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33–963—PDF 2006

S. HRG. 109–832

PREPARING YOUR TAXES: HOW COSTLY IS IT?

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

APRIL 4, 2006

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

CHARLES E. GRASSLEY, Iowa, Chairman

ORRIN G. HATCH, Utah

TRENT LOTT, Mississippi

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

CRAIG THOMAS, Wyoming

RICK SANTORUM, Pennsylvania

BILL FRIST, Tennessee

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

MAX BAUCUS, Montana

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JAMES M. JEFFORDS (I), Vermont

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

KOLAN DAVIS, Staff Director and Chief Counsel

RUSSELL SULLIVAN, Democratic Staff Director

(II)

(III)

C O N T E N T S

OPENING STATEMENTS

Page

Grassley, Hon. Charles E., a U.S. Senator from Iowa, chairman, Committee

on Finance ............................................................................................................ 1

Baucus, Hon. Max, a U.S. Senator from Montana ................................................ 2

WITNESSES

Brostek, Michael, Director, Strategic Issues Team, U.S. Government Accountability Office, Washington, DC; accompanied by Paul R. Desaulniers and

Christine A. Hodakievic, Special Agents, U.S. Government Accountabilty

Office, Washington, DC ....................................................................................... 5

DuMars, Bert, Director, Electronic Tax Administration, Internal Revenue

Service, Washington, DC ..................................................................................... 7

Olson, Nina E., National Taxpayer Advocate, Taxpayer Advocate Service,

Washington, DC ................................................................................................... 9

Weinberger, Robert A., member, Free File Alliance, LLC ................................... 11

Degen, Francis X., E.A., president, National Association of Enrolled Agents,

Washington, DC ................................................................................................... 13

Duncan, Harley, executive director, Federation of Tax Administrators, Washington, DC ............................................................................................................. 15

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baucus, Hon. Max:

Opening statement ........................................................................................... 2

Prepared statement .......................................................................................... 39

Brostek, Michael:

Testimony .......................................................................................................... 5

Prepared statement .......................................................................................... 42

Responses to questions from committee members ......................................... 77

Degen, Francis X., E.A.:

Testimony .......................................................................................................... 13

Prepared statement .......................................................................................... 80

Responses to questions from committee members ......................................... 85

DuMars, Bert:

Testimony .......................................................................................................... 7

Prepared statement .......................................................................................... 93

Responses to questions from committee members ......................................... 100

Duncan, Harley:

Testimony .......................................................................................................... 15

Prepared statement .......................................................................................... 123

Responses to questions from committee members ......................................... 139

Grassley, Hon. Charles E.:

Opening statement ........................................................................................... 1

Prepared statement .......................................................................................... 144

Olson, Nina E.:

Testimony .......................................................................................................... 9

Prepared statement .......................................................................................... 146

Responses to questions from committee members ......................................... 167

Schumer, Hon. Charles E.:

Prepared statement with attachment ............................................................. 195

Smith, Hon. Gordon H.:

Prepared statement .......................................................................................... 199

Page

IV

Weinberger, Robert A.:

Testimony .......................................................................................................... 11

Prepared statement .......................................................................................... 201

Responses to questions from committee members ......................................... 204

COMMUNICATIONS

Free File Alliance .................................................................................................... 225

Nash, William A. ..................................................................................................... 232

National Association of Tax Professionals (NATP) ............................................... 234

National Society of Accountants (NSA) ................................................................. 244

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PREPARING YOUR TAXES: HOW COSTLY IS IT?

TUESDAY, APRIL 4, 2006

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC.

The hearing was convened, pursuant to notice, at 10:15 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Charles E.

Grassley (chairman of the committee) presiding.

Also present: Senators Thomas, Bunning, Baucus, Wyden, and

Schumer.

OPENING STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S.

SENATOR FROM IOWA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. I am sure you are well-aware of the fact that we

had a vote. I am going to put a longer statement in the record.

Hopefully I have shortened it some on my own volition.

[The prepared statement of Senator Grassley appears in the appendix.]

The CHAIRMAN. Today’s hearing will examine the current state

of tax preparation, electronic filing services, looking at how States

are succeeding in the area of electronic filing, with 20 States offering direct Internet filing.

State electronic filing has consistently grown at a faster rate

than what we do at the Federal level, with five States exceeding

what we do at the Federal level. With so many people using preparers who are paid and electronic filing, we need to ensure that

these preparation methods are helpful and user-friendly.

The feedback that we are receiving is that the tax preparation

system is breaking down, so we will look today at some bad practices that seem to be systemic, calling for action on the part of this

committee, I believe.

Given the complexity of our current system, taxpayers should be

entitled to a tax preparation method that they can rely upon.

Today, more than 60 percent of all returns are completed by paid

preparers, annually preparing more than 78 million returns.

While I believe that a large majority of tax return preparers are

honest, highly educated individuals who serve the community well

in providing sound financial advice, we are also getting reports

from various sources that an increasing minority is doing a disservice to the American public, some through bad advice, some

through incompetence, and some through taking advantage

through unscrupulous means towards the taxpayer.

Adequate training within the paid preparer community is essential. The IRS needs to impose penalties against the unscrupulous.

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Today, it seems like any old Joe can hang up a shingle and prepare

income tax returns, because there are no requirements of competence.

It is incredible that we have legal requirements for someone to

qualify as a barber to cut your hair, and yet there are no requirements for someone preparing your taxes.

The vast majority of Americans want to do the right thing and

pay their taxes. Americans have a right to expect that when they

hire a tax preparer they are going to get honest, straightforward

advice.

One of our witnesses, Mr. Brostek, will testify about the experience of GAO in reviewing the practices of tax preparers on an undercover basis. The results of that investigation are very troubling.

For those taxpayers who can prepare their own returns, they

should be able to do so electronically, without cost, to achieve that

goal. Congress allowed the IRS to establish the Free File program

in 2002. The Taxpayer Advocate will comment on their findings on

that aspect of it.

Here is some of what we know from our internal staff review. For

the year 2004 tax year, the Free File Alliance offered free filing

services to everyone, without restriction.

For the 2005 tax year, the new Free File agreement signed by

IRS restricted the availability of Free File by placing income restrictions on the program, and so, not surprisingly, the IRS statistics show that the use of the program has decreased by more than

21 percent.

Also, taxpayers are being inundated with additional charges from

private preparers that may accrue and the sale of ancillary services

such as fees for State return preparation and filing, resetting passwords, printing and mailing services, professional tax return review, audit protection, live chat help, telephone technical support,

and per-question fees for consultation with tax professionals. These

are things that I am unfamiliar with, with the very complicated return that I have as a farmer and as a public official.

Taxpayers entitled to a refund from the government receive offers then for anticipation loans, having fees deducted from their refunds, offers to get their refunds by cashier’s check, pre-paid Visa

cards, and retail gift cards. It sounds like a commercial enterprise.

Meanwhile, we have H&R Block, the Nation’s largest tax preparer, being charged with breaching fiduciary duties to customers.

So those are the issues before us, and we will be exploring those

issues in anticipation of Senator Baucus and I having legislation in

this area.

Senator Baucus?

OPENING STATEMENT OF HON. MAX BAUCUS,

A U.S. SENATOR FROM MONTANA

Senator BAUCUS. Thank you, Mr. Chairman. T.S. Eliot wrote,

‘‘April is the cruelest month.’’ Many consider doing their taxes to

be the cruelest part of all.

Filling out burdensome income tax forms is so stressful that most

Americans pay someone to do it for them. Taxpayers are willing to

spend hundreds of dollars to make sure that their taxes are done

right.

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Most taxpayers want to do the right thing. I think that is very

true. Most Americans, red-blooded Americans, want to do the right

thing. They do not like paying their taxes, but they feel it is their

duty to pay their taxes and it is their duty to pay their taxes the

right way, no more than they have to, but pay the taxes that they

feel they legally owe and should pay.

I feel very strongly that most Americans feel that way, and I

think that is sort of the bedrock that we should all keep in mind

as we are trying to figure out how best to make the system even

more efficient. They are willing to trust a paid preparer, many

times, often a complete stranger, with their most intimate financial

information to do just that.

Every year, paid preparers serve as a link between 80 million

taxpayers and the IRS. This year, another 10 million taxpayers

bought tax software to file on their home computers. That is a big

influence on our tax system. The state of the tax preparation industry is a warning signal for the health of our Nation’s voluntary tax

system. It is like a canary in a coal mine. Regrettably, the canary

is dying.

Today we will hear the serious symptoms of an ailing system.

