the budget was printed.
\a\ IRS considers savings to be gained through process or systems improvements and reinvestments to be those
savings that were realized and available for other purposes.
\b\ IRS reported actuals for 2004 and 2005, and year-end projections for 2006.
______
Appendix IV: State Mandates
Of the 50 states, 12 have electronic filing mandates for tax
practitioners in effect for the 2006 filing season (see fig. 4). The
mandates differ in their implementation dates and schedules, thresholds
for filing, and penalties. The differences between mandates may affect
the magnitude of electronic filing increases in each state.
Figure 4: States with Electronic Filing Mandates for Tax Preparers
[GRAPHIC] [TIFF OMITTED] T0443A.004
We recently reported that state mandates encourage electronic
filing of federal tax returns and recommended that IRS develop better
information about the costs to tax practitioners and taxpayers of
mandatory electronic filing of tax returns for certain categories of
tax practitioners.\42\ These mandates require tax practitioners who
meet certain criteria, such as filing 100 individual state tax returns
or more, to file individual state returns electronically.
---------------------------------------------------------------------------
\42\ GAO-06-51.
---------------------------------------------------------------------------
Between tax years 2001 and 2004, electronic filing had grown in the
9 states with mandates from an average of 36.7 percent to 56.8 percent,
or an increase of over 20 percentage points, compared to an increase of
14 percentage points for the 41 non mandated states over the same time
period. We expect this trend to continue as 3 additional states--New
York, Utah and Connecticut--implemented mandates in time for the 2006
filing season. Of these 3 states, New York may have the most to gain
because it currently has the lowest rate of electronic filing rate,
with fewer than 38 percent of its nearly 9 million federal individual
income tax returns electronically filed last year.
______
Appendix V: Bibliography of GAO Resources
Filing Season Performance:
Tax Administration: IRS Improved Some Filing Season Services, but
Long-Term Goals Would Help Manage Strategic Trade-offs, GAO-06-51
Washington, D.C.: November 14, 2005.
Tax Administration: IRS Improved Performance in the 2004 Filing
Season, but Better Data on the Quality of Some Services Are Needed,
GAO-05-67 Washington, D.C.: November 10, 2004.
Tax Administration: IRS's 2003 Filing Season Performance Showed
Improvements, GAO-04-84 Washington, D.C.: October 31, 2003.
IRS's 2002 Tax Filing Season: Returns and Refunds Processed
Smoothly; Quality of Assistance Improved, GAO-03-314 Washington, D.C.:
December 20, 2002
IRS's Budget Requests:
Internal Revenue Service: Assessment of Fiscal Year 2006 Budget
Request, GAO-05-566 Washington, D.C.: April 27, 2005.
Internal Revenue Service: Assessment of Fiscal Year 2006 Budget
Request and Interim Results of the 2005 Filing Season, GAO-05-416T
Washington, D.C.: April 14, 2005.
Internal Revenue Service: Assessment of Fiscal Year 2005 Budget
Request and 2004 Filing Season Performance, GAO-04-560T Washington,
D.C.: March 30, 2004.
Tax Gap and Compliance:
Tax Gap: Making Significant Progress in Improving Tax Compliance
Rests on Enhancing Current IRS Techniques and Adopting New Legislative
Actions, GAO-06-453T Washington, D.C.: February 15, 2006.
Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term
Goals Are Needed to Improve Taxpayer Compliance, GAO-06-208T
Washington, D.C.: October 26, 2005.
Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal
Sustainability but Will Require a Variety of Strategies, GAO-05-527T
Washington, D.C.: April 14, 2005.
Taxpayer Information: Data Sharing and Analysis May Enhance Tax
Compliance and Improve Immigration Eligibility Decisions, GAO-04-972T
Washington, D.C.: July 21, 2004.
Compliance and Collection: Challenges for IRS in Reversing Trends
and Implementing New Initiatives, GAO-03-732T Washington, D.C.: May 7,
2003.
Financial Statement Audits:
Financial Audit: IRS's Fiscal Years 2005 and 2004 Financial
Statements, GAO-06-137 Washington, D.C.: November 10, 2005.
Internal Revenue Service: Status of Recommendations from Financial
Audits and Related Financial Management Reports, GAO-05-393 Washington,
D.C.: April 29, 2005.
Financial Audit: IRS's Fiscal Years 2004 and 2003 Financial
Statements, GAO-05-103 Washington, D.C.: November 10, 2004.
Internal Revenue Service: Status of Recommendations from Financial
Audits and Related Financial Management Reports, GAO-04-523 Washington,
D.C.: April 28, 2004.
Financial Audit: IRS's Fiscal Years 2003 and 2002 Financial
Statements, GAO-04-126 Washington, D.C.: November 13, 2003.
Business Systems Modernization:
Business Systems Modernization: Internal Revenue Service's Fiscal
Year 2006 Expenditure Plan, GAO-06-360 Washington, D.C.: February 21,
2006.
Business Systems Modernization: Internal Revenue Service's Fiscal
Year 2005 Expenditure Plan, GAO-05-774 Washington, D.C.: July 22, 2005.
IRS Modernization: Continued Progress Requires Addressing Resource
Management Challenges, GAO-05-707T Washington, D.C.: May 19, 2005.
Business Systems Modernization: IRS's Fiscal Year 2004 Expenditure
Plan, GAO-05-46 Washington, D.C.: November 17, 2004.
Business Systems Modernization: Internal Revenue Service Needs to
Further Strengthen Program Management, GAO-04-438T Washington, D.C.:
February 12, 2004.
IRS Modernization: Continued Progress Necessary for Improving
Service to Taxpayers and Ensuring Compliance, GAO-03-796T Washington,
D.C.: May 20, 2003.
Other:
Tax Administration: IRS Can Improve Its Productivity Measures by
Using Alternative Methods, GAO-05-671 Washington, D.C.: July 7, 2005.
21st Century Challenges: Reexamining the Base of the Federal
Government, GAO-05-325SP Washington, D.C.: February 2005.
High Risk Series: An Update, GAO-05-207 Washington, D.C.: January
21, 2005.
Internal Revenue Service: Challenges Remain in Combating Abusive
Tax Schemes, GAO-04-50 Washington, D.C.: November 19, 2003.
Tax Administration: IRS Is Implementing the National Research
Program as Planned, GAO-03-614 Washington, D.C.: June 16, 2003.
Tax Administration: IRS Needs to Further Refine Its Tax Filing
Season Performance Measures, GAO-03-143 Washington, D.C.: November 22,
2002.
The Results Act: An Evaluator's Guide to Assessing Agency Annual
Performance Plans, GAO/GGD-10.1.20 Washington, D.C.: April 23, 1998.
For more information on Department of the Treasury major management
challenges, see http://www.gao.gov/pas/2005/treasury.htm
Chairman RAMSTAD. Thank you to all four of you
distinguished gentlemen for your testimony. The Chairman and
each Member of the Committee appreciates the expertise that you
literally bring to the table, and appreciate your testimony
again here today.
Mr. George, I would like to ask you the first question, and
I think it is important that we delve into a little more deeply
the Free File agreement situation. I think it is important that
we focus on what the agreement was all about. Now, in your
written testimony, Mr. Hugo, you claim that the original intent
of the agreement was to serve low-income and disadvantaged
persons, taxpayers. Looking at the original agreement, I see no
support for this contention.
In your view, Mr. George, what was the original purpose of
the Free File agreement?
Mr. GEORGE. Thank you, Mr. Chairman. Let me quote, if I
may, from the original agreement. It states that, ``This
agreement provides for free online tax return preparation and
filing to individual taxpayers,'' and it delineates five
points, which I will briefly summarize.
It wanted to ensure free and secure electronic preparation
and filing options for additional taxpayers. It wanted to make
sure that tax return preparation was easier and would reduce
the burden on the individual taxpayer. Third, it wanted to
support the IRS' goal to increase e-filing pursuant to the
Restructuring Act 1998, and the goal of the IRS to achieve 80
percent of electronically filed returns by 2007. Four, it
wanted to provide greater service and access to taxpayers, and
last, it wanted to support the President's proposal in his
fiscal year 2003 budget, which again, specifically encouraged
further growth in electronic filing.
Nowhere in the original agreement was there any mention on
restrictions placed on who could participate in the program.
Chairman RAMSTAD. That was my reading as well.
Mr. White, do you agree?
Mr. WHITE. Yes, Mr. Chairman.
Chairman RAMSTAD. Chairman Wagner?
Mr. WAGNER. Yes, sir, Mr. Chairman. I am not aware of any
restrictions in the original agreement, and I would think the
spirit of the original agreement should be carried forward
today as well.
Chairman RAMSTAD. Mr. Hugo, do you want to respond?
Mr. HUGO. Yes, sir.
Chairman RAMSTAD. By the way, if I may--excuse my
interruption--we have two votes. The first vote will last 17
minutes. I would like to finish with this panel prior to going
to vote, so we will adhere to the five-minute limit so we won't
have to detain you unnecessarily, and then we will recess for
15 minutes, 20 minutes max, until the next panel.
Please proceed, Mr. Hugo.
Mr. HUGO. Mr. Chairman, thank you for the opportunity.
I think one of the things, that question arose when we came
before your staff earlier a couple weeks ago, and also with
TIGTA. One of the things that I wanted to clarify--again, I
have been there since July of 2005. So, what we did is went
back to some of the original negotiators. In fact, we conferred
with Mr. Rossotti, the original Commissioner at the time this
was negotiated, and got an e-mail from him, some communication
from him just the other day, saying that the original intent
was to make sure that low and moderate income tax payers were
not deterred by the fee, that the fee was not a deterrent.
In the information that we also supplied to the Committee
here, within months of that first agreement, there was an
amendment, and again, I think we furnished that to your staff,
that again talked about serving low and underserved
communities. That was the purpose, and I think you have that
information. So, that amendment that we talked about that is
part of the agreement that has been part of the ongoing dialog
is something that has been in place for 4 years, and then we
have also received direction from Congress, not just from a
bill that has passed one house, but in the Treasury
Appropriations bill there has been language that talks about
serving the low and underserved communities, and that was in
some of the Treasury appropriation bills that have passed.
Chairman RAMSTAD. Well, I think everyone here probably
agrees, or most, that the Free File Alliance should not have to
provide free preparation software to people like Bill Gates and
Warren Buffett, but what about a husband and wife living in the
third district of Minnesota. Each, let's say, has an adjusted
gross income of $26,000. The filed jointly. Why shouldn't they
be allowed to use Free File this year? Mr. Hugo.
Mr. HUGO. Yes, sir. One of the things that perplexes me,
what the Alliance agreement that we negotiated with the IRS, it
covers $93 million Americans, 70 percent. I am perplexed, quite
candidly, that we are focusing on the--you say the Warren
Buffetts, the Bill Gates, that top 30 percent. I am curious why
we are not focusing on maximizing that $93 million.
Mr. Chairman, I am an elected official. I am a Member of
the Virginia legislature. I am even on the Finance Committee. I
had a real job at one time. I was Chief of Staff to a
Congressman, a job that was halfway important. For preparation
for this hearing, one of the things I was thinking about--and I
conferred with the IRS before. I said, ``Did you tell every
Member of Congress that they could let their constituents know
in newsletters or communications that they can have free tax
preparation for under 50 adjusted gross income?`` No, didn't
happen.
One of the things I think we are going to do is write every
Member of Congress and every U.S. Senator next year, and say,
please understand this is available to your constituents. That
way we are maximizing, focusing on the $93 million, the low to
moderate income, the direction we have gotten from Congress,
which is direction we have gotten in legislative language that
has passed, and I would be happy----
Chairman RAMSTAD. It seems to me, Mr. Hugo, that you are
missing a point relative to the original agreement. Your
written testimony claims that the new Free File agreement
covers more taxpayers than the original agreement, but the
point you are missing is that the original agreement
established a floor, that 60 percent of taxpayers had to be
covered, while the new agreement establishes a cap, only 70
percent of taxpayers are allowed to be covered. It seems to me
that is an important distinction, and it seems to me that that
point has been missed.
Let me ask Mr. White. Under the new agreement, as we have
seen previously, more than 40 millon taxpayers who were
eligible for Free File last year are not eligible this year,
and again, that is depicted graphically over there on the
screen. Has this cap that we have discussed led to the 21
percent decrease we see in Free File usage this year in your
judgment, Mr. White?
Mr. WHITE. It is certainly something that it has very
likely contributed to that. We don't know all the reasons that
have contributed, but it seems very logical that that has to be
part of the explanation.
Chairman RAMSTAD. As a follow up, has the decreased use
then of Free File contributed to the lower than expected rate
of growth in electronic filing, in e-filing this year?
Mr. WHITE. There are a number of factors that have
contributed to that, but again, it seems very logical that this
has to be one factor that is contributing to that.
Chairman RAMSTAD. The only conclusion the Chairman can
reach, based on the testimony, is that, simply put, under the
new agreement, fewer taxpayers are eligible for Free File,
fewer taxpayers are using it, and electronic filing is not
growing as projected. So, how can we call this agreement good
for taxpayers, Mr. White?
Mr. WHITE. Well, the----
Chairman RAMSTAD. Let me rephrase that.
Mr. WHITE. Sir, the questions that you are asking are
valid.
Chairman RAMSTAD. That is more than leading, even by
Congressional standards.
[Laughter.]
Chairman RAMSTAD. Let me ask you, do you, in your view,
believe this agreement is good for taxpayers?
Mr. WHITE. Mr. Chairman, the agreement involves some
tradeoffs. Taxpayers, some taxpayers get free filing. The
private sector agreed to provide free return filing for those
taxpayers. IRS got some other things in the agreement. There is
more disclosure on the terms and conditions attached to RALs,
for example. It is a judgment call about whether on balance,
overall, it is a good agreement or not.
