[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
AUDITS AND ATTITUDES: IS THE IRS HELPING OR HURTING SMALL BUSINESSES?
=======================================================================
HEARING
before the
SUBCOMMITTEE ON ECONOMIC GROWTH, TAX AND CAPITAL ACCESS
OF THE
COMMITTEE ON SMALL BUSINESS
UNITED STATES
HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
SECOND SESSION
__________
HEARING HELD
JUNE 22, 2016
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Small Business Committee Document Number 114-065
Available via the GPO Website: www.fdsys.gov
______
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HOUSE COMMITTEE ON SMALL BUSINESS
STEVE CHABOT, Ohio, Chairman
STEVE KING, Iowa
BLAINE LUETKEMEYER, Missouri
RICHARD HANNA, New York
TIM HUELSKAMP, Kansas
CHRIS GIBSON, New York
DAVE BRAT, Virginia
AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
STEVE KNIGHT, California
CARLOS CURBELO, Florida
CRESENT HARDY, Nevada
NYDIA VELAZQUEZ, New York, Ranking Member
YVETTE CLARK, New York
JUDY CHU, California
JANICE HAHN, California
DONALD PAYNE, JR., New Jersey
GRACE MENG, New York
BRENDA LAWRENCE, Michigan
ALMA ADAMS, North Carolina
SETH MOULTON, Massachusetts
MARK TAKAI, Hawaii
Kevin Fitzpatrick, Staff Director
Jan Oliver, Chief Counsel
Michael Day, Minority Staff Director
C O N T E N T S
OPENING STATEMENTS
Page
Hon. Tim Huelskamp............................................... 1
Hon. Judy Chu.................................................... 1
WITNESSES
Mr. Pete Sepp, President, National Taxpayers Union, Washington,
DC............................................................. 3
Mr. Lee Davenport, Member, Electronic Tax Administration Advisory
Committee (ETAAC), Washington, DC.............................. 4
Mr. Roger Harris, President & COO, Padgett Business Services,
Athens, GA..................................................... 6
Ms. Emily Peterson-Cassin, Project Coordinator, Bright Lines,
Washington, DC, testifying on behalf of Public Citizen......... 8
APPENDIX
Prepared Statements:
Mr. Pete Sepp, President, National Taxpayers Union,
Washington, DC............................................. 18
Mr. Lee Davenport, Member, Electronic Tax Administration
Advisory Committee (ETAAC), Washington, DC................. 38
Mr. Roger Harris, President & COO, Padgett Business Services,
Athens, GA................................................. 41
Ms. Emily Peterson-Cassin, Project Coordinator, Bright Lines,
Washington, DC, testifying on behalf of Public Citizen..... 47
Questions for the Record:
None.
Answers for the Record:
None.
Additional Material for the Record:
None.
AUDITS AND ATTITUDES: IS THE IRS HELPING OR HURTING SMALL BUSINESSES?
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WEDNESDAY, JUNE 22, 2016
House of Representatives,
Committee on Small Business,
Subcommittee on Economic Growth,
Tax and Capital Access,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:00 a.m., in
Room 2360, Rayburn House Office Building, Hon. Tim Huelskamp
[chairman of the Subcommittee] presiding.
Present: Representatives Huelskamp, Chabot, Radewagen, and
Chu.
Chairman HUELSKAMP. Good morning. Thank you all for being
with us today. I call this hearing to order.
Whether we want to or not, each and every one of us has a
relationship with the IRS. Benjamin Franklin famously said,
``In this world, nothing can be said to be certain except death
and taxes.''
In the administration of the tax code, the IRS has dual
roles, collection and enforcement. Small businesses have a
right to be treated fairly on both counts. Unfortunately, that
is not always the case. Many can appreciate that the IRS is a
tough job to do; however, the best outcomes will result from
the IRS and taxpayers working together to improve voluntary
compliance and efficiently allocate resources.
The Small Business Committee has heard from a number of
small businesses that have been harmed in one way or another by
the IRS. In at least two cases, aggressive audits have resulted
in these companies actually closing their doors.
Today's hearing will focus on some of the ways the IRS can
proactively work with small business taxpayers to improve
communication and compliance, as well as on some things the IRS
needs to do differently.
I would like to thank our witnesses for coming today. I
look forward to your testimony.
I now yield to the ranking member for her opening remarks.
Ms. CHU. Thank you, Mr. Chairman.
One of the focuses of this Subcommittee is to ensure that
small businesses are given the tools to comply with regulations
without increasing their costs. This is particularly true when
it comes to taxes and interacting with the Internal Revenue
Service.
In the past, when small businesses have testified before
the Committee, they have told us that complexity and
uncertainty create difficulty when filing tax returns. Many
business owners worry that one simple mistake can lead to a
costly and timely audit, and at a time when many businesses are
striving to expand and hire additional employees, every hour
and dollar counts.
As a result of IRS procedures and administrative
challenges, small firms must devote greater resources towards
accounts and lawyers to properly report income and pay taxes.
Over a quarter of small businesses in the 2015 National Small
Business Association's Taxation Survey stated that they spent
over $10,000 on tax compliance, and another 8 percent stated
that they employ an outside tax expert to handle tax issues.
Unlike larger, multinational corporations, the time spent
by small businesses in complying with tax laws is much more
costly, impacting business expansion, job growth, economic
prosperity, and growth of small businesses. They should not
also have to face intense scrutiny from the IRS through
business audits and inadequate IRS compliance with the
Regulatory Flexibility Act. Nevertheless, small firms cite
filing hardships, aggressive auditing, and collection
procedures as confusing as to how a new regulation will affect
their business.
Seeing as our nation's fiscal constraints are an ongoing
priority, I understand that closing the $450 billion tax gap is
critical to our long-term prosperity, but so are small
businesses. Any effort to increase tax compliance must be done
in a way that is responsible, fair, and not disproportionately
burdensome to small firms.
Today's hearing will give us a better grasp of the scope
and collection techniques regarding small business audits. This
hearing also allows us to examine what is being done to
minimize IRS regulatory procedural burdens for small entities.
I believe that this information is even more important right
now as the agency seeks to be more efficient due to financial
realities. The fact of the matter remains that the IRS cannot
review and modify the procedures impacting small businesses if
Congress continues to cut their budget every year. These
actions have weakened the IRS's ability to enforce the nation's
tax laws while also providing sufficient customer service for
our small businesses. With the proper tools, America's small
firms can sustain the economic growth currently underway by
investing in their operations without fear of an audit and
confusing regulations.
With that, I would like to thank the witnesses for being
here today. I yield back.
Chairman HUELSKAMP. Thank you for that opening statement.
A quick summary again on timing. First, if Committee
members have an opening statement prepared, I ask that it be
submitted for the record.
I would like to take a moment to explain the timing lights
for you. You will each have 5 minutes to deliver your
testimony. The light will start at green. When you have 1
minute remaining, the light will turn yellow. Finally, at the
end of 5 minutes it will turn red. I ask that you kindly adhere
to that time limit.
Our first witness this morning is Mr. Pete Sepp, president
of the National Taxpayers Union here in Washington, D.C. Mr.
Sepp first started with the NTU in 1988. Currently, he
supervises their government affairs, public relations, and
development activities. Mr. Sepp has testified before Congress
on a wide range of tax-related issues and has also been a guest
on several nationally broadcast radio and television programs.
Mr. Sepp, you have 5 minutes, and you may begin.