Over the last several weeks, GAO undercover investigators visited

the offices of five national tax preparation chains. Using simple tax

scenarios, they tested how paid preparers treat their customers,

and the Nation. The results were shocking.

The preparers failed at their most important task: only 10 percent of their returns were prepared correctly. Frequently, preparers

did not ask enough questions to know if they were getting the right

answers. Many preparers were eager to probe for additional deductions or credits, but many did not report cash income.

Many preparers ignored the answers that the undercover investigators gave them; they used answers of their own. They made up

their own facts, and they made up their own tax laws. Several refunds were $2,000 more than they should have been.

Many preparers seemed to be more interested in coming up with

a big refund than they were in getting it right. They were acting

not for their client’s benefit, but for their own. The bigger the refund, the more preparers can sell products like refund anticipation

loans or audit insurance.

Many preparers quoted fees that were substantially less than

what they ended up charging. Many preparers levied extra charges

for unnecessary forms, refund anticipation checks, or products like

debit cards. Charges like these raise the cost of filing considerably.

Today we are also going to learn that the IRS’s Free File program is not always so free. The Free File program is a partnership

between the IRS and private preparers. That is what it is.

Taxpayers that use the program encounter hidden costs and baitand-switch offers to buy upgrades or products like refund anticipation loans. These loans make taxpayers have to pay for borrowing

their own money.

In sum, many tax preparers perpetuate a cruel hoax on taxpayers and the Treasury alike, and the Treasury has not done all

they can to avoid this cruel result.

I want to acknowledge that there are many hardworking, wellqualified, and competent professionals in the tax business. I am

4

proud that my home State of Montana boasts some of the more rigorous industry standards in the country. These professionals must

meet stringent training, they must have experience, and continuing

education requirements to practice. These are not the preparers

about whom we are talking today.

But we cannot stick our heads in the sand. We cannot pretend

that problems do not exist. Instead, we should listen carefully to

our witnesses and find solutions that will mend what is broken.

Last year, I co-sponsored S. 832, the Taxpayer Protection Assistance Act of 2005, along with my colleague Senator Bingaman—

whom I think is the primary sponsor—the Chairman, Senator

Grassley, Senator Schumer, Senator Smith, and Senators Akaka

and Pryor. It goes right to the heart of many of these problems.

It requires paid preparers to meet minimal training and competency standards before they can hang out their shingle. It makes

it easier for the IRS to discipline bad preparers. It helps to protect

taxpayers from unexpected or excessive charges. It requires disclosing the cost of refund anticipation loans.

We should make it easy to comply with the tax law. So, maybe

it is time to really strongly consider making electronic filing available at no cost to all taxpayers.

Just a few weeks ago, everyone received a package of forms and

instructions in the mail, or they could have gone to their local library to get them. Recently, the forms have become available

through the IRS website. All the forms and instructions are free.

So why do we force taxpayers to pay a preparer or buy software

to file electronically? Why? Taxpayers do not have to go to a bookstore and buy forms to file a paper return. They should not have

to pay to file an electronic one, either.

Today’s hearing highlights tough issues that affect all of us. I

want to thank all the witnesses for agreeing to appear before the

committee. I look forward to your testimony.

As Simon and Garfunkel sang, ‘‘April, come she will.’’ And today,

until we reform the tax code, we are fated annually to confront onerous forms to meet April’s deadline.

Let us ensure that the work of tax preparers does not add to

April’s cruelty. Let us ensure that the bad apples among them do

not continue to play a cruel hoax on the Nation’s finances. Let us

look forward to a better spring after we do.

The CHAIRMAN. Thank you, Senator Baucus.

Now we have Michael Brostek, who is with the Government Accountability Office. He is accompanied by a team that includes Paul

Desaulniers, and we also have Christine Hodakievic with him. We

have Mr. Bert DuMars, Director of Electronic Tax Administration,

IRS; Nina Olson, National Taxpayer Advocate of the Taxpayer Advocate Service, IRS; Mr. Robert Weinberger, member of the Free

File Alliance; Mr. Francis Degen, president of the National Association of Enrolled Agents; and, lastly, Mr. Harley Duncan, executive

director of the Federation of Tax Administrators.

So we will go in that order. Then if you folks have a longer statement than the 5 minutes that have been allotted, it will be put in

the record.

Also, as a reminder, because of so many votes and committee

meetings this morning, if members cannot come, you will probably

5

get some questions in writing from those of us who are there, and

for sure from people who are not here.

So, we would appreciate it if those questions from members

would be in in 48 hours, and then an answer maybe in a couple

of weeks from you folks.

So we will start with Mr. Brostek.

STATEMENT OF MICHAEL BROSTEK, DIRECTOR, STRATEGIC

ISSUES TEAM, U.S. GOVERNMENT ACCOUNTABILITY OFFICE,

WASHINGTON, DC; ACCOMPANIED BY PAUL R. DESAULNIERS

AND CHRISTINE A. HODAKIEVIC, SPECIAL AGENTS, U.S. GOVERNMENT ACCOUNTABILITY OFFICE, WASHINGTON, DC

Mr. BROSTEK. Good morning, Mr. Chairman, Senator Baucus,

and members of the committee. My colleagues and I are pleased to

participate in the committee’s hearing today.

As requested, my statement will focus on who uses paid return

preparers, how preparers are regulated, and the experiences our investigators had when they had tax returns prepared by 19 offices

of five major commercial preparer chains.

Paid preparers play a critical quality control role in the tax system. Given the complexity of our tax laws and the desire of taxpayers to avoid audits, about 56 percent of the 130 million tax returns prepared in 2002 were professionally prepared.

The use of paid preparers was fairly evenly distributed across income levels, and, in general, taxpayers with more complex returns

used preparers the most.

Paid preparers all operate under some common regulatory requirements, but regulations also vary based on the characteristics

of the paid preparers, such as whether they are approved to represent taxpayers before IRS.

Certain regulatory requirements define practices that all preparers must follow. Some of these requirements have associated

civil penalties. For instance, preparers must not understate a taxpayer’s liability due to willful or reckless disregard of the tax laws.

Preparers must also provide taxpayers a copy of the return, sign

the return, and provide an identifying number. In addition, preparers must ask a series of questions provided by IRS in determining whether taxpayers are eligible to claim the Earned Income

Credit.

Finally, certain actions on the part of paid preparers could result

in criminal penalties. Among these are willful preparation of a

false or fraudulent return or other document, and knowingly providing fraudulent returns or documents to IRS.

We used two scenarios to gain a better understanding of how

preparers actually perform. In one scenario, a plumber and his wife

had wage income, mutual fund investment income, and cash income from some side jobs. One of their two children was in college.

In the other scenario, a sales clerk had two children; one lived

with her all year and one lived all year with the grandmother. The

sales clerk also had some cash income from baby-sitting.

In constructing the scenarios, we attempted to avoid complex

rules. We had nine plumber returns prepared, and 10 for the sales

clerk. With one exception, each scenario was done in two outlets of

the same firm.

6

At the beginning of the session with a paid preparer, we ask preparers about likely charges. Ultimately, the preparers charges varied highly, even within the same firms for the same returns, as

shown on page 25 of my statement and on the board to my left.

Only one firm charged us the same fee at two separate outlets

for the same return. In 11 cases, the final cost was close to the preparer’s initial estimate, or less. We went to five different preparer

chains, and for each one we went to two of their outlets for each

scenario, so the white and the gray represent two different visits

for the same scenario to the same preparer. We grouped the bars

together so you can see that there was a variation in the fees

charged for the same return.

Moving on, as is summarized on pages 16 and 17 of my statement and on the boards that are being put up, of 10 key lines on

the return, all of the preparers were correct in only one case, that

is recording the wage income from the forms W-2 for our taxpayers.

The preparers made a wide range of errors on the other lines, but

I will highlight four.

First, 10 preparers failed to record our taxpayer’s side income.

Failure to report cash income is one of the largest contributors to

the tax gap for individual taxpayers.

Second, 5 of the 10 preparers reported two qualifying children for

the Earned Income Credit when only one qualified. The EIC has

long been plagued by a high non-compliance rate, and qualifying

child errors are the largest portion of non-compliance for EIC.

Third, in two cases where itemizing deductions would have benefitted our plumber, the preparer took the standard deduction instead. In 2002, we estimated that about 2 million tax returns had

this error; half involved paid preparers. In total, the taxpayers may

have overpaid by $1 billion.

Fourth, in three plumber returns, the preparer did not take the

Hope education credit, thereby costing our taxpayer hundreds of

dollars.