Chairman RAMSTAD. Any of the other witnesses, would you
like to comment? Mr. George?
Mr. GEORGE. I would just note, Mr. Chairman, that even when
the program was available to any taxpayer, you had only about 5
million of an approximately 130 million eligible taxpayers
taking advantage of it. So, while giving people access to it is
good, it wasn't promoted to the point where it was taken
advantage of.
Chairman RAMSTAD. Chairman Wagner?
Mr. WAGNER. Mr. Chairman, I think the agreement and the
Alliance is very good for 93 million taxpayers, but I also
think that it ought to extend to all the other taxpayers. I
think in my own personal State, my parents, I assisted them in
preparing their returns through the Free File Alliance a few
years or so ago, and this year they will just barely not
qualify. So, we will be confronted with either buying the
product or pushing the paper.
Chairman RAMSTAD. Prior to recessing for our vote, the
Chairman recognizes the gentleman from North Dakota.
Mr. POMEROY. I thank the Chair. So, I get this all
straight, basically this public-private partnership has its
origination in trying to advance the goal of expanding
electronic filing of taxpayers. Is that correct, Mr. White?
Mr. WHITE. Yes, sir.
Mr. POMEROY. That is the goal of it. Mr. Hugo, are you in
the State Senate or State House?
Mr. WHITE. House.
Mr. POMEROY. Representative Hugo--I like the House, by the
way.
Mr. HUGO. Yes, sir, the people's body.
Mr. POMEROY. The people's body. Would you say,
Representative Hugo, that if there was a mission statement from
the Alliance, expanding e-filing of taxpayers is the goal of
the Alliance?
Mr. HUGO. The goal of the Alliance, and this was stated in
the operating agreement and the recent MOU, it was stated, like
you said, within months the comment that we put in writing----
Mr. POMEROY. The goal of the Alliance----
Mr. HUGO. Is to provide free tax preparation to low and
moderate income underserved communities.
Mr. POMEROY. Okay. The goal of the Alliance is not to
expand electronic filing of taxpayers?
Mr. HUGO. I think that is part of it. I think that will
accomplish the fact that----
Mr. POMEROY. What is the goal? This is very important. I
believe the only reason that we ought to be in a public-private
partnership is if the public goal of expanding electronic
filing is advanced. Is that the primary goal?
Mr. HUGO. I think it is the goal and I think it is that we
are----
Mr. POMEROY. How many of the 5 million last year were over
50,000?
Mr. HUGO. I am sorry.
Mr. POMEROY. I am sorry. Representative Hugo, how many of
the 5 million taxpayers were over $50,000 last year?
Mr. HUGO. That I don't know the answer. I can provide that
information to you, sir.
Mr. POMEROY. It seems to me just basic, if you put a cap on
who gets to use this, you are inconsistent with the goal of
expanding e-filing, and I think it is related, maybe not in a
huge way, but certainly related in a direct way to the comment
made by Mr. George that we are falling off pace in terms of
electronic filing.
Mr. HUGO. Mr. Chairman and Mr. Pomeroy, let me answer, and
I would like to take from the direct testimony that the head of
the Electronic Tax Administration Mr. Dumars made in front of
the Senate. One of the reasons he believes the numbers are down
this year is because we did not get the press. A year ago, it
was on the front page of USA Today. The IRS budget to advertise
this program has been slashed and----
Mr. POMEROY. My time is short, and we have got a vote. I
appreciate----
Mr. HUGO. I would say----
Mr. POMEROY. --that line of argument, but let me tell you--
--
Mr. HUGO. No, no, I--okay.
Mr. POMEROY. --as one that is going to continue to evaluate
whether we ought to have a public-private partnership in any
event, I am going to look at whether or not this thing is
operating with focus and as a clear priority, advance the
public goal of electronic take-up rates with taxpayers. If this
thing starts to be diverted where it seems like the goal is
advancing the ancillary business interests of the Alliance
members or the biggest alliance members, then I have got some
concerns.
Mr. George, as you have evaluated this, do you see the
Alliance in any of its operations having kind of a cartel
effect, an anticompetitive effect on what might be the emerging
enterprises in this electronic filing business?
Mr. GEORGE. Mr. Pomeroy, we are in the process of reviewing
this, and we have not yet looked at that issue.
Mr. POMEROY. It is very important. I will be really eager
for your report. Has the GAO had a chance to look at that, Mr.
White?
Mr. WHITE. No, we have not, Mr. Pomeroy.
Mr. POMEROY. I think the message we have delivered loud and
clear. We hate this 50,000 cap. I hope that it is not in the
next agreement. I think the IRS did not operate consistent with
Congressional intent in doing it. I think it is bad public
policy, and I am disappointed with this report this year.
Moving on, though, to other issues, Chairman Wagner, we
really appreciate what the Advisory Committee does.
Mr. WAGNER. Thank you, sir.
Mr. POMEROY. We think that you play a very important role
in terms of oversight and sometimes advocacy beyond what the
IRS can itself self-advocate.
Mr. WAGNER. Thank you.
Mr. POMEROY. Is there a----
Chairman RAMSTAD. Excuse me, Mr. Pomeroy. The Chairman will
recess the Subcommittee for 20 minutes or subject to the call
of the Chair. We are running out of time.
Mr. POMEROY. I think we can clarify--when you don't come up
with the appropriation you need, does that diminish the ability
of the Service to efficiently and effectively collect taxes?
Mr. POMEROY. When you do not get the appropriation you
need, does that impact the Service's ability to efficiently and
effectively----
Mr. WAGNER. It requires more creativity at that point, but
I think the Service can efficiently fulfill its mission with
the resources that it has been provided.
Mr. POMEROY. I am done.
Chairman RAMSTAD. The Subcommittee is in recess subject to
the call of the Chair. It should not be more than 20 minutes.
[Recess.]
Chairman RAMSTAD. The Committee will come to order. While
our witnesses are taking their seats, let me welcome to the
Subcommittee on Oversight, Chairman Dennis Drapkin, the
American Bar Association (ABA) section of Taxation; Chair
Thomas Purcell, of the Tax Executive Committee of the American
Institute for Certified Public Accountants (AICPA); and Francis
X. Degen, President, National Association of Enrolled Agents
(NAEA).
We will begin with your testimony, please, Mr. Drapkin.
STATEMENT OF DENNIS B. DRAPKIN, CHAIRMAN, SECTION OF TAXATION,
AMERICAN BAR ASSOCIATION
Mr. DRAPKIN. Thank you, Mr. Chairman, for the opportunity
to appear before the Subcommittee this morning. My name is
Dennis Drapkin. I am the Chair of the Tax section of the ABA,
and my testimony is presented on behalf of the ABA.
I will focus on three keys issues essential to the
administration of the tax laws and also briefly address pending
legislation relating to offers in compromise.
First, the importance of adequate funding for the IRS. The
ABA has consistently supported full funding of the IRS. We note
that the administration's proposed 2007 budget includes an
increase in IRS funding as compared with the prior year enacted
level, and we urge that Congress fund the IRS at least at the
level the administration has proposed.
Adequately funding is essential for the IRS to provide
taxpayers with quality service. The IRS needs these resources
to collect taxes fairly and efficiently without imposing undue
burdens on taxpayers.
Second, let me speak to the need for balance between
enforcement and taxpayer service. Achieving acceptable levels
of compliance requires a balance of effective taxpayer service
and vigorous enforcement. Up-front taxpayer service enhances
voluntary compliance, which reduces the demands on enforcement.
Credible enforcement of the tax laws, in turn, encourages
greater voluntary compliance.
Complex tax laws make taxpayer service a necessity.
Taxpayers must be able to obtain accurate information on the
tax laws that affect them. The IRS responds in ways that are
vital to providing taxpayers with the information they require.
Adequate funding is also essential for effective enforcement.
Taxpayers must believe that the laws will be enforced and that
those who cheat will be caught. Enforcement must be apparent
throughout all parts of the economy. Funding must be sufficient
for those in the Service whose primary mission is compliance.
In addition, funding must be adequate to support ongoing
administration of the tax laws. The Service must be able to
publish clear and understandable guidance, train its personnel,
continuously improve compliance programs, and obtain accurate
information about how the tax system is functioning.
The third key issue is the need to simplify the tax laws.
Complexity is a major obstacle to efficient and effective
administration of the tax laws. For 30 years, the ABA and the
section of Taxation have been on record urging tax law
simplification. Making the tax system simpler is also a
legislative priority of the ABA. We appreciate the efforts that
the Chairman and other Members of the Subcommittee have made
over the past few years to focus attention on the need for
simplification and to motivate Congress to enact important
simplification legislation. Achieving simplification is not
easy. Often it must be weighed against concerns relating to
equity and fairness. Yet simplification is worth the effort. It
can ease the burden of compliance for all taxpayers and reduce
the demands placed on the IRS.
As always, the Tax section stands ready to work with you
and your staff to achieve simplification. We commend you for
what you have done, but it is vital that your efforts continue
and that they succeed.
Finally, speaking on behalf of the ABA Tax section, I would
like to address pending legislation regarding offers in
compromise. Offers in compromise are an important tax
collection tool. The Tax Relief Act of 2005, S. 2020, would add
a 20-percent downpayment requirement to lump-sum offers in
compromise. The downpayment would be nonrefundable and retained
by the IRS even if the offer is rejected. This change is
intended to reduce offers that are not made in good faith.
We, and others, have serious concerns about the proposal.
Relatives and employers are often the source of funds for
offers. They will be far less willing to do so if this proposal
is enacted. As a result, the new downpayment requirement could
dramatically reduce outside funding for potential offers. This
would decrease the number of legitimate offers submitted, the
number of offers accepted, and the number of individuals re-
entering the tax system. This is not a desirable outcome.
Mr. Chairman, thank you again for the opportunity to appear
before the Subcommittee today, and I will be pleased to respond
to any questions.
[The prepared statement of Mr. Drapkin follows:]
Statement of Dennis B. Drapkin, Chairman, Section of Taxation,
American Bar Association
Thank you, Mr. Chairman. My name is Dennis Drapkin. I am the Chair
of the American Bar Association Section of Taxation. This testimony is
presented on behalf of the American Bar Association (the ``ABA'').
The ABA is comprised of more than 400,000 members. The Section of
Taxation includes more than 18,000 tax lawyers who work in law firms,
corporations and other business entities, government, nonprofit
organizations, academia, accounting firms and other multidisciplinary
organizations. Our members provide advice on every substantive and
procedural area of the tax laws, and interact regularly with the
Internal Revenue Service (the ``Service'' or ``IRS''), the Treasury
Department, and other government agencies and offices responsible for
administering and enforcing the tax laws. Many of our members have
served in staff and executive-level positions at the Service, the
Treasury Department, the Tax Division of the Department of Justice, and
Congressional tax-writing committees.
I greatly appreciate the opportunity to appear before the
Subcommittee on Oversight (the ``Subcommittee'') today. My testimony
will focus on three key issues bearing on the administration of the tax
laws: (i) the importance of adequate funding for the Internal Revenue
Service, (ii) the need for a balance between enforcement and providing
services to taxpayers, and (iii) the need to simplify the tax laws. I
will also briefly address pending legislation relating to offers in
compromise.
IRS Funding
The ABA has consistently supported full funding of the IRS to carry
out its missions of taxpayer service and fair administration and
enforcement of the tax laws. We note that the Administration's proposed
2007 Budget includes an increase in IRS funding as compared with the FY
2006 enacted level. We urge that Congress fund the Service at least at
the level the Administration has proposed.
Adequate funding is central to the ability of the Service to
provide America's taxpayers with top quality service by helping them to
understand and meet their tax responsibilities and by applying the tax
law with integrity and fairness to all. Fulfilling this mission is
possible only if the Service has the resources necessary to collect
taxes owed efficiently and effectively without imposing undue burdens
on taxpayers.
The Need for Balance Between Enforcement and Service
Achieving acceptable levels of compliance requires a balance of
effective taxpayer service and vigorous enforcement. Effective front-
end taxpayer service enhances voluntary compliance, thereby reducing
the demands on enforcement down the road. Consistent fair and credible
enforcement of the tax laws, in turn, encourages greater voluntary
compliance.
Given the level of complexity of our tax laws, taxpayer service is
a necessity. Taxpayers must be able to obtain accurate information on
complicated tax law provisions affecting them. The Service fulfills
this task in a number of ways, e.g., telephonic call-in lines, walk-in
information sites, print publications, and, increasingly, electronic
communications. All these activities are vital to providing taxpayers
with the information they need to fulfill their responsibilities and to
obtain the benefits to which the law entitles them. In her 2005 Annual
Report to Congress, the National Taxpayer Advocate underscored the need
for adequate taxpayer services, and suggested a number of areas that
could be improved. At the February 8, 2006 meeting of the IRS Oversight
Board, the need for greater and more effective taxpayer service was
stressed by many of the speakers.
The Service must also have adequate funding to perform its
fundamental enforcement mission. In order for our voluntary tax system
to work, taxpayers must believe that the laws will be enforced and
those who cheat will be caught. To be effective, the Service's
enforcement efforts must be broad-based in two senses. First, an
enforcement presence must be apparent throughout the economy. A
perception that the Service's enforcement efforts are too narrowly
targeted leads to noncompliance in areas perceived to be out of the
spotlight. Second, funding must be sufficient for all those in the
Service whose primary mission is compliance, i.e., auditing revenue
agents, appeals officers, tax litigators, and revenue officers, to do
their jobs. Neglect of any of these inevitably compromises the ability
of the others to fulfill their compliance responsibilities.