STATEMENTS OF PETE SEPP, PRESIDENT, NATIONAL TAXPAYERS UNION;
LEE DAVENPORT, MEMBER, ELECTRONIC TAX ADMINISTRATION ADVISORY
COMMITTEE; ROGER HARRIS, PRESIDENT AND COO, PADGETT BUSINESS
SERVICES; EMILY PETERSON-CASSIN, PROJECT COORDINATOR, BRIGHT
LINES
STATEMENT OF PETE SEPP
Mr. SEPP. Mr. Chairman, Madam Ranking Member, I am honored
to be here to discuss a central feature of our tax system, the
examination process. Back in 1988, my organization, National
Taxpayers Union, led a transpartisan coalition, which included
American Civil Liberties Union and National Council of La Raza,
business organizations, taxpayer groups, all on behalf of a
taxpayer bill of rights. There have been subsequent coalitions,
subsequent pieces of legislation, but one interesting facet of
this process has been a lack of focus on improving
examinations. They tended to focus instead on making reforms to
the collection process. There is a wide range of problems that
have been identified in the small business community that still
need to be addressed, particularly pertaining to examinations.
I call them ``fear factors.'' One major fear factor has to
do with the complexity of the tax system itself and the
uncertainty that brings. The Ranking Member of the Full
Committee, Congresswoman Velazquez, said this very eloquently
in 2013. I quote, ``Many business owners worry that one simple
mistake can lead to a costly and timely audit and at a time
when many businesses are striving to expand, every dollar and
hour counts.'' Quite true.
I also think we have to worry about intimidation tactics
used against small businesses. We are witnessing right now a
counter and paradoxical trend of speed up audits where
businesses are getting audit notices and being asked to respond
almost immediately to whether they want to even appeal. They do
not even have time to consider the central issues of the audit
itself. On the other hand, there are ``slow-down'' audits where
the procedure drags on and on. Interest keeps accruing through
no fault of the taxpayer and abatement of that interest is a
very difficult matter to resolve indeed.
We also have the question of opportunity costs. When you
look at very small businesses, under $100,000 in receipts, they
tend to have a tax liability after examination, an additional
tax of less than $10,000. They could easily rack up that much
in legal and audit representation costs. Many if not most of
them decide, in my opinion, not to fight it. That is why the
audit appeal rate is so low. It hovers between 5 and 7 percent
annually.
When they have these problems, the remedies in court remain
pitifully small. The cap on attorney fees that they can recover
if they prevail in court nowhere near matches the amount that
they actually need to spend to prove their position.
There are other problems on the horizon. We are part of a
coalition called the Coalition for Effective and Efficient Tax
Administration involving more than a dozen associations
representing thousands of businesses. We are identifying
problems in the large business and international division with
issuing designated summonses and designating cases for
litigation, tactics which are normally supposed to be reserved
for a very small number of uncooperative taxpayers or broad
ranging, and they are being applied in consistently greater
fashion and with more force, and the threat is being wielded to
compel taxpayers into accepting the IRS's position. That is
going to be a major problem for smaller businesses down the
road. Taxpayer experts and litigation representatives, like
Daniel Pilla, who has been before Congress in the past, has
said he fully expects those kinds of tactics to migrate into
the small business area and the self-employed area sooner or
later.
There is the issue that is being discussed in Committee
markup for the Financial Services and General Government Bill.
One of your colleagues, Congressman Katko, is offering an
amendment to block the IRS from hiring private outside counsel
to participate deeply in the examination process. Essentially,
farming out audits.
Now, this is currently applying to large business, the IRS
hiring thousand-dollar-an-hour attorneys. You could easily see
$300, $400 an hour attorneys working on small business
liabilities. It happens because the IRS may consider the hazard
of litigation in an appeal situation. They do not have to
consider the cost of that litigation versus the tax due. So we
have a volatile situation here.
We need to enact reforms ranging from S. 2809 by Senator
Portman, which would address some of the CEETA Coalition's
concerns, and the Small Business Taxpayer Bill of Rights, H.R.
1828, to reviewing the taxpayer advocates' most serious
problems affecting small businesses, and coming together in a
bipartisan fashion to address the factors of lack of trust,
lack of certainty, and lack of remedies for small businesses in
the audit process. We did it in 1988 and 1998. We can do it
again. Thank you.
Chairman HUELSKAMP. Thank you, Mr. Sepp. We appreciate your
testimony.
Our next witness is Mr. Lee Davenport, member of the
Electronic Tax Administration Advisory Committee here in
Washington, D.C. Mr. Davenport is in his third year as a member
of the Advisory Committee, which serves as a public forum to
discuss electronic tax administration issues. He is principal
of Davenport Consulting, which provides business consulting and
private financing services. He was also the architect of
Myfreetaxes.com, which assists those who earn less than $62,000
per year to file their state and federal taxes for free.
Mr. Davenport, thank you for being here today. You may
begin.
STATEMENT OF LEE DAVENPORT
Mr. DAVENPORT. Thank you. Chairman, I thank you for holding
today's hearing on how the IRS could help small businesses.
Twenty-eight million small businesses in America are a
cornerstone to our economy. Small businesses account for over
half of all U.S. sales and 55 percent of all jobs, and they pay
significant amounts of income, employment, and excise taxes
into the U.S. Treasury.
Helping small businesses easily file and pay their taxes is
a critical mission of the IRS Electronic Tax Administration
Advisory Committee, ETAAC. ETAAC was formed by law in 1998 to
make strategic recommendations to Congress on how to improve
tax administration and better serve taxpayers, including small
business taxpayers through electronic means. In short, we are
objective, digital, strategy consultants to the IRS.
The Committee believes that modernizing the IRS taxpayer
service communication platform is an urgent and strategic
priority for the IRS. In the 2015 tax season, the IRS was in
its fourth consecutive year of budget reductions and IRS
service levels plummeted. IRS answered only 38 percent of its
calls from taxpayers. IRS has been unable to modernize its tax
service platform to move away from traditional paper and phone
interactions. A current phone and paper taxpayer service
platform is also not the preferred choice of the IRS or the
many taxpayers who expect secure online services.
Along with this issue is a lack of transparency with the
IRS. For most taxpayers, the information the IRS has about them
is a complete mystery. It is not easy for taxpayers to access
and understand their tax information on file with the IRS,
their previous tax-related interactions, or their tax
compliance obligations.
For small business taxpayers, this issue is even more
critical because small businesses are more likely to complete
multiple year-round transactions with the IRS. In many cases,
when there is a compliance issue, small business taxpayers find
out through a surprising IRS notice after they file, or even
more stressful, an audit that can take months or years to
resolve. For all types of taxpayers, accessing and using their
information to proactively comply is almost entirely out of the
question in our current system.
The Committee believes that a key solution to these
problems is a more digitally-enabled, modernized IRS that
better equips taxpayers with information on how they can
proactively comply, rather than solely focusing on detecting
and enforcing compliance.
In the past 3 years, ETAAC has provided recommendations
based on a simple vision of how the IRS could serve taxpayers.
The vision allows taxpayers to fully understand their tax
obligations, to have transparent access to their tax
information status with the IRS, and effectively and securely
interact with their tax administrator on the way they want to
be served, in the way they want to be served.
The end state is a tax system that is less burdensome. It
is a tax system that relies less on reactive measures, such as
audits, and more on preventative and educational measures for
taxpayers to remain proactively compliant. There are two
challenges the IRS faces in achieving this vision.
First, the current tax system is designed to be reactive.
It does not leverage tax information to help taxpayers meet
their obligations.
Second, the IRS cannot quickly develop and implement its
digital roadmap, including online accounts to address the needs
of preferences of taxpayers. Our last two reports to Congress
explain this dilemma and provide recommendations to overcome
these challenges. In our 2015 report to Congress, we
recommended that the IRS accelerate its digital taxpayer
service strategy; that is, develop and implement secure online
accounts for all business and individual taxpayers. We know
that businesses are much more likely to use a tax professional
for tax filing compliance needs. Online accounts for these tax
professionals should be a priority. ETAAC advocates for the IRS
to commit to quickly developing online accounts for business
taxpayers and the tax professionals who serve them, and we
encourage the Committee to do the same.
In our most recent 2016 report, which actually comes out
today, ETAAC addresses the lookback tax system that centers on
post-filing programs that detect current noncompliance. We
challenge Congress and the IRS to move to a system that
verifies taxpayer identities and tax return information before
accepting the return.
