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+
+ - 2004 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2005
+
+[House Hearing, 108 Congress]
+[From the U.S. Government Publishing Office]
+
+
+
+
+
+ 2004 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2005
+
+=======================================================================
+
+ HEARING
+
+ before the
+
+ SUBCOMMITTEE ON OVERSIGHT
+
+ of the
+
+ COMMITTEE ON WAYS AND MEANS
+ U.S. HOUSE OF REPRESENTATIVES
+
+ ONE HUNDRED EIGHTH CONGRESS
+
+ SECOND SESSION
+
+ __________
+
+ MARCH 30, 2004
+
+ __________
+
+ Serial No. 108-70
+
+ __________
+
+ Printed for the use of the Committee on Ways and Means
+
+
+
+ U.S. GOVERNMENT PRINTING OFFICE
+23-828 WASHINGTON : 2005
+_____________________________________________________________________________
+For Sale by the Superintendent of Documents, U.S. Government Printing Office
+Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512�091800
+Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001
+
+
+ COMMITTEE ON WAYS AND MEANS
+
+ BILL THOMAS, California, Chairman
+
+PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
+E. CLAY SHAW, JR., Florida FORTNEY PETE STARK, California
+NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
+AMO HOUGHTON, New York SANDER M. LEVIN, Michigan
+WALLY HERGER, California BENJAMIN L. CARDIN, Maryland
+JIM MCCRERY, Louisiana JIM MCDERMOTT, Washington
+DAVE CAMP, Michigan GERALD D. KLECZKA, Wisconsin
+JIM RAMSTAD, Minnesota JOHN LEWIS, Georgia
+JIM NUSSLE, Iowa RICHARD E. NEAL, Massachusetts
+SAM JOHNSON, Texas MICHAEL R. MCNULTY, New York
+JENNIFER DUNN, Washington WILLIAM J. JEFFERSON, Louisiana
+MAC COLLINS, Georgia JOHN S. TANNER, Tennessee
+ROB PORTMAN, Ohio XAVIER BECERRA, California
+PHIL ENGLISH, Pennsylvania LLOYD DOGGETT, Texas
+J.D. HAYWORTH, Arizona EARL POMEROY, North Dakota
+JERRY WELLER, Illinois MAX SANDLIN, Texas
+KENNY C. HULSHOF, Missouri STEPHANIE TUBBS JONES, Ohio
+SCOTT MCINNIS, Colorado
+RON LEWIS, Kentucky
+MARK FOLEY, Florida
+KEVIN BRADY, Texas
+PAUL RYAN, Wisconsin
+ERIC CANTOR, Virginia
+
+ Allison H. Giles, Chief of Staff
+
+ Janice Mays, Minority Chief Counsel
+
+ ______
+
+ SUBCOMMITTEE ON OVERSIGHT
+
+ AMO HOUGHTON, New York, Chairman
+
+ROB PORTMAN, Ohio EARL POMEROY, North Dakota
+JERRY WELLER, Illinois GERALD D. KLECZKA, Wisconsin
+SCOTT MCINNIS, Colorado MICHAEL R. MCNULTY, New York
+MARK FOLEY, Florida JOHN S. TANNER, Tennessee
+SAM JOHNSON, Texas MAX SANDLIN, Texas
+PAUL RYAN, Wisconsin
+ERIC CANTOR, Virginia
+
+Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
+hearing records of the Committee on Ways and Means are also published
+in electronic form. The printed hearing record remains the official
+version. Because electronic submissions are used to prepare both
+printed and electronic versions of the hearing record, the process of
+converting between various electronic formats may introduce
+unintentional errors or omissions. Such occurrences are inherent in the
+current publication process and should diminish as the process is
+further refined.
+
+
+ C O N T E N T S
+
+ __________
+ Page
+
+Advisory of March 23, 2004, announcing the hearing............... 2
+
+ WITNESSES
+
+Internal Revenue Service, Hon. Mark W. Everson, Commissioner..... 5
+U.S. General Accounting Office, James R. White, Director of Tax
+ Issues......................................................... 33
+Internal Revenue Service Oversight Board, Nancy Killefer, Chair.. 55
+
+ ______
+
+LFS Professional IRSs, Inc., Allen I. Orwick..................... 73
+American Bar Association, Tax section, Richard Shaw.............. 76
+American Institue of Certified Public Accountants, Tax Executive
+ Committee, Robert Zarzar....................................... 80
+National Association of Enrolled Agents, James D. Leimbach....... 86
+Tax Executives Institute, Inc, Timothy J. McCormally............. 99
+
+ SUBMISSION FOR THE RECORD
+
+Scorse, Gerald E., New York, NY, statement....................... 115
+
+
+ 2004 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2005
+
+ ----------
+
+
+ TUESDAY, MARCH 30, 2004
+
+ U.S. House of Representatives,
+ Committee on Ways and Means,
+ Subcommittee on Oversight,
+ Washington, DC.
+
+ The Subcommittee met, pursuant to notice, at 3:04 p.m., in
+room 1100, Longworth House Office Building, Hon. Amo Houghton
+(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 23, 2004
+OV-12
+
+ Houghton Announces Hearing on
+
+ 2004 Tax Return Filing Season and the
+
+ IRS Budget for Fiscal Year 2005
+
+ Congressman Amo Houghton (R-NY), Chairman, Subcommittee on
+Oversight of the Committee on Ways and Means, today announced that the
+Subcommittee will hold a hearing on the 2004 tax return filing season
+and the Internal Revenue Service (IRS) budget for fiscal year 2005. The
+hearing will take place on Tuesday, March 30, 2004, in the main
+Committee hearing room, 1100 Longworth House Office Building, beginning
+at 3:00 p.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 Everson, and representatives of
+the U.S. General Accounting Office (GAO), the IRS Oversight Board, the
+tax section of the American Bar Association (ABA), the American
+Institute of Certified Public Accountants (AICPA), Tax Executives
+Institute, Inc. (TEI), and the National Association of Enrolled Agents
+(NAEA).
+
+
+BACKGROUND:
+
+
+ The 2004 tax return filing season refers to the period from January
+1st to April 15th when U.S. taxpayers will file more than 130 million
+tax returns, including more than 50 million e-filed returns. During
+this period the IRS is expected to issue more than 105.7 million tax
+refunds, answer nearly 36.8million telephone calls from taxpayers
+asking for assistance, and its homepage is projected to receive more
+than 4.8 billion hits.
+
+ The Administration's budget requests $10.67 billion to fund the IRS
+for fiscal year 2005. This level of funding will support approximately
+101,272 employees who will collect an estimated $1.716 trillion in
+taxes (net of refunds), according to Administration estimates. Beyond
+supporting the traditional activities of the filing season, the fiscal
+year 2005 budget request addresses the Administration's key strategic
+goals for the IRS.
+
+ In announcing the hearing, Chairman Houghton stated, ``During the
+next 3 weeks, tens of millions of Americans will perform a key duty of
+citizenship. They will file their federal income tax return. Also,
+millions of aspiring citizens and residents will file faithfully.''
+
+ ``This is a great country for many reasons, not the least being our
+sense of honesty and decency. For most, rather than gaming the system
+on April 15th, they try to uphold it. Maybe this is one of the sacred
+strengths of our country. I applaud the efforts of IRS Commissioner
+Everson and the Bush Administration in upholding our standards.''
+
+
+FOCUS OF THE HEARING:
+
+
+ The hearing will focus on the 2004 tax return filing season and the
+IRS budget for fiscal year 2005.
+
+
+DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
+
+
+ Please Note: Any person or organization wishing to submit written
+comments for the record must send it electronically to
+[email protected], along with a fax copy to
+(202) 225-2610, by close of business Tuesday, April 13, 2004. In the
+immediate future, the Committee website will allow for electronic
+submissions to be included in the printed record. Before submitting
+your comments, check to see if this function is available. Finally,due
+to the change in House mail policy, the U.S. Capitol Police will refuse
+sealed-packaged deliveries to all House Office Buildings.
+
+
+FORMATTING REQUIREMENTS:
+
+
+ Each statement presented for printing to the Committee by a
+witness, any written statement or exhibit submitted for the printed
+record or any written comments in response to a request for written
+comments must conform to the guidelines listed below. Any statement or
+exhibit not in compliance with these guidelines will not be printed,
+but will be maintained in the Committee files for review and use by the
+Committee.
+
+ 1. All statements and any accompanying exhibits for printing must
+be submitted electronically to
+[email protected], along with a fax copy to
+(202) 225-2610, in WordPerfect or MS Word format and MUST NOT exceed a
+total of 10 pages including attachments. Witnesses are advised that the
+Committee will rely on electronic submissions for printing the official
+hearing record.
+
+ 2. Copies of whole documents submitted as exhibit material will not
+be accepted for printing. Instead, exhibit material should be
+referenced and quoted or paraphrased. All exhibit material not meeting
+these specifications will be maintained in the Committee files for
+review and use by the Committee.
+
+ 3. All statements must include a list of all clients, persons, or
+organizations on whose behalf the witness appears. A supplemental sheet
+must accompany each statement listing the name, company, address,
+telephone and fax numbers of each witness.
+
+ Note: All Committee advisories and news releases are available on
+the World Wide Web at http://waysandmeans.house.gov.
+
+ The Committee seeks to make its facilities accessible to persons
+with disabilities. If you are in need of special accommodations, please
+call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
+business days notice is requested). Questions with regard to special
+accommodation needs in general (including availability of Committee
+materials in alternative formats) may be directed to the Committee as
+noted above.
+
+
+
+ Chairman HOUGHTON. Good afternoon, ladies and gentlemen. We
+are delighted to have you here. I am going to make an opening
+statement, and then I will ask the Democratic leader of this
+Committee, Mr. Pomeroy, to make his statement. Nice to see you
+here, Mr. Portman.
+ Mr. PORTMAN. Good morning, Mr. Chairman.
+ Chairman HOUGHTON. Nice to see you here. Commissioner, we
+are obviously honored that you are going to be here expressing
+your views and giving us your wisdom. During the next 3 weeks,
+as most people know, tens of millions of Americans will perform
+a key duty of citizenship. They are going to be filing their
+Federal income tax returns. Millions of aspiring citizens and
+residents will also file. As we all know, this is a great
+country for a variety of reasons, not the least of which is our
+sense of honesty and decency. For most, rather than gaming the
+system on April 15th, they will try to uphold it. I don't think
+there is another Nation in the world that does this as well. It
+is for the benefit of the vast majority of law-abiding
+taxpayers that we are holding this hearing today. We owe it to
+these honest and decent taxpayers to see that we are served by
+a Federal tax agency that treats all taxpayers with dignity and
+respect and one that is both efficient and strong enough to
+deter cheating and bring the others to justice.
+ Appearing before us today, is Internal Revenue Service
+(IRS) Commissioner Mark Everson, who has made it one of his key
+priorities to reverse the decline in voluntary compliance
+consistent with taxpayer rights. On the next panel, we are
+going to have representatives from the IRS Oversight Board and
+the U.S. General Accounting Office (GAO). Finally, we have a
+distinguished panel of practitioners who represent some of the
+organizations that have helped the IRS and Congress to shape
+tax policy and tax administration in the past. I welcome you
+all and look forward to your testimony, all of the witnesses,
+and I am now pleased to yield to our Ranking Democrat, Mr.
+Pomeroy.
+ Mr. POMEROY. I thank the Chairman. I thank him for his
+leadership of this Committee, for convening this meeting and
+for being my friend. An important function of the Subcommittee
+on Oversight is to keep an evaluation of how the tax-filing
+season is proceeding. We are aware that there will be 130
+million tax returns filed during this filing season which ends
+in about 2 weeks. During this time, we will have received over
+50 million e-filed returns, issued over 100 million tax refunds
+and answered nearly 40 million telephone calls from taxpayers
+seeking assistance. The reports indicate that the 2003 tax
+return filing season is progressing smoothly, and we certainly
+look forward to your further testimony on that. I must say that
+I am concerned about the Washington Post story. I will just
+read you the lead paragraph:
+ ``President Bush's 2005 budget request for the IRS would
+seriously shortchange the Agency's tax-collection activities,
+leaving half a million tax accounts uncollected, 15 million
+service calls unanswered and nearly 46,000 audits unscheduled,
+according to the President's own IRS Oversight Board.'' So, as
+we look at the performance of the IRS relative to this tax-
+filing season, I would also like to have one eye down the road
+where we will be in 1 year, if we cannot adequately fund these
+essential collection activities the statutes direct the IRS to
+perform. I would cite this article that is in today's paper to
+everyone to really look at the daunting issues before the IRS
+relative to performing activities.
+ Congress has to understand--I think Congress may have a
+tendency to note problems in the field, haul in the
+Commissioner or other representatives of the IRS, rail
+indignantly about the administrative failings relative to the
+tax season and never accept any responsibility for the fact
+that we have never given you the resources you need to do the
+job. I hope if nothing else could come from this hearing, Mr.
+Chairman, it would represent a bit of Congress owning up to its
+own responsibilities to giving you the resources so that the
+job can done in the first place. There is a specific item of
+concern that I have asked to be addressed in the course of this
+hearing, and I am very pleased that among the practitioner
+panel, Allen Orwick, a constituent of mine from North Dakota,
+will be on the panel.
+ He will be presenting testimony concerning the recent e-
+file program and also talk about a recent ruling by the IRS
+regarding the Conservation Reserve Program CRP), a recent Chief
+Counsel's letter ruling that now appears to change what has
+been longstanding practice relative to the treatment of CRP
+rent to retired farmers as active income from the farm
+requiring the self-employment tax to be administered. This is
+different than it has been in the past, has caused a lot of
+concern in farm country, can be clarified in ways that I will
+suggest in the course of this hearing. Thank you for, even
+while we talk about the macro issues, allowing the discussion
+of this particular issue, so important not just to North
+Dakota, but all of farm country. Mr. Chairman, thank you, and I
+look forward to this hearing.
+ Chairman HOUGHTON. Thank you very much. We are going to try
+to move this thing along pretty fast. Unless anybody has an
+opening statement, we are going to go right to Mr. Everson.
+There are going to be votes. I do not know when they are going
+to be. They may be at 3:30 p.m. We are going to do the best we
+can, and we will roll this thing as fast as we can, and then we
+will have to just stop until we have the votes, and then we
+will be coming back. I would like to introduce, once again, the
+Honorable Mark Everson, Commissioner of the IRS. Thanks for
+being here.
+
+ STATEMENT OF THE HONORABLE MARK W. EVERSON, COMMISSIONER,
+ INTERNAL REVENUE SERVICE
+
+ Mr. EVERSON. Thank you, Mr. Chairman, Ranking Member
+Pomeroy, and Members of the Subcommittee. I appreciate the
+opportunity to testify this afternoon on the President's 2005
+budget request for the IRS and the 2004 tax filing season. At
+the onset, let me indicate how much I appreciate the
+Subcommittee's ongoing support for the IRS. In particular, I am
+very thankful for your efforts to secure adequate budgetary
+resources for the IRS.
+ Mr. Chairman, Ranking Member Pomeroy, and Congressman
+Portman, in your March 24th letter to Chairman Istook and
+Ranking Member Olver of the Appropriations Subcommittee, with
+jurisdiction over the IRS, you wrote: ``we hope you will fully
+fund the President's budget, and in particular the 10.7-percent
+increase in enforcement funding.'' You went on to write that
+the ``new moneys for enforcement will allow the IRS to make up
+ground in compliance that was lost while the IRS conducted the
+IRS restructuring.'' Thank you.
+ As you know, my working equation for the IRS is service
+``plus'' enforcement equals compliance not service ``or''
+enforcement. The IRS must do both. We must run a balanced
+system of tax administration based on a foundation of taxpayer
+rights. Earlier this month, we released our enforcement
+statistics for fiscal year 2003. They demonstrate that we have
+arrested the enforcement decline which began in the nineties
+and worsened with the implementation of Restructuring and
+Reform Act 1998 (RRA 98). Audits, criminal investigations and
+moneys collected were all up. In particular--and you can see
+the chart over on the easel--when compared with the fiscal year
+which started October 1, 2000, audits of taxpayers with incomes
+over $100,000 were up by over 50 percent.
+ [The charts are being retained in the Committee files.]
+ The President's 2005 budget request for the IRS will
+continue to rebuild our enforcement activities. I would note
+that two-thirds of the new moneys will be devoted to enhancing
+our compliance efforts in the high-income and corporate arenas,
+as well as increasing our criminal investigations. These
+incremental resources will help us address the tax gap--the
+difference between what is owed and what is paid, due to
+nonfiling, underreporting, and underpayment--and secure
+billions of extra dollars for the Department of the Treasury.
+ Furthermore, over a 4-year period, we have seen an increase
+in the percentage of Americans who think it is okay to cheat on
+their taxes from 11 percent to 17 percent. I find this
+alarming, as do you. I believe, however, that enhanced
+enforcement efforts will improve attitudes concerning
+compliance by reassuring the average American, who pays his or
+her taxes, that when he or she pays, neighbors and competitors
+will do the same. I am convinced we can augment our enforcement
+activities without diminishing our commitment to service. Our
+filing season results thus far in 2004 show that we can.
+Through last Friday, returns filed have increased almost 2
+percent, but our electronically filed returns are up 12 percent
+from last year. Electronic filing is more reliable, both for
+the taxpayer and the IRS, and it is faster, allowing the IRS to
+issue refunds in half the time.
+ Also, noteworthy is that the Free File Initiative, which
+helps low--and middle-income taxpayers, has grown in volume by
+over 24 percent from last year. Our other IRS indicators, for
+the most part, also show improvement. We have handled increased
+call volumes with stable resources and bettered our level of
+service, and there is increased usage of automated services
+both on the phone and the Internet. While we made some changes
+to improve tax law accuracy and had some startup problems
+earlier in the season, in recent weeks, our tax law accuracy
+results have recovered. While we have 2 weeks yet to go, I
+expect good results through the remainder of the filing season.
+Thank you.
+ [The prepared statement of Mr. Everson follows:]
+
+ House Committee on Ways and Means
+
+Statement of The Honorable Mark Everson, Commissioner, Internal Revenue
+ Service
+INTRODUCTION
+ Chairman Houghton, Ranking Member Pomeroy, and Members of the
+Subcommittee, thank you for the opportunity to testify today on the
+2004 tax filing season, our FY 2005 budget request and the progress
+that the Internal Revenue Service is making in the fair and efficient
+administration of taxes.
+ Our working equation at the IRS is service plus enforcement equals
+compliance. The better we serve the taxpayer, and the better we enforce
+the law, the more likely the taxpayer will pay the taxes he or she
+owes.
+ This is not an issue of service OR enforcement, but service AND
+enforcement. As you know, IRS service lagged in the 1990s. In response,
+we took important and necessary steps to upgrade service--we
+significantly improved the answering of taxpayer telephone inquiries
+and electronic filing to name just a couple areas.
+ Unfortunately, improvement in service coincided with a drop in
+enforcement of the tax law. Since 1996, the number of IRS revenue
+agents, officers, and criminal investigators has dropped by over 25
+percent.
+ We currently have a serious tax gap--the difference between what
+taxpayers are supposed to pay and what is actually paid--in this
+country. By our best estimates, we lose a quarter trillion dollars each
+year due to non-filing, under-reporting, and underpayment. (This is a
+rough estimate based largely upon data from our old Taxpayer Compliance
+Measurement Program, most of which was collected in the 1980s. Our
+estimates have been updated to reflect changes in the economy during
+the intervening years, but a key assumption is that compliance behavior
+has remained largely unchanged. If taxpayer compliance has changed in
+the last 15 years, the tax gap could well be much different than our
+estimate suggests.)
+ In addition, over the last four years, the number of Americans
+saying it is OK to cheat on taxes rose from 11 to 17 percent. Sixty
+percent of Americans believe that people are more likely to cheat on
+taxes and take a chance on being audited. (See Roper ASW, 2003 IRS
+Oversight Board Annual Survey on Taxpayer Attitudes, September 2003.)
+ We must restore the balance between service and enforcement, but
+that will not come at the expense of continued improvements to taxpayer
+service. In recent years, we have begun to attack these declines by
+revitalizing our investigations, audits and prosecutions against those
+who do not pay their taxes. The President's FY 2005 budget--if approved
+by Congress--will help with our efforts to boost enforcement while
+maintaining our levels of service. The submission requests an
+additional $300 million for enforcement activities over the FY 2004
+consolidated appropriations level.
+ In a moment, I will talk much more about service and enforcement
+and the President's budget request. But first, let me give you an
+update on the 2004 filing season and what we are doing to make the tax
+season easier and more convenient for the American taxpayer.
+
+2004 FILING SEASON
+ Mr. Chairman, I have been on the job for not quite a year so I am
+still going through my first filing season. Each year at the IRS, we
+process billions of tax-related documents. We process well over one
+hundred million taxpayer returns. We send out about one hundred million
+refunds. And we do a lot of other things as well.
+ It all peaks, of course, on April 15, a little more than two weeks
+away.
+ Here are some highlights as of March 19th (unless otherwise
+indicated):
+
+Return Receipts
+ The IRS has received 68 million total individual returns. 25
+million returns (36.86%) are paper and 43 million (63.14%) are e-file.
+Total returns have increased 1.2 million from last year, a 1.81%
+growth.
+
+ The number of online returns is at 9.88 million, a 22.9%
+increase from last year.
+ Through March 17h, 2.46 million Free File returns have
+been accepted, an increase of 24% from last year (1.98 million).
+
+Funds
+ Refund measures continue to show an increase over 2003. Total
+refunds are up from 2003 by 4.6%. Total dollars paid are 9.77% higher
+than last year, with an average refund of $2,128 paid.
+
+Telephone Measures
+ Assistor level of service, at 84%, is up 1.9% compared to last
+year. Assistors have answered approximately 731,000 more calls than
+they did during the same period in 2003.
+ Automated calls completed are 304,000 more than the same period in
+2003. A major contributor to this increase is Advanced Child Tax Credit
+(ACTC) related calls.
+ We created automated ACTC applications for use in providing
+taxpayers the correct amount of ACTC to report on their 2003 tax
+return. These applications are available through telephone automation
+and interactive web applications.
+
+Telephone Quality Rates
+ We measure telephone quality two ways, 1) customer account accuracy
+and 2) tax law accuracy. While our customer account accuracy estimates
+are 89.75%, up slightly over the previous two years, our tax law
+accuracy has declined from 84% in 2002 to 75.79% thus far in 2004.
+ FY 2004 Quality Review results indicate that two of our most
+frequent tax law defects are: Incomplete Research and Applying Tax Law
+Incorrectly.
+ We are undertaking the following efforts to improve performance:
+
+ Identifying root cause of performance deficiencies and
+implementing corrective initiatives through analysis;
+ Establishing Quality Review Improvement Teams to
+determine the drivers of Customer Accuracy rates and to establish
+resolution priorities as needed; and
+ Strengthening accountability to the frontline managerial
+level to facilitate improvement in services provided.
+
+Taxpayer Assistance Sites (TACS)
+ The number of taxpayers walking into a TAC for assistance has
+decreased as a result of streamlined services in the TACs and
+initiatives to educate taxpayers on alternate methods of obtaining
+services generally requiring a face-to-face contact. The advent of
+technological advances in irs.gov services such as ``Free File'' and
+``Where's My Refund'', and the accessibility of forms online have all
+contributed to the decline in the number of customers walking into a
+TAC.
+
+IMPROVING SERVICE
+ As this snapshot of the filing season makes clear, we are improving
+service to the taxpayer. Let me give a broader picture of service and
+compliance, and how the President's budget will lead to more effective
+and fair collection of taxes.
+ It was not long ago that IRS service was not all that it should
+be--some would even say it was poor. In many areas the service level we
+provided, or more accurately stated, failed to provide, frustrated
+taxpayers in their effort to understand and comply with the tax law.
+ Regardless of the merits of some of the allegations directed
+against the IRS in the mid-1990s, there was a significant gap between
+the quality of service that the IRS was providing taxpayers and the
+quality of service that the public had a right to expect. This
+shortfall in services clearly warranted the fundamental improvements
+and reorganization established under the Internal Revenue Service
+Restructuring and Reform Act of 1998 (RRA 98).
+ The reorganization of the IRS along customer lines of business and
+the other changes brought about by RRA 98 were, taken as a whole, sound
+reforms. The twin themes of the legislation were improvement of service
+and protection of taxpayer rights.
+ Through an almost single-minded focus on RRA 98 implementation, the
+IRS has demonstrated unmistakable progress in improving customer
+service and increasing its recognition of, and respect for, taxpayer
+rights. While we still aim to reach a higher level of customer service,
+our improvement and commitment with respect to these core goals is
+measurable.
+ Last year 53 million individuals filed their returns
+electronically. Thus far this year, nearly 2 weeks away from ``tax
+day'', electronic filing is up again, by about 11 percent. Electronic
+filing is more reliable, both for the taxpayer and the IRS. And it is
+faster. Over three-quarters of Americans get refunds, and we issue the
+refund in about half the time when a taxpayer files electronically.
+ Another challenge in the 1990s was getting through to the IRS at
+all. We now have a world-class telephone call routing system. A call is
+directed to the right person, someone who knows something about
+charitable contributions or IRAs--whatever the subject may be--and the
+system balances workforce planning against predictable workload
+patterns to reduce waiting time. Busy signals--the crudest indication
+of service failure--decreased from 400 million in 1995 to 600 thousand
+in 2003.
+ All told, we have reduced taxpayer call-waiting time in half,
+reduced the number of abandoned calls by 50%, and doubled the number of
+refund inquiries from our Spanish-speaking taxpayers.
+ Meanwhile, we have delivered other applications that provide
+tangible benefits to taxpayers and improve the efficiency and
+effectiveness of our tax administration system. They include:
+
+ Where's My Refund?/Where's My Advance Child Tax Credit?,
+which gives taxpayers instant updates on the status of their tax
+refunds and advance child tax credits. These applications have received
+over 40 million requests since the beginning of the year. By shifting a
+significant volume of customer demand to the Internet, we have seen a
+measurable improvement in service to taxpayers who still choose to
+call.
+ e-Services, which includes preparer tax identification
+number (TIN) applications with instant delivery, individual TIN
+matching for 3rd party payers, on-line registration for electronic e-
+Services, and on-line initiation of the electronic originator
+application (currently released to a controlled segment of external
+users). I am pleased to announce that we recently made the first part
+of e-Services available on our public web site. The remaining parts
+will come out over the next several months.
+ Internet EIN, which permits small businesses to apply
+for, and receive, an Employer Identification Number on-line.
+ HR Connect, which allows IRS users to perform many
+personnel actions on-line. This technological advance will enable the
+Service to redirect hundreds of positions to enforcement activities by
+the time it is fully deployed, which we have planned for October 2005.
+ Are we where we need to be on service? Not yet. As you know, I have
+been emphasizing enforcement, but I do not want this subcommittee or
+anyone to think the IRS will walk away from service. We still continue
+to maintain and improve service.
+ Our objectives for improved taxpayer service are three-fold:
+ First, to improve and increase service options for the
+tax-paying public;
+ Second, to facilitate participation in the tax system by
+all sectors of the public; and
+ Third, to simplify the tax process.
+
+ These are service objectives that recognize the dynamics of a
+rapidly changing world, one in which the Internet will be the dominant
+communications tool. Yet we realize there will remain a wide range of
+computer and technological literacy among individual taxpayers, and we
+must not fail to provide the same level of service to all taxpayers
+regardless of their technological sophistication. Our objectives also
+recognize an America with an increasingly diverse population, and that
+diversity will create challenges for us as tax administrators.
+Nevertheless, we are confident that we can and will serve all American
+effectively.
+ Continued changes in traditional media will make it harder to cover
+the waterfront as we seek to educate taxpayers. Moreover, the
+complexity of our tax laws, along with the frequency of changes to
+these laws, is not only a challenge to taxpayers trying to comply with
+the tax laws, but a basis of cynicism about complying with the tax
+laws. The Administration is committed to addressing this complexity.
+While it remains, we have an obligation to help taxpayers navigate
+these laws and make it as easy as possible for them to comply.
+ In a world increasingly impatient for prompt and reliable
+information and transaction processing, all of these factors pose
+significant challenges to the IRS as it strives to improve the level of
+service provided to the American taxpayer.
+ A good example of the challenges we will face is reconciling our
+desire to standardize our processes through electronic filing with the
+reality that some groups, such as immigrants and the elderly, will need
+different, targeted services. Electronic filing is important to the IRS
+and to taxpayers, but we cannot overemphasize it to the detriment of
+services to taxpayer groups who will not utilize it. Addressing
+competing priorities on the service side of the IRS will not be easy,
+but we will work diligently to provide a balanced, effective program.
+
+EFFECTIVE ENFORCEMENT
+ Our focus on the strong mandate of RRA 98 to improve IRS services
+to the taxpaying public made it difficult for us to balance both the
+service and enforcement elements that are so necessary to the success
+of our tax system. Improved taxpayer service enhances compliance and
+respect for our laws among the vast majority of Americans who do their
+best to pay their fair share. Improved taxpayer service also may help
+discourage those who might not otherwise do what is necessary to comply
+with our tax laws. Taxpayer service, however, does not address those
+who actively seek to avoid paying their fair share. I believe most
+people would agree that we achieved improvement of IRS taxpayer
+services in large part at the expense of needed enforcement activities.
+ Over a five-year period beginning in 1997, the IRS refocused its
+enforcement resources significantly. The number of revenue agents
+(those who conduct audits), the number of revenue officers (those who
+collect monies due), and the number of criminal investigators (those
+who prepare cases for possible prosecution by the Justice Department)
+each declined by over a quarter.
+ In essence, we did not observe the wise admonition of President
+John F. Kennedy that ``Large continued avoidance of tax on the part of
+some has a steadily demoralizing effect on the compliance of others.''
+ We are correcting our course and re-centering the agency. We are
+strengthening the IRS enforcement of the tax laws in a balanced,
+responsible fashion. And we will do so without compromising taxpayer
+rights. As the IRS enhances enforcement, we have four priorities:
+ First, we are working to discourage and deter non-compliance, with
+emphasis on corrosive activity by corporations and high-income
+individuals. Attacking abusive tax shelters is the centerpiece of this
+effort. What is at stake is greater than many billions of dollars of
+lost tax revenues. Our surveys indicate that 80 percent of Americans
+believe it is very important for the IRS to enforce the law as applied
+to corporations and high-income individuals. Enforcing compliance in
+these sectors is critical to maintaining Americans' faith that our
+system is fair. The abuses of recent years have to a very real degree
+strained the credibility of our tax administration system.
+ The IRS is moving aggressively to attack these transactions.
+Working with our partners in the Treasury Department, we have
+accelerated the issuance of guidance identifying abusive and
+potentially abusive transactions and improved disclosure requirements
+to provide greater transparency--sorely needed in today's complex
+world. And we have over 100 promoter audits underway, not to mention
+thousands of audits of high-income individuals and corporations who
+have entered into potentially abusive transactions. Where necessary,
+the Treasury Department, on behalf of the Administration, has proposed
+legislation that would stop abusive transactions that we may not be
+able to fully or quickly address under existing law.
+ But we need to do better. We need to do more, and we particularly
+need to do it faster. The length of time it takes us to complete the
+audit of a large, complex corporation is five years from the date the
+return is filed, which in most cases is already eight and one-half
+months after year end. And these figures don't include the appeals
+process, which runs another two years before the matter is settled or
+goes to court. That means that half of our current inventory of large
+cases is from the mid 1990s or the early 1990s. In today's rapidly
+changing world, we might as well be looking at transactions from the
+Civil War.
+ Simply stated, the IRS did not detect and deter the abusive
+transactions that spread during the 1990s on an adequate or timely
+basis because we did not have an informed view of current taxpayer
+behavior, only an historical understanding of events long past. And the
+challenge is becoming greater every day, as promoters of abusive tax
+transactions operate globally, without regard to national boundaries.
+ The lessons we have learned make it imperative to get current in
+our audits, to identify transactions and shorten the feedback loop so
+that abusive transactions can be shut down promptly. I am convinced we
+can do it. Technology will help. Right now it takes two years on
+average before complicated corporate returns find their way into the
+hands of the assigned examiner. We are addressing this issue.
+Electronic filing by corporations will facilitate our analysis of data
+and help us calibrate risk. Through speedier audits we will provide
+better service to the compliant taxpayer by resolving ambiguity
+earlier, and hold accountable those who seek to game the system. And we
+are creating a web of disclosure, registration and maintenance of
+investor lists that will provide information about abusive
+transactions.
+ Second, we are working to ensure that attorneys, accountants and
+other tax practitioners adhere to professional standards and follow the
+law. In recent decades, with an accelerated slide in the nineties, the
+model for accountants and attorneys changed. The focus shifted from
+independent audit and tax functions, premised on keeping the client out
+of trouble, to value creation and risk management. The tax shelter
+industry had a corrupting influence. It got so bad that in some
+instances blue-chip professionals actually treated compliance with the
+law--in this case IRS registration and list maintenance requirements--
+as a business decision. They weighed potential fees for promoting
+shelters but not following the law against the risk of IRS detection
+and the size of our penalties.
+ Our system of tax administration depends upon the integrity of
+practitioners. The vast majority of practitioners are honest and
+scrupulous, but even they suffered from the erosion of ethics by being
+subjected to untoward competitive pressures. The IRS is acting. We have
+augmented our Office of Professional Responsibility by doubling its
+size and appointing as its director a tough, no nonsense, former
+prosecutor; we are tightening the regulatory scheme; and we are
+receiving excellent support from the Justice Department in our promoter
+and associated investigations. But we need the Congress to enact the
+tougher penalties proposed by the Administration for those promoters
+who have not yet gotten the message.
+ Third, we must detect and deter domestic and offshore-based
+criminal tax activity, our traditional area of emphasis, and financial
+criminal activity. Our Criminal Investigation Division is a storied and
+proud law enforcement agency. Their expertise comprises not just
+criminal tax matters but other financial crimes. Our investigators are
+the best in law enforcement at tracking and documenting the flow of
+funds. In addition to our tax investigations, the IRS has over one
+hundred agents assigned on an ongoing basis to support the President's
+Corporate Fraud Task Force. We will continue and intensify these
+important efforts.
+ Two factors account in significant part for America's great
+economic vigor and success. They are our pervasive culture of
+entrepreneurship, on the one hand, and the stability and transparency
+of our markets on the other. The reputation and attractiveness of our
+markets have been compromised by the scandals of recent years. The
+President's Corporate Fraud Task Force and the President and Congress
+with Sarbanes-Oxley have taken important steps to restore confidence.
+Through these three enforcement initiatives, the IRS will do its part
+so that sound tax administration contributes to public confidence in
+our economic system.
+ We have one more enforcement priority. The stakes for America in
+this area are also important. We will discourage and deter non-
+compliance within tax exempt and government entities, and the misuse of
+such entities by third parties for tax avoidance or other unintended
+purposes. Non-compliance involving tax-exempt entities is especially
+disturbing because it involves organizations that are supposed to be
+carrying out some special or beneficial public purpose. Enforcement in
+this area has suffered as IRS staffing in the exempt organizations area
+fell from 1996 through 2003. Enactment of the President's budget would
+allow us to gradually build up staffing in this important area and step
+up enforcement.
+ If we do not act to guarantee the integrity of our charities, there
+is a risk that Americans will lose faith in and reduce their support
+more broadly for charitable organizations, damaging a unique and vital
+part of our nation's social fabric.
+ A case in point is credit-counseling agencies. These organizations
+have been granted tax-exempt status because they are supposed to be
+educating and assisting people who are experiencing credit or cash flow
+problems. Based on the information we have reviewed, we believe that a
+troubling number of these organizations, however, instead are operating
+for the benefit of insiders or in league with profit-making companies,
+such as loan companies, to generate income from lending to these
+distressed individuals and families. We are taking a close look at
+these organizations to ensure that they are operating within the bounds
+of the law.
+ It is, of course, imperative as we reinvigorate the enforcement
+program that IRS employees maintain their respect for and diligence to
+all taxpayer due process rights and protections.
+ We are making progress in our effort to reduce the annual tax gap.
+Our enforcement statistics for Fiscal 2003, released in early March,
+demonstrate that we have arrested the enforcement decline that began in
+the 1990s and worsened with the implementation of RRA 98. Audits,
+criminal investigations and monies collected were all up. In
+particular, the number of high-income taxpayer audits again increased
+by 24 percent. Moreover, audits of taxpayers with income over $100,000
+were up over 50 percent from two years ago. Overall audits of all
+taxpayers increased to 849,296, an increase of 14 percent from 2002.
+
+BUSINESS SYSTEMS MODERNIZATION AT THE IRS
+ While not as publicly visible as service or enforcement,
+modernization of IRS information technology is also a high priority.
+This effort is often referred to as Business Systems Modernization or
+BSM. Most of our tax administration systems are very old and difficult
+to keep current with today's fast paced environment--they must be
+modernized.
+ We are committed to resizing our modernization efforts to allow
+greater management capacity and to focus on the most critical projects
+and initiatives. Last summer, we used comprehensive studies to help us
+identify opportunities to improve management, re-engineer business
+processes and implement some new systems and technology.
+ As I have noted, the IRS has made progress on applications such as
+improved telephone service, electronic filing, and a suite of e-
+services to tax practitioners. But we have failed thus far to deliver
+several important projects with which taxpayers are not directly
+involved.
+ The projects include replacing our master file system, implementing
+the on-line security features, and building the modernized
+technological infrastructure on which all of our future modernization
+applications will depend.
+ Four studies completed last year consistently identified the
+following problems in delivering the large information technology
+efforts:
+
+ Insufficient participation in the technology program by
+IRS business units;
+ An overly ambitious portfolio;
+ Inadequate performance by the contractor.
+ The IRS is responding by to this challenge by:
+ Increasing business unit ownership of projects;
+ Resizing the project portfolio and reducing the
+modernization program from $388 million this year to $285 million in
+the President's FY 2005 request;
+ And revising our relationships with the contractor and
+ensuring joint accountability.
+
+ While we have much work to do on modernization, I can assure you
+that it is one of my top priorities as Commissioner. We need to put in
+place the foundation upon which the tax system will build and rely for
+decades to come.
+
+PRESIDENT'S FY 2005 BUDGET SEEKS INCREASE IN ENFORCEMENT
+ The President has asked for an IRS fiscal year 2005 budget of
+$10.674 billion, a 4.8 percent increase over the fiscal year 2004
+consolidated appropriations level for the IRS.
+ This budget includes the goals of customer service, infrastructure/
+modernization and enforcement. After a period of declining enforcement
+resources, the IRS has stabilized and increased the amount of resources
+dedicated to enforcement.
+ This budget has an increase of $300 million for a more vigorous
+enforcement of the tax laws. This strong commitment to tax
+administration will provide a significant augmentation of our
+enforcement resources.
+ The additional $300 million will increase enforcement in several
+key ways:
+
+ Discourage and deter non-compliance, with emphasis on
+corrosive activity by corporations, high-income individual taxpayers
+and other contributors to the tax gap;
+ Assure that attorneys, accountants and other tax
+practitioners adhere to professional standards and follow the law;
+ Detect and deter domestic and off-shored based tax and
+financial criminal activity;
+ Discourage and deter non-compliance within tax-exempt and
+government entities and misuse of such entities by third parties for
+tax avoidance or other unintended purposes.
+
+ Let me now provide more details on the broad categories of the
+budget request for the IRS.
+
+PROCESSING, ASSISTANCE, AND MANAGEMENT
+ We are seeking $4,148,403,000 for processing, assistance and
+management. This includes necessary expenses for prefiling taxpayer
+assistance and education, filing and account services, shared services
+support, and general management and administration. Up to $4.1 million
+of the $4.1 billion total will be for the Tax Counseling for the
+Elderly Program and $7.5 million of the total will be available for
+low-income taxpayer clinic grants.
+ The Processing, Assistance, and Management (PAM) appropriation
+handles all functions related to processing tax returns, including both
+manual and electronic submissions, and provides assistance and
+education to taxpayers to enable them to file accurate returns. The PAM
+appropriation issues refunds, maintains taxpayer accounts, and provides
+tax law assistance that includes tax law interpretation and rulings and
+agreements related to tax law issues. This appropriation is responsible
+for IRS personnel, facilities, and procurement services.
+ The IRS will continue to focus on pre-filing services and is
+requesting funding for taxpayer communication and education to help all
+taxpayers comply with tax laws and assume their fair share of the tax
+burden. Funding is being requested for resources to warn taxpayers of
+abusive tax schemes and improve compliance by preventing fraud and
+abuse. The IRS is redirecting funding to enhance customer service by
+reengineering processes to complement new technology and to develop an
+outreach strategy for the Child Tax Credit.
+ The IRS is reinvesting resources for filing and account services by
+providing funding for field assistance to reduce filing season details
+of compliance staff, funding the Business Master File workload
+increase, improving the level of telephone service to taxpayers, and
+updating processes to complement technology.
+ As part of the shared services program, the IRS will reinvest
+resources in new training and training delivery methods to develop and
+to improve expert consultative skills. This effort will significantly
+improve administrative and resource management decisions that will
+enhance delivery of compliance initiatives. Additional resource
+reinvestments will be used to defer rent annualization costs (based on
+partial year costs extrapolated annually for approved FY 2003 space
+expansion projects) to fulfill the IRS' operational mission objectives.
+Shared services will implement HR Connect, the integrated Human
+Resources Management System over the next two years. This system will
+seamlessly link multiple Human Resource applications that should result
+in significant program efficiencies.
+ The OMB Program Assessment Rating Tool (PART) review of Submissions
+Processing recommends that IRS successfully implement the Modernized E-
+File IT projects. IRS is enabling e-file growth by increasing the
+numbers of returns eligible to be electronically filed. In FY 2005, the
+IRS plans to complete the architecture and engineering analysis
+required to develop and deploy functionality, allowing taxpayers to
+electronically file Forms 1065, 990T, and 1041.
+
+TAX LAW ENFORCEMENT
+ For enforcement, we are requesting $4,564,350,000. This
+appropriation ensures IRS' ability to: provide equitable and
+appropriate enforcement of the tax laws, identify possible non-filers
+for examination, investigate violations of criminal statutes, support
+the Statistics of Income program, conduct research to identify
+compliance issues and support the national effort to combat domestic
+and international terrorism.
+ The resources in the Tax Law Enforcement (TLE) Appropriation
+provide service to taxpayers after a return is filed and support
+activities such as research to identify compliance and tax
+administration problems, as well as tabulation and publication of
+statistics related to tax filing. In FY 2001, Tax Law Enforcement was
+realigned and redefined as mandated by RRA 98 to better serve the needs
+of taxpayers. The modernized IRS structure is similar to those widely
+used in the private sector: organized around customers' needs, in this
+case taxpayers. The IRS has set up four operating divisions to service
+the four major categories of taxpayers; Wage and Investment Income
+(W&I), Small Business and Self-Employed (SBSE), Tax Exempt and
+Government Entities (TEGE) and Large and Mid-Sized Business (LMSB).
+Each of these business units has substantial operations within the Tax
+Law Enforcement appropriation. The Criminal Investigation (CI) business
+unit investigates criminal violations of the Internal Revenue Code and
+also supports the National effort to combat terrorist financing by
+integrating CI special agents into the Joint Terrorism Task Forces and
+other anti-terrorism task forces. CI has the largest part of its
+operation within the Tax Law Enforcement appropriation.
+ The TLE appropriation is the primary source of funding for the
+compliance functions of the IRS, including: (1) automated, in-person
+and correspondence collection of delinquent taxpayer liabilities, (2)
+the matching of reporting documents with taxpayer returns, to insure
+reporting compliance, (3) face-to-face examination to determine
+taxpayers' correct income levels and corresponding tax liabilities, (4)
+service center support of the field examination function and
+correspondence with taxpayers regarding tax issues, (5) investigation
+of criminal violations of the tax laws, (6) processing of currency
+transaction reports over $10,000, (7) tax litigation, (8) acting as an
+advocate to provide prompt resolution of taxpayer problems and (9) a
+general counsel function to offer legal advice and guidance to all
+components of the IRS.
+ The functions in TLE are essential to accomplishing the primary
+goals of the FY 2005 Budget Request. To accomplish this goal, the IRS
+must restore the strength of the compliance function. Staffing devoted
+to compliance and enforcement operations has declined in recent years.
+Annual growth in return filings and additional work related to RRA 98
+have contributed to a steady decline in enforcement presence, audit
+coverage and case closures in front-line compliance programs.
+ The FY 2004 Appropriations Act merged the Earned Income Tax Credit
+(EITC) Appropriation with the TLE Appropriation. The merge of EITC into
+the TLE appropriation will provide for customer service and public
+outreach programs, strengthened enforcement activities and enhanced
+research efforts to reduce over claims and erroneous filings associated
+with the Earned Income Tax Credit (EITC) compliance initiative.
+ Customer service for the EITC initiative includes dedicated toll-
+free telephone assistance, community-based tax preparation sites and a
+coordinated marketing and educational effort (including paid
+advertising and direct mailings) to assist low--income taxpayers in
+determining their eligibility for EITC. Improved compliance activities
+include increased staff and systemic improvements in submission
+processing, examination, and criminal investigation programs. Increased
+examination coverage, prior to issuance of refunds, reduces
+overpayments and encourages compliance in subsequent filing periods; in
+addition, post-refund correspondence audits by service center staff aid
+in the recovery of erroneous refunds. Criminal investigation activities
+target individuals and practitioners involved in fraudulent refund
+schemes and generate referrals of suspicious returns for follow-up
+examination. Examination staff assigned to district offices audit
+return preparers and may apply penalties for non-compliance with ``due
+diligence requirements.''
+ OMB Program Assessment Rating Tool (PART) observations concluded
+that the IRS does not work enough collection cases with its current
+resources, work processes and technology to ensure fair tax
+enforcement. Each year IRS fails to work billions of dollars worth of
+collection cases. Consequently, the Budget includes a legislative
+proposal to allow IRS to hire private collection contractors to assist
+the IRS in addressing a significant number of cases. In addition to the
+increased resources requested, the IRS is making internal process
+improvements, including: developing models to better identify high
+priority work, better use of the predictive dialer, realigning the
+workforce to core hours and creating a performance support tool to
+provide employees with technical guidance while handling calls. The
+PART review also determined that IRS financial management systems
+remain weak. In response, the IRS plans to modernize its' collection
+technology to improve effectiveness. New technology tools will be
+developed to collection employees, (e.g., eACS, contact recording, and
+desktop integration), which will improve program efficiency.
+
+HEALTH INSURANCE TAX CREDIT ADMINISTRATION
+ We are requesting $34,841,000for expenses necessary to implement
+the health insurance tax credit included in the Trade Act of 2002. This
+appropriation provides operating funding to administer the advance
+payment feature of the Trade Adjustment Assistance health insurance tax
+credit program to assist dislocated workers with their health insurance
+premiums. The Trade Act of 2002 created the tax credit program and it
+became effective in August of 2003.
+
+INFORMATION SYSTEMS
+ We are requesting $1,641,768,000 for information systems. This
+appropriation is for necessary expenses of the Internal Revenue Service
+for information systems and telecommunications support, including
+developmental information systems and operational information systems.
+ It provides for IRS information systems operations and maintenance,
+investments to enhance or develop business applications for the IRS
+Business Units and staff support for the Service's Modernization
+program.
+ The appropriation includes staffing, telecommunications, hardware
+and software (including commercial-off-the-shelf), and contractual
+services. It also provides for Servicewide Information Systems (IS)
+operations, IRS staff costs for support and management of the Business
+Systems Modernization effort, and investments to support the
+information systems requirements of the IRS business units. It includes
+staffing, telecommunications, hardware and software (including
+commercial-off-the-shelf software), and contractual services.
+ Staffing in this activity develops and maintains the millions of
+lines of programming code supporting all aspects of the tax-processing
+pipeline as well as operating and administering the Service's hardware
+infrastructure mainframes, minicomputers, personal computers, networks,
+and a variety of management information systems.
+ In addition, the Information Systems ``Tier B'' modernization
+initiatives fund projects that modify or enhance existing IRS systems
+or processes, provide changes in systemic functionality, and establish
+bridges between current production systems and the new modernization
+architecture being developed as part of the Servicewide Business
+Systems Modernization efforts. Investment activities also include
+improvements or enhancements to business applications that support
+requirements unique to one of the IRS business units. These Tier B
+projects yield increased efficiency and allow the Service to
+progressively improve the quality of its interactions with the
+taxpaying public and its many other internal and external customers.
+
+BUSINESS SYSTEMS MODERNIZATION
+ We are seeking $285,000,000, for our Business Systems Modernization
+(BSM) efforts. This request is based upon the resizing efforts we began
+following the various internal and external reviews of BSM.
+ This appropriation provides for the planning and capital asset
+acquisition of information technology systems, including related
+contractual costs of such acquisition and contractual costs associated
+with operations authorized by 5 U.S.C. 3109, to modernize IRS'
+antiquated business systems.
+ The IRS collects $1.7 trillion in revenues annually through an
+assortment of computer systems developed over a 40-year period. The IRS
+developed the most important systems that maintain all taxpayer records
+in the 1960s and 1970s. These outdated systems do not allow the IRS to
+meet today's taxpayer and business needs. Failure to modernize IRS's
+tax administration business systems will result in a significant
+increase in resources required to maintain legacy systems--systems that
+no longer efficiently or effectively serve America's taxpayers.