In addition to supporting adequate service and enforcement,
constant attention must be given to ongoing administration of the tax
laws. The economic environment in which the tax law operates is
constantly changing. The Treasury Department and the Service must
address these changes through publication of clear and understandable
guidance to taxpayers, through training of Service personnel, and
through improvements to processing, audit, and controversy resolution
techniques. Techniques and procedures for prompt and efficient
resolution of recurring errors must be formulated and implemented, and
longer term solutions to eliminate such errors through simplifying
legislation or otherwise must be identified. Such solutions, in turn,
are possible only when decision makers have accurate information
concerning how the system is actually functioning. Thus, adequate
funding for those who compile statistics of income and perform research
on administration and compliance is also vital. There have been
important initiatives at the Service aimed at improving audit currency
and achieving better resource targeting in audits. These are worthwhile
programs that should be encouraged and continued.
The Need for Simplification
We believe that complexity is at the root of many significant
obstacles to efficient and effective administration of the tax laws.
Indeed, the National Taxpayer Advocate and others have demonstrated
repeatedly that complex tax law provisions make life harder for
everyone. They cost taxpayers time in simply trying to understand what
is required of them, and they make errors by taxpayers and the IRS a
virtual certainty. Reducing complexity must be a continuing priority of
the Congress.
Making the tax system simpler is a legislative priority of the ABA.
For 30 years, the ABA and the Section of Taxation have been on record
urging tax law simplification, so that laws can be (1) easily
understood and complied with by taxpayers, and (2) fairly and
consistently administered and enforced by the IRS. We know that
simplification is an issue the Subcommittee takes seriously, and we
appreciate the efforts the Chairman and other Members of the
Subcommittee have made over the past few years to focus attention on
the need for simplification and to motivate Congress to enact important
simplification legislation.
In this regard, we wish to acknowledge that in 2004 Congress
enacted important simplification of the definition of a ``child'' under
the Internal Revenue Code. After the new definition was adopted, issues
were raised with respect to the allocation of dependency exemptions
between custodial and noncustodial parents. On September 1, 2005, we
wrote to the Chairman and Ranking Members of the House Committee on
Ways and Means and the Senate Committee on Finance to suggest changes
to the technical corrections originally introduced to address these
issues. In the Gulf Opportunity Zone Act of 2005, Congress enacted
technical corrections to resolve these issues adopting the approach
suggested in our letter. We applaud the quick action of Congress in
addressing these issues.
Questions have since been raised about other unintended
consequences of the new definition of a child. We are studying these
questions and the solutions that have been proposed, including the
recent proposals by the Treasury, and we stand ready to work with you
and your staff to address these questions. It is important, however,
that the issues that have arisen with respect to simplifying the
definition of a child not deter the Congress from pursuing additional
simplification of other complex provisions of the Code.
As this recent experience indicates, simplification is not easy.
The new issues regarding the definition of child, for example,
illustrate the difficulties inherent in balancing simplification, on
the one hand, against addressing a multitude of perceived inequities,
on the other. In addition to requiring careful examination of possible
unintended consequences, simplification frequently requires either
foregoing revenue or making choices that benefit some taxpayers and
adversely affect other taxpayers. But simplification is worth the cost.
Simplification pays dividends in terms of easing the burden of
compliance for all taxpayers, simplifying the task of taxpayer
education and law enforcement for the IRS, and improving taxpayer
morale by making it easier to understand how the law operates.
In recent years, the Section of Taxation has worked with the
American Institute of Certified Public Accountants (``AICPA'') and the
Tax Executives Institute (``TEI'') to identify simplification
priorities and realistic simplification initiatives. Together with
these other organizations, the Tax Section will continue this important
work. But it is important that Congress--in every tax bill--also join
in the effort and actually enact viable simplification proposals. There
is a consensus for tax simplification, and we urge you to call on us
and our colleagues in the AICPA and TEI to help you make it a reality.
We would like to take this opportunity emphasize a few
simplification matters requiring urgent attention. The dual tax system
created by the alternative minimum tax is one of the most serious
complexity problems in the current Code. The ABA recommends that the
individual AMT be repealed. We recognize that replacement sources of
revenue likely will have to be identified to accomplish this--but the
time has come to eliminate the complexity and burden of having a
growing number of middle-class Americans each year compute individual
taxes under two different systems.
Even if big-ticket simplification such as AMT repeal cannot be
accomplished immediately, there are other important, but smaller scale,
simplification proposals that can be adopted in the near term if
appropriate legislative focus is applied. For example, we have called
your attention in prior testimony to the need to address the complexity
arising from the numerous provisions such as educational benefits, the
earned income tax credit, and retirement savings provisions that are
phased out as a taxpayer's income increases. Because these provisions
have typically not been coordinated, the phase-out thresholds and
ranges in such provisions vary widely--and often overlap. The result is
not merely mind-numbing complexity but often disappointed taxpayer
expectations as the complicated calculations make it difficult for
taxpayers to plan whether they will be able to utilize tax benefits
subject to phase outs. Perhaps even more important are the
disincentives that occur when a taxpayer attempts to avail himself of
benefits under several provisions and the combined phase-outs create
marginal tax rates well in excess of what the section 1 tax table says
the taxpayer's marginal rate should be. We recognize the action taken
by the Congress to address the phase-out problem in the context of
personal exemptions and the overall limitation on itemized deductions.
But much more can and should be done.
We also note that the President's Advisory Panel on Tax Reform
offered a number of separate recommendations in its November 2005
report that could promote significant simplification of the federal
income tax, including repeal of the individual and corporate AMT. The
Panel also recommended a limited number of tax credits relating to
family status; simplifying tax benefits for charitable donations, home
ownership and health coverage; and restructuring numerous individual
savings and retirement provisions. We commend the Panel for its focus
on simplification. Its report has made numerous useful suggestions that
merit further study and consideration.
We and others previously testified before the IRS Oversight Board
in support of Treasury and IRS efforts to achieve simplification
through the regulatory process. Fundamental to this effort is the
publication of prompt and clear administrative guidance dealing with
new legislation as well as new developments in the way business is
transacted. The Treasury and IRS deserve commendation for their efforts
to publish guidance on the 2004 Act, and we have publicly applauded the
prompt guidance they issued in response to Hurricane Katrina. The
guidance process is, however, continuous, and the work of the IRS and
Treasury is never done. Timely, clear guidance advances the goal of
simplification by reducing ambiguity and uncertainty. We believe that a
strong published guidance program constitutes one of the most important
contributions the Treasury and IRS can make to simplification.
As always, Tax Section members stand ready to work with you and
your staff members to achieve simplification. We commend you for what
you have done, but it is vital that your efforts continue and that they
succeed.
Offers in Compromise
Offers in compromise are an important collection tool that can
provide taxpayers with a ``fresh start'' and foster long term
compliance. The Tax Relief Act of 2005, S. 2020, proposes adding a 20-
percent down payment requirement to lump-sum offers-in-compromise. It
is apparently intended that the lump-sum down payment would be
nonrefundable and retained by the Service if the offer is rejected.
While the apparent objective of the proposed changes--to reduce the
number of offers that are not made to the IRS in good faith--is
laudable, we nevertheless have serious concerns about this proposal.
A successful offer-in-compromise program raises revenue both from
the offer and by bringing taxpayers back into the system. Relatives and
employers of the taxpayer are often the source of funds for offers in
the current system. These parties will understandably be far less
willing to commit non-refundable monies under the regime that would be
created by the Senate bill. Because the 20-percent nonrefundable down
payment requirement could dramatically reduce available outside funding
for potential offers, there is a significant risk that the proposal
could decrease the number of legitimate offers submitted, the number of
offers accepted and the number of individuals reentering the tax
system. The provision also marks a change in direction from the 1998
Taxpayer Bill of Rights. Accordingly, we recommend that the proposal
not be adopted.
Mr. Chairman, thank you for the opportunity to appear before the
Subcommittee today. I will be pleased to respond to any questions.
Chairman RAMSTAD. Thank you, Mr. Drapkin. Dr. Purcell,
please?
STATEMENT OF THOMAS J. PURCELL, CHAIR, TAX EXECUTIVE COMMITTEE,
AMERICAN INSTITUTE FOR CERTIFIED PUBLIC ACCOUNTANTS
Mr. PURCELL. Mr. Chairman, thank you for this honor of
being able to present our testimony today before the
Subcommittee. I have two main points that I would like to make,
and the bulk of my comments are taken from the written
testimony that we have already provided to you, and I would be
happy to answer questions as we have time at the end of my
comments.
First, with regard to the progress so far in the filing
season, we have no evidence from our members that there have
been any issues, insurmountable issues that have arisen with
regard to filing individual tax returns. It seems to be a
relatively typical filing season from that perspective.
Obviously, there is going to be the last-minute crunch that
happens in the next 2 weeks, and then also the extension
period, which now is a 6-month period that will take us into
the fall. Other than those types of things, we have not heard
anything from members that would give us any pause.
We do have concerns, though, that continue with regard to
the mandatory e-filing for larger taxpayers, the corporations
with over $50 million and the nonprofit organizations of over
$100 million. Our sense is that people are going slow on this,
that the numbers that you are seeing that people are filing on
time, these go slow at this point because there is still
pushback from software providers that have not stepped up to
fully implement the software necessary to make this happen.
Companies are still having difficulties conforming their
software and their information with the platform that will need
to be used. So we anticipate that there could be a significant
crunch when we get toward the 6-month filing timeframe for
corporations, which would be September 15. So, we anticipate
that sometime in late August, early September, there is going
to be a flurry of activity. We do not know how that will be
resolved because the IRS has been very adamant that they are
going to be very careful on providing waivers for this, but we
do not know how that will be resolved. Frankly, we are
concerned about that.
The second level of concern on that would then extend to
next year because the filing threshold drops to $10 million,
which is a significantly larger net of taxpayers. So our
concern there is that more people be pulled in that do not
anticipate this, and we have only had one season to try and get
it ready. So, hopefully we can continue to work with the IRS on
making this be a more painless process.
As you know, there were some issues early on with regard to
Schedule D reporting. We continue to work with the IRS on this,
and we are grateful that they have taken the approach to try
and work with us on trying to clarify the type of information
and what will be acceptable to them for reporting transactions
with regard to stocks and bonds and other things that might
come from brokers.
We do not have a position on the free file. I have listened
to the discussion today, but we have not had a position on free
file because it is not an issue that many of our clients would
be involved in.
On the budget side, I would echo Dennis's comments that we
continue to remain very much in favor of funding for the IRS at
appropriate levels so it can do the job it is expected to do.
We watch with anticipation the business modernization approach
because those business systems are where we interact very much
with the IRS, and our concern is that as we go to a 21st
century agency, a 21st century tax practice, that the
technology is sufficient to support what is needed by both the
taxpayer and by the IRS.
We also look at the user fees as a level of concern. The
approach that was taken was that we would increase--the IRS has
increased the user fees, in some cases quadrupling the size of
them. Our concern is that there will be twofold impacts from
this: one, if they are anticipating an increase in revenues
because of that, taxpayers could well push back and not pay the
fees because they are so much higher; and, two, if you do not
get that type of service as a taxpayer, it could create a
situation where there is greater compliance issues on the back
end and enforcement issues because you do not have the surety
that the transaction that you are looking at will be given
favorable treatment by the IRS.
Finally, we watch with concern the outsourcing of
collections, the reduction in taxpayer services. We understand
the service plus compliance attitude that the IRS has, but we
do remain concerned that all taxpayers are able to get the
services they need in order to fulfill their obligation, and
that if the Service cuts too many services that are not
available to taxpayers that otherwise we serve, there could be
a deleterious effect on enforcement.
Thank you for the opportunity to testify.
[The prepared statement of Mr. Purcell follows:]
Statement of Thomas J. Purcell, Chair, Executive Tax Committee,
American Institute for Certified Public Accountants
Mr. Chairman and members of the House Ways and Means Subcommittee
on Oversight, the American Institute of Certified Public Accountants
thanks you for the opportunity to appear before you today. I am Tom
Purcell, Chair of the AICPA Tax Executive Committee; and Associate
Professor of Accounting and Professor of Law at Creighton University,
Omaha, Nebraska.
The AICPA is the national, professional organization of certified
public accountants comprised of approximately 330,000 members. Our
members advise clients on federal, state, and international tax matters
and prepare income and other tax returns for millions of Americans.
They provide services to individuals, not-for-profit organizations,
small and medium-sized businesses, as well as America's largest
businesses. It is from this broad base of experience that we offer our
comments today on the IRS budget and the 2006 tax filing season.
The AICPA is happy to report that the 2006 filing season is
progressing largely without any significant problems and American
taxpayers and practitioners are generally pleased with the Service's
performance. However, while generally not developing into problems
during the filing season, tax professionals expressed strong opposition
in late 2005 to sections of the 2005 Form 1040 instructions involving
(1) tax preparation cost estimates and (2) the requirement to list all
capital gains or loss transactions on Form 1040, Schedule D.
Our comments today focus on a number of programs of critical
importance to the Service, specifically: (1) the IRS budget for fiscal
year 2007, (2) Business Systems Modernization, (3) Form 1040
instructions and stakeholder outreach, (4) achieving e-filing goals,
(5) the increase in user fees, (6) tax practitioners and professional
responsibility, (7) private debt collection efforts, (8) offers in
compromise, and (9) tax simplification.
1. THE IRS BUDGET
The AICPA urges Congress to support full funding of the Internal
Revenue Service's fiscal year 2007 budget. We have long advocated
funding levels which would allow the IRS to efficiently and effectively
administer the tax laws and collect taxes. Giving the Service the
resources necessary to properly process tax returns and enforce the tax
laws is vital to maintaining our voluntary compliance tax system. We
expect the Service to identify responsible ways to allocate any
additional resources it receives over prior year funding; and Congress
will, through its oversight responsibilities, ensure that those
resources are properly utilized.