A system that uses information statements, such as forms
1099 and W-2 to verify taxpayer tax return information is
essential to fighting fraud and reducing the taxpayer burden.
The IRS should support taxpayers in filing accurate returns,
giving them full electronic access to their tax account
information at the time of filing. This proactive system would
verify accuracy upfront and reduce audits, particularly those
on small businesses.
ETAAC is pleased with the IRS's first steps in its digital
service plans. IRS released an initial draft of the Future
State Initiative in January of this year that specifically
incorporated ETAAC recommendations from the past 3 years. The
initiative specifically contemplates small business taxpayers
and their needs. ETAAC endorses this digital service component
of the Future State plans, and we clearly identified the urgent
need for small businesses. The IRS needs to accelerate online
accounts for businesses and tax professionals.
On behalf of the entire ETAAC, I thank you for inviting us
to testify on this important topic.
Chairman HUELSKAMP. Thank you, Mr. Davenport. We appreciate
your testimony and your service on the Advisory Committee.
Our third witness this morning is Mr. Roger Harris,
President and COO of Padgett Business Services in Athens,
Georgia. Mr. Harris has served twice as Chairman of the
Internal Revenue Advisory Council, and has previously testified
before this Committee, as well as before the Senate Small
Business Committee. He has been named one of Accounting Today's
Top 100 People. Mr. Harris, you have 5 minutes.
STATEMENT OF ROGER HARRIS
Mr. HARRIS. Thank you, Mr. Chairman, and Ranking Member
Chu. It is a pleasure to be here today.
To give you a little background, Padgett Business Services
provides accounting, tax, and payroll services to small
businesses. We are currently celebrating our 50th year and have
over 200 offices throughout the United States.
We define a small business as someone with less than 20
employees. Now, a lot of people consider that to be a ``mom-
and-pop'' type business, but I would remind those people that
almost 90 percent of people who have employees would fit that
definition, so it is a very powerful part of our economy.
Our history and our relationship with our clients gives us
a good perspective to comment on the interactions that small
businesses have with the IRS and, in our case, their
representative. Specifically as it relates to audits, no
taxpayer, be it an individual or small business, ever wants to
receive a notice that they are being audited. But in a
voluntary tax system like we have, there is an element of
enforcement that must be present. So, if you are successful and
stay in business long enough, there is a good possibility you
are going to interact with the IRS in some form of audit or
some sort of correspondence.
Currently, the IRS really executes two different types of
audits on small business. The one that seems to be most
prevalent and continues to increase over the years is the
correspondence audit. Now, the idea behind a correspondence
audit is that some computer or some person somewhere in the
bureaucracy selects what appears to be some simpler issues and
the small business owner is notified by mail, as the name
indicates, and they are to respond to that notice about the
specific issues in question. In theory, this is a very good
system and I think it is partly the reason that we are seeing
more and more of these is for the better use of IRS resources.
It eliminates face to face, which is intended, again, I think,
to minimize the cost and burden that a small business owner or
their representative might face.
Unfortunately, it does not work always as intended. First
and foremost, sometimes the tax code is a little more
complicated than it might seem, and what looks like a simple
issue that can be very easily dealt with through correspondence
really has more complicated pieces in it than may be on the
surface. Sometimes that lack of face-to-face is a disadvantage,
not an advantage, because the small business owner or their
representative may feels like they are just talking to the
bureaucracy and they do not really know where their information
is and what is being done with it, and if there is something
that needs to be questioned explained, there is not a real
convenient process to do that.
The thing that we probably hear the most as a criticism of
correspondence audit through our company and our experiences,
is that there is an inconsistency in the quality of this
unknown person responding from the IRS. In many instances it is
almost as if they do not know the issue as well as the
representative or the taxpayer does. Eventually, you really do
need to move to a face-to-face environment to get the issue
resolved. So, in many instances, what starts as a
correspondence audit can only be resolved if it moves to some
sort of face-to-face contact.
We understand that correspondence audits are probably going
to continue to be the preferred method of auditing small
businesses, but if that is the case, I think there are three
areas that the IRS needs to focus on and address.
First of all, they need to do a better job of selecting the
issues that work in this type of environment, so if it is going
to be done through correspondence, it is an issue that can be
resolved through corespondence. Secondly, they need to have
more consistency and better training of their employees. And
finally, I think something that is very important is they need
to develop a tracking system. It is interesting to us that
FedEx or UPS can track packages all the way through the
delivery process, but the IRS cannot allow a taxpayer or a
representative to track the status of their information in
their audit. There needs to be better tracking of the
information as it is submitted and as it is going through the
process.
The audits that I think we all associate with the IRS are
field audits where people come out and spend time either at the
small business owner's place of business or the
representative's place of business. The good news for that is
you tend to get a more trained and better qualified IRS
representative. The bad news is those audits can last days,
weeks, months, and sometimes years, and the cost of those are
almost exclusively the burden of the small business owner.
Again, they are necessary evils because they can be very costly
and very expensive.
I agree almost completely with some of the comments of Mr.
Davenport as we move forward with online accounts. The IRS is
setting up individual accounts, which I commend them for.
However, there is a vast need for business accounts and
practitioner accounts. Currently, about 70 percent of small
business owners have some sort of relationship with a
practitioner, and, therefore, you need to give access to
accounts to the people who would be most likely to use them.
Unless you operate as a Schedule C, if you are a partnership or
a corporation, there are no accounts right now, but I think we
need those accounts as well.
Finally, even on the individual accounts, which I think are
a step in the right direction, and I certainly understand the
challenges of identity theft that the service is facing, but
right now the service says that the way to authenticate those
accounts today, by their own admission, are only successful 30
percent of the time. If we are going to have individual
accounts, they need to be something that the average person can
actually access when needed.
So with that, I see my time is up, again, thank you for
allowing me to being here, and I look forward to your
questions.
Chairman HUELSKAMP. Thank you, Mr. Harris, we appreciate
your testimony.
I now yield to our Ranking Member for the introduction of
the final witness.
Ms. CHU. It is my pleasure to introduce Ms. Emily Peterson-
Cassin. Ms. Cassin is the Coordinator of Public Citizen's
Bright Lines Project. The Bright Lines Project was founded in
2008 and worked to change the big test that currently defines
political activity for nonprofits. Before joining Public
Citizen, she worked as an attorney in ERISA litigation and in
indigent representation. She received her juris doctorate from
Georgetown University Law School.
Welcome, Ms. Peterson-Cassin.
Chairman HUELSKAMP. I thank the Ranking Member for that
introduction.
Ms. Peterson-Cassin, you may begin.
STATEMENT OF EMILY PETERSON-CASSIN
Ms. PETERSON-CASSIN. Thank you. Mr. Chairman, Madam Ranking
Member, thank you for the opportunity to testify today.
My name is Emily Peterson-Cassin. I am the Bright Lines
Project coordinator at Public Citizen Congress Watch. Public
Citizen is a national, nonprofit, public interest organization,
with more than 400,000 members and supporters.
For 45 years, we have successfully advocated for stronger
health safety, consumer protection, and other rules, as well as
for a robust regulatory system that curtails corporate
wrongdoing and advances the public interest. My own work at
Public Citizen is to coordinate the Bright Lines Project, an
expert team of attorneys and nonprofit partners working for an
improved definition of political activity for all nonprofits.
I do not need to tell this Committee how important small
business is to our economy and our society. Congress can, and
should, protect small business by ensuring a clear, predictable
framework of tax rules and regulations. Rules that are easy to
follow and enforce allow small businesses to thrive, while
minimizing opportunities to abuse the tax system.
The IRS should be doing more to ensure that small
businesses can easily comply with the regulations already in
existence, and work to improve its ability to provide accurate
and timely guidance. The Bright Lines project focuses on
nonprofits, advocating for a definition of political activity
that increases civic participation and creates objective
standards for the IRS to follow when enforcing the law. Clear
rules are just as important for a small business. Indeed,
nonprofits can be likened to small businesses with a social
mission. At the same time, it is important to recognize the
benefits to small business and our society of having a safe and
healthy workforce made possible by sensible government
regulation.