+ The BSM Appropriation provides for revamping business practices and
+acquiring new technology. The IRS is using a formal methodology to
+prioritize, approve, fund and evaluate its portfolio of BSM investments
+across the IRS Business Units and Modernization and Information
+Technology Services (MITS). This methodology enforces a documented,
+repeatable and measurable process for managing investments throughout
+their life cycle. The MITS Enterprise Governance (MEG) Committee, which
+includes the Chief Information Officer and other senior MITS
+executives, the Chief Financial Officer, and the heads of the Business
+Operating Divisions, approves investment decisions. This executive-
+level oversight ensures that products and projects delivered under the
+Business Systems Modernization program are fully integrated into IRS
+Business Units. The Department of the Treasury Investment Review Board
+also reviews the BSM expenditure Plan once the IRS executive-level
+oversight board approves the investment decisions. The plan is then
+cleared through OMB and submitted through the Appropriations
+Committees.
+ The IRS has undergone an intensive servicewide portfolio
+prioritization effort, leading to a long-term modernization plan
+identifying selected modernization projects, a release sequence for
+each project, and estimated costs for each project. The effort is based
+on vision and strategy initiatives that created an enterprise-wide
+view, which unified the needs of the IRS Business Units. FY 2005
+resources will fund the infrastructure, program management, and
+releases of business applications to support the successful delivery of
+a modernized tax administration system. More complete details are
+provided in the BSM Expenditure Plan.
+ A partial FY 2004 BSM Expenditure Plan was submitted by the
+Department of Treasury for Congressional approval in January 2004, and
+the full-year revision incorporating current project information should
+be completed by this spring.
+
+PROGRAM PERFORMANCE
+ The IRS expects to achieve the following levels of performance
+after attaining full performance of the requested FY 2005 initiatives:
+
+ Examine an additional 30,000 investor returns in the
+Small Business and Self-Employed(SB/SE) business unit and increase
+coverage of high-income taxpayers, generating an additional $170
+million in FY 2006. SB/SE also anticipates closing an additional 50,000
+taxpayer delinquent accounts, resulting in an estimated $215 million in
+additional revenue.
+ Hire and train over 2,000 new staff in the Examination,
+Collection and Document Matching programs. These increases will
+generate some $2.8 billion in direct enforcement revenue through FY
+2007. Additional audits of investor returns and high-income taxpayers,
+together with 55,000 correspondence examinations, will yield more than
+$1.0 billion during that same period and help to maintain an overall
+audit coverage rate of 0.57%. Collection closures will increase by
+240,000 and taxpayer contacts through the Automated Underreporter
+Program by some 300,000 through FY 2007--generating an additional $1.8
+billion.
+ Increase the overall audit coverage rate in the Large and
+Mid-Sized (LMSB) business unit from 5.1% in FY 2004 to 9.6% in FY 2007
+and increase projected return closures by 63% from 16,067 returns in FY
+2004 to 26,193 returns in FY 2007. Enforcement revenue recommended for
+the three years FY 2005 through FY 2007 should increase by over $3
+billion.
+ Complete 229 significant Corporate Fraud investigations
+through FY 2007. Tax-related completed investigations will increase by
+approximately 20 percent over the FY 2003 level by FY 2007. In
+addition, CI is striving to reduce elapsed time on completed
+investigations by 30 percent from FY 2002 levels.
+
+CONCLUSION
+ The IRS has lagged behind, for reasons that are understandable, in
+tax enforcement. But that is changing. We will continue to improve
+service and respect taxpayer rights. But we will also enforce the law.
+We won't relax until taxpayers who are unwilling to pay their fair
+share see that that is not a worthwhile course to follow.
+ Mr. Chairman, the great majority of Americans honestly and
+accurately pay their taxes. Average Americans deserve to feel confident
+that, when they pay their taxes, their neighbors and competitors are
+doing the same.
+ The President's budget request will help us enforce the tax law
+more fairly and efficiently. I am most grateful for your support of
+increased enforcement, and I look forward to working with you on this
+important budget request.
+ Thank you very much. I'd be happy to take your questions.
+
+
+
+ Chairman HOUGHTON. Thank you very much. I would just like
+to ask one question to kick this off, and then I am sure that
+others would like to ask some questions. What is the
+relationship between the number of audits and the increase in
+revenues?
+ Mr. EVERSON. There are two components, I would say, Mr.
+Chairman. When you address audits or any of our enforcement
+activities, there is a direct relationship to revenues, which
+is to say that through an audit or through a criminal
+investigation or any enforcement action, you secure the
+incremental dollars for the Treasury, and then there is what
+some call a spillover effect, which is to say changes in
+behavior more broadly. If you are sitting at the country club
+and down in the locker 5 yards away you hear somebody saying,
+``Geez, I never should have gotten into that abusive shelter. I
+was audited by the IRS, and now I have got to pay the moneys
+due, interest and penalties,'' well, not only have we recovered
+money from that audit, but we have had a change in behaviors
+that we believe takes place when that fellow who overheard that
+conversation is a little more conservative and reluctant to
+engage in a pattern or practice of abuse.
+ Chairman HOUGHTON. When you take a look at the audits of
+$100,000-taxpayers on the rise, does it give you the feeling
+that we are regaining the sense of trust that we so desperately
+have held onto for so many years?
+ Mr. EVERSON. I think that one component of this erosion in
+the attitudes toward compliance was a feeling on the part of
+many that others were getting away with something they should
+not be getting away with. So, clearly, we needed to augment the
+audits. I cannot tell you a magic number as to where those
+ought to be, frankly, Mr. Chairman. I think we need to do more,
+particularly in the high income. We need to do audits
+responsibly, though, in a way that treats people fairly and
+does not, in any way, intimidate folks as we go through the
+process.
+ Chairman HOUGHTON. Mr. Pomeroy?
+ Mr. POMEROY. I think that that chart is interesting and
+alarming. It shows to me how quickly things can come apart in
+terms of a national mores that you better pay what you owe. I
+believe that we have got a period of about 6 years there of
+declining audits, and ultimately a substantially fewer set of
+audits at the bottom of the trough than at the beginning of the
+decline. You indicate national statistics showing that those
+who believe you can cheat on your taxes has gone from 11
+percent to 17 percent. I suspect, just from anecdotally, it
+might even be higher. After all, who is going to respond to a
+pollster, ``do you think it is okay to cheat on your taxes or
+not?'' I believe there will be people that will never fess up
+to such a thing, but would do it in a heartbeat if they had the
+chance.
+ That is why I believe that Congress, in administering, as
+the ultimate authority on our Nation's revenue collection
+system, has to be very careful. We cannot go off on some kind
+of ideological lark/funding on compliance because we are mad at
+taxes and basically try to make ideological statements about
+the role and function of government based upon whether you can
+do the job that you are statutorily required to do. We can
+fight tax rates, tax levels, we can fight role of government.
+Those are stand-alone questions that need their own fighting,
+but we can't fight them by proxy by trying to hurt and cripple
+the IRS from doing the job it is supposed to do.
+ I will read to you a statement from the Chair of your
+Oversight Board, which was presented in testimony yesterday,
+and ask whether you agree or disagree with the statement.
+Admittedly, this is from Nancy Killefer, the Chair, not your
+words, but the statement, ``the IRS is doing a better job of
+identifying egregious noncompliance. Now, it needs the
+resources to fight back. In the past 2 years, IRS has sharpened
+its compliance focus to identify and pursue promoters and
+participants of abusive tax shelters and tax evasion schemes.
+For example, the agency is now targeting its resources on
+promoters of illegal tax schemes that are often marketed to
+high-income individuals, but are also finding their way to
+middle-market businesses. Despite this focus, enforcement
+activities are still at an unacceptable level simply because
+the IRS does not have the resources needed to accomplish its
+mission. It continues to be outmanned and outgunned. In fiscal
+year 2003, the agency was able to pursue only 18 percent of
+known cases of abusive devices designed to hide income, leaving
+an estimated $447 million uncollected, and that is from known
+cases. We knew $447 million was out there. We knew it was
+illegally withheld from tax payment, but we didn't have the
+resources to go and get it.'' Do you ascribe to the statements
+made by the Chair? Let me put it differently. Do those
+statements made by the IRS Oversight Board Chairman accurately
+reflect the situation?
+ Mr. EVERSON. I agree that the IRS needs more resources to
+combat compliance issues. I believe that the President has made
+a very strong commitment to improved tax administration,
+through the 5 percent budget increase. The increase is over 10
+percent, as you know, in the enforcement funding for the IRS. I
+think that coupled with our own emphasis on improving our
+business processes on the enforcement side, much as the IRS has
+done on the service side over the last several years, we will
+further improve our compliance and enforcement efforts, and
+bring in more moneys, bring up the audits and increase the
+investigations and the criminal prosecutions. There will be
+more to do, undoubtedly. I will continue to look at the funding
+levels on an ongoing basis and discuss, within the Treasury
+Department and with Office of Management and Budget (OMB), what
+I believe is necessary to run a balanced program.
+ What I want to emphasize at this point is my principal goal
+to make sure that we do secure 100 percent of the President's
+request. That is the real key for me, if you will, because, as
+you have indicated, in the past, on average, over the last 10
+years, there has been a 3-percent shortfall between what
+President Clinton or President Bush has requested and what
+ultimately the Congress has provided. So, I would like to first
+secure the full funding of the President's request this year,
+which would be a departure from the past. If we need more from
+there, I will take that up in the 2006 budget process within
+the Administration.
+ Mr. POMEROY. Mr. Chairman, if I might have a couple of more
+minutes' leave. I will pursue quickly. When we have some of the
+major accounting firms in this country marketing these shady or
+illegal tax-dodge schemes, I think it goes to show you the
+impunity with which noncompliance has become socially
+acceptable. Are the major accounting firms out of that
+business?
+ Mr. EVERSON. I think we are seeing changes in what I would
+call the larger accounting firms and the larger blue-chip
+corporations. Our concern has been, though, that as we clamp
+down in one area, we continue to see issues in mid-size
+businesses or also on a continued basis with wealthy
+individuals. We have a great partnership with the Department of
+Justice on this issue. They are supporting us in litigation
+with the accounting firms and the law firms. As you know, first
+time ever where we have litigated against law firms, in terms
+of those who are acting as promoters, so that they are handled
+as promoters.
+ There are matters before the Justice Department now that
+include criminal investigations that will send a real signal
+through the professions, and I do expect that this will
+continue to receive a lot of attention on an ongoing basis. I
+was at the President's Corporate Fraud Task Force meeting just
+a week ago, and this was emphasized to all, not just by myself,
+but by the leader of the task force, the Deputy Attorney
+General, that combatting abusive tax shelters are part of the
+effort to clean up corporate governance and should receive top
+priority.
+ Mr. POMEROY. Thank you.
+ Chairman HOUGHTON. Mr. Portman?
+ Mr. PORTMAN. I thank you, Mr. Chairman. Commissioner, thank
+you for being here today. It is timely to talk about the filing
+season, but also to go over some of these budget issues with
+regard to 2005. I will say that, as I read this, your budget
+request this year is a 4.8-percent increase over the enacted
+amount from 2004.
+ Mr. EVERSON. Correct.
+ Mr. PORTMAN. This is a substantial increase. I just did the
+math, which may be wrong, but it seems to me that from 2002 to
+now we have a 13.5-percent increase during this Administration.
+I sometimes fight for more than that, as do my two colleagues
+on the left. They happen to be to my left right now.
+ [Laughter.]
+ We have had substantial increases at a time when, frankly,
+we are looking at practically a freeze in your budget for the
+non-defense and non-homeland security domestic discretionary
+spending, and so I am pleased that we had the 4.8 percent. I
+appreciate your comment that a lot of this is about allocation.
+In fact, when I look--and I know Ms. Killefer is going to
+testify later, and I look forward to her testimony, although I
+need to run out to another meeting, and I will try to come
+back--but Congress has funded, since 1998, all but about 1
+percent of what the IRS has requested, and we have increased
+funding every year. Again, I would like to see more sometimes.
+There is a sense out there somehow that Congress has cut
+funding. We have not.
+ There have been allocation of those resources, as you say,
+during the restructuring more toward customer service and less
+toward enforcement, and I think that is now being corrected,
+and I think appropriately so. I couldn't agree with you more
+that they are not inconsistent with one another. I will also
+say that we were 2.6-percent below the request from the
+Oversight Board in the past 3 years.
+ This year, it looks like we will be more below, but I think
+that request is about 5 percent above yours. So, these are not
+big numbers as compared to the overall budget, and although I
+would like to see more funding into enforcement, I think it
+would be wrong to leave the impression that somehow Congress
+has been reducing this funding. We fight for it for every year,
+and we will fight for it again this year, to be sure that the
+IRS gets additional funding which is needed. Three other quick
+questions if I could. One on simplification. You have indicated
+in your statement and elsewhere that simplification would help
+you, particularly the Sub S filings have increased. Do you have
+any advice for us, as Congress, as to how we could help you to
+enforce this Tax Code?
+ Mr. EVERSON. I think simplification is critical because
+there really are two components to compliance: One is the
+service side, and by service we mean helping taxpayers
+understand their filing obligation and facilitating their
+participation. Clearly, there is a very real drag on
+understanding obligations and on facilitating participation in
+the system that occurs from the increasing complexity of the
+Tax Code. Some people just throw up their hands, increasing
+errors that are made. So, anything that we can do on
+simplification in terms of the Tax Code is important.
+ The other point I would make is that, as you and I have
+discussed, as you add more missions to the IRS, you also put
+further stresses on the tax administration system. When you get
+a new responsibility to embed a benefits program, say, in the
+IRS, you have to devote adequate management, and technical, and
+human resource talents to achieving that new program. It makes
+it more complicated to administer the Tax Code and diverts our
+attention from other normal activities.
+ Mr. PORTMAN. Those are key points I hope we will always
+keep in mind. That is really where the Commission ended up was,
+yes, we need a change at the IRS, but ultimately the Tax Code
+itself was one of the major problems, and this Subcommittee has
+been focused on the simplification issue, but it is as to
+compliance, as you say, but also as to cost----
+ Mr. EVERSON. Yes.
+ Mr. PORTMAN. What your costs are increase. This goes to the
+next question I have, which is training. Are you putting
+adequate resources against training, and could we put more
+resources against training, which would then lead to having
+better audits, more targeted audits and perhaps less resources
+over time in enforcement?
+ Mr. EVERSON. I think we are carefully looking at our
+training, particularly in what we will need to do as we augment
+the enforcement resources, because we are not going to just
+hire several thousand more Revenue agents, Revenue officers and
+criminal investigators. We also have a very seasoned work
+force, and we are going to have a lot of turnover, particularly
+in our people who do the corporate returns or in appeals. It is
+critical, therefore, that as we add new people and as we ask
+others to step up to greater responsibility, that we do our
+training. We are trying to benchmark now against the
+corporations as to how they train their work force, but I think
+this is an area where we are going to have to devote a lot of
+attention. I do not think our plans are yet fully crystallized,
+but they need to be.
+ Mr. PORTMAN. We would like to work with you on that
+training. Final question, quickly. You talked about increased
+audits of those making over $100,000 a year. How about your
+audits of corporations, where are they, and does it concern you
+that audits are off on corporations, if I understand that to be
+the case?
+ Mr. EVERSON. I think that we will see, when we look at
+corporate audits for 2004 versus 2003, that we have arrested
+what was a decline that was much like the decline in individual
+audits. Part of the most recent decrease was really related to
+the fact that as we have worked on these abusive shelters, and
+as we have devoted more resources to promoters, we did draw
+down a bit some of the numbers of the audits we were doing. So,
+I think that this was, in fact, at least in fiscal year 2003, a
+wise decision, and it was one that was based on a risk
+assessment as to where the real problems were. I would note
+that part of the President's budget request, for instance, it
+will double audit rates for corporations between $10--and $250
+million of assets. Right now, the audit rate is about 5 percent
+or so. It will double it to 10 percent. That is an important
+step, and it is why we need the money.
+ Mr. PORTMAN. Thank you, Commissioner. Thanks for your good
+work.
+ Mr. EVERSON. Thank you.
+ Chairman HOUGHTON. Mr. Ryan?
+ Mr. RYAN. Thank you, Mr. Chairman. Thank you, Mr. Everson,
+for being here. I have two very specific questions. My first
+question is in regard to child tax credit overpayments as a
+result of the child tax credit advance payments that were sent
+out last year. I can go through the whole scenario, but the
+sense basically where you have divorced couples, you have this
+anomaly where they take every other year, they claim their
+children as a dependent. So, what you had in this last year,
+with an advance payment on the child tax credit, was in 2002
+spouse, ex-spouse claimed the dependent, and in 2003 they got
+the advance payment. Whereas, the other spouse takes the credit
+of the child as a dependent in 2003, and according to your
+rules, it is my understanding, they will get the full tax
+credit. What is the estimate of the difference? It is also my
+understanding that you will not claw back or require a
+repayment from the other spouse who doesn't legitimately claim
+the dependent in 2003. What is the measurement of those
+overpayments of child tax credits?
+ Mr. EVERSON. I am going to have to supply----
+ Mr. RYAN. Could you look into that for me.
+ Mr. EVERSON. Supply that for you for the record. I will say
+this, that----
+ Mr. RYAN. I just wanted to make sure I was clear on how I--
+--
+ Mr. EVERSON. I think that is a question I cannot answer
+directly. I will say this, that the most common problem we have
+seen so far in the filing season is accounting correctly for
+the child credit. It accounts for about two-thirds of the
+errors that we are seeing. We automatically correct for the
+calculation, but I am not sure that our corrections would run
+to the matching that you are talking about in this instance.
+ Mr. RYAN. Let me just make sure I can clarify your policy,
+which is you will not require a repayment by a spouse who gets
+the advance credit from having their child as a dependent on
+2002, even though, in 2003, they will not have that person as a
+dependent, and you will give that 2003 parent who claims them
+that year as a dependent the full tax credit; is that correct?
+ Mr. EVERSON. I want to make sure that I have a correct
+understanding of that. We will give you a complete answer to
+that.
+ Mr. RYAN. If you could, and I would like to just see an
+estimate if I could.
+ Mr. EVERSON. Certainly.
+ Mr. RYAN. My second question is with the The Federal Tax
+Refund Offset Program (TOPS) program. It allows government
+agencies to submit to the IRS claims for delinquent debts up to
+10 years old. The State of Wisconsin is currently participating
+in this, and it is for the purpose of recovering State-owed
+debts. Right now, local municipalities are not permitted to
+participate in the TOPS program to include debts owed to local
+and municipal agencies. Do you believe that the current system
+could accommodate local municipalities to participate in TOPS?
+If not, what would your position be on allowing them to do so?
+ Mr. EVERSON. I am going to want to take a look at this
+because we are working very actively with the States in a whole
+variety of ways. You may know recently we signed an agreement,
+and we are implementing it, cooperating with 46 different
+States on the abusive tax shelter transactions.
+ Mr. RYAN. Right.
+ Mr. EVERSON. We are working everywhere we can to help the
+States. As to whether there is additional capacity in this
+question, I will come back to you on that.
+ Mr. RYAN. Could you get back to me in writing.
+Specifically, you will find, as you look into this, that a lot
+of States already have agreements with the State government,
+where their local municipalities and counties can work together
+to reclaim debts. Does the current statute allow you to give
+that same participation that you are giving right now to States
+to municipalities and county governments or does it not, and
+what is your position if it does?
+ Mr. EVERSON. I will take a look at that and make sure we
+come back to you.
+ Mr. RYAN. That would be great. Thank you.
+ Mr. EVERSON. Thank you, sir.
+ Chairman HOUGHTON. Thanks, Mr. Ryan. Mr. Johnson?
+ Mr. JOHNSON. Thank you, Mr. Chairman. Good evening.
+ Mr. EVERSON. Good afternoon.
+ Mr. JOHNSON. Glad to see you. Let me ask you a technical
+question, if I might. Is there ever a time when you would have
+tax people walk up to somebody's door unannounced?
+ Mr. EVERSON. Unannounced, in the sense of just launching an
+audit or a criminal investigation?
+ Mr. JOHNSON. I am a guy in a house, and I am sort of, I
+have got a case in mind, and I will talk to you about it
+privately, but where the wife is at home, in a residential
+area, good housing, and two people walk up to the door and say,
+``You did not file your tax returns.''
+ Mr. EVERSON. I do not think that is our normal procedure.
+What we would tend to do is contact someone, initially by a
+letter, indicating that we would like to--we are initiating an
+audit. We do audits that are either correspondence audits,
+which is a big block of the work, or else field audits, where
+we would visit a taxpayer.
+ Mr. JOHNSON. Yes, but not without notice.
+ Mr. EVERSON. I would imagine that this was an exceptional
+circumstance. I would like to understand what the circumstances
+were.
+ Mr. JOHNSON. Well, you are not denying that it never
+happens, then.
+ Mr. EVERSON. I do not know that it has happened, but you
+seem to know more than I do about a specific case, so----
+ Mr. JOHNSON. No, I am trying to solve the problem, if I
+could.
+ Mr. EVERSON. Right.
+ Mr. JOHNSON. If you do not have enough people, and you need
+more money, blah, blah, blah, and yet you have got people
+running out there being accusatory without first warning the
+people that they are going to, I do not think that is right.
+ Mr. EVERSON. We have, and we do follow very specifically,
+procedures that were put into place about notices on
+collections, and there were changes in the new law, as you
+know, from 1998. If our people are violating those procedures,
+they are held accountable. So, if you could tell me about the
+case, I would be happy to take a look at it, and if there has
+been some irregularity that is improper, I will make sure that
+we deal with it.
+ Mr. JOHNSON. Well, and I know that you have people in there
+that you can talk to, too, about those sorts of things, but I
+have never encountered you being heavy-handed like that before,
+and I will talk to you separately about it. One of the
+proposals in this year's budget would make changes in 1203,
+called, ``The 10 Deadly Sins'' provision. Can you explain why
+those changes are necessary and important?
+ Mr. EVERSON. I think that if you go back to the hearings
+that took place in the mid and late nineties, clearly, I agree
+with the substance of the reforms, taken as a whole, that came
+out of RRA 98. There was a big gap between the service level
+that Americans had every right to expect of the IRS and what we
+were actually delivering or failing to deliver.
+ At the same time, I think there was a climate that was a
+difficult climate. Some charges were made against IRS employees
+which, as you would remember, were subsequently found to be
+unproven or slightly exaggerated. The folks who have worked in
+the Agency inform me that all of this had a real overhang, in
+terms of for a while a reluctance to pursue the enforcement
+activities. To some degree, that clearly contributed to the
+decline in actions. In terms of these ``deadly sins,'' I think
+that what we are trying to get at there is simply to allow more
+discretion to the Commissioner to mitigate some of these areas
+of problems if, on a balanced basis, that seems warranted. It
+doesn't make it in any way automatic. It just says that there
+should be more discretion in some cases if it is warranted.
+ Mr. JOHNSON. Thank you very much. Thank you, Mr. Chairman.
+ Chairman HOUGHTON. Thank you. Mr. Pomeroy.
+ Mr. POMEROY. Thank you, Mr. Chairman. I have been looking
+with great interest at a couple of these charts that you
+brought along. I'm wondering if you could put up the
+enforcement chart, just to show you the pattern that we have
+followed. It tracks very closely this audit history. Then,
+after that, Commissioner, if you don't mind, if you would pull
+up the exempt organizations and just give us as brief read on
+that one.
+ Mr. EVERSON. This simply says that over a period of years
+we have kept the resources stable in terms of manpower on the
+service side, the infrastructure side of the IRS. We brought
+down year after year the enforcement personnel. That red line
+is the number of revenue agents, revenue officers and criminal
+investigators. Those are the people who develop cases for
+potential prosecution by Justice. We brought that back up, and
+it will go up further with the President's 2005 request, if we
+get the funding. So, we're bringing it back up.
+ I would say it's not only about money, but it's also about
+bettering our procedures and also about prioritization, because
+it comes back to the Chairman's question on what is the effect
+of the audits. You don't only have a direct effect; you have
+the indirect effect, too. So, it's not only about augmenting
+resources. Just to zoom in on something that this Committee has
+had an interest in, which is credit counseling and sureties,
+you had a hearing when I was here last November looking at
+credit counseling organizations. The challenge, as you know,
+one of our enforcement priorities is to discourage, deter
+abuses within tax-exempt entities.
+ Mr. POMEROY. Just to refresh the audience's memory on this
+one, if I recall, now we see omnipresent debt counseling ads
+everywhere you turn. Some of the main entities involved in
+that, as we looked in the course of this hearing, basically
+operating under the guise of being nonprofits, had extremely
+highly paid founders or Presidents. It was in the millions in
+terms of wages, something that would certainly raise all kinds
+of questions about whether they are actually operating
+appropriately in a tax-exempt structure, and whether the value
+of what they offer to the consumer comports with what they say
+it does.
+ Mr. EVERSON. That's correct. In fact, I indicated last week
+that I expected, as a result of ongoing audits that we have
+underway, we will be lifting tax-exemption status for some of
+these entities and may, in fact, also end up making criminal
+referrals. So, this is a very serious area of focus for us. All
+this does is it zooms into that tax-exempt area and says that,
+over time, you had a real increase in total assets, you've had
+an increase in the returns filed, and now, after years of the
+staffing going down, we're bringing the staffing back up.
+ To show you just what has to be done here, we are also
+harnessing technology, again improving procedures. So, I would
+hasten to add that I don't expect that you need to take these
+lines up as high as the increases in the activity, but clearly,
+you can't continue on this trajectory that we've been on. We
+have arrested it and we're bringing it back up. I think you see
+from the budget request that we've got new moneys and new
+personnel coming into this tax-exempt area. This is not just
+credit counseling; this is the whole tax-exempt sector.
+ Mr. POMEROY. I would just note that I had hoped our hearing
+might have some positive effect in terms of diminishing that
+blatant and what I find to be offensive practice of their
+solicitations. It seems as though they have redoubled their
+efforts. So, I'm looking forward to this getting out of the
+private matter of internal IRS auditing and into the much more
+publicized criminal arena, because I believe many of their
+activities are criminal. If we hang one or two from the
+yardarm, maybe it will have some positive effect in terms of
+their activities in the future.
+ Mr. EVERSON. That may very well happen. What I suggested,
+Congressman, last week on the Senate side--they had a hearing
+on this, the Levin/Coleman permanent Subcommittee. As we went
+through this, I was shocked, because I found that the schemes
+of the interlocking relationships between the charity and the
+related profit-making entities, they rivaled the complexity of
+the interlocking network of reinforcing relationships that you
+see in the tax shelter area. That is all the more disturbing
+because these aren't people out there just trying to make
+money; these are folks who are supposedly serving the public
+good. Yet they have become equally sophisticated in some
+instances and equally, I would say, hardened toward their true
+mission.
+ Mr. POMEROY. I totally agree with that. A final question.
+The CRP payments to retired farmers has since the 1988 letter
+ruling largely been viewed as not subject to self-employment
+tax. A letter ruling issued in May of 2003 was written broadly
+enough so that it appears to apply now to retired farmers with
+CRP income. This would be very much unlike other rental income
+they would be receiving.
+ We learned in a meeting with IRS staff in North Dakota last
+Friday that that letter ruling was not drafted with
+contemplation of the circumstance of retired farmers. The
+result of it has been to put a big question mark on the
+shoulders of taxpayers and retired farmers alike about what to
+do with this income. Needless to say, it represents a very
+substantial new tax obligation to people living on fixed
+incomes, especially when they all had available the option of
+renting the land in the first place, which would carry no self-
+employment tax.
+ I will hand you a copy and put into the record a treatise
+by Dr. Neil Harl, who is a tax expert operating out of Iowa, on
+the question of the tax status of this income for retired
+farmers. He recommends withdrawal of the letter ruling of 2003,
+sorting this out in a more comprehensive way and dealing with
+it going forward, based on a more comprehensive resolution but
+lifting the cloud that affects this tax filing season.
+ [The information follows:]
+
+ Self-employment Tax Aspects of the Conservation Reserve Program* by
+ Neil E. Harl**
+
+ I. The Food Security Act 1985 instituted a 10-year conservation
+reserve program (CRP) under which the Secretary of Agriculture entered
+into contracts with owners and operators of highly erodible cropland to
+take such cropland out of crop production and place it in conservation
+and soil and water improving use in exchange for payments of cash and
+commodities. 16 U.S.C. 3831, added by Pub. L. No. 99-198, Sec. 1231,
+99 Stat. 1508 (1985). Final regulations were issued in 1987
+implementing the program. 7 C.F.R. Pt. 704, 52 Fed. Reg. 4,269 (1987).
+---------------------------------------------------------------------------
+ * Presented at a conference, Washington, D.C., sponsored by Cong.
+Earl Pomeroy, June 8, 2004.
+ **Charles F. Curtis Distinguished Professor in Agriculture and
+Emeritus Professor of Economics, Iowa State University, Ames, Iowa;
+Member of the Iowa Bar.
+---------------------------------------------------------------------------
+ II. The self-employment tax treatment of CRP payments
+
+ A. Initially, tax practitioners relied on prior authority drawn
+from other settings. E.g., Rev. Rul. 60-32, 1960-1 C.B. 23 (payments
+under soil bank program includible as self-employment income of owner-
+operator).
+ B. The Associate Chief Counsel, Technical, of IRS, stated in 1987,
+that where the farm operator or owner is materially participating in
+the farm operation, CRP payments constitute receipts from farm
+operations includible in net earnings from self-employment. Letter from
+Peter K. Scott, Associate Chief Counsel, Technical, March 10, 1987. The
+Commissioner of Social Security agreed.
+ C. In 1988, the Internal Revenue Service, in a letter ruling,
+indicated that, for a retired taxpayer who is not materially
+participating, payments received under the federal Conservation Reserve
+Program would not be considered net income from self-employment. Ltr.
+Rul. 8822064, March 7, 1988 (no tenant involved; landowner's activities
+under CRP did not constitute material participation).
+ D. In a 1996 Tax Court case, Ray v. Commissioner, T.C. Memo. 1996-
+436, the Tax Court held that, for taxpayers who materially participate
+in the operation, CRP payments are to be reported as self-employment
+income if the CRP land had a ``direct nexus'' with the farming
+business. The Tax Court found that a direct nexus in that case existed
+where the CRP land was in the same general vicinity as the farming
+operation, the CRP seeding was maintained with equipment used in the
+farming operation and the farmer admitted that, at the termination of
+the CRP contract, the land involved would be used in the farm business.
+ E. A 1996 letter ruling involving a husband and wife as directors
+and officers of a family ranch corporation held that they had
+materially participated in the overall operation. Ltr. Rul. 9637004,
+May 1, 1996.
+ F. In 1998, the Tax Court held that CRP payments were ``rents''
+and, therefore, not subject to self-employment tax by virtue of I.R.C.
+ 1402(a)(1). Wuebker v. Commissioner, 110 T.C. 431 (1998). The Tax
+Court said the primary purpose of the CRP contract was to achieve
+specified environmental benefits by converting highly erodible cropland
+to soil conserving use. Thus, the contract payments represented
+compensation from the use restrictions on the land rather than
+remuneration for the taxpayer's labor. However, that case was reversed
+on appeal in 2000 by the Sixth Circuit Court of Appeal. Commissioner v.
+Wuebker, 205 F.3d 897 (6th Cir. 2000).
+ G. Legislation was first introduced in April of 2000 to treat CRP
+payments as rent for self-employment tax purposes and reintroduced in
+2001 and 2003. S. 2422, S. 2344, H.R. 4212, 106th Cong., 2d Sess.
+(2000); S. 315, 107th Cong., 1st Sess. (2001); S. 665, S. 1316, 108th
+Cong., 1st Sess. (2003).
+ H. In a Chief Counsel's Letter Ruling dated May 29, 2003, IRS took
+the position that a landowner's activities under a CRP contract
+amounted to material participation and the payments should be reported
+on Schedule F, not Schedule E or Form 4835. CCA Ltr. Rul. 200325002,
+May 29, 2003I. The letter ruling did not except retired landowners
+(taxpayer B is an individual not engaged in the trade or business of
+farming) and so the 2003 CCA Letter Ruling was counter to Ltr. Rul.
+8822064, March 7, 1988.
+ The text of the CCA Letter Ruling, CCA Ltr. Rul. 200325002, May 29,
+2003, is included in full in Appendix A hereto.
+
+ III. In summary, before the issuance of CCA Ltr. Rul. 200325002,
+May 29, 2003, landowners could be separated into four categories with
+respect to liability for SE tax on CRP payments.
+ A. Landowners who were retired when the land was bid into CRP and
+were not materially participating in retirement were not liable for SE
+tax on the CRP payments. Ltr. Rul. 8822064, March 7, 1988.
+ B. For landowners who were not carrying on the trade or business of
+farming and there was no direct nexus between the CRP land and a
+farming business (or landowners who were carrying on the trade or
+business of farming but there was no direct nexus between the CRP land
+and the farming business), the landowner was not liable for SE tax on
+the CRP payments. See Ray v. Commissioner, T.C. Memo. 1996-436.
+ C. For landowners who were carrying on the trade or business of
+farming and there was a direct nexus between the CRP land and a farming
+business, the individual or individuals were liable for SE tax on the
+CRP payments.
+ D. For landowners who retired after the land was bid into the CRP
+program, and who were liable for SE tax on CRP payments before
+retirement, there were conflicting authorities>
+ 1. Some authorities have focused on the taxpayer's status at the
+time the agreement was entered into and that status prevailed for the
+duration of the contract. Notice 87-26, 1987-1 C.B. 470 (dairy
+termination payments); Rev. Rul. 60-32, 1960-1 C.B. 23 (soil bank
+payments).
+ 2. Other authorities suggested that it is the taxpayer's status at
+the time payment is received that determines liability for SE tax. Soc.
+Sec. Rul. 67-42 (cropland adjustment income; dictum).
+ IV. Recommendations
+ A. Withdrawal of CCA Ltr. Rul. 200325002, May 29, 2003, or
+reissuance with a narrowing of the ruling to harmonize with Ltr. Rul.
+8822064, March 7, 1988, would remove much of the current confusion.
+ B. The CCA Ltr. Rul. seems to apply to all Federal conservation
+programs also. It would be helpful to know whether that was intended.
+ C. Guidance on the matter of SE tax liability for those who retire
+during the term of the CRP contract would be helpful.
+
+ APPENDIX A
+
+ CCA Ltr. Rul. 200325002, May 29, 2003.
+ TO: Virginia E. Cochran, Deputy Area Counsel (Great Lakes & Gulf
+Coast Area), Office of Division Counsel/Associate Chief Counsel (Tax
+Exempt & Government Entities), CC:TEGE:GLGC:DAL
+ FROM: Michael A. Swim, Senior Technician Reviewer, Employment Tax
+Branch 1, Office of Division Counsel/Associate Chief Counsel (Tax
+Exempt & Government Entities), CC:TEGE:EOEG:ET1
+ SUBJECT: Conservation Reserve Program & SECA
+ This Chief Counsel Advice responds to your request for advice
+regarding the Conservation Reserve Program (CRP) of the United States
+Department of Agriculture (USDA) and Self-Employment Contributions Act
+(SECA) tax. In accordance with section 6110(k)(3) of the Internal
+Revenue Code, this Chief Counsel Advice should not be cited as
+precedent.
+
+ISSUES
+ 1. Whether annual ``rental'' payments received by Taxpayer A, who
+is an individual, for land enrolled in the CRP constitute self-
+employment income to Taxpayer A that is subject to SECA tax where
+Taxpayer A was engaged in the trade or business of farming prior to
+enrolling the land in the CRP and Taxpayer A personally fulfilled her
+CRP contractual obligations.
+ 2. Whether annual ``rental'' payments received by Taxpayer B, who
+is an individual, for newly acquired land, that had been enrolled in
+the CRP by the land's previous owner and the enrollment is continued by
+the Taxpayer B, constitute self-employment income to Taxpayer B subject
+to SECA tax where Taxpayer B was not engaged in the trade or business
+of farming prior to acquiring the land but Taxpayer B personally
+fulfilled his CRP contractual obligations.
+ 3. Whether the annual ``rental'' payments respectively received by
+Taxpayer A and Taxpayer B under the CRP should be reported (i) on
+Schedule F (Form 1040), Profit or Loss from Farming, as farming income
+from a trade or business, (ii) on a Schedule E (Form 1040),
+Supplemental Income and Loss, as rental income from real estate, or
+(iii) on a Form 4835, Farm Rental Income and Expenses, as rental income
+from crop or livestock production.
+
+CONCLUSIONS
+ 1. The annual ``rental'' payments received by Taxpayer A for land
+enrolled in the CRP constitute self-employment income to Taxpayer A
+that is subject to SECA tax where Taxpayer A was engaged in the trade
+or business of farming prior to enrolling the land in the CRP and
+Taxpayer A personally fulfilled her CRP contractual obligations.
+ 2. The annual ``rental'' payments received by Taxpayer B for newly
+acquired land, that had been enrolled in the CRP by the land's previous
+owner and the enrollment is continued by Taxpayer B, constitute self-
+employment income to Taxpayer B subject to SECA tax where Taxpayer B
+was not engaged in the trade or business of farming prior to acquiring
+the land but Taxpayer B personally fulfilled his CRP contractual
+obligations.
+ 3. The annual ``rental'' payments respectively received by Taxpayer
+A and Taxpayer B under the CRP constitute self-employment income to the
+recipient taxpayer that is subject to SECA tax and is not rental income
+that is excludible under the rentals-for-real-estate exclusion. The
+respective payments received by each recipient taxpayer must be
+reported on a Schedule F and Schedule SE (Form 1040), Self-Employment
+Tax, filed by that taxpayer with that taxpayer's Form 1040, U.S.
+Individual Income Tax Return. The use of Schedule E or Form 4835 is not
+allowed.
+
+FACTS
+ The CRP, 16 U.S.C. 3801, 3831-36, is a USDA voluntary
+conservation reserve program under which land is enrolled through the
+use of contracts. The program generally assists owners and operators of
+land to conserve and improve the soil, water, and wildlife resources of
+such land. The CRP offers, among other things, annual ``rental''
+payments to owners and operators for converting highly erodible
+cropland normally devoted to the production of an agricultural
+commodity to less intensive use. In general, the durations of contracts
+are from 10 to 15 years. The Farm Security and Rural Investment Act of
+2002, Pub. L. No. 107-171, provides that up to 39.2 million acres can
+be enrolled in CRP at any one time during the 2002 through 2007
+calendar years.
+ No specific taxpayer or detailed factual situation was provided in
+regards to the requested advice. Accordingly, we address two
+hypothetical situations.
+ Taxpayer A was a farmer who owned highly erodible cropland. After
+planting crops on the land for 6 years, Taxpayer A decided to enroll
+Taxpayer A's cropland into the CRP and entered into a CRP contract with
+the USDA.
+ Under the CRP contract, Taxpayer A agreed to certain terms and
+conditions as to the cropland under contract. Among the terms and
+conditions, Taxpayer A Agreed to: (1) implement a conservation plan for
+converting the land normally devoted to the production of an
+agricultural commodity on the farm to a less intensive use, such as
+pasture, permanent grass, legumes, shrubs, or trees; (2) not to use the
+land for agricultural purposes except as permitted by the USDA; (3)
+establish approved vegetative cover or maintain existing cover on the
+land; and (4) not engage in or allow grazing, harvesting, or other
+commercial use of the land, except with USDA's permission (e.g.,
+harvesting and grazing in response to a drought or other emergency).
+ Taxpayer B purchased highly erodible cropland that had been
+enrolled in the CRP by its previous owner. As the new owner, Taxpayer B
+executed an agreement to continue and assume all obligations of the CRP
+contract under the same terms and conditions as the original owner.
+These terms and conditions were identical to those in Taxpayer A's CRP
+contract. Taxpayer B was not engaged in the trade or business of
+farming prior to acquiring the cropland that was and continues to be
+subject to a CRP contract.
+ Taxpayer A and Taxpayer B each personally fulfilled their duties
+under their respective CRP contracts and received annual ``rental''
+payments. Neither Taxpayer A nor Taxpayer B disputed the taxability of
+the CRP payments as includible in gross income under section 61.
+However, both taxpayers reported the payments as rental income not
+subject to SECA tax. Taxpayer A reported the amounts received as rental
+income from real estate on Schedule E. Taxpayer B reported the amounts
+as rental income from farm production and crop shares on Form 4835.
+
+LAW AND ANALYSIS
+ Section 1401 imposes SECA tax on the self-employment income of
+every individual. SECA tax consists of the Old-Age, Survivors and
+Disability Insurance tax (OASDI tax which is commonly referred to as
+Social Security tax) and the Hospital Insurance tax (HI tax which is
+commonly referred to as Medicare tax).
+ Section 1402(b), in pertinent part, defines ``self-employment
+income'' as the net earnings from self-employment derived by an
+individual (other than a nonresident alien individual, except as
+provided by an agreement under section 233 of the Social Security Act)
+during any taxable year; except that such term shall not include:
+ (1) in the case of the OASDI tax imposed by section 1401(a), that
+part of the net earnings from self-employment which is in excess of (i)
+an amount equal to the contribution and benefit base (as determined
+under section 230 of the Social Security Act) which is effective for
+the calendar year in which such taxable year begins, minus (ii) the
+amount of the wages paid to such individual during such taxable years;
+or
+ (2) the net earnings from self-employment, if such net earnings for
+the taxable year are less than $400.
+ Section 1402(a) defines the term ``net earnings from self-
+employment'' as the gross income derived by an individual from any
+trade or business carried on by such individual, less the deductions
+allowed by subtitle A which are attributable to such trade or business,
+plus the individual's distributive share (whether or not distributed)
+of income or loss described in section 702(a)(8) from any trade or
+business carried on by a partnership of which the individual is a
+member, with certain enumerated exceptions.
+ Section 1402(a)(1) generally excludes from the computation of ``net
+earnings from self-employment'' rentals from real estate and from
+personal property leased with the real estate (including such rentals
+paid in crop shares) together with the deductions attributable thereto,
+unless such rentals are received in the course of a trade or business
+as a real estate dealer, with an exception. Under this exception, any
+income derived by the owner or tenant of land must be included in the
+computation of ``net earnings from self-employment'' if:
+ (A) such income is derived under an arrangement, between the owner
+or tenant and another individual, which provides that such other
+individual shall produce agricultural or horticultural commodities
+(including livestock, bees, poultry, and fur-bearing animals and
+wildlife) on such land, and that there shall be material participation
+by the owner or tenant (as determined without regard to any activities
+of an agent of such owner or tenant) in the production or the
+management of the production of such agricultural or horticultural
+commodities, and
+ (B) there is material participation by the owner or tenant (as
+determined without regard to any activities of an agent of such owner
+or tenant) with respect to any such agricultural or horticultural
+commodity.
+ See also, Income Tax Reg. 1.1402(a)-4.
+ Section 1402(c) provides that the term ``trade or business'' when
+used with reference to self-employment income or net earnings from
+self-employment shall have the same meaning as when used in section 162
+(relating to trade or business expenses), with certain enumerated
+exceptions. In order for an individual to have net earnings from self-
+employment, the individual must carry on a trade or business, either as
+an individual or as a member of a partnership. Whether or not the
+individual is engaged in carrying on a trade or business will be
+dependent upon all of the facts and circumstances in the particular
+case. See also, Income Tax Reg. 1.1402(c)-1.
+ In considering whether an individual is engaged in a trade or
+business, the U.S. Supreme Court has stated that ``to be engaged in a
+trade or business, the taxpayer must be involved in the activity with
+continuity and regularity and that the taxpayer's primary purpose for
+engaging in the activity must be for income or profit. A sporadic
+activity--does not qualify.'' Commissioner v. Groetzinger, 480 U.S. 23,
+35 (1987) [87-1 USTC 9191]. The question of whether a taxpayer is
+engaged in a trade or business requires an examination of the relevant
+facts in each case. Id. at 36.
+ In order for income received by an individual to be taxable as
+self-employment income, not only must the income in question derive
+from a trade or business carried on by the individual, but there must
+be a nexus between the income and the trade or business. Newberry v.
+Commissioner, 76 T.C. 441, 444 (1981) [CCH Dec. 37,756]. The income
+``must arise from some actual (whether present, past, or future)
+income-producing activity of the taxpayer.'' Id. at 446.
+ In determining what income is includible in self-employment income,
+sections 1401 and 1402 are to be broadly construed to favor coverage
+for Social Security purposes. Braddock v. Commissioner, 95 T.C. 639,
+644 (1990) [CCH Dec. 47,046]. In order to achieve this end, the rental
+exclusion under section 1402(a)(1) is ``narrowly construed.'' Johnson
+v. Commissioner, 60 T.C. 829, 833 (1973) [CCH Dec. 32,117], see also
+Delno v. Celebrezze, 347 F.2d 159, 165 (9th Cir. 1965) (noting that a
+parallel provision of the Social Security Act relates Congress'
+specific intent for the ``rental exclusion to be narrowly restricted to
+payments for occupancy only'').
+ In Wuebker v. Commissioner, 205 F.3d 897 (6th Cir. 2000) [2000-1
+USTC 50,254], the Sixth Circuit reversed a Tax Court decision that
+CRP payments received by Frederick and Ruth Wuebker (taxpayers) were
+excludible from their self-employment income as rentals from real
+estate. The Sixth Circuit held that CRP payments received by a farmer
+in exchange for the farmer's implementation of a conservation plan were
+includible in self-employment income from the trade or business of
+farming that were subject to SECA tax pursuant to section 1401.
+ In Wuebker, the taxpayers had been farming for approximately twenty
+years when they enrolled a portion of their farmland into the CRP. The
+Sixth Circuit held that because the taxpayers were ``engaged in the
+business of farming prior to and during the term of their CRP
+contract'' and their ``agreement . . . required them to perform several
+ongoing tasks with respect to the land enrolled in the CRP, the very
+land they already owned and had previously farmed,'' the CRP payments
+``were `in connection with' and had a `direct nexus to' their ongoing
+trade or business.'' Id. at 902. The Sixth Circuit noted that the
+taxpayers were required under the CRP contract to perform tasks that
+are intrinsic to the farming trade or business (e.g., tilling, seeding,
+fertilizing, and weed control) that required the use of their farming
+equipment. Id. at 903.
+ The Sixth Circuit found that the taxpayers' contention that their
+involvement with the CRP land was insufficient to constitute ``material
+participation'' within the meaning of section 1402(a)(1) had no bearing
+on whether the CRP payments constituted rentals from real estate. The
+issue of material participation arises only when there is an
+arrangement between an owner or tenant and another individual whereby
+the other individual is to produce agricultural or horticultural
+commodities on the land. No such arrangement was present in Wuebker.
+ In addition, because of the narrow construction required of the
+exclusion for rentals from real estate, the Sixth Circuit held that the
+CRP payments were not true rental payments for the use or occupancy of
+property. The essence of the CRP program is to prevent participants
+from farming of the property and to require the participants to perform
+various activities in connection with the land continuously throughout
+the life of the contract with the government's access limited to
+inspection. Id. at 904. Furthermore, the Sixth Circuit looked to the
+``substance, rather than the form, of the transaction'' \1\ in
+determining that the income derived from the CRP contract is includible
+in self-employment income earned in lieu of farm income, for which SECA
+tax was due.
+---------------------------------------------------------------------------
+ \1\ Although the CRP contract referred to the payments as annual
+``rental'' payments, such reference does not compel the conclusion that
+they should fall within the rentals-from-real estate conclusion.
+Wuebker 904; citing Cline v. Commissioner, 617 F.2d 192, 195 (6th Cir.
+1980) [80-1 USTC 9315] (``Courts must look to the substance, rather
+than the form, of the transactions--'').
+---------------------------------------------------------------------------
+ The CRP payments are not excludible per se as rentals from real
+estate. Rent is defined as ``consideration paid--for the use or
+occupancy of property (esp. real property).'' Id. at 904 citing Black's
+Law Dictionary 1299 (7th ed. 1999). Under a CRP contract, the USDA does
+not obtain the right to ``occupy'' the land enrolled in the CRP. The
+government's access is limited to inspecting the property and
+determining whether the recipients of the CRP payments are in
+compliance with the CRP contract. See id. at 904.
+ In Hasbrouck v. Commissioner, T.C. Memo. 1998-249 [CCH Dec.
+52,783(M)], taxpayers purchased land that had already been enrolled in
+the CRP. The taxpayers, who fulfilled their obligations under the terms
+and conditions of the CRP contract, considered themselves engaged in
+the trade or business of farming and reported their CRP income and
+expenses on Schedule F. Prior to the purchase, the taxpayers were not
+engaged in the trade or business of farming. The Service initially
+reclassified the income and expenses as rentals from real estate on the
+basis that the taxpayers were not engaged in the trade or business of
+farming when they acquired the land. The Service, however, following
+the decision in Ray v. Commissioner, T.C. Memo 1996-436 [CCH Dec.
+51,573(M)], reconsidered its position, and conceded the case.
+ In Ray, the Tax Court found that payments received under a CRP
+contract were includible in self-employment income. In this case, the
+taxpayers were engaged in the business of farming and cattle grazing
+and had acquired additional land that had been previously enrolled in
+the CRP. The Tax Court held that there was a sufficient nexus between
+the CRP payments received and the taxpayer's trade or business of
+farming to support the finding that the payments were includible in
+self-employment income subject to SECA tax.
+ In Rev. Rul. 60-32, 1960-1 C.B. 23, the Service held that annual
+payments received under the Soil Bank Act \2\, an earlier acreage
+reserve program of the USDA, were includible in determining the
+recipient's net earnings from self-employment, if the recipient
+operated his farm personally or through agents or employees. The
+Service reasoned that the payments were in the nature of receipts from
+farm operations in that they replaced income which producers could have
+expected to realize from the normal use of the land devoted to the
+program. This was also true if the recipient's farm was operated by
+others and he participated materially in the production of commodities,
+or management of such production, within the meaning of section
+1402(a)(1). However, if the recipient did not so operate or materially
+participate, payments received were not to be included in determining
+net earnings from self-employment.
+---------------------------------------------------------------------------
+ \2\ Soil Bank Act, Title I of the Agricultural Act 1956, 7 U.S.C.