In 2005, we reported that hundreds of thousands of taxpayers

did not claim the education benefit that was best for them, and half

of those used a paid preparer.

As shown on page 23 of my statement and on the board being

put up, the errors that preparers made on our returns resulted in

refunds that were substantially higher or lower than they should

have been in 8 of the 19 cases.

In some cases, errors that could have resulted in substantially

erroneous refunds did not, only because the preparer made an offsetting, equally significant error. In total, our taxpayers would

have received refunds overstated by over $12,000, and understated

refunds totaling about $3,500.

That the preparers’ errors were significant is underscored by the

potential penalties that could apply, as is shown on the board being

put up and on pages 9 and 10 of my statement.

IRS officials said that they seldom have clear evidence regarding

a preparer’s conduct, but if the conduct we observed was found for

real tax returns, several penalties would apply.

For example, for not reporting the cash income of our taxpayers,

the preparers could be fined up to $1,000 for willful or reckless disVerDate 11-MAY-2000 15:01 Mar 23, 2007 Jkt 095484 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 33963.000 SFIN1 PsN: SFIN1
7

regard of tax rules and regulations, or perhaps the $1,000 penalty

for aiding and abetting understatement of tax liability.

For not asking the required EIC due diligence questions, the preparers would be subject to a $100 penalty. For improperly including the cost of books when claiming the Hope credit, which was a

material error, in IRS officials’ view, the preparers could be subject

to a negligence penalty.

And although prosecutors might not accept the case due to the

dollar amount involved, failing to report cash income might even

be subject to a criminal penalty for willful preparation of a false

or fraudulent return. The penalty carries a fine of up to $100,000,

imprisonment up to 3 years, or both.

Undoubtedly, many paid preparers do their best to provide clients with returns that are accurate in all regards. However, the

problems that we experienced with paid preparers suggest that taxpayers need to exercise caution.

Taxpayers are ultimately liable for the accuracy of their returns,

and the poor performance of a preparer can result in taxpayers

being audited, having to pay taxes plus interest, and possibly even

penalties. From the tax administration perspective, our results are

troubling.

Preparers play a vital role. A preparer who performs poorly may

do so throughout the filing season with many, many clients. When

a preparer provides bad advice to a taxpayer, such as that cash income need not be reported, the taxpayer may well tell family and

friends, adversely affecting their compliance as well.

Our work is, however, anecdotal. We went to 19 locations in one

metropolitan area. However, if taxpayers rarely make serious errors, it is odd that we would have found so many in the cases that

we did.

Given the key role of paid preparers, we are recommending that

IRS study whether the poor performance we found is an aberration

or a more common problem. Further, we have referred the matters

we encountered to IRS for follow-up as may be appropriate.

This concludes my statement. My colleagues and I would be

happy to answer questions.

[The prepared statement of Mr. Brostek appears in the appendix.]

The CHAIRMAN. For the benefit of the other people, we gave 8

minutes or a little longer to GAO because they were reporting on

their investigation. So if there is unequal treatment, I just wanted

to explain that we said that they should take more time.

Mr. DuMars?

STATEMENT OF BERT DuMARS, DIRECTOR, ELECTRONIC TAX

ADMINISTRATION, INTERNAL REVENUE SERVICE, WASHINGTON, DC

Mr. DUMARS. Thank you. Good morning, Mr. Chairman, Ranking

Member Baucus, and members of the Senate Committee on Finance. My name is Bert DuMars, and I am the Director of Electronic Tax Administration for the Internal Revenue Service. It is

my pleasure to be with you this morning to discuss, from an electronic perspective, return preparation options for taxpayers.

8

My written statement has been submitted for the record, and in

my oral remarks I would like to address two key points.

First, I want to update you on the status of our overall tax administration efforts. We have made enormous progress in ETA,

spurred on partially by the IRS Restructuring and Reform Act of

1998, and the ambitious targets established in that law.

The IRS expects to process almost 135 million individual tax returns in 2006, and we anticipate a continued growth in the number

of those that are e-filed. This year marks the 20th anniversary of

e-filing, and each year we have made steady and sustained progress. We are continuing that progress in this current filing season.

Through March 26, 68.5 percent of the individual returns that

have been filed have been e-filed. But electronic tax administration

is more than individual e-filing. Currently, over 96 percent of all

information returns are e-filed as well.

More than 240,000 corporations have already e-filed their returns to us in this filing season. We are continually expanding requirements that corporations and large tax-exempt entities take

advantage of e-filing.

We are also making good use of our award-winning website,

irs.gov, which allows taxpayers to get answers to many of their

questions at their convenience utilizing their home computer. We

have had over 90 million visits to our website thus far in 2006.

A robust ETA program will reduce time spent by taxpayers dealing with the IRS. It will reduce the number of phone calls, thus

freeing up our compliance employees to focus on real compliance

issues rather than just retrieving or correcting information.

The second issue that I wish to address is the Free File program.

In November of 2001, OMB’s Quicksilver Task Force established 24

e-government initiatives as part of the President’s management

agenda. One initiative instructed the IRS to provide free on-line

tax return preparation and filing services to taxpayers.

As we began to implement this initiative, it was our judgment,

subsequently supported by various amendments, legislative proposals, and Congressional directives that IRS should stay out of the

tax software preparation business. Thus, we began negotiating

with private software providers, and out of that was born the Free

File Alliance.

The original agreement called for free filing to be made available

to 60 percent, or 78 million individual taxpayers. That agreement

expired in 2005 and, as such, had to be renegotiated with the private companies.

One of the prime concerns in the negotiations, particularly

among some of the smaller companies, was the fact that, in 2005,

many Free File providers had expanded their offerings to all taxpayers. While this was good for taxpayers, it posed a threat to the

continued existence of the Free File Alliance.

While it was IRS’s objective to make Free File available to as

many taxpayers as possible, ultimately the negotiations ended with

a program to cover anyone with an adjusted gross income of less

than $50,000, or 70 percent of all taxpayers. This means that it

was made available to 93 million taxpayers, or 70 percent.

9

This represents a significant improvement over the previous

agreement. I know there has been some concern with the ability of

Free File providers to sell ancillary services to taxpayers.

The one area where we have some information on these services

is refund anticipation loans. Only 0.6 percent of the taxpayers utilizing Free File have utilized a RAL, and that number is actually

going down. As of today, it is 0.59 percent, so it is shrinking.

In fact, half of the Free File vendors do not even offer refund anticipation loans; actually, it is more than half, 11 of 20 do not.

This 0.6 percent is the lowest rate of any electronic filing. The

highest rate is for those electronic returns filed by tax preparers.

Twenty percent of those returns involve a RAL.

Thank you, Mr. Chairman. I will be happy to respond to any

questions.

The CHAIRMAN. Thank you.

[The prepared statement of Mr. DuMars appears in the appendix.]

The CHAIRMAN. Ms. Olson?

STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER

ADVOCATE, TAXPAYER ADVOCATE SERVICE, WASHINGTON, DC

Ms. OLSON. Mr. Chairman, Senator Baucus, and members of the

committee, for most Americans the annual rite of preparing and filing their tax returns represents their most significant contact with

the U.S. Government. The importance of making this process run

smoothly, therefore, cannot be overstated. More than 60 percent of

American taxpayers pay preparers to prepare their returns, and

GAO’s findings today underscore the significant problems that exist

in the tax preparation industry.

In my 2002 annual report to Congress, I proposed a plan for the

IRS to register, test, and certify unenrolled Federal income tax preparers.

It is remarkable to me that, in the United States today, an insurance agent cannot sell insurance without a license, a contractor

cannot build without a license, and a hair stylist cannot touch a

lock on a person’s head without a license, yet anyone can prepare

a tax return for a fee with no training, no licensing, and no oversight required.

In the 108th Congress, the Senate passed my proposal to regulate unenrolled preparers as part of the Tax Administration Good

Government Act. The proposal was introduced again in this Congress as part of S. 832, and I am pleased that the Chairman and

Ranking Member of the Senate Finance Committee are again cosponsors.

I encourage Congress to pass this common-sense legislation. As

I recommended in my 2003 report to Congress, I also encouraged

Congress to enact a more stringent compliance and penalty regime

to deter reckless disregard of the rules or negligence by paid preparers.

Of course, these proposals would help only the 60 percent of taxpayers who use return preparers. We also need to do more to help

taxpayers who self-prepare their returns.

Four years ago, the IRS and the software industry created the

Free File program to make e-filing more accessible to taxpayers.

10

Unfortunately, the Free File program has done little to increase the

number of taxpayers who e-file their returns. This year, it appears

that roughly 135 million individual taxpayers will file income tax

returns, yet only about 4 million taxpayers, or 3 percent, will use

Free File.