Under President Bush's fiscal year 2007 budget proposal, the IRS
would have an operating budget of approximately $10.7 billion,
supplemented by certain additional user fees and reimbursable
resources. According to the Department of Treasury's fiscal year 2007
budget summary document, ``The IRS budget request--supports the IRS's
five year strategic plan. This plan underscores the IRS' commitment to
provide quality service to taxpayers while enforcing America's tax laws
in a balanced manner.'' \1\
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\1\ Department of Treasury--Budget in Brief Fiscal Year 2007,
February 6, 2006, pages 59-60.
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Giving the Service with the proper resources to fund its mission
will empower the Service to fulfill both its customer service and
enforcement responsibilities. We appreciate Commissioner Everson's
recognition that any increase in enforcement funding must be balanced
with positive responses to the taxpaying public as customers. We
encourage this type of balanced approach and stand ready to work with
the Service to ensure that the needs of America's taxpayers are
fulfilled. As we have stated in the past, all taxpayers must have
access to resources that enable them to fulfill their responsibilities,
and budgetary funding must be provided to insure this access.
Many AICPA members are tax practitioners. As such, we have seen
first-hand the problems caused by an IRS that is not responsive to
taxpayers as customers. We have also witnessed the improvements
initiated by Commissioner Everson, particularly with respect to
enforcement. Reductions in IRS funding requests that focus on customer
service will only undercut efforts to improve compliance, and the
nation's taxpayers will suffer as a direct result.
2. BUSINESS SYSTEMS MODERNIZATION
The fiscal year 2007 budget submission generally recommends
reducing the budget for the Service's Business Systems Modernization
(BSM) program by 15.1 percent from the level approved by Congress for
2006. In recommending this sizable cut in the BSM budget, the Treasury
(on behalf of the Administration) maintains that the ``BSM program has
begun to improve its performance on delivering projects and releases on
time, on budget, and meeting or exceeding scope expectations.'' \2\
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\2\ Id., page 62.
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We appreciate the Treasury's view that the Service is now achieving
its project costs, scheduling, and performance goals, especially after
the long period of implementation difficulties. While the AICPA cannot
easily discern whether a 15.1 percent cut in the BSM's fiscal year 2007
budget is prudent under the circumstances, we encourage Congress to
closely scrutinize the Administration's proposed budget for BSM. In the
end, it is critical for Congress to provide the Service with the
appropriate funding levels for the modernization effort.
BSM must remain a central feature of the Service's strategic plan.
It is designed to provide benefits to both taxpayers and IRS employees,
through implementation of (1) the Customer Account Data Engine (CADE),
which is designed to replace the Service's ancient Master File System,
(2) Modernized e-File, and (3) the Filing and Payment Compliance
system. We strongly support these objectives.
3. FORM 1040 INSTRUCTIONS AND STAKEHOLDER OUTREACH
The IRS has generally done a very good job in recent years, of
seeking the input of the AICPA and other stakeholders prior to the
agency's announcement of a new program, initiative, or policy change.
Examples of previous initiatives in which the Service did seek the
input of the practitioner community with positive results include the
National Research Program, and the development of the new Schedules K-1
and M-3.
However, when the Service has inadvertently failed to consult with
the practitioner community about a new initiative, the IRS has found
itself at times in a difficult position. The most recent examples of
what we believe were poor communications and collaboration efforts on
the Service's part involve the inclusion of (1) tax return preparation
cost estimates as part of the 2005 Form 1040 instructions and (2) the
specific requirement in the 2005 Form 1040, Schedule D instructions for
taxpayers to physically list all capital gains or loss transactions on
Schedule D.
The tax return preparation cost estimates, appearing on page 79 of
the 2005 Form 1040 Instructions, provide estimates of the average
preparation times and expenses associated with certain Form 1040
schedules that have been (1) self-prepared without tax software, (2)
self-prepared with tax software, and (3) prepared by a paid
professional. We informed the Service that these cost estimates did not
fully reflect marketplace reality and lacked any contextual explanation
that might mitigate confusion.\3\
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\3\ AICPA letter to Commissioner Everson (dated November 30, 2005)
regarding the IRS's inclusion of tax preparation cost estimates in the
2005 Form 1040 instructions.
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With respect to the requirement for taxpayers to list all capital
gains and loss transactions on Form 1040, Schedule D, we suggested that
the time needed to manually list each capital gains or loss transaction
could create significant taxpayer burden and in the case of taxpayers
using paid preparers, unnecessarily raise the overall cost of preparing
the return.\4\
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\4\ AICPA letter to Commissioner Everson (dated December 23, 2005)
regarding the reporting of capital gains and loss transactions on Form
1040, Schedule D.
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While expressing our strong opposition to the preparer cost
estimates and the Schedule D instructions matters, it is critical to
mention that IRS executives have assured us that they value the input
of the practitioner community on important policy initiatives; and as
evidence, the Service did quickly respond to practitioner concerns
regarding the preparer cost estimates and Schedule D. However, our
members continue to express concern that even the recent clarifications
by the IRS do not fully address the Schedule D issue and so we do not
consider this issue resolved. We will continue to work with the IRS on
satisfactory resolution of these issues. Unfortunately, we believe the
Service has lost credibility and generated unnecessary frustration with
tax professionals over the initial communication of their positions on
these policy issues.
4. ACHIEVING E-FILING GOALS
Modernized E-File
The AICPA recognizes the administrative efficiencies and budgetary
savings the IRS's electronic tax administration program achieves for
the agency, as well as the customer service benefits that accrue to
taxpayers from an effective electronic filing (e-file) program. The
administrative benefits of e-filing include faster tax processing,
reduced cycle time, quicker identification of emerging audit trends,
and the potential for more current resolution of taxpayer
uncertainties.
We applaud the success the IRS is having with the e-filing program
during the 2006 filing season. According to IRS statistics, 68 percent
of the 73.4 million individual returns filed through March 24 were
electronically filed; with returns filed from home computers up about
16.8 percent over last year. We will continue to work closely with the
Service to meet its expectations of approximately 135 million
individual e-filed returns during 2006 filing season.
The IRS has done a commendable job of introducing programs--such as
the Free File and the Volunteer Income Tax Assistance (VITA) programs--
to help low income taxpayers (who often don't own computers) to file
their own income tax returns. Another critical component of helping low
income taxpayers is to consider funding for low income tax return
preparation clinics, in a similar fashion to the funding low income tax
(controversy) clinics receive under Internal Revenue Code section 7526.
We believe funding for tax return preparation clinics would encourage
e-filing and improve compliance by low income taxpayers generally.
We support the IRS's suite of web-based products for tax
professionals and taxpayers called ``e-services.'' Through e-services,
practitioners and taxpayers have access to a suite of online products,
including the Preparer Tax Identification Number (PTIN) Application;
the Online e-file Application; Electronic Account Resolution (EAR);
submission of Form 2848, Power of Attorney and Declaration of
Representative; and the Service's Transcript Delivery System (TDS).
When the program was launched in 2004, e-services was made
available to tax professionals who e-filed 100 or more individual
returns. Last year, the IRS lowered this threshold by making the e-
Services suite available to tax professionals who e-file 5 or more
individual and business income tax returns. The AICPA believes this
expansion of e-services to more practitioners has the added benefit of
making the IRS's interaction with tax professionals more efficient,
thereby generating significant cost savings to the Service. Since e-
services benefits the IRS and tax professionals in so many ways, such
as fostering the Service's enforcement and collection activities, we
recommend that the IRS strongly consider dropping the 5 return
threshold altogether.
E-File for Large Corporations and Exempt Organizations
The AICPA is closely consulting with the IRS on implementation of
the mandatory e-file program during the current 2006 filing season, a
program that generally requires large corporations (total assets of $50
million or more) and tax exempt organizations (total assets of $100
million or more) to file returns electronically.
As the 2006 filing season progresses, the IRS must remain mindful
of the difficult experience that taxpayers and the agency had with the
mandatory large partnership e-file program rolled-out several years
ago. The AICPA has previously recommended that the IRS delay the start
of the new mandatory e-file program for one year, and we continue to
observe that it is not unreasonable for the Service to anticipate
significant issues with respect to implementation of this new program
for large corporations and exempt organizations. This situation is
especially critical as we move closer to September 15, the due date for
calendar year-end corporate returns on extension.
Our members remain concerned about a number of implementation
issues, such as the potential for security breaches and the ability of
the IRS's computer systems to handle peak load demands by taxpayers.
Moreover, we continue to recommend that the IRS maintain a posture of
flexibility in terms of granting hardship waivers to corporations and
exempt organizations, as opposed to a policy that grants waivers only
in exceptional cases.
Even though this is the first filing season for implementation of
the mandatory corporate and exempt organization e-file program, we
cannot over-emphasize the need for the Service to also adopt a posture
of flexibility on critical implementation decisions for next year's
filing season. For purposes of the 2007 filing season, the e-file
thresholds will drop even further, subjecting middle-sized market
corporations and exempt organizations to the mandatory e-file program,
taxpayers who routinely (1) don't employ tax professionals on the
entity's payroll and (2) utilize the services of tax professionals
working for large and smaller-sized accounting firms. We will continue
to work with the IRS in resolving the various implementation issues as
e-filing is expanded.
5. INCREASE IN USER FEES
The IRS announced a series of increases in user fees in December
2005, effective for 2006. These user fees are levied to charge
taxpayers for the privilege of receiving advance assurance from the IRS
about the tax consequences of certain transactions. For example, under
the new fee schedule, the IRS Chief Counsel has increased the fees for
private letter rulings by $2,500 to $10,000 (with lower fees for
taxpayers earning under $1 million); requests for changes in accounting
method by $1,000 to $2,500; corporate pre-filing agreements to a flat
fee of $50,000, and Advance Pricing Agreements to as much as $50,000.
We understand that these increases generally reflect an attempt to
respond to an Office of Management and Budget directive for agencies to
charge user fees reflecting the full cost of goods or services.
Moreover, it is our understanding these user fee increases are
considered as a supplement (in addition) to any final fiscal year 2007
IRS budget approved by Congress.
The AICPA is concerned these increases in user fees (many of which
are dramatic increases over previous levels) will result in a
substantial reduction in general taxpayer use of critical IRS programs
that encourage taxpayers to seek advance assurance about the tax
consequences of their proposed actions. Any actions that discourage use
of these programs could result in greater compliance costs for
taxpayers and enforcement costs for the IRS. The AICPA does not support
the Service's possible use of fee increases as a management tool to
control its workload burden.
6. TAX PRACTITIONERS AND PROFESSIONAL RESPONSIBILITY
The AICPA applauds Commissioner Everson's commitment to high
standards for tax professionals and his efforts to upgrade the Office
of Professional Responsibility. In this context, we have a longstanding
track record of establishing high professional standards for our CPA
members, including the AICPA Code of Professional Conduct and
enforceable Statements on Standards for Tax Services.
We have recently sent submissions to Treasury and IRS on two very
important topics involving professional responsibility, as well as
presented oral testimony before the IRS on April 4, 2006. These topics
involve the Circular 230 written tax advice standards and the proposed
amendments to the regulations under Internal Revenue Code (IRC) section
7216. We recommend that the Subcommittee closely monitor the
deliberations between the tax professional community and the federal
government as these issues evolve.
Circular 230
The AICPA has been actively communicating with our membership and
state CPA societies regarding the Circular 230 provisions on ``best
practices'' and written tax advice. In this context, we are encouraged
by recent comments by Treasury and the IRS officials that the
government is considering whether it may be appropriate to make
substantial changes to the Circular 230's standards involving written
tax advice. The AICPA shares many of the concerns expressed within the
practitioner community that, as currently written, these regulations
are having an adverse impact on the delivery of tax advice to clients
and on the role of tax advice in facilitating the administration of the
tax system.
We strongly support the drafters' goals of increased public
confidence in the tax system and greater transparency in the
practitioner-client relationship. Like other commentators, however, we
also are concerned that the breadth and specificity of the current
rules are inhibiting the provision of written tax advice to taxpayers,
and increasing the expense to taxpayers of written tax advice,
including for routine transactions, without a corresponding benefit to
the tax system.
Both Treasury and the IRS have expressed willingness to consider a
principle-based approach within the standards to better support
Circular 230's essential role. We support this reconsideration to
alleviate the unintended consequences that have occurred.
In a March 6, 2006 letter to Treasury and IRS, we suggested several
ways that the government could adopt a principle-based approach. We
also offered an alternative approach for revising the covered opinion
rules (under Circular 230, section 10.35) by substituting broader
principles, with examples or illustrations, for the detailed rules
currently in section 10.35. A model for discussion might include AICPA
Interpretation No. 1-2, Tax Planning, of AICPA Statement on Standards
for Tax Services No. 1, Tax Return Positions.
Proposed Section 7216 Regulations
In December 2005, the IRS released proposed amendments to the
regulations under Internal Revenue Code (IRC) section 7216, which in
large part respond to (1) suggestions that the section 7216 regulations
needed to be updated to reflect current common industry practices,
particularly in the area of electronic preparation or filing of tax
returns, and (2) concerns about the outsourcing of tax return
preparation to foreign countries.
In comments we submitted to the IRS on March 8, 2006, the AICPA
suggested that the Service generally not attempt to regulate the
disclosure or use of tax return information by preparers in the context
of section 7216--which is a criminal statute. Rather, we believe a
civil penalty is a more practical mechanism for regulating a
practitioner's everyday disclosure and use of taxpayer information.