+1801-37 (repealed 1965). Under 103(a) of the Act, the Secretary of
+Agriculture is authorized and directed to carry out an acreage reserve
+program from the crops of specified commodities. Producers
+participating in the program are compensated for reducing their acreage
+of a commodity below their farm acreage allotments or their farm base
+acreage, whichever may be applicable. Producers must enter into a
+contract where they agree to perform various activities in connection
+with the land.
+---------------------------------------------------------------------------
+ In Rev. Rul. 65-149, 1965-1 C.B. 434, the Service addressed whether
+grain storage fees paid to a farm operator under the price support loan
+program of the Commodity Credit Corporation are to be regarded as
+attributable to the operator's trade or business of farming and
+considered in computing the operator's self-employment income. The
+Service argued that income derived from the operation of a farm,
+regardless of the form of the income (cash sales, Commodity Credit
+Corporation loans, government subsidies, including soil bank payments,
+conservation reserve payments, and so forth.), should be treated in a
+manner consistent with the position set forth in Rev. Rul. 60-32. That
+is to say, if this income is received by a farm operator, or a landlord
+who materially participates, it should be treated as self-employment
+income. If it is received by a landlord who does not materially
+participate, it should be treated as rental income and excluded from
+net earnings from self-employment.
+ More recently, in Announcement 83-43, 1983-10 I.R.B. 29, the
+Service concluded that if a farmer participates in the Payment-in-Kind
+(PIK), or any other land diversion program sponsored by the USDA, and
+receives cash or a payment in kind from the USDA with respect to the
+diverted acres, the farmer is liable for SECA tax on the cash or
+payment in kind received. The announcement further provided that, for
+estate tax purposes (sections 2032A and 6166), land diverted from the
+production of an agricultural commodity under a USDA land diversion
+program will be treated as being used as a farm for farming purposes
+and in the active conduct of a farming business.
+ Furthermore, participation in a USDA land diversion program and in
+the devotion of such land to conservation purposes under such programs
+will be treated as material participation in the operation of a farm
+with respect to the diverted acres.
+ As to reporting requirements, section 6017 provides that every
+individual (other than a nonresident alien) having net earnings from
+self-employment of $400 or more for the taxable year shall make a
+return with respect to SECA tax. Income Tax Reg. 1.6017-1(a)(2)
+provides that the return required by section 6017 for SECA tax shall be
+Form 1040.
+ Schedule SE is the form used to report net earning from self-
+employment and SECA tax. See 2002 Instructions for Schedule SE, Self-
+Employment Tax.
+ Schedule F is the form used to report farm income and expenses. See
+2002 Instructions for Schedule F, Profit or Loss From Farming.
+ Schedule E is the form used to report income and expenses for
+rentals of real estate (including personal property leased with real
+estate) and royalty income and expenses. See 2002 Instructions for
+Schedule E, Supplemental Income and Loss.
+ Form 4835 is the form used by landlords or sub-lessors to report
+farm rental income and expenses based on the crops or livestock
+produced by the tenant where the landlord or sub-lessor did not
+materially participate (for SECA tax purposes) in the operation or
+management of the farm. The use of Form 4835 only applies to those
+circumstances where there is an arrangement between an owner or tenant
+and another individual whereby the other individual is to produce
+agricultural or horticultural commodities on the land. See General
+Instructions for Form 4835.
+ In each case, the annual ``rental'' payments that Taxpayer A and
+Taxpayer B individually receive for land enrolled in the CRP are in the
+nature of receipts from farm operations earned in lieu of income that
+each taxpayer could have expected to realize from the normal use of
+their respective cropland, if they had not enrolled the cropland in the
+CRP. See Rev. Rul. 60-32.
+ Pursuant to the terms of the CRP contract, each taxpayer is
+required to engage in soil conservation practices, to establish or
+maintain approved vegetative cover on the cropland, to not use the land
+for agricultural purposes except as permitted by USDA, and to not
+conduct any harvesting or grazing on the cropland. The income is
+derived from the income-producing activity of the taxpayers in
+performing under the CRP contract. The CRP contracts require Taxpayer A
+and Taxpayer B to perform tasks that are intrinsic to the farming trade
+or business. The fact that Taxpayer A was previously engaged in the
+trade or business of farming prior to enrolling Taxpayer A's land in
+the CRP is an additional fact that helps establish that Taxpayer A is
+continuing to be engaged in the trade or business of farming. However,
+Taxpayer B, who was not engaged in farming prior to the purchase of
+land subject to a CRP contract, becomes engaged in trade or business of
+farming in personally fulfilling Taxpayer B's obligations under the
+terms and conditions of the CRP contract. See Hasbrouck. As long as
+Taxpayer A and Taxpayer B are actively fulfilling their respective
+obligations under their respective CRP contracts, they will both
+individually be considered to be engaged in the trade or business of
+farming.
+ The CRP payments are in connection with and have a direct nexus to
+the taxpayer's ongoing business of farming. See Wuebker; see also Ray.
+ Although the payments are labeled as ``rental'' payments for
+purposes of the CRP, the narrow-construction placed on the section
+1402(a)(1) exclusion for rentals from real estate eliminates these
+payments from its provisions. See Wuebker. Further, under our facts,
+neither Taxpayer A nor Taxpayer B leased the land to a third party,
+such as another individual, on a rental basis. Thus, the test regarding
+material participation by the owner of rented land to a third party is
+irrelevant.\3\
+---------------------------------------------------------------------------
+ \3\ Under the rentals-from-real estate exception, the owner of a
+farm operated on a rental basis must include the rental income in
+determining net earnings if (1) such income is derived under an
+arrangement between the owner and another individual which provides
+that there be material participation by the owner in the production or
+the management of the production of such commodities, and (2) there is
+material participation by the owner with respect to such commodity.
+---------------------------------------------------------------------------
+ The income derived from the CRP contract is includible in self-
+employment income subject to SECA tax. Taxpayer A must report the CRP
+payments as self-employment income from farming subject to SECA tax.
+Similarly, Taxpayer B must report the CRP payments as self-employment
+income from farming subject to SECA tax.
+ After having concluded that CRP payments are includible in self-
+employment income from farming, such CRP payments should be reported on
+Schedule F, filed with Form 1040. See Pub 225, Farmer's Tax Guide; and
+Instructions for Schedule F; Cf. Hasbrouck. Any profit or loss from
+farming should then be reported on a Schedule SE for SECA tax purposes
+pursuant to form instructions. See 2002 Instructions for Schedule F,
+Profit or Loss From Farming.
+ CRP payments are not considered rental income from real estate nor
+are they rental income from farm production or crop shares.\4\
+Accordingly, the use of Schedule E or Form 4835, under our facts, is
+not allowed.
+---------------------------------------------------------------------------
+ \4\ An arrangement for the production of agriculture or
+horticulture commodities is not present under the CRP contract for
+either Taxpayer A or Taxpayer B.
+---------------------------------------------------------------------------
+CASE DEVELOPMENT, HAZARDS AND OTHER CONSIDERATIONS
+ This memorandum does not address cost-share assistance.
+ This writing may contain privileged information. Any unauthorized
+disclosure of this writing may have an adverse effect on privileges,
+such as the attorney client privilege. If disclosure becomes necessary,
+please contact this office for our views.
+ Please call if you have any further questions.
+
+ APPENDIX B
+
+Ltr. Rul. 8822064, March 7, 1988.
+ ______
+
+ Under the Food Security Act 1985, the Secretary of Agriculture
+instituted a 10-year conservation acreage reserve program under which
+the Secretary enters into contracts with owners and operators of highly
+erodible cropland to take the cropland out of production of intertilled
+crops and place the land in conservation and soil and water conserving
+uses. Those bidding their lands into a CRP program are compensated on a
+pre-acre basis in cash or, occasionally, commodities. Not more than 25
+percent of the acreage in a county may be placed in the reserve, unless
+the Secretary of Agriculture determines that additional acres in the
+program in that county will not affect adversely the local economy.
+ Approximately 34 million acres are presently enrolled in the CRP
+program. Periodically, the Secretary of Agriculture announces that, for
+a designated time, owners wanting to enroll land in the Conservation
+Reserve Program can make an offer in bid form to idle the land in
+exchange for the bid price per acre. In accepting bids, the Secretary
+of Agriculture is to take into consideration the extent of erosion on
+and the productivity of the land involved; accept offers that provide
+for permanently vegetated stream borders and filter strips; establish
+criteria for different regions of the country; and give priority to
+owners and operators under the greatest economic stress.
+ The amount of rental payments made to a ``person'' may not exceed
+$50,000 per year, which is in addition to payments that can be received
+under any other agricultural commodity program.
+ Under a CRP contract, the owner or operator must agree to:
+
+ 1. implement a plan approved by the local conservation district
+to convert highly erodible crop land to less intensive use, including
+pasture, grass, legumes, forbs, shrubs or trees;
+ 2. place the highly erodible land specified in the contract in
+reserve so as not to be used for agricultural purposes except as
+permitted by the Secretary of Agriculture;
+ 3. establish vegetative cover on the land;
+ 4. forfeit all rights to rental and cost sharing payments and
+refund any rental and cost sharing payments received under the
+contract, with interest, upon termination of the contract resulting
+from a violation of the terms of the contract;
+ 5. refund to the Secretary of Agriculture or accept adjustments
+to the rental and cost sharing payments provided to the owner for
+violation of the terms of the contract which does not cause termination
+of the contract;
+ 6. forfeit all rights to rental and cost sharing payments under
+the contract upon transfer of the land, unless the transferee of the
+land agrees to assume all obligations of the contract;
+ 7. refund rental and cost sharing payments or accept adjustments
+in the rental and cost sharing payments, unless the transferee of the
+land agrees to assume all obligations of the contract;
+ 8. not make any commercial use, such as harvesting or grazing, of
+the forage on the contract land, unless permitted by the Secretary of
+Agriculture in case of drought or other emergency;
+ 9. not plant trees on the contract land unless permitted by the
+contract, except that customary forestry practices may be allowed on
+land converted to forestry use;
+ 10. not adopt any practice specified in the contract which may
+defeat the purposes of the program; and
+ 11. comply with any additional contract provisions.
+
+ Charles F. Curtiss Distinguished Professor in Agriculture and
+Emeritus Professor of Economics, Iowa State University, Ames, Iowa.
+Member of the Iowa Bar.
+
+
+
+ Mr. POMEROY. I don't expect necessarily that you can speak
+to what might be under contemplation at the IRS, but I would
+like your attention to those recommendations, and as quickly as
+possible, because people literally have dozens, if not
+hundreds, of tax filings and a questioned status in their
+offices, not knowing how to treat this new development.
+ Mr. EVERSON. I had a discussion on this before the hearing
+today with some of my folks who were familiar with the meeting
+that I think you held last week on this.
+ Mr. POMEROY. Yes.
+ Mr. EVERSON. As we indicated in the early conversation,
+this is a discussion that has broad ramifications, particularly
+as the country moves to a model where there are more
+individuals who are self-employed or running small businesses.
+We need to tread very carefully as we look at this. I give you
+my commitment that we will look at this very carefully.
+ Mr. POMEROY. Mr. Commissioner, can we expect to have any
+guidance from the IRS prior to the filing date for this tax
+season?
+ Mr. EVERSON. I don't know the answer to that. I would
+imagine that would be quite expedited, since we're only a
+couple of weeks away from April 15th. I will ask that specific
+question. It is not one that we discussed or had an expectation
+of something that rapid in the conversation I had, in fact,
+earlier today on this subject. I will check.
+ Mr. POMEROY. To sharpen the point to you, by
+acknowledgement of the IRS, the letter ruling--which is private
+and nonbinding, but nonetheless stands with some authority
+about what the tax treatment might be in this area--was
+prepared without contemplation of retired farmers but the
+wording of it is broad enough to sweep them in. It leaves
+people in a very difficult position on whether to ignore it, as
+has been the treatment of this matter since 1988, or whether
+you change based on the IRS wording that was put out not in
+contemplation of this specific issue. So, some clarification I
+believe in this instance would be appropriate. Again, we're not
+asking the IRS not to--what we want them to do is lift the
+confusion by basically lifting the letter ruling as it applies
+to retired farmers, and then come forward with a more
+definitive statement with the contemplation of this particular
+set of circumstances, going forward for future guidance. I
+thank the Commissioner.
+ Chairman HOUGHTON. Thanks very much, Mr. Pomeroy. Well,
+thank you, Mr. Commissioner. We appreciate your testimony.
+ Mr. EVERSON. Thank you, sir.
+ Chairman HOUGHTON. Now we've got a time problem. I'm going
+to ask Mr. White, who is Director of Tax Issues for the GAO,
+and also Nancy Killefer, Chairman of the IRS Oversight Board,
+if you be willing to maybe squeeze in your testimony in maybe 3
+minutes apiece in order that we can get through your testimony.
+Then when we come back from these three votes, we can get right
+into the questions. Is that all right with you, Ms. Killefer?
+ Ms. KILLEFER. Absolutely.
+ Chairman HOUGHTON. Good. Thanks very much. Okay, Mr. White.
+
+STATEMENT OF JAMES R. WHITE, DIRECTOR, TAX ISSUES, U.S. GENERAL
+ ACCOUNTING OFFICE
+
+ Mr. WHITE. Mr. Chairman and Members of the Committee, we
+are pleased to be here. For several years, we have reported on
+the opposing trends in taxpayer service and enforcement that
+we've heard discussed already. IRS' 2005 budget addresses both
+enforcement and systems modernization.
+ One point I want to make about the budget request for 2005
+is that this is not IRS' first request for additional
+enforcement staff. It follows similar requests in IRS' past
+five budgets. You can see what actually has happened in figure
+1 on page 8 of my statement. Staffing in three key enforcement
+occupations--revenue agents, revenue officers and special
+agents--declined by over 21 percent between 1998 and 2003.
+These declines occurred, even though IRS' budget requests were
+almost fully funded and IRS did realize some savings. IRS
+funded other priorities, such as unbudgeted cost and
+improvements to taxpayer services.
+ Switching quickly to systems modernization, as you are
+aware, some projects have been completed but many of the
+projects that have not been completed are over cost and behind
+schedule. The point I want to make here is that this impacts
+taxpayers. The customer account data engine, for example, is
+intended to facilitate faster refund processing and better
+answers to taxpayer questions. IRS, in response to these
+problems, has reduced its modernization budget request to focus
+on fewer projects and is implementing action plans to correct
+deficiencies.
+ Turning to the 2004 filing season, IRS is continuing to
+improve most but not all taxpayer services, and we see this as
+a payoff from the completed modernization projects. I have some
+examples in my statement but I will skip most of those. Another
+point to make related to customer service and IRS' budget both
+has to do with elec-
+
+tronic filing. Electronic filing is continuing to grow, but it
+is not growing at the rate that would meet either IRS' 80
+percent goal but, in fact, is growing at a slower rate each
+year. This continues a trend that we have seen over time.
+ Electronic filing is important because it's a way to gain
+efficiencies. It's much cheaper to process electronically filed
+returns than to process paper filed returns, which is a very
+labor-intensive process. An example of the consequence of the
+growth of electronic filing that we've seen is that IRS has
+been able to reduce processing staff. In 2003, for example,
+about 1,000 full time equivalents in the processing area of IRS
+was the size of the decline there. So, it's a significant
+saving in that area.
+ Mr. Chairman, my three themes--declines in enforcement
+staff, systems modernization, and improved service--are
+related. Recent history causes us to question whether IRS will
+be able to increase enforcement staffing as much as proposed in
+the 2005 budget. IRS already expects some unbudgeted costs. If
+all IRS's planned savings are not realized, then funds for
+enforcement could be further reduced. One near term option for
+increasing enforcement staff is to reconsider the level and
+types of services IRS provides. For example, the improvements
+in phone and Internet service raise a question about whether
+IRS needs to operate as many walk-in sites. Longer term systems
+modernization, if successful, could generate efficiencies and
+increase e-filing which would allow IRS to do more with less.
+ I want to make a final point on enforcement staffing. As
+noted, many fear that declines could be reducing taxpayers'
+incentives to voluntarily comply. However, IRS currently does
+not have a measure of voluntary compliance. IRS is working to
+develop a measure, but won't have results until 2005. Those
+results could impact future IRS budgets. If compliance is
+stable or has improved, the pressure to increase IRS'
+enforcement staff might diminish in the future. If, however,
+compliance is down, the pressure on IRS' budget will likely
+increase in the future. Thank you, Mr. Chairman.
+ [The prepared statement of Mr. White follows:]
+
+ Statement of James R. White, Director of Tax Issues, U.S. General
+ Accounting Office
+
+ Mr. Chairman and Members of the Subcommittee:
+ We are pleased to participate in the Subcommittee's hearing on the
+Internal Revenue Service's (IRS) fiscal year 2005 budget request and
+its performance to date during the 2004 tax filing season.
+ Effective tax administration requires a combination of quality
+taxpayer service to help those who want to comply, and effective
+enforcement measures against those who do not. Although tax
+administrators continually debate the proper balance between taxpayer
+service and enforcement, the ultimate goal is to assure a high level of
+voluntary compliance. Currently, about 98 percent of the money IRS
+collects is received voluntarily--without any IRS enforcement action.
+ For the last few years, we have been reporting on trends in
+taxpayer service and enforcement. During this period, IRS has
+noticeably improved the quality of service to taxpayers. At the same
+time, there have been declines in many of IRS's enforcement programs
+and in the numbers of the most skilled enforcement staff. Many inside
+and outside IRS have become concerned that the declines in enforcement
+efforts have reduced taxpayers' incentive to voluntarily comply with
+the tax laws. While the actual impact on voluntary compliance is
+unknown, because IRS does not have a reliable current estimate of the
+overall compliance rate, the fear is that taxpayers could lose
+confidence in IRS's ability to ensure that all taxpayers pay what they
+should. If taxpayers ever lose confidence that their friends,
+neighbors, and business competitors are paying their fair share of
+taxes, then they could become less willing to pay themselves.
+ One key to improving taxpayer service and enforcement is IRS's
+Business Systems Modernization (BSM) effort, now in its 6th year. If
+successful, BSM is expected to allow IRS to better serve taxpayers and
+enforce the tax laws without a major increase in staffing and other
+resources. However, we continue to report that modernization is a high-
+risk area, the scope and complexity of BSM is growing, and BSM projects
+are experiencing additional costs and delays.
+ As you requested, our statement discusses both IRS's 2005 budget
+request and its 2004 filing season performance to date. With respect to
+the budget, we assessed the likelihood that (1) IRS will be able to
+allocate more resources to enforcement, and (2) BSM and other
+technology efforts will deliver cost savings and efficiencies in the
+immediate future. With respect to the filing season, we assessed IRS's
+performance in processing returns and providing assistance to
+taxpayers.
+ Our assessment of the budget request and BSM is based on a
+comparative analysis of IRS's fiscal year 2002 through 2005 budget
+requests, funding, and expenditures, supporting documentation, and
+interviews with IRS officials. Our assessment of the filing season is
+based on a comparison of IRS's performance this year to the previous
+two filing seasons, site visits to an IRS processing center and walk-in
+sites, monitoring processing status meetings, interviews with IRS and
+Treasury Inspector General for Tax Administration (TIGTA) officials and
+other external stakeholders, reviews of TIGTA and other external
+reports, and reviews of IRS's Web site. We used historical budget and
+performance data including filing season performance data from reports
+and budget requests used by the IRS, Department of Treasury, and Office
+of Management and Budget (OMB). Although we have not verified the
+accuracy of the most recent data, in past reports we have assessed
+IRS's budget and performance data.\1\ As a result, we considered the
+data to be sufficiently reliable for purposes of this testimony. The
+budget and performance projections for fiscal years 2004 and 2005 are
+subject to change. Also, we did not independently validate planned BSM
+projects' cost estimates or confirm, through system and project
+management documentation, the validity of IRS-provided information on
+the projects' content and progress. We performed our work in
+Washington, D.C. and Atlanta, Ga. from December 2003 through March
+2004, in accordance with generally accepted government auditing
+standards.
+---------------------------------------------------------------------------
+ \1\ U.S. General Accounting Office, Tax Administration: IRS Needs
+to Further Refine Its Tax Filing Season Performance Measures, GAO-03-
+143 (Washington, D.C.: Nov. 22, 2002) and U.S. General Accounting
+Office, Financial Audit: IRS's Fiscal Years 2003 and 2002 Financial
+Statements, GAO-04-126 (Washington, D.C.: Nov. 13, 2003)
+---------------------------------------------------------------------------
+ In summary, our assessment of IRS's 2005 budget request shows that:
+
+ IRS is requesting $10.7 billion, an increase of $489.8
+million over fiscal year 2004. The 2005 budget proposes $377.3 million
+to fund new initiatives, primarily increases in enforcement staff, and
+$373 million to cover the increased costs, such as salary increases, of
+maintaining current programs. IRS plans to fund the additional spending
+from three sources--the budget increase, program reductions ($149.7
+million) and internal savings ($110.8 million). IRS has made increasing
+enforcement staff a priority in its last five budget requests. However,
+despite getting its requests almost fully funded and despite realizing
+some savings--although not all that were projected--IRS did not achieve
+increases in enforcement staff. Staffing in three key enforcement
+occupations--revenue agents, revenue officers, and special agents--
+declined by over 21 percent between 1998 and 2003. IRS funded other
+priorities such as unbudgeted expenses and improvements to taxpayer
+service. This raises several questions and concerns. One is whether IRS
+will be able to increase enforcement staff as planned in 2005. Another
+is whether the declines in enforcement staff, and the resulting
+declines in statistics related to IRS's enforcement programs, are
+eroding taxpayers' incentive to voluntarily comply with the tax laws.
+ Included in IRS's budget request is about $1.93 billion
+(including 7,385 staff years) in information technology resources. This
+includes (1) $285 million for the agency's multiyear capital account
+that funds contractor costs for the BSM program and (2) about $1.64
+billion for information systems, of which $1.55 billion is for
+operations and maintenance. The BSM request has been developed
+consistent with federal guidance on budget preparation. While BSM
+management controls have improved, some weaknesses, such as cost and
+schedule estimating, still remain. Most BSM projects have experienced
+cost overruns and schedule delays that have postponed the delivery of
+benefits to taxpayers and IRS operations. In an effort to better ensure
+that projects are delivered within budget and on schedule, IRS has
+reduced its BSM budget request to focus on a smaller modernization
+project portfolio and is implementing action plans to respond to
+deficiencies noted in several recent assessments of the BSM program. In
+addition, with respect to its information systems budget request, IRS
+has made progress in implementing investment management best practices
+for developing and supporting it. However, until IRS fully implements
+planned process improvements, its ability to develop supportable
+information systems operations and maintenance budget requests will
+remain limited.
+
+ Our assessment of the 2004 filing season to date shows that:
+
+ IRS's performance during the 2004 filing season has
+improved in most areas compared to this time last year and the year
+before, based on the data we reviewed on key filing season activities--
+paper and electronic processing, telephone assistance, IRS's Web site
+and walk-in assistance. In particular, access to IRS's telephone
+assistors has improved and Web site usage has increased. However, the
+accuracy of responses to tax law questions provided by telephone
+assistors declined the last two years. Additionally, the number of
+taxpayers seeking assistance at IRS's walk-in sites continued to
+decline and IRS is shifting work from its walk-in sites to alternative
+means of providing assistance, such as its volunteer organizations and
+its Web site. Although it cannot be quantified, the improvements
+overall in the 2004 filing season performance appear to represent a
+payoff from IRS's modernization and increased emphasis on service since
+1998.
+
+Enhancing Enforcement Is A Key Priority But Devoting More Resources To
+ Enforcement May Be Difficult
+ The fiscal year 2005 budget is the fifth consecutive budget request
+where IRS is proposing increased staffing for enforcement and the third
+where it has identified internally-generated savings to help fund the
+increase. The 2005 budget proposes that, of the $377.3 million for new
+initiatives to be paid for either through new funding and reinvested
+savings, $315.2 million or 84 percent go to enforcement. In the past,
+IRS has not been able to realize all the projected savings intended to
+help fund enforcement staffing increases. In addition, other
+priorities, including unbudgeted expenses and taxpayer service, have
+consumed budget increases and internally-generated savings. This raises
+the question about IRS's ability to increase enforcement staffing as
+planned in 2005.
+
+IRS is Asking For Significantly More For Enforcement in 2005
+ IRS's fiscal year 2005 budget request is $10.7 billion, up $489.8
+million or 4.8 percent from the amount appropriated for fiscal year
+2004. IRS's request identifies a total of $750.3 million of new
+proposed spending--$377.3 million for new initiatives, primarily
+enforcement, and $373 million to maintain current operations (such as
+salary increases included in the budget). IRS plans to fund the
+additional spending from three sources--budget increases, program
+reductions, and internal savings. IRS is proposing to receive $489.8
+million in budget increases, gain $149.7 million from program
+reductions, primarily from reducing the amount for BSM, and save $110.8
+million from process improvements. For context about IRS's staff
+resources, we provide information about how IRS allocated those
+resources in fiscal year 2003 to various functions including returns
+processing, taxpayers service and enforcement in appendix I.
+ In its 2005 budget request, IRS makes increasing enforcement
+staffing its priority. IRS identified its priority enforcement areas
+as:
+
+ promoters of tax schemes,
+ misuses of offshore transactions,
+ uses of corporate tax avoidance transactions,
+ underreporting of income by higher income taxpayers, and
+ failures to file and pay large amounts of employment
+taxes.
+
+ IRS is proposing to spend $377.3 million on new initiatives; $315.2
+million, or 84 percent is slated for enforcement initiatives. The rest
+is for infrastructure projects to, for example, consolidate paper
+processing operations. The major enforcement initiatives include:
+
+ $90.2 million and 874 Full Time Equivalents (FTEs) to
+target noncompliance by small business and self-employed taxpayers by
+hiring field examination and collection, automated collection and
+service center-based compliance staff;
+ $65 million and 260 FTEs for additional criminal
+investigation resources to combat corporate fraud, increase tax
+enforcement, and enhance criminal investigation capabilities by hiring
+additional criminal investigators and special agents to focus on
+corporate financial fraud, general tax enforcement, improve forensic
+electronic evidence capabilities and increase special agent support
+staff;
+ $36 million and 207 FTEs to combat corporate abusive tax
+shelters by devoting more resources to reviewing offshore transactions;
+ $15.5 million and 175 FTEs to increase individual
+taxpayer compliance by focusing on the full spectrum of individual
+taxpayer noncompliance, including nonfilers, nonpayers of tax owed, and
+more tax assessments on underreported income; and
+ $15.1 million and 144 FTEs to combat diversions of
+charitable assets and stop abusive transactions in the tax-exempt area
+by focusing on terrorism funding and civil fraud by charities, and
+targeting tax avoidance strategies by charities.
+
+ IRS is proposing to spend $373 million to maintain current
+operations, which would cover increased costs of continuing current
+operations. The increased costs include $133 million for salary
+increases assumed in IRS's budget. IRS's 2005 budget assumes a federal
+salary increase of 1.5 percent. If the actual federal salary increase
+is higher than 1.5 percent, IRS will have to cover the unbudgeted
+portion of the increase.
+ For 2005, IRS has identified $110.8 million in savings to be
+generated from process and system improvements. Key savings initiatives
+include:
+
+ $34.0 million and 408 FTEs from a reorganization of the
+information systems function that will consolidate three parallel
+organizations, and reduce staff, to improve operations and support to
+IRS customers;
+ $15.7 million and 220 FTEs from consolidating insolvency
+and exam/collection field support from over 80 to 5 or fewer locations;
+ $14.9 million and 167 FTEs from the termination of
+transition employees who could not be placed when offices closed and
+jobs shifted when IRS's reorganization into business units; and
+ $5.1 million and 130 FTEs due to more electronic filing.
+
+ In addition to the savings, IRS has identified $149.7 million in
+program reductions to help fund its 2005 spending priorities. The
+reductions include $102.7 million due to reductions in the scope of
+certain BSM projects (discussed later in more detail) and $18 million
+in overhead reductions.
+
+Recent History Suggests Increasing Enforcement Staffing May Be
+ Difficult
+ In its last five budget requests, IRS has asked for more
+enforcement staff, to be funded partly by budget increases and partly
+through internal savings. Despite budget requests that were almost
+fully funded and despite achieving some savings, the number of skilled
+enforcement staff actually declined. The budget increases and savings
+were consumed by other priorities including unbudgeted expenses.
+
+IRS's Recent Budget Requests Were Almost Fully Funded, and Some Savings
+ Were Achieved
+ Table 1 shows that IRS has received almost 98 percent or more of
+its budget requests since fiscal year 2002.
+
+ Table 1: IRS's requested and approved budget for fiscal years 2002 through 2005 (in millions)
+----------------------------------------------------------------------------------------------------------------
+ Fiscal Year
+ Fiscal Year Fiscal Year Fiscal Year 2005
+ 2002 (Actual) 2003 (Actual) 2004 (est.) (Requested)
+----------------------------------------------------------------------------------------------------------------
+Requested budget $9,422 $9,916 $10,437 $10,674
+----------------------------------------------------------------------------------------------------------------
+Budget approved 9,437 9,835 10,185
+----------------------------------------------------------------------------------------------------------------
+Source: IRS data.
+
+ Table 2 shows that in 2003 IRS realized about 34 percent of its
+anticipated budget savings and about 41 percent of its anticipated
+staff savings. In 2004, IRS officials believe they did a better job in
+both estimating and tracking the savings and estimate they will be able
+to reinvest 77 percent of the anticipated budget savings and 53 percent
+of the anticipated staff savings.\2\
+---------------------------------------------------------------------------
+ \2\ Although IRS officials were able to produce more complete
+supporting documentation on cost estimates and savings justifications
+than for fiscal year 2004, we were unable to verify actual IRS claims
+on savings and reinvestments. IRS's budget office generally accepts the
+savings and reinvestment data claimed by various IRS operating
+divisions, and reduces the budget allocation of the unit that
+identified the savings. If expected savings do not materialize, the
+operating division must either find a way to make up the savings
+elsewhere with new efficiencies, reduce expected expenditures, or
+petition for additional resources from other parts of the organization.
+
+ Table 2: IRS's reported actual and estimated savings and reinvestments for fiscal year 2003 and 2004 (In
+ millions)
+----------------------------------------------------------------------------------------------------------------
+ Fiscal Year 2003 Fiscal Year 2004 Fiscal Year 2005 (est)
+ -----------------------------------------------------------------------
+ Staff Staff Staff
+ Dollars Levels Dollars Levels Dollars Levels
+----------------------------------------------------------------------------------------------------------------
+Savingsa
+----------------------------------------------------------------------------------------------------------------
+Budgeted 157.8 2,287 166.5 2,145 110.8 1,442
+----------------------------------------------------------------------------------------------------------------
+Actual 53.4 944 113.0 1,120
+----------------------------------------------------------------------------------------------------------------
+Percentage of actualb 34% 41% 68% 53%
+----------------------------------------------------------------------------------------------------------------
+Reinvestmentsa
+----------------------------------------------------------------------------------------------------------------
+Projected 157.8 1,830 166.5 649 110.8 712
+----------------------------------------------------------------------------------------------------------------
+Actual 47.4 2 39 99.5 259
+----------------------------------------------------------------------------------------------------------------
+Percentage of actualb 30% 13% 77% 53%
+----------------------------------------------------------------------------------------------------------------
+Source: GAO analysis of IRS data.
+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 2003 and end of year projections for 2004.
+
+ IRS should be commended for identifying saving and reinvestment
+opportunities in its budget request. While IRS has been unable to
+achieve its savings targets, we recognize that budget preparation
+begins about 18 months before the beginning of the fiscal year, making
+it difficult to accurately predict future savings. IRS officials
+believe they are doing a better job both estimating and tracking
+savings. Nevertheless, IRS's history raises questions about its ability
+to achieve the 2005 savings targets.
+
+IRS Has Been Unable to Achieve Increases In Enforcement Staffing in
+ Recent Years
+ Despite budget requests that were almost fully funded, and despite
+realizing some savings, IRS has been unable to achieve the enforcement
+staffing increases projected in its recent budgets.
+ As shown in figure 1, the number of revenue agents (those who audit
+complex returns), revenue officers, (those who do field collection
+work), and special agents (those who performed criminal investigations)
+has decreased over 21 percent between 1998 and 2003.
+
+Figure 1: Revenue agents, revenue officers, and special agents, fiscal
+ years 1998-2003
+
+[GRAPHIC] [TIFF OMITTED] T3828A.001
+
+ The Large--and Mid-size Business (LMSB) operating division,
+responsible for combating abusive corporate tax shelters and assuring
+that large businesses are in compliance with the tax laws, is an
+example of these staffing trends. According to LMSB officials, at the
+beginning of fiscal year 2002, they had 5,047 revenue agents on board.
+This was reduced to 4,431 at the beginning of fiscal year 2004--a 12
+percent reduction--due to attrition and the inability to hire.
+ The declines in enforcement staff have been associated with
+declines in enforcement efforts. For example, audit rates are below the
+levels of the mid-1990s, even after accounting for recent increases.
+Figure 2 shows the trend in total audits of individual taxpayers since
+1993. Total audits includes both face-to-face audits and less complex
+correspondence audits. IRS and GAO have reported \3\ that IRS has
+experienced steep declines in audit rates since 1996, although the
+audit rate has slowly increased since 2000.
+---------------------------------------------------------------------------
+ \3\ U.S. General Accounting Office, Tax Administration: IRS Should
+Continue to Expand Reporting on Its Enforcement Efforts, GAO-03-378,
+(Washington, D.C.: Jan. 31, 2003).
+---------------------------------------------------------------------------
+
+ Figure 2: Audit rate individual income tax returns, fiscal year 1993-
+ 2003
+
+[GRAPHIC] [TIFF OMITTED] T3828A.002
+
+ The link between the decline in enforcement staff and the decline
+in enforcement actions, such as audit rates, is complicated by other
+factors, such as changes over time in the mix of complex and simple
+enforcement actions. However, IRS officials have stated that the
+decline in enforcement staff has restricted their enforcement efforts.
+For example, LMSB officials stated that they hired about 200 fewer
+revenue agents than planned in fiscal year 2003 and expect to hire
+about 95 fewer in fiscal year 2004 because of budget constraints. They
+estimated that had this hiring occurred as planned, LMSB could have
+examined an additional 505 returns and 1,877 returns in fiscal years
+2003 and 2004 respectively. In addition, the 2005 budget request
+attributes the decline in enforcement actions to the decline in
+enforcement staff.
+ The impact of the recent declines in enforcement staffing and
+enforcement actions on taxpayers' rate of voluntary compliance is not
+known. This leaves open the question of whether these declines are
+eroding taxpayers' incentives to voluntarily comply. As we have
+reported,\4\ the IRS's National Research Program (NRP), which is
+developing new estimates of taxpayer compliance, is underway. These
+estimates will be the first based on data more recent than 1988, when
+IRS last measured voluntary compliance. According to IRS officials the
+new estimates should be available in 2005. Until the NRP estimates are
+available, IRS lacks current data on compliance including changes in
+taxpayers' compliance rate.
+---------------------------------------------------------------------------
+ \4\ U.S. General Accounting Office, Tax Administration: IRS is
+Implementing the National Research Program as Planned, GAO-03-614,
+(Washington, D.C.: June 16, 2003).
+---------------------------------------------------------------------------
+ NRP is important for several reasons beyond measuring compliance.
+It is intended to help IRS better target its enforcement actions, such
+as audits, on non-compliant taxpayers, and minimize audits of compliant
+taxpayers. It could also help IRS better understand the impact of
+taxpayer service on compliance.
+
+Other IRS Priorities Have Consumed Recent Budget Increases and Savings
+ Priorities other than enforcement, including unbudgeted expenses
+and taxpayer service, have consumed IRS's budget increases and savings
+over the last few years. Unbudgeted expenses include unfunded portions
+of the annual pay increases, that can be substantial given IRS's large
+workforce, and other costs, such as postage increases and higher-than-
+budgeted rent increases. According to IRS officials, these unbudgeted
+expenses accounted for
+
+ $154 million of IRS's budget in 2002;
+ $311 million of IRS's budget in 2003; and
+ $169 million of IRS's budget in 2004.
+
+ IRS officials also told us that they anticipate having to cover
+unbudgeted expenses in 2005. As of March 2004, they were projecting
+unbudgeted salary increases for fiscal year 2005 of at least $100
+million. This projection could change since the actual federal salary
+increase for 2005 has not been finalized.
+ Another reason for the reduction in enforcement staff has been
+IRS's emphasis on improving service to taxpayers. According to IRS
+officials, much of this improvement has been at the expense of
+additional resources for enforcement and has resulted in less hiring of
+new staff for enforcement activities.
+
+IRS's Information Technology Budget Includes Funding For BSM and
+ Information Systems
+ IRS is requesting about $1.93 billion (including 7,385 staff years)
+in information technology (IT) resources for fiscal year 2005. This
+includes (1) $285 million for the agency's multiyear capital account
+that funds contractor costs for the Business Systems Modernization
+(BSM) program and (2) about $1.64 billion for information systems, of
+which $1.55 billion (including 7,137 staff years) are for operations
+and maintenance. BSM is important for IRS's future because it has the
+potential for long-term efficiency gains without major increases in
+staffing or other resources.
+
+Fiscal Year 2005 BSM Request Developed Consistent with Federal Guidance
+ Consistent with the Clinger-Cohen Act of 1996 \5\ and the
+Government Performance and Results Act of 1993,\6\ OMB guidance on
+budget preparation and submission \7\ require that, before requesting
+multiyear funding for capital asset acquisitions, agencies develop
+sufficient justification for these investments. The guidance requires
+that agencies implement key IT management practices, including an
+integrated IT architecture and a process for managing information
+systems projects as investments. In addition, agencies are to prepare
+business cases that reasonably demonstrate how proposed investments
+support agency missions and operations, and provide positive business
+value in terms of expected costs, benefits, and risks.
+---------------------------------------------------------------------------
+ \5\ This fiscal year 1997 Omnibus Consolidated Appropriations Act,
+Pub. L. 104-208, renamed both Division D (the Federal Acquisition
+Reform Act) and E (the Information Technology Management Reform Act) of
+the 1996 Department of Defense Authorization Act, Pub. L. 104-106, as
+the Clinger Cohen Act of 1996.
+ \6\ P.L. 103-62.
+ \7\ See, for example, Office of Management and Budget, Preparing,
+Submitting, and Executing the Budget, Circular No. A-11 (Washington,
+D.C.: July 25, 2003).
+---------------------------------------------------------------------------
+ Beginning in 1995, when IRS was involved in an earlier attempt to
+modernize its tax processing systems, and continuing since then, we
+have made recommendations \8\ that IRS implement fundamental
+modernization management capabilities before acquiring new systems. We
+recommended, among other things, that IRS (1) put in place an
+enterprise architecture \9\ (modernization blueprint) to guide and
+constrain its business system investments, and (2) implement
+disciplined processes for investment decision management and system
+development management.
+---------------------------------------------------------------------------
+ \8\ See U.S. General Accounting Office, Tax Systems Modernization:
+Management and Technical Weaknesses Must Be Corrected If Modernization
+Is to Succeed, GAO/AIMD-95-156 (Washington, D.C.: July 26, 1995); Tax
+Administration: IRS' Fiscal Year 1997 Spending, 1997 Filing Season, and
+Fiscal 1998 Budget Request, GAO/T-GGD/AIMD-97-66 (Washington, D.C.:
+March 18, 1997); Tax Systems Modernization: Blueprint is a Good Start
+But Not Yet Sufficiently Complete to Build or Acquire Systems, GAO/
+AIMD/GGD-98-54 (Washington, D.C.: February 24, 1998); and Tax
+Administration: IRS' 2000 Tax Filing Season and Fiscal Year 2001 Budget
+Request, GAO/T-GGD/AIMD-00-133 (Washington, D.C.: March 28, 2000).
+ \9\ An enterprise architecture provides an institutional
+``blueprint'' for defining how an organization operates today (baseline
+environment) in both business and technological terms, and how it wants
+to operate in the future (target environment). It also includes a
+sequencing plan that provides a road map for transitioning between
+these environments.
+---------------------------------------------------------------------------
+ In response to our recommendations, IRS developed and is using an
+enterprise architecture, which describes IRS's current and target
+business and technology environments, and the associated high-level
+transition strategy that identifies and conceptually justifies needed
+investments to guide the agency's transition over many years from its
+current to its target architectural state. In addition, IRS also
+implemented a capital planning and investment control process for
+developing business cases and managing BSM projects as part of an
+investment portfolio, as well as a systems life cycle management
+methodology, which IRS refers to as the enterprise life cycle.
+ IRS's $285 million request for the BSM account for fiscal year 2005
+is based on its enterprise architecture as well as its related
+investment management process and life cycle management methodology.
+IRS's BSM budget request constitutes a reduction of greater than 25
+percent from the planned fiscal year 2004 spending level of $388
+million, and reflects the agency's decision, in light of ongoing
+project delays, to focus on a smaller modernization project portfolio
+in an effort to better ensure cost targets are maintained, project
+schedules are met, and the promised projects are delivered.
+
+BSM Management Controls Improved, But Weaknesses Remain
+ Pursuant to statute,\10\ funds from the BSM account are not
+available for obligation until IRS submits to the congressional
+appropriations committees for approval an expenditure plan that meets
+certain conditions.\11\ In January 2004, IRS submitted an expenditure
+plan seeking approval to obligate funds from the BSM account for its
+planned fiscal year 2004 projects and program-level initiatives. IRS's
+fiscal year 2004 plan reported the deployment of modernization projects
+during fiscal year 2003 that have benefited taxpayers and the agency,
+including an application that provides refund status for the advanced
+child tax credit and the first release of a new human resources system,
+HR Connect, which has now been delivered to 73,000 IRS employees.
+---------------------------------------------------------------------------
+ \10\ P.L. 108-199, Div. F, Title II, Jan. 23, 2004.
+ \11\ IRS's BSM expenditure plans are required to (1) meet the
+capital planning and investment control review requirements established
+by OMB, (2) comply with IRS's enterprise architecture, (3) conform with
+IRS's enterprise life cycle methodology, (4) be approved by IRS,
+Treasury, and OMB, (5) be reviewed by GAO, and (6) comply with federal
+acquisition rules, requirements, guidelines, and systems acquisition
+management practices.
+---------------------------------------------------------------------------
+ In our briefing to the staff of the relevant appropriations
+subcommittees on the results of our review of the fiscal year 2004
+expenditure plan, we reported that IRS has made progress in
+implementing our prior recommendations to improve its modernization
+management controls and capabilities. However, certain of these
+controls and capabilities related to configuration management, human
+capital management, cost and schedule estimating, and contract
+management have not yet been fully implemented or institutionalized.
+Our analysis has shown that weaknesses in these controls and
+capabilities have contributed, at least in part, to cost and schedule
+shortfalls experienced by most BSM projects. In the absence of
+appropriate management controls, systems modernization projects will
+likely be hampered by additional costs and schedule shortfalls. The
+reasons are twofold: the tasks associated with those projects that are
+moving beyond design and into development are, by their nature, more
+complex and risky. Also, the fiscal year 2004 expenditure plan supports
+progress toward the later, more complex phases of key projects as well
+as continued development of other projects.
+
+BSM Projects Continue to Incur Cost Increases and Schedule Delays
+ Based on IRS's expenditure plans, BSM projects have consistently
+cost more and taken longer to complete than originally estimated. In
+its fiscal year 2004 plan, IRS disclosed that key BSM projects have
+continued to experience cost and schedule shortfalls against prior
+commitments. Table 4 shows the life cycle variance in cost and schedule
+estimates for completed and ongoing BSM projects. These variances are
+based on a comparison of IRS's initial and revised cost and schedule
+estimates to complete initial operation \12\ or full deployment \13\ of
+the projects. We did not independently validate planned projects' cost
+estimates or confirm, through system and project management
+documentation, the validity of IRS-provided information on the
+projects' content and progress.
+---------------------------------------------------------------------------
+ \12\ Initial operation refers to the point at which a project is
+authorized to begin enterprisewide deployment.
+ \13\ Full deployment refers to the point at which enterprisewide
+deployment has been completed and a project is transitioned to
+operations and support.
+
+ Table 4: IRS BSM project life cycle cost/schedule variance and benefits summary for completed and on-going
+ projects
+----------------------------------------------------------------------------------------------------------------
+ Reported/
+ Cost revised Schedule Reported/
+ Project variance estimated variance revised Reported IRS/taxpayer
+ (in cost (in (in estimated benefits
+ thousands) thousands) months) completion date
+----------------------------------------------------------------------------------------------------------------
+Completed Projects
+----------------------------------------------------------------------------------------------------------------
+Security and Technology +$7,553 $41,287 +5 1/31/02 Provides
+ Infrastructure Release 1............ (initial infrastructure for
+ operation) secure telephony and
+ electronic
+ interaction among IRS
+ employees, tax
+ practitioners, and
+ taxpayers.
+----------------------------------------------------------------------------------------------------------------
+Customer Communications 2001......... +5,310 46,420 +9 2/26/02 (full Improves
+ deployment) telecommunications
+ infrastructure,
+ including telephone
+ call management, call
+ routing, and customer
+ self-service
+ applications.
+----------------------------------------------------------------------------------------------------------------
+Customer Relationship Management Exam -1,938 7,375 +3 9/30/02 (full Provides commercial-
+ deployment) off-the-shelf
+ software to IRS
+ revenue agents to
+ allow them to
+ accurately compute
+ complex corporate
+ transactions.
+----------------------------------------------------------------------------------------------------------------
+Human Resources ConnectRelease 1..... +200 10,200 0 12/31/02 Allows IRS employees
+ (initial to access and manage
+ operation) their human resources
+ information online.
+----------------------------------------------------------------------------------------------------------------
+Internet Refund/ Fact of Filing...... +12,923 26,432 +14 9/26/03 (full Provides instant
+ deployment) refund status
+ information and
+ instructions for
+ resolving refund
+ problems to taxpayers
+ with Internet access.
+----------------------------------------------------------------------------------------------------------------
+Ongoing Projectsa
+----------------------------------------------------------------------------------------------------------------
+Modernizede-File Release 1........... +17,057 46,303 +4.5 3/31/04b Provides a single
+ (initial standard for filing
+ operation) electronic tax
+ returns.
+----------------------------------------------------------------------------------------------------------------
+e-Services +86,236 130,281 +18 4/30/05 (full Provides a Web portal
+ deployment) and other e-Services
+ to promote the goal
+ of conducting most
+ IRS transactions with
+ taxpayers and tax
+ practitioners
+ electronically.
+----------------------------------------------------------------------------------------------------------------
+Customer Account Data Engine-- +36,760 97,905 +30c 6/30/05c (full Provides the
+ Individual Master File Release 1.... deployment) modernized database
+ foundation to
+ eventually replace
+ the existing
+ individual master
+ file processing
+ systems. Facilitates
+ faster refund
+ processing and more
+ timely response to
+ taxpayer inquiries
+ for Form 1040EZ
+ filers.
+----------------------------------------------------------------------------------------------------------------
+Integrated Financial System Release 1 +53,916 153,786 TBDc TBDc (full Provides a single
+ deployment) general ledger for
+ custodial and
+ financial data and a
+ platform to integrate
+ core financial data
+ with budget,
+ performance, and cost
+ accounting data.
+----------------------------------------------------------------------------------------------------------------
+Custodial Accounting Project Release +72,058 119,219 TBDc TBDc (full Provides integrated
+ 1................................... deployment) tax operations and
+ internal management
+ information to
+ support evolving
+ decision analytics,
+ performance
+ measurement, and
+ management
+ information needs.
+----------------------------------------------------------------------------------------------------------------
+Source: GAO analysis of data contained in IRS's BSM expenditure plans. a Projects ongoing as of 9/30/03. b IRS
+ subsequently reported that Modernized e-File began initial operation on 2/23/04. c Project schedules for the
+ Customer Account Data Engine, the Integrated Financial System, and the Custodial Accounting Project are
+ currently under review.
+
+ As the table indicates, the cost and schedule estimates for full
+deployment of the e-Services project have increased by just over $86
+million and 18 months, respectively, which included a significant
+expansion from the initial project scope. In addition, the estimated
+cost for the full deployment of Customer Account Data Engine (CADE)
+Release 1 has increased by almost $37 million, and project completion
+has been delayed by 30 months. In addition to the modernization
+management control shortcomings discussed above, our work has shown
+that the increases and delays were caused, in part, by
+
+ inadequate definitions of systems requirements. As a
+result, additional requirements have been incorporated into ongoing
+projects.
+ increases in project scope. For example, the e-Services
+project has changed significantly since the original design. The scope
+was broadened by IRS to provide additional benefits to internal and
+external customers.
+ underestimating project complexity. This factor has
+contributed directly to the significant delays in the CADE release 1
+schedule.
+ competing demands of projects for test facilities.
+Testing infrastructure capacity is insufficient to accommodate multiple
+projects when testing schedules overlap.
+ project interdependencies. Delays with one project have
+had a cascading effect and have caused delays in related projects.
+
+ These cost overruns and schedule delays impair IRS's ability to
+make appropriate decisions about investing in new projects, delay
+delivery of benefits to taxpayers, and postpone resolution of material
+weaknesses affecting other program areas.
+ Producing reliable estimates of expected costs and schedules is
+essential to determining a project's cost-effectiveness. In addition,
+it is critical for budgeting, management, and oversight. Without this
+information, the likelihood of poor investment decisions is increased.
+ Schedule slippages delay the provision of modernized systems'
+direct benefits to the public. For example, as table 4 shows, slippages
+in CADE will delay IRS's ability to provide faster refunds and respond
+to taxpayer inquiries on a timely basis.