Partly in request to a response from the staff of this committee,

I asked several tax attorneys in my office to test four fact patterns

on each of the 20 Free File sites.

We designed each of our examples to test tax provisions that

were common to various segments of the taxpayer population. We

tested scenarios involving Katrina relief provisions, self-employment and depreciation provisions, the application of the Alternative

Minimum Tax, and the recently enacted Uniform Definition of a

Qualifying Child.

Here are some of the results we found. Only 7 of the 20 Free File

sites calculated the correct tax in the Katrina relief scenario; 12

sites did not apply the special casualty loss tax benefits available

to Hurricane Katrina victims, causing users to overpay their taxes.

Nine sites did not increase the lifetime learning credit for eligible

education expenses for individuals affected by Hurricane Katrina,

as authorized by the Gulf Opportunity Zone Act of 2005, again

causing users to over-pay their taxes.

Schedule C, the sole proprietorship schedule, was not supported

by several sites. Some of these sites did not warn taxpayers sufficiently prior to data entry into the program. Other sites did not

support the section 179 depreciation deduction. At least two sites

did not support more than four dependents. I do not know what

happened to the other children you might have had in that calculation.

At least three sites omitted the Alternative Minimum Tax calculation, thus understating the tax due. These taxpayers can expect to hear from the IRS.

Cross-marketing of ancillary products and services is common on

many of the sites, despite their being accessed from irs.gov, the official IRS website. For example, one well-known software product

charges taxpayers who want to prepare and file their State returns

$19.95, and then offers to deduct that fee directly from their refund

if they pay an additional processing fee of $29.95, for a total cost

of $49.90.

Several of the sites offered bank products as a method to receive

tax refunds; others charged a fee per question for answers to tax

law inquiries, and did not mention that this service is free if the

taxpayer called the IRS.

The results of our testing demonstrate that Free File is not an

easy service for taxpayers to navigate, and it can even result in inaccurate returns. As currently structured, Free File amounts to a

wild, wild west of differing eligibility requirements, differing capabilities, and differing availability of, and fees for, add-on products.

Where do we go from here? Considering the poor performance of

many of the Free File sites, the tiny fraction of taxpayers who use

them, concerns about exploitative cross-marketing of other products, the appearance that the IRS is endorsing the Free File products, and taxpayer concerns about the confidentiality of their tax

data, there is little justification to continue with Free File and

11

every justification for the IRS to develop a tax preparation template and to provide free filing for all taxpayers, just as it does for

paper filers. The IRS template and direct filing portal should be

simple, accurate, and confidential.

The issues I have discussed in my testimony make clear that the

role of tax preparation is central to effective tax administration. As

the tax administrator, the IRS should do more to oversee more

closely those persons and entities that provide tax preparation

services and to provide a high-quality, free vehicle for paper and

electronic return preparation and filing. Thank you.

The CHAIRMAN. Thank you, Ms. Olson.

[The prepared statement of Ms. Olson appears in the appendix.]

The CHAIRMAN. Mr. Weinberger?

STATEMENT OF ROBERT A. WEINBERGER,

MEMBER, FREE FILE ALLIANCE, LLC

Mr. WEINBERGER. Thank you, Mr. Chairman and members of the

committee.

The landscape of tax return preparation has evolved significantly

since enactment of the IRS Restructuring and Reform Act in 1998.

First, electronic tax preparation and filing have become commonplace. Over 80 percent of returns are now prepared on a computer,

and over 50 percent are now e-filed. Do-it-yourself tax preparation

assisted by software is growing, up 17 percent this year alone. But

the majority of e-filed returns still come from paid and volunteer

return preparers.

At H&R Block, 95 percent of tax returns prepared in our offices

this year so far were e-filed. While steady progress is being made,

we join with others in suggesting that Congress consider extending

the 80 percent e-file goal set for 2007 to 2011 to maintain focus on

e-filing.

One innovative e-filing channel is the Free File Alliance. Over 14

million returns, including 3 million this year, have been e-filed

through this public/private partnership, which includes 20 companies. Taxpayers have saved more than $42 million through donated

services, and the IRS has saved far more.

This year, 70 percent, or 93 million, low- and moderate-income tax filers with adjusted gross incomes of $50,000 or less are eligible

for free Federal income tax preparation and on-line filing using the

same products offered commercially, not stripped down versions.

Free File standards exceed government regulatory requirements.

Free File is a positive example of government/industry partnership in the public interest. Second, Americans are increasingly

turning to professionals for tax assistance.

About 60 percent of all taxpayers use a paid return preparer.

Their reasons include complexity, convenience, and counseling.

Good tax return preparers help us navigate a complex tax system

and ease the burden and anxiety that most Americans feel at tax

time.

Increasingly, there is recognition that tax time is an opportunity

for an annual financial check-up. Since nearly 80 percent of taxpayers receive refunds averaging $2,100, it is both a teachable moment and an opportunity to save for a family’s key financial goals

of college, home ownership, and retirement.

12

We also use the opportunity to alert our low-income clients to

their eligibility for a variety of under-utilized government benefits

outside the tax code, including Children’s Health Insurance, food

stamps, and prescription drug discounts.

Our fees vary by location. They are based on the forms used and

the work done, not on a client’s income or the size of his refund.

They can be as low as $24 for the simplest 1040–EZ. This year they

average $154 for a Federal, State, and any local return needed.

A third change over the last decade is the growing need for

meaningful minimum quality standards. Thirty years ago, with a

much simpler tax code, Henry Block testified and proposed IRS

registration of all tax return preparers. We renew that call today,

and go further.

We believe IRS certification of paid return preparers, which

would require validation of tax knowledge, background checks, and

continuing tax education, would benefit the public. This could be

accomplished through enactment of section 4 of S. 832, co-sponsored by Chairman Grassley, Ranking Member Baucus, and other

members of the committee.

It would require testing for technical knowledge, competence and

ethics, continuing education, and stiffer penalties for misconduct.

The new program would complement existing laws covering tax return preparation, and extensive rules covering practitioners who

represent taxpayers before the IRS and those who originate electronic returns.

Because some 80 million taxpayers get help from over a million

tax practitioners in a compact, 10- or 11-week period, adequate

staffing is critically important for effective enforcement.

High-quality tax returns depend on practitioner training and

education, especially given frequent changes in the tax code. The

average H&R Block tax return preparer has over 225 hours of

training, and nearly half have 5 or more years of experience. Over

5,000 are enrolled agents or CPAs. Minimum requirements include

a basic 66-hour tax course, with equal amounts of homework and

a passing grade.

For re-hiring, at least 24 hours of continuing education are required yearly. We offer 59 advanced courses. Our tax professionals

are also trained on systems, products, policies, and procedures,

which require an additional 20 to 35 hours in class.

We follow a strict code of business conduct, and our electronic return originators require IRS approval, which may include background checks and tax compliance verification.

Our tax pros work with state-of-the-art software that checks calculations, theory, and accuracy. Approximately 10,000 diagnostics

help flag items to review and will not let the user file unless identified errors are corrected. We also utilize a second review by another professional for many tax returns.

With a complex tax code and 16 million returns prepared in our

offices by over 100,000 return preparers, occasional errors are possible. However, we believe our error rate at that volume level is

small as compared to competitors or other professions. For all clients, we stand behind the quality of our work and guarantee that

we will pay any interest or penalties if we err.

13

Mr. Chairman, while the tax landscape continues to change,

some things remain constant. Our training and compliance culture

remains strong. We assist our clients in determining their correct

tax liability to pay precisely what they owe, no more and no less.

And for over a half century, H&R Block has built its reputation

as a trusted tax and financial advisor to middle America. Our best

practices and code of ethics reflect longstanding commitments to integrity and professionalism, which we renewed today. Thank you.

The CHAIRMAN. Thank you, Mr. Weinberger.

[The prepared statement of Mr. Weinberger appears in the appendix.]

The CHAIRMAN. Now, Mr. Degen?

STATEMENT OF FRANCIS X. DEGEN, E.A., PRESIDENT, NATIONAL ASSOCIATION OF ENROLLED AGENTS, WASHINGTON, DC

Mr. DEGEN. Thank you, Mr. Chairman. Thank you for asking the

National Association of Enrolled Agents to testify before you today.

We are the premiere organization representing the interests of

46,000 enrolled agents across the country.

Enrolled agents are the only practitioners in whom the IRS directly attests to competency and ethical behavior.