Civil penalties have long been recognized as effective tools for
encouraging compliance, modifying behavior and deterring unwanted
behavior. Criminal provisions by their very nature inject a level of
complexity and concern which may well prove counterproductive in this
area. One possible approach would be to prescribe primary regulations
under IRC section 6713 while utilizing regulations under section 7216
to address the circumstances under which a preparer's behavior would
satisfy the ``knowing or reckless'' standard to justify criminal
sanctions.
We are also concerned about the extent to which the proposed
regulations fashion an entirely new consent regime for any return
preparation activities that involve parties located outside the borders
of the United States. The proposed regulations are drafted in a manner
that adds unnecessary and extremely burdensome steps to the current tax
return processes used by many professional service providers. It
appears that at the very time the IRS is eliminating barriers to the
achievement of its goal for increasing electronic filings and payments,
the agency is incongruously making it more complex for its partners--
the professional providers of tax assistance and return preparation--to
sustain their current professional business processes.
To properly complete the tax return of a U.S. or non-U.S.
multinational company with offices in the United States and overseas,
tax professionals located in the United States typically consult with
tax professionals located overseas. The same circumstances exist when
preparing returns for thousands of U.S. citizens (expatriates)
stationed around the world in the employment of U.S. and non-U.S.
multinational companies. In the normal course of these engagements the
client generally anticipates that the tax return preparer would
disclose tax return information to an overseas office, consistent with
the applicable legal and ethical responsibilities of the tax preparer
unless the taxpayer directs otherwise. The examples of how tax return
information may be used in providing services to multinational
companies go far beyond a tax return preparation context. Examples
include audits of financial statements and cross border tax planning.
These uses serve the needs of taxpayers and aren't efforts to market
unwanted services or use information for inappropriate ways.
We do not believe that these situations should require the tax
preparer to obtain consent from the taxpayer in the specific format
described in proposed regulation section 301.7216-3 and the proposed
revenue procedure (set out in Notice 2005-93) because these taxpayers
anticipate their tax information will be disclosed outside of the
United States. We believe the AICPA ethics rules (regarding outsourcing
services to third-party service providers) are more in line with modern
business practicesthan what is provided for under the proposed
regulations.\5\
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\5\ Rule 102, Integrity and Objectivity, of the AICPA Code of
Professional Conduct requires that, prior to sharing confidential
client information (such as a tax return) with a service provider, the
AICPA member must inform the client, preferably in writing, that he or
she may be using a third-party service provider when providing
professional services to the client. In addition, Rule 201, General
Standards, and Rule 202, Compliance With Standards, states the AICPA's
longstanding belief that members who use third-party service providers
in providing professional services to clients remain responsible for
the work performed by the service provider.
Finally, Rule 301, Confidential Client Information, of the AICPA
Code of Professional Conduct was updated to require an AICPA member to
(1) enter into a contractual agreement with the third-party service
provider to maintain the confidentiality of the client's information
and (2) be reasonably assured that the third-party service provider has
appropriate procedures in place to prevent the unauthorized release of
such information.
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The AICPA strongly encourages the IRS to adopt the approaches
suggested in our March 8 comments. If that is not acceptable, we urge
the IRS to engage the professional service provider industry in a
substantive discussion prior to issuing final regulations about how to
best ensure the requisite security of tax return information in the
context of today's modern (global) business practices.
7. PRIVATE DEBT COLLECTION EFFORTS
The IRS is in the process of launching a private debt collection
program, as authorized by the American Jobs Creation Act of 2004. We
appreciate that using private collection agencies could help the IRS
resolve a portion of its collection inventory, and could potentially
enable the Service to focus the energies of its employees on the more
difficult or complex collections cases. The Service has announced that
private debt collection agencies will be held to the ``same standards
of service and protection of taxpayer rights'' required of IRS
employees. We believe that this program is a critical test program for
the Service, especially in terms of enabling the IRS to leverage
private sector involvement with a reallocation of vital resources
towards programs of critical needs. Nevertheless, because collections
is a program area which has historically been an area of chronic
taxpayer complaint and alleged taxpayer rights abuse, we strongly urge
the Subcommittee on Oversight to closely monitor implementation of the
private debt collection program; and work with the IRS on establishing
positive and realistic performance measures for the private debt
collection firms.
8. OFFERS IN COMPROMISE
Section 523 of S. 2020, the Tax Relief Act of 2005, generally
requires a taxpayer who submits a ``lump-sum'' offer-in--compromise
(OIC) to include 20 percent of the amount of such offer at the time the
offer is submitted. The provision defines the term ``lump-sum'' offer
to mean the payment of 5 or fewer installments. The AICPA is very
concerned about the negative impact that this measure will have on the
future viability of the overall OIC program.
The AICPA has received numerous reports from practitioners that the
IRS's OIC program is not working, due in large part to the Service's
continual classification of large numbers of offers as ``non-
processable'' and based on the agency's high rejection rate of offers
being submitted. These reports are consistent with the public comments
of National Taxpayer Advocate Nina Olson on May 18, 2005. In that
communication, she revealed that taxpayers submitted approximately
39,000 offers during the first six months of fiscal 2005, which amounts
to a 45 percent drop in the number of offers submitted from the same
period in 2004.
Based on the significant drop in the number of offer submissions,
coupled with the IRS's high rejection and return rate for offers, we
believe this provision--while intended to be a revenue raiser--will in
actuality raise little or no revenue.
In general, a taxpayer submits an offer to the IRS because he or
she is in financial distress and thus, looking for a ``fresh start''
financially. Under these circumstances, a taxpayer who has a
significant outstanding tax liability with the government is not likely
to be able to afford a 20 percent up-front ``down-payment'' on an
offer. In all likelihood, enactment of the up-front 20 percent payment
on offers is likely to shut down the OIC program and instead, because
of the increased financial burden on the taxpayer, increase the
attractiveness of federal bankruptcy filings.
To the extent Congress includes the 20 percent offer payment
provision as part of a final bill, we recommend that there be an
exemption for low-income taxpayers. If you accept this recommendation,
we encourage you to use an existing statutory definition for ``low-
income'' to avoid adding another level of complexity to the Code. For
example, section 7526 of the Internal Revenue Code generally defines a
low-income taxpayer as someone who has income that does not exceed 250
percent of the poverty level.
S. 2020 also requires any taxpayer who submits a ``periodic
payment'' offer to comply with the taxpayer's proposed installment
schedule during the period that the IRS is evaluating the offer for
acceptance. Thus, the taxpayer is required under this proposal to
effectively make installment payments to the IRS during the time period
that the Service has the offer under review. The legislative language
is not clear as to what would happen to these payments should the IRS
subsequently reject the taxpayer's offer. One possible interpretation
is that the taxpayer would be permitted to stop making the installment
payments, but the Service would(1) keep all payments made by the
taxpayer to date and (2) retain the right to begin enforcement action.
Moreover, if the taxpayer does not maintain his or her proposed payment
schedule, while the Service is reviewing the offer, the legislation
does state that the offer would be considered withdrawn by the taxpayer
at the time the payments cease.
We believe that the periodic payment offer proposal--like the 20
percent offer payment provision described above--will have a negative
impact on the future viability of the overall OIC program. The periodic
payment proposal does not do anything to encourage efficiency on the
part of the IRS, i.e., for the Service to be more efficient in the
processing and review of offers on a timely basis. In fact, the
proposal would appear to create a situation in which the IRS would be
better off by not rejecting too quickly an offer that the agency might
otherwise find unacceptable.
There may also be circumstances in which, for legitimate reasons,
the taxpayer may be required to discontinue (i.e., may no longer be
able to afford financially) the periodic payments while the IRS is
reviewing the taxpayer's offer submission. We do not believe that IRS
consideration of the taxpayer's offer should cease under such
circumstances. A fairer result would be for the IRS to provide
guidance--under a reasonable cause standard--as to the circumstances
that a taxpayer's offer would continue to be reviewed and considered by
the Service.
9. TAX SIMPLIFICATION
Enacting tax simplification measures is integral to the success of
future filing seasons. As Commissioner Everson stated in his March 3,
2005 testimony before the Tax Reform Commission:
Complexity in the tax code compromises both the [IRS's] service and
enforcement missions. That is because complexity obscures
understanding. Those who seek to comply but cannot understand their tax
obligations may make inadvertent errors or ultimately throw up their
hands and say why bother. In the enforcement context, complexity in the
code facilitates behaviors at variance with those intended by Congress.
Simplification of the tax laws is a high priority of the AICPA. We
have worked closely with the American Bar Association and the Tax
Executives Institute to jointly identify specific proposals for
simplification. Similarly, we have recently released a study entitled,
Understanding Tax Reform: A Guide to 21st Century Alternatives,
September 2005. Our study discusses how many of the goals of tax reform
can be achieved by modifying the current income tax system through
significant simplification. Some of the more important proposals to
reduce administration and compliance costs are discussed. The text of
the full study is available at: http://www.aicpa.org/taxreform/.
The IRS released updated statistics in February 2006 that the tax
gap is about $345 billion. We believe tax simplification can play a
significant role in helping to reduce the overall tax gap, as
simplification would (1) result in fewer errors on tax returns and (2)
reduce taxpayer susceptibility to the marketing of abusive tax
shelters.
Thank you for the opportunity to share these views with you.
Chairman RAMSTAD. Thank you very much, Dr. Purcell. Mr.
Degen, please?
STATEMENT OF FRANCIS X. DEGEN, PRESIDENT, NATIONAL ASSOCIATION
OF ENROLLED AGENTS
Mr. DEGEN. Thank you, Mr. Chairman, for asking the NAEA to
testify before you today. I will limit my comments pretty much
to tax filing season issues.
I am happy to report that, for the most part, the 2006
filing season is progressing smoothly. Nonetheless, we need to
bring a handful of issues to your attention. As we heard only
too starkly at the Finance Committee hearing on Tuesday,
unenrolled tax return prepares continue to be a problem for
taxpayers and the tax administration system. Mr. Chairman, I
have previously brought this issue before your Subcommittee,
and I urge you to move expeditiously to pass legislation to
require all paid tax return preparers to demonstrate competency
and ethical standards through licensure and continuing
education. The NAEA believes that such legislation will greatly
aid all taxpayers, especially low-income taxpayers, to comply
with our Nation's tax laws by helping to ensure access to
competent and ethical tax preparation services.
As usual, complexity rears its ugly head in the 2006 filing
season. While the AMT continues to stand out as the poster
child for today's taxpayers, two new issues have been
particularly troublesome for practitioners this filing season.
The first is the new definition of ``dependent'' as defined in
section 152 of the Internal Revenue Code. While we applaud
Congress for trying to simplify the definition of ``child,''
the law of unintended consequences has reared its head with
respect to the new definitions of ``qualifying child'' and
``qualifying relative.'' Quite frankly, the definitions have
probably resulted in more rather than less confusion. The
examples we cite in our letter to Commissioner Everson--and I
believe you have a copy of that, sir--need to be addressed.
I would also like to comment on the IRS expectation that
the details of every capital transaction be reported on a
Schedule D. The goal in submitting a tax return is to report
the correct tax liability of the taxpayer. The NAEA fails to
understand why the listing of every transaction on a Schedule D
is necessary to achieve that goal. The IRS espouses that it
strives to lessen the burden on taxpayers. This requirement of
reporting every detail is counterproductive to that claim and
greatly increases the burden on taxpayers.
Taxpayers who use professional assistance in preparing
their tax returns are facing extra costs due to this
requirement. Given the fact that many taxpayers now trade in
the stock and bond markets, the goal should be to prepare an
accurate tax return and not a meaningless exercise in reporting
details.
Along a similar vein, our members cite a growing problem
with information reporting on 1099 forms and cite example after
example of brokerage firms sending two, three, and sometime as
many as four corrections of the Form 1099. We would like to
caution Congress as it considers possible legislation to expand
reporting requirements in this area, to give the IRS and the
industries involved plenty of lead time to develop and
implement such an expansion. Otherwise, the taxpayer will
suffer and be required to file amended tax returns.
While not a specific filing season problem, NAEA is
concerned, as the ABA noted, that the Senate offer in
compromise (OIC) proposal in the reconciliation bill now in
conference is unduly burdensome to taxpayers. While the steep
entry cost would certainly deter frivolous offers, it will also
certainly prevent most, if not all, earnest taxpayers from
making their offers as well.
We urge Congress to drop this provision or, alternatively,
to work with us to put forward an alternative such as the one
outlined in our written testimony, which I know you have.
Finally, NAEA has been a strong proponent of beefing up
enforcement at the IRS while maintaining good customer service
level for taxpayers. There are full details in my written
testimony, but in the interest of time, I will only note that
the IRS needs to consider building in some level of flexibility
for its employees to be able to work with practitioners during
the filing season. The clear result will be higher-quality
audits and better responses to IRS inquiries.
In closing, Mr. Chairman and Members of the Subcommittee,
NAEA and its members stand prepared to work with you and the
IRS in ensuring a strong tax administration system and
improving voluntary compliance, and we welcome any questions
you may have.
[The prepared statement of Mr. Degen follows:]
Statement of Francis X. Degen, President, National Association
of Enrolled Agents
Thank you, Mr. Chairman, Ranking Member Lewis, and members of the
Oversight Subcommittee for asking the National Association of Enrolled
Agents (NAEA) to testify before you today. NAEA is the premier
organization representing the interests of the 46,000 enrolled agents
(EAs) across the country. EAs are the only practitioners for whom the
IRS directly attests competency and ethical behavior. NAEA is dedicated
to increasing the professionalism of its members and the integrity of
the tax administration system as a whole.
In regard to the 2006 filing season, I am happy to report that for
the most part, the season is progressing smoothly. Nonetheless, a
number of major issues are affecting taxpayers and tax practitioners,
and we would like to take to take this opportunity to bring a handful
of issues to your attention.
1. A few ``bad eggs'' in the paid preparer community are adversely
affecting the public's faith in the tax system.