+ Delays in the delivery of modernized systems also affect the
+remediation of material internal management weaknesses. For example,
+the Custodial Accounting Project is intended to address a material
+weakness in IRS's financial reporting process and provide a mechanism
+for tracking and summarizing individual taxpayer transactions. This
+release has yet to be implemented, and a revised schedule has not yet
+been determined. In addition, the Integrated Financial System is
+intended to address financial management reporting weaknesses. When IRS
+submitted its fiscal year 2003 BSM expenditure plan, Release 1 of the
+Integrated Financial System was scheduled for delivery on October 1,
+2003. However, it has yet to be implemented, and additional cost
+increases are expected.
+IRS Is Acting to Resolve Issues Identified in Recent BSM Assessments
+ Given the continued cost overruns and schedule delays experienced
+by these BSM projects, IRS and the prime systems integration support
+(PRIME) contractor, Computer Sciences Corporation (CSC), initiated and
+recently completed several in-depth and more comprehensive assessments
+of BSM. These assessments revealed several significant weaknesses that
+have driven project cost overruns and schedule delays and also provided
+a number of recommendations for IRS and CSC to address the identified
+weaknesses and reduce the risk to BSM. The deficiencies identified are
+consistent with our prior findings. IRS developed a BSM action plan to
+address the findings and recommendations resulting from these
+assessments. IRS expects to complete implementation of its actions by
+the end of the calendar year. Because of the significant risks
+associated with the findings of these various assessments, continued
+monitoring by IRS and validation of the effectiveness of corrective
+actions is critical to reducing the likelihood of additional cost
+overruns and schedule delays.
+ It will be important for IRS to continue its efforts to balance the
+scope and pace of the program with the agency's capacity to handle the
+workload, and to institutionalize the management processes and controls
+necessary to resolve the deficiencies identified by our reviews and the
+recent program assessments. Meeting these challenges and improving
+performance are essential if IRS and the PRIME contractor are to
+successfully deliver the BSM program.
+
+Continued Efforts Needed to Strengthen Information Systems Budget
+ Request Development Process
+ The Paperwork Reduction Act (PRA) \14\ requires federal agencies to
+be accountable for their IT investments and responsible for maximizing
+the value and managing the risks of their major information systems
+initiatives. The Clinger-Cohen Act of 1996 \15\ establishes a more
+definitive framework for implementing the PRA's requirements for IT
+investment management. It requires federal agencies to focus more on
+the results they have achieved and introduces more rigor and structure
+into how agencies are to select and manage IT projects.
+---------------------------------------------------------------------------
+ \14\ 44 U.S.C. 3506(h).
+ \15\ P.L. 104-106.
+---------------------------------------------------------------------------
+ Leading private--and public-sector organizations have taken a
+project--or system-centric approach to managing not only new
+investments but also operations and maintenance of existing systems. As
+such, these organizations
+
+ identify operations and maintenance projects and systems
+for inclusion in budget requests;
+ assess these projects or systems on the basis of expected
+costs, benefits and risks to the organization;
+ analyze these projects as a portfolio of competing
+funding options; and
+ use this information to develop and support budget
+requests.
+
+ This focus on projects, their outcomes, and risks as the basic
+elements of analysis and decision-making is incorporated in the IT
+investment management approach that is recommended by OMB and GAO.\16\
+By using these proven investment management approaches for budget
+formulation, agencies have a systematic method, on the basis of risk
+and return on investment, to justify what are typically very
+substantial information systems operations and maintenance budget
+requests.
+---------------------------------------------------------------------------
+ \16\ See, for example, U.S. General Accounting Office, Information
+Technology Investment Management: A Framework for Assessing and
+Improving Process Maturity, GAO-04-394G (Washington, D.C.: March 2004,
+Version 1.1).
+---------------------------------------------------------------------------
+ In our assessment of IRS's fiscal year 2003 budget request, we
+reported that the agency did not develop its information systems
+operations and maintenance 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.\17\ To address our recommendation, IRS agreed to take the
+following actions:
+---------------------------------------------------------------------------
+ \17\ U.S. General Accounting Office, Internal Revenue Service:
+Assessment of Budget Request for Fiscal Year 2003 and Interim Results
+of 2002 Tax Filing Season, GAO-02-580T (Washington, D.C.: Apr. 9, 2002)
+and Internal Revenue Service: Improving Adequacy of Information Systems
+Budget Justification, GAO-02-704 (Washington, D.C.: June 28, 2002).
+
+ develop an activity-based cost model to plan, project,
+and report costs for business tasks/activities funded by the
+information systems budget;
+ develop a capital planning guide to implement processes
+for capital planning and investment control, budget formulation and
+execution, business case development, and project prioritization; and
+ implement a process for managing all information systems
+investments as a portfolio, patterned after the BSM program.
+
+ IRS has made progress in implementing investment management best
+practices in developing and supporting its information systems budget
+request. IRS officials reported that the agency is managing all
+information systems funding requirements as a portfolio within
+Treasury's IT investment portfolio system, and preparing business cases
+for many of its operational program activities, as required by OMB.
+According to IRS, these business cases are updated on a periodic basis
+and are evaluated within the context of the agency's overall IT funding
+portfolio. IRS plans to align this portfolio management process with
+the capital planning and investment control system now being
+implemented to provide a uniform process to select, manage, and control
+all IT investments, including modernization, enhancements, and
+sustaining operations.
+ Although progress has been made, IRS has not yet completed all of
+its planned actions to implement our prior recommendation. Completion
+of IRS's capital planning and investment control guide has been delayed
+due to changing roles and responsibilities within the Modernization and
+Information Technology Services organization, and thus was not used in
+preparing the fiscal year 2005 information systems budget request.
+According to IRS, the capital planning guidance will not be completed
+until September 2004. In addition, as of March 2004, IRS has not yet
+developed an activity-based cost accounting system to enable it to
+account for the full cost of operations and maintenance projects and
+determine how effectively IRS projects are achieving program goals and
+mission needs. This cost model, which is being developed in conjunction
+with the Integrated Financial System modernization project, has been
+delayed, and due to Integrated Financial System schedule delays, will
+not be available until the fiscal year 2008 budget formulation cycle.
+Until IRS implements the capital planning and investment control
+guidance and the activity-based cost model and incorporates them into
+the preparation of its information systems budget request, the agency
+will not be able to ensure that the information systems operations and
+maintenance request is adequately supported.
+
+Interim Results Of IRS's 2004 Filing Season Show Improvement Except In
+ Telephone Accuracy
+ IRS's filing season performance through mid-March has improved in
+most areas compared to recent years, based on data we reviewed on five
+key filing season activities--paper and electronic processing,
+telephone assistance, IRS's Web site, and walk-in assistance. However,
+the accuracy of tax law answers provided by IRS telephone staff
+declined. Although we cannot quantify the connection between these
+improvements and IRS's actions, they appear to represent a payoff from
+IRS's modernization and an increased emphasis on service since the IRS
+Restructuring and Reform Act of 1998.\18\
+---------------------------------------------------------------------------
+ \18\ P.L. 105-206.
+---------------------------------------------------------------------------
+ Table 5 summarizes IRS's filing season performance so far this year
+compared to recent years. The following sections will address IRS's
+specific performance in key areas.
+
+ Table 5: IRS performance in the first weeks of the 2002 through 2004
+ filing seasons
+------------------------------------------------------------------------
+ Volume in thousands 2002 2003 2004
+------------------------------------------------------------------------
+Actual returns processeda
+------------------------------------------------------------------------
+Paper 24,491 22,117 20,232
+------------------------------------------------------------------------
+Electronic 35,067 38,627 42,988
+------------------------------------------------------------------------
+Telephone assistance
+------------------------------------------------------------------------
+Total callsb 34,489 27,905 29,058
+------------------------------------------------------------------------
+Answered by assistors 9,208 9,434 10,116
+------------------------------------------------------------------------
+Answered by automation 25,281 18,471 18,942
+------------------------------------------------------------------------
+Customer service 62% 82% 84%
+ representative level of
+ service
+------------------------------------------------------------------------
+Accounts customer accuracy 88% +/- 1% 88% +/- 1% 89% +/- 1%
+ rate estimatesc
+------------------------------------------------------------------------
+Tax law customer accuracy rate 84% +/- 1% 81% +/- 1% 76% +/- 1%
+ estimatesc
+------------------------------------------------------------------------
+Internet assistance
+------------------------------------------------------------------------
+Forms and publications 158,000 195,000 205,000
+ downloadedd
+------------------------------------------------------------------------
+Refund status inquiriese N/A 9,300 14,300
+------------------------------------------------------------------------
+Child Tax Credit inquiriesf N/A N/A 8,500
+------------------------------------------------------------------------
+Walk-in assistance
+------------------------------------------------------------------------
+Total Walk-in Contactsg N/A 2,740 2,433
+------------------------------------------------------------------------
+Returns prepared at IRS walk- 436 291 186
+ in sitesh
+------------------------------------------------------------------------
+Returns prepared at volunteer 466 594 737
+ sitesj
+------------------------------------------------------------------------
+Source: IRS Data.
+a From January 1 to March 22, 2002, January 1 to March 21, 2003, and
+ January 1 to March 19, 2004.
+b Total calls, calls answered by assistors and automation, and CSR level
+ of service are based on actual counts from January 1 to March 16,
+ 2002, January 1 to March 15, 2003, and January 1 to March 13, 2004.
+ 2002 totals include increased call demand as a result of the Economic
+ Growth and Tax Relief and Reconciliation Act of 2001 (P.L.107-16).
+ Employer Identification Number data has been added to 2002 and 2003 to
+ ensure valid data comparisons can be made to 2004 which includes
+ Employer Identification Numbers.
+c Based on a representative sample estimated at the 90 percent
+ confidence level from January to February 2002, 2003 and 2004.
+d From January 1 to February 28, 2002, January 1 to February 28, 2003,
+ and January 1 to February 29, 2004.
+e From January 1 to March 20, 2003, and January 1 to March 20, 2004.
+f From January 1 to March 21, 2004.
+g From January 1 to March 15, 2003, and January 1 to March 13, 2004.
+h From January 1 to March 16, 2002, January 1 to March 15, 2003, and
+ January 1 to March 13, 2004.
+i From January 1 to March 9, 2002, January 1 to March 8, 2003, and
+ January 1 to March 6, 2004.
+
+IRS's Processing Operations Have Gone Smoothly, and Electronic Filing
+ Continues to Grow, But Not at Rate to Meet 2007 Goal
+ According to IRS officials, tax industry representatives and data
+reviewed, the 2004 filing season is progressing smoothly (meaning
+without disruptions in IRS computer systems used in processing that
+would have a negative impact on taxpayers) and IRS is either meeting or
+exceeding its goals for the number of days to process an individual
+income tax returns, depending on the type of return. As table 5 shows,
+through March 19, 2004, IRS has processed about 63 million individual
+tax returns--of which 43 million were received electronically, which is
+about 4.4 million more electronically filed returns than this time last
+year. IRS officials have attributed this year's performance, in part,
+to having planned appropriately for issues such as correcting errors
+related to the advanced child tax credit. Through March 12, 2004, IRS
+had identified about 2.7 million individual tax returns with errors,
+with approximately 1.6 million related to the advanced child tax
+credit.\19\
+---------------------------------------------------------------------------
+ \19\ In 2003, the IRS, through Financial Management Service, issued
+advanced child tax credit payments to more than 25 million taxpayers in
+a manner similar to the 86 million advance refund checks issued in
+2001. See U.S. General Accounting Office, Tax Administration: IRS
+Issued Advance Child Tax Credit Payments on Time, but Should Study
+Lessons Learned, GAO-04-372 (Washington, D.C.: Feb. 17, 2004).
+---------------------------------------------------------------------------
+ Electronic filing has grown from the same time last year. It has
+also grown by about 250 percent overall--from about 15 million returns
+in 1996 to about 53 million in 2003. Although electronic filing
+continues to grow, IRS is not on track to reach the long-term
+electronic filing goal of 80 percent by 2007 set by Congress in the IRS
+Restructuring and Reform Act of 1998.\20\ IRS officials recognizes that
+they will not achieve the goal of having 80 percent of all individual
+income tax returns filed electronically by 2007. However, IRS officials
+told us they will continue to strive to achieve that goal in the
+future. Moreover, as we reported last year,\21\ the growth rate from
+1996 through 2003 has been generally decreasing, with the 13 percent
+growth rate in 2003 representing the smallest percentage increase in
+the number of individual tax returns filed electronically since
+1996.\22\ Although the current growth rate is about 11 percent,
+according to IRS officials, the number of electronic filings is ahead
+of their estimates at this time. Consequently, IRS officials believe
+IRS will meet and might exceed the annual growth rate goal of 12
+percent by the year's end.
+---------------------------------------------------------------------------
+ \20\ P.L. 105-206.
+ \21\ U.S. General Accounting Office, Internal Revenue Service:
+Assessment of Fiscal Year 2004 Budget Request and 2003 Filing Season
+Performance to Date, GAO-03-641T (Washington, D.C.: Apr. 8, 2003).
+ \22\ Some slowing of the growth rate might be expected because, for
+example, taxpayers most easily attracted to electronic filing have
+already been converted.
+---------------------------------------------------------------------------
+
+ Figure 3: Growth rate in the number of individual income tax returns
+ filed electronically 1996--2004
+
+[GRAPHIC] [TIFF OMITTED] T3828A.003
+
+ Note: For 2004, the growth rate compares to the number of returns
+filed electronically as of March 12, 2004 to the same period in 2003.
+
+ Growth in electronic filing remains a key part of IRS's
+modernization strategy. Electronic filing has allowed IRS to reduce
+resources devoted to processing (discussed in appendix I) and begin
+consolidating paper processing centers. It also reduces errors because
+IRS would not have to transcribe tax returns information and some up-
+front checks are built into electronic filing. Finally, taxpayers get
+refunds quicker with electronic filing--IRS's goal for refunds for
+electronically filed returns is about half the 40 days that IRS allows
+for refunds for returns filed on paper.
+ IRS has implemented numerous initiatives over the years intended to
+increase electronic filing usage. IRS's new major electronic filing
+initiatives this year are related to business not individual income tax
+returns. They are modernized E-File, which allows the electronic filing
+of corporate income tax form 1120 and E-Services, which is a suite of
+Internet services offered to tax practitioners such as electronic
+account resolution and transcript delivery. IRS officials do not expect
+these initiatives to dramatically increase electronic filing of
+individual tax returns this year, because taxpayers and practitioners
+will need to adjust their behavior and take advantage of the new
+services. However, these initiatives are important, because they should
+increase the willingness of tax practitioners to file both corporate
+and individual tax returns electronically in future filing seasons,
+which can currently be done only on a limited basis for corporate
+returns.
+ IRS made some changes to improve the Free File Alliance \23\
+program, which began last year to promote electronic filing of
+individual income tax returns. As of March 7, 2004, IRS had received
+almost 2.5 million free file tax returns compared to 2.0 million for
+the same time last year--an increase of 24 percent. One issue with the
+Free File program is that IRS cannot determine how many of the Free
+File users are new electronic filers. We plan to follow up on this
+issue as part of our annual filing season report.
+---------------------------------------------------------------------------
+ \23\ In 2003 IRS entered into a 3-year-agreement with the Free File
+Alliance, a consortium of tax preparation companies, to provide free
+electronic filing to taxpayers that access any of the companies via a
+link from the IRS Web site. IRS is in the second year of its initiative
+with the Free File Alliance, and there are currently 17 companies that
+are offering free filing via IRS's Web site.
+---------------------------------------------------------------------------
+Telephone Access Improved Over Last Two Years, While Tax Law Accuracy
+ Declined
+ Access to IRS's toll-free telephone lines has improved over the
+last two years, although account accuracy (the accuracy of answers to
+questions from taxpayers about the status of their accounts) has
+stabilized and tax law accuracy declined. As table 5 shows, as of March
+13, 2004, IRS had received 29 million telephone calls. The percentage
+of taxpayers that attempted to reach an assistor and actually got
+through and received service--referred to as the Customer Service
+Representative (CSR) level of service--increased to 84 percent, which
+is 2 percentage points over the same period last year and 22 percentage
+points over the same period in 2002. According to IRS officials, the
+gains in CSR level of service are largely due to continued improvements
+resulting from increased specialization, improved technology, and
+continued focus on maintaining telephone staffing.
+ IRS estimates that accounts accuracy is essentially the same this
+year as for the last two years at this time. As shown in table 5,
+taxpayers who called about their accounts received correct information
+an estimated 89 percent of the time in 2004. IRS officials said that
+accounts accuracy rates remained stable, because the accounts workload
+has remained relatively stable.
+ At the same time, table 5 shows that IRS estimates that tax law
+accuracy declined from 84 percent in 2002 and 81 percent last year to
+76 percent so this year. IRS officials said that tax law accuracy rates
+declined because formatting changes made in 2003 to the guide CSRs use
+to help them answer questions have not enhanced the usability as IRS
+anticipated. According to IRS, although training was provided to the
+staff for the changes to their assigned subjects, IRS underestimated
+the impact these changes would have on overall quality. Also, IRS
+officials said they have begun redesigning the CSRs' guide and are
+continuing to conduct detailed analysis of quality data to identify
+immediate opportunities to improve the accuracy of service.
+
+Web Site Usage is Increasing, But Concerns About Usability Still Exist
+ IRS's Web site use has increased over the last 2 years as shown in
+table 6. Also, an independent Web site rater reported that, for 7 of
+out 10 weeks of the filing season, IRS's Web Site has ranked in the top
+10 out of 40 in a government Web site index for time it took to
+download information.
+ Over the last 2 years, IRS has added two features to assist
+taxpayers, which likely contributed to the increased usage of IRS Web
+site. In fiscal year 2003, IRS added the ``Where's My Refund?'' and in
+2004 added ``Remember Your Advanced Child Tax Credit'' features. The
+``Where's My Refund?'' feature enables taxpayers to access IRS's Web
+site to determine if IRS received their tax return, whether their
+refund was processed, and if processed, when approximately to expect
+the refund. Table 5 shows that as of March 20, 2004, the use of this
+feature was up by 53 percent from last year, from about 9.3 million
+attempts to about 14.3 million. The ``Remember Your Advanced Child Tax
+Credit'' enables a person to access IRS's Web site to determine the
+amount of the advanced child tax credit they received. As of March 21,
+2004, about 8.5 million accesses have been made to the ``Remember Your
+Child Tax Credit'' feature.
+ Overall we found that IRS's Web site continues to improve when it
+comes to providing services to taxpayers. However, we continue to have
+concerns about the forms and publication search function. We found that
+the forms and publication search function still does not always make
+the most pertinent information readily available. For example, when we
+typed, ``earned income tax credit'' into the forms and publication
+search function, Publication 596--the primary publication on the earned
+income tax credit--was the 79th item on the list and we had to scroll
+through eight pages to find it.
+Use of IRS's Walk-in Assistance Sites Continues to Decline
+ The number of taxpayers receiving assistance at IRS walk-in sites
+continued to decline. At any one of IRS's over 400 walk-in sites,
+taxpayers get various types of assistance, including answers to tax law
+questions, assistance with their accounts, and return preparation
+assistance (generally for low income taxpayers).
+ The number of people who received assistance at an IRS walk-in site
+declined by 11 percent compared to the same period last year. IRS
+continues to restrict free tax preparation services to, for example,
+taxpayers with an annual gross income level of $35,000 or less, because
+of the labor intensive nature of that work and to enable staff to
+concentrate on other services that only IRS can provide such as account
+assistance. IRS reduced the number of staff available for return
+preparation by 20 percent from 2003. As the data in table 5 indicate,
+the number of returns being prepared has decreased by about 36 percent
+over this time last year. These trends are consistent with ones we have
+previously reported for recent filing seasons.\24\
+---------------------------------------------------------------------------
+ \24\ GAO-04-84.
+---------------------------------------------------------------------------
+ Figure 4 shows a downward trend in the overall assistance provided
+and in the return preparation at the walk-in sites.
+
+Figure 4: Assistance provided by IRS walk-in and volunteer sites,
+ 2000-2003 filing seasons
+
+[GRAPHIC] [TIFF OMITTED] T3828A.004
+
+ Notes: Total walk-in figures shows all IRS face-to-face assistance,
+including return preparation, account services, and tax law assistance.
+It does not include the number of taxpayers assisted by walk-in
+employees via telephone or correspondence, which ranged from about
+96,000 in 2000 to over 150,000 in 2003. Total figures do not include
+returns prepared at volunteer sites. The number of returns prepared at
+volunteer sites was not available for the 2000 filing season. The time
+periods covered by this figure each began on January 1 and ended on
+April 22, 2000; April 21, 2001; April 20, 2002; and April 19, 2003.
+ Sites staffed by volunteers certified by IRS do not provide the
+range of services IRS provides, such as account assistance, and operate
+primarily during the filing season. IRS is promoting these as
+alternatives to its walk-in assistance sites for certain types of
+service. IRS works to ensure that walk-in sites have a listing of
+services, hours, and locations of the volunteer sites in their area. As
+of March 2004, there are approximate 11,600 volunteer sites. IRS also
+promotes its telephone operations and Web site at its walk-in sites as
+well.
+ The quality of tax law assistance \25\ provided at IRS's walk-in
+sites in 2004 was comparable to the same period last year. This
+conclusion is based on TIGTA reviews \26\ through February 2004.
+---------------------------------------------------------------------------
+ \25\ IRS determines the quality of account assistance after the
+filing season. Only tax law assistance is evaluated during the filing
+season.
+ \26\ TIGTA determines tax law accuracy by measuring the percentage
+of correct answers to questions asked during anonymous visits to a
+sample of walk-in sites. Questions were designed by TIGTA to cover a
+range of tax law topics and assess whether taxpayers were receiving
+correct answers to questions that a taxpayer might ask when visiting a
+walk-in site. The TIGTA are statistically valid only for the times and
+the locations within which respondents were surveyed.
+---------------------------------------------------------------------------
+Concluding Observations
+ Congress has been supportive of IRS's efforts to improve service to
+taxpayers and increase enforcement staff and IRS has succeeded at the
+former. However, despite budgets that were almost fully funded and
+realizing savings through efficiency gains, IRS has not been able to
+increase enforcement staff. In fact, staffing of key enforcement
+occupations has declined. The declines in IRS's enforcement staff and
+the related declines in its enforcement efforts raise concerns that
+taxpayers' incentives to voluntarily comply with their tax obligations
+could be eroding.
+ Strengthening enforcement programs by increasing staffing while
+providing a high level of taxpayer service will continue to be a
+challenge for IRS. Unbudgeted costs are expected to compete for the
+funds IRS has allocated in its 2005 budget request for new spending
+including the enforcement initiatives. If, as has been the case in
+recent years, IRS fails to realize all expected savings then the funds
+available for new spending would be further reduced.
+ One option for increasing enforcement staff in the near-term is to
+reconsider the level and types of service IRS provides to taxpayers.
+Taxpayer services are much improved raising a question about the
+appropriate balance to strike between investing in further service
+improvements and enforcement. At the same time, the use of IRS's walk-
+in assistance sites is declining. The improvements in telephone
+service, increased Web site use, and the availability of volunteer
+sites raise a question about whether IRS should continue to operate as
+many walk-in sites. Reconsidering the level and types of service is an
+option--but not a recommendation--to be considered by IRS management
+and the Congress.
+ The challenge of increasing IRS's enforcement staff highlights the
+importance of succeeding with NRP and BSM. NRP should, if completed
+successfully, provide the first new data to estimate the voluntary
+compliance rate since IRS last estimated the compliance rate using 1988
+data. The new estimates could have implications for future IRS budgets.
+If compliance rates are comparable to those estimated using 1988 data,
+the pressure to increase IRS' s enforcement staff would likely
+diminish. If, however, compliance rates are down, the pressure to
+increase enforcement staff and the pressure on IRS's budget could
+increase.
+ BSM and related initiatives such as electronic filing hold the
+long-term promise of efficiency gains that could allow IRS to improve
+both taxpayer service and enforcement without budget increases.
+However, cost overruns and schedule delays associated with on-going BSM
+projects, along with planned reductions in the BSM project portfolio
+mean, that many of these benefits will not be realized in the short
+term. As we have recommended, various management controls and
+capabilities need to be fully implemented and institutionalized.
+Otherwise the projects will likely encounter additional cost and
+schedule shortfalls.
+
+Appendix I: How IRS Aoolcated Expenditures and Staff Resources in
+ Fiscal Year 2003
+ In our review of IRS's 2004 budget request, we provided figures
+showing IRS's expenditures and staff allocations in fiscal year
+2002.\27\ Figures 5 and 6 illustrate how the Internal Revenue Service
+(IRS) allocated expenditures and staff in fiscal year 2003.
+---------------------------------------------------------------------------
+ \27\ GAO-03-641T.
+---------------------------------------------------------------------------
+ Figure 5 shows that total expenditures increased from $10.4 billion
+in 2002 to $11.8 billion in 2003. While the division of expenditures
+across categories has generally remained the same as 2002 allocations,
+equipment increased from 4 to 6 percent of total expenditures from 2002
+to 2003.
+
+ Figure 5: IRS's expenditures in fiscal year 2003
+
+[GRAPHIC] [TIFF OMITTED] T3828A.005
+
+ Figure 6 shows IRS's total staff resources have decreased slightly
+from 99,180 in 2002 to 98,381 in 2003. IRS's allocation of staffing
+resources remained largely similar, but with a 1 percentage point
+decrease in the percent of staff years processing tax returns. The
+boundaries between the categories presented in these figures may not be
+well defined. For example, staff categorized under providing management
+and other services could also be considered under taxpayer service,
+processing, or compliance. Therefore, the figures are meant to provide
+a summary of how IRS uses its resources and should be interpreted with
+caution. However, the 1 percentage point decrease in staff years
+devoted to processing tax returns is important because it represents a
+cumulative payoff from electronic filing and shows the potential for
+shifting IRS resources from one area to another.
+
+ Figure 6: How IRS spent its 98,381 staff years in fiscal year 2003
+
+[GRAPHIC] [TIFF OMITTED] T3828A.006
+
+
+
+ Chairman HOUGHTON. Thank you very much. We're just going to
+have to stop now. Miss Killefer, I'm sorry about this. We will
+just suspend the hearing until we come back from the votes.
+We'll be back as fast as we can. Thank you very much.
+ [Recess.]
+ Could we re-commence the hearing, please? Ms. Killefer,
+thanks very much.
+
+ STATEMENT OF NANCY KILLEFER, CHAIR, INTERNAL REVENUE SERVICE
+ OVERSIGHT BOARD
+
+ Ms. KILLEFER. Mr. Chairman, thank you for inviting us here
+to testify. The Board believes that the IRS Budget is more than
+dollars or cents. It is really about the choices we as a nation
+make about the future of our tax administration system, and how
+we help over 100 million American taxpayers deal with,
+unfortunately, an increasingly complex Tax Code and ensure that
+every American citizen pays his or her fair share of their
+taxes. We strongly believe that this is a critical time in our
+tax system's history, and it is a time to strengthen it, not
+merely to maintain it. As we all know, billions of dollars in
+uncollected taxes are left on the table because the IRS simply
+does not have the resources to do the job, and with each
+passing year, as the Board has done in its own research with
+the Roper Survey, we know that more Americans believe that it
+is more acceptable to cheat. This is particularly true of young
+Americans, and that is a very disturbing trend.
+ In crafting our budget to present to Congress, the Board
+addressed the concerns head on by reinvesting in the IRS to
+produce tangible increases in enforcement while maintaining the
+high level of customer service that we have achieved through
+the implementation of RRA 98. The Board is calling for a 10
+percent increase in funding which should result in an increase
+of over 3,000 enforcement personnel, which would allow the IRS
+to improve its enforcement while maintaining customer service,
+and we also call for an increase in the budget for
+modernization versus the administration.
+ While we applaud the Administration, and particularly
+Secretary Snow, for requesting a funding increase for the IRS,
+we feel there is a fatal flaw in the budget and it comes
+because left uncorrected are the lack of funding for what we
+believe will be pay parity between the civilian and military
+budgets, an issue that you are grappling with here on the Hill,
+as well as unfunded costs in areas such as rent, postage, that
+have gone on for the 3 years preceding this. What this problem
+ends up with is the IRS has never been able to hire the FTEs
+that it projects. Each year for the past 4 years, and perhaps
+before, those increases have been eaten up by pay parity that
+was unfunded in the President's budget, as well as other
+unfunded liabilities. In an organization like the IRS that it
+80 percent people, there is no choice but to hold back on
+hiring.
+ Our concern with the Administration's budget is that if you
+believe that pay parity will happen yet again, and that many of
+the increases that we know will already be there from GSA in
+terms of rent increases, and so forth, you will not be able to
+hire any of the additional people that the Administration
+recommends. We feel, as private sector members of the Board,
+that we cannot let this trend go on. It simply will lead to
+once again with increasing tax load from both more taxpayers
+filing as well as more schemes out there, that their
+enforcement will become hollow, and we think that is a terribly
+disturbing trend.
+ What we are recommending therefore is a 10-percent increase
+which would assume the funding of, if you will, a parity pay
+increase as well as full funding of rent increases that are
+already on the table from GSA, and other increases we
+anticipate, and then allow for the hiring of over 3,000
+additional enforcement personnel, which we feel are badly
+needed, and which I think in fact the Commissioner and GAO
+absolutely support. One last point I would like to make from
+the Board's perspective is RRA 98 gave us, in fact demanded,
+that we submit a budget to you directly that represented our
+best judgment about the requirements of the IRS to fulfill its
+strategic mission.
+ From our collective expertise and familiarity with the
+private sector and best practices on the IRS' problems, we
+believe that these investments in enforcement pay for
+themselves many times over, not only in the revenue dollars
+that are directly collected through these enforcement
+activities, but by also reinforcing our voluntary tax system
+through the belief that every person is paying his or her fair
+share, and that is the fundamental strength of our tax system.
+Thank you.
+ [The prepared statement of Ms. Killefer follows:]
+
+ Statement of Nancy Killefer, Chair, IRS Oversight Board
+
+Introduction
+ Mr. Chairman, thank you for the opportunity to testify before the
+House Ways and Means Subcommittee on Oversight. The Internal Revenue
+Service (IRS) Oversight Board is required by 26 U.S.C. Section 7802(d)
+to review and approve the budget request prepared by the IRS, submit a
+request to Treasury, and ensure that the approved budget supports the
+annual and long-range strategic plans of the IRS.
+ This year, the IRS drafted a special report presenting its
+recommended FY2005 IRS budget, comparing it to the Administration's
+request, and explaining why the Board believes its recommended budget
+is needed to support the annual and long-term needs of the IRS. My
+testimony today will discuss that report. The complete version is
+available on the Board's web site at www.irsoversightboard.treas.gov.
+
+The IRS Oversight Board Budget Recommendation
+ Mr. Chairman, the IRS budget is more than dollars and cents. It
+represents the choices that we as a nation make about the future of our
+tax administration system and how we help over 100 million American
+taxpayers deal with an increasingly complex tax code while ensuring
+that everyone pays his or her fair share of taxes.
+ The IRS Oversight Board acknowledges that the IRS's budget has
+increased in each year of President Bush's Administration, and that the
+Administration's request for FY2005 is significant against other non-
+defense, non-homeland security discretionary funding. That commitment
+is commendable, and the Board recognizes and thanks Secretary Snow for
+his efforts, especially at a time when the nation must balance many
+important and competing priorities.
+ However, the Board believes that now is a critical time for our tax
+system to be strengthened, not merely maintained at current levels.
+Enforcement activities are still at unacceptable levels. Our nation's
+tax gap is estimated at $311 billion,\1\ leaving billions of dollars on
+the table simply because the IRS does not have the resources to do its
+job.\2\
+---------------------------------------------------------------------------
+ \1\ Nina Olson, National Taxpayer Advocate's 2003 Annual Report to
+Congress, (Washington, DC: December 31, 2003) p. 20-21. This is based
+on a July 2001 IRS Office of Research report.
+ \2\ Charles O. Rossotti, Report to the IRS Oversight Board:
+Assessment of the IRS and the Tax System (Washington, DC: September
+2002), p. 16.
+---------------------------------------------------------------------------
+ The Board's own research shows that each year, more Americans
+believe it is acceptable to cheat on their taxes. At the same time, our
+already complex tax code continues to be a changing, tangled mystery to
+most honest taxpayers--and an asset to those intent on skirting the
+law. Every effort must be made to provide quality service to honest
+taxpayers who want to comply with the law.
+ In crafting its FY2005 budget for the IRS, the Board addressed
+these concerns head on by reinvesting in the IRS to produce tangible
+benefits and results for America's taxpayers and our nation. It is a
+sensible and pragmatic budget that reflects the real world in which the
+IRS must operate and be funded.
+ The Board recommends a 10 percent increase in funding from FY2004
+to $11.204 billion, with a significant increase of 3,315 full-time
+equivalents (FTEs) to boost enforcement efforts. If enacted, the
+Board's budget would increase our nation's revenue by approximately $5
+billion each year once the IRS has hired and trained additional
+enforcement personnel.\3\
+---------------------------------------------------------------------------
+ \3\ These estimates are based upon the projected revenue
+anticipated by hiring and training full-time employees who would audit
+or collect owed taxes in known cases of taxpayers who did not file or
+pay, or who substantially underreported their taxes, as described in
+former IRS Commissioner Charles O. Rossotti's Report to the IRS
+Oversight Board: Assessment of the IRS and the Tax System, p. 16.
+---------------------------------------------------------------------------
+ Under the Board's budget, the IRS would have the additional
+resources to:
+
+ Close over an additional 1,000 cases involving high risk/
+high-income taxpayers and promoters who avoid paying income taxes by
+using offshore credit cards and abusive trusts and shelters.
+ Boost audit rates by 42 percent from FY2004 to examine
+companies that use aggressive tax avoidance tactics, such as offshore
+transactions and flow-through entities.
+ Contact an additional 200,000 taxpayers who fail to file
+or pay taxes due; a 40 percent boost from FY2004 and a 27 percent
+increase from the Administration's request. This alone will allow the
+IRS to collect $84 million more in revenue owed than the
+Administration's request would allow.
+ Sustain the one-on-one assistance that millions of
+Americans rely on at tax time. The Board's budget will ensure that the
+IRS will be able to maintain its improved service to taxpayers by
+answering eight out of ten phone calls.
+
+IRS Must Stay the Course on Customer Service
+ Mr. Chairman, the vast majority of Americans want to file their
+returns and pay their fair share, yet our nation's tax code continues
+to become more complex. Resources must be available so the IRS can
+answer taxpayers' questions and promptly and accurately, whether it is
+over the phone, through the IRS web site, by mail, or at walk-in
+center.
+ Under the board's proposed budget, customer service funding will
+remain at about the same level as FY2004; however, service should
+improve due to the deployment of self-service technology.
+ For taxpayers, that means eight out of ten phone calls will be
+answered. For tax practitioners calling the IRS toll-free hotline to
+resolve problems regarding clients' accounts, hold-time will remain at
+current levels.
+ The IRS call-routing systems as well as web-site applications that
+allow taxpayers to check the status of their tax refunds have already
+shown dramatic benefits in speeding service to taxpayers. New systems,
+such as e-Services, will soon be available, providing additional
+automated services to tax practitioners.
+ Clearly, service to taxpayers has improved in the past five years.
+Such improvements make it all the more imperative that we sustain them
+and not allow this positive trend to languish, or worse, decline. The
+agency must stay the course.
+
+Days of ``Outmanned and Outgunned'' IRS Must End
+ The IRS is doing a better job of identifying egregious
+noncompliance--now it needs the resources to fight back. In the past
+two years, the IRS sharpened its compliance focus to identify and
+pursue promoters and participants of abusive tax shelters and tax
+evasion schemes. For example, the agency is now targeting its resources
+on promoters of illegal tax schemes that are often marketed to high-
+income individuals, but are also finding their way to middle-market
+businesses.
+ Despite this focus, enforcement activities are still at an
+unacceptable level simply because the IRS does not have the resources
+needed to accomplish its mission. It continues to be outmanned and
+outgunned. In FY2003, the agency was able to pursue only 18 percent of
+known cases of abusive devices designed to hide income, leaving an
+estimated $447 million uncollected.\4\
+---------------------------------------------------------------------------
+ \4\ Rossotti, p. 16.
+---------------------------------------------------------------------------
+Tax Cheating: Alarming Trends
+
+[GRAPHIC] [TIFF OMITTED] T3828A.007
+
+ Public attitudes towards tax cheating show some alarming trends,
+particularly among young Americans. The Board's 2003 Survey on Taxpayer
+Attitudes found that support for total tax compliance diminished by
+four points over the previous year to 81 percent. In other words,
+nearly one out of five Americans now believe that it is acceptable to
+cheat at least a little on their taxes. Almost one-third (30%) of young
+adults age 18-24 age are among those most likely to feel that any
+amount of cheating is acceptable, an increase of six points since last
+year. Yet ironically, ``fear of being audited'' has the greatest impact
+on these non-compliers at a time when actually being audited is near
+historic lows.\5\
+---------------------------------------------------------------------------
+ \5\ Roper ASW, 2003 IRS Oversight Board Annual Survey on Taxpayer
+Attitudes, September 2003, p.17.
+---------------------------------------------------------------------------
+ The IRS must prove to the public that it can and will identify and
+pursue those who show contempt for the tax code. The Board's proposed
+budget allows the IRS to begin to reverse this disturbing trend.
+ The Board's recommendation would increase our nation's revenue by
+almost $5 billion each year once the IRS has hired and trained
+additional enforcement personnel. The Board believes the additional
+revenue achieved makes a strong business case for the recommended
+additional enforcement resources. While this is a modest boost in
+closing our compliance gap, it will also send a message to those
+contemplating tax avoidance: the IRS' hands are no longer tied.
+
+Modernization Critical to Tax Administration
+ In December 2003, the Oversight Board released an independent
+analysis of the IRS Business Systems Modernization (BSM) program. The
+Board called for nine specific recommendations for turning around the
+critical but troubled program that has experienced significant and
+unacceptable delays and cost overruns.
+ However, the Board still believes that the overall Modernization
+plan is sound and well-designed. Moreover, it is critical to the future
+of tax administration. As a nation, we must remain committed to the
+IRS' computer modernization program. The Board testified before the
+House Ways & Means Subcommittee on Oversight on Feb 12, 2004:
+ The IRS Oversight Board firmly believes that the IRS Modernization
+program cannot be allowed to fail. The IRS cannot continue to operate
+with the outmoded and inefficient systems and processes it uses today.
+Over time, the existing systems will become impossible to maintain and
+at that point, the ability to administer our country's tax system will
+be in grave danger. Such a risk to our nation is unacceptable. We
+remain convinced that the overall Modernization plan is sound and well-
+designed. The challenge is executing that plan. The IRS and the Prime
+must get it right this time.\6\
+---------------------------------------------------------------------------
+ \6\ Larry R. Levitan, IRS Oversight Board Testimony before House
+Ways and Means Oversight Subcommittee Hearing on IRS BSM Program,
+February 10, 2004.
+---------------------------------------------------------------------------
+ The Board's proposed budget provides the stable resources needed to
+focus and stabilize the steady stream of funding for the IRS' computer
+modernization initiative. Special controls are in place to ensure that
+no funding in this account is spent until the IRS has the capability to
+spend it effectively. If the IRS does not correct the weaknesses in the
+BSM program by FY2005, the Board advocates that the funds earmarked for
+modernization should not be spent. However, the Board does not believe
+the IRS should plan for failure. The agency must be poised to move
+forward with BSM once it has demonstrated that it has corrected the
+program's weaknesses. The funding level recommended by the Board sets
+the foundation for genuine progress for the program in FY2005.
+ The Board expects that the Customer Account Data Engine (CADE)
+Release 1 will occur in 2004. Over the next year, the IRS will test and
+build upon that system. The IRS should continue to strengthen its
+ability to manage the program and the Prime to deliver projects on
+budget and on time. By the end of FY2005 and early FY2006, the IRS
+should be able to proceed with the remaining releases of CADE as
+quickly as possible. This will minimize future risk and the long-term
+cost of modernization while providing a basis to deliver tangible
+results for taxpayers.
+ If the IRS' FY2005 BSM funding is reduced to $285 million, as it is
+in the Administration's budget, future funding likely will be adversely
+affected. If that happens, the projects will drag on, risk will
+increase, and ultimately, the program will cost taxpayers much more.
+ For that reason, the Board believes FY2005 BSM funding should be
+set at $400 million, with only $285 million put into the FY2005 spend
+plan. This will allow the IRS' Business Systems Modernization fund to
+operate like a multi-year fund, as originally envisioned by Congress
+and as the Board has recommended each year since its inception.
+ Further, as its archaic, tape-based computers begin to give way to
+modern business systems, the IRS must plan for a smooth transition. The
+Board's budget recognizes that need. As new systems are incorporated,
+the IRS must plan to operate both the old and new systems in parallel
+for some time. The IRS must also retain employees with critical skills
+while training existing and new employees to use new systems. This will
+allow the IRS to reduce the risk of a catastrophic disruption to the
+system.
+ In addition, the Board believes that the transition to
+modernization is a real cost that must be incurred. There are no short
+cuts to successful modernization--the IRS' budget must reflect the real
+cost of maintaining legacy systems while simultaneously supporting
+modernized systems. Accordingly, the Board recommends an additional $25
+million to cover these costs. The Administration's budget fails to
+acknowledge them.
+
+The Administration's FY2005 Budget Request
+ By comparison, the Board believes the Administration's FY2005
+budget cannot achieve its stated goal to add almost 2,000 personnel to
+bolster the IRS' enforcement efforts, and will threaten hard-earned
+improvements in customer service. This year's request will lead to a
+$230 million shortfall in the IRS budget because it fails to budget
+adequately for the anticipated $130 million of congressionally-mandated
+civilian pay raises, rent increases, and at least $100 million of
+unfunded expenses.
+ In its FY2005 budget recommendation, the Board anticipates a 3.5
+percent pay raise for civilian employees, which achieves parity with
+the Administration's call for a 3.5 percent military pay raise. The
+Administration, but contrast, calls for a 1.5 percent civilian pay
+raise. While discussions are now underway in Congress regarding parity,
+the Board believes that the 1.5 percent civilian pay increase fails to
+recognize recent history.
+ In fact, FY2005 is the fourth year in a row in which the
+Administration has called for IRS staff increases, while not covering
+pay raises or required expenses.
+ As a result, the Administration's proposed increase in the IRS'
+FY2005 budget will erode before new employees can be hired, more
+taxpayer phone calls can be answered, or new audits of possible tax
+cheats can be conducted.
+Impact of $230 Million Budget Shortfall on Three Major IRS Functions
+
+[GRAPHIC] [TIFF OMITTED] T3828A.008
+
+Board Cites Complexity as Fundamental Flaw
+ The IRS Oversight Board is precluded by law from addressing tax
+policy issues, but it would be remiss not to address the cost of our
+nation's complex tax system; a cost ultimately borne by taxpayers and
+the IRS. The Administration's legislative proposals contained in its
+budget request only begin to address the problems caused by complexity.
+The approach so far to tax simplification fails to address a
+fundamental flaw in our tax system: its costly, confusing, and
+debilitating complexity. The Administration has, however, requested
+that Congress provide some relief in FY2005 on the Alternative Minimum
+Tax, but has not yet identified a long-term solution.\7\ In her annual
+report, IRS National Taxpayer Advocate Nina Olson recommended repeal of
+the AMT, saying:
+---------------------------------------------------------------------------
+ \8\ Recent public remarks by Treasury Secretary Bodman noted that
+the President's budget extends through 2005 the temporary increase in
+the AMT exemption and the provision that allows certain personal
+credits to offset the AMT. These temporary provisions will keep the
+number of taxpayers affected by the AMT from rising significantly in
+the near-term. More importantly, they will allow the Treasury
+Department the time necessary to develop a comprehensive set of
+proposals to deal with the AMT in the long-term. Treasury Press Release
+JS-1250 contains the full statement of his remarks.
+---------------------------------------------------------------------------
+ The AMT is extremely and unnecessarily complex and results in
+inconsistent and unintended impact on taxpayers. . . . [T]he AMT is bad
+policy, and its repeal would simplify the Internal Revenue Code,
+provide more uniform treatment for all taxpayers, and eliminate the
+oddity of dual tax systems. AMT repeal would also allow the IRS to
+realign compliance resources to facilitate more efficient overall
+administration of the tax code.\8\
+---------------------------------------------------------------------------
+ \8\ Olson, p. 16.
+---------------------------------------------------------------------------
+ The Board fully concurs with her assessment, and urges the
+Administration and Congress to consider accepting this recommendation
+in future legislation.
+
+Conclusion
+ The Board was established to bring to bear its collective expertise
+and familiarity with private sector best practices on the IRS'
+problems. To the private-life Board members, investments in enforcement
+pay for themselves many times over, not only in revenue dollars but by
+the deterrence value of reinforcing the belief that all taxpayers are
+paying their fair share. A strong business case can be made for
+providing the IRS with several hundred million dollars so it can
+collect billions in revenue. At a time when federal revenue as a
+percentage of the economy has shrunk to 1950s levels and we face a $500
+billion deficit, the Board believes it imperative that we strengthen
+our tax collection system.
+ For that reason, the Board recommends that both Congress and the
+Administration reevaluate their methodology by including the revenue
+value to the country when estimating budget requests for the IRS.
+Indeed, considering the positive impact of additional resources
+provides a better framework for making informed decisions and will lead
+to a more effective IRS.
+ In conclusion, the Board calls for Congress to stay the course it
+set more than five years ago with the passage of the IRS Restructuring
+and Reform Act. The IRS has made progress in carrying out the spirit
+and letter of the Act; we must now give it the resources to finish the
+job.
+ ______
+
+
+ IRS Oversight Board FY2005 IRS Budget Recommendation and Administration
+ Request: Program Summary Comparison
+ Administration FY2005 Budget Request Preogram Summary
+ (dollars in millions)
+------------------------------------------------------------------------
+ Increase
+ Appropriation Title FY2004 FY2005 OB ---------------------
+ Enacted request $millions Percent
+------------------------------------------------------------------------
+Processing, Administration $4,009 $4,148 $139 3.5%
+ and Management
+------------------------------------------------------------------------
+Tax Law Enforcement $4,171 $4,564 $393 9.4%
+------------------------------------------------------------------------
+Information Systems $1,582 $1,642 $60 3.8%
+------------------------------------------------------------------------
+Business Systems $388 $285 -$103 -26.5%
+ Modernization
+------------------------------------------------------------------------
+Health Insurance Tax Credit $35 $35 $0 0.0%
+ Administration
+------------------------------------------------------------------------
+Appropriation $10,185 $10,674 $490 4.8%
+------------------------------------------------------------------------
+
+
+ IRS Oversight Board FY2005 Budget Request Program Summary
+ (dollars in millions)
+------------------------------------------------------------------------
+ Increase
+ Appropriation Title FY2004 FY2005 OB ---------------------
+ Enacted request $millions Percent
+------------------------------------------------------------------------
+Processing, Administration $4,009 $4,291 $282 7.0%
+ and Management
+------------------------------------------------------------------------
+Tax Law Enforcement $4,171 $4,770 $598 14.3%
+------------------------------------------------------------------------
+Information Systems $1,582 $1,708 $126 8.0%
+------------------------------------------------------------------------
+Business Systems $388 $400 $12 3.1%
+ Modernization
+------------------------------------------------------------------------
+Health Insurance Tax Credit $35 $35 $0 0.3%
+ Administration
+------------------------------------------------------------------------
+Appropriation $10,185 $11,204 $1,019 10.0%
+------------------------------------------------------------------------
+
+ ______
+
+
+ Unfunded IRS Costs, FY 2002-2004
+ (in millions, rounded)
+------------------------------------------------------------------------
+ Detail FY 2002 FY 2003 FY 2004
+------------------------------------------------------------------------
+Labor Inflation
+------------------------------------------------------------------------
+Unfunded Pay Raise Increase $42.3 $128
+ (President's Request to Congressional
+ Action)
+------------------------------------------------------------------------
+ $42.30 $128
+------------------------------------------------------------------------
+Non-Labor Inflation
+------------------------------------------------------------------------
+Rent Shortfall $32 $54.0
+------------------------------------------------------------------------
+Postage $16 $53.0
+------------------------------------------------------------------------
+Corporate & Electronic Contracts $23
+------------------------------------------------------------------------
+Health Service Contract $3 $2
+------------------------------------------------------------------------
+Interpreter's Contract $0.5 $0.3
+------------------------------------------------------------------------
+Child Care Subsidy $1
+------------------------------------------------------------------------
+Increased Department of Labor EFAST $2
+ Contract Processing Costs
+------------------------------------------------------------------------
+ $55 $132.00
+------------------------------------------------------------------------
+Added Requirements
+------------------------------------------------------------------------
+Background Investigations $4
+------------------------------------------------------------------------
+Increase Cash Awards from 1.24% to $8 $16
+ 1.42%
+------------------------------------------------------------------------
+Competitive Sourcing $8
+------------------------------------------------------------------------
+Campus Security Response $15
+------------------------------------------------------------------------
+Congressional Mandates $5
+------------------------------------------------------------------------
+Guard Services $20 $16
+------------------------------------------------------------------------
+Public Transportation Subsidy $9
+------------------------------------------------------------------------
+ $56 $44
+------------------------------------------------------------------------
+
+------------------------------------------------------------------------
+Total $153 $304
+------------------------------------------------------------------------
+Total less pay raise and rent $79 $122
+------------------------------------------------------------------------
+
+------------------------------------------------------------------------
+
+
+ Where the Additional Enforcement Resources Are Applied
+ (in thousands rounded)
+----------------------------------------------------------------------------------------------------------------
+ Oversight Board Administration Difference
+ Recommendation Recommendation ---------------------
+ Enforcement Initiatives --------------------------------------------
+ Budget FTE Budget FTE Budget FTE
+----------------------------------------------------------------------------------------------------------------
+SBSE-2 Curb Egregious Non-Compliance 159,264 1,408 90,161 874 $69,103 534
+----------------------------------------------------------------------------------------------------------------
+SBSE-3 Select High-Risk Cases for Examination 5,500 0 0 0 $5,500 0
+----------------------------------------------------------------------------------------------------------------
+SBSE-7 Savings through Consolidation--Case 16,085 200 14,469 144 $1,616 56
+ Processing
+----------------------------------------------------------------------------------------------------------------
+SBSE-8 Savings through Consolidation-- 7,656 69 5,531 65 $2,125 4
+ Insolvency Processing
+----------------------------------------------------------------------------------------------------------------
+WAGE-2 Increase Individual Taxpayer Compliance 46,406 521 15,469 175 $30,937 346
+----------------------------------------------------------------------------------------------------------------
+WAGE-9 Improve ITIN Application Process 15,484 50 0 0 $15,484 50
+----------------------------------------------------------------------------------------------------------------
+WAGE-10 Eliminate Erroneous EITC Payments 18,000 0 0 0 $18,000 0
+----------------------------------------------------------------------------------------------------------------
+LMSB-1 Combat Corporate Abusive Tax Schemes 60,017 394 36,100 207 $23,917 187
+----------------------------------------------------------------------------------------------------------------
+TEGE-1 Combat Diversion of Charitable Assets 3,914 44 3,914 44 $0 0
+----------------------------------------------------------------------------------------------------------------
+TEGE-5 Stop Abusive Transactions in the TEGE 11,140 100 11,140 100 $0 0
+ Community
+----------------------------------------------------------------------------------------------------------------
+CI-1 Combat Financial Fraud in the Corporate 25,600 98 25,600 98 $0 0
+ Sector
+----------------------------------------------------------------------------------------------------------------
+CI-2 Dismantle International and Domestic 12,208 80 0 0 $12,208 80
+ Terrorist Financing
+----------------------------------------------------------------------------------------------------------------
+CI-3 Reinforce Core Mission Tax Enforcement 34,086 130 34,086 130 $0 0
+ Resources
+----------------------------------------------------------------------------------------------------------------
+CI-7 Forensic Electronic Evidence Acquisition 3,104 4 3,104 4 $0 0
+ and Analysis
+----------------------------------------------------------------------------------------------------------------
+CI-10 Leverage/Enhance Special Agent 2,500 28 2,500 28 $0 0
+ Productivity
+----------------------------------------------------------------------------------------------------------------
+APPEALS-1 Resolve Appeals 13,945 112 7,000 56 $6,945 56
+----------------------------------------------------------------------------------------------------------------
+COUNSEL-1 Combat Abusive Tax Avoidance 10,852 75 5,426 38 $5,426 37
+----------------------------------------------------------------------------------------------------------------
+NHQ-2 Deliver Strategic Compliance Data 2,712 2 0 0 $2,712 2
+----------------------------------------------------------------------------------------------------------------
+FY2005 Enforcement Increases 448,472 3,315 254,500 1,963 $193,972 1,352
+----------------------------------------------------------------------------------------------------------------
+
+
+
+
+ Chairman HOUGHTON. Let me ask Mr. White a question, and
+then we will come back to you, Ms. Killefer. Mr. White, the
+Commissioner showed us a chart showing the audit rates of those
+making over $100,000 and they are increasing. The GAO has done
+previous work on the ways the IRS assures compliance through
+other means, such as document matching. Do you think the IRS
+has taken the right steps to make sure all taxpayers are paying
+what they owe?