I would like to suggest how our system of voluntary compliance

is threatened by unlicensed return preparers who, in many instances, we have found to be unscrupulous or incompetent, and,

unfortunately, in far too many cases, both unscrupulous and incompetent.

To help remedy this disturbing situation, NAEA urges members

of this committee to take action by reporting out Senator Bingaman’s bill, S. 832, the Taxpayer Protection and Assistance Act of

2005.

For EAs, who abide by the highest levels of ethical and competency standards in order to live up to the requirements set by

Federal regulation, the competitive disadvantages of the situation

are stark. Time and time again when our members are surveyed,

they relate instances of what we call ‘‘preparer shopping’’ during

the tax season.

Indeed, some taxpayers gather up their tax documents and walk

out because someone right down the street has guaranteed them a

minimum refund, $1,000, $3,000, or even more. Or the taxpayer

wants the preparer to help them incorrectly report expenses or income from rental property, or not report under-the-table income.

The list goes on and on.

As I have stated before at the Committee on Ways and Means,

people drive in excess of the speed limit until they notice the cop.

Then they all observe the speed limit for a while. But when the cop

leaves the beat, speeds begin to creep back up. Mr. Chairman, it

has been too long since the tax cop has been out circulating the

neighborhood is his black-and-white.

While it is easy to focus only on fraud, one must not forget that

preparer incompetence probably causes as much heartache. We all

know that the tax code is quite complicated. Unfortunately, too

many preparers today fail to attain adequate training and eduVerDate 11-MAY-2000 15:01 Mar 23, 2007 Jkt 095484 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 33963.000 SFIN1 PsN: SFIN1
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cation and do not make the investment in time and money to keep

up with the constantly changing tax code.

Mr. Chairman, it is important to place negligence and incompetence on an equal footing with intentional fraud when attempting to understand the magnitude of the non-compliance program

among unregulated preparers. Parenthetically, I think we have

heard some testimony about that today.

NAEA strongly endorses the concept of regulating all paid return

preparers, requiring an initial test for competency, background

checks, annual minimum continuing education requirements, and

compliance with the current Circular 230 ethical standards.

Additionally, the Office of Professional Responsibility needs adequate resources to both enforce the rules and promote all preparers

covered by Circular 230.

After many months of working with the practitioner community,

Senator Bingaman, in concert with both you, Mr. Chairman, and

Senator Baucus and Senator Schumer, has developed thoughtful

legislation that addresses most of these elements.

NAEA has endorsed this legislation as the most comprehensive

road map to address the problem of unregulated preparer noncompliance. We would urge the committee to report out this piece

of legislation as soon as possible.

Mr. Chairman, before I close I would like to take one minute to

talk about e-services. The e-services product is one of the best and

most useful IRS has launched in recent memory for the practitioner community. NAEA remains troubled that the Agency continues to predicate e-service access on participation in the e-filing

program.

Clearly, meeting the congressionally mandated 80 percent e-file

participation rate is important to the Agency. At the same time,

using the e-services program to incent e-filing participation without

regard to the specialized services of the practitioner’s best position

to use it—enrolled agents, attorneys, certified public accountants—

is distressing to NAEA members and appears to run counter to the

Service’s commitment to customer service.

The Service’s refusal to open e-services to all Circular 230 practitioners opens the Agency to a criticism I have heard often, namely,

while the IRS has in place a framework that prescribes competency

and ethics and holds EAs, attorneys, and CPAs to a higher standard, the Agency consistently fails to support its licensed practitioners, fails to distinguished between licensed and unlicensed

practitioners, and fails to promote anything except e-filing.

In closing, Mr. Chairman, we unconditionally endorse Senator

Bingaman’s bill and stand ready to work with you in passing it expeditiously.

As I have said previously while testifying before Congress, most

taxpayers would be astounded to find that, while their barber or

their manicurist is licensed, their tax preparer may not be.

Comparing the down side of a bad haircut to that of an incorrect

tax return, it is time to establish Federal standards to ensure basic

competence and ethical behavior. I thank you, and will take any

questions that you have.

[The prepared statement of Mr. Degen appears in the appendix.]

The CHAIRMAN. Mr. Duncan?

15

STATEMENT OF HARLEY DUNCAN, EXECUTIVE DIRECTOR,

FEDERATION OF TAX ADMINISTRATORS, WASHINGTON, DC

Mr. DUNCAN. Thank you, Mr. Chairman, members of the committee. We appreciate the opportunity to present to you the viewpoint of State tax agencies on the issues before this committee.

What I would like to do is to give you a snapshot of State electronic filing practices and experience, and then address a few selected issues that are before this committee.

In terms of State electronic filing practices and experience, our

States began electronic filing in 1990. At the present time, each of

the 41 States and the District of Columbia that has a broad-based

State income tax provides at least one avenue for the electronic filing of State income tax returns.

The bulk of those programs operate in a joint Federal/State program where either the practitioner or the individual, if they use

third-party software, can file both the State and the Federal return

in a single transmission, and the State information is later made

available to the State tax agency.

In addition to those traditional practitioner and on-line programs, we have a group of States, 21 States, that provide a direct

Internet filing option, where a taxpayer may, at no charge, interact

with a State website to file his/her State tax return. We also have

10 States that still operate a tele-file program.

State electronic filing has been growing at a rate of about 25 percent per year through 2004. It slowed to 15 percent last year and

is running at about 7.7 percent through March 17 of this year. In

2005, there were 50 million State electronic returns filed.

In terms of the proportion of State returns, some States exceed

60 percent of all their returns received electronically, including

Minnesota and Iowa, and nine others have in excess of 50 percent

of their returns received electronically, I might add, including Montana.

The mix of electronic returns in 2005 was 75 percent from practitioners, 18 percent using third party on-line software, 4 percent direct Internet filing, and 3 percent through the tele-file programs.

With respect to direct Internet filing programs where a taxpayer

may, at no charge, interact with the State website to file his/her

State return, I would note that we have no position as to whether

a State should do it or should not do it. Rather, they should have

the choice to evaluate their circumstances and determine whether

they would like to.

There are 21 States that now have these filing programs in 2006.

In 2005, they generated about 2 million returns. In several States,

direct Internet-filed returns exceeded 15 percent of all electronic returns, particularly in some of the longer-standing programs, such

as in Pennsylvania, Delaware, and New Mexico.

It has been suggested by some that the direct Internet filing programs are an inappropriate form of competition with the private

sector and represent a conflict of interest on the part of State tax

agencies. I think for our part, the State tax agencies that offer it

see it differently.

They view it as an extension of their obligation to provide tax

forms and information to the taxpayer that enable them to complete their obligations. They see it as an additional electronic servVerDate 11-MAY-2000 15:01 Mar 23, 2007 Jkt 095484 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 33963.000 SFIN1 PsN: SFIN1
16

ice that they are providing, one of several that they provide, whether it is electronic payments, account maintenance, on-line help, and

the like.

They see it as simply a matter of moving their business in the

same direction that all other businesses are moving, and in a way

that people expect to interact with business and their government.

If a direct program is considered for the Federal Government,

there are at least several issues that would need to be considered,

not the least of which is the complexity of the Federal return. State

Internet filing sites can eliminate a good bit of that complexity because of their reliance on a starting point of Federal adjusted gross

income and not considering the calculations behind that.

A word on Free File. Selected members of the Free File Alliance

offer free services in the 21 States that do not operate a direct

Internet filing program. There are generally two to four vendors

that have chosen to offer services to some taxpayers in those

States.

While the States are appreciative of these efforts, there is a concern among the States that complete information on whether a taxpayer qualifies for a free State return is not easily available to the

taxpayer when they begin the free filing of the Federal return.

Under the current system, one has to go back and forth between

a practitioner’s site and the IRS site to get that. We would argue

that complete information on who qualifies for State and Federal

returns should be available on irs.gov.

The last point I would make, Mr. Chairman, is about electronic

filing mandates. There are 12 States that have those, they have

proven useful in increasing electronic filing, and there is some experience at the States that would be helpful to the Federal Government if you were interested. Thank you very much.

[The prepared statement of Mr. Duncan appears in the appendix.]

The CHAIRMAN. We thank all of you very much for your testimony. We will have 5-minute rounds. I will probably have a couple

rounds of questions I will want to ask.

I will start with you, Mr. Brostek. Your agency uncovered some

things that can result in fines against tax preparers. You had

things come up like improper claims for child-related benefits, some

preparers failing to properly include their identifying information

and signing the returns as required by statute. I think you said

that you are going to take steps of turning this over to the IRS for

IRS follow-up.

Mr. BROSTEK. Yes, we already did.