2. Complexity for individual taxpayers continues unabated,
centering this year on AMT, definition of dependent, and Schedule D
information.
3. The Offers-in-Compromise program is in jeopardy because of a
provision of the Reconciliation bill currently in conference.
4. Increased enforcement actions during filing season are creating
some significant headaches for enrolled agents and their clients.
HOW TO DEAL WITH A FEW BAD EGGS
Lately, it seems as if every day we pick up the papers only to read
about another scheme with the potential for defrauding taxpayers. Last
year, this subcommittee reviewed the trend of linking tax preparation
with some unrelated services or goods, such as car or furniture sales.
This season, the great new idea is to load tax refunds on gift cards.
Further, we have been hearing a lot about the sale of questionable
financial services linked to tax preparation. Last week, we awoke to
headlines, however dubious, screaming of practitioners being allowed to
sell tax data to the highest bidder.
Very quietly hidden behind these juicy headlines is in actuality a
much more sinister yet mundane story: the growing problem of taxpayers'
forum shopping to maximize their refunds at the expense of the
Treasury. In other words, enrolled agents are seeing taxpayers pick up
their records and move down the street looking for unscrupulous
preparers who will ``pump-up'' their refunds. Unlicensed tax return
preparers are making outrageous guarantees on refunds, saying, ``Come
to us and we promise you a $1,000 back from Uncle Sam.'' Suddenly the
taxpayer is taking phony home office or business deductions or finding
long lost children.
The message to taxpayers with respect to cheating is that everyone
is doing it and you are a dupe if you aren't doing it too. As
practitioners licensed to practice before the IRS, we too often end up
representing these taxpayers once the IRS catches up with them.
Unfortunately, unlicensed paid return preparers are often outside the
current regulatory rules governing competency and ethical behavior. It
is our contention that this issue is the key to maintaining, and even
to restoring, taxpayer faith in a fair and equitable tax collection
system.
To address this situation, Mr. Chairman, we urge the subcommittee
to move expeditiously to pass legislation to require all paid tax
return preparers to demonstrate competency and ethical standards
through licensure and continuing education.
NAEA believes that such legislation will greatly aid all
taxpayers--but especially low income taxpayers--to comply with our
nation's tax laws by helping to ensure access to competent and ethical
tax preparation services. In her 2003 and 2004 annual reports, the
National Taxpayer Advocate expressed that oversight of unenrolled
return preparers was one of the most serious problems facing taxpayers.
In 2003, she noted that over 55 percent of the 130 million individual
taxpayers paid a return preparer to prepare their returns. Close to
half these preparers did not possess a legitimate license demonstrating
basic competency or ethical standards. Shockingly, at least 57 percent
of EITC earned income overclaims were attributable to returns prepared
by unlicensed paid preparers, resulting in billions of dollars in lost
revenue to the government.
NAEA supports S. 832 (the Taxpayer Protection and Assistance Act of
2005) because we believe the bill will help ensure the integrity of the
tax system by promoting licensed tax professionals to the general
public and ensuring strong enforcement against the unlicensed and
unethical. We believe the proposed legislation:
A. Contributes significantly to taxpayer access to competent and
ethical tax preparation services.
The legislation would require all paid preparers to pass an exam
testing their understanding of basic tax laws and ethical standards.
Further, paid preparers would be required to undergo annual continuing
education and be subject to the ethical requirements of Circular 230.
This will help ensure that only qualified and ethical individuals
will be preparing returns.
B. Builds on the existing regulatory framework and consolidates
enforcement under one entity
Rather than constructing a parallel regulatory framework and
enforcement entity for different groups of paid preparers, the
legislation would consolidate all persons preparing returns (lawyers,
CPAs, EAs, and paid preparers) under the current regulations (Circular
230) and the existing Office of Professional Responsibility (OPR). In
other words, there would be one ethical code, coordinated exams that
would allow for advancement within the profession, and standardized
continuing education requirements all administrated under the already
existing system.
In addition to being cost effective, this consolidation would
ensure uniformity of standards and enforcement across all preparers.
C. Ensures adequate resources for administration, promotion, and, most
importantly, enforcement.
The legislation would allow OPR to retain all registration fees for
administration of the program, including policing all practitioners and
preparers under their jurisdiction. Most importantly, the authorization
to retain these fees would ensure that the office would have adequate
resources to investigate and penalize unlicensed individuals. This will
discourage taxpayers from shopping for the ``best deal'' among
preparers and will help shut down many EITC mills across the country.
Additionally, the bill would authorize OPR to retain penalties
administered under the program for promotion of all Circular 230
preparers to the general public. This will assist the public in
understanding the importance of paying only licensed individuals for
tax preparation and will assist the public in understanding the
difference between the various groups allowed to do paid preparation.
D. Strikes the correct balance for creating a new tax practice
credential.
Congress needs to be cognizant of the ramifications of creating a
new credential in the world of tax administration. Currently, the
general public is presented with three options for individuals who are
licensed to practice before the IRS: lawyers, CPAs, and enrolled
agents. Circular 230 is very specific as to how these individuals may
advertise and generally present themselves to the public. A credential
that implies a higher level of authority and competency than merely
preparing basic individual tax returns will cause confusion and
undermine the general intent of the legislation.
Since the passage of the IRS Restructuring and Reform Act, there
has been a great deal of confusion as to the credentials and bona fides
of Electronic Return Originators or EROs. The IRS has issued signage
denoting official endorsement of individuals qualifying as EROs, as
well as financed a public awareness campaign in support of the program.
Anecdotal evidence (the appearance of billboards and bus stop signage)
in poorer neighborhoods demonstrates the danger of putting out to the
public confusing titles or credentials that overstate competency.
Additionally, state regulators would be very leery if not outright
hostile toward the creation of a new credential in the accounting/tax
preparation marketplace. States regulate the use of credentials and
many list a litany of titles (e.g., certified tax consultant, chartered
accountant, registered accountant) and abbreviations likely or intended
to be confused with CPA that may not be used. After years of conflict,
the majority of state boards of accountancy have accepted that a person
recognized by IRS as being enrolled may use the enrolled agent name and
EA abbreviation. Creating nomenclature that might overstate its
intended mission is likely to re-ignite this battle, and at the very
least potentially counter the underlying intent of the legislation.
PRACTITIONER CONCERNS
While the alternative minimum tax--which holds the distinction of
being both unfair and extremely complex--continues to stand out as the
poster child for dazed taxpayers, two new issues have been particularly
troublesome for practitioners this filing season.
The first is the new definition of dependent as defined in 152 of
the Internal Revenue Code. While we applaud Congress for trying to
simplify the definition of child, the law of unintended consequences
has reared its head with respect to the new definition of qualifying
child and qualifying relative. (Please see our attached letter to
Commissioner Everson). Quite frankly, the definitions have probably
resulted in more rather than less confusion. The examples we cite in
our letter need addressing. We note that the Treasury Department's Blue
Book for the 2007 budget attempts to offer solutions to some of these
problems, but we need to act before the 2007 tax year.
NAEA supports efforts to simplify the filing of federal taxes and
its 11,000 members stand ready to assist Congress and the President in
accomplishing real, practical reform for the American taxpayer. While
the concept of simplifying the tax code often plays well on the
campaign trail, the nitty-gritty of what is reform and how it is
accomplished makes comprehensive reform a daunting political
undertaking for policymakers. May I be so bold as to suggest that the
practitioner community have some role in future changes? Those of us
``in the trenches'' may, based on practical experience, be able to see
problems staff writers may not envision.
I would also like to comment on the IRS expectation that the
details of every capital transaction be reported on a Schedule D. The
goal in submitting a tax return is to report the correct tax liability
of the taxpayer. NAEA fails to understand why the listing of every
transaction on a Schedule D is necessary to achieve that goal. The IRS
should strive to lessen the burden on taxpayers. This requirement of
reporting every detail is counterproductive to that concept and greatly
increases the burden on taxpayers. Taxpayers who use professional
assistance in preparing their tax returns are facing extra costs due to
this requirement. Given the fact that many taxpayers now trade in the
stockand bond markets, the goal should be to prepare an accurate tax
return and not a meaningless exercise in reporting details.
Along a similar vein, our members cite a growing problem with
information reporting from third parties (e.g., Forms 1099 and
Schedules K-1). While Congress and the IRS have become more reliant on
third-party reporting to ensure compliance, the process has become
incredibly complex. Our members cite example after example of brokerage
firms sending two, three, and sometimes as many as four corrections of
the Form 1099. The brokerage firms point out that in this complex,
multinational world we live in it is becoming more and more difficult
to provide the required information within the required deadlines. We
would like to caution Congress as it considers possible legislation to
expand reporting requirements in this area to give the IRS and the
industries involved plenty of lead time to develop and implement such
an expansion.
OFFERS-IN-COMPROMISE
While increasing offer quality is an admirable goal, NAEA is
concerned that the approach taken by the Senate in the Reconciliation
bill now in conference is unduly burdensome to taxpayers. While the
steep entry cost would certainly deter frivolous offers, it will also
certainly prevent most, if not all, earnest taxpayers from making their
offers as well.
As you are aware, the provision requires that a taxpayer make a
good faith down payment of 20 percent of any lump sum offer-in-
compromise with any application for an offer. For periodic payment
offers, the taxpayer is required to comply with his or her own payment
schedule. The proposal also repeals the $150 user fee. Additionally, it
provides that an offer will be deemed accepted if the IRS does not
reject it within twenty-four months (twelve months beginning in 2010).
The proposal is estimated to raise $683 million over five years.
With IRS permitted to wait twenty-four months to accept an offer,
at least until 2010, one of the common concerns is the possibility that
IRS may use this new rule to further slow its processing of offers
(particularly in the case of taxpayers making monthly ``good faith''
payments).
A further concern is that many taxpayers borrow to meet their tax
obligations (often from family or friends) and such taxpayers would see
this plan as a great disincentive to make an offer. We do not believe
it makes sense for a taxpayer to borrow in an effort to square up with
the IRS only to risk that a rejected offer would put the taxpayer even
more in debt, both to IRS and to the source of the borrowed ``good
faith'' payment.
It is not clear how the provision, which NAEA believes will reduce
significantly the number of offers submitted to IRS, would generate the
10-year dollars that the Senate bill claims it will.
NAEA would like to offer a counter proposal that we believe would
provide true reform. In short, our proposal would:
Require that if a taxpayer uses a paid third party to
prepare the offer that such preparer be a current Circular 230
practitioner;
Create a $5,000 frivolous filing penalty for the taxpayer
and for any paid preparer assisting in the preparation of the frivolous
offer;
Maintain the current user fee; and
Deem an offer accepted if not rejected by the IRS within
twelve months.
This alternative approach should eliminate most of the frivolous
offers, while at the same time giving taxpayers a time-certainfor
response from the IRS.
ENFORCEMENT DURING TAX FILING SEASON
NAEA has been a strong proponent of beefing up enforcement at the
IRS, while maintaining good customer service levels for taxpayers. We
are encouraged by the improved numbers we are seeing from the agency on
both audit and collection. Many of our members, however, have reported
a problem arising from this renewed emphasis. Namely, there has been a
major increase in the number of audits, collections, and notices coming
from the agency during the height of the tax filing season. This
situation is coupled with an absolute unwillingness to work with
practitioners to accommodate the sheer crush of work brought about at
this time of the year. The IRS needs to consider building in some level
of flexibility for its employees to be able to work with practitioners
during filing season. The clear result will be higher quality audits
and better responses to IRS inquiries.
In closing, Mr. Chairman and members of the subcommittee, NAEA and
its members stand prepared to work with you and the IRS in ensuring a
strong tax administration system and improving voluntary compliance.
Thank you and I stand ready to answer any questions you may have.
______
[i] The National Association of Enrolled Agents (NAEA) is the
professional society representing enrolled agents (EAs), which number
some 46,000 nationwide. Its 11,000 members are licensed by the U.S.
Department of the Treasury to represent taxpayers before all
administrative levels of the IRS, including examination, collection,
and appeals functions.
While the enrolled agent license was created in 1884 and has a long
and storied past, today's EAs are the only tax professionals tested by
IRS on their knowledge of tax law and regulations. EAs provide tax
preparation, representation, tax planning, and other financial services
to millions of individual and business taxpayers. EAs adhere to a code
of ethics and professional conduct and are required by IRS to take
continuing professional education. Like attorneys and CPAs, EAs are
governed by Treasury Circular 230 in their practice before the IRS.
Since its founding in 1972, NAEA has been the enrolled agents'
primary advocate before Congress and the IRS. NAEA has affiliates and
chapters in forty-two states. For additional information about NAEA,
please go to our website at www.naea.org.
Chairman RAMSTAD. Thank you very much, Mr. Degen, and the
Chairman thanks all three distinguished members of this panel.
I would like to address the first question to any or all of
you, for that matter, about the proposed regulations to expand
the permissible use of taxpayer information by tax return
preparers. I, as other Members have expressed today, have some
serious privacy concerns about the proposed regulations to
expand the use of such information.
In your judgment--again, any or all of you may respond--are
there any compelling reasons for the IRS to broaden tax return
preparers' ability to use taxpayer information? Mr. Drapkin?
Mr. DRAPKIN. Well, the ABA and the Tax section do not have
a position, so I will be speaking on my own behalf. In
reviewing the materials for this hearing, it struck us that,
for one thing, the sharing of information has been authorized
by regulation since 1974, both by a tax return prepared with
its own affiliates and at direction of the taxpayer to disclose
return information to anyone. So, these authorizations have
existed in the law effectively since Congress enacted the
statute in 1971. The privacy----
Chairman RAMSTAD. Pursuant, of course, to taxpayer consent.