Regulation is also essential for opening up new markets for
small businesses and helps incentivize innovation in safer and
cleaner technologies. Regulations make our country stronger,
safer, cleaner, healthier, and more fair to small business.
The regulatory system must not operate to give large
corporations an unfair advantage by delaying important
regulations or muddying the rulemaking process. Making the
rulemaking process too complicated for commonsense regulations
harms small businesses rather than helps them. The analysis
required under SBREFA, for example, can delay the already
laborious rulemaking process for months. A recent GAO report,
which investigated the slow process of rulemaking at OSHA,
found that it takes 8 extra months of work for OSHA to prepare
for the SBREFA panel. In addition, small business analysis
should be narrowly targeted to benefit small business.
Though the advisory panel component of SBREFA legislation
often results in unnecessary delays to needed regulations,
other aspects of the law do help small businesses comply with
regulations and could be expended to be even more helpful.
Supporting and expanding the Small Business Ombudsman and
Compliance Assistance programs is a sensible way to give
direct, tangible help to small business.
The information the IRS provides to business taxpayers is
essential to increasing compliance and decreasing hassle for
small business. However, funding cuts to the IRS in the past
few years has made that assistance more difficult to provide.
Since fiscal year 2010, the IRS's funding has been drastically
cut again and again. Consequences of those cuts have led to
reductions in staff available to assist taxpayers and in the
training available to that staff. An IRS staff that is
adequately knowledgeable and available to small business
taxpayers makes filing taxes easier and prevents compliance
problems from compounding. Yet, over and over, the IRS is
unfairly attacked and prevented from fulfilling its mission.
Therefore, it is essential that the IRS is fully funded.
It is in our nation's interest that small businesses are
able to grow and thrive in a society that protects health and
safety and ensures that the market operates fairly to
businesses of all sizes. Small changes to SBREFA, fully funding
the IRS, and ensuring a predictable rulemaking process will
ensure that the playing field is level for small business.
Again, it is an honor to come before you today, and I look
forward to your questions.
Chairman HUELSKAMP. Thank you, Ms. Peterson-Cassin. I
appreciate your testimony. We will begin with questions.
I would first like to direct a question to Mr. Harris. I
appreciate your experience as a practitioner. Looking at this
and after a correspondence audit, what do we really know how
the IRS determines who is going to be audited? The New York
Times article contends they have a secret algorithm. What is
your experience or your best guess in what is occurring over
there?
Mr. HARRIS. They have what they call a DIF score. Tax
returns are scored and compared to some norms of other returns
and their prior returns, which, I guess, is the most common
way. They also at times target specific issues where they see
problems either in a tax part of a law or taxpayer behavior.
Sometimes they are just random. They do some audits that are
for research purposes, and those are done randomly and are done
in great depth and detail. Quite honestly, sometimes you just
do not know why you are selected. You see some returns that you
think, wow, I do not know why that one is not getting an audit
and one that looks fairly simple gets one, so, I think there
are a lot of different reasons. I am not sure anybody knows
them all.
Chairman HUELSKAMP. Another question for Mr. Sepp about the
auditors. How are they currently held accountable when they
make errors that might cause a catastrophic result for
taxpayers and/or small businesses?
Mr. SEPP. There are some methods by which taxpayers can see
redress if the IRS either loses documentation or if, perhaps, a
math error on an examiner's part is discovered. That was
something brought up to me in an interview I conducted with a
tax professional. Interestingly, the IRS issues millions of
math correction error notices on its own. Sometimes the IRS's
own staff make mistakes in the calculation of a tax. The
problem is, beyond going to appeals, and assuming the taxpayer
even understands his or her appeal rights, getting into tax
court or district court is a very expensive proposition. One of
the elements of H.R. 1828, the Small Business Taxpayer Bill of
Rights, would begin a pilot program for alternative dispute
resolution in small business tax cases. That was an idea that
had been developed by an IRS Reform Commission some 30 years
ago, or 20 years ago I should say, and it is a good idea now. I
think we should move forward with it.
Chairman HUELSKAMP. With a tax appeal rate of 5 to 7
percent, is this because businesses are a function of being
scared as well as not knowing, or not worth the price of entry?
There is a lot of discussion about large corporations that will
draw audits for years. For a small business with 20 folks or
less a couple days is a major crippling factor on their
business if they are shut down or have to spend all their time
with an auditor on an appeal.
Mr. SEPP. Yes, absolutely. Some professionals have reported
to me, just the basic misunderstanding, that when taxpayers
receive the so-called 30-day letter with an RAR, the report of
the examiner, as to the issues and the position of the IRS,
they think it is a bill. They think they have to pay it.
Chairman HUELSKAMP. Who would they call?
Mr. SEPP. It is very difficult sometimes. That is a problem
the Taxpayer Advocate has pointed out, that there needs to be a
single point-of-contact with a phone number that a citizen
under examination can get in touch with. The IRS has
interpreted that mandate in a very fluid fashion, and that is
not very helpful.
Chairman HUELSKAMP. Mr. Davenport, what is your sense of
volume of audit activity? Could that be diminished, and more
targeted, and more efficient? You filed recommendations for the
council you are on. Can you describe that a little bit more,
how we could actually make it more efficient and better
allocate the resources? Thoughts on that?
Mr. DAVENPORT. I do not know if I can speak to the volume
of the audits and their current status. I think that they would
be increased. You would have more efficiency in the system if
you allowed the small businesses to transparently see
information that is on file. If the IRS presented to you an
electronic account or a format, that they could say this is
what we have for you. These are the kinds of things we are
going to be talking about.
As was previously mentioned, they could track the audit
process, the paperwork through the entire cycle of the audit.
Their interactions are, as I mentioned, largely unaccountable
for, so you can change hands of the audit process several
times. You can speak with people on one issue or event in the
IRS and then speak with another person in another department.
They do not have a way to be able to speak knowledgeably about
all the information held in one place at one time, and I think
it would improve dramatically.
Chairman HUELSKAMP. They have, certainly, some type of
internal processes, but are taxpayers not privy to those? Or if
they ask who is looking at it next or who looked at it, where
it is, what do they tell a small business man or woman that is
appealing? Where is the appeal? Will they even answer that
question?
Mr. DAVENPORT. I think it would require several lengthy
responses back and forth. I think putting all the information
we have into the same place and having an important and dynamic
conversation about the information that we have at the same
time would be fair and transparent for both the filer and the
service.
Chairman HUELSKAMP. Well, thank you. I appreciate that.
Next, I would like to recognize the ranking member for her
5 minutes of questions.
Ms. CHU. Thank you, Mr. Chair.
Ms. Peterson-Cassin, the Regulatory Flexibility Act, or
RegFlex, was passed by Congress and mandates that Federal
agencies consider the potential economic impact of Federal
regulations on small entities. In fact, it was this Committee
that created the RegFlex Act over 25 years ago. How can the
lack of RegFlex compliance from the IRS impact the ability of
small businesses to adjust according to a new regulation?
Ms. PETERSON-CASSIN. Well, clarity and predictability are
essential to a good regulatory system to any regulation that
comes out. It makes compliance easier and it makes enforcement
easier. Small businesses want to comply with regulations, and
when they do not know when the regulations are coming out, what
the regulations will be, whether the regulations are going to
affect them, it is impossible to comply. Furthermore,
compliance problems, once they start, have a tendency to
compound, which leads to a lot of the problems with difficult
audits that we have been discussing previously.
Ms. CHU. Well, this Regulatory Flexibility Act, RegFlex,
and the Small Business Regulatory Enforcement Fairness Act,
were designed with small business compliance in mind. What are
the most advantageous aspects of these laws and could these
tools be extended to further assist small firms?