+ Mr. WHITE. I would make several points, Mr. Chairman. It is
+true that there are substitutes for certain types of audits.
+There may not be substitutes for the more complex face-to-face
+types of audits. Another point I would make though is that
+right now IRS does not know the size of the compliance problem.
+They do not have a current measure of the compliance rate. The
+last time they measured the compliance rate was using 1988 tax
+return data. So, they are in the process of developing a new
+measure, but it is not going to be available for at least
+another year, so we do not know the size of the problem.
+ In terms of steps that IRS can take to actually increase
+enforcement, there are several things they can do. One is to
+use their existing enforcement resources more efficiently.
+Their efforts to measure compliance should help them better
+target pockets of noncompliance, and therefore better allocate
+their existing resources. Right now they are sort of flying
+blind when it comes to allocating resources because it has been
+so long since they researched where noncompliance is. Another
+thing they need to do to use the existing enforcement resources
+more efficiently is make sure the business systems
+modernization is successful. They need to bring the new systems
+online. That will help.
+ Finally, something else they can do is free up resources
+from other parts of IRS and transfer those resources,
+reallocate those resources into enforcement work. One example
+is e-filing. I said in my statement that e-filing has now
+started to result in decreases in the number of processing
+staff at IRS. In 2003 they reduced the number of processing
+FTEs by about 1,000. They can also reconsider the level and
+types of services that they offer. Now the telephone service is
+so much improved, now that the Internet provides options that
+didn't exist even a couple of years ago, maybe it is time to
+raise the question of whether as many walk-in sites are needed
+at IRS. In fact, taxpayers are already making this decision.
+The number of taxpayers who use walk-in sites has been steadily
+declining at IRS. So, there are some opportunities to free
+resources from other parts of IRS and shift them into
+enforcement.
+ Chairman HOUGHTON. It seems almost impossible for me to
+believe that they do not know the size of the problem. Break
+that down a little bit.
+ Mr. WHITE. The last time they measured compliance, the rate
+at which taxpayers are paying what they know--this gets back to
+the measure of the tax gap which is the difference between what
+people ought to owe and what they are actually paying. The last
+time they estimated that compliance rate with a statistically
+valid approach was based on 1988 tax return data. Since then we
+have had tremendous changes in the economy. They now have their
+National Research Program to come up with a new measure of the
+compliance rate, but as I said, those results will not be
+available for another year.
+ Chairman HOUGHTON. What about the chart that the
+Commissioner used in terms of the enforcement resources that
+have been halted, and the effort remains below what is needed?
+There has got to be some relationship to the resources put in
+and to the people that are not complying or they don't think
+are complying.
+ Mr. WHITE. That is the fear that many people have, that
+because of the decline in those enforcement resources and what
+that has meant for their ability to conduct enforcement, that
+people's willingness to voluntarily comply may be going down.
+They have less incentive to comply than they did before, that
+they view IRS as less of a credible enforcement threat. The way
+I often think about this is from the point of view of honest
+taxpayers. Those taxpayers--and I think you raised this issue
+yourself--the system depends on trust. The confidence that
+honest taxpayers have that their friends, neighbors and
+business competitors are paying their fair share of the taxes,
+and if we ever lose that, then the compliance rate will suffer.
+ Chairman HOUGHTON. Ms. Killefer, I would like to go back to
+some of your statements. I suppose the law which created the
+Oversight Board gave you the proper authority and the resources
+to do your job. Is that right?
+ Ms. KILLEFER. In many ways, yes. I think we have learned
+over the course of the first three plus years of the Oversight
+Board we have a couple of things that were not foreseen. For
+example, as you all know, the nomination process is a lengthy
+one, and we currently have two vacant Board seats. We will have
+a couple more coming up. It is very difficult to conceive of
+the Board operating without a full membership as it was
+conceived. So, there are some things that we are learning as we
+go. Indeed, we were given the authority to submit a budget, but
+we have learned that we have become a footnote in the
+President's budget. Hence, we have started to issue our own
+report and appreciate the opportunity to testify here to be
+clear about what we think are the necessary resources.
+ Chairman HOUGHTON. I am sure you are very worried about the
+expense to revenue ratio. Whether this is going to turn around
+overnight or not, I have no idea. Probably not. The nonmilitary
+discretionary account, which is now about one-sixth of the
+overall budget, is getting squeezed all the time. I think it is
+a good idea. We are in a national crisis. We have to support
+our troops abroad. Hopefully it will not be as much in the
+future as it has been the last 2 years, but we have to do our
+bit here. If you look at a budget of an agency that is $10.7
+billion, you have to believe that there is some opportunity for
+maneuvering, and I know it is not what you want, and I know you
+have suggested other resources, and I know there are other
+things as far as compliance that are important. Isn't there an
+opportunity with that size budget to do some of the things,
+particularly since we are in such a cost crunch in the country?
+ Ms. KILLEFER. Chairman, what I would say is from a private
+sector point of view it is unfortunate that the Federal budget
+views this as a cost center and fails to be able to recognize
+its revenue potential. If you had a company--and I know you
+have--and had the opportunity to invest in growth and revenue,
+would you do it? I know the answer is yes. That is what we are
+facing here. When you talk about the IRS, and it is 100,000
+people, recognize that the sheer processing of returns, which
+has gone up every year and become more complex every year, and
+the answering of the phone calls, right, the very basic
+processing simply needs to get done. That is what has driven
+down the enforcement resources. It has not been a desire to do
+less enforcement. It has been the problem of with a fixed
+amount of resource--you have seen they have not gone up--the
+number of returns has gone up, the complexity of the returns
+has gone up, so you have an increasing workload with a fixed
+amount of resources, and what you have to do is process basic
+returns, answer the phone calls, put out the tax forms, and the
+discretionary becomes enforcement.
+ Chairman HOUGHTON. Yes, but there was a seismic shift in
+the structure of the IRS that took away from some of the
+enforcement capabilities, but now, getting back into balance, I
+would imagine that that would be lightened a bit.
+ Ms. KILLEFER. If you call it a seismic shift to take the
+phone service from less than 50 percent to now currently 80
+percent, it was. If you consider that you want to go back to 50
+percent so that you can fund enforcement? I think that is a
+promise that we would disagree with as a Board. We believe
+that----
+ Chairman HOUGHTON. That is not my process.
+ Ms. KILLEFER. Why did we put----
+ Chairman HOUGHTON. My question is this: you have $11.7
+billion. Why can't you work something in terms of the things
+you think are important within that overall figure?
+ Ms. KILLEFER. Chairman, there have been productivity
+improvements at the IRS, in fact, completely in line with the
+financial sector of this country. So, they have achieved
+productivity. As Jim pointed out, we have gotten more
+electronic returns. The Brookhaven Center has shut down. We are
+shutting down another center. There will be another coming.
+Productivity improvements have occurred, but what you have here
+is an increasing workload at the same time, and we are off
+base--and I think a false base--of an unacceptable level of
+service, and we don't know whether it was the right level of
+enforcement. So, the premise that we started out with an
+adequate base and therefore can achieve productivity and
+redeploy, I think is a false premise. We were at an
+unacceptable level. I think if you go back and look over
+history, there are times that the IRS was funded at a much
+greater level, in the mid nineties. It is simply, if you just
+run the workload numbers, you cannot do the work that needs to
+get done and support an enhancement of the enforcement efforts.
+ Chairman HOUGHTON. Mr. Pomeroy.
+ Mr. POMEROY. That was a very interesting exchange and I
+agree with both perspectives that were voiced. I think the
+Chairman raises a good point, that we want to capture all
+efficiencies and the savings flowing from them, and redirect
+them to agency priorities, and that would certainly be
+enforcement. At the same time I think you have been such an
+advocate, Ms. Killefer, I am making certain we understand
+enforcement takes funding. Failure to fund enforcement means
+people don't pay their taxes and you leave revenue uncollected,
+revenue that is owed under the law, revenue that most law-
+abiding taxpayers are paying, but some who are breaking the law
+are not paying. It is indeed a revenue center. Do you have any
+ball-park notion of for every dollar spent on enforcement, what
+you might collect in revenues?
+ Ms. KILLEFER. As Jim said, there are no recent
+calculations. The old numbers were approximately 10 or $11 per
+dollar spent, but those are very, very old, and I would not
+suggest that those are correct today.
+ Mr. POMEROY. When I was in the State legislature we enacted
+a program called Catch the Tax Cheater Program, and for every
+dollar expended we got $10 in revenue. I would believe, in
+fact, when we look at the demise of collections, driven by
+demise of audits, we might even do better than 10 to 1 in this
+environment. Mr. White, do you have any notions in that regard?
+ Mr. WHITE. We don't have any independent estimates. IRS has
+done some very crude guesstimates on it which suggest that you
+could bring in more than a dollar that you spend. They don't
+have a very good database for making those estimates, however.
+ Mr. POMEROY. I think that in helping Congress understand
+that funding IRS is in part a revenue center, not a cost
+center, some greater quantification of this would be helpful.
+ Ms. KILLEFER. Absolutely.
+ Mr. POMEROY. I hope we can work toward getting some better
+figure here. Let me turn to the back part of your testimony,
+Ms. Killefer, which talks about specifically enforcement
+activities requested but not collected. We spent an awful lot
+of time talking about abusive corporate tax shelters. I note
+that the funding requested by the Oversight Board was almost
+double what was funded by the Administration. Funding was
+reduced $23 million, 187 positions. Is that correct?
+ Ms. KILLEFER. That is correct.
+ Mr. POMEROY. Is it your belief that there will therefore be
+abusive corporate tax shelters that will not be caught, and
+there will be tax revenues owed but not paid because of these
+abusive corporate tax shelters and our somewhat limited ability
+to catch and deal with them?
+ Ms. KILLEFER. We do have that concern, and history would
+suggest that that is true.
+ Mr. POMEROY. There is another line item that is even more
+stark in terms of positions requested by the Oversight Board
+but not funded, and this is dismantling international and
+domestic terrorist financing. You request $12 million, 80
+positions. Nothing was granted, no positions, no dollars to
+this request for dismantling international and domestic
+terrorist financing. Can you give us some background on that?
+ Ms. KILLEFER. The IRS I think traditionally over time has
+played an important role beyond sheer tax collection, be it the
+old Al Capone case. We feel that it really has the ability and
+the talent from its financial actuarial skills actually to play
+a great service to the country. So, we felt it was worthy to
+fund. I am not sure what the Administration is thinking. I am
+sure that they share our intent. I just think that that is the
+way the dollars fell out.
+ Mr. POMEROY. We have been working for some years to try and
+get at the financial underpinnings of international terrorism.
+Is the IRS without the capability to participate in that
+effort?
+ Ms. KILLEFER. I am not sure how they will actually end up
+allocating resources when they finally get their budget.
+ Mr. POMEROY. The Oversight Board came to the conclusion
+that we need to play a more robust role in attacking the
+international financing of terrorist, and 80 positions ought to
+be committed in this regard. None were allowed by the
+Administration.
+ Ms. KILLEFER. That is correct.
+ Mr. POMEROY. Thank you, Mr. Chairman.
+ Chairman HOUGHTON. Thanks, Mr. Pomeroy. Mr. Portman.
+ Mr. PORTMAN. Thank you, Mr. Chairman. I would like to hear
+the Administration's response to that 80 positions. I would
+imagine that they have allocated resources through some means,
+and I hope we can get that in writing from the Administration.
+ Ms. Killefer, I thank you very much for not just being here
+today, but for the work you do on the Board, and as you know, I
+think the Board is critically important, and when we created
+the Board we gave the Board a few very important
+responsibilities that were in the area of approval and not just
+review and oversight, and one was in preparing a budget which
+would go to the Secretary, to the President and then require it
+to be submitted to the Hill. This year your budget, as I read
+it, is about 5 percent greater than the Administration's
+request, last years, about 2.7 percent.
+ This is, frankly, what we expected to have happen. You
+indicated that back in the nineties the IRS was funded better.
+I assume you mean that in relative terms because in the mid
+nineties you referred to, we went from 7.4 billion down to 7.3
+billion, down to 7.2 billion by 1997, and in 1998, when we
+issued our Restructuring and Reform Commission Report and then
+legislated, we went back up to 7.8 billion, and since then we
+have gone up. Earlier we said this proposal the Administration
+has before us is for a 4.8 percent budget increase. Remembering
+that there will be, in the congressional, budgeting process, I
+believe, a freeze on all non-security domestic discretionary
+spending, which includes the IRS, the Administration had less
+than a 1-percent increase, so the IRS did relatively well
+compared to other agencies and Departments.
+ Given what our deficit is and given where we are as a
+country right now, in fighting the war on terrorism, that is a
+fairly healthy increase. So, I just want to put that in some
+perspective to make sure we are not leaving the impression with
+those who might be listening that somehow we are terribly
+shortchanging the agency. In fact, in the Bush years, we have
+gone up almost 14 percent in spending for the IRS. It is tough.
+Every year this Subcommittee or at least some of its membership
+takes into account what the Oversight Board tells us, and our
+own independent analysis, and we fight with the appropriations
+process to try to be sure that there is adequate funding. The
+IRS is not always the most popular agency to fund. This year I
+think a 4.8-percent increase, again, is generous, and that is
+why we wrote a letter, the three of us, to the appropriators
+asking that that be fully funded. We are not suggesting how
+that is allocated between various enforcement and taxpayer
+service accounts, but we believe that at a minimum we ought to
+have this rather substantial increase in funding, again,
+relative to other agencies and Departments.
+ So, having said all that, I very much appreciate your
+budget and I appreciate the fact that you have laid out for us
+what you think the priorities are. I do think it is a little
+dangerous to get into saying, gee, because the Oversight Board
+has said specifically there ought to be 80 positions here, that
+if the budget of the Administration doesn't fund those, that
+that function somehow isn't accommodated--I don't know if it is
+or not--but that wasn't really the purpose of the Board, to get
+into that kind of micro management. It was the purpose to give
+us your unvarnished view of what you think the needs really are
+within a realistic framework, and I think you have done that.
+One quick question for you. The Oversight Board, as you know,
+is currently being reviewed as well, and as a strong supporter
+of the Board and someone who believes that it has met its
+intended purpose to provide oversight, do you think the Board
+itself is being given adequate support and adequate resources
+to do its job?
+ Ms. KILLEFER. That was a question that Chairman Houghton
+asked before, and I said we have learned through this first 3
+plus years of the Board that there are some things that were
+not foreseen. As you know, having spent time with us, we
+actually are short two members and the nomination process has
+proved quite lengthy, and that has left us understaffed from a
+member standpoint. We also have some issues about continuity of
+our Board staff that concern us, and so we actually would
+suggest there may be some changes that we all want to make in
+the interest of ensuring the Board actually fulfills its intent
+over time, and having the strength of a full membership at all
+time and continuity in its staff support.
+ Mr. PORTMAN. That would be sensible since one of the main
+reasons for the Board was to provide continuity as well as
+expertise and accountability, and I think those are functions
+that have been performed very well. This hearing today is an
+example of that. I would just again say we need to keep it in
+perspective, that the Administration is proposing a substantial
+increase. The Commissioner, as you testified earlier, is
+focusing that increase where it needs to go right now, which is
+on enforcement, at the same time recognizing that we should
+never sacrifice the service gains we have made. We cannot allow
+this pendulum to swing, and that is where the Board provides an
+invaluable break on what might otherwise be the tendency in
+government to swing from one, in this case, enforcement, away
+from taxpayer service. They are consistent with one another I
+believe, and we will have that theory tested I suppose over the
+next couple of years as we try to do both. Thank you, Ms.
+Killefer.
+ Chairman HOUGHTON. Thank you, Mr. Portman. Mr. Pomeroy.
+ Mr. POMEROY. Ms. Killefer, I would like to come back to
+these positions in the international and domestic terrorist
+budget request. Can you tell us a little bit about the
+activities that you envisioned this corps doing? If you are not
+prepared to speak to it, I will certainly request some follow
+up writing regarding this matter, but it really does jump out
+as a pretty serious difference of opinion between the Oversight
+Board and the Administration. Can you give us information on
+it?
+ Ms. KILLEFER. Let me say that I don't know that it is as
+serious a disagreement as it would appear. I think what we
+reviewed as a Board in putting together the budget is where we
+felt there were initiatives that required increased resources.
+That was one of them you see among many in the enforcement
+arena. I am not sure the thinking that went on in the
+Administration as they tried to generate a budget that fit into
+the total budget, but they clearly brought down their request
+that both the IRS and we submitted. In doing that they made
+some choice. I am not sure that they are the ultimate choices
+that they will actually make when they receive a budget level.
+How they allocate resources post getting a budget among
+initiatives, I am not sure what they will do. I would be happy
+to provide you with detail around that initiative to give you
+some sense of why we approved it.
+ Mr. POMEROY. I would very much like that information, and I
+believe you have been kind in your characterization. You
+requested 80 positions. They did not give you any positions.
+This isn't just kind of differing at the edges of this
+proposal. It seems as though you believe that within the IRS
+structure and competencies, tracking the international flow of
+money to finance terrorism is something you would have very
+substantial enforcement powers to move out. I believe that most
+Americans think we need all hands on deck on this one, and if
+IRS can play a role along with the major criminal investigatory
+powers of this country, and whatever resources are being
+brought to bear, it would in all likelihood be a very helpful
+addition. So, I am going to want to pursue this and get some
+answers.
+ Ms. KILLEFER. We certainly do believe they can play a
+meaningful role in this, given their skills.
+ Mr. POMEROY. Then I would certainly like to know where
+specifically you see that and then engage the OMB in some
+discussions as to why they so completely disagreed and
+eliminated you from participating in this area. I thank the
+Chair and look forward to receiving the information from the
+witness. Thank you.
+ Chairman HOUGHTON. Mr. Portman.
+ Mr. PORTMAN. I should probably stop here, but I just have
+to say to my friend, Mr. Pomeroy, and to my friend, Nancy
+Killefer, I do think the Oversight Board has incredible
+expertise and specifically under law you are supposed to have
+expertise in management, which you do, and information
+technology, as Larry does, and in reorganization of large
+corporations and even small business expertise. We did not
+select you for your expertise on terrorism. So, I would hope
+that those who are listening, again, would not assume that this
+Oversight Board has the ability to decide how our government
+should be drying up resources to terrorists. That is not a
+function we looked for you to perform, and I am frankly
+disappointed that the Oversight Board is making recommendations
+about where they think terrorism ought to be approached within
+the IRS budget. That was not the idea. We do respect your
+budget, and I am again delighted to have it, but I would hope
+that we would understand that this Board--and this was a very
+controversial Board to set up--was put in place with some very
+specific constraints and very specifically looking for
+expertise in the areas where the IRS was most lacking, and that
+was in management, information technology and small business,
+and taxpayer sensitivity, and not, as important as it is, in
+fighting the war against terrorism. Thank you, Mr. Chairman.
+ Mr. POMEROY. You know the depth of my regard for my
+colleague, Rob Portman, and there has not been a legislator of
+the 435 of us more committed over the long haul to making sure
+the IRS is focusing on the right priorities and has the
+resources to do it, and he is in the weeds in technical
+competencies and he has worked it over time with great
+conscientiousness, and I admire his work in this area a great
+deal. I want to take a little issue with what he was just
+talking about in this area. Ms Killefer, you, as one Board
+Member, do have some background in international finance; is
+that correct?
+ Ms. KILLEFER. Yes, sir, some.
+ Mr. POMEROY. You are in fact a senior partner at McKenzie
+and Company, and indeed have a specific expertise within that
+company in international management consulting; is that
+correct?
+ Ms. KILLEFER. It is an international management consulting
+company.
+ Mr. POMEROY. You have held a variety of positions, public
+and private, relating not just to the flow of finance
+domestically, but internationally; is that correct?
+ Ms. KILLEFER. To some extent. I would say what--just to
+clarify for both of you--that what the Board does when it
+construct its budget--is work very closely with the IRS and
+look at a series of initiatives that we don't propose, that
+they propose to us as ones that would meet their mission. It is
+through that process that among other things this was one of
+their initiatives. So, we did not propose it, nor would we
+expect to propose initiatives to them.
+ Mr. POMEROY. Many illegal conspiracies have ultimately been
+brought down by investigators following the flow of money.
+Following the flow of money is something the IRS is pretty good
+at, isn't it?
+ Ms. KILLEFER. I would think so. There are other elements of
+government that do the same.
+ Mr. POMEROY. Undoubtedly, and there have been no
+discussions this afternoon about taking all other investigative
+areas here and stripping it from those agencies and putting it
+in the IRS. That is not what we are talking about at all, but
+we are talking about being able to tap some of the
+extraordinary institutional potential in the agency that
+through history has been in charge of basically following the
+money, finding out what is owed to our government, collecting
+it, including not just taxpayers at the H&R Block Office this
+afternoon, but very sophisticated international enterprises.
+That some of this in-house expertise, if augmented with
+appropriate resources, could have played a very interesting
+additional role perhaps in back-stopping these other agencies.
+So, as the Board, with all of its tremendous sophistication in
+international finance, evaluated this proposal from the IRS, it
+isn't as though you are without expertise, without competence
+to have an informed opinion on this matter, in my belief, and
+that is why I look forward very much to receiving this
+additional information from you. I thank the Chair. I yield
+back.
+ Chairman HOUGHTON. I feel like I have been at a tennis
+match here.
+ [Laughter.]
+ Mr. White, you and I ought to have our own session here.
+Anyway, I thank you very much for your testimony. I appreciate
+the work. You are great citizens. I think we will now move on
+to our next panel. Mr. Orwick, who is the President and Owner
+of the LFS Professional IRSs; Richard Shaw, Chair of the Tax
+section, American Bar Association, Robert Zarzar, who is
+Chairman of the Tax Executive Committee at the American
+Institute of Certified Public Accountants, James Leimbach,
+Enrolled Agent, National Association of Enrolled Agents, and
+Timothy McCormally, Executive Director of the Tax Executives
+Institute. Now, Mr. Pomeroy, would you like to introduce the
+invited witness, Mr. Orwick?
+ Mr. POMEROY. I would be delighted. Allen Orwick is
+President and Owner of LFS Professional IRSs, a tax accounting
+and property management company located in Lakota, North
+Dakota, where he prepares income tax returns on more than 500
+filers. He has done this for 23 years.
+ We have had some exposure, Mr. Chairman, to some of the
+fanciest firms out there in terms of financial consulting and
+tax preparation. In my view, none exceed the professional
+integrity that Mr. Orwick brings to bear on behalf of his
+clients. He is not trying to stretch the law. He is trying to
+understand it, and he is trying to, therefore, give his advice
+to his taxpayer clients in terms of what they owe and what they
+do not owe. There is a significant issue that has come up
+relative to a major part of his work, and that is servicing
+retired farmers, and so we will hear from him on this question
+in the course of this panel.
+ I thank the Chairman, but I most particularly thank Mr.
+Orwick. I would just note as an aside, he is also the Mayor of
+Michigan, North Dakota. So, while he is in the depth of filing
+season, he is out here testifying, and, by the way, Michigan,
+North Dakota, is having significant flooding, which he is also
+dealing with at the same time. So, this is a man of many hats,
+but we are glad he is bringing his tax preparer hat to this
+table this afternoon. Thank you.
+ Chairman HOUGHTON. Well, Mr. Orwick, we are going to give
+you a chance to prove that you are as good as Mr. Pomeroy says
+you are.
+ [Laughter.]
+ So, thank you very much. Would you give your testimony?
+
+ STATEMENT OF ALLEN I. ORWICK, PRESIDENT AND OWNER, LFS
+ PROFESSIONAL SERVICES, INC., LAKOTA, NORTH DAKOTA
+
+ Mr. ORWICK. Thank you, Mr. Chairman and Mr. Pomeroy. I
+appreciate the opportunity to be here today. I am not so sure
+that I can live up to that billing, but I will do my best. Just
+to revisit, I have a tax practice located in Lakota, North
+Dakota. It is the northeastern part of the State, very
+agriculturally involved, also a county that has an aged
+population. So, the various issues that Mr. Pomeroy alluded to
+earlier are big, big issues in our home area. Overall, I would
+say our tax season is going very well. The day-to-day workings
+of the complex tax law, of course, seem to put more and more
+hours on myself and my staff every year. If I were to wish for
+one thing, I guess it would be simplification, like everybody
+else.
+ We have had various contacts with State agencies and the
+IRS and feel very fortunate to work with such high-quality
+people, and the courtesy and help that they have given us
+throughout the season are appreciated. Since 1997, we have been
+very involved in the e-file program, and as of last Sunday,
+when I tallied it up, we had utilized the e-file program for
+99.2 percent of the qualified tax returns. Of those that we did
+transmit, 98.4 percent were approved on the first transmission,
+which is something that we are very proud of. We are a big
+believer in the program and recommend use of the program to our
+peers.
+ In regard to the situation of the CRP, prior to the letter
+ruling that Mr. Pomeroy referred to earlier that was issued
+last May, it has been our understanding that CRP is to be
+reported as self-employment income for those who are actively
+farming, and rental income for those who are not. With this
+recent ruling, it has really thrown everybody into a frenzy as
+to whether or not that is the correct process or not. I
+participated in a meeting last Friday, put together by
+Congressman Pomeroy in Bismarck, North Dakota, and we had
+members of the IRS, myself, Dr. Harl, and our State Agriculture
+Commissioner there. During that meeting, there were a lot of
+different thoughts brought forward, but what we did notice is
+no resolution.
+ It is a huge item to a retired person, and it looks as
+though about 10 percent of my clientele could be adversely
+affected by this ruling if that is the case, with an average
+cost of $1,200 per taxpayer, which out of my firm alone is
+$60,000. This is money that the taxpayers did not count on
+paying when they walked into my office. It was something that I
+had to inform them of possibly being out there. My clients are
+very conservative, and they are law-abiding citizens, and they
+want to do what is right. The problem we have today is that we
+don't know what is right because of the situation with this
+recent ruling.
+ I would like to mention Dr. Harl's recommendations at that
+meeting, one of which was the withdrawal of CCA Letter Ruling
+200325002 or reissue it and bring it into harmony with Private
+Letter Ruling 8822064 and giving us some time to go through and
+sort this matter out. I would hope that the IRS would look upon
+these recommendations and adopt them so that we can bring some
+certainty and closure to this matter. I would also like to
+mention that I support legislation that is being offered by
+Congressman Pomeroy and others to completely exempt CRP
+payments from self-employment tax. I want to thank you for the
+opportunity to be here today. I will answer any questions that
+you may have.
+ [The prepared statement of Mr. Orwick follows:]
+
+ Statement of Allen I. Orwick, President and Owner, LFS Professional
+ Services, Inc., Lakota, North Dakota
+
+ I am Allen Orwick, President and owner of LFS Professional
+Services, Inc., a tax accounting and property management company
+located in Lakota, North Dakota. I have been preparing income tax
+returns professionally for twenty-three years, owning my own practice
+since 1984. LFS Professional Services, Inc. specializes in the
+preparation of income tax returns for active and retired farmers in
+northeastern North Dakota, preparing approximately five hundred returns
+annually.
+ We have been very active in the Internal Revenue Service e-file
+program, first using the system to e-file 1997 tax returns. In 1999,
+the Internal Revenue Service chose LFS Professional Services, Inc. as
+an Exemplary Electronic Return Originator.
+ During the current tax season we have utilized the IRS e-file
+program for 99.2% of qualified returns. As of March 28, 2004, 98.4% of
+our transmitted returns were accepted the first time. We are very proud
+of our accomplishments in the e-file program and promote its use among
+our peers at every opportunity.
+ The current filing season has gone quite well. Our contacts with
+both federal and state agencies have been very positive experiences.
+Dealing with the complexity of the tax law is not always an easy task,
+my firm works very hard everyday to provide a high quality,
+professional service to our clients. The main area of concern this tax
+season has been Conservation Reserve Program payments and the manner in
+which they are to be taxed for retired taxpayers.
+ Many of our clients have some involvement with the Conservation
+Reserve Program. Prior to this year we have reported CRP payments based
+on previous Internal Revenue Service guidelines and court cases
+indicating that CRP payments received by an active farmer were subject
+to self-employment tax and those received by retired farmers were
+generally considered rental payments and exempt from self-employment
+taxes.
+ On June 23, 2003, the Internal Revenue Service released a Chief
+Counsel's letter ruling on the taxability of CRP payments for self-
+employment tax purposes. In CCA Ltr. Rul. 200325002 (May 29, 2003), the
+IRS took the position, one which appears to be directly contrary to
+Priv. Ltr. Rul. 8822064 (March 7, 1998), that a landowner's activities
+under a CRP contract amount to material participation and the payments
+should be reported on Schedule F, not Schedule E or Form 4835. In other
+words, even retired farmers must now pay self-employment taxes on CRP
+rental payments.
+ The ruling dealt with two fact situations involving CRP payments.
+In the first fact situation the taxpayer was engaged in the trade or
+business of farming and bid land into the Conservation Reserve Program.
+The second situation was of a taxpayer, not involved in the trade or
+business of farming, who acquired land that had already been bid into
+CRP. This ruling stated the CRP payments in both fact situations should
+have been reported on Schedule F and were liable for self-employment
+tax.
+ This latest CCA ruling on the second fact situation is at variance
+with prior Private Letter rulings and commentary issued with Tax Court
+decisions. It has created great concern and much confusion on how CRP
+proceeds are to be reported for retired landowners.
+ I participated in a panel discussion on this issue in Bismarck,
+North Dakota on March 26, 2004. At this meeting John Schmittdiel, an
+IRS Associate Area Counsel for the SB/SE division of Chief Counsel in
+St. Paul, Minnesota stated that CCA Lrt. Rul. 200325002 and Priv. Ltr.
+Rul. 8822064 were issued in response to single cases and were not meant
+to set a precedent. Another member of the panel, Dr. Neil E. Harl, the
+Charles F. Curtiss Distinguished Professor in Agriculture and Professor
+of Economics at Iowa State University, and one of the country's most
+respected agricultural tax scholars, stated that without clarification
+from Congress or specific rulings from the IRS, tax practitioners had
+to rely on what guidance is available including the two previously
+noted rulings on this matter.
+ The 2003 Internal Revenue Service Publication 225 (Farmer's Tax
+Guide) instructs taxpayers that ``Under, the Conservation Reserve
+Program (CRP), if you own or operate highly erodible or other specified
+cropland, you may enter into a long-term contract with the USDA,
+agreeing to convert to a less intensive use of the cropland. You must
+include the annual rental payments and any one-time incentive payment
+you receive under the program on lines 6a and 6b of Schedule F. Cost-
+share payments you receive may qualify for the cost-sharing exclusion.
+CRP payments are reported to you on Form CCC-1099-G.''
+ It is ironic that the instructions refer to these payments as
+``annual rental payments''. While rental payments a landlord might
+receive are not generally subject to the self-employment tax, rental
+payments under the CRP program are now subject to the self-employment
+tax. The USDA Farm Service Agency also uses the term ``rent'' when
+reporting CRP payments on Form CCC-1099-G. If it is truly ``rental
+income'' it should not be subject to self-employment taxes.
+ Legislation to exempt all CRP payments from self-employment tax was
+introduced for consideration in legislative bills of 2000, 2001 and
+2003. Many tax professionals feel legislative action is necessary to
+clearly define the Congress's intent relative to the circumstances
+when, if ever, CRP and other similar land idling program payments will
+be subject to or exempt from self-employment tax.
+ My clients are surprised to learn that self-employment taxes may
+apply to their CRP income while they are retired. There has been very
+little publicity on this subject in farm publications and local
+newspapers. Because of the IRS' recent ruling, tax preparers and
+retired landowners participating in the CRP program are unsure of how
+to file their income tax returns for 2003. Tax practitioners range from
+being unaware of the ruling to believing that CCA Ltr. Rul. 200325002
+is the most recent authority and must be followed. Others believe the
+recent ruling will be overturned or that it does not really apply to
+retired farmers based on previous authority. Unfortunately, this ruling
+does not address prior rulings and case law and the IRS has not issued
+any additional guidance.
+ It is my firm's opinion that each client must choose between two
+alternatives when filing their 2003 income tax return. The first choice
+is to pay the additional tax and hope for future relief, either from
+the IRS or Congress. The second choice is to prepare the return in the
+same manner as in previous years and disclose to the IRS that they are
+filing contrary to CCA Ltr. Rul. 200325002. If retired farmers are
+required to pay self-employment tax on their CRP income it will make a
+large difference on the total taxes they will be required to pay.
+ Based on all of the clients I have met with so far this tax season,
+approximately ten percent will be adversely affected by this recent IRS
+ruling, and all of the retired farmers owning CRP are affected. The
+average additional cost to those taxpayers is about $1,200. This
+equates to an additional $60,000 of self-employment taxes being paid by
+my clients alone. Most of these taxpayers are elderly and living a very
+moderate lifestyle. These are not private landowners who have never
+farmed and are looking at the CRP program as easy money or an
+investment, but instead are people who have generally farmed the same
+land for much of their lives and CRP payments are a significant source
+of their retirement income. This additional tax is a severe financial
+burden for them.
+ My clients are all law-abiding citizens and they want to do what is
+right. At this point I can not tell them what is right, because I do
+not know. My clients are conservative and tend to select the option
+that they feel has the least risk. A majority are choosing to pay the
+self-employment tax and hope that additional clarification will allow
+them an opportunity to amended their return and apply for a refund.
+ During the aforementioned March 26, 2004 panel discussion, Dr. Harl
+made the following recommendations:
+
+ 1. Withdrawal of CCA Ltr. Rul. 200325002, May 29, 2003, or
+reissuance with a narrowing of the ruling to harmonize with Ltr. Rul.
+8822064, March 7, 1988, this would remove much of the current
+confusion.
+ 2. The CCA Ltr. Rul. seems to apply to all federal conservation
+programs payments. It would be helpful to know whether that was
+intended.
+ 3. Have the IRS give guidance on the matter of SE tax liability
+for those who retire during the term of the CRP contract bringing
+clarification to this question.
+
+ I agree with Dr. Harl's recommendations. In addition, I believe
+that Congress should pass legislation to clear up once and for all it's
+intent on the tax treatment of Conservation Reserve Payments. It is
+very important to taxpayers and tax professionals that certainty and
+closure be brought to this issue. It is my hope that common sense will
+prevail and that at least those whom are retired, will not be subject
+to the self-employment tax.
+ Thank you for your consideration.
+
+
+
+ Chairman HOUGHTON. Well, I thank you very much for that.
+Also, I thank you for coming in under your time limit. That is
+very helpful.
+ Mr. Shaw.
+
+STATEMENT OF RICHARD A. SHAW, CHAIR, TAX SECTION, AMERICAN BAR
+ ASSOCIATION
+
+ Mr. SHAW. Good afternoon, Mr. Chairman and Mr. Pomeroy.
+Thank you. My name is Richard Shaw. I am Chair of the American
+Bar Association (ABA) section of Taxation. This testimony is
+presented on behalf of the 400,000 members of the American Bar
+Association and the 20,000 members of the section of Taxation.
+We appear before you today to specifically talk about one
+primary subject, and that is the subject of simplification. We
+want to emphasize it today. The ABA and the section of Taxation
+have long been advocates of simplification of the Tax Code.
+Last month, the Board of Governors and the House of Delegates
+of the Bar Association adopted a resolution which treats
+simplification as one of 12 of the highest priority legislative
+areas where we believe emphasis needs to be placed. We believe
+that complexity is at the root of many of the significant
+obstacles to efficient and effective administration of the tax
+laws. Let's talk first about complexity creates controversy.
+ As the National Tax Advocate and others have well
+documented, the scope and complexity of the tax laws make it
+virtually certain that taxpayers will face procedural,
+technical, and bureaucratic obstacles in trying to meet their
+tax obligations. This not only creates problems on the front
+end, when they are trying to prepare their returns, but when
+errors appear it appears at the back end, where it results in
+complexity and litigation and controversy that should not have
+to take place. Second, let's consider the problem of fairness.
+Complexity has materially reduced the taxpayers' perceptions of
+fairness of the Federal tax system by creating disparate
+treatment of similarly placed and situated taxpayers. It is
+hard to imagine how taxpayers and Congress can see the IRS as
+an efficient, modern service or agency when the taxpayer cannot
+perceive the tax system as even being fair.
+ Finally, let's evaluate the manipulation. Tax law
+complexity creates opportunities for technical manipulation of
+the tax laws, often in ways not contemplated by Congress.
+Aggressive exploitation of ambiguities in the laws not only
+further aggravates the perception problem but it forces the
+IRS, the IRS, to divert resources from working with compliant
+taxpayers to having to interpret and aggressively avoid the
+problem of--or the ability to deal with aggressive
+noncompliant. We would prefer that they be able to deal with
+the voluntary taxpayers, but recognize the need for dealing
+with noncompliance as well.
+ What we are saying is that legislation on simplification is
+necessary. It results in difficult choices. The political
+realities of seeking a fiscal balance limits the ability to
+seek simplification. We know that. Simplification necessitates
+a willingness to embrace objective standards without dealing
+with passionate and political constituencies. Simplification
+requires that you avoid popular proposals and deal with
+realistic ones that avoid complexity. The code is replete with
+burdens where there are complexity, and these burdens are
+greater than the benefits that are obtained by engaging in
+simplification. Frequently, taxpayers have to engage in
+torturous struggles between a maze of cross-references and
+inconsistent definitions in order to examine an issue and then
+determine finally that it is not even relevant.
+ There is a problem of deadwood where we have many statutes
+that were fair and applicable when they were first enacted, but
+because of changes are no longer relevant. I want to draw
+attention to several just quick examples where we believe
+simplification is helpful. It is necessary and appropriate that
+we deal with a phase-out of tax benefits. The Joint Committee
+on Taxation has sought that they be phased out. The child
+definition creates problems. There are at least five different
+definitions. When the taxpayers find that one works, they tend
+to think that it works for all. This results in complexity and
+it interferes with efficiency of the system. We think that
+there is a need for the elimination of the alternative minimum
+tax. It has created complexity that is unnecessary. The capital
+gains provisions apply several definitions and notes. Schedule
+D is almost impossible to complete.
+ The foreign tax rules need to be modified. In a true sense,
+we believe that simplification must be dealt with at this time.
+We also touch on the fact that regulatory simplification should
+be dealt with. We recognize that Congress prepares and enacts
+the law. We also think that Congress needs to oversee the IRS
+in a way that will assure that there is more efficient
+administration that will provide guidance for taxpayers so that
+they are able to comply properly with the tax laws and satisfy
+their obligations.
+ I have cut my comments very short, but I would like to
+summarize by simply stating that our primary message is the
+need for Congress to devote its energy and its resources to
+promote changes in the tax laws that will result in greater
+simplification. It is difficult to expect taxpayers to have
+confidence in taxes imposed under current laws when even
+experienced tax return preparers consistently get different
+results on similar data because of the complexity of the tax
+laws. The integrity, the fairness, and the equity of the tax
+system required and do require a concerned effort to obtain
+simplification now and not 10 years from now.
+ [The prepared statement of Mr. Shaw follows:]
+
+Statement of Richard Shaw, Chair, Tax Section, American Bar Association
+
+ Thank you, Mr. Chairman. My name is Richard A. Shaw. I am Chair of
+the American Bar Association Section of Taxation. This testimony is
+presented on behalf of the American Bar Association.
+ The American Bar Association appreciates the opportunity to appear
+before the Subcommittee on Oversight (the ``Subcommittee'') today to
+discuss the critical need for simplification of the federal tax laws.
+We know this is an issue the Subcommittee takes seriously, and we
+appreciate the efforts the Chairman and other Members of the
+Subcommittee have taken over the past few years to focus attention on
+the need for simplification.
+
+ ABA Section of Taxation
+
+ The ABA is comprised of more than 400,000 members and its Section
+of Taxation has approximately 20,000 tax lawyers who work in law firms,
+corporations and other business entities, government, nonprofit
+organizations, academia, accounting firms and other multidisciplinary
+organizations. Accordingly, to make the tax system fairer, simpler and
+easier to administer is one of the Association's legislative
+priorities.
+ Our members provide advice on every substantive and procedural area
+of the tax laws, and interact regularly with the Internal Revenue
+Service (the ``Service''), 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.
+
+ The Need for Simplification
+
+ The ABA and its Section of Taxation have long been strong advocates
+for simplification of the Internal Revenue Code. For nearly thirty
+years, the ABA has been on record urging tax law simplicity, a broad
+tax base and lower tax rates.
+ We have reiterated this position in testimony before Congressional
+tax-writing committees on numerous occasions. For a number of years,
+the Section of Taxation has worked with our colleagues at the AICPA Tax
+Division and the Tax Executives Institute on this important issue. The
+Tax Section will continue these efforts and we remain optimistic that
+real steps can be taken by Congress to simplify the tax laws.
+ We believe that complexity is at the root of many significant
+obstacles to efficient and effective administration of the tax laws.
+ First, as the National Taxpayer Advocate and others have well
+documented, the scope and complexity of the tax laws make it virtually
+certain that taxpayers will face procedural, technical and bureaucratic
+obstacles in meeting their tax obligations. This not only creates
+problems on the front end, when taxpayers attempt to prepare and file
+returns, but also at the back end, when errors rooted in complexity
+result in audits and controversy with the Service.
+ Second, as the staff of the Joint Committee on Taxation documented
+in their comprehensive 2001 study on tax simplification, complexity has
+materially reduced taxpayers' perceptions of fairness of the federal
+tax system by creating disparate treatment of similarly situated
+taxpayers. Although perceptions--and their impact--are difficult to
+measure, it is hard to imagine how taxpayers or Congress can see the
+Service as an efficient, modern and responsive agency if they do not
+perceive the tax law itself to be fair.
+ Third, as we have seen in recent years, tax law complexity creates
+opportunities for technical manipulation of the tax laws--often in ways
+never contemplated by Congress. Aggressive exploitation of ambiguities
+in the laws not only further aggravates the perception problem, but
+also forces the Service to divert resources from working with compliant
+taxpayers in resolving legitimate issues of interpretation to pursuing
+the aggressively noncompliant instead.
+
+ Legislative Simplification
+
+ Of course, we recognize that simplifying the tax law requires
+Congress to make difficult choices. This is particularly true when, as
+now, the political realities of the fiscal balance limit the ability to
+simplify in a manner that reduces revenue. Simplification necessitates
+a willingness to embrace objective proposals that are often dull and
+without passionate political constituencies. Simplification also
+requires that politically popular proposals be avoided if they would
+add significant new complexity. Simplification--and preventing greater
+complexity--may not garner political capital or headlines, but it is
+crucial to a tax system that is fair and can be efficiently
+administered.
+ The Code is replete with tax provisions where the burden of
+complexity is much greater than the perceived abuse to which the
+provision was aimed, or the benefit that was deemed gained by its
+addition.
+ Frequently, taxpayers, or more likely their tax representatives,
+must engage in a torturous struggle through a maze of cross-references
+and inconsistent definitions to ascertain that a set of complex
+provisions are not relevant to a transaction or tax obligation.
+ The Code contains many provisions that at the time of enactment may
+have been desirable, but with the passage of time, or the enactment of
+other changes, have truly become ``deadwood.'' Despite the absence of
+any practical utility in such provisions (whether in a relative or
+absolute sense), analysis of the effect of such provisions will
+generally be required, either in the preparation of the tax return or
+in the consummation of a proposed transaction. The elimination of such
+provisions would greatly simplify the law.
+ In the past, working with our colleagues in the AICPA and TEI,
+examples of provisions have been offered that, when analyzed, do not
+justify their continuation in the law. We are grateful that the
+Congress has acted to address some of these problems. We encourage you
+to continue these efforts, as every step taken to simplify the tax laws
+is an important part of providing tax relief to the American taxpayers.
+ Today I want to draw your attention to a few areas in particular:
+the complexity wrought by the numerous provisions of the tax code that
+phase-out tax benefits based on income levels, and the complexity
+caused by the multiple definitions of a ``child'' under the tax code.
+ As you know, the tax code is often used to distribute benefits
+under a variety of social policy programs among selected groups of
+taxpayers. To accomplish these diverse goals, many code sections phase-
+out available deductions and credits over various income ranges based
+on differing measures of taxpayer income. Currently, these phase-out
+ranges are not consistent either in defining income, the applicable
+levels of income, the range of income over which the phase-out applies,
+or the method of applying the phase-outs. The phase-out ranges even
+differ depending on the filing status of the taxpayer, and these
+differences are also internally inconsistent. As a result, phase-outs
+cause inordinate complexity--particularly for taxpayers attempting to
+prepare their own returns without the assistance of tax preparation
+software.
+ The staff of the Joint Committee on Taxation recommended three
+years ago that most phase-outs be eliminated and in 2002, the ABA
+adopted a formal policy to support that position. Congress has already
+taken an initial step in this effort by providing that, beginning in
+2006, two of these troubling phase-out provisions, dealing with
+personal exemptions and the overall limitation on itemized deductions,
+will begin to be eliminated. We applaud this legislative action, and
+encourage the Subcommittee to seek out ways of building on that
+experience to address further the problem of unduly complex phase-outs.
+ As the Subcommittee is undoubtedly aware, the use of different
+definitions to determine who is a qualifying child for purposes of:
+
+ (1) the dependency exemption;
+ (2) the earned income tax credit (``EITC'');
+ (3) the child credit;
+ (4) the dependent care credit;
+ (5) and head of household filing status,
+
+has led to widespread confusion and inadvertent errors. Taxpayers
+mistakenly believe that if they have a ``child'' who qualifies for one
+of the benefits, they are entitled to all of them. These errors
+inevitably lead to controversies with the Service that are very
+difficult for taxpayers and particularly, lower-income families to
+handle.
+ To the extent that the Service is required to devote its limited
+resources to sorting through the controversies caused by five (5)
+different definitions of ``child,'' the end result is that the Service
+is not able to focus attention on other taxpayers in need of assistance
+or in pursuing enforcement against tax evasion.
+ The problems wrought by these confusing definitions of a child are
+well-documented, and similar approaches to simplifying this part of the
+tax laws have been endorsed by both the Treasury Department and the
+staff of the Joint Committee on Taxation, as well as several Members of
+this Subcommittee. We encourage the Subcommittee to take whatever steps
+it can to further these efforts this year. We note that the 2005 budget
+proposals contain nine (9) specific tax simplification items. We
+strongly recommend consideration of the many recommendations made in
+the 2001 Joint Committee on Taxation Staff Report.