Mr. DRAPKIN. Pursuant to the taxpayer's consent in both
cases.
Now, the IRS commendably spends a good deal of effort in
the proposed regulation and the proposed revenue procedure on
the consent side, beefing up consent, making it meaningful and
apparent. This may well be a subject that this Committee might
want to look into because it overlaps both the proposed
regulations and the existing regulations as to whether or not
this information should be shared, what are the compelling
interests either way, the commercial advantages to the tax
return preparer versus the concerns on privacy.
Chairman RAMSTAD. Well, let me ask the obvious question
then that flows from your statements. Do you believe current
regulations on disclosure of taxpayer information by preparers
should be reconsidered?
Mr. DRAPKIN. Well, in light of what has happened since
December, when the proposed regulations came out, and we
understand in part outsourcing was one of the issues that
concerned the government in coming back to this area really for
the first time in 30 years, that the nature of privacy concerns
and the nature of consumer interests has changed so much since
1971 to 1974, when the legislation was enacted and the rules
developed, that a Committee like this one, Mr. Chairman, might
well want to look into, again, what are the legitimate
concerns, how well does the statute and the legislation reflect
those concerns, and not just the ones raised by the proposed
changes, but also by those raised by the existing rules.
Chairman RAMSTAD. Dr. Purcell, please.
Mr. PURCELL. Mr. Chairman, our concern--and we had provided
testimony on Tuesday, as well as in our comments for today. The
7216 is a criminal statute, and its penalties are criminal in
nature. So much of the disclosure question should be carefully
considered in the fact that you are imposing criminal sanctions
on people as opposed to many concerns that you might have in
the relationship with your tax preparer, which might be
inadvertence or oversight, but not intentional criminal
conduct. So, we urge going slowly on trying to overkill with
the process of legislating here or regulating something that
could well be better handled through an ethical concern.
The second concern that we have is that the discussion
about the disclosure really is the means to the end, and the
end is whether taxpayers are being unfairly taken advantage of
through the existing regimen, being asked to do something or
being the victim of identity or some other type of exposure of
their information because someone is trying to sell an
additional service or trying to use that information for
financial gain. It might be better to focus on some of the
things you have already heard this morning, such as the RAL, as
an entity in itself rather than the means that it's being used
to get there, which is the perhaps aggressive use of taxpayer
information.
So, I think it is important as a policy matter, what is the
information being used for and should it even be used for this
in any circumstance. Should anybody be able to do this, yes or
no? Then if this is a legitimate use of information, what
safeguards should we put in to make sure the information is not
unfairly shared?
Chairman RAMSTAD. I certainly agree with that. I think you
couched the threshold question very well, and secondary ones as
well, and we need to address those questions. I also think your
caveat as to proceeding with due caution is a good one. Thank
you, Dr. Purcell.
Mr. Degen, please.
Mr. DEGEN. Yes, Mr. Chairman, I think it is fair to say
that we would agree primarily with the position of the Taxpayer
Advocate. I think she basically said that, as a policy
decision, it is up to the Congress to decide whether there
should be any disclosure or not. However, given the fact that
their existing regulations do allow a certain amount, the
proposed regulations actually enhance protection for the
taxpayer. So, if the Congress is not going to make a complete
change, then we would support those regulations in terms of
enhancing.
I think there was also one other point--I believe this was
mentioned at the hearing on Tuesday when the IRS had the
hearing on the proposed regulations--that it would be seemingly
in the interests of the taxpayer and the IRS to perhaps involve
the practitioner community before some of these things are
proposed. Quite often, we feel that the IRS would be better
served, the public would be better served if they operated in a
mode called ``consult, then decide,'' as opposed to in a mode
of ``decide, then explain.'' So, I think that is something that
we would hope that the practitioner community--while clearly we
do not make decisions and we do not make policy, but I think
there is a lot of insight and input from the trenches, so to
speak, that may be in the best interest of the Service to look
at beforehand.
Chairman RAMSTAD. I think that point is very well made, and
you certainly bring an expertise that is important, and I think
we need to work more in that collaborative way.
Let me ask you, Mr. Drapkin, in your testimony you touched
on the need for simplification of tax laws. I do not think you
will get much disagreement anywhere in any venue that we need
to simplify the Tax Code, and we have been going in the wrong
direction if you look at it en masse, in todo. I know the ABA
has been advocating simplification of the Tax Code for a number
of years.
I think also everyone concedes around here at least that
wholesale simplification is off the table for this year. Yet
are there some viable incremental steps that Congress can take
now to simplify the Tax Code short of dealing with it in a
comprehensive way? Or should we not deal with it an incremental
way pending comprehensive reform?
Mr. DRAPKIN. Well, I think there are a number of avenues,
as has been mentioned. The AMT, both in its individual and
corporate form, is a source of immense complexity, and it has
also become clear that in recent years, particularly the
individual AMT is hitting sectors of the taxpayer community
that, I think it is fair, Congress probably did not contemplate
when it first enacted the provisions. So, I do not know if you
could call removal of a provision of that magnitude
``incremental,'' but short of wholesale tax reform, that is
certainly one area.
We mentioned in our testimony this time and before that re-
examination of the phase-out provisions and trying to
coordinate and correlate them would be greatly simplifying. I
would also point out, as I think the Chairman well knows, the
report of the President's panel on tax reform made a number of
proposals that actually could be isolated from the broader
proposals, areas that could merit attention from this Committee
and others, such as bringing together various provisions on
education credits and other types of credits and trying to
unify them into one single provision.
So, I think there are a large number of possibilities out
there that the Subcommittee and other entities in Congress
could examine if they wanted to find fruitful areas for
simplification short of wholesale tax reform.
Chairman RAMSTAD. I certainly agree the AMT is a ticking
time bomb and needs to be addressed, and I would also go
further than you and say the AMT is hitting taxpayers that
Congress definitely--not probably, but definitely did not
intent to impact. So I appreciate that.
Do either of you gentlemen have any additional input on
that point?
Mr. PURCELL. I think I would--on behalf of the AICPA, I
think we would echo Dennis's comments, and certainly we have
worked together, ABA and the AICPA, extensively on
simplification issues.
When we look at the issues that come up, though, I think
two things that would be kind of broader, I guess, cautions or
concepts, we seem to have had--I have been in tax practice in
one form or another since the late 1960s, early 1970s, and I
keep on my shelf a copy of every tax law that has been passed.
Well, there is no room on my shelf anymore because so many have
been passed. We seem to have accelerated the rate of change so
that we are writing not just simplification laws, but we are
writing technical correction laws before the first law has even
been fully enacted.
So, one caution would be just we need to slow down. We need
to make sure that if we are going to pass something that it is
needed. So, rather than rush to get something done, I think
calling us, calling in different constituent groups to look at
an issue such as education credits and education incentives or
issues such as the AMT and making sure that before we try to
fix it we have got a good fix that will stand up for 5 or 10
years.
The other thing is anytime Congress puts in a threshold
amount, it needs to be very careful to make sure that it is
inflation adjusted. We would not have the problem we have today
with the AMT if the exemption had been inflation adjusted when
it was first enacted. We would not have the problem we have
today with the estate tax if the exemption amount had been
inflation adjusted back in 1916, because most taxpayers would
then not be subject to either one of those taxes.
When we look back to try to fix it after years and years
and you look at the revenue cost, it becomes very problematic,
if not impossible. So, as a matter of activity that if you just
inflation-adjust something when you first enact it, that could
certainly help.
So, those would be the two other thoughts besides the ones
Dennis raised.
Chairman RAMSTAD. Thank you.
Mr. Degen, did you want to comment further?
Mr. DEGEN. Yes, I would like to, I think, echo what Dr.
Purcell said in terms of new legislation going slow. I would
ask that the Congress do take a look at that section 152. That
has been a huge problem in the practitioner community. In a
typical Ozzie and Harriet family, it is not a problem. Yet in
America today, we do not have as many Ozzie and Harriet
families as we used to. We have a lot of families where people
are not married, they live together, they have children, they
have nieces, nephews, people die. What that section has done--
the intent was good. It is always easy, Mr. Chairman, to be a
Monday morning quarterback. Hindsight is the best sight, isn't
it? In all seriousness, the Treasury Department has recognized
this. In their Blue Book, they call the 2007 budget proposal an
attempt to fix some of these things. Yet their fixes seem to
create just as many problems. The 152 needs to be looked at.
One of the problems that we have had is the interpretation
of the IRS. In the law it says ``another taxpayer.'' Well, the
Internal Revenue Code defines a taxpayer basically as anyone
that breathes. When they made the ``qualifying child,'' I
thought the intent of Congress was to prohibit two people from
claiming the same child as a dependent. I do not know how the
law was written. I am not an expert in that, but the IRS has
interpreted ``taxpayer'' in the sense of anyone who breathes is
qualifying. They use the phrase ``another person'' or ``someone
else.'' I am not terribly sure that was the intent of Congress
to use that in the same--so I really believe that, in fairness
to the taxpayer, because, quite frankly, practitioners--and I
am not talking about Circular 230 necessarily, but just
practitioners in general--are interpreting it in different ways
and not everyone is being treated the same.
So, I really think that is an issue that needs to be looked
at seriously.
Chairman RAMSTAD. Thank you, Mr. Degen.
I want to ask you another question, Mr. Degen. The last
numbers I saw claimed that 60 percent of taxpayers use a
professional tax preparer to complete their return--60 percent
of taxpayers. Obviously, then, it is important that tax
practitioners receive adequate assistance from the IRS when the
paid preparers have questions about the Code.
Are members of your constituent group, your association,
tax practitioners you represent, are they receiving the
assistance they need from the IRS? Have things improved in that
regard?
Mr. DEGEN. Quite frankly, Mr. Chairman, I do not believe
too many of our members would actually solicit responses from
the IRS in terms of typical tax situations. I think most of our
members take a lot of continuing education and do not rely on
the IRS for guidance on mundane issues. Clearly on the issue I
brought up before about the section 152 is a different ball
game. I do think that would be a fairer question to ask if
taxpayers who do not use professional assistance are getting
what they need from IRS. That I cannot answer, but I do think
that it is not an issue for most of us in terms of the IRS
providing assistance.
Chairman RAMSTAD. Maybe I should have asked the question:
Which, if any, of the taxpayers services that the IRS offers
are utilized by practitioners in preparing returns?
Mr. DEGEN. Well, one issue--this is not necessarily in
preparing returns, but I think it may be apropos to your
question--will be the notion of the e-services. E-services are
something that the IRS has provided for tax practitioners to
avail themselves of being able, with appropriate power of
attorney, to electronically download transcripts of taxpayer
information reporting and that type of thing.
Unfortunately, the Service has made a decision that access
to that is predicated upon the fact whether you file five
returns electronically or not. It makes no difference whether
or not you have any expertise. That is the criteria.
The Service, through the Office of Professional
Responsibility, monitors Circular 230 practitioners, and yet
they refuse to allow the practitioners who they monitor access
unless they file five tax returns. I am sure ABA has many
members who do not file tax returns but do represent taxpayers.
These folks, as well as enrolled agents--and I am sure
certified public accountants are in the same position. These
folks have the most need for these e-services, and they are not
available to them. So it does not make sense that you predicate
a very important service based on filing five tax returns
electronically.
Chairman RAMSTAD. Dr. Purcell, did you want to address
that?
Mr. PURCELL. I think I would echo Frank's comment that we
are on record as supporting a drop in the threshold level for
qualification for the Electronic Return Originator (ERO)
because it does not make sense, and for the reasons that Frank
has already outlined.
Chairman RAMSTAD. Any further comment, Mr. Drapkin?
Mr. DRAPKIN. No, Mr. Chairman.
Chairman RAMSTAD. Well, the Chairman again wants to thank
all three of you for your continuing input to the Subcommittee
on Oversight as well as the full Committee on Ways and Means.
We appreciate your expertise and counsel, and thank you for
your indulgence today. Hopefully you will be able to grab lunch
despite the hour, and the Subcommittee will stand adjourned.
[Whereupon, at 12:43 a.m., the Subcommittee was adjourned.]
[Submissions for the Record follow:]
Statement of the National Society of Accountants
The National Society of Accountants (NSA) welcomes the opportunity
to submit our views regarding any difficulties encountered during the
current tax return filing season, the ``Estimates of Taxpayer Burden''
tables that appeared in the instructions for the 2005 Form 1040 and the
regulation of federal income tax preparers. NSA is a voluntary
association of certified public accountants, enrolled agents, licensed
public accountants, licensees of State Boards of Accountancy, tax
practitioners who are licensed by state agencies and accountants and
tax practitioners who hold credentials from ACAT, a nationally
recognized credentialing body.
NSA and its affiliated state organizations represent approximately
30,000 practitioners who provide accounting, advisory and tax related
services to more than 19 million individuals and small businesses. NSA
represents accountants who serve Main Street rather than Wall Street.
2006 Filing Season
NSA members have encountered a greatly increased work load during
the current tax return filing period and believe that this has proven
costly to taxpayers due to the increased number of hours required to
prepare their returns. Some of the increase in the work load has
resulted from changes to forms and instructions. For example, one NSA
member was asked to prepare a return that required more than 600 stock
transaction entries on Schedules D and D-1 in order to e-file the
return. Another example involved one of our members whose client
received a Form 1099 from a stock brokerage firm and just recently
received an amended Form 1099B due to the division between ordinary and
qualified dividends. This resulted in a delayed filing that will be
followed by the filing of an amended return. I am sure that entities
that must send and re-send Forms 1099 are frustrated by the complexity
of the requirements, but a taxpayer is virtually unable to prepare a
return during the early part of the filing season if there is any
possibility of receiving an amended Form 1099. All of this also
dramatically increases the cost of preparing a return accurately the
first time.