Ms. PETERSON-CASSIN. Absolutely. The best thing these laws
do is to provide direct tangible assistance to small
businesses, including creating small business ombudsmen. Most
agencies already have one, including Treasury. Those ombudsmen
are there to answer questions, provide guides, and help small
businesses comply with existing procedures. But the program
should be expanded to include more outreach, make sure that
small businesses know that those resources are available and
can be found easily. There should also be best practices
guidelines on how to do that outreach. More compliance
assistance and making that assistance meaningful will have
enormous benefits, and remove burdens also to small businesses.
Ms. CHU. Absolutely. Now I would like to ask you about the
significant budget cuts at the IRS. The IRS has had significant
budget cuts and it has resulted in limited resources. Is it
realistic to think that the IRS can appropriately and
efficiently perform all the duties it has been tasked to do
while also reviewing the modified problem areas, like the price
of audit on taxpayer accounts? How can increasing the IRS
budget, and therefore increasing personnel, address many of the
problems we are hearing about today?
Ms. PETERSON-CASSIN. An answer to your first question,
unfortunately, I do not think it is realistic at all to expect
the IRS to carry out its vast mission of enforcing the tax code
with the cuts that have been in place. Since 2010, as Mr.
Davenport mentioned, the IRS has lost about 17,000 full-time
employees, including 5,000 from enforcement. As we have been
hearing, audits are an imperfect tool. Increasing compliance
assistance and guidance, before the problems compound, makes
those audits easier, and increasing the training available to
staff through adequate funding would decrease the problems that
those audits cause as well.
Ms. CHU. How about increasing personnel and increasing the
budget? What could that do to address these problems that we
are hearing about?
Ms. PETERSON-CASSIN. That is exactly right. I mean, the
most obvious thing that the IRS can do to increase its
compliance is answer their phones. As Mr. Davenport mentioned,
he cited the statistic that the IRS has a 38 percent service
level on their phones. That is obviously unacceptable. When
they do get more funding, as they did, they got a little bit of
funding in 2015 to address that problem, the service level goes
up. In fact, when that extra funding came up, they were able to
hire 1,000 temporary workers and increase the phone level
service to about 70 percent. Now, that is not even talking
about the first thing I do when I have a problem or I have a
question, which is go to the internet. The IRS needs that extra
funding in order to create easy-to-find compliance guides so
that small businesses do not have to wonder what they are
supposed to be doing. They should be able to find those answers
right away. More funding will make sure that happens.
Ms. CHU. Thank you. I yield back.
Chairman HUELSKAMP. Thank you. Next, I would like to
recognize Mrs. Radewagen for her 5 minutes of questions.
Mrs. RADEWAGEN. Thank you, Mr. Chairman. I, too, would like
to welcome the panel. Thank you for appearing today.
Mr. Davenport, you talk about a system that verifies
taxpayer identities and tax return information before the IRS
accepts a return. How would this work in practice?
Mr. DAVENPORT. In my mind there are a few things that would
have to change. There are some regulations in place now to
bring in information returns in earlier, much earlier.
Information now from the 1099s and the W-2 passes through
Social Security and then gets to the IRS sometime around the
summer or late summer. If information was to arrive earlier and
it would be usable by the IRS, searchable and cross-matched, we
could better identify information that was included on those
information statements, like W-2s and 1099s, and use it to
verify, authenticate the individual.
I think there is some movement in the spending bill this
year, the IRS will start issuing refundable credits on February
17th this year. This has some negative impacts for the system,
but if you move back the date the refunds come out and you move
up the date information comes in, you have a better chance of
matching that information, and then knowing who the individual
is and if they are getting the right number.
This is not to stop me stealing his information at a coffee
shop; this is to stop the 500,000 returns and refunds that are
issued improperly to people who do not exist. They are phantom
corporations that have filed for millions of people.
Mrs. RADEWAGEN. Given the IRS cybersecurity challenges, as
well as those of taxpayer identity theft and refund fraud, how
do we ensure that the taxpayer online portals you recommend are
secure?
Mr. DAVENPORT. Security is an evolving thing. Even 3, 4
years ago, we thought security questions were lightyears ahead
of where we are. Now you can find that stuff on Ancestry.com
and this is a pretty common thing that we think the status of
evolving authentication, for me knowing who an individual is,
the computer must be smarter than we are and those are powered
by people and people have to make the decisions, and
cybersecurity is a big deal. Right? So if we can improve that,
if we can know who they are and if we can master information,
we will have a better chance of making those payments
correctly.
The thing is now I can choose to interact with the IRS on
the schedule I want. I can come in and out of the system at any
point. I can file and not file next year and no one will know
the better. We will know later, years later, but if we were to
create an online system that I could match my information the
employer sent me. I am a small business owner, if I got 1099s
in the mail, as did the IRS, and if I could actually see what
was there, what they had, what I had, in a prefiling season I
could know my compliance was going to be right and I was going
to file the right return. I could submit my return through an
online account. They would send me a note, we received your
return today. Thank you very much. We are going to drop your
refund in your account today. Is that okay? Well, if it was not
me or that was not my return I would say no and we would stop
immediately.
I think there are some security concerns around how to do
it, but does it need to be done? It absolutely has to be done.
Mrs. RADEWAGEN. Okay. I am running out of time here.
I wanted to ask Mr. Sepp, the current audit process seems
to be a bit of a mess based on a number of issues you
identified: lack of centralized management, lack of
transparency, flawed IDR process, et cetera. But it appears
that many of these issues could be resolved administratively
within IRS. What recommendations would you make to the agency
to make the process work as intended?
Mr. SEPP. Some of these recommendations are being made by
the Coalition for Effective and Efficient Tax Administration,
but I think they apply not only to the large business and
international division but small business and self-employed.
There needs to be more centralized case management and points
of contact. There needs to be much more consultation between
the auditors and the audited about deadlines for information
document requests, about timelines for completion of the audit,
and about issues identified in the audit. I would echo the
testimony of those here who say we need better training of IRS
staff to focus more intently on the issues and to refrain from
tactics such as designated summons or threatening to designate
cases for litigation or hiring outside firms. Those kinds of
issues, again, are eventually going to migrate into the small
business community in some form or another. We need to address
those now.
Mrs. RADEWAGEN. Thank you, Mr. Chairman. I yield back.
Chairman HUELSKAMP. I have a feeling we may have some
members streaming in from other committees, and I have a couple
of additional questions and the members will have another round
of questions.
Mr. Sepp, you did mention the option of farming out audits,
which is a new concept to me. I understand the current system
where we actually do in most States, if not all, participate in
assisting the IRS in tax administration. But the current
system, farming out audits to hire private companies are
perhaps conflicts of interest? Describe why that should be
allowed or your opinion on the IRS doing that. Apparently, it
is doing it on a number of cases.
Mr. SEPP. Well, certainly, National Taxpayers Union has in
the past supported allowing the private sector to deliver
services more efficiently and effective than government, but
you have to draw a line. This is an inherently governmental
function involving sensitive information and very sensitive
issues. When a business is involved, of course, anything that
gets made public can affect the reputation of the business, its
ability to attract capital and the like.
This issue was first raised when the Internal Revenue
Service retained Quinn Emanuel in an investigation, an audit of
a very large firm, and this has led to concerns on the Senate
Finance Committee side of all kinds of things. We have privacy
issues, we have whether this is worth the expense. We also have
the issue of whether this is something that reinforces the
intimidation factor when you have attorneys at over $1,000 per
hour participating in the examinations. We are not talking
about appearing as expert witnesses about issues that the
examiners within the IRS might need help with, but rather,
deposing witnesses. That could be very troubling.
Chairman HUELSKAMP. Is this a new route for the IRS? Or
have they been doing this for a long time?