The CHAIRMAN. All right. You have done that. And so whatever

is done will be the IRS following up with that. All right.

Then maybe to you and your investigators, Paul and Christine,

whoever wants to answer it. The percentage of paid preparers who

failed to include cash income on the returns, of course, is a very

disappointing finding that you had.

Taxpayers need to ensure that they provide their preparers with

correct information to properly calculate the tax liability. But responsibility also falls on the preparer to perform an income and expense probe to make sure that everything is considered.

17

The preparer is also responsible for correctly reflecting the tax

treatment of the income and expense items, which is, after all, why

they were hired in the first place. If cash income is left off the returns more often than it is included, one has to wonder what the

circumstances were surrounding that omission.

It seems to me the only way this could occur is if the income was

intentionally left off the return, or that the taxpayer and the preparer failed to properly communicate with each other about the income.

So I would like to ask the three of you to tell me a little bit about

the circumstances under which you discussed the income with the

preparers and what the reaction to the income was.

How about you, Ms. Hodakievic. Would you be able to help us in

regard to that?

Ms. HODAKIEVIC. Yes, Mr. Chairman. For consistency and to give

the preparers every opportunity to complete a correct return, if we

had not been prompted to provide the information by the preparer,

in every case we had not been asked up front, we brought it to the

attention of the preparer that we had this side income. In my case,

it was from baby-sitting, in the amount of about $20 a week.

Each preparer responded to that information differently. In one

case, I had a preparer simply stare at me and then ignore the information and continue preparing my return by answering the

questions for me that he was prompted to by his computer.

On another occasion, I had a preparer tell me outright, ‘‘it’s best

not to report that.’’ Then on another occasion, I had a preparer tell

me that since the amount was below $3,200, there was no requirement to report that income.

The CHAIRMAN. One thing that bothers me about the Government Accountability Office testimony is that, out of all the nine

preparers that Paul visited in his plumber scenario, no two reached

the same tax liability. In fact, out of all 19 visits, I am told that

only twice was the correct tax liability achieved, and one of those

times was only because the investigator told the preparer to re-do

the return to properly reflect the income and the child-related benefits.

Didn’t any of the preparers, Paul, that you went to perform a

quality review? Didn’t they respond properly to what you were saying, or were they trying to be very evasive?

Mr. DESAULNIERS. Well, of the nine preparers that I visited, one

of them did a review, had a supervisor review it, and I had to come

back and pick up the return the next day. But they are reviewing

the information that was entered into the form, not the information

that was taken from me. So, if the person did not report side income, for instance, there is no way that the reviewer would have

of knowing that.

The CHAIRMAN. Senator Baucus?

Senator BAUCUS. Thank you, Mr. Chairman. I would like to follow up. This is astounding, frankly. I mean, what was it, only 10

percent were prepared correctly? Is that basically what the Agency

came up with?

Mr. BROSTEK. Well, we ended up with two that came up with the

right refund, but they did not necessarily prepare the return correctly. They made offsetting errors in some cases.

18

Senator BAUCUS. So what percent of the returns were prepared

correctly?

Mr. BROSTEK. None.

Senator BAUCUS. None. Is that right? None?

Mr. BROSTEK. That is true.

Senator BAUCUS. None. Out of how many? Nineteen? Is that correct?

Mr. BROSTEK. Correct.

Senator BAUCUS. Nineteen. None were prepared correctly out of

19.

How did you choose these preparers?

Mr. BROSTEK. Well, we selected one metropolitan area where we

understood that there were many of the nationwide chains located.

Within that metropolitan area, we went to places all over the area,

in large part so we would not be seen going into one store, and

then across the street into the next one. So we were, throughout

the metropolitan area, going to at least two of the same chain with

the same scenario.

Senator BAUCUS. All right. And your returns were fairly ordinary, or were they complicated?

Mr. BROSTEK. Well, we think they were fairly ordinary. We attempted to avoid really complex rules. In the cases where the preparers made some of the more significant errors, in my judgment,

the rule was not difficult to follow at all.

For the Earned Income Credit, your child has to live with you

more than half the year. Whenever we were asked, and in fact, we

would even write down on a piece of paper, one of these children

did not live with us at all during the year, yet the preparer would

record the child as living with us.

Senator BAUCUS. Now, your impression, just being objective

about this. Why were no returns prepared correctly? To what degree is it incompetence and to what degree is it intentional?

Mr. BROSTEK. We do not really know entirely.

Senator BAUCUS. Just your gut guess. I mean, you got a feel

when you walked in there.

Mr. BROSTEK. Let Paul give you an idea.

Senator BAUCUS. Paul, yes, if you could. Just your honest assessment of what you saw, and why.

Mr. DESAULNIERS. Right. Many of them were confident that they

knew what they were doing.

Senator BAUCUS. They were confident.

Mr. DESAULNIERS. Confident.

Senator BAUCUS. Competent?

Mr. DESAULNIERS. No, I did not say that. Confident.

Senator BAUCUS. Confident, with an ‘‘F.’’

Mr. DESAULNIERS. With an ‘‘F.’’ They were confident as they took

the information from me. And some of them were, it appeared,

knowledgeable, but there were also a few that—myself, I am not

that familiar with preparing taxes, and I quickly discovered that

they were asking me questions that they should already have

known I was not entitled to.

For instance, child care. Once they found out that my wife did

not work, there should not be any more questions, but they continVerDate 11-MAY-2000 15:01 Mar 23, 2007 Jkt 095484 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 33963.000 SFIN1 PsN: SFIN1
19

ued to ask questions as if they were going to take a deduction for

child care.

Senator BAUCUS. Did you run into situations where there should

have been side income, side cash that should have been reported?

Mr. DESAULNIERS. Yes. In each instance, they either asked me or

I offered to them that I had side income. Four of the nine people

that I met with recommended that I not report the income.

Senator BAUCUS. Was that a recommendation in the sense that

you do not have to, or that maybe you should if you can maybe get

away with it?

Mr. DESAULNIERS. Right.

Senator BAUCUS. Which was it?

Mr. DESAULNIERS. That it was unnecessary to report it. I would

say two of them said it was unnecessary, the others said you do

not need to report it.

Senator BAUCUS. All right.

Mr. DESAULNIERS. Some said, there is no law requiring me to report it, and other ones said it was my choice, but they would recommend that it not be reported.

Senator BAUCUS. So some of it was incompetence. Was it all incompetence or was there also some ulterior motive, do you think?

Mr. DESAULNIERS. Well, I would have to think that they would

know that side income should be reported.

Senator BAUCUS. That is pretty common knowledge, is it not?

Mr. DESAULNIERS. I do not prepare taxes, but I would think it

would have to be reported.

Senator BAUCUS. Yes.

Ms. Hodakievic, your impression as to what is going on here.

How much is incompetence and how much is more than incompetence? That is, how much is failure to prepare returns accurately?

Ms. HODAKIEVIC. In terms of the failure to report the side income, I believe in a couple cases it may have been due to their desire to expedite the process. It was easier and faster to complete

the tax return by not going back and then once again including the

income.

In other cases, from their responses, I can only assume it is incompetence, given the information that I provided and the reasons

they said not to include the income. I failed to mention earlier, in

one of the scenarios, a tax preparer asked me if I had the Social

Security information for the persons who had paid me for babysitting.

And when I told them that I did not, they told me I was not able

to report that income because I needed their Social Security numbers to be able to do so. So from what I know now, and after seeing

the returns that they had prepared, a large percent was incompetence there.

Senator BAUCUS. I will have more questions. My time has expired.

The CHAIRMAN. Senator Wyden, then Senator Bunning.

Senator WYDEN. Thank you, Mr. Chairman.

Ms. Olson, your annual report to Congress recommends as one

of the core principles for tax reform that ‘‘the tax laws should be

simple enough so that taxpayers can prepare their own returns

20

without professional help, simple enough so that taxpayers can

compute their liabilities on a single form, and simple enough so

that IRS telephone assisters can fully and accurately answer taxpayers’ questions.’’

Now, I have introduced S. 1927, the Fair Flat Tax Act, that does

exactly what your core principles call for. In fact, my legislation includes a 1-page, 30-line 1040 form. I filled it out myself for my own

return in a half an hour.

Recently, the folks at Money magazine took my proposal, and the

fellow called back and said he did his, using my form, in 15 minutes. Would you not agree that having the kind of simplified tax

system we would have under my legislation would achieve your

core principles for tax reform?

Ms. OLSON. Well, sir, I would have to agree that any form that

you are able to fill out in that amount of time would meet my core

principles. In saying that, I stay scrupulously clear of any issues

of tax policy and setting rates and things like that.