+
+ Regulatory Simplification
+
+ We also want to touch on the need to encourage regulatory
+simplification within the Treasury Department and the Service.
+ We appreciate that the Treasury Department and the Service have
+stepped up their efforts in recent years to work towards simplification
+through the regulatory process. The ABA and the Section of Taxation are
+committed to work with Treasury and the Service to continue such
+efforts. We also commend the Service for steps taken since 1998 to
+streamline the administrative system and improve the way the Service
+interfaces with taxpayers. We applaud efforts underway to redesign the
+examination and appeals processes to make them work more efficiently
+for both taxpayers and the Service. However, more can be done in the
+regulatory and administrative areas. As we recently advised the IRS
+Oversight Board, a cornerstone of the IRS strategic plan for the next
+five years must be a meaningful effort to simplify the tax law itself
+and the Service's procedures for interacting with taxpayers.
+ The Service's efforts to refine its modernization program should
+consistently consider the necessity for quality and efficiency in
+dealing with taxpayers. The lack of efficiency is evidenced by the
+inability of the system to satisfy adequately the statutory and
+regulatory objectives of the Offers-in-Compromise program. Taxpayers
+should not be stranded in compliance limbo while offers take more than
+three years to be processed through Appeals.
+ Prompt issuance of guidance advances the goal of simplification by
+reducing ambiguity and uncertainty. This can take the form of formal
+Revenue Rulings and Revenue Procedures that provide clarity and
+simplify the administration of complex and ambiguous laws and
+regulations. Prompt public releases are essential to provide guidance
+on new tax legislation. There have been at least twenty (20) new tax
+acts within the past five years affecting more than 300 sections of the
+Code. In addition, a strong program to modernize forms and instructions
+that make them more readily understandable and manageable to the
+average taxpayer can advance procedural simplification.
+ There are success stories. Much litigation was eliminated when the
+Treasury adopted a ``check-the-box'' system for unincorporated
+associations to elect to be treated as either corporations or
+partnerships. Likewise, the Service adopted practical procedural
+guidelines for remedying defecting Selections without requiring
+taxpayers to file expensive requests for revenue ruling approval.
+ Additional training is essential so that auditors and appeals
+officers are better able to explain and apply complex tax laws in a
+fair, consistent and just manner. Taxpayers and the system are not
+served well by Service Center communicators who are correct on complex
+tax laws only about 70% of the time.
+ We have encouraged the Service to actively work with this
+Subcommittee and the other tax-writing committees to ensure that you
+are fully educated on how much complexity adversely impacts the ability
+of the Service to achieve its mission.
+ In summary, our primary message today is the need for Congress to
+devote its energy and resources to promote changes in the tax laws that
+will lead to greater simplification. It is difficult to expect
+taxpayers to have any confidence that taxes imposed under current laws
+are collected accurately, when even experienced tax return preparers
+consistently get different tax results on similar data because of the
+complexity of the tax laws. The integrity, fairness and equity of the
+tax system require a concerted effort to obtain simplification.
+
+ * * * *
+
+ The ABA Section of Taxation hopes that the foregoing observations
+and suggestions are helpful to the Subcommittee. The Tax Section would
+be pleased to meet with you to further discuss these views or any other
+matters. Thank you.
+
+
+
+ Chairman HOUGHTON. All right. Thank you very much, Mr.
+Shaw. I don't think anybody disagrees. We will get into this a
+little later. Could I ask the rest of you if you could stay
+within the 5 minutes? I sure would appreciate that. Mr. Zarzar.
+
+STATEMENT OF ROBERT A. ZARZAR, CHAIR, TAX EXECUTIVE COMMITTEE,
+ AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
+
+ Mr. ZARZAR. Thank you, Chairman Houghton and Ranking Member
+Pomeroy, for this opportunity to appear here today. The
+American Institute of Certified Public Accountants (AICPA) is
+the national, professional organization of certified public
+accountants comprised of more than 330,000 members. We believe
+that the 2004 filing season is progressing largely without any
+significant problems, and American taxpayers and practitioners
+generally are pleased with the IRS' performance. I would first
+like to commend Chairman Houghton for his sponsorship and
+active support of H.R. 22, the Individual and Small Business
+Tax Simplification Act of 2003. As Mr. Shaw has said, we firmly
+believe that the enactment of tax simplification measures is
+integral to the success of future filing seasons, and we
+encourage Congress to continue to make tax simplification a
+major legislative priority. As for the IRS budget and the
+Business Systems Modernization program, we urge Congress to
+support full funding of the IRS' fiscal year 2005 budget.
+ We note and appreciate the Administration's fiscal year
+2005 request to increase the IRS' funding. We have long
+advocated funding levels that would allow the IRS to
+efficiently and effectively administer the tax laws and collect
+taxes. Giving the IRS the resources necessary to properly
+enforce the tax laws is vital to maintaining our voluntary
+compliance tax system. Last month, before this Subcommittee,
+Commissioner Everson reported on the difficulties the IRS has
+faced with implementation of its Business Systems Modernization
+program--testimony that was generally consistent with the
+conclusions found in the Oversight Board's December report.
+Despite these problems, we strongly urge Congress to stay the
+course in terms of support for appropriate funding for this
+modernization effort. This is an issue that must remain a
+central feature of the IRS' strategic plan for the next 5
+years.
+ As for the IRS' e-filing goals, we support their long-range
+goals for electronic tax administration. We applaud the IRS'
+current success with e-filing for the 2004 season, following on
+its successes of last year. We also commend the IRS' efforts to
+phase in the electronic filing of business returns and its
+rollout of the ``Electronic IRSs'' section on the IRS website.
+During the last year, the IRS has taken positive steps to
+listen to the practitioner community about the myriad problems
+tax professionals still face when contemplating conversion of
+their firms to practices offer e-file services to their
+clients. We appreciate this effort on the IRS' part, and to
+this end, we look forward to serving as a positive e-file
+partner with the IRS.
+ Now, I do regret to inform you that there have been some
+information return problems this year along the whole line of
+complication rather than simplification. The 2003 Tax Act (P.L.
+108-27) cut the rate to 15 percent for qualified dividends
+received by individuals. Unfortunately, compliance with the new
+15-percent dividend tax rate has proved to be the biggest
+challenge for taxpayers and practitioners during the current
+filing season. Brokerage firms and mutual funds are having
+major difficulties determining when dividends are qualified
+dividends, which has resulted in large numbers of erroneous
+Forms 1099-DIV being mailed to taxpayers. This situation has
+caused havoc for many taxpayers and practitioners.
+ Many taxpayers filed their Forms 1040, only to receive an
+amended Form 1099-DIV after the fact from a financial
+institution. The taxpayer and preparer thus are faced with a
+dilemma as to whether an amended return should then be filed,
+including State amended returns, or whether an earlier filed
+return remains the realistic snapshot of the taxpayer's
+position for 2003 and wait for the IRS' matching program to
+satisfy the ultimate obligation of tax. The AICPA stands ready
+to work with Congress and the IRS to develop procedures to
+minimize the processing burdens placed on taxpayers and
+practitioners from such changes.
+ Finally, with respect to tax practitioners and their
+professional responsibility, the AICPA commends the IRS and
+Treasury for its efforts to address the professional
+responsibility standards of tax professionals generally, and
+particularly with respect to the eradication of abusive tax
+transactions. These are actions that we support. We have a
+longstanding track record of establishing professional
+standards for our CPA members. The AICPA has adopted and has in
+place a Code of Professional Conduct, as well as enforceable
+``Statements on Standards for Tax IRSs.''
+ On the issue of return outsourcing, the AICPA's
+Professional Ethics Executive Committee appointed a task force
+in January 2004 to consider what changes, if any, should be
+made to our Code of Professional Conduct in connection with
+third-party-provider information. We are currently awaiting the
+task force's recommendations on this matter. Regardless of what
+decision a tax professional may make in this area,
+nevertheless, the public should understand that the
+practitioner remains fully responsible for the accuracy of a
+return and for ensuring confidentiality of client information.
+Mr. Chairman, I have completed my remarks and would be pleased
+to answer any questions you may have.
+ [The prepared statement of Mr. Zarzar follows:]
+
+ Statement of Robert Zarzar, Chair, Tax Executive Committee, American
+ Institue of 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 Robert
+A. Zarzar, Chair of the AICPA's Tax Executive Committee. The AICPA is
+the national, professional organization of certified public accountants
+comprised of more than 330,000 members. Our members advise clients on
+federal, state, and international 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 2004 tax filing season.
+ The AICPA is happy to report that the 2004 filing season is
+progressing largely without any significant problems and American
+taxpayers and practitioners generally are pleased with the Service's
+performance. We note that enactment of tax simplification measures is
+integral to the success of future filing seasons. Mr. Chairman, the
+AICPA is particularly encouraged by your sponsorship and active support
+of H.R. 22, the Individual and Small Business Tax Simplification Act of
+2003.
+ Our comments herein focus on the IRS budget for fiscal year 2005
+and a number of programs of critical importance to the Service.
+Specifically, we are pleased to address: (1) the IRS budget, (2)
+Business Systems Modernization, (3) achieving E-filing goals, (4)
+information return problems, (5) tax practitioners and professional
+responsibility, and (6) tax simplification.
+
+1. The IRS Budget
+ The AICPA urges Congress to support full funding of the Internal
+Revenue Service's fiscal year 2005 budget. The AICPA has 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 enforce the tax laws is vital to
+maintaining our voluntary compliance tax system. Obviously, 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.
+ We note and appreciate the Administration's fiscal year 2005 budget
+request to increase the Service's funding to $10.674 billion,
+representing an approximate increase of $490 million in funding and
+2,200 staff positions over fiscal year 2004. The AICPA supports the
+objectives of the Administration's budget proposal, which principally
+focuses on increasing staffing and resources in the enforcement area.
+Commissioner Mark Everson recognizes 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
+American taxpayers are fulfilled.
+ Many AICPA members are tax practitioners. As such, we have seen
+first-hand the problems caused by an IRS that is not responsive to the
+taxpaying public as customers. We have also witnessed the improvements
+initiated by former Commissioner Charles Rossotti and Commissioner
+Everson, initiatives involving the reorganization mandated by Congress
+in the IRS Restructuring and Reform Act of 1998. Any lack of attention
+to the IRS's funding needs will likely only serve to undercut the tax
+administration improvements Congress expects and we believe the
+nation's taxpayers will suffer as a direct result.
+
+2. Business Systems Modernization
+ In testimony before the House Ways and Means Subcommittee on
+Oversight on February 12, 2004, Commissioner Everson reported on the
+difficulties the IRS has faced with implementation of the agency's
+Business Systems Modernization (BSM) program; testimony that was
+generally consistent with the conclusions on BSM found in the December
+2003 report by the IRS Oversight Board. While touching on a number of
+BSM projects, Everson testified about the Service's continuing problems
+with implementation of the customer account data engine (CADE), the
+system designed to replace the agency's master file of taxpayer
+records.
+ Despite the problems the IRS has experienced with Business Systems
+Modernization, we strongly urge Congress to stay the course in terms of
+their support for appropriate funding for the modernization effort.
+This is an issue that must remain a central feature of the Service's
+strategic plan for the next five years.
+ The BSM goals are critical to the future successes of the Service.
+The program is designed to change the entire way the IRS conducts
+business with taxpayers and stakeholders, by (1) implementing systems
+to improve the IRS's effectiveness in receiving, routing, and
+responding to millions of taxpayer telephone calls; (2) supplying
+Revenue Agents with software capable of accurately assessing a
+taxpayer's liability when faced with a complex tax matter or
+calculation; (3) establishing a modern, reliable data base; and (4)
+implementing a nationwide e-mail and voice-mail messaging system for
+Service employees.
+
+3. Achieving E-Filing Goals
+ The AICPA supports the IRS's long-range goals for electronic tax
+administration in general, and electronic filing (ELF) in particular.
+We applaud the Service's current successes with e-filing for the 2004
+filing season, as well as the successes of last year. As of March 17,
+2004, taxpayers have submitted 43 million e-filed returns, or an 11.4
+percent increase over the same period last year. Approximately 53
+million Americans utilized e-file options in 2003.
+ We also applaud the Service's efforts to phase-in the electronic
+filing of business returns; and its rollout of the ``Electronic
+Services'' section on the IRS website, which includes a suite of web-
+based products for practitioners to do business with the IRS
+electronically. With respect to the Form 1040 e-file program, the IRS
+has implemented a number of improvements to the program in recent years
+that should prove positive for practitioners who file returns
+electronically. We especially appreciate that (1) nearly all Form 1040
+forms and schedules have been made available to electronic filers; (2)
+electronic filers are no longer required to use a paper signature
+document; and (3) the electronic payment options have been expanded.
+ One drawback with electronic filing is that it is not an option for
+many low income taxpayers who don't own a computer. These taxpayers
+routinely find that they must rely on commercial preparers who often
+charge disproportionately large fees. Also, blinded by the appeal of
+immediate cash, these taxpayers have high-interest refund anticipation
+loans (RALs) foisted on them by some commercial preparers. As an
+alternative to the regrettable RAL situation, taxpayers can go to a
+low-income taxpayer clinic or get assistance through programs like the
+Volunteer Income Tax Assistance (VITA) Program.
+ Unfortunately, funding for low-income taxpayer clinics was
+curtailed last year due to an IRS Chief Counsel interpretation that IRS
+``matching'' funds should only be available to controversy clinics that
+don't prepare returns. National Taxpayer Advocate Nina Olson has
+recommended that the IRS support separate funding for low-income return
+preparation clinics, a recommendation that should encourage e-filing
+and improve compliance by low-income taxpayers generally. Senator Jeff
+Bingaman has introduced legislation that includes a provision
+supporting funding for low-income return preparation clinics. We
+support these recommendations and initiatives.
+ The IRS has taken some positive steps during the last year to
+listen to the practitioner community about the myriad problems tax
+professionals still face when contemplating offering e-file services to
+their clients. For a long time the AICPA had been frustrated by the
+Service's response to our attempts both to partner with the IRS in
+promoting ELF to our membership and in explaining the effects of the
+current e-file programs' limitations on our constituency. As the IRS
+shifts its electronic filing focus from individual returns to business
+returns, the importance of involving, listening to, and responding to
+the various stakeholder groups will become all the more critical.
+ We recognize the many hurdles on the road to achieving the goals
+established for the electronic filing program by Congress, but look
+forward to a positive partnership in traveling the ELF road.
+
+4. Information Return Problems
+ The Jobs and Growth Tax Relief Reconciliation Act of 2003 cut the
+tax rate to 15 percent for ``qualified dividends'' received by
+individuals for tax years 2003 through 2008, the same rate that applies
+to a net capital gain. The 15 percent rate is not available for
+individuals who (1) do not meet certain securities holding period
+requirements and (2) are obligated to make related payments on
+positions in substantially similar or related property.
+ Compliance with the new 15 percent dividends tax rate has proved to
+be the biggest challenge for taxpayers and practitioners during the
+current filing season. Brokerage firms and mutual funds are having
+major difficulties determining which dividends that a taxpayer receives
+qualify as a ``qualified dividend'' and the new 15 percent tax rate,
+resulting in large numbers of erroneous Forms 1099-DIV being mailed by
+financial institutions to taxpayers. This situation is causing havoc
+for many taxpayers and practitioners.
+ Many taxpayers filed their Form 1040, only to receive an amended
+Form 1099-DIV from a financial institution after the fact from a
+financial institution. The taxpayer and preparer are faced with the
+dilemma as to whether an amended return should be filed; or whether the
+earlier filed return remains a realistic and reasonable ``snapshot'' of
+the taxpayer's tax position for 2003 and therefore, obviating the need
+to file an amended return. Unfortunately, there is nothing to say that
+the same taxpayer will not receive a third generation of corrected
+Forms 1099-DIV.
+ We have also received reports that ``eligible education
+institutions'' also are having difficulty providing ``correct'' Forms
+1098-T (Tuition Statement) to students. This form reports the amount of
+qualified tuition and related expenses that a student is required to
+pay when enrolled at an eligible education institution. A number of
+AICPA members have informed us that education institutions are making a
+number of mistakes on the Form 1098-T, including (1) incorrectly
+including income on the information return and (2) reporting inaccurate
+education tax credit information. Practitioners suggest that the
+instructions and tax regulations for the Form 1098-T are not fully
+developed, and that the eligible education institutions are not
+generally experienced in tax compliance.
+ The AICPA stands ready to work with Congress and the IRS to develop
+procedures to minimize processing burdens placed on taxpayers and
+practitioners to ensure proper compliance with the new dividend law, as
+well as the filing and processing of Form 1098-T.
+
+5. Tax Practitioners and Professional Responsibility
+ The AICPA commends the IRS and Treasury for its efforts to address
+the professional responsibility standards of tax professionals in
+general, and particularly with respect to the eradication of abusive
+tax transactions. We are encouraged by Commissioner Everson's
+commitment to upgrade the Office of Professional Responsibility; and we
+are pleased to have had the opportunity to testify at the February 19,
+2004 IRS hearing on the proposed amendments to Circular 230 involving
+tax opinion standards.
+ We have a longstanding track record of establishing professional
+standards for our CPA members. The AICPA has adopted and has in place a
+Code of Professional Conduct, as well as enforceable Statements on
+Standards for Tax Services (SSTSs). Both the Code of Professional
+Conduct and the SSTSs provide meaningful guidance to CPA members in the
+performance of their professional responsibilities. We believe
+compliance with professional standards also confirms the public
+awareness of the professionalism that is associated with CPAs as well
+as the AICPA.
+ The AICPA has a clear position on abusive tax transactions--they
+should be eradicated. We have consistently supported the protection of
+the public interest and prohibitions on the misuse of our tax system.
+Our enforceable SSTSs are a clear example of this. We continue to be
+actively engaged in proposing and evaluating various legislative and
+regulatory measures that are designed to identify and prevent taxpayers
+from undertaking, and tax advisers from rendering advice on,
+transactions having no purpose other than the reduction of federal
+income taxes in an abusive manner.
+ Through our Tax Executive Committee, over the last several years,
+we have shared with Congress and relevant regulatory bodies our
+recommendations to help them deal with misuse of the tax code through
+inappropriate tax avoidance transactions. The conceptual framework of
+our solution is built on our belief that the most effective way to
+combat abusive tax shelters, without interfering with a taxpayer's
+right to legally minimize taxes, is through disclosure.
+ We support the objectives of the (final) tax shelter/reportable
+transaction regulations issued by the Treasury Department on February
+28, 2003, regulations that have existed in various forms (Proposed,
+Temporary) for several years. In specific, these regulations strive to
+(1) identify and shut down abusive tax avoidance transactions and (2)
+provide greater clarity; which, if met, will trigger enhanced taxpayer
+and promoter responsibilities and obligations--accomplished principally
+through disclosure.
+ In addition to any governmental sanctions under the February 2003
+reportable transaction regulations, our own disciplinary process will
+be (and has been) invoked where our rules of professional conduct,
+including the enforceable Statements on Standards for Tax Services, are
+violated. Tax practice by AICPA members has always been subject to the
+Institute's Code of Professional Conduct. Most recently, the AICPA
+adopted an Interpretation to SSTS No. 1, which discusses a member's
+ethical obligations and responsibilities in connection with tax
+planning. The Interpretation clarifies how the standards would apply
+across the tax practice spectrum, including situations involving tax
+shelters (regardless of how that term is defined).
+ On the issue of tax return outsourcing, the AICPA's Professional
+Ethics Executive Committee appointed a task force in January 2004 to
+consider what changes, if any, should be made to our Code of
+Professional Conduct in connection with the use of third party
+providers; and we are currently awaiting the task force's
+recommendations on the matter. Also, in the March 2004 Journal of
+Accountancy, we have published an article entitled, ``Legal and Ethical
+Considerations Regarding Outsourcing,'' authored by Alan W. Anderson,
+AICPA Senior Vice President--Member and Public Interests, and Richard
+I. Miller, AICPA General Counsel and Secretary.\1\
+---------------------------------------------------------------------------
+ \1\ Journal of Accountancy, Vol. 197, No. 3 (March 2004); http://
+www.aicpa.org/pubs/jofa/mar2004/miller.htm.
+---------------------------------------------------------------------------
+ The Journal of Accountancy article provides our CPA members with
+guidance regarding the current state of the ethical and legal climate
+surrounding the outsourcing issue. Concerned CPAs have inquired about
+their professional responsibilities regarding the use of third party
+providers in the performance of professional services. This AICPA
+article responds to their questions.
+ The AICPA first addressed the use of third-party service providers
+in 1973, in response to the then-new practice of computerizing tax
+return preparation. (See Ethics Ruling No. 1, AICPA Code of
+Professional Conduct Rule 301.) Then, as now, to satisfy their
+professional responsibilities, our members should investigate and be
+satisfied with a third-party provider's competence, quality controls,
+security controls, and confidentiality controls. But, regardless of who
+the CPA teams with to provide the service, the CPA always remains fully
+responsible for the accuracy and completeness of the services, the
+confidentiality of client information, and to assure the services are
+performed with due professional care. The article also reviews the
+privacy notification regulations under the Gramm-Leach-Bliley Act, and
+the Internal Revenue Code prohibition on inappropriate disclosures of
+tax-related information (section 7216) and client confidentiality
+requirements (section 7525).
+
+6. Tax Simplification
+ The AICPA believes that one of the best ways of ensuring a positive
+tax filing season for taxpayers, practitioners, and the IRS is through
+the passage of major simplification of the tax laws. We encourage the
+Administration and the Congress to continue to make tax simplification
+a major legislative priority.
+ Mr. Chairman, the AICPA supports your tax simplification bill (H.R.
+22), the Individual and Small Business Tax Simplification Act of 2003.
+While the AICPA supports outright repeal of the alternative minimum
+tax, we believe the AMT simplification provisions of your legislation
+should provide taxpayers with meaningful burden reduction and relief
+from tax law complexity. Also, we support the provisions of H.R. 22
+that (1) accelerate the repeal of the phase-outs for personal
+exemptions and the limitation on itemized deductions and (2) simplify
+and harmonize the definition of ``child.''
+ We have worked closely with the American Bar Association and the
+Tax Executives Institute to jointly identify specific proposals for
+simplification. Tax simplification should result in fewer errors on tax
+returns. Also, we believe tax simplification should mitigate many
+taxpayers' reliance on vague, contorted interpretations of the law that
+have resulted in the marketing of abusive transactions.
+ The AICPA is similarly encouraged by the Administration's inclusion
+of simplification proposals in its fiscal year 2005 revenue proposals.
+The Administration's proposals should result in meaningful
+simplification of the tax laws for families by (1) providing for a
+uniform definition of a child, (2) eliminating the income related
+phase-outs for the adoption credit and exclusion, and (3) abolishing
+the household maintenance test for ``head-of-household'' filing status.
+ Thank you for the opportunity to share these views with you.
+
+
+
+ Chairman HOUGHTON. Thank you very much, Mr. Zarzar. Mr.
+Leimbach.
+
+ STATEMENT OF JAMES D. LEIMBACH, ENROLLED AGENT, NATIONAL
+ ASSOCIATION OF ENROLLED AGENTS, PANAMA CITY, FLORIDA
+
+ Mr. LEIMBACH. Mr. Chairman, I am deeply honored today to
+present this statement on behalf of the 10,000 members of the
+National Association of Enrolled Agents (NAEA), the
+professional society of Enrolled Agents. I am James Leimbach,
+and I became an Enrolled Agent in 1997 while on active duty in
+the United States Air Force. My wife, Kelly, and I jointly
+operate a private practice in Panama City, Florida, where we
+work with both individual and small business taxpayers in the
+preparation and electronic filing of their returns. I also
+represent taxpayers before the IRS.
+ With regards to filing season readiness, overall, filing
+season has run very smoothly. At the beginning of the season,
+however, we did experience processing problems in e-filing.
+Practitioners received a number of erroneous reject notices
+from overwhelmed e-filing centers. During this period, the IRS'
+Quick Alert e-mail system provided practitioners immediate
+notification of these problems, and it was invaluable. This
+information allowed us to plan around the problems as we were
+notified of them. Many practitioners also rely on an IRS CD-ROM
+or Volume 2 of Package X to get their updated forms and
+publications. It is particularly important for practitioners
+who live in areas where they do not have access to high-speed
+Internet service. Unfortunately, the products didn't arrive
+until as late as February 20th.
+ NAEA has long supported full funding of the IRS. We believe
+that a properly resources IRS can efficiently process tax
+returns, collect taxes, and resolve taxpayer problems. For far
+too long, IRS has been hamstrung by its legacy computer system.
+NAEA realizes that billions of dollars have been poured into
+the modernization effort. I am here today to tell you that it
+has not been in vain, as I am one of 14 NAEA members testing
+the new suite of e-services products allowing us to represent
+taxpayers electronically. In January of this year, the IRS
+reached a major milestone in the development of new electronic
+capabilities that will revolutionize the way we as tax
+practitioners will conduct future business with the IRS.
+ This new electronic capability, which I prefer to call ``e-
+representation,'' will enable tax practitioners to quickly
+resolve their clients' IRS individual or business account
+problems via the Internet in a secure environment. It has taken
+the IRS 7 years to reach the point we are at today, and based
+on my experience in computer technology, I do not find that
+unusual in the least. The difficulty in integrating a sixties-
+era mainframe with the Internet and doing so in an environment
+using highly complex encryption is enormous, costly, and worth
+every effort and every dime spent. This new e-services
+capability is truly going to revolutionize the way we conduct
+business with the IRS in resolving taxpayer problems.
+ Under the new suite of e-services products called
+Disclosure Authorization, Transcript Delivery System, and
+Electronic Account Resolution, I have the ability 24 hours a
+day, 7 days a week, to submit processing requests to the IRS'
+computer system. This access provides me instant processing of
+my power of attorney submittals and instant processing of my
+requests for crucial transcripts. It also allows me to submit
+proposals for problem resolution at any time I choose. When you
+combine the capabilities of Disclosure Authorization,
+Transcript Delivery System, and the Electronic Account
+Resolution, the end result is phenomenal e-representation
+capability. This will truly revolutionize the way we do
+business with the IRS.
+ Even though these products are undergoing testing and are
+not yet ready for nationwide deployment, NAEA has concerns
+about the future of this new capability. Our concerns are
+regarding Enrolled Agents that will be denied access due to the
+100 e-file requirement established by the IRS; limitation on
+the types of issues that can be addressed electronically;
+granting full access of e-services to unenrolled tax preparers;
+potential results from premature nationwide deployment. Aside
+from these concerns, NAEA understands, respects, and supporting
+the need for more e-filing of tax returns. We also believe in
+leading by example. Therefore, we respectfully would like to
+make the following suggestion: The IRS needs to lead by example
+when promoting e-filing to the tax practitioner community. They
+can do so easily by requiring all IRS employees to e-file their
+personal and individual returns.
+ With regards to regulation of commercial preparers, I have
+included NAEA's recent statement before the IRS Oversight Board
+on the proposed regulation of commercial tax preparers. This is
+not my area of expertise, but NAEA would be pleased to provide
+a written response to any questions in this area. Mr. Chairman,
+it truly is a pleasure and an honor to be able to have shared
+with you our members' views, and if I may be able to answer any
+of your questions, I would be very delighted. Thank you.
+ [The prepared statement of Mr. Leimbach follows:]
+
+Statement of James D. Leimbach, Enrolled Agent, National Association of
+ Enrolled Agents, Panama City, Florida
+
+ Mr. Chairman and members of the Oversight Subcommittee, I am deeply
+honored today to present this statement on behalf of the National
+Association of Enrolled Agents (NAEA), the professional society of
+Enrolled Agents.
+ I am James Leimbach, and I became an Enrolled Agent in 1997 while
+on active duty in the United States Air Force. My wife, Kelly, and I
+jointly operate our private practice in Panama City, FL where we work
+with both individual and small business taxpayers in the preparation
+and electronic filing of their returns. I also represent taxpayers
+before the IRS for problem resolution. I believe you already have a
+copy of my biography in your notebook.
+ Today, I am representing NAEA whose 10,000 members are tax
+professionals licensed by the U.S. Department of Treasury to represent
+taxpayers before all administrative levels of the Internal Revenue
+Service (IRS).
+ Enrolled Agents were created in 1884 to ensure ethical and
+professional representation of claims brought to the Treasury
+Department. Members of NAEA ascribe to a Code of Ethics and Rules of
+Professional Conduct and adhere to annual Continuing Professional
+Education standards that exceed IRS requirements.
+ Like attorneys and CPAs, we are governed by Treasury Circular 230
+in our practice before the IRS. We are the only tax professionals who
+are tested by the IRS on our knowledge of tax law.
+ Each year, we collectively work with millions of individual and
+small business taxpayers by providing tax preparation, tax planning,
+representation, and other financial services. Consequently, Enrolled
+Agents are uniquely positioned to observe and comment on the average
+American taxpayer's experience within our system of tax administration.
+Filing Season Readiness
+ Overall, filing season has run very smoothly. NAEA members did
+experience some processing problems in e-filing during the opening of
+filing season. Practitioners received a number of erroneous reject
+notices from overwhelmed filing centers. Most software companies were
+able to quickly recover. I would have to praise IRS for its Quick Alert
+system by which practitioners can receive e-mailed notices of problems.
+Information is the key. If we have it, we can plan around it.
+ A greater problem occurred with late delivery of the IRS 2003 CD-
+ROM. Many practitioners rely on this to get their updated forms and
+publications. It's particularly important for practitioners who live in
+areas where they don't have access to high speed Internet service.
+Unfortunately, some practitioners reported that they didn't receive
+their CDs until as late as February 20, long after the start of filing
+season.
+ Another problem involved distribution of Volume 2 of Package X, a
+paper bound volume which contains essential tax forms and instructions.
+Some NAEA members reported that their copy did not arrive until mid
+February which is far later than normal.
+ In both cases, these glitches are unfortunate because these are
+tools practitioners have come to rely upon to get their tax returns
+prepared accurately. We hope that this lateness will not be repeated.
+
+IRS Budget and Modernization: E-Services: Electronic IRS Representation
+ NAEA has long supported full funding of the IRS. We believe that a
+properly resourced IRS can efficiently process tax returns, collect
+taxes, and resolve taxpayer problems. For far too long, IRS has been
+hamstrung by its legacy computer system. NAEA realizes that billions of
+dollars have been poured into the modernization effort. I am here today
+to tell you that it has not been in vain as I am one of 14 NAEA members
+who is testing the new Electronic Account Resolution Service (EAR). I
+have attached two EA Journal articles which explain the EAR program.
+ In January of this year, the IRS reached a major milestone in the
+development of new electronic capabilities that will revolutionize the
+way we, as tax practitioners, will conduct future business with the
+IRS. This major milestone involved using real taxpayers in the final
+testing of the suite of new capabilities that will be available through
+the IRS' e-services secure Web site this year. I was very pleased and
+honored to have been chosen by the IRS to be the first tax professional
+to use this new e-services capability. The new suite of e-services
+products, which will allow tax practitioners to represent their clients
+electronically and in a highly secure environment, has left me utterly
+speechless. I can assure you that I do not make that statement lightly.
+ This new electronic capability which I prefer to call ``E-
+Representation,'' will enable tax practitioners to quickly resolve
+their client's IRS individual or business account problems via the
+Internet in a secure environment. The goal of the IRS is to provide a
+response to the tax practitioner within three business days versus the
+weeks and months we currently experience.
+ It is important to note that the effort to provide this capability
+has been ongoing since November 26, 1997, when the Electronic Tax
+Administration (ETA) released a Request for Agreement to which NAEA
+responded. NAEA submitted a proposal that members be provided the
+capability to resolve exam and collection issues with the IRS via
+secure email.
+ In response, the IRS established a working group in July 1998 that
+determined it would be expedient to provide the capability to address
+electronically the types of account and notice issues normally resolved
+by the IRS' Customer Service sites.
+ From that 1997 NAEA initiative, the IRS in February of 2000
+launched a prototype secure Web site that would be used to develop and
+test the concept of electronic representation and was the forerunner of
+the final secure Web site that will be implemented nationwide this
+year. The prototype was called the Practitioner Secure Messaging System
+(PSMS) and it provided NAEA members with the ability to securely
+resolve account and IRS notice related issues.
+ After two years of extensive testing by approximately 450 NAEA
+members, Terence Lutes, Director of ETA, deemed the PSMS prototype a
+success. Mr. Lutes stated in his email to the PSMS participants that,
+``For the first time in the history of the Service, we demonstrated the
+capability to interact securely with our practitioners over the
+Internet to resolve account-related inquiries.''
+ The PSMS prototype was unfortunately discontinued in May of 2002
+due to budgetary constraints, but that did not hamper the IRS' effort
+with the development of the final secure Web site. Usability Testing of
+the IRS' final secure Web site was conducted on April 22--23, 2003, by
+a small group of tax practitioners, myself included.
+ In January 2004, the IRS reached a major milestone when live
+taxpayers were represented electronically through the IRS' e-services
+secure Web site. It has taken the IRS seven years to reach the point we
+are at today and I do not find that unusual in the least. The
+difficulty in integrating a 1960s era mainframe with the Internet and
+doing so in an environment using highly complex encryption is enormous,
+costly, and worth every effort and every dime spent. This new
+capability is truly going to revolutionize the way we conduct future
+business with the IRS. The ultimate beneficiary is your constituent,
+the American taxpayer. I am truly amazed and thrilled beyond
+description at this new way of doing business with the IRS and I would
+like for you to understand why I feel as I do.
+ Representing taxpayers before the IRS is very challenging due to
+the complexity of our tax code. It is also very frustrating due to the
+difficulty we encounter in trying to obtain the necessary information
+we need in order to resolve the taxpayer's problem and receiving a
+timely response from the IRS. There are three crucial steps. The first
+is to establish with the IRS the taxpayer's authority to represent
+them, which is done via a Power of Attorney. The next step is to obtain
+the information the IRS has on the taxpayer for the year or years in
+question. The final step is in receiving the response from the IRS on
+our proposed resolution for the taxpayer.
+ In our current way of doing business with the IRS, the first step
+of establishing the authority to represent the taxpayer is done by
+either faxing or mailing in the IRS' Form 2848, Power of Attorney and
+Declaration of Representative or acceptable substitute. An IRS employee
+then manually enters the POA into the IRS' computer system. The normal
+turnaround for this to occur is two to three days via fax, and slightly
+over a week for those that are mailed in to the IRS.
+ Today, I have the ability, 24 hours a day, seven days a week, to
+submit directly into the IRS' computer system the POA for instant
+processing. This electronic version of the POA is called the Disclosure
+Authorization.
+ Through Disclosure Authorization, I can also view and modify those
+POAs that were previously faxed or mailed into the IRS. This is an
+enormous step forward and one that is certainly going to result in a
+cost savings to the IRS by reducing the manpower needed to manually
+input those POAs into the IRS' computer system.
+ The next step is to request transcripts, which are printouts of the
+taxpayer's account reflecting pertinent actions that have been recorded
+by the IRS. For example, these actions would include the date a tax
+return was received by the IRS and tax assessed, the detailed
+information on the return, penalties and interest assessed, other
+crucial dates and the like.
+ When I first began representing clients before the IRS, the
+quickest I could ever obtain that information from the IRS was to drive
+20 minutes to the local IRS office, stand in line for another 20
+minutes, obtain the necessary transcripts, and then drive 20 minutes
+back to my office. I was fortunate in that the IRS office was only 20
+minutes away. Others are not as fortunate as I am and they end up
+having to use either mail or fax services which can take days to weeks,
+sometimes months, to receive those crucial transcripts.
+ With very rare exceptions, I simply cannot represent a client
+before the IRS without transcripts.
+ Today, I have the ability, 24 hours a day, seven days a week, to
+submit directly into the IRS' computer system a request for that
+crucial transcript. This capability within the IRS' e-services Web site
+is known as the Transcript Delivery System.
+ The process of preparing the Transcript Delivery System submittal
+takes about one minute. Once I submit the request, the transcript is
+delivered immediately. I now find it takes me longer to print the
+transcript than it does to receive it from the IRS. This remarkable
+capability leaves me speechless.
+ The cost savings to the IRS because of TDS will be significant. The
+tax practitioner is going to be thrilled beyond words, and the taxpayer
+will be the ultimate beneficiary in that his or her representative can
+begin addressing their IRS issues more quickly than ever before.
+ The final step in resolving the taxpayer's IRS problem is receiving
+a timely response from the IRS to our proposed solution. This is the
+most frustrating aspect for the taxpayer when he or she is told to
+expect an IRS reply in several weeks if we are lucky; but more than
+likely it will take months before we have an IRS reply.
+ These taxpayers are very anxious for their problem to be resolved
+and I am unable to adequately describe the anguish I have witnessed
+that some of these people go through waiting for their IRS problem to
+finally come to an end.
+ Today, I have the ability at any time of the day or week to submit
+directly to the IRS's Customer Service Representative our proposed
+resolution. This capability within the IRS' e-services Web site is
+known as Electronic Account Resolution.
+ The IRS' goal is to provide a response to our Electronic Account
+Resolution submittal within three business days. That has been
+achieved.
+ When you combine the capabilities of Disclosure Authorization,
+Transcript Delivery System, and Electronic Account Resolution, the end
+result is phenomenal e-representation capability. This is going to
+revolutionize the way we do business with the IRS; it will result in
+cost savings in the days to come; and it will have a significant
+positive impact on taxpayers dealing with perhaps the most stressful
+and agonizing experience of their lives, running afoul of the IRS.
+ All of this testimony is not to imply that the system is working
+flawlessly, it is not. The system is undergoing the final stages of
+testing for security, disclosure, and privacy issues. Users are
+encountering some processing problems and this is the normal result for
+such a complex project as Disclosure Authorization, Transcript Delivery
+System, and Electronic Account Resolution. Those processing problems
+are being identified and resolved which is the whole intent of this
+final testing stage. I witnessed the same while in the U.S. Air Force
+with the new technology they brought into operation.
+ Much like a child who is learning to take his first few steps, this
+new capability will encounter some stumbling and an occasional bruising
+of the knees. So long as the tax professional community is allowed and
+encouraged to help nurture and guide the maturing of this new
+capability, I foresee e-representation becoming the standard way of
+practice when resolving taxpayer problems.
+ Like any parent with a newborn child, concerns for the future will
+arise and the tax professional community has already recognized
+concerns about the future of this new capability.
+
+Concerns of NAEA Members:
+ The ability to electronically represent taxpayers through the e-
+services Web site is limited by the IRS to only those tax practitioners
+who e-file more than 100 individual returns in a season. The intent of
+the IRS is to offer this extraordinary capability as an incentive to
+tax practitioners who continue to prepare returns and file them in
+paper format to start incorporating e-filing into their practices. It
+is working. I have seen tax practitioners who were adamantly opposed to
+e-filing incorporate e-filing into their practice solely upon hearing
+about this new capability.
+
+Enrolled Agents Denied Access:
+ The unfortunate aspect of the IRS' decision to restrict this
+capability to only those tax practitioners who meet the e-file
+requirement is that many of our most experienced and knowledgeable tax
+professionals will be denied this access because they do not prepare
+returns. Their sole focus is on IRS representation. Another type of tax
+professional is one who prepares far fewer than 100 individual returns
+and will never meet the e-file requirement.
+ This will be a huge travesty that will adversely affect thousands
+of tax professionals and millions of taxpayers if left unresolved.
+
+Limitation of Problem Resolution Issues:
+ Another concern we have is the level of issues that can be
+addressed electronically through the Electronic Account Resolution
+element of e-services. Issues that are currently being handled by the
+collections and under reporter entities within IRS cannot be addressed
+through Electronic Account Resolution. This represents a large segment
+of our workload that will continue to be handled in a less efficient
+manner and it does not need to happen. A possible remedy would be
+either expanding the level of authority and responsibility of the
+Customer Service Representative responding to the Electronic Account
+Resolution submittals or integrating both collections and under
+reporter entities within e-services. Either of which need to be done
+soon since not being able to address collection and under reporter
+issues will undermine to some degree the intent of this new way of
+doing business; namely, the timely resolution of taxpayer problems and
+encouragement of tax practitioners to e-file.
+
+Access Granted to Unenrolled Tax Preparers:
+ Allowing unenrolled tax preparers who have no training, experience,
+or knowledge in IRS representation full access to the e-services
+capabilities while at the same time denying access to highly-trained,
+experienced, and knowledgeable tax professionals is nothing more than a
+disaster just waiting to happen. Aside from the huge uproar you can
+expect to hear from the tax professional community about this inequity,
+unenrolled tax preparers pose a significant problem. In all states
+except California and Oregon, all it takes to declare yourself a tax
+preparer is to hang out a shingle. There are no CPE requirements, no
+code of ethics, no disciplinary action by IRS, except loss of ERO
+status if the individual is an e-filer. The end result is they can
+potentially bog the Electronic Account Resolution capability with
+frivolous and wasteful submissions thereby denying the tax professional
+the attention of the Customer Service Representative in a problem
+resolution submission that is based on sound knowledge of tax law and
+regulations.
+ NAEA would strongly urge you and the IRS to at the very least limit
+the Electronic Account Resolution portion of e-services to just
+Circular 230 tax practitioners--Enrolled Agents, CPAs, and attorneys.
+
+Lead by Example:
+ The IRS needs to lead by example when promoting e-filing to the tax
+practitioner community. They can do so easily by requiring all IRS
+employees to e-file their personal individual returns. If this
+suggestion were to be adopted, then it would need to be promulgated to
+the tax practitioner community and NAEA believes it would have a
+positive impact on the tax practitioners' perception of the importance
+of e-filing.
+
+Premature Nationwide Deployment:
+ NAEA is concerned that disastrous results may occur due to a
+premature deployment of this new capability. It is imperative that the
+actual deployment of this new capability only occur after all involved
+in its development have had an opportunity to voice--in an environment
+free from coercion--any and all problem areas they feel could undermine
+the success of this long and expensive effort. Much like Mission
+Control at the Kennedy Space Center prior to a launch, everyone has an
+opportunity to give a ``go'' or ``no go'' from their respective areas.
+Without such input from all involved in the development, we could be
+setting ourselves up for disastrous consequences.
+
+Regulation of Commercial Preparers
+ At this point, I would like to include NAEA's recent statement
+before the IRS Oversight board in my testimony. NAEA is aware of S.
+882, the Tax Good Government Act which includes a proposal by National
+Taxpayer Advocate Nina Olson on registration and regulation of
+commercial preparers. The NAEA statement follows:
+ ``The members of NAEA are dedicated to the integrity of the tax
+system and the roles professional responsibility and ethics play in
+preserving that integrity. It therefore is disturbing to us that there
+is an increase of taxpayer belief that tax returns will be accepted
+regardless of the facts reported on them. This growth principally
+emanates from the declining rate of audits conducted on returns in
+recent years. It seems that a great number of taxpayers have been
+lulled into concluding that gaming the system and playing the audit
+lottery are acceptable behavior. A recent Gallup survey of taxpayers
+found that there is a marked increase in taxpayers feeling it is all
+right to cheat on their tax returns. An obvious centerpiece concern in
+this respect is that promoters and some tax professionals are selling a
+wide range of tax schemes and devices designed to improperly reduce
+taxes based on the simple premise that they can get away with it. It is
+clear that addressing this concern is needed. However, its resolution
+undoubtedly will not be limited to such schemes and devices.
+ ``The IRS has undergone major changes in the last several years.
+Former Commissioner Rossotti's reorganization of the IRS and the
+emphasis he placed on customer service may in part have been a catalyst
+in modifying taxpayer attitude. Most agree that his initiatives were
+good, were consistent with the 1998 IRS Restructuring and Reform Act,
+and have produced a better IRS. However, their implementation resulted
+in resources being shifted away from enforcement activities. Other
+contributing factors include discontinuance of the Taxpayer Compliance
+Measurement Program (TCMP), ineffective technology, and tax law
+complexity.
+ ``Commissioner Everson has begun efforts to turn that around. While
+he acknowledges that customer service plus enforcement equal
+compliance, he has announced that effective enforcement of the tax laws
+rather than further improving customer service will be the main focus
+of his administration. In this connection, he implicated the tax
+practitioner community in the diminishment of compliance and challenged
+all practitioners to raise their ethical standards in order to avoid
+actions being taken against them by the government. While much of this
+was done in regard to abusive tax schemes, it seems clear to NAEA (and
+we believe him) that his efforts will not stop there. For example, at a
+November [2003] meeting of the IRS Advisory Council (IRSAC), he was
+asked what IRSAC could do to help his enforcement endeavor. The IRSAC
+members were told in essence to stress the important role practitioners
+play in making our tax system work as it should. He did not limit his
+response to abusive tax schemes. Recent amendments to the regulations
+governing practice before the IRS (Circular 230) bear this out. The
+increased staffing in the Office of Professional Responsibility, the
+office that enforces those regulations, emphasizes his intent. Very
+recent proposed amendments to Circular 230, designed primarily to deal
+with abusive tax schemes, contain a ``best practices'' section that
+appears to address all aspects of tax advice and return preparation,
+which is further evidence of the role ethics play in our tax system. In
+addition, Mark Matthews has joined the IRS as deputy commissioner for
+services and enforcement. Mr. Matthews has a strong enforcement
+background, including having served as director of the IRS Criminal
+Investigation Division. Cono Namorato recently was appointed Director,
+Office of Professional Responsibility, replacing the incumbent who was
+in office for just one year. We surmise that it is Mr. Namorato's
+enforcement experience that resulted in his entry into the Office of
+Professional Responsibility and further evidence of the Commissioner's
+resolve.
+ ``Other initiatives, such as the replacement of TCMP by the
+National Research Program, enforcement programs being implemented in
+all four divisions of the IRS, and the recent announcement by the
+Commissioner of reallocation of human resources in order, in part, to
+complement his enforcement mandate, help round out the conclusion that
+cannot be escaped. He means business.
+ ``All who provide tax services must be cognizant of the strong
+enforcement component of tax compliance. It has the possibility of
+touching every aspect of tax advice and return preparation.
+Consequently, the topic of this panel at today's meeting is both
+important and timely.
+ ``NAEA finds that commercial return preparers are an enigma in
+today's tax practice world. We all seem to know there are problems in
+connection with services performed by paid preparers, but in many
+respects those problems are unknown and the product of anecdotal
+information and conjecture.
+ ``The first order of business is to define commercial return
+preparers. We define them as those (1) who prepare federal tax returns
+for a fee and (2) who are not required to possess any knowledge of tax
+law and procedure. At the state level, only California and Oregon
+regulate commercial tax return preparers and it is unlikely that there
+will be a significant increase in states engaged in that type of
+program in the future.
+ ``The number of commercial preparers is not known with any
+accuracy, but estimates of upwards of 1 million individuals have been
+bandied about. With 55% of returns having been prepared by someone
+other than the taxpayers in 2001 and perhaps even more in 2002 and
+2003, it seems safe to conclude that the number of returns prepared by
+commercial preparers is considerable and growing. A great number of
+these commercial preparers probably work in a structured environment,
+such as being with a return preparation chain, or those who are
+entrepreneurs in the tax business. Others undoubtedly are seasonal tax
+return preparers who set up shop in January and close them down in
+April--sometimes referred to as ``card table jockeys.'' Still others
+may be somewhere in the middle. Even if we had the numbers, we do not
+know the extent of training, if any, many of the commercial preparers
+have had and the manner in which they keep abreast of the changes in
+tax laws and procedures. Perhaps of greatest concern is the belief the
+public is not aware of the fact that many commercial preparers have no
+credentials. This may in part be the reason taxpayers ``shop'' for
+preparers who will prepare tax returns the way taxpayers wish them to
+be prepared (often unsigned by those preparers), to the detriment of
+responsible return preparers and the integrity of the tax system.
+ ``NAEA understands that tax return preparer penalties asserted in
+recent years have been minimal in number as related to the apparent
+potential for such penalties. Those that have been imposed in large
+measure have not been collected. We also know that attempts to
+implement recognition procedures in the electronic filing area, i.e.
+electronic filer originators (EROs), have been the subject of criticism
+due to systemic problems in background checks and the like as
+documented in the Treasury Inspector General for Tax Administration
+(TIGTA) report of June 2002. Further, many of the problems in the
+Earned Income Tax Credit (EITC) program are attributable to paid
+preparer involvement. Again, there does not seem to be a great deal of
+empirical data to support a conclusion as to the number of commercial
+preparers involved in the program and whether or not they do a
+consistently worse job than other preparers, even though there have
+been some informative and well-written white papers on the subject.
+ ``Last year the National Taxpayer Advocate recommended in her
+report to Congress that there be a program to register commercial
+return preparers. It was an extremely ambitious program and one that
+would be expensive to establish and run. The IRS disagreed with the
+recommendation citing, among other factors, the expense of the program
+and that the issue is one for states to address rather than the federal
+government. NAEA believes there are problems both with the
+recommendation and the IRS response. We understand that Ms. Olson plans
+to propose more rigorous penalties and liability for commercial EITC
+preparers. While it may be unfair to opine on this year's proposal
+since we have not seen it, a threshold concern is the basis for
+believing that the IRS will be more successful than it has been in the
+past in collecting the penalties, buying into the program, and/or
+putting the troublesome violators out of business.
+ ``So what is the solution? There does not seem to be an easy one.
+We don't have hard facts. The available data is said to be
+inconsistent. Attempts to address the issues have not been successful.