Mr. SEPP. No. It is very recent. Very recent. We are
essentially ahead of the curve here in our ability to curtail
this practice before it becomes commonplace. As I mentioned,
one of your colleagues, Congressman Katko, is already offering
an amendment regarding this. Senator Portman's legislation has
a somewhat different approach to curtailing the practice, but
we need to get on this as quickly as possible.
Chairman HUELSKAMP. It seems very shocking to me and I was
actually in a different type of regulatory setting of
environmental regulations with the idea we would bring in a
competing firm to help enforce or decide what permits their
competitive firm gets and it is just beyond unbelievable the
IRS would do this as well.
Ms. Peterson-Cassin, you said you had experience in the
nonprofit world as well, and there have been a lot of
discussions in the last few years in trying to figure out who
gets targeted for audits or selection of special scrutiny,
which has come under a lot of discussion lately. Can you
provide an insight? Should the IRS be using special words they
target, or how do they pick these out in the nonprofit world
for this tax-exempt status, which of course raised plenty of
concerns, I think, by many folks. Can you describe what they
should have done, what you think they did?
Ms. PETERSON-CASSIN. Absolutely. What happened in that case
is that the laws governing what political activity is for
nonprofits are so vague that they are not only hard for
nonprofits of all stripes to comply with, but they are also
very, very difficult to enforce. This is exactly the discussion
we have been having. Compliance and enforcement are two sides
of the same coin.
So I liken it to a speed limit sign that says do not go too
fast. When the rule is that vague, there are going to be plenty
of people who do go too fast for whatever reason. Then there
are going to be even more people, in fact, the most common
thing we hear from nonprofits is they just do not engage. They
restrict themselves from things that they could be doing, could
be participating in, could be furthering their mission, and
they say we are too afraid. We are too afraid and we are not
going to do it. The Bright Lines project exists to make that
clear so that everyone can be on the same page.
Chairman HUELSKAMP. In my conversations with the
Commissioner, there are things that he told me they could do
that no one in their right mind in the nonprofit world would
even try to do because they know they are going to be hit on
the wrist or even worse. How do you know what you know? How do
you find out? Now we are in the middle of just trying to figure
out what exactly they were doing in Cincinnati, which is the
subject of other hearings of other committees, so I appreciate
that insight.
Ms. Chu, did you have any additional questions?
Ms. CHU. Yes. Mr. Davenport, I was intrigued by the
recommendations of the Electronic Tax Administration Advisory
Committee. Electronic signatures is just such a basic common
sense idea and would allow small business owners to save time
and money when filing their taxes electronically. How could
such a simple administrative change create efficiency for small
businesses and the IRS?
Mr. DAVENPORT. You hit on a multiyear problem and I think
this has come out of ERSAC before as well, but it is the way
the form line 40-ES, the employment form for small businesses,
it is a form that is filed quarterly and their employment taxes
paid. It is administratively much easier to go to the form,
print the form itself, sign it, and then scan it back than it
is to create an electronic account to do this. It is a simple
fix, but, you know, if we talk about the 80 percent goal to get
electronic filing above 80 percent, which is going to charter
ETAAC in 1998, we are close in most categories: individual
filings, 87 percent of individual taxpayers; businesses are
below 80 percent, just below 80 percent, because the 94X
series, which there are 20-something million of these forms
that come in every year, only about 37 percent of them come in
electronically. It is something that the IRS has formed a
working group on, they did that when I was in my first year in
ETAAC. They formed a working group in e-services. They will
make recommendations, and they expect to implement those
recommendations in fiscal year 2018. And so you can see the arc
for change is not as agile as you would expect in the private
sector, but I do think that we are going to see some changes in
that soon because it is honestly just an easier thing to do
than not to do.
Ms. CHU. What makes implementing these changes so difficult
for the IRS? Why is it taking so long? Also, are there any
downfalls to allowing electronic signature, such as fraud or ID
theft?
Mr. DAVENPORT. I think one of the things they are dealing
with is that an individual must authenticate for a business, on
behalf of a business, and as a Schedule C filer. There are
millions of Schedule C filers, it is no problem for me to
authenticate myself with my own social, but to do so on behalf
of a business, you have to share your own personal identity on
behalf of a business as a business owner, and sometimes as
businesses grow, that information then has to pass to internal
accounting services or external folks.
Again, it may just be an administrative thing that can
change, that we can fix the system and make it easier, but I
think they have to think about authentication as a whole
strategy. That is just kind of wound up in it. I would probably
defer to Mr. Harris, he may have strategies.
Mr. HARRIS. No, I think your comments are true. We need to
move to more electronic filing capabilities, and I think the
service, if I was going to be critical, it is the old saying,
``The enemy of good is perfect.'' At some point we need to
begin to allow businesses--there is always a reason not to do
something. We need to start trying to find a reason to do
something.
Ms. CHU. Mr. Harris, collecting tax debt is possible
through flexible collection tools and can be an efficient way
of helping these individuals, yet these tools are rarely
utilized by the IRS and instead tax liens, levies, and seizures
are used. What makes liens and levies, which are much harsher
points of collection, the preferred method for IRS agents?
Mr. HARRIS. I really have no idea why it would be the
preferred method because it is the most cumbersome method. It
creates the most difficulties. I guess if you have exhausted
every other tool. As you said, there are plenty of
opportunities through any collection process through the use of
installment agreements or offers in compromise or just paying
the tab, it should be in all cases the place of last resort. If
it moves up anywhere beyond that, then something in the system
has not gone as intended because, again, that should be the
last thing anyone gets to because that has the most severe
impact of all on a small business owner.
Ms. CHU. I yield back since I think votes have been called.
Chairman HUELSKAMP. Are there votes this early? I did not
know that, so I appreciate that. We got sidelined with another
Committee, so I would like to thank all of you witnesses for
participating today. You have raised a number of issues and
potential solutions--I like hearing solutions--that require
some serious attention at the IRS. It seems we have a lot more
work to do in this area but this hearing is a good start.
I know the Full Committee and this Subcommittee will follow
up with the IRS and other stakeholders on the issues raised
today. You have not heard the last from us. It is important
that these issues and other related concerns are identified,
addressed, and corrected.
I ask unanimous consent that members have 5 legislative
days to submit statements and supporting materials for the
record. Without objection, so ordered.
This hearing is now adjourned.
[Whereupon, at 11:28 a.m., the Subcommittee was adjourned.]
A P P E N D I X
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Prepared remarked from the
IRS Electronic Tax Administration Advisory Committee
Chairman, thank you for holding today's hearing on how the
IRS can help small businesses. The 28 million small businesses
in America are a cornerstone to our economy. According to the
Small Business Administration and the IRS, small businesses
account for over half of all US sales and 55% of all jobs. They
pay significant amounts of income, employment, and excise taxes
to the US Treasury.
Helping small businesses easily file and pay their taxes is
a critical mission of the IRS Electronic Tax Administration
Advisory Committee, or ETAAC. ETAAC was formed by law in 1998
to make strategic recommendations to Congress on how to improve
tax administration and better serve taxpayers--including small
business taxpayers--through electronic means. In short, we are
objective digital strategy consultants to the IRS. Recently,
the committee has sharpened its focus on how the IRS could make
the tax system less reactive and intrusive by providing
taxpayers with digital access to their tax information and a
better understanding of their compliance requirements.
The committee believes that modernizing the IRS taxpayer
service platform is an urgent, strategic priority for the IRS.
In the 2015 tax season, the IRS was in its fourth consecutive
year of budget reductions, and IRS service levels plummeted.
The IRS answered only 38% of its calls from taxpayers. The IRS
has been unable to modernize its taxpayer-service platform to
move away from traditional paper and phone interactions. The
current phone and paper taxpayer-service platform is also not
the preferred choice of the IRS or the many taxpayers who
expect secure online services.