Senator WYDEN. With respect to your views and Mr. Brostek’s,

if the tax code were reformed along the lines Ms. Olson recommends so that people could fill it out on one piece of paper,

something my bill does—others have offered the same thing—

would it not be possible for taxpayers to save a significant amount

of time and a substantial amount of money compared to what is

happening today? For you, Ms. Olson, and you, Mr. Brostek.

Ms. OLSON. Yes. Even if people insisted on going to preparers,

as they do for the simplest returns, it would eliminate some of the

mistakes, one would hope, that we are hearing about today.

Senator WYDEN. Mr. Brostek?

Mr. BROSTEK. Yes. I would agree that if we were able to have

a much simpler form, it should decrease the amount of record keeping that people need to do, the amount of time they need to spend

to complete the return, and would likely reduce the number of people who go to pay someone to do their return.

Senator WYDEN. Would it not be correct that a simplified system

could save taxpayers billions of dollars and hundreds of millions of

hours of time? I base this on the comments made by Mr. Rossotti,

who served on the President’s commission.

The new Tax Foundation report has figures that are substantially higher than Mr. Rossotti’s. The new report says that the

$265.1 billion tax compliance cost is greater than the revenue of

Wal-Mart, the largest company in America.

So would the proposal that I am advocating and the core principles that you are talking about, Ms. Olson, not save taxpayers billions of dollars and hundreds of millions of hours of time?

Ms. OLSON. Yes, sir. And it would also save the IRS, and that

would, in return, save taxpayers millions of dollars, at least.

Senator WYDEN. Mr. Brostek?

Mr. BROSTEK. I think that is a reasonable conclusion, that it

would save both the taxpayers and IRS.

Senator WYDEN. One of the most alarming parts of the new

study by the Tax Foundation indicates that the cost of tax compliance ranged from 14 to 16 cents per dollar of tax collected during

the 1990s, but in 2002, the cost of compliance soared to almost 22

21

cents per dollar of tax collected, and it has stayed between 22 and

24 cents per dollar collected in the past 3 years.

So the cost per dollar of tax collected is about 50 percent higher

than it was 10 years ago. For you, Ms. Olson, and you, Mr.

Brostek, why have the costs of tax compliance soared just in the

last couple of years?

Ms. OLSON. Well, let us just look at the education provisions. The

number of education provisions that we have has soared, and taxpayers have to keep records for that and they have to spend time

figuring out which one is the right one for them. You multiply that

by many of the other provisions that we have in the code today.

Mr. BROSTEK. I do not know precisely why the costs would have

been going up recently. We did do some work last year, reporting

on the number of tax expenditures, special provisions in the code

that reduce people’s taxes. Those have risen steadily since 1974.

They have risen in the last couple of years at a steeper rate. The

tax provisions affect individuals far more than corporations.

Most of these tax expenditures affect individual taxpayers, and

thus, all of the 130-plus million people who are paying taxes have

to take those into account, in some sense, generally, when they are

doing their returns.

Senator WYDEN. My time is up. But I think this alone, Mr.

Chairman and colleagues, ought to be a wake-up call for bipartisan

tax reform. The fact that the cost of tax compliance has soared just

since the year 2000 makes the case, in my view, for us getting to

work on a bipartisan basis. The Chairman knows that I am interested in pursuing my bill. I think there are a variety of other approaches that would make sense as well.

But if Ronald Reagan, Bill Bradley, Dan Rostenkowski and Bob

Packwood could get it done in 1986, I think 20 years later we can

do it again. I look forward to talking to these able people at the

witness table about that, and you and Senator Bunning as well.

Thank you, Mr. Chairman.

The CHAIRMAN. Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

Twelve years ago in the Ways and Means Committee, we did

something similar. We handed out 25 tax returns with exactly—exactly—the same set of circumstances. And guess what? We got 25

different results on the tax liability on those returns. This is 1994,

1995—somewhere in there—when we did it. Now it is even more

complicated because we have added new and changing things to

the tax code.

And we talked about doing exactly what my good colleague from

Oregon said, simplifying the tax code, making a flat tax, or sales

tax, or whatever, and no one could come to a conclusion at that

time.

So I am going to ask the GAO, I was particularly troubled that

side income was often not reported, despite the preparers being

told that side income existed. I realize that this requires some speculation on their part, but did the investigators get the feeling that

it was a preparer mistake or did they feel that the preparer was

deliberately under-reporting the income?

22

Mr. DESAULNIERS. In one case, I had a preparer that I told about

side income, and her response was to wave her hands and tell me,

no, you do not want to report that.

Senator BUNNING. Not knowing the law that it has to be reported.

Mr. DESAULNIERS. I do not think it was a question of her not

knowing the law. I think she was trying to——

Senator BUNNING. Hurry you through the process?

Mr. DESAULNIERS. No. I think she was trying to increase my refund.

Senator BUNNING. All right.

Mr. Weinberger, you said that your company pays penalties and

interest for your customers if there was a mistake in their return.

How often has your company been called on to do that?

Mr. WEINBERGER. I do not have the data, but I would be happy

to try to get it.

Senator BUNNING. Would you please furnish that for us?

[The information appears in the appendix.]

Senator BUNNING. Do you know what percentage of your customers get audited by the IRS?

Mr. WEINBERGER. No, because they would not necessarily all call

it to our attention. But generally the audit rates are 1 percent or

less throughout the tax system.

Senator BUNNING. Mr. Degen, can you explain for us what types

of qualifications enrolled agents must have?

Mr. DEGEN. Well, Senator, in order to become an enrolled agent,

if this answers your question, there are two paths that you can

take. One path is to have worked for the Internal Revenue Service

for 5 years in a capacity that interprets the Internal Revenue Code,

typically a revenue agent or a revenue officer.

Senator BUNNING. Someone with a green shade who sits and audits your return?

Mr. DEGEN. Right. Exactly.

Senator BUNNING. All right.

Mr. DEGEN. And the second way is for an individual such as myself, who did not work for the Internal Revenue Service, to pass

what is called the Special Enrollment Examination. This, up to the

current time, has been a 2-day, 11-hour examination which basically tests your knowledge of the Internal Revenue Code.

What it allows you to do is to represent taxpayers in dealing before the IRS. So you can represent taxpayers in examination, in

collections, and at the appeals level. The intent of the exam is to

make sure that you are proficient so that when you deal with the

IRS you can ably serve your clients.

Senator BUNNING. And it is your recommendation in your written testimony that all paid return preparers should be regulated.

Mr. DEGEN. Yes.

Senator BUNNING. Is that correct?

Mr. DEGEN. Yes. I am not advocating that they all become enrolled agents. I think that is a far step right now. But, yes.

Senator BUNNING. But anybody you pay should be regulated.

Mr. DEGEN. Anyone you pay. Right. There needs to be oversight.

I think that is the key to it. We have a system in place already

in the Office of Professional Responsibility. They do oversight, but

23

only on enrolled agents, certified public accountants, and attorneys.

Basically, what we would propose is that oversight be expanded,

and let them look at all tax preparers and regulate them.

Senator BUNNING. Mr. Weinberger, would you like to comment

on that recommendation?

Mr. WEINBERGER. Well, we do favor testing and certification.

Whether the program would be administered under Circular 230 by

that office or administered elsewhere, for example, joined to the

Administration of Electronic Return Originators, as the IRS increasingly moves to electronic filing, is something I think needs to

yet be determined.

But the thing to point out, I think, also with respect to enrolled

agents, is their credential primarily relates to representing taxpayers before the IRS, and 99 percent of taxpayers do not have

post-filing disputes with the IRS. So while they are qualified——

Senator BUNNING. Do you feel that is because they are so well

represented, or do you feel that the IRS just does not have the

manpower to audit that many returns?

Mr. WEINBERGER. Maybe a combination, but certainly the latter

is the case.

Senator BUNNING. All right. Thank you. My time has expired.

The CHAIRMAN. Thank you very much, Senator Bunning.

I am going to turn to Ms. Olson. There has been a lot of press

lately regarding the disclosure of taxpayer information. The IRS released proposed regulations under section 7216 that many privacy

advocates fear will open the door for the sale of tax information by

preparers. The IRS’s goal in rewriting the regulation was actually

to tighten the disclosure rules and update them for today’s electronic age.

As Taxpayer Advocate, I would like to have your perspective on

the proposed regulation and your position on what is a correct solution.