+The IRS in fact may not be interested in the subject at this moment in
+time. Attempts by former advisory groups to come to grips with
+commercial preparer issues have met resistance. While there was support
+for a commercial preparer program by the National Commission on IRS
+Restructuring, it was removed from its final report. In addition,
+legislation sponsored by Senator Bingaman of New Mexico appears not to
+have gone anywhere. A recommendation by last year's IRSAC did not
+endorse a course of action for recommendation to the Commissioner, even
+though a subgroup supported a preparer certification program that would
+enhance the competency of individuals or firms that prepare tax returns
+for a fee.
+ ``In spite of all the above, NAEA supports Ms. Olson's quest, if
+not her vehicles for achieving it. If left unchecked, the perceived
+problems will continue to grow. In this connection, we believe the
+IRSAC Wage & Investment and Small Business/Self Employed subgroup
+reports warrant favorable consideration. In particular, the SB/SE
+subgroup's belief that the IRS should begin working with outside
+stakeholders to develop a program after examining a number of the
+``unknowns'' would be beneficial.
+ ``NAEA subscribes to the belief that ethics are the fabric that
+holds a profession together. In the tax arena, Congress has identified
+those who qualify as federally-authorized tax practitioners (FATPs),
+i.e., Enrolled Agents, Attorneys, and CPAs. All are licensed
+individuals whose professional practice is circumscribed by codes of
+professional conduct and continuing education requirements. NAEA, of
+course, believes that the most meaningful step in overcoming the
+commercial preparer issues is to have all preparers attain Enrolled
+Agent status. Perhaps our Attorney and CPA colleagues have similar
+aspirations.
+ ``With the above said, FATPs have dual loyalties. One, of course,
+is to their clients. The other is to the tax system itself. NAEA thinks
+it safe to conclude that all FATPs share the goal of safeguarding the
+integrity of our tax system and would be willing to work to make that
+happen. A possible beginning to assist the IRS in this respect is to
+form a task force comprised of representatives from the Enrolled Agent,
+attorney, and CPA organizations to work with the Service and others to
+help make this happen. NAEA would be pleased to head a practitioner
+organization steering committee to do this. Other organizations,
+individuals, academicians, and the like with similar goals could be
+invited to participate to the extent that the numbers would be
+manageable.
+ ``We are eager to move off dead center in our support of overcoming
+the frustrations we all share with respect to the unknown factors
+relative to the issue and doing our part in establishing a program
+evidencing ethics as a vital part of our tax system's integrity.''
+Conclusion:
+ Mr. Chairman and members of the subcommittee, I am pleased and
+honored to have been able to share with you our members' views. If I
+may answer your questions or provide you with any additional
+information, it would be an honor and my pleasure to do so.
+ Thank you.
+ ______
+
+
+ Lend Me Your Ear
+
+ By James Leimbach, EA
+
+ For Enrolled Agents, the word ``ear'' will be taking on a whole new
+meaning next spring when the IRS unveils, nationwide, to tax
+professionals the ``Electronic Account Resolution'' program (EAR).
+ EAR will, quite simply, enable tax professionals to quickly resolve
+their clients' IRS individual or business account problem(s) via the
+Internet in a secure environment. EAR will be one of several electronic
+services available through the IRS' e-services Web site. The technology
+has been available for quite some time now; implementing it, though,
+was easier said than done.
+ Thanks mainly to the more than 250 Enrolled Agents that
+participated in the IRS' prototype named Practioner Secure Messaging
+System (PSMS), that capability is now becoming a reality.
+ The PSMS--launched in February of 2000--was the test project
+designed to precede the nationwide implementation of the EAR program.
+PSMS participation was limited to only EAs who met, among other
+criteria, a high level of involvement in the e-file arena. The
+prototype testing involved test-case scenarios as well as live cases
+submitted by EAs. As can be expected with the implementation of any new
+security intensive Internet technology, problems did arise. The intent
+of PSMS was to identify and develop the procedural and software
+corrections for the problems encountered.
+ ``For the first time in the history of the service, we demonstrated
+the capability to interact securely with our practitioners over the
+Internet to resolve account-related inquiries'' wrote Terence H. Lutes,
+Director of Electronic Tax Administration (ETA) in his email to the
+PSMS participants. Unfortunately, due to budgetary constraints, the IRS
+was forced to discontinue the PSMS prototype on May 1, 2002. Initially,
+the EAR program was scheduled for nationwide implementation this fall;
+however, due to the demands of project management and testing, the IRS
+found that a more realistic date will be after the 2003 filing season.
+ Operating the prototype was invaluable not only for the IRS, but
+also for EAs. The EA profession was the only one selected to
+participate in the prototype testing of what will have a profound
+impact on all tax professionals in future representation before the
+IRS.
+ Unlike PSMS, EAR will be much easier to use. The PSMS system
+required users to download and install a Digital ID on their computer.
+The IRS' PSMS web site then used the Digital ID to ensure that the user
+connecting to the site was in fact authorized access. Without the
+Digital ID, nothing could be accessed on the PSMS Web site, not even
+the home page.
+ In addition to the Digital IDs required, all users had to install
+Rivest-Shamir-Adleman (RSA) Security Keys on their computers. The RSA
+Security Keys were required in order to decrypt the encrypted email the
+IRS sent in reply to the user's PSMS submission.
+ Instead of Digital IDs and RSA Security Keys, the EAR system will
+utilize a transparent version of the Secure Sockets Layer (SSL)
+software--an IRS issued PIN number and password. Users will go to the
+IRS' e-service site and simply log on. The elimination of Digital IDs
+and RSA Security Keys was a major improvement in streamlining access
+for users, particularly for AOL users.
+ A significant problem encountered with the PSMS system for AOL
+users was the encrypted email they received. The AOL software was
+unable to handle decrypting the IRS' email due to it being in a Secure/
+Multipurpose Internet Mail Extensions, (smime).p7m format. This major
+roadblock required AOL users to set up a separate email account with
+another email service such as Microsoft's Hotmail and use other
+software such as Microsoft Outlook Express in order to access and read
+the encrypted email.
+ All of those previous PSMS security problems will be eliminated
+with the use of SSL, IRS issued PINs, and passwords. To be sure,
+security is a paramount issue for the IRS in implementing the EAR
+program. By utilizing SSL encryption, the IRS' security concerns have
+been resolved. Users will log on to the EAR system via a transparent
+security system and retrieve their IRS email response(s) from a secure
+mailbox.
+ As with the PSMS system, EAR will require the user to have a Form
+2848, Power of Attorney (POA) or equivalent on file with the
+Centralized Authorization File (CAF) system prior to being granted
+access to a client's account.
+ To handle the POA requirement, the PSMS system had a dedicated fax
+machine for its users. After transmitting the POA, users would usually
+have to wait 1--3 days for the POA to be manually input into the CAF
+system before being able to address a client's account electronically.
+ With the EAR system, users will access the IRS' Web site, prepare a
+Disclosure Authorization (DA) application which is an electronic
+alternative for submitting a POA. Once the form has been filled out
+completely, the user hits ``Submit'' on the screen, and the DA is
+immediately processed into the CAF system. Practitioners will then be
+able to immediately access their clients' accounts electronically with
+no waiting.
+ Another constraint for PSMS users was the inability to
+electronically obtain IRS transcripts such as an IRP, IRMF, etc. The
+Transcript Delivery System (TDS), which is a separate IRS e-service
+from EAR, will resolve that problem by enabling practitioners to obtain
+transcripts from the IRS' secure Internet site.
+ The TDS system is planned for implementation at roughly the same
+time that the IRS unveils the EAR Program in 2003. TDS will not be a
+direct part of the EAR system, but instead a separate electronic
+option.
+ The ability of a tax professional to resolve a client's IRS account
+problem in a matter of hours via the Internet as opposed to weeks or
+months using the postal system is worthy of every EA's attention.
+ With the nationwide implementation of the EAR, DA, and TDS systems,
+tax professionals will be able to have POAs processed immediately into
+the CAF system, obtain transcripts in a matter of minutes, and resolve
+client account problems in a matter of hours.
+ As a client with an IRS account problem, which of the following
+would you rather engage:
+
+ 1. A tax professional who estimates 4--8 weeks (or more) for
+resolution of your IRS problem?
+
+ OR
+
+ 2. An EA who estimates a few hours to resolve your problem?
+
+ This is a major change for our profession and it is one that we can
+all participate in and help nurture to become what our clients, the
+IRS, and we need.
+ The bottom line is that \2/3\ of the EAR name already has our EA
+credential in it. We, as EAs, need to take advantage of this golden
+opportunity.
+About the Author:
+ James D. Leimbach, EA (USAF Ret.) is a retired U.S. Air Force
+Senior Master Sergeant who obtained his EA credential while on active
+duty. While in the USAF, he held positions as Superintendent of
+Operations, Chief of Computer Operations, Chief of Systems Control,
+Database Manager and various other computer operations and programming
+positions. His practice provides tax preparation, e-filing, IRS
+representation, with a special focus on military clients. He was the
+36th person selected to participate in PSMS.
+
+ EA Journal
+
+ ______
+
+
+ Electronic Account Resolution (EAR) Update Are You Listening?
+
+ By Jim Leimbach, EA
+
+ A new client came in today. We'll just call him Mr. Joe Smith. He's
+single with no dependents. He came in with a letter from the IRS,
+Letter Number 2566 (SC/CG) a ``Proposed Individual Income Tax
+Assessment.'' Mr. Smith had lost the tax calculation summary that had
+been sent with the letter, so I did not know what the basis was for the
+proposed tax assessment.
+ While Mr. Smith was in my office, I informed him that in order for
+me to address his problem with the IRS, I would need his permission to
+represent him. He concurred that was what he wanted and I then accessed
+the IRS' e-services, secure Web site. From there, I selected the
+Disclosure Authorization (DA) product and I then asked him to sign the
+electronic version of the Form 2848, Power of Attorney and Declaration
+of Representative (POA) called a DA.
+ He first entered in his AGI, AGI year, and date of birth to
+authenticate who he was, and then entered his electronic signature
+which was done by entering in a self-selected PIN he made up. I also
+electronically signed the DA by entering in my Centralized
+Authorization File (CAF) Number, my password for accessing the IRS' e-
+services Web site, and then my self-selected PIN. After hitting the
+``Send'' button, it took about five seconds for me to obtain
+confirmation that the DA had been successfully processed into the CAF
+system.
+ I then informed my client that I needed to obtain a transcript
+showing all the income he had received during the year in question in
+order to ascertain the correctness of the proposed tax assessment.
+While he was in my office, I submitted a ``Wage and Income Documents''
+transcript request from the Transcript Delivery System (TDS) portion of
+the e-services Web site for the year in question.
+ There were two choices in how I could receive the transcript: the
+first choice was to have it displayed on my screen and the other choice
+was to retrieve an IRS email response from my secure (encrypted)
+mailbox on the e-services Web site. I chose to have it displayed on my
+screen since I would still be able to print it when displayed. After
+hitting the ``Send'' button, it took approximately one minute to
+receive the transcript.
+ I printed all six pages and after reviewing the information,
+concluded the proposed tax assessment was correct. My client owed
+$7,890 but he was not in any position to pay the full amount. I
+discussed the options available and we both agreed that an Installment
+Agreement (IA) was the only alternative available to him.
+ I went back to the e-services Web site, and selected the EAR
+product which then allowed me to access the IA feature. I completed our
+proposed IA and I explained to my client that it could take up to three
+business days for a response on the IA submittal but that I expected to
+receive a response later in the afternoon. At the end of the day, six
+hours after having submitted the IA, I received the IRS approval for
+our proposed IA via an email I retrieved from my e-services secure
+(encrypted) mailbox.
+ Just before going to lunch, a prior client, we'll just call him Mr.
+Huffy, came in with a CP2000 Notice containing proposed changes to his
+2001 tax return. Again, using the e-services Web site, I submitted the
+DA; obtained transcripts; and after reviewing the transcripts,
+determined that the CP2000 Notice was in error. The proposed change
+involved income that had, in fact, been reported on the client's 2001
+return.
+ I logged onto the EAR portion of the e-services Web site and this
+time I accessed the ``Notice'' feature which would allow me to address
+the CP2000 Notice and submit our disagreement with the proposed change.
+The Notice form provided me plenty of room to describe how the income
+had in fact been reported in my client's return. After transmitting our
+``Notice'' submittal, I received my onscreen confirmation number which
+I printed for future reference.
+ After returning from lunch, I went back to the e-services Web site
+and retrieved the IRS' response from my e-services secure mailbox
+concurring that an error had been made and that they were updating my
+client's account to reflect no change.
+ All this sounds pretty far fetched doesn't it?
+ While it did not actually occur, the capability to electronically
+represent our clients via a secure session on the Internet will be
+unveiled nationwide late this year, and you can be sure it will have a
+tremendous impact on the services we provide to our clients.
+ The IRS' effort to provide Electronic Account Resolution has been
+on going for several years. It all started back on November 26, 1997
+when the Electronic Tax Administration (ETA) released a Request for
+Agreement (RFA) that NAEA responded to, by submitting a proposal that
+members be provided the capability to resolve exam and collection
+issues with the IRS via secure email.
+ From that NAEA initiative, the IRS, in February 2000, launched a
+prototype secure Web site that would be used to develop and test the
+concept of electronic representation and would be the forerunner of the
+final secure Web site that would be implemented nationwide in 2003. The
+prototype was called the Practitioner Secure Messaging System (PSMS)
+and it provided NAEA members the ability to securely resolve account
+related issues.
+ After two years of testing by approximately 450 NAEA members,
+Terence H. Lutes, Director of ETA, deemed PSMS a success. Lutes stated
+in his email to the PSMS participants that, ``For the first time in the
+history of the Service, we demonstrated the capability to interact
+securely with our practitioners over the Internet to resolve account-
+related inquiries.''
+ The PSMS prototype was discontinued in May 2002 due to budgetary
+constraints, but that did not hamper the IRS' effort with the
+development of the final secure Web site. Usability Testing of the IRS'
+final secure Web site was conducted on April 22-23 of this year by a
+group of six practitioners. The following capabilities are those you
+can expect when the IRS unveils nationwide the Electronic Account
+Resolution (EAR) Web site and are based on my firsthand experience from
+participating in the Usability Testing.
+ Practitioner Qualifications: Circular 230 practitioners (in good
+standing) must have e-filed 100 or more returns in the latest filing
+season. Exception: The IRS waived the 100 e-file requirement for the
+PSMS participants.
+ Practitioner EAR Registration: Practitioners will register over the
+Internet (via secure session) and submit specific personal tax
+information. IRS will validate the information, and the practitioner
+will then obtain a username, password, and PIN. The IRS will send the
+practitioner a confirmation number by mail and the practitioner must
+confirm the registration within 28 days.
+EAR Services
+ 1. Disclosure Authorization (DA): The DA is essentially an
+electronic version of the Form 2848, POA that is processed directly
+into the CAF system via the IRS' secure (encrypted) Web site. The data
+elements needed for the Web site DA pages are the same as those
+required for the Form 2848 and follow the same flow. The biggest
+difference is how a client and practitioner sign the form.
+
+ For the client to sign, the practitioner will need to ensure the
+client has the following:
+ AGI (from any return filed in the last three years)
+ AGI Year
+ Date of Birth
+ PIN (self selected PIN like the e-file)
+
+ For practitioners to be able to sign, they will need:
+
+ CAF number
+ Password used for e-services Web site access
+ PIN (self-selected)
+
+ DA Pros:
+
+ Immediate processing into the CAF system
+ Immediate access to client's account
+
+ DA Cons:
+
+ Additional representatives must be able to access the
+Web site in order to digitally sign the DA. Not all practitioners will
+be granted access due to the IRS' 100 e-file requirement.
+ DA is not available for business clients other than Sch
+C. Form 2848 must be mailed or faxed for manual input into the CAF
+prior to e-service access.
+
+ 2. Tax Information Authorization (Form 8821): An additional option
+to the DA, this form can also be submitted to obtain information
+pertaining to a client. The digital signature requirement is the same.
+
+ 3. Transcript Delivery System (TDS):
+ The TDS was hands down, the most impressive portion of the
+Usability Testing. The TDS is actually a separate portal of the e-
+services Web site, yet a key component of EAR. After accessing TDS, the
+user is provided a pop-down menu from which to select the type of
+transcript desired. Transcript menu selections are all in plain English
+such as ``Wage and Income Documents'' versus the computer transaction
+ID such as RTVUE or IRPOL, making it very easy for users to determine
+what type of transcript to select.
+ Transcripts can only be selected for one year at a time, but
+multiple requests can be submitted together in one session. So if a
+user needed transcripts for the last three years, they would fill out
+the form once and the tax period separate for each of the three years.
+Each tax period/type of return appears in a box at the bottom of the
+request screen. Once all information on the client is entered, you
+submit the transcript request containing all three years. There are
+five types of transcripts to be made available, they are:
+
+ TDS
+ Similar To:
+
+ 1. Account Transcript
+ MFTRA-X
+ 2. Return Transcript
+ RTFTP
+ 3. Record of Account
+ MFTRA-X + RTFTP
+ 4. Verification of Non-filing
+ IRS Letter
+ 5. Wage & Income Documents
+ IRPTR
+
+ The user can choose from two delivery methods as to how they wish
+to receive the transcripts. The first choice is to receive the
+transcript online (directly on the user's screen) and the second is to
+have it sent to the Secure Online Repository (SOR) which is a secure
+(encrypted) mailbox repository that the user will have to register for
+and receive during the e-services registration process. The secure
+mailbox can only be accessed by the authorized userafter logging on to
+the e-services Web site. The user's SOR mailbox will contain all IRS
+responses from EAR and TDS submittals sent by the user. Either
+selection will allow a user to print the transcript.
+ The transcripts received will show the typical Transaction Code
+(TC) and also a short literal definition of the TC. This will be
+especially helpful for those practi-
+
+tioners who are not familiar with the multitude of TCs or who are not
+in possession of documentation to decipher the codes.
+TDS Pros:
+ Ease of navigation. Web pages are kept simple and
+concise.
+ Transcripts received in just a few minutes (at most).
+ Two selections of transcript delivery: onscreen or SOR
+(either of which can be printed).
+TDS Cons:
+ No help is available in determining exactly what data is
+provided in a particular transcript.
+ TC literal description is much shorter than the full
+description which is not available to the user.
+ SOR does not provide any identification in the email
+header that clearly identifies the taxpayer it pertains to, which makes
+it difficult to locate the desired email if several taxpayers are being
+addressed at similar times.
+Electronic Account Resolution:
+ The EAR portal of the e-services Web site is where practitioners
+will correspond directly with the IRS to resolve a client's tax issue.
+The products to be offered for individuals and businesses are:
+
+ Account Problem
+ Notice
+ Complex Refunds
+ Payment Tracer
+ Installment Agreement
+
+ All selections provide a free text or memo area in which to
+elaborate on the details for a client's issue as you normally would in
+a letter. If additional information is requested by the IRS, the
+practitioner will submit a ``Follow-up Inquiry'' that will be linked to
+the previous submission.
+ Account Problem: Provides the practitioner the capability to
+address specific account posting issues such as those related to exam,
+collection, record of payments, and resolution of tax form(s) filed for
+a taxpayer, to name just a few. For instance, you would use Account
+Problem if you needed to find out the current balance owed or how
+1040ES payments were posted.
+ Individual Notice: Provides the capability to address any IRS-
+generated notice that has been sent to the taxpayer. For instance, a
+practitioner would be able to resolve a CP2000 Notice (Notice of
+Proposed Changes) by submitting an agreement or disagreement for the
+CP2000.
+ Comples Refunds: Provides the capability to address refunds that
+can involve multiple years and a range of issues involving a taxpayer
+who has not received a refund due to 1040ES posting errors, 1040
+refunds applied to other years, FMS Offsets, undeliverable or destroyed
+refund(s), and erroneous refund(s).
+
+Payment Tracer: Provides the tracing of payments made by a taxpayer to
+ the IRS that have not been posted by the IRS.
+
+Installment Agreement: Provides the capability to submit an IA on
+ behalf of a taxpayer. IAs are limited to just guaranteed and
+ streamlined.
+ The Usability Testing of EAR and TDS did uncover shortfalls with
+both, which is to be expected in any development project this complex.
+Most notably was the excessive amount of Web pages required to complete
+for a particular submittal. There were numerous tutorials some of which
+were a bit excessive and others contained hard to read graphics
+imbedded in the tutorial. All-in-all though, the IRS has made a huge
+step forward in providing the tax practitioner community the capability
+to electronically represent clients and resolve their problems in a
+more efficient, timely, and secure manner.
+ The lessons learned from the two-year testing of PSMS were
+invaluable to the progress made so far. One significant improvement
+made as a result of PSMS was replacing the use of Digital IDs and RSA
+Security Keys with 128-bit encryption call Secure Socket Layer (SSL).
+The use of SSL provides the highest degree of security available for
+the IRS' e-services Web site while at the same time making it much
+easier for the user to access the Web site.
+ EAR and TDS will continue to undergo additional levels of testing
+before being implemented nationwide later this year. Earlier projected
+implementation dates had envisioned late August or early September for
+implementation. However, it appears that it will more than likely occur
+in November. The possibility of additional delays in the final
+implementation is certainly there but the IRS recently solicited the
+PSMS participants for verification of their name and EFIN, which is an
+encouraging step forward.
+ I believe that EAR and TDS will grow much like e-file has, in which
+each year; new and improved capabilities are added. Once the general
+public is aware of tax practitioners having the capability to represent
+them electronically before the IRS, you can be sure that those
+utilizing EAR and TDS will be the preference of choice by taxpayers
+when it comes to meeting their representation needs.
+
+About the Author:
+ James D. Leimbach, EA (USA Ret.) is a retired U.S. Air Force,
+Senior Master Sergeant who obtained his EA credential while on active
+duty. While in the USAF, he held positions as Superintendent of
+Operations, Chief of Computer Operations, and Chief of Systems Control,
+Database Manager, and various other computer operations and programming
+positions. His practice involves individual and business tax
+preparation, e-filing, and IRS representation, with a special focus on
+military clients.
+
+ EA Journal
+
+
+
+ Chairman HOUGHTON. Well, thanks very much, Mr. Leimbach.
+Mr. McCormally?
+
+ STATEMENT OF TIMOTHY J. McCORMALLY, EXECUTIVE DIRECTOR, TAX
+ EXECUTIVES INSTITUTE, INC.
+
+ Mr. MCCORMALLY. Good afternoon, Mr. Chairman. I am Timothy
+McCormally, Executive Director of Tax Executives Institute
+(TEI), whose 5,400 members work for 2,800 of the largest
+companies in North America and Europe. Almost without
+exception, the companies employing TEI's members have been
+assigned to the IRS' Large and Mid-Size Business Division
+(LMSB). The largest 1,600 taxpayers within LMSB are subject to
+heightened scrutiny and ongoing audits as part of LMSB's
+Coordinated Industry Cases program. Our members cannot play the
+audit lottery because, for the most part, they are audited
+every year. From this perspective, TEI has long supported
+adequate funding for the IRS, particularly in respect of
+training and technology, and collaborative efforts between
+taxpayers and the IRS to enhance tax administration, and the
+proper balance between taxpayer service and compliance
+activities.
+ At the outset, I wish to echo the testimony of Mr. Shaw and
+the written statement of Mr. Zarzar, as well as the comments of
+the Commissioner and Mrs. Killefer, about how the complexity of
+the tax law strains the limited resources of taxpayers and the
+IRS and impairs the ability of the government to administer a
+fair and efficient tax system. While we are pleased that the
+Bush Administration has included several simplification
+provisions in its 2005 budget, we believe that much broader
+efforts must be undertaken. These include the repeal of both
+the individual and the corporate alternative minimum tax and
+the reform of the international provisions of the Tax Code.
+These changes are necessary to enhance taxpayers' ability to
+comply and the IRS' ability to perform efficient and effective
+audits.
+ Effective management of human resources is not a new
+challenge, but it takes on added importance as the government's
+work force ages. Within LMSB, for example, 40 percent of all
+revenue agents will be eligible to retire in fiscal year 2006,
+and that number will rise to more than half just 2 years later.
+This development underscores one of the IRS' greatest
+challenges: the recruitment, retention, and training of
+qualified personnel. Nowhere is that need greater than within
+the LMSB Division, which is responsible for ensuring compliance
+by the country's largest and most complicated enterprises. The
+success of the agency--and LMSB in particular--depends on
+having an effective, efficient, well-trained, and motivated
+staff. Adequate funding is a prerequisite to achieving that
+goal.
+ Adequate funding is also required if the IRS is to maintain
+effective compliance strategies. LMSB has developed several
+important programs to streamline the compliance process and
+empower revenue agents and others to resolve issues and settle
+cases more quickly and efficiently. One recent effort deserves
+mention: a project to develop a focused audit planning process,
+which was rolled out to taxpayers and LMSB personnel last fall.
+TEI was pleased to participate not only in the design of the
+program but also in LMSB's training strategy with respect to
+it. A fuller explanation of the program is in our written
+statement.
+ Several other innovative procedures--such as the Advance
+Pricing Agreement program, Limited Issue Focused Examinations,
+and Pre-Filing Agreements--have also been used to improve the
+examination process and to promote currency and compliance.
+These initiatives should be encouraged, first, by providing
+ample training resources in connection with them, and then by
+ensuring that the IRS' renewed focus on enforcement does not
+mute their ongoing value. These procedures enable personnel to
+make decisions at a lower level, to resolve disputes fairly and
+more quickly, and thereby to preserve resources. Mr. Chairman,
+TEI commends the Subcommittee for holding this hearing, and we
+look forward to working with you, the staff, and the IRS to
+improve tax administration. I, like the other witnesses, would
+be pleased to respond to your questions.
+ [The prepared statement of Mr. McCormally follows:]
+
+Statement of Timothy J. McCormally, Executive Director, Tax Executives
+ Institute, Inc.
+
+ Good afternoon. I am Executive Director of Tax Executives
+Institute, the preeminent association of business tax professionals.
+The Institute is pleased to participate in today's hearing on the tax
+filing season and the Internal Revenue Service's budget.
+
+Background
+ Tax Executives Institute was established in 1944 to serve the
+professional needs of in-house tax practitioners. Today, the Institute
+has 53 chapters in the United States, Canada, and Europe. Our 5,400
+members are accountants, attorneys, and other business professionals
+who work for 2,800 of the leading companies in North America and
+Europe; they are responsible for conducting the tax affairs of their
+companies and ensuring their compliance with the tax laws. Hence, TEI
+represents the business community as a whole, and our members deal with
+the tax code in all its complexity, as well as with the Internal
+Revenue Service, on almost a daily basis. TEI is dedicated to the
+development and effective implementation of sound tax policy, to
+promoting the uniform and equitable enforcement of the tax laws, and to
+reducing the cost and burden of administration and compliance to the
+benefit of taxpayers and government alike.
+ The companies that employ TEI's members have almost without
+exception been assigned to the IRS's Large and Mid-Size Business (LMSB)
+Division. The largest 1,600 taxpayers within LMSB are part of the
+Coordinated Industry Cases (CIC) program; this means that they are
+subject to heightened scrutiny and, indeed, continual audit by the IRS.
+As non-participants in the so-called audit lottery, TEI members and the
+companies they represent have a keen interest in ensuring the efficient
+operation of the IRS and the proper balance of the agency's taxpayer
+service, enforcement, and other activities. Specifically, TEI has long
+supported adequate funding for the IRS, particularly in respect of
+training and technology, and collaborative efforts between taxpayers
+and the IRS. We are pleased to offer our views on the IRS's budget for
+fiscal year 2005.
+
+Increased Demand, Decreased Resources
+ The Bush Administration has proposed a budget for the IRS for
+fiscal year 2005 of $10.674 billion, a 4.8 percent increase from 2004.
+The proposal would increase funding for the agency's enforcement
+program by $366 million while decreasing funds for business systems
+modernization by $105 million. According to the Administration, the
+reduction in funding for the modernization program flows from
+independent studies concluding that the program should be resized. The
+IRS Oversight Board has also recently recommended that the IRS reduce
+the number of modernization projects to permit better management of the
+program.
+ Given current budgetary constraints, TEI agrees that the IRS must
+reexamine its goals and objectives. If the agency is to respond to
+taxpayer needs and to administer the tax code in a fair and efficient
+manner, it must have the resources necessary to fulfill its mission.
+TEI has consistently supported both adequate funding for the Internal
+Revenue Service--including its training and modernization programs--
+complemented by oversight by the IRS Oversight Board, the Treasury, and
+Congress. We know the Subcommittee shares our concern and urge you to
+continue to support adequate funding of the IRS to fulfill its
+responsibilities for taxpayer service and enforcement.
+ Our testimony today focuses primarily on two areas where adequate
+funding is particularly crucial: (i) the need to attract, train, and
+retain top-notch tax professionals, and (ii) the need to obtain
+currency on audits. But before addressing these issues, we believe that
+it is appropriate to note how the complexity of the tax code strains
+the limited resources of both the IRS and taxpayers and impairs the
+fair and efficient operation of the tax system.
+
+Achieving Simplification
+ Complexity and changes in the tax system have important
+ramifications for tax administration and compliance. During the five-
+year period ending in 2002, there were 19 enacted tax bills that
+changed 292 tax code sections and required 515 changes to forms and
+instructions. More changes--including the introduction of a new
+Schedule M-3 (which is intended to advance the goal of currency by
+providing the IRS with much more detailed and timely information on the
+differences between financial and tax accounting)--are inevitably on
+the horizon. And each change, no matter how laudable in isolation, will
+require revision of forms and instructions, as well as new training
+efforts that cannot help but detract from the IRS's goals of achieving
+currency on audits.
+ More than five years ago, TEI joined with the American Institute of
+Certified Public Accountants and the American Bar Association Section
+of Taxation to recommend changes to simplify the law not only for
+taxpayers--both large and small--but the government as well. We believe
+that even small changes--such as harmonizing the various definitions of
+``child'' as the Administration has proposed--can have a positive
+effect on job performance. Larger changes--such as the repeal of both
+the individual and corporate alternative minimum tax--can have
+significant effect on taxpayers' ability to comply with the law and the
+IRS's ability to perform efficient and effective audits. Enactment of
+simplifying measures can ease pressures and make workers more
+productive. In this regard, we are pleased that the Bush Administration
+has included several simplification provisions in its 2005 budget
+request.
+ Incremental simplification is commendable, but steps must also be
+taken to address systemic and structural complexity in the tax law. For
+example, the international tax provisions are among the tax code's most
+complicated and need significant reform and simplification. Several
+pending bills--such as H.R. 2896, the American Jobs Creation Act of
+2003, and S. 1637, the JOBS Act of 2003--contain provisions to address
+this complexity. We urge Congress to move forcefully to make the law
+less complex and therefore more competitive and efficient.
+
+Achieving a Well-Trained Workforce: Management of Human Resources
+ Effective management of human resources is not a new challenge, but
+it is one that demands more attention as the government's workforce
+ages. The IRS Oversight Board's 2003 report to Congress observed an
+increased demand for IRS services and a decreased level of resources.
+Specifically, the Board documented a 16-percent increase in the IRS's
+workload between 1992 and 2002 and, during the same period, a 16-
+percent decrease in the number of full time equivalent employees (from
+115,205 to 96,714). The Board explained that the result of these trends
+is a huge gap between what taxpayers need and what the IRS can deliver.
+Closing the gap is one of the IRS's greatest challenges, the Board
+concluded.
+ During the past few years, the LMSB workforce declined by 600
+employees, 40 percent of LMSB's revenue agents will be eligible to
+retire in FY2006, and that number will rise to more than 50 percent in
+FY2008. Among the division's managers, approximately 40 percent are
+currently eligible to retire.
+ These statistics underscore what may be the greatest challenge for
+the IRS over the next five years--its personnel. LMSB is responsible
+for ensuring compliance by approximately 180,000 entities each of whom
+has more than $10 million in assets. These taxpayers are the largest
+enterprises, and correspondingly have the most complex issues and the
+most complex organizational structures. They themselves employ
+qualified tax attorneys and accountants and, in return, they require
+experienced, well-trained agents to understand the complexities and to
+audit those returns. The success of the agency--and the LMSB Division
+and CIC program in particular--depends on an effective, efficient,
+well-trained, and motivated staff. Adequate funding for new hiring is
+an obvious prerequisite to achieve this goal.
+ We urge the Subcommittee to ensure that the IRS receives the
+funding it needs to maintain a qualified workforce.
+
+Achieving Currency: Tools for Enforcement
+ Adequate funding is required if the IRS is to maintain effective
+enforcement strategies. LMSB has initiated several important
+initiatives to enhance collaboration between taxpayers and IRS
+personnel; to focus on significant (as opposed to immaterial) issues;
+and, more generally, to empower its agents to resolve issues and settle
+cases more quickly and efficiently. Over the years, TEI is pleased to
+have cooperated in numerous efforts to bring greater efficiency to the
+examination process.
+ One recent effort deserves mention--a project to develop a focused
+audit planning process, which was rolled out to taxpayers and LMSB
+personnel in October. The goals of the LMSB-TEI Joint Audit Planning
+Process are two-fold: (i) to establish accountability in executing a
+jointly developed audit plan, and (ii) to develop an issue-focused plan
+to, if you will, separate the ``wheat from the chaff'' and thereby
+increase audit efficiency. The resulting report emphasizes that the
+keys to a successful audit are communication, trust, and openness.
+ 1. Joint Audit Planning--The Benefits of Collaboration. This
+project produced a planning and monitoring tool that lists the steps a
+taxpayer and audit team can take to enhance the quality and timeliness
+of tax examinations. A key to this initiative is the delineation of
+both the individual and the joint responsibilities of all
+participants--the taxpayer, team manager, audit team, specialists, and
+Counsel--thereby focusing time and resources on the most important
+areas.
+ The Joint Audit Planning Process brings home the message that, even
+though taxpayers and the IRS sit on opposite sides of the table, they
+share an interest in ensuring that the resources expended in examining
+corporate tax returns are used efficiently and wisely. The initiative
+also underscores the continuing merit of collaborative efforts.
+ Several other innovative procedures--such as Limited Issue Focused
+Examination (LIFE), Pre-Filing Agreements, Fast Track Mediation and
+Settlement, Accelerated Issue Resolution, and Early Referral to
+Appeals--have also been introduced in the past few years to improve the
+examination process and promote currency. The Advance Pricing Agreement
+(APA) program--begun more than a decade ago--is also a worthwhile
+process that should be continued and encouraged; the program permits
+the tax system to work more efficiently and effectively without costly
+litigation by resolving fact-intensive pricing issues before tax
+returns are filed. In TEI's view, the APA program is a model
+alternative dispute resolution process that benefits the government and
+taxpayers alike.
+ An informal survey of TEI members recently confirmed that LMSB's
+LIFE initiative--which focuses on materiality of issues and risk
+analysis of issues to be audited--is streamlining the examination
+process. We understand that LMSB's interim review of LIFE validates
+this conclusion, and accordingly strongly recommend that future
+initiatives be designed to complement and supplement these programs,
+not replace or supplant them. In addition, we believe that these audit
+techniques could be adapted for other divisions and may resolve some of
+the frustrations felt by personnel concerning their ability to make
+decisions.
+ 2. Overriding Importance of Training. Training is a critical
+element to the success of these initiatives. Procedures such as LIFE
+and other initiatives empower personnel to make quality decisions at
+the lowest level, to resolve disputes fairly and more quickly, and to
+husband and preserve resources. Training also enhances employee job
+satisfaction and encourages employees to continue pursuing public
+service careers. Many agents are still receiving the training needed to
+implement the initiatives discussed in this testimony. In addition, it
+is our understanding that more significant changes are under
+consideration that will require even more training. While LMSB and the
+IRS generally should remain open to new ideas and programs, the costs
+and consequences of change cannot be ignored. Each new program creates
+new training needs, and a ``flavor-of-the-month'' approach to
+examination techniques has the potential for causing confusion and
+malaise in the field. Steps must be taken to ensure that agents receive
+consistent and timely training.
+ TEI recommends that funding be provided to permit continued
+training of revenue agents in alternative dispute resolution
+techniques.
+ Tax Executives Institute commends the Oversight Subcommittee for
+holding this public hearing. TEI looks forward to working with the
+Subcommittee and the IRS itself to improve tax administration.
+
+
+
+ Chairman HOUGHTON. Well, I thank you very much. Mr. Pomeroy
+has a question. I have questions, but what I would like to do,
+because of the time here and because we have votes, is to
+submit them in writing to you gentlemen? Would that be all
+right? We just do have a crunch, and I am terribly sorry, but
+there was not anything we could do about it. It is out of our
+hands. Mr. Pomeroy, you probably want to ask a question. I will
+leave. I will leave the whole thing in your hands. Can I trust
+you?
+ Mr. POMEROY. You can.
+ [Laughter.]
+ Chairman HOUGHTON. Well, thank you very much. Gentlemen, I
+really appreciate your participation here today. Thanks very
+much.
+ Mr. POMEROY. [Presiding.] Mr. Chairman, let me just advise
+the panel what an odd thing it is, an unusual thing it is for a
+Member of the majority to leave the hearing still in process
+with the minority now to chair it. I assure you I will confine
+my comments only to the CRP issue, and after Mr. Orwick has
+traveled so far, I thank you so much for letting me get some
+information from him into the record. My apologies to the rest
+of the panel. I would like to explore some of these issues with
+you as well, but I believe under the circumstances I should
+best focus on CRP and Mr. Orwick's expertise in that area. If
+you would make one request of the IRS today relative to the
+existing confusion about the taxable status of CRP income for
+retired farmers, what would it be?
+ Mr. ORWICK. I think it would be the first of Dr. Harl's
+recommendations, which would be the withdrawal of CCA Letter
+Ruling 200325002 of May 29, 2003, or the reissuance with a
+narrowing of the ruling to harmonize it with Letter Ruling
+8822064, March 7, 1998, that this would remove much of the
+current confusion.
+ Mr. POMEROY. There was a 1988 ruling that very clearly
+addressed the question of retired farmers and determined that
+CRP income was not subject to self-employment tax. Is that
+correct?
+ Mr. ORWICK. For retired individuals, yes.
+ Mr. POMEROY. For retired individuals. So, harmonizing the
+two letter rulings would simply be some clarification to
+indicate, as they orally indicated to us when we met with IRS
+representatives in North Dakota Friday, that this was not--that
+the subsequent letter ruling in 2003 was not written in
+contemplation of the retired farmer and should not have
+application for this tax reporting period to the retired
+farmer. Is that essentially what you would----
+ Mr. ORWICK. Yes, that is correct. My understanding of the
+meeting was the IRS' position was that each of these rulings
+were geared specifically to the people in question in each of
+those rulings and not to be used as a precedent, but as Dr.
+Harl indicated, without any other rulings to go by, by default
+we did need to use those to guide us in our decisionmaking
+process.
+ Mr. POMEROY. The Commissioner indicated this afternoon--and
+you heard him--that there could be a lot at issue here in light
+of types of income that may or may not involve SE tax, and it
+gets quite involved. I believe that that is a little over
+thinking on this particular question. The fact is, from 1988
+on, the IRS has essentially had one position. People have
+relied upon that position. It was inadvertently placed in
+question by a letter ruling that the IRS now indicates they
+wrote without any contemplation of the retired farmer. So, some
+simple clarification of that letter ruling harmonizing with the
+earlier letter ruling would at least get us through this tax
+season, and we would welcome further clarification from the IRS
+in the area. Is that essentially the state of play?
+ Mr. ORWICK. Yes, that is very true. I think that it really
+puts the tax practitioners and taxpayers in an awful position
+the way that it is right now, because we have no idea what is
+our real guidance. Each client is having to step up to the
+plate and make the decision based on their own circumstances,
+and they are not tax professionals and not attorneys well
+versed in this area. We as practitioners can guide them as best
+we can with the facts and circumstances, but they really
+shouldn't be placed in a position to have to make that decision
+and lay awake at night wondering if the IRS is going to be
+knocking on their door with an audit or that there would be
+extra money to pay; or, as most of my clients are choosing to
+do, pay the extra tax because of their conservative nature and
+the fact that they want to be law-abiding citizens.
+ Mr. POMEROY. You indicated at the hearing or the meeting
+that we had in North Dakota, you are a conservative
+practitioner, and you have a very conscientious group of
+clients; and if they think they may owe it, they pay it. That
+is why this situation is really particularly unfair to them. It
+will have broad--I believe by far most retired farmers may not
+be aware of this letter ruling, will not be paying the self-
+employment tax. In light of the discussion in this area in our
+community, they will be aware of it. Maybe they will pay the
+tax. The thing to do is lift the uncertainty relative to this
+filing season and then deal with it in a more comprehensive and
+involved way with the kind of fact gathering that the IRS would
+appropriately do prior to issuing such further rules in this
+area. Is that right?
+ Mr. ORWICK. Yes, that would be a very prudent process.
+ Mr. POMEROY. Well, I want to thank all of the panel, and
+especially, again, in absentia, express my appreciation for the
+Chairman. There is only 5 minutes left in the vote, and I
+believe it is his indication that the hearing will end at this
+point in time, so I will do something I have never done before
+and gavel adjournment. Thank you.
+ [Whereupon, at 5:35 p.m., the hearing was adjourned.]
+ [Questions submitted by Chairman Houghton and
+Representative Ryan to Commissioner Everson, Mr. Orwick, Mr.
+Zarzar, and Mr. Leimbach, and their responses follow:]
+
+ Questions from Chairman Houghton to Mr. Leimbach
+
+ Question: As more and more Americans turn to tax preparers to
+prepare their returns, the role of practitioners in the tax system has
+become more important. According to the National Taxpayer Advocate, as
+many as half of the 1.2 million tax preparers have no formal training
+and are not required to adhere to any professional standards. As you
+may know, the Advocate and others have discussed limited registration
+of paid preparers. What is your view of the proposal?
+ Answer: The members of the National Association of Enrolled Agents
+are dedicated to the integrity of the tax system and the roles
+professional responsibility and ethics play in preserving that
+integrity. It therefore is disturbing to us that there is an increase
+in taxpayer belief that tax returns will be accepted regardless of the
+facts reported on them.
+ The IRS has undergone major changes in the last several years.
+Former Commissioner Rossotti's reorganization of the IRS and the
+emphasis he placed on customer service may in part have been a catalyst
+in modifying taxpayer attitude. Most agree that his initiatives were
+good, were consistent with the 1998 IRS Restructuring and Reform Act,
+and have produced a better IRS. However, their implementation resulted
+in resources being shifted away from enforcement activities. Other
+contributing factors include discontinuance of the Taxpayer Compliance
+Measurement Program (TCMP), ineffective technology, and tax law
+complexity.
+ Commissioner Everson has begun efforts to turn that around. While
+he acknowledges that customer service plus enforcement equal
+compliance, he has announced that effective enforcement of the tax laws
+rather than further improving customer service will be the main focus
+of his administration. In this connection, he implicated the tax
+practitioner community in the diminishment of compliance and challenged
+all practitioners to raise their ethical standards in order to avoid
+actions being taken against them by the government. While much of this
+was done in regard to abusive tax schemes, it seems clear to NAEA and
+we believe to him that his efforts will not stop there.
+ All who provide tax services must be cognizant of the strong
+enforcement component of tax compliance. It has the possibility of
+touching every aspect of tax advice and return preparation.
+ NAEA finds that commercial return preparers are an enigma in
+today's tax practice world. We all seem to know there are problems in
+connection with services performed by paid preparers, but in many
+respects those problems are unknown and the product of anecdotal
+information and conjecture. We define commercial preparers as those 1)
+who prepare Federal tax returns for a fee, 2) who are not required to
+possess any knowledge of tax law and procedure, and 3) who are subject
+to very limited oversight. At the state level, only California and
+Oregon regulate commercial tax return preparers.
+ The number of commercial preparers is not known with any accuracy
+but, as your question suggests, estimates of upward of 1 million
+individuals have been bandied about. With 55% of returns having been
+prepared by someone other than the taxpayers in 2001 and perhaps even
+more in 2002 and 2003, it seems safe to conclude that the number of
+returns prepared by commercial preparers is considerable and growing.
+Even if we had the numbers, we do not know the extent of training, if
+any, many of the commercial preparers have had and the manner in which
+they keep abreast of the changes in tax laws and procedures. Perhaps of
+greatest concern is the belief the public is not aware of the fact that
+many commercial preparers have no credentials. This may in part be the
+reason taxpayers ``shop'' for preparers who will prepare tax returns
+the way taxpayers wish them to be prepared (often unsigned by those
+preparers), to the detriment of responsible return preparers and the
+integrity of the tax system.
+ NAEA understands that tax return preparer penalties asserted in
+recent years have been minimal in number as related to the apparent
+potential for such penalties. Those that have been imposed in large
+measure have not been collected. We also know that attempts to
+implement recognition procedures in the electronic filing area, i.e.
+electronic filer originators (EROs), have been the subject of criticism
+due to systemic problems in background checks and the like as
+documented in the Treasury Inspector General for Tax Administration
+(TIGTA) report of June 2002. Further, many of the problems in the
+earned income tax credit (EITC) program are attributable to paid
+preparer involvement. Again, there does not seem to be a great deal of
+empirical data to support a conclusion as to the number of commercial
+preparers involved in the program and whether or not they do a
+consistently worse job than other preparers, even though there have
+been some informative and well-written white papers on the subject.
+ As you are aware, the National Taxpayer Advocate's report to
+Congress for the year 2002 recommended that there be a program to
+register commercial return preparers. It would be an extremely
+ambitious program and one that would be expensive to establish and run.
+The IRS disagreed with the recommendation citing, among other factors,
+the expense of the program and that the issue is one for states to
+address rather than the federal government. NAEA believes there are
+problems both with the recommendation and the IRS response.
+Consequently, we were pleased that her request for the year 2003
+compromised the previous recommendation by recommending that there be a
+legislatively mandated task force established to study the situation
+and the many unknowns.
+ In spite of the above, NAEA supports Ms. Olson's quest, if not her
+vehicles for achieving it. If left unchecked, the perceived problems
+will continue to grow. In this connection, we believe the IRS Advisory
+Council's Wage & Investment and Small Business/Self Employed subgroup
+reports warrant favorable consideration. In particular, the SB/SE
+subgroup's belief that the IRS should begin working with outside
+stakeholders to develop a program after examining a number of the
+``unknowns'' would be beneficial.
+ NAEA subscribes to the belief that ethics are the fabric that holds
+a profession together. In the tax arena, Congress has identified those
+who qualify as Federally authorized tax practitioners (FATPs), i.e.
+Enrolled Agents, Attorneys, and Certified Public Accountants. All are
+licensed individuals whose professional practice is circumscribed by
+codes of professional conduct and continuing education requirements.
+ With the above said, FATPs have dual loyalties. One, of course, is
+to their clients. The other is to the tax system itself. NAEA thinks it
+safe to conclude that all FATPs share the goal of safeguarding the
+integrity of our tax system and would be willing to work to make that
+happen. A possible beginning to assist the IRS in this respect is to
+form an independent private sector task force comprised of
+representatives from the Enrolled Agent, attorney, and CPA
+organizations to consider the issue and make recommendations addressing
+them. NAEA would be pleased to head a practitioner organization
+steering Committee to implement this. Other organizations, individuals,
+academicians, and the like with similar goals would be invited to the
+extent that the numbers would be manageable.
+ We are eager to move off dead center in our support of overcoming
+the frustrations we all share with respect to the unknown factors
+relative to the issue and doing our part in establishing a program
+evidencing ethics as a vital part of our tax system's integrity.
+However, our eagerness would be meaningful only if there is an intent
+by Congress to pursue the matter through legislation or another
+vehicle.
+ Question: In your written statements, all of you have emphasized
+the need to simplify the Tax Code. How did the tax code become so
+complex, and what should Congress do to simplify our tax Code?
+ Answer: Our current tax system tries to address every aspect of our
+economy and, to a large degree, social issues as well. The complexity
+resulting therefrom warrants simplification of the tax laws and their
+administration. The National Association of Enrolled Agents believes
+that incremental changes are the most effective means by which to
+accomplish tax simplification. For example, in the recent years, NAEA
+has requested simplification of the Alternative Minimum Tax (AMT), the
+definition of a child, particularly in the context of the earned income
+tax credit, and rationalization of phase-ins and phase-outs.
+ Question: Occasionally, we have heard opposition from practitioners
+to a tax simplification proposal that might alter or upset the
+practitioner's chosen specialty of tax. Are your members willing to
+give up a lucrative practice that depends on a wrinkle in the Tax Code?
+How important is tax simplification to your membership and to the tax
+system as a whole?
+ Answer: The practice of the members of the National Association of
+Enrolled Agents would not be adversely affected by an incremental
+approach to simplifying the tax system.
+ Question: I understand that the IRS is in the process of launching
+a new program that will allow tax preparers to access certain
+information on behalf of the clients and will improve communication
+with the IRS. What is your impression of the new service so far? Are
+there any improvements the IRS should make?
+ Answer: The capabilities being referred to are Disclosure
+Authorization, Transcript Delivery System, and Electronic Account
+Resolution within the IRS' e-services, secure Web site. NAEA believes
+that these three (secure) capabilities are, without question, going to
+revolutionize the way tax practitioners conduct business with the IRS.
+ The Disclosure Authorization (DA) capability allows tax
+practitioners the ability to submit an electronic Power of Attorney
+(POA) directly into the IRS' Centralized Authorization File (CAF)
+computer system. The process of preparing a DA for a taxpayer takes
+approximately 3-5 minutes. Once the DA is prepared, the submittal and
+processing of the DA into CAF is instantaneous.
+ The DA capability will replace the current process of faxing (or
+mailing) a POA into the IRS' IRS Centers for manual input into CAF. The
+normal wait time for the manual input into CAF is usually 2-3 days. The
+cost savings to the IRS will be truly significant when this capability
+becomes available this year once the final testing has been completed.
+The instantaneous processing of the DA into CAF allows tax
+practitioners immediate access to account information on the
+taxpayer(s) being represented via the Transcript Delivery System.