Aligned with this issue is a lack of transparency with the
IRS. For most taxpayers, the information the IRS has about them
is a mystery. It's not easy for taxpayers to access and
understand their tax information on file with the IRS, their
previous tax-related interactions or their tax compliance
obligations. For small-business taxpayers, this issue is even
more critical, because small businesses are more likely to
complete multiple year-round transactions with the IRS. In many
cases, when there is a compliance issue, small-business
taxpayers find out with a surprising IRS notice after they
file, or--even more stressful--an audit that can take months or
years to resolve. For all types of taxpayers, accessing and
using their tax information to proactively comply is almost
entirely out of the question in the current system.
The committee believes that a key solution these problems
is a more digitally enabled, modernized IRS that better equips
taxpayers with information on how they can proactively comply,
rather than solely focusing on detecting and enforcing
compliance.
In the past three years, ETAAC has provided recommendations
based on a single vision of how the IRS should serve taxpayers.
This vision allows taxpayers to:
Fully understand their tax obligations,
Have transparent access to their tax
information and status with the IRS, and
Effectively and securely interact with their
tax administrator in the way that they want to be
served
The end state is a tax system that is less burdensome. It
is a tax system that relies less on reactive measures, such as
audits, and more on preventative and educational measures for
taxpayers to remain proactively compliant.
First, the current tax system is designed to
be reactive, and does not leverage tax information to
help taxpayers meet their tax obligations, and
Second, the IRS cannot quickly develop and
implement its digital roadmap, including online
accounts, to address the needs and preferences of
taxpayers.
Our last two reports to Congress explain this dilemma and
provide recommendations to overcome these challenges.
In ETAAC's 2015 report to Congress, we recommended that the
IRS accelerate its digital taxpayer-service strategy--that is,
develop secure online accounts for all business and individual
taxpayers. Taxpayers should have secure digital access to their
tax information, and they should be equipped with comprehensive
tools to interact effectively with the IRS online.
In the report, we directly addressed key problems in the
IRS strategy that affect small businesses, and we advocated for
an expedited release of online accounts and tools for
businesses--still not a stated IRS priority.
Additionally, we know that businesses are much more likely
to use a tax professional for tax filing and compliance needs.
Online accounts for these tax professionals should be a
priority. In the current IRS digital plan, online accounts for
business taxpayers and their tax professionals arrive much
later. ETAAC advocates for the IRS to commit to quickly
developing online accounts for business taxpayers and the tax
professionals who serve them, and we encourage this committee
to do the same.
In our most recent 2016 report, ETAAC addresses the ``look-
back'' tax system that centers on post-filing programs that
detect and correct noncompliance. We challenge Congress and the
IRS to move to a system that verifies taxpayer identities and
tax return information before accepting a return.
A system that uses information statements, such as Forms
1099 and W-2, to verify taxpayers and their tax return
information is essential to fighting fraud and reducing
taxpayer burden. The IRS should support taxpayers in filing
accurate returns by giving them full electronic access to their
tax account information at the time of filing. This proactive
system would verify accuracy upfront and reduce audits,
particularly those on small-business taxpayers.
ETAAC has been pleased with the IRS' first steps in its
digital service plans. The IRS released an initial draft of its
Future State Initiative in January of this year. The initiative
specifically contemplates small-business taxpayers and their
needs. However, the delivery date of these digital capabilities
is unknown.
Many of the ETAAC's recommendations from the past three
years are incorporated into the IRS Future State Initiative's
digital plans. ETAAC endorse4s the digital-service components
of the IRS' Future State plan, and we have advocated to
Congress that the IRS should accelerate these plans. Our
recommendations clearly identify the urgent needs of small
businesses. The IRS needs to accelerate online accounts for
businesses and tax professionals.
On behalf of the entire ETAAC, thank you for inviting us to
testify on this important topic.
For more information on ETAAC's recommendations to the IRS,
and those impacting small businesses, please see the
committee's recent reports at https://www.irs.gov/uac/
electronic-tax-administration-advisory-committee-etaac-annual-
reports.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Good morning, I am Roger Harris, President and Chief
Operating Officer of Padgett Business Services. I have been a
tax practitioner for over 40 years and have served on the
Internal Revenue Service Advisory Council for four years and
was its Chair for two of those years. I believe this experience
gives me a balanced approach to small business taxation--I have
had the opportunity to see what works and what doesn't work in
the real world.
For nearly fifty years, Padgett Business Services has been
providing accounting, income tax planning and preparation,
payroll and payroll tax services to thousands of small business
owners through our network of over 200 offices across the
United States. Our clients generally have 20 or fewer employees
and are what some people would consider ``mom & pop''
businesses; however, based on recent studies almost 90% of all
firms that have employees operate in our target market.
Internal Revenue Service Audits of Small Businesses
Padgett's business model brings us in contact with our
clients throughout the year, not just during filing season. We
assist our clients in establishing good accounting,
recordkeeping and tax processing. This ongoing communication
allows us to understand these small business owners well beyond
just knowing their numbers. Our strong belief is the best way
to survive an audit is to do everything within your means to
never have one. Enforcement being a prerequisite for our tax
system to work, there is a real possibility for all small
business owners to one-day experience the pleasure of an IRS
audit. Because of that possibility the second best way to get
through the process is to have a clear, traceable record of
financial transactions and of course to keep and organize
receipts and invoices. A disciplined approach throughout the
year generally results in less trouble with the tax man--local,
state and federal.
In those occasions where audits do arise, either for
established clients or individuals new to the small business
world, it's important to have a broad overview of the process.
In general, there are two kinds of audits: Correspondence
and Field. According to IRS data for 2014, the IRS conducted
just over 291,000 Field Audits and over 950,000 Correspondence
Audits. Both of these numbers have dropped considerably since
their peak in 2010 of 391,000 and 1.173 million, respectively.
Because Correspondence Audits tend to focus on more moderate
income tax returns, and more basic issues that should not
require a face to face meeting, mom-and-pop small businesses
are much more likely to experience these than actually sitting
across from an IRS auditor.
Correspondence Audits, known within the IRS as Campus
examinations, are the most basic type of audit and are
conducted--as the name implies--by mail. They are usually
triggered by software that compares returns against common
trends and selects those that might be considered outliers.
Field Audits typically occur when the IRS suspects major
violations or they are part of an IRS research program. IRS
auditors may ask that taxpayers come to their offices, but they
typically visit the place of business at least once during the
process.
The vast majority of small business audits are
Correspondence Audits. While they are intended to cover only
simple issues, because of the IRS's focus on efficiency, they
can be frightening to small business taxpayers, as well as
being time consuming and expensive. In some circumstances when
things go wrong, they can be devastating to a business.
For a Correspondence Audit, the IRS will mail small
business taxpayers either a Letter 566 or a CP 2000 notice. 566
letters advise taxpayers that their returns have been selected
for examination and will list documents such as receipts needed
to verify positions on returns. The CP 2000 notice will contain
adjustments based on third-party documents associated with the
return. A taxpayer typically must respond within 30 days.
If taxpayers agree with a notice, they simply sign the
letter and return it with a check made out to the US Treasury;
the problem arise usually when there is a dispute.
When responses from taxpayers arrive at the Examination
center, they sit in a queue at the IRS processing center for
weeks or even months depending on the backlog--causing great
anxiety on the part of taxpayers. Eventually, files are
assigned to auditors. If all goes well, taxpayers will receive
letters thanking them for their responses and telling them
nothing more is needed. Sometimes, for whatever reasons,
taxpayers do not receive these acknowledgements, forcing them
or their representatives to hunt down their case files or to
keep resending them.
As expected a good number of these responses are denied by
auditors due either to the quality of the records or because of
a dispute over a matter of law. While many people believe tax
law is black and white the reality is most areas are gray. This
graying requires the law to be applied to the facts and
circumstances that exist and are specific to that small
business. Sometimes it is difficult to understand all of the
facts and circumstances when the discussion is by
correspondence.