In preparation for the current filing season the Internal Revenue
Service has also encouraged taxpayers to prepare their own tax returns
using computer tax software programs. A number of NSA members have
heard from taxpayers who are finding it often takes an entire day to
prepare their tax return, even though it may not be a complex return.
In many instances, our members have been called upon to correct costly
mistakes that have been made.
Preparers from all over the country are being bombarded with
taxpayer complaints due to the Alternative Minimum Tax adding to the
taxpayer's tax burden and tax liability. Taxpayers feel they are unable
to present their views to the IRS, so preparers are forced to take the
brunt of these protests. This adds more hours to the preparers' already
overloaded schedule and can add significantly to the cost of preparing
a return as preparers explain the AMT and why it adds to the tax that
must be paid.
IRS Estimates of Taxpayer Burden
The Internal Revenue Service recently published an ``Estimates of
Taxpayer Burden'' tables as part of its Form 1040 instructions. The
National Society of Accountants (NSA) believes these estimates to be
patently wrong, make no distinction with respect to the sophistication
of the self-filing preparer or the complexity of a return even assuming
the criteria the tables set forth. Further, the tables encourage the
conclusion that business self-filers use improper and invalid
assumptions to prepare their tax returns. Finally, the tables purport
to set forth the fees charged by tax preparation professionals without
any apparent thought to regional cost of living differences or in the
types of schedules required for various types of income.
NSA questions the estimates and how they were obtained. Clearly,
judging from the number of comments we and other representatives of the
professional tax preparation community have received, very few if any
of our members were asked to provide any estimates of the time spent to
prepare a particular return and the fee charged. Any such request would
have quickly revealed that our members believe that every taxpayer is
different. For example, one table makes a particular estimate about a
nonbusiness filer who files a Schedule D but not a Schedule A. How many
transactions are assumed to be reflected on the Schedule D? Even if
there is only one transaction, what is assumed about the availability
of information related to basis, capital improvements and other
necessary and relevant information? There is no way a tax professional
can ``blanket charge'' his clients in light of those differences.
Further, the fee charged for tax preparation services is likely to
vary substantially based on where the services are performed. Tax
preparation professionals practicing within a large metropolitan area
such as New York or Chicago must charge more than their counterparts
living in small town or farming communities because their overhead is
far greater. Every area of the United States is different. For the IRS
to issue a table suggesting to taxpayers how much a tax professional
should charge to prepare a return is absolutely misleading and
counterproductive.
Another concern is the assertion in the table that a business filer
who prepares a return himself without tax software will spend less time
(45.1 hours) preparing the return than if that same individual used tax
software (67.1 hours) or used the services of a paid professional 47.9
hours). It seems obvious that someone who sees a particular form once
per year will spend more time than a professional who is not only
familiar with the form but has likely prepared the same form thousands
of times. The only way this can possibly be true is if the self-
preparer ignores the time needed to actually obtain the numbers
required to prepare a return properly and instead relies on estimates
(or the numbers on last year's return). Reputable tax professionals
know that the majority of time spent on a return is the process of
compiling all of the figures necessary. That being the case, the
numbers are either wrong or the tables assume that taxpayers who self-
file are using estimates rather than going through the tedium of
looking through their records for the actual numbers. If the latter is
true, where does that put the IRS's push for compliance?
We sincerely hope the IRS will reconsider the publication of these
estimates of taxpayer burden contained in the tables.
S. 832
NSA members have noticed an increase in the number of fraudulent
tax preparers. In fact, a recent GAO report found that, of the 19 chain
tax preparer offices tested, all returns were prepared incorrectly.
Further, USA Today conducted a recent study and concluded that the
number of fraudulent preparers has increased substantially in the last
5 years. Competence and reliability can be very hard for taxpayers to
determine, especially in light of limited government oversight. The IRS
has pushed electronic filing to the forefront, and unfortunately this
has led to an abundant increase of unenrolled preparers who operate
from their cars, their homes, storefronts, on a table in their
businesses, etc.
Senate Bill S. 832 proposes new regulation for the federal tax
preparation industry. This proposed legislation would have a
significant impact on the profession and the Internal Revenue Service.
Estimates of the number of tax practitioners required to register in
the first year of the program range from 200,000 to as high as 600,000.
The Senate bill instructs Treasury to develop (or approve) and
administer an eligibility examination designed to test the knowledge
and technical competency of individuals who prepare federal income tax
returns. NSA has supported the concept of registration for federal
income tax preparers since we first introduced the concept several
years ago. NSA further supports the use of an eligibility examination.
However, NSA can fully support the Senate bill, and any similar
legislation, only if it provides recognition of tax practitioners who
have already demonstrated their professional competence and their
commitment to life-long learning either by earning credentials offered
by a nationally recognized credentialing body or by being licensed to
practice accounting by a state Board of Accountancy or by being
licensed to prepare income tax returns by an agency established under
state law. Allowing individuals who possess such credentials or
licenses to receive a waiver from the initial examination requirement
will achieve that recognition. These individuals would still be
required to register, pay the appropriate fees and meet the other
requirements specified in the bill.
The Accreditation Council for Accountancy and Taxation (ACAT), a
nationally recognized credentialing organization, offers three
credentials that fully satisfy the competency and ethical standards
that the Senate bill seeks to achieve. Those credentials are:
Accredited Business Accountant (ABA), Accredited Tax Advisor (ATA) and
Accredited Tax Preparer (ATP). Individuals who hold these credentials
have demonstrated their knowledge and competency through a regimen that
includes education, experience and examination on topics that include
substantial taxation and ethical components. To maintain their
credentials, they comply with rigorous annual continuing professional
education requirements. ACAT credentials are recognized for licensing
or regulatory purposes in a number of states, including Iowa and
Minnesota, and NSA believes that S.832 should be modified to recognize
that any individual who has taken and passed an ACAT examination and
maintains his accreditation is exempt from any testing required by the
bill.
Any individual holding a license from a state Board of Accountancy
has likewise demonstrated a level of competence that is based on a
long-established regulatory standard that has education, experience and
examination as required components. Every state accountancy regulatory
scheme requires continuing professional education as a condition for
license renewal.
The states of California and Oregon license tax preparers in their
respective jurisdictions. The licensing qualifications differ slightly
in each state, but both require a substantial educational element,
including state and federal taxation and ethical conduct, as a
prerequisite to granting a license. In both states, continuing
professional education is a requirement for license renewals.
California currently licenses approximately 36,000 tax preparers and
Oregon licenses approximately 8,000 preparers under their respective
programs. These states already impose adequate and efficient licensing
requirements on their tax and accounting professionals. We do not
believe additional federal requirements should be imposed on these
individuals or similarly situated individuals in other states.
In addition, the Internal Revenue Service has extended Circular 230
privileges to public accountants in the States of Pennsylvania, New
Jersey and Rhode Island. Under the provisions of Circular 230, a
``certified public accountant'' is a person duly qualified to practice
as a certified public accountant in any state, territory, or possession
of the United States. Certified public accountants that are not
currently under suspension or disbarment from practice before the
Internal Revenue Service may practice before the Internal Revenue
Service. A number of other states have a public accountant license
class that has practice rights substantially equivalent, if not
identical, to those granted to CPAs. These licensed public accountants,
like their CPA counterparts, are subject to regulation and supervision
by state Boards of Accountancy and must meet continuing education,
professional standards and other requirements in order to maintain
their practice rights. We firmly believe that if the Internal Revenue
Service has already recognized the competence and integrity of these
tax and accounting professionals in these states, Congress should as
well.
The Senate bill has a section that ``clarifies'' the Enrolled Agent
credential. NSA supports this concept because it will establish a
uniformity of regulation and eliminate ambiguities and conflicting
restrictions that have evolved in many state regulatory schemes over
time. The truthful use of earned credentials is an individual right
that all responsible regulatory legislation should serve. National
attention to this issue is both appropriate and overdue.
The descriptor used to identify this new class of regulated tax
preparers deserves the attention of your Committee. The staff notes,
accompanying the Senate bill, include the term ``enrolled preparer''
when referencing those individuals subject to the proposed regulation.
NSA believes that this term diminishes the Enrolled Agent credential
and has the potential to confuse the public. Further, it does not
adequately describe the services performed by this group of tax
preparers. We recommend that terminology used to describe this group be
neutral. We suggest ``Registered Federal Tax Return Preparer.''
Another section of the Senate bill provides for levying fines and
then keeping the money to fund a public awareness campaign. We question
the propriety of this provision and ask that Congress reconsider the
potential for abuse. Principled legislation should allow Treasury to
abate a punitive fine for an inadvertent human error. Perhaps there
should be a ``pattern of neglect or misconduct'' before heavy fines are
levied.
The ``one-year from enactment'' provision is another area that must
concern everyone. Such a short time period to develop both a testing
and a registration system certainly has the potential to disrupt the
subsequent tax-filing season. The staff description of the Senate bill
states, ``Efficiencies will be gained by coordinating the exam
requirement with the enrolled agent exam.'' Until such time as the
enrolled agent exam is successfully outsourced and its structure
entirely revised, we believe this conclusion is questionable at best
and could lead to a disruption of the filing season in the first year
of implementation. Processing the exams and the attending record
keeping for 200,000 to 600,000 individuals certainly has the potential
to overwhelm the system. A safer approach would be to instruct Treasury
to devise a testing system independent of the Special Enrollment
Examination that applicants could use throughout the year. Such a
process would follow the proven model that the securities and insurance
industries use. We think that development of a workable regulatory
structure, as anticipated by S. 832, simply requires more time to both
develop and implement. Extending the time frame to two years or perhaps
three would be more realistic.
In summary, with respect to S. 832 NSA supports:
1. The concept of registration of tax preparers.
2. The use of an initial examination by those who have not taken
and passed an existing national examination, including those offered by
the Accreditation Council for Accounting and Taxation.
3. A requirement for ongoing continuing professional education.
4. The requirement for registration renewal every three years.
5. A waiver of initial examination for individuals who:
a. Hold credentials offered by nationally recognized
credentialing bodies; or
b. Hold a license to practice accountancy from a state Board of
Accountancy; or
c. Hold a license to prepare tax returns established under
state law.
6. The clarification of the Enrolled Agent credential.
7. Finding a better descriptor than ?enrolled preparer.
8. Reconsideration of using preparer penalty money to fund public
awareness efforts.
9. Extending the time period for development and implementation of
the structure.
Statement of Gerald E. Scorse, New York, NY
My testimony today will make the same point, and urge the same
action, as my testimony before this honorable Subcommittee in 2003,
2004 and 2005.
With one key difference: I now count as an ally National Taxpayer
Advocate Nina E. Olson. Let me quote from the legislative
recommendations of the Advocate's 2005 Annual Report to Congress:
Requiring Brokers to Track and Report Cost Basis for Stocks and Mutual
Funds.
Many financial institutions through which investors own stocks and
mutual funds (?brokers') do not currently keep track of an investor's
basis in the stocks or mutual funds, and no brokers report basis
information to both taxpayers and the IRS on a Form 1099-B, Proceeds
from Broker and Barter Exchange Transactions. The absence of
information reporting creates serious problems for many taxpayers and
the government alike. For taxpayers, tracking basis can be
extraordinarily complex and many taxpayers seeking to comply with the
law find they simply cannot do so with accuracy, leaving them exposed
if audited. From the government's perspective, the absence of
information reporting enables underreporting by taxpayers who
deliberately overstate their basis (thereby reducing their gain or even
generating a loss), because they know the IRS generally cannot detect
errors in basis reporting in the absence of an audit. One recent
estimate puts the revenue loss to the government from such
underreporting at $250 billion over the next 10 years. We recommend
that brokers be required to keep track of an investor's basis, transfer
basis information to a successor broker if the investor transfers the
stock or mutual fund holding, and report basis information to the
taxpayer and the IRS (along with the proceeds generated from the sale)
on Form 1099-B. To offset the cost of implementing such a tracking
system, we note that Congress could provide a one-time tax credit for
brokers.''
And so the National Taxpayer Advocate comes down on the side of
third-party reporting of capital gains for stock transactions. (Aside:
I suggested to Ms. Olson and would suggest to the Subcommittee that the
same rule should apply to home sales and other real estate
transactions. Even more than with stocks, there is no defensible reason
for self-reporting of this income.)
Ms. Olson bases her recommendation on the twin pillars of tax
simplification for taxpayers and ending billions of dollars in annual
revenue losses by the Treasury. Both are hugely worthwhile, and reason
enough to translate her proposal into law.
I would add other reasons as well.
I was drawn to the issue in the beginning as a simple matter of tax
fairness.
It is inequitable to have a stricter tax reporting standard for
wages than for capital gains; it is inequitable to require third-party
reporting of wage income and not have the same requirement for capital
gains income.
I owe it to IRS Commissioner Mark Everson for pointing to another,
allied reason. In remarks prepared for this Subcommittee's 2005
hearing, the Commissioner noted that ``Average Americans pay their
taxes honestly and accurately, and have every right to be confident
that when they do, their neighbors--are doing the same.''
So the integrity of the tax system, and the belief of average
Americans in the integrity of the system, are also at issue here.
I respectfully ask the Subcommittee, and all the members of the
House, to address the Taxpayer Advocate's recommendation and bring it
to fruition. A House bill directly along these lines is being prepared,
and I urge your support when it is introduced.
In these divisive political times, allow me to offer a final
thought:
Third-party reporting of capital gains is a nonpartisan issue. Tax
simplification is not a Democratic or a Republican issue; billions of
dollars lost to the Treasury, year after year, is not a Democratic or a
Republican issue; tax fairness and the integrity of the tax system are
not Republican or Democratic issues.
They are issues on which both sides of the aisle should be able to
unite, and do the right thing.
Thank you.