+ The Transcript Delivery System (TDS) is the true powerhouse of the
+three capabilities. With TDS, tax practitioners can access the specific
+account related information that is crucial to problem resolution for
+the taxpayer(s). The account information is delivered to tax
+practitioners instantly. It now takes a practitioner longer to print
+the account information transcripts than it does to actually fill out
+the request and receive them. The type of information that can be
+obtained is:
+
+ 1. Account Transcript (Reflects a summary of the return and all
+subsequent information posted to the account.)
+ 2. Return Transcript (Contains most of the lines from an original
+return, including the various forms and schedules submitted with the
+return. The transcript contains both the ``per return'' and ``per
+computer'' entries from IRS databases.)
+ 3. Record of Account (Merger of both Account Transcript and Return
+Transcript)
+ 4. Verification of Non-Filing (This transcript is used in
+circumstances where a taxpayer may need a letter from the IRS
+indicating that he or she did NOT file a tax return. A good example
+would be where a taxpayer has applied for a state-backed mortgage
+subsidy bond.)
+ 5. Wage and Income Transcript (W-2, 1099-DIV, 1099-MISC, and so
+forth. Practitioners can also select ``All Documents'' to retrieve
+every wage and income document reported to the IRS)
+
+ Prior to TDS the practitioner either had to drive to the local IRS
+office and obtain transcripts which took a total of 1 hour, or contact
+the IRS' Practitioner Priority IRS and request transcripts to be faxed
+to me. The general turnaround time for receipt of the faxed transcripts
+was anywhere from 1 hour to 1 day.
+ TDS is an utterly amazing capability for tax practitioners and will
+have a major impact on the practitioner's ability to better serve their
+clients.
+ Once the DA and TDS capabilities have provided the necessary
+service to the tax practitioner, the final step is in the electronic
+(secure) correspondence with the IRS for problem resolution. The secure
+Internet interaction with the IRS is achieved via the Electronic
+Account Resolution (EAR) capability.
+ EAR provides practitioners the following:
+
+ 1. Account Problems Inquiry: This type of inquiry will allow users
+to address account related issues (not in ACS or Under Reporter) for
+resolution. A good example would be abatement of penalties due to
+reasonable cause.
+ 2. Notice Inquiry: This inquiry will allow users to respond to IRS
+Notices with the exception of those that are outside the scope of EAR
+such as a CP2000, Notice of Underreported Income.
+ 3. Complex Refund Inquiry: The Complex Refund inquiry will allow
+users to address refunds that were issued via direct deposit or by
+paper check and have either been destroyed, lost, not received, or
+stolen. It is also possible to inquire about refunds that have been
+offset by the Financial Management System (FMS) or have been applied to
+other tax debt owed to the IRS.
+ 4. Payment Inquiry: The Payment Tracer will allow you to inquire
+on behalf of an individual or business, payments made to the IRS but
+not yet posted or to verify the posting of a payment on the account. A
+good example would be 1040-ES payments.
+ 5. Installment Agreement Inquiry: The Installment Agreement
+provided in EAR is limited to Guaranteed Installment Agreements (under
+$10,000) and Streamlined Installment Agreements (under $25,000).
+Installment Agreements for amounts over $25,000 cannot be processed
+through EAR at the present time. In addition, the only payment method
+available is through Direct Debit. In addition to submitting a new
+Installment Agreement, you can revise an existing one or reinstate a
+previous Installment Agreement, which are two features that will be
+very useful.
+ 6. Follow Up Inquiry: The Follow Up Inquiry will allow users to
+address previously submitted EAR inquiries that require additional
+information for the original submittal (i.e. not enough room in
+comments area), or in responding to a CSR's request for additional
+information.
+ 7. Multiple Inquiry: The Multiple Inquiries function allows tax
+practitioners to address simultaneously the first five types of
+inquiries above on behalf of an individual or business.
+
+ The current turnaround for an IRS response to a proposed problem
+resolution is generally 1 month, many times much longer. With EAR, the
+IRS' response will be within three business days.
+ The combination of DA, TDS, and EAR is just plain phenomenal
+capability in IRS representation. The products will be the first of its
+kind and certainly, enhancements will be needed since many of the
+desired representation aspects will not be included in the initial
+release. Two excellent examples for future inclusion in EAR would be
+the ability to address collection related issues and those handled by
+the under reporter IRS entities.
+ The IRS has already solicited the Enrolled Agents and CPAs that
+have been testing the products for their input for future enhancements.
+NAEA's biggest concern for future enhancements is whether or not
+adequate funding will be available. It is crucial that Congress ensure
+that adequate funding for this new capability and the future
+enhancements will be there when needed.
+ Question: One of the things that make the tax system complex is
+that the IRS does not always provide a clear answer to the tax
+treatment of a common transaction. Is the IRS doing enough to publish
+clear and concise guidance to taxpayers? Would increasing the resources
+available to the IRS in this area help to make the tax system more
+transparent?
+ Answer: The IRS has made progress in its effort to publish clear
+and concise guidance to taxpayers. Part of such progress is making
+information available on the Internet and CDs. The problem in trying to
+publish clear and concise guidance is that the tax issue itself is
+complex and can only be simplified to a point. For example, taxpayers
+with children are faced with numerous different definitions of a child
+for 1) Dependent, 2) Child Tax Credit, 3) Earned Income Credit, 4)
+Credit for Child and Dependent Care Expenses, 5) Adoption Credit.
+Having one definition versus numerous definitions for a child is a
+longstanding problem that has been addressed repeatedly without
+success.
+ Increasing the number of IRS personnel working the Customer IRS
+telephone lines and answering questions from the public, especially
+during the tax season would be a sound objective. Bright line guidance
+for IRS employees and the public is agoal worth pursuing. All of this
+would require appropriate training.
+ Question: We have discussed the IRS budget with the government
+panelists. What is your view of the budget, as practitioners? Where do
+you believe the IRS should allocate its resources?
+ Answer: The National Association of Enrolled Agents always has
+supported full funding for the IRS. In addition to the training
+discussed above, we believe the IRS should focus its resources on
+modernizing antiquated computer systems, expanding the new electronic
+capabilities such as DA, TDS, and EAR, and increasing enforcement,
+especially with respect to non-filers.
+ Question: I imagine you have heard about the delays in Business
+Systems Modernization program. Can you explain why it is important to
+you, as practitioners, to complete this important program? What
+benefits do you see, and what services should the IRS provide in the
+future?
+ Answer: The Business Systems Modernization effort is crucial for
+the future administration of our tax system. The effective
+administration of our tax system depends, to an enormous degree on
+having computer systems that can process the workload. A 19sixties-era
+mainframe cannot be expected to handle the demands placed upon it fifty
+years later. The volume of taxpayers now and in the future is just
+beyond the computer processing power built in the sixties.
+ Question: The IRS has hired a new director of the Office of
+Professional Responsibility, and it is beginning to coordinate the
+efforts of the various working divisions to interact with
+practitioners. What is your initial impression of the IRS's efforts in
+this area, and what should be done in the future?
+ Answer: NAEA is very pleased that IRS is finally able to address
+the resource and modernization needs of the Office of Professional
+Responsibility (OPR). As practitioners, we look forward to seeing
+progress in having OPR address longstanding issues involving tax
+professionals. In doing so, we hope that the OPR will be sensitive to
+the independence of this office in fulfilling its quasi-judicial role.
+We believe it is too early to assess the success of its initiatives.
+ Question: What is your assessment of the state of the tax system
+today, compared to 6 years ago, when Congress enacted the IRS
+Restructuring and Reform Act?
+ Answer: The IRS Restructuring and Reform Act resulted in a
+tremendous cultural shift at IRS. During the process (which is
+ongoing), practitioners found that IRS employees were placed in new
+positions without adequate training. On the front lines, they did not
+know where to send taxpayers for proper resolution or assistance and
+the negative impact it had on the morale of the IRS employees is still
+evident today. The IRS failed in the proper planning and execution of
+the reorganization and it still plagues the IRS today. This is not to
+imply the RRA was wrong. NAEA believes that the same shift in culture
+affecting IRS employees also has affected taxpayers and practitioners.
+ ______
+
+
+ Questions from Chairman Houghton to Mr. Orwick
+
+ Question: As more and more Americans turn to tax prepares to
+prepare their returns, the role of practitioners in the tax system has
+become more important. According to the National Taxpayer Advocate, as
+many as half of the 1.2 million tax prepares have no formal training
+and are not required to adhere to any professional standards. As you
+may know, the Advocate and others have discussed limited registration
+of paid prepares. What is your view of the proposal?
+ Answer: I do not oppose limited registration of paid prepares if
+those whom do questionable work are ``weeded'' out of the business of
+preparing tax returns. This registration should have some sort of
+grandfather clause included for qualified prepares.
+ Question: In your written statements, all of you have emphasized
+the need to simplify the Tax Code. How did the Tax Code become so
+complex, and what should Congress do to simplify the tax Code?
+ Answer: I started preparing tax returns in 1980. Since that time
+every new tax law has added some degree of complication. IRS rulings
+such as Rev. Rul. 2000-4 regarding depreciation and those of which I
+spoke on the taxation of CRP income for retired taxpayers, adds to the
+confusion and frustration of taxpayers and practitioners. The
+alternative minimum tax has also become a burden for many average
+taxpayers; this was not the original intent when it became part the tax
+Code many years ago. When Congress passes tax legislation, it is very
+important that their intent be clear, so the IRS knows how to interpret
+and enforce the law. This alone would ``simplify'' the current tax
+system.
+ Question: Occasionally, we have heard opposition from practitioners
+to a tax simplification proposal that might alter or upset the
+practitioner's chosen specialty of tax. Are your members willing to
+give up a lucrative practice that depends on a wrinkle in the Tax Code?
+How important is tax simplification to your membership and to the tax
+system as a whole?
+ Answer: Since I do not represent any particular organization I can
+only speak for myself. I believe that simplification is the cornerstone
+to the success of our current tax system. If we as practitioners or the
+taxpayers themselves cannot comply with the law because it is to
+complicated the system no longer works. As to altering or upsetting my
+particular practice with simplification, I feel that we have a broad
+base of clients whom even in a more ``simple'' tax system would
+continue to require the professional services we offer. However,
+simplification would allow my staff and myself to work a normal
+workweek rather than eighteen hours a day, 7 days a week for the tax
+season.
+ Question: I understand that the IRS is in the process of launching
+a new program that will allow tax prepares to access certain
+information on behalf of clients and will improve communication with
+the IRS. What is your impression of the new service so far? Are there
+any improvements the IRS should make?
+ Answer: I have had limited exposure to the current system and do
+not feel that this exposure has yet given me an opportunity to make an
+educated comment on it's effectiveness. However, I was part of a pilot
+program a few years ago dealing with the same issues and found the
+system a fantastic tool in resolving my clients' account problems with
+the IRS.
+ Question: One of the things that makes the tax system complex is
+that the IRS does not always provide a clear answer to the tax
+treatment of a common transaction. Is the IRS doing enough to publish
+clear and concise guidance to taxpayers? Would increasing the resources
+available to the IRS in this area help to make the tax system more
+transparent?
+ Answer: Yes, I believe it would. Also the passage of clear and
+concise tax legislation would aid the IRS in reaching their goals.
+ Question: We have discussed the IRS budget with the government
+panelists. What is your view of the budget, as practitioners? Where do
+you believe the IRS should allocate its resources?
+ Answer: As with anything, the more funds that are available the
+easier it is to do a better job. I feel the IRS is currently doing a
+good job, additional programs designed to build a team effort between
+the IRS, taxpayers and practitioners would be a positive place to apply
+additional funding.
+ Question: I imagine you have heard about the delays in the Business
+Systems Modernization program. Can you explain why it is important to
+you, as practitioners, to complete this important program? What
+benefits do you see, and what services should the IRS provide in the
+future.
+ Answer: I do not feel that I have enough facts to comment on this
+issue.
+ Question: The IRS has hired a new director of the Office of
+Professional Accountability, and it is beginning to coordinate the
+efforts of the various working divisions to interact with
+practitioners. What is your initial impression of the IRS's efforts in
+this area, and what should be done in the future?
+ Answer: I believe that all advances in this area are very positive
+steps and I commend them for their efforts. I have not personally been
+exposed to this program, so I do not at this time have an initial
+impression of the IRS's efforts in this area.
+ Question: What is your assessments of the state of the tax system
+today, compared to 6 years ago, when Congress enacted the IRS
+Restructuring and Reform Act?
+ Answer: I believe that the IRS has become more customer service
+orientated. This along with movement toward electronic filing and other
+advancements of technology have been very positive steps. On the
+downside, I believe the tax legislation passed during this period along
+with the interpretation of it and previous laws by the IRS has made
+working with the current tax system more complicated and cumbersome.
+ ______
+
+
+ Questions from Chairman Houghton to Mr. Zarzar
+
+ Question: As you may know, the Advocate and others have discussed
+limited registration of paid preparers. What is your view of the
+proposal?
+ Answer: National Taxpayer Advocate Nina Olson, as part of the
+Advocate's 2003 Annual Report to Congress, calls for the establishment
+of a ``registration, examination, certification, and enforcement
+program for Federal tax return preparers.''
+ The legislative intent of the tax return preparer registration
+proposal is to raise the professional standards for unenrolled
+preparers. Providing meaningful guidance to practitioners in the
+performance of their professional responsibilities is an objective we
+strongly support, as reflected by the AICPA's Code of Professional
+Conduct and our Statements on Standards for Tax IRSs. However, we are
+concerned that this registration initiative has not undergone
+sufficient review regarding the level of financial resources required
+for proper administration of the program. No budgetary commitment to
+this program is reflected in the Administration's proposed IRS budget
+for fiscal year 2005.
+ In conjunction with any review of the proposal, we also recommend
+that the IRS and Congress study how the current Electronic Return
+Originator (ERO) application process might overlap or duplicate even a
+``limited'' registration process for tax return preparers. Under the
+current ERO application process, IRS conducts a background check of all
+principals and responsible officials affiliated with a tax return
+preparer's firm. This background check includes: (1) an FBI criminal
+background review; (2) a credit history check; and (3) an IRS records
+check with respect to the preparer and the firm's adherence to tax
+return and tax payment compliance requirements, including a review of
+any prior non-compliance under the IRS e-file program.
+ Question: In your written statement, all of you have emphasized the
+need to simplify the Tax Code. How did the Tax Code become so complex,
+and what should Congress do to simplify the Tax Code?
+ Answer: In our testimony, the AICPA reaffirmed its support of
+efforts to reduce complexity in existing tax law and to curtail
+incremental complexity in the future. While we acknowledge that an
+absolutely simple tax system is not feasible in today's complex
+business and economic environment, we believe it is possible to design
+a simpler tax system.
+ We believe that the problem of undue complexity has arisen in part
+because of the dominance of other legislative goals (such as revenue
+enhancement, rate reduction, economic incentives and social policy)
+over the goal of simplification. As a starting point, lawmakers need to
+balance the goal of tax simplification with these competing objectives.
+Incremental additional complexity can be curtailed by following basic
+guiding principles for tax law simplification.\1\ For example, as
+legislation and administrative guidance is drafted, legislators and
+regulators should: (1) seek the simplest approaches; (2) minimize both
+compliance and administrative burdens; (3) avoid inconsistent concepts
+and definitions; and (4) avoid enacting provisions that apply to only a
+few or for only a short period of time.
+---------------------------------------------------------------------------
+ \1\ See AICPA comments on 2001 Recommendations of the Staff of the
+Joint Committee on Taxation to Simplify the Federal Tax System,
+February 2002.
+---------------------------------------------------------------------------
+ Congress must then undertake meaningful tax simplification to
+existing law. Considerable consensus has developed in recent years
+identifying desirable proposals that would simplify the law for a large
+number of taxpayers. For example, the AICPA provided lengthy comments
+on the 2001 Recommendations of the Staff of the Joint Committee on
+Taxation to Simplify the Federal Tax System.\2\ In addition, in
+February 2000, the AICPA sent to Congress a package of tax
+simplification recommendations the Institute hammered out in a historic
+joint initiative with the Tax Executives Institute and the American Bar
+Association Section of Taxation.\3\ Among the recommendations were: (1)
+repeal of the alternative minimum tax; (2) harmonization of family
+status definitions; (3) streamlining education tax incentives; and (4)
+eliminating or making uniform the numerous phase-outs contained in the
+Code.
+---------------------------------------------------------------------------
+ \2\ See AICPA, American Bar Association section of Taxation and Tax
+Executives Institute Tax Simplification Recommendations, February 25,
+2000.
+ \3\ Id.
+---------------------------------------------------------------------------
+ These changes alone would make the Code more consistent, rational,
+fair, and transparent--particularly for low--and middle-income
+taxpayers. While there are revenue costs associated with simplification
+reforms, it is also important to recognize that there are significant
+compliance burdens that will be eliminated by such reforms.
+ We note with pleasure Chairman Houghton's introduction of nine
+separate tax simplification bills on April 2, 2004, many of which
+address our top complexity concerns.
+ Question: Occasionally, we have heard opposition from practitioners
+to a tax simplification proposal that might alter or upset the
+practitioner's chosen specialty in tax. Are your members willing to
+give up a lucrative practice that depends on a wrinkle in the Tax Code?
+How important is tax simplification to your membership and to the tax
+system as a whole?
+ Answer: The AICPA has surveyed its membership on the topic of tax
+law simplification. This has resulted in our firm belief that it is
+essential to simplify the Tax Code in order to preserve our voluntary
+compliance tax system and, as a consequence, preserve a viable tax
+practice for our membership. As a consequence, the AICPA has actively
+supported many Congressional tax simplification efforts and has offered
+Congress many specific recommendations over the years.
+ Tax advisers spend considerable time assisting clients with
+compliance problems; time that they believe would be better spent on
+activities such as personal financial or strategic business planning.
+ Question: I understand that the IRS is in the process of launching
+a new program that will allow tax preparers to access certain
+information on behalf of clients and will improve communication with
+the IRS. What is your impression of the new service so far? Are there
+any improvements the IRS should make?
+ Answer: The IRS has taken a number of positive steps during the
+last year to listen to the practitioner community about the myriad of
+problems tax professionals still face when contemplating offering e-
+file services to their clients. This includes the IRS's efforts to
+phase-in the electronic filing of business returns and its rollout of
+the ``Electronic IRSs'' section on the IRS Website, including a suite
+of Web-based products for practitioners to do business with the IRS
+electronically. Electronic IRSs would enable practitioners who e-file
+more than 100 ``accepted'' individual tax returns in a season to (1)
+submit many commonly used IRS contact forms electronically and receive
+an acknowledgement of acceptance from the IRS; (2) make electronic
+inquiries about individual and business tax account problems and
+issues; and (3) request tax return transcripts and account transcripts.
+We support the new e-services, but we encourage the IRS to eliminate
+the 100 return threshold, allowing all practitioners to benefit and
+contribute to the growth of e-filing and account resolution.
+ Question: Is the IRS doing enough to publish clear and concise
+guidance to taxpayers? Would increasing the resources available to the
+IRS in this area make the tax system more transparent?
+ Answer: All IRS guidance must be effective, clear, timely, and
+designed to promote a uniform understanding and consistent application
+of the tax laws. In this context, we support any initiative designed to
+improve the quality of published IRS guidance. The IRS has made great
+strides in recent years, and we look forward to increased efficiency
+and timeliness in the future. Allocating appropriate resources to
+increase the volume of guidance published will make the tax system more
+transparent.
+ Question: What is your view of the IRS budget, as practitioners?
+Where do you believe the IRS should allocate its resources?
+ Answer: We applaud Congressional efforts to provide full funding
+for the IRS's fiscal year 2005 budget. The AICPA has long advocated
+funding levels which would allow the IRS to efficiently and effectively
+administer the tax laws and collect taxes. We support the objective of
+the Administration's budget proposal which focuses on increasing
+staffing and providing more resources for enforcement. In addition, we
+believe the budget should strive to provide a positive balance among:
+(1) improving taxpayer service; (2) enhancing enforcement of the tax
+law; and (3) modernizing the IRS through its people, processes, and
+technology.
+ Question: Can you explain why it is important to you, as
+practitioners, to complete the Business Systems Modernization program?
+What benefits do you see, and what services should the IRS provide in
+the future?
+ Answer: The IRS Oversight Board's December 2003 Business Systems
+Modernization and the IRS have detailed continuing delays in
+implementing the customer account data engine designed to replace the
+IRS Master File of taxpayer records.
+ Despite these problems, we urge Congress to stay the course in
+supporting appropriate funding for the modernization effort that must
+remain a central feature of the IRS's strategic plan for the next 5
+years. The Business System Modernization goals are critical to the
+future of the IRS, taxpayers, and the effectiveness of our tax system.
+ Question: The IRS has hired a new director of the Office of
+Professional Responsibility and it is beginning to coordinate the
+efforts of various working divisions to interact with practitioners.
+What is your initial impression of the IRS's efforts in this area, and
+what should be done in the future?
+ Answer: The AICPA is encouraged by Commissioner Everson's
+commitment to upgrade the Office of Professional Responsibility, and
+his appointment of Cono Namorato as the office's new Director. These
+efforts should greatly enhance the IRS's ability to address
+professional responsibility standards for all tax professionals and
+help eradicate abusive transactions.
+ We also commend Treasury and the IRS for their commitment to issue
+final regulations under Circular 230 over the next several months to
+address: (1) ``best practices'' for tax advisors (which we believe
+should be aspirational in nature); and (2) tax shelter opinions. These
+regulations should help to ``raise the bar'' of professionalism for tax
+advisors, as well as the quality of written tax opinions. The final
+regulations should clearly address the need for restoring integrity and
+confidence in the tax system, and we are proud to join with the
+Treasury and the IRS to ensure that tax practitioners have a role in
+that restoration.
+ Question: What is your assessment of the state of the tax system
+today, compared to 6 years ago, when Congress enacted the IRS
+Restructuring and Reform Act?
+ Answer: The IRS Restructuring and Reform Act has resulted in: (1)
+improved taxpayer service; (2) greater equity in the administration of
+the tax law; and (3) higher productivity of the IRS's workforce.
+Nevertheless, we recognize that further improvements can and should be
+made--improvements that can result in an even higher level of service
+for America's taxpayers. We support Commissioner Everson's push to
+increase staffing in the compliance area and to ensure a proper balance
+between service and enforcement within the context of the IRS budget
+initiatives for fiscal year 2005 and the IRS's strategic plan for the
+next 5 years.
+ ______
+
+
+ Questions from Chairman Houghton to Mr. McCormally
+
+ Question: As more and more Americans turn to tax preparers to
+prepare their returns, the role of practitioners in the tax system has
+become more important. According to the National Taxpayer Advocate, as
+many as half of the 1.2 million tax preparers have no formal training
+and are not required to adhere to any professional standards. As you
+may know, the Advocate and others have discussed limited registration
+of paid preparers. What is your view of the proposal?
+ In your written statements, all of you have emphasized the need to
+simplify the Tax Code. How did the Tax Code become so complex, and what
+should Congress do to simplify the tax Code?
+ Occasionally, we have heard opposition from practitioners to a tax
+simplification proposal that might alter or upset the practitioner's
+chosen specialty of tax. Are your members willing to give up a
+lucrative practice that depends on a wrinkle in the Tax Code? How
+important is tax simplification to your membership and to the tax
+system as a whole?
+ I understand that the IRS is in the process of launching a new
+program that will allow tax preparers to access certain information on
+behalf of clients and will improve communication with the IRS. What is
+your impression of the new service so far? Are there any improvements
+the IRS should make?
+ One of the things that makes the tax system complex is that the IRS
+does not always provide a clear answer to the tax treatment of a common
+transaction. Is the IRS doing enough to publish clear and concise
+guidance to taxpayers? Would increasing the resources available to the
+IRS in this area help to make the tax system more transparent?
+ We have discussed the IRS budget with the government panelists.
+What is your view of the budget, as practitioners? Where do you believe
+the IRS should allocate its resources?
+ I imagine you have heard about the delays in the Business Systems
+Modernization program. Can you explain why it is important to you, as
+practitioners, to complete this important program? What benefits do you
+see, and what services should the IRS provide in the future?
+ The IRS has hired a new director of the Office of Professional
+Accountability, and it is beginning to coordinate the efforts of the
+various working divisions to interact with practitioners. What is your
+initial impression of the IRS's efforts in this area, and what should
+be done in the future?
+ What is your assessment of the state of the tax system today,
+compared to six years ago, when Congress enacted the IRS Restructuring
+and Reform Act?
+ Answer: On behalf of Tax Executives Institute, I am pleased to
+respond to your follow-up questions to the Oversight Subcommittee's
+hearing on the 2004 IRS filing season and IRS budget for FY 2005. TEI
+appreciates the opportunity to express our views.
+ In your April 5, 2004, letter, you asked about the effect of the
+complexity of the Internal Revenue Code on tax administration. The IRS
+National Taxpayer Advocate (NTA) has consistently identified the
+complexity of the tax laws as the number one problem facing taxpayers.
+In her 2003 annual report, Nina Olson ranked the alternative minimum
+tax (AMT) for individuals as the number one problem, noting that
+according to IRS estimates, taxpayers spent more than 29 million hours
+in 2000 completing and filing AMT tax forms, or roughly 63 hours per
+taxpayer who actually pays the AMT. ``The AMT is extremely and
+unnecessarily complex,'' the report concludes, ``and results in
+inconsistent and unintended impact on taxpayers.'' Your recent proposal
+(H.R. 4131) to gradually raise the AMT exemption amount and repeal the
+individual AMT after 2013 is a good first step in reducing complexity.
+ The corporate AMT, however, suffers from the same policy and
+administrative deficiencies as the individual AMT: It creates enormous
+compliance burdens. TEI strongly believes that taxpayers should not be
+required to compute their taxes twice or to keep two sets of books. In
+addition, the AMT taxes corporations when they can least afford it--
+when they are struggling to survive in a down economy. The AMT
+represented poor public policy when it was enacted, and ensnares
+taxpayers who do no more than engage in activities that Congress
+independently determined should be encouraged. The AMT should be
+repealed for all taxpayers, individuals and corporations.
+ Everyone--Congress, the U.S. Department of Treasury, the IRS, tax
+professionals, and taxpayers--bears responsibility for the current
+complex state of the law. More than five years ago, TEI joined with the
+AICPA and ABA Tax section to draw attention to the problem and to seek
+solutions. Mr. Chairman, you have been a strong supporter of these
+efforts, and, indeed, during your 17 years in Congress, you have been a
+strong champion for making the tax law simpler. TEI commends you and
+this Subcommittee for highlighting this issue.
+ TEI wishes you well on your retirement at the end of this year and
+pledges to continue seeking changes that will make the tax law simpler
+for all of us.
+ If you have any questions, please do not hesitate to contact me or
+Fred F. Murray, TEI's General Counsel and Director of Tax Affairs, at
+202.638.5601.
+ ______
+
+
+ Questions from Representative Paul Ryan to Commissioner Everson
+
+ Question: My question is in regards to child tax credit
+overpayments as a result of the child tax credit advance payments that
+were sent out last year.
+ A constituent shared with me that they approached the IRS with the
+following scenario: In the case of divorced parents, the individual ex-
+spouses may alternate tax years in which they claim the personal
+exemptions and the child tax credit. One parent, for example, may have
+claimed the child tax credit in 2002 and received the child tax credit
+advance payment in 2003. This parent, however, will not claim the child
+tax credit for tax year 2003 because it is the turn of the other parent
+to claim the child tax credit. The constituent asked the IRS if the
+parent who received the child tax credit advanced payment in 2003 would
+have to repay the advance in some way to the IRS? The constituent also
+asked if the parent who will claim the child tax credit for 2003 would
+have to reduce the $1,000 per child credit by the amount of the advance
+payment received by the other parent?
+ The IRS indicated to the constituent that if the advance payment
+exceeds the total of the child tax credit and the additional child tax
+credit, the taxpayer does not have to repay the difference. This is
+true even if the taxpayer isn't eligible for the credit in 2003. In
+addition, the IRS told the constituent that a taxpayer takes into
+account only his or her advance payment, not the amount received by
+someone else, even if that person had claimed the qualifying children
+the previous year. Therefore, in the constituent's situation, no
+repayment would need to be made and the other parent would claim the
+full credit allowable without subtracting the advance payment amount.
+ My question is, first, is this true? Second, if this is in fact
+true, what does IRS estimate these child tax credit overpayments will
+amount to for tax year 2003?
+ Answer: In the scenario described, your constituent was given the
+correct answer. The divorced parent claiming the child for 2003 may
+claim the full credit without regard to the advance child tax credit
+payment received by the other divorced parent. The parent that is not
+claiming the child for 2003 but received the advanced child tax credit
+payment is not required to repay the credit to the IRS.
+ IRS does not have a way to calculate the amount of overpaid ACTC to
+parents that have alternating support agreements.
+ Question: The Federal tax refund offset program, which is referred
+to as the Treasury Offset Program (TOP), allows government agencies to
+submit to the IRS claims for delinquent debts up to 10 years old. The
+State of Wisconsin is currently participating in this program for the
+purpose of recovering state-owed debts. Local municipalities, however,
+are not permitted to participate in TOP to include debts owed to local
+and municipal agencies.
+ Do you believe that the current system could accommodate local
+municipalities to participate in TOP? If so, what is needed to allow
+local municipalities to participate in TOP? If you do not believe the
+current system could accommodate local municipalities, why?
+ Answer: Although the IRS participates in the TOP, the Treasury
+bureau responsible for the operation of TOP is the Financial Management
+IRS (FMS). Therefore, we referred your question to FMS for a response.
+FMS's response is below.
+ State debt currently collected through TOP is limited to delinquent
+child support obligations and delinquent state income taxes, which may
+include delinquent local income taxes administered by the chief tax
+administration agency of the state. Legislation would be required to
+expand the program to include debts owed to local and municipal
+agencies.
+ FMS receives information about state debt from the U.S. Department
+of Health and Human IRSs for delinquent child support obligations and
+from a single point within each state for state/local income tax debt.
+TOP could not accommodate debt owed to local and municipal agencies
+because to do so would require telecommunications connections with
+hundreds of end-points and extensive systems modifications to
+accommodate hundreds of connections per state. Additionally, we do not
+currently have the resources required to manage and troubleshoot a
+program to collect large volumes of debt owed to local and municipal
+agencies nor to handle debtor inquiries, transfer funds to hundreds of
+end-points, and train thousands of new users.
+ To accommodate debt owed to local and municipal agencies, the
+Financial Management IRS would need to forego other priority projects
+and increase development, operational and program staff. Such a project
+would require a significant development effort and modification to debt
+systems with no substantial benefit to the Federal Government. Even if
+these challenges could be met, Treasury might be reluctant to support
+expansion of the program to collect debts that do not have a Federal
+component or a Federal/State partnership interest.
+ [Submission for the record follows:]
+
+ Statement of Gerald E. Scorse, New York, New York
+
+ I first want to thank the Committee for the opportunity to make a
+Submission for the Record. Thousands of voices clamor to be heard as
+you go about the nation's business. What claim do I have to be listened
+to? Only this: that the Ways and Means Committee, as the originator of
+all tax legislation, is the proper place to make this petition; that
+the issue I raise is just, as this document will demonstrate; and that
+the issue has a clear and ready solution, if the Committee chooses to
+seek a solution.
+ I grew up believing that all income is reported to the Internal
+Revenue Service. Starting with my teen years I received a W-2, which
+reported my wages. In later years I received the 1099 forms on which
+bank interest is reported (and dividends as well, though it would be a
+while before I saw any of those).
+ In the 1980s and 1990s, when I began to put money into the stock
+market, I gradually became aware that capital gains income is not
+reported; when it comes to stock transactions, the only information
+reported by a third party to the IRS is the amount of the proceeds and
+the date of the sale. The IRS receives no information on the initial
+purchase of the stock. It does not know the price that was paid; it
+does not know the date of the purchase. I was offended when I found
+this out. It seemed to me then, and seems to me now, profoundly unfair.
+ Wages are earned income. People get up early and work late for
+wages. Capital gains are unearned income. (Mine included. I don't work
+for them. I don't sweat for them. They come to me like manna from
+heaven.) Fairness is crucial to our income tax system. When it comes to
+capital gains, the system is unfair. I resolved to find out why, and to
+try to change it. On March 5, 2001, I took my cause to Washington. I
+wrote to Charles Rangel, my Congressman and the ranking Democrat on the
+Ways and Means Committee.
+
+Why Third-Party Reporting is Not Currently Required
+ Third party reporting is the foundation of income tax collection in
+the United States. Third parties report income from wages, dividends,
+and interest to the Internal Revenue Service. They report all manner of
+miscellaneous income, e.g., non-employer compensation and gambling
+winnings. Safe to say, our income tax system would collapse without
+third-party reporting.
+ Yet this standard reporting requirement does not apply to capital
+gains income. Why so? The answer arrived in a letter dated May 23,
+2002, from Pamela F. Olson, Acting Assistant Secretary (Tax Policy),
+Department of the Treasury, to Representative Rangel, with a carbon to
+myself. Rep. Rangel had relayed my concerns to Treasury Secretary
+O'Neill, who had asked Secretary Olson to reply.
+ Secretary Olson restated my position and offered the Treasury's
+opinion: ``. . . Mr. Scorse believes that tax compliance would be
+improved if information reporting for capital gains included the amount
+of capital gains income that a taxpayer is required to show on his or
+her return. We couldn't agree more! Information reporting is the most
+efficient, least intrusive way of helping taxpayers comply with their
+tax obligations to the federal government.''
+ So why, when it comes to capital gains from stock transactions, do
+we not help taxpayers comply? In two words, ``specific
+identification''. A brief explanation will suffice. An investor buys
+100 shares of IBM on one date, and 100 additional shares on another
+date. Later, the investor sells 100 shares. As Secretary Olson stated,
+the broker does not know which 100 shares the taxpayer will treat as
+sold. In addition, the purchases might have been handled by different
+brokers.
+ Therefore, the Secretary concluded, ``unless taxpayers are denied
+the flexibility of specific identification,'' capital gains income
+cannot be reported by third parties to the IRS. In this view, third-
+party brokerage houses and mutual funds simply do not have the
+information. My reply pointed out that there are millions, indeed
+billions of occasions when ``specific identification'' has no
+application. These include 1. When there is a single purchase and a
+single sale of a stock or a mutual fund; 2. When there are many
+purchases of a stock or mutual fund, but a single sale of the entire
+holding. In both instances, third-party holders have exact information
+on taxpayers' capital gains; in neither instance would ``specific
+identification'' stand in the way of third-party reporting.
+ I also addressed the issue of shares that move from one financial
+institution to another: ``It should be required . . . that basis prices
+and acquisition dates travel with shares; complete information should
+be part and parcel of any equities transfer.'' (An analogy: do medical
+records vanish when people change doctors?) But ahead of these points,
+I stressed to Secretary Olson and would stress to the Committee, there
+is the larger issue. That issue is the fairness and integrity of the
+tax system.
+ The current tax treatment of capital gains income is inherently
+inequitable. It separates taxpayers into first-class and coach. Those
+in first class are allowed to self-report their income, while those in
+coach are required to have their income reported by a third party. It
+hardly needs saying that first-class taxpayers are concentrated among
+the well-to-do and ultra-rich, while those in coach are overwhelmingly
+in the lower income brackets. All so that IRS might provide ``the
+flexibility of specific identification'' to a privileged group of
+taxpayers, myself included.
+
+The Case for Instituting Third-Party Reporting
+ The late Senator Everett M. Dirksen is most remembered for a
+statement he likely never made: ``A billion here, a billion there, and
+pretty soon you're talking real money.'' Apropos revenues lost because
+of unreported capital gains income, a paraphrase might well read: ``Ten
+billion here, ten billion there, and pretty soon you're talking real
+money.'' (*The website for the Dirksen Congressional Center says there
+is no record that the fiscally conservative senator ever spoke those
+famous words. The Center is quick to add, however, that he undoubtedly
+would have agreed with the sentiment.)
+ Now let's look at several ways by which an interested party, such
+as the Committee, might arrive at that $10 billion figure. It comes as
+no surprise that revenue from capital gains taxes varies sharply from
+year to year, and that it rose by leaps and bounds in recent years. A
+generation ago, in 1980, capital gains taxes netted the Treasury $12.5
+billion. The figure climbed close to 50% by 1983, when it reached $18.5
+billion. In 1992 it was almost double that amount, or $32 billion. That
+number, too, was almost doubled in 1996 when the revenue inflow hit $62
+billion.
+ And of course there were the stock market's peak years. Capital
+gains taxes ratcheted up to $84 billion in 1999 and to a record $110
+billion in 1999. All of this, of course, from reported capital gains
+income. What about the revenue shortfall from income that went
+unreported because of the third-party loophole?
+ And so we arrive at one of the ways by which the yearly tax
+shortfall, resulting from unreported capital gains income, can be
+estimated at $10 billion or more. That figure could easily be reached
+by an underreporting rate in the neighborhood of 10% to 15%. Is this a
+harsh assessment of the nation's taxpayers? On the contrary, such an
+estimate assumes a remarkable degree of personal honesty; it assumes
+that 85-90 out of 100 people will be completely honest even when
+presented with a golden opportunity to be dishonest, to profit from
+their dishonesty, and to get away clean.
+ Here are some less sanguine viewpoints: In a December 2002 op-ed
+piece in The New York Times, Manhattan district attorney Robert M.
+Morgenthau decried what he saw as an escalating disregard for tax laws.
+He cited a survey which found that one in four Americans believe it's
+alright to cheat on their taxes, double the percentage who answered the
+same in a 1999 survey.
+ Or consider the valedictory of Charles O. Rossotti, who retired
+after five years as IRS commissioner with the admission that ``the
+agency is steadily losing the war with tax cheats, especially the
+wealthiest and most sophisticated among them.'' Messrs. Rossotti and
+Morgenthau did not single out capital gains tax evasion, but Pulitzer
+journalists Donald L. Barlett and James B. Steele spoke directly to it
+in their book, The Great American Tax Dodge: How Spiraling Fraud and
+Avoidance Are Killing Fairness, Destroying the Income Tax, and Costing
+You. Here is a key sentence: ``Of all the areas where fraud is easy to
+commit and most difficult to identify, capital gains income ranks near
+the top.''
+ But all of this is only words. The most compelling rationale for
+third-party reporting of capital gains comes from hard data assembled
+by the IRS itself. We turn now to that information, and to its clear
+implications. Less than a year ago, Kim M. Bloomquist of the IRS
+presented a paper entitled ``Trends as Changes in Variance: The Case of
+Tax Noncompliance '' at the 2003 IRS Research Conference. Early on, the
+paper addressed and reaffirmed the common-sense assumption that tax
+compliance (and non-compliance) correlate directly with third-party
+reporting: ``One of the few generally accepted facts in the literature
+on tax compliance economics is the existence of a positive relationship
+between transaction visibility and reporting compliance. Over the
+years, various Government and academic studies have affirmed this
+relationship (Klepper and Nagin, 1989; Long and Swingden, 1990;
+Andreoni, Erard, and Feinstein, 1998). Random taxpayer audits conducted
+by the Internal Revenue Service (IRS) have consistently shown higher
+compliance rates among income items subject to third-party information
+reporting and withholding (i.e., matchable) versus nonmatchable sources
+of income (Christian, 1994). In the 1988 Taxpayer Compliance
+Measurement Program (TCMP) study, the average weighted net misreporting
+percentage of reported income was 1.8 percent for matchable income and
+22.6 percent for nonmatchable income (Internal Revenue Service, 1996).
+Therefore, ceteris paribus, we would predict a positive correlation
+between the evasion rate and share of nonmatchable income.''
+ Unfortunately for the Treasury, and for the nation's honest
+taxpayers, nonmatchable income has been increasing. Not surprisingly,
+one of the major causes has been capital gains income: ``Table 1 shows
+the trend in matchable and nonmatchable sources of income between 1980
+and 2000. In 1980, 91.3 percent of total reported taxpayer income was
+matchable. By 2000, this percentage had fallen nearly 10 percentage
+points to 81.6 percent. The principal factor responsible for this trend
+was the faster than average growth in the nonmatchable income
+components of taxable net capital gains and partnership and small
+business corporation (SBC) net income.'' (*Table not included in this
+submission.)
+ Leading, of course, to the predictable tax evasion consequences:
+``Holding constant the 1988 TCMP misreporting rates for matchable and
+nonmatchable income, it is estimated that, between 1980 and 2000,
+overall income underreporting rose from 3.6 percent to 5.6 percent of
+reported income due solely to the increase in the percentage of
+nonmatchable income. This trend of rising noncompliance is not driven
+by a change in taxpayer behavior but is simply the result of improved
+success from existing behavior. Therefore, if tax noncompliance is
+increasing, it is possible that this trend is unrelated to taxpayers'
+higher tax burdens or tax law complexity. Instead, taxpayers simply may
+be enjoying greater success at evasion due to reduced transactions
+visibility.''
+ Summing up, the paper reiterated the role played by capital gains
+in driving up the share of unreported income: ``What has caused the
+share of nonmatchable income to increase during the last two decades?
+Clearly, the stock market bubble of the late 1990's contributed
+significantly to the explosive growth in the value of financial assets.
+Between 1995 and 2000, the share of taxpayer reported adjusted gross
+income (AGI) from net capital gains jumped from 4 percent to 9=
+percent.''
+ Let me repeat for the Committee, from the IRS paper, the tax
+compliance consequences that flow from reported and unreported income:
+``. . . the average weighted net misreporting percentage of reported
+income was 1.8 percent for matchable income and 22.6 percent for
+nonmatchable income.''
+ And then there is the fairness issue. Let me suggest, first of all,
+that there really is no issue. It is inequitable on its face that
+capital gains income should be exempt from the third-party reporting
+requirements that apply to wages and other forms of income.
+ I am hardly alone in noting this inequity. On March 26, 2001, IRS
+Commissioner Charles O. Rossotti wrote to Senator Charles Grassley,
+chairman of the Senate Finance Committee. Senator Grassley had seen an
+article in The New York Times quoting from an interview with Mr.
+Rossotti, and had written to him for elaboration. Here is some of what
+Mr. Rossotti said in reply: ``One of my real concerns about the decline
+in audits is fairness to the majority of taxpayers whose income is
+reported and can be readily verified. It is relatively easy for the IRS
+to verify the returns and reported income of taxpayers whose income
+results from wages, interest and dividends and who take the standard
+deduction, who comprise the majority of taxpayers. It is harder, and
+often requires audits, to verify the income of taxpayers with other
+forms of income and deductions or more complex returns, who are often
+higher income taxpayers. The proportion of income that cannot be
+verified through document matching is 10% for taxpayers with income
+under $100,000, as compared with 35% for taxpayers over $100,000. Also,
+91% of returns reporting income over $100,000 itemize deductions,
+compared to 26% of those below $100,000, and most itemized deductions
+cannot be verified through document matching. To the extent that the
+IRS uses more and more document matching and less and less auditing,
+the effect may be perceived as, and will in fact be unfair because
+higher income taxpayers will not have their returns verified to the
+same degree as middle income taxpayers.''
+ So that the original inequity, the non-reporting of capital gains,
+helps spawn a downstream inequity, the disproportionate surveillance by
+the IRS of the tax returns of the middle class. These inequities should
+not and need not stand. Neither should the Treasury have to lose
+upwards of $10 billion a year, year after year, to a tax loophole that
+could easily be closed. (As an aside, realize the difficulty of trying
+to estimate Treasury losses from unreported income. Exactly how is
+anyone to know? The IRS, for instance, has promised the Ways and Means
+Committee an answer by June 1 of this year to the question of whether
+annual tax losses on partnership/K-1 income are in the range of $9
+billion to $64 billion. This is a huge range, and for much the same
+reason; such income is self-reported, and not subject to verification.)
+ Shortly before his retirement from the IRS, Rossotti spoke movingly
+of ``the crown jewel, which is the fairness and faith the honest
+taxpayer has in the system.'' The crown jewel needs burnishing. Capital
+gains, like wages and other forms of income, should be subject to
+third-party reporting. There are a number of ways by which this can be
+accomplished. They are both simple and feasible, and I commend them to
+the Committee's attention.
+
+Proposed Methods for Instituting the Reform
+ While the methods discussed below are different, and would yield
+different capital gains income figures, they share important
+characteristics. Each has particular qualities, but no special ones.
+None requires any exotic software, any development time, any trial-and-
+error experimentation. All are standard, everyday tools, employed by
+mutual funds and brokerage houses to calculate their customers' capital
+gains, and to communicate this information to them. Customers with
+internet access can view the information 24 hours a day, 7 days a week;
+other customers receive written statements monthly or quarterly, or, if
+they desire, can obtain the same information by telephone any business
+day.
+ Putting it another way, it would impose no burden on financial
+institutions to require third-party reporting of capital gains income.
+The institutions routinely compile the information, routinely update it
+on a daily basis, and routinely report it to their customers. Come tax
+time, they should be required to report the same information to the
+IRS.
+ Any of the methods presented here could be the sole method by which
+third-party reporting is implemented. Alternatively, the methods could
+be offered as a choice to investors. And of course there are methods
+other than these. A small reminder before proceeding. This submission
+is not about which method to use. The only issue at hand is third-party
+reporting of capital gains income, by whatever method the Congress
+elects. Here are three ways that third-party reporting might be
+achieved.
+
+Average Cost Basis
+ Average cost basis is probably the most commonly used method,
+particularly by mutual funds, of calculating investors' basis costs. It
+simply totals the number of shares and the prices paid, and determines
+the basis by dividing the total price by the number of shares held. It
+does not consider when any particular shares were purchased, or how
+much was paid for any particular group of shares. It is simple and
+straightforward, and would be a perfectly equitable method of third-
+party reporting. However, thanks to computer technology, two other
+methods offer investors superior tax-efficiency.
+
+Highest-In, First-Out (HIFO)
+ Current tax rules require that mutual funds distribute essentially
+all of their dividends and realized capital gains each year as taxable
+income. These rules have led to a relatively new breed of so-called
+tax-managed funds. The objective of these funds is to keep the taxable
+gain to shareholders as low as possible; the funds do this by first
+selling their highest-cost shares, which can be a much more tax-
+efficient method than FIFO (first-in, first-out). HIFO not only
+minimizes capital gains, it also maximizes capital losses. Losses of
+course can be written off dollar-for-dollar against gains, and an
+additional $3,000 can be used to offset ordinary income; losses greater
+than $3,000 can be carried forward and used to offset future gains. All
+things considered, HIFO would probably be the most attractive method
+for investors of determining basis costs for third-party reporting of
+capital gains. And the higher the tax bracket, the more investors would
+stand to gain from HIFO accounting.
+
+Specific Identification
+ ``Specific Share Trading for Mutual Fund Shares Now Available.''
+ That was the announcement from Fidelity Investments on October 18,
+2002 to its customers, including myself. The announcement went on:
+``Looking to use the specific share method when selling your mutual
+fund positions online? Look no further. Fidelity now offers customers
+who hold eligible mutual fund positions in non-retirement accounts to
+track and specify shares when selling those positions.''
+ Among other things, subject to ``certain exceptions and
+limitations,'' the company said that customers could 1) ``Request
+Fidelity to sort and pre-select the tax lots that best match your tax
+objectives . . .'', 2) ``Sort and review up to 150 open tax lots by
+holding period (short--or long-term) and/or by cost basis per share,''
+3) ``Get a confirmation of your specific share instructions on either
+your regular trade confirmation or via special correspondence. The gain
+or loss is then reported both online and on your regular Investment
+Report.''
+ As Fidelity put it, ``Fidelity customers have always been able to
+use the specific share method for their mutual fund holdings. However,
+they needed to maintain their own cost basis tracking--a complicated
+recordkeeping requirement that deterred many from taking advantage of
+the accounting feature. Now, Fidelity is taking all that recordkeeping
+off of your hands.'' It deserves to be noted that investors have no
+inherent right to specific identification as a means of calculating
+basis costs. While current tax law grants such a privilege, it is
+outweighed by both tax equity and fiscal policy considerations. That
+said, specific identification is in fact another possible means of
+achieving third-party reporting of capital gains income. We have this
+information from an excellent source. We have it from Fidelity
+Investments, which announced the availability of specific
+identification more than a year and a half ago.
+
+Summary
+ We have examined and explored the lack of third-party reporting of
+capital gains income. To what conclusions does the evidence lead? There
+is no tax equity defense (nor has the author ever seen one put forth)
+for allowing self-reporting of capital gains income while requiring
+third-party reporting of wages, dividends, interest, and all manner of
+miscellaneous income. Similarly, it makes no fiscal sense for the
+Congress to tolerate the untold billions of dollars lost to the
+Treasury, year after year, due to the lack of third-party capital gains
+reporting. The IRS's own statistics show that tax evasion is 12= times
+more frequent when income is self-reported than when it is reported by
+third parties; this alone should be inducement enough for the Congress
+to require third-party reporting of capital gains.
+ In a sense, the Committee is blessed to face this problem. There is
+no complexity here; there is no opaqueness. The problem is simple and
+straightforward, and the solution as well. The problem is the absence
+of third-party reporting of capital gains; the solution is to require
+such reporting, and the systems are essentially already in place to
+perform it. If the Committee will allow, let me repeat the quote from
+Assistant Treasury Secretary Olson's letter of May 23, 2002: ``. . .
+Mr. Scorse believes that tax compliance would be improved if
+information reporting for capital gains included the amount of capital
+gains income that a taxpayer is required to show on his or her return.
+We couldn't agree more! Information reporting is the most efficient,
+least intrusive way of helping taxpayers comply with their tax
+obligations to the federal government.'' I ask the Committee to review
+the facts, and to do the right thing.
+
+
+
+