Unfortunately, it is not uncommon for a small business
taxpayer to fail to respond to the original correspondence from
the IRS in a timely manner. If taxpayers do not respond, the
IRS issues a second notice, and if there still is no response,
it will issue statutory notices of deficiency, known as a ``90-
day letter.'' At the end of that time, the IRS ``assesses'' the
tax, including penalties and interest. Assessment establishes
that taxpayers legally owe the amounts in question and then the
cases are move over to collections.
The problems associated with the audit process for small
businesses can range from the mundane to the Kafkaesque. First,
even the simplest correspondence audits consume time and focus
for business owners to find, gather and mail the requested
records to the auditor. The IRS often states ``but, it is up to
taxpayers to keep proper records.'' This is correct but it
doesn't make it any less burdensome. Even for the most
organized among us, it takes time to locate and organize the
correct documents. In addition to time requirements, the small
business owner is usually under a great deal of stress. For
many taxpayers this is their first dealing with the IRS in this
way. Their minds wander to the horror stories they have all
heard and they wonder how bad will this be and can I do this
without help?
Second, over 70 percent of small business owners rely on
enrolled agents, CPAs or attorneys when they are contacted by
the IRS. Because of this, even mundane correspondence audits
can have significant cost, even for small disputes the cost of
representation can easily exceed the taxes in question. Many
business owners do the math and decide to just pay the extra
tax instead of fighting it. For those instances when small
businesses respond to correspondence audit notices and auditors
reject their records or legal position, outside practitioner
costs can quickly add up to thousands of dollars. Longer more
complex field audits can be even more cost prohibitive for
taxpayers.
Another problem area for taxpayers that cost both time and
money is when responses are seemingly lost or delayed in the
system. The deadlines come and go and taxpayers believe that
they have responded. The nature of the Correspondence Audit
process is that it is almost wholly automated. If the computer
at the examination campus does not know taxpayers have
responded it continues to send out notices, deadlines will
continue to not be met, as the IRS claim marches inevitably
into assessment and collection. The IRS seems to have gotten
better over the years at tracking cases but approximately a
million cases go through Campus Examination centers each year.
Cases can either be lost, not processed correctly, or they are
not submitted in a timely manner. It is important to keep in
mind that there is no one point of contact taxpayers or their
representatives can call at the center to track down a
particular case. This lack of a responsible human being within
the bureaucracy is often the most frustrating aspect of the
Correspondence Audit.
A similar problem, except on the taxpayer side, is the non-
receipt of notices because taxpayers have moved, or for
whatever reason are not receiving them. Taxpayers are
blissfully ignorant. And on top of that the computer processing
correspondence audits is blissfully ignorant as well, belching
out notice after notice until cases end up in collections.
Taxpayers can first learn they have a problem when their
business checking accounts are frozen or another collection
action has been taken. Once again unwinding these cases can be
particularly time consuming and expensive.
Finally, our franchise owners have experienced inconsistent
quality in personnel. It is readily apparent that older more
experienced auditors have the benefits of more training, a
deeper understanding of the law, and more real life experience
to guide them. Younger personnel only have a basic
understanding of the law or do not have the experience that
only time can provide. This lack of experience can cause
delays, or even worse an incorrect determination. There has
been a long term practice of allowing more complicated
Correspondence Audits to be transferred to a local area office
at the request of taxpayers. It has become very difficult to
have these transfers approved. Similarly, requests to speak to
managers and referrals to appeals can be ignored. The IRS is
clearly experiencing a shortage of personnel and suffering from
a lack of training.
The small business taxpayer is also at the mercy of the
knowledge and experience of their tax preparer or
representative. Additionally, a less qualified tax preparer may
be the very reason the small business owner finds themselves in
the mess they find themselves in.
At the end of the day no matter if it's the small business
taxpayer, the tax practitioner, or the individual from the IRS,
the cost of an extended process will be paid by the small
business owner.
So, what can the IRS improve even within the constraints of
fewer resources? We believe they better facilitate the tracking
of cases. If Federal Express can manage millions of packages
all over the world, it seems that the IRS could come up with
some sort of bar code or other tracking system that would allow
both the IRS and the taxpayers to track correspondence
responding to notices and the status of their cases. Most
importantly, the IRS may need to be willing to assign cases
earlier to an auditor or a team of auditors if the taxpayer
believes such a request is in their best interest. And finally,
leading to my next discussion, the IRS needs to drive a large
part of the Correspondent Audit communications to the interest.
IRS Future State Vision for Small Businesses and
Practitioners
The IRS vision for Future State could provide significant
relief to many of the problems associated with Correspondence
Audits. A taxpayer receiving one of these notices could simply
activate an individual account through IRS.GOV, view their
status online, scan the requested documents and email them to
the examination campus, and respond to any follow ups. All of
these communications would be done through a secure email
system that would track all communications. If taxpayers are
required to make payments, they can do so through their
accounts or enter into installment agreements all online. We
believe strongly that Future State accounts could provide their
greatest return on investment in managing Correspondence
Audits.
Unfortunately, like most things there is good news and bad
news. First, IRS plans to roll out online applications for
individual taxpayers over the next year or so. Similar accounts
for practitioners, however, will not be available for at least
a year or two beyond that. It is important to keep in mind that
over 70 percent of small businesses choose to have an enrolled
agent, CPA or lawyer deal with notices from the IRS. This means
that most small businesses will effectively be stuck in the
current snail-mail process.
Another considerable problem has to do with authentication.
In order to access these accounts, taxpayers must provide
information associated with their tax returns, their account
numbers for a loan or credit cards, and cell phone numbers
associated with their name and social security number.
Unfortunately, for taxpayers who have not filed a tax return,
or do not have loans or credit cards, or have cell phones
provide by work or a family member, they will be effectively
locked out of their own accounts. The IRS estimates that only
30 percent of taxpayers will be able to authenticate themselves
and use their accounts. Currently, unlike a typical financial
institution, there is no 800 line planned that taxpayers could
use to authenticate themselves over the phone.
Additionally, the agency has no real plans for providing
business level accounts. Luckily, most sole proprietors or LLCs
filing a schedule C will be able to use the individual
accounts. More complex small businesses organized as C
corporations or partnerships will not have access to these
accounts.
Generally, because of the real threat of online hackers,
the IRS is creating a very high authentication barrier to
access online accounts. The reality is, however, that most
taxpayers will rarely, if ever, need access to their accounts.
They will try once, with 70 percent of the time failing to gain
access, and then picking up the phone or using the U.S. Mail as
their primary method of contract. While practitioners and
businesses, both of whom have many more interactions with the
agency, will do whatever it takes to go through the
authentication juggernaut in order to access the accounts.
Additionally, in the case of practitioners, they are well
known to the IRS, having registered for a PTIN and a Central
Authorization File number. Further, if necessary, the IRS could
require a one time in-person authentication similar to the
FAA's PreCheck system.
In short, as the IRS moves forward with online accounts, it
must include access by practitioners--enrolled agents, CPAs,
and attorneys--and businesses in order for the strategy to be
successful. The agency needs to find practical methods to
authenticate Circular 230 practitioners and to authorize them
to solve their clients' problems. Any solution that omits
practitioners fails to recognize many taxpayers benefit from
representation because they (a) do not want to represent
themselves, (b) recognize they are not proficient enough to
represent themselves, or (c) are afraid to engage with IRS
enforcement staff. Forcing a portal to face taxpayers only will
place taxpayers with practitioners at a disadvantage, as a
result, practitioners will continue to be parked on phone
lines, and it will significantly impede taxpayers' rights to be
represented before the agency.
We urge the Internal Revenue Service to consider four
important policies:
1. Develop robust individual and practitioner online
accounts at he same time.
2. Allow Circular 230 practitioners to execute and
file authorizations electronically and immediately
represent those clients.
3. Allow the use of electronic signatures for all
power of attorney and disclosure authorization forms.
4. More expeditiously to provide access to business
accounts.
Thank you for this opportunity to testify today and Padgett
Business Services looks forward to working with the Committee
on this crucial area of tax administration.
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