Ms. OLSON. All right. First of all, the world is wide open right

now for the disclosure and sale of taxpayer information by the preparer. Under current regulations, there is no hindrance to disclosure of that information being disclosed to third parties, sold to

third parties, and those third parties can re-disclose that information to anyone.

It was precisely that wide-open nature that drove me to want the

current regulations to be revised so that taxpayers had to be specifically told that that might happen, that that could possibly happen, and that they had to understand that before they consented,

and that there would be a limit on the period of time in which any

consent the taxpayers gave would run. Under the current regulations, it is, again, wide open. That consent stands for ever, and

ever, and ever, and ever, and ever.

So I think the regulations did a very good job in trying to tamp

down and control some of what I consider the very wide-open provisions of the current regulations. Having said that, I think if I had

had my druthers, I would have probably eliminated the disclosure

language entirely, because I think that that is so wide open.

I would have limited taxpayer consent to use, and maybe some

very limited disclosure, only in the context of tax return purposes,

in connection with tax return preparation, so that we did not get

24

people disclosing it to used car salesmen and all these other uses

that we are seeing, but that it serves some tax administration purposes. So, I think that is where I would have gone if we had to go

back to the drawing board, or actually, frankly, if you wanted to

review 7216 statutorily.

The CHAIRMAN. Thank you very much.

I am going to move on to Mr. DuMars. It is my understanding

that you are very supportive of the status quo in terms of electronic

filing. So as a committee, we are interested in getting your view

on direct Internet filing at the Federal level.

Does the IRS support Direct I-File or the development of electronic portals? Do you believe that Direct I-File is a service that

should be provided by the government to the taxpayer? Assuming

that I-File is desirable, what are the key issues that Congress

should keep in mind in drafting the enabling legislation?

Mr. DUMARS. Well, I think that the Free File program actually

works very well, and it works very well at a very low cost. Literally, in my organization we only have a very minimal number of

full-time employees who actually have to manage it. To consider

something at a much broader development is going to be very expensive, very time-consuming, and probably require significant resources and investment.

The other thing that has occurred, and I think this is something

from what happened over the last couple of years, is the guidance

from the Senate and the Congress on this, especially when we were

in the negotiations, the amendment that occurred right at the end

of the last two weeks of the negotiations with this current agreement pretty clearly stated that we were to work with the industry

and comply with the Free File Alliance agreement that we came up

with.

So, those are some of the things that, when we looked at what

would be the right way, and then also going back to RRA 1998,

where it states that we should be working with industry to come

up with a solution in the space—those are the things we looked at

with regards to this.

The other thing just to think about when you are looking at what

solutions might we consider, one advantage of the Free File Alliance is there are 20 members of that alliance currently today, and

that actually will fluctuate over time as new companies come on

board, and so on.

That actually provides a lot of innovation and development in

this space, especially with, as many people have said here, the complexity of the tax code.

One thing we have to realize with Free File or any type of an

electronic software package, is what it is doing is hiding the forms

from the taxpayer. It is doing that to try to simplify it, to make

it easier for them to understand their obligation. So, those are the

things that we kind of take into consideration as we look at this.

I would be concerned about a one-size-fits-all type solution that

we would come up with and how that would actually meet the

needs of a taxpayer versus the 20 solutions that we have today,

where they get very specific on the taxpayer needs.

The CHAIRMAN. All right.

Senator Baucus, then Senator Bunning.

25

Senator BAUCUS. Mr. DuMars, I do not quite understand this. A

person can deal directly with his or her paper return. Kitchen

table. Fill out the return. I have done this. Kitchen table. Fill out

the tax return and just send it in.

Yet, I cannot do that electronically today. Why? What is the difference? Why do I have to deal with a preparer if I file electronically, and do not have to deal with a preparer if I file a paper return? What is the difference?

Mr. DUMARS. I think it is kind of having this understanding of

how the system has actually been developed. Remember, this is the

20th year of e-file, so we are sitting on a system that is literally

20 years old, that was developed for bringing in batch processing

of returns in bulk from the different organizations that deliver

those returns. It was not designed specifically for a direct interface

on a one-to-one basis. That requires significant enhancements.

Senator BAUCUS. No. I am sorry. You are not answering my

question. My question is, what theoretical difference is there? I do

not care what has happened historically. What theoretical difference is there between my filing a paper return directly with IRS,

fill it out, envelope, address it, put my stamp on it, mail it in?

Mr. DUMARS. So you are talking, from a process perspective.

Senator BAUCUS. Yes. Why should I, from a process perspective,

not be able to do that?

Mr. DUMARS. All right.

Senator BAUCUS. Why can I not just go on the computer, access

the IRS site, and IRS sends back to me my return electronically.

It is all electronic, on my computer screen. IRS then asks certain

questions, which prompts my responses. I just fill it out and just

send it in directly. Push a button, ‘‘return,’’ and off it goes to IRS,

just like I send my paper return in. What is the difference? Should

there be a difference?

Mr. DUMARS. Should there be a difference?

Senator BAUCUS. Let me ask more precisely. Why should I not

be able to file directly an electronic return, just as I am now able

to file directly a paper return?

Mr. DUMARS. So are you asking the question from a policy perspective or technological perspective?

Senator BAUCUS. Either one.

Mr. DUMARS. Either one. From a policy perspective, it has been

made clear to my——

Senator BAUCUS. No. I am not going down that road.

Mr. DUMARS. All right. All right.

Senator BAUCUS. I will get to that later.

Mr. DUMARS. All right.

Senator BAUCUS. I am going directly just from a technical concern or from a philosophical point of view.

Mr. DUMARS. All right.

Senator BAUCUS. From a policy point of view. Forget legislation.

Assume there is no legislation on this issue whatsoever. Let us assume you have made no agreement with the Free File Alliance. Put

that all aside for a moment, just starting fresh.

Mr. DUMARS. All right. From a technological perspective.

Senator BAUCUS. Yes.

26

Mr. DUMARS. It would require significant investment and significant development to make a system like that work. You have to understand, with today’s environment, we actually have processes

where the returns go to a software preparer, and even in the preparer’s space, it goes to the same place.

Then they batch them up and they send them to us in large bulk.

If we were to take them directly, we would have to have the capability of taking millions of returns in a day directly through an

interface.

We would actually have to go through significant amounts of development to make that occur. Just from a purely technological

perspective, it would require significant investment.

If you look at how much investment, the software industry today

just does it for their small slices of this market. You would probably have to multiply that at a much higher level just for us to do

it as well. It would require a large investment.

Senator BAUCUS. Has IRS done a study on this to determine

what it would cost, what it would be?

Mr. DUMARS. I do not think we have done one in a while.

Senator BAUCUS. Any reason why you have not?

Mr. DUMARS. I think at this point because of the current system,

the current way we are set up. I think, if this is something you

want us to look at, this is something we could look at.

Senator BAUCUS. Some States do this.

Mr. DUMARS. At a significantly lower volume than what we

would have to deal with.

Senator BAUCUS. All right. We will take it up later, that is, how

you go about doing all this.

Here is my problem. I think, honestly, most preparers are preparers for one reason: they want to make money. Nobody is a preparer altruistically, out of the goodness of his heart. It just does not

work that way, I do not think. That is the only way they make

money.

So many preparers charge so many additional fees, so many different services ancillary to preparing a return, and I have to think

they do that because they want to make money.

For example, one preparer in the Free File Alliance urges taxpayers to go out and drum up more business for the preparer and

you get $20, $40 per return. It is a business. It is to get more business.

Then there are the anticipation loans charging usurious rates. I

have heard rates up to 150 percent, 200 percent. Then there is the

question of tax return information going to someone else, to a

banker, for example, a credit card company, whatnot, all done by

preparers.

I have to think—and I will let Mr. Weinberger address this—that

the primary reason anybody is a preparer is to earn some income

for the preparer or for the company. That is why they are there.

I doubt seriously whether any preparer would do this, again, totally altruistically, out of the goodness of his heart, and lose money

as a consequence. By definition, they would have to lose money, because time is money, by taking the time with a taxpayer where

that time could be spent elsewhere.

27

Mr. Weinberger, is it not true that H&R Block likes to earn income?

Mr. WEINBERGER. It is, Senator. But I would also point out that

the seasonal tax return preparers whom we hire are often retirees

or housewives. It is probably hard to get rich preparing tax returns

in that environment.

I think a lot of those individuals derive considerable psychic benefit from helping their fellow citizens comply with their tax responsibilities, and from the gratification they get in seeing people improve their financial circumstances as a result of the advice that

they gave.

Senator BAUCUS. So, you pay preparers. That is a cost to the

company, to pay preparers. What do you get out of that? What income do you get? What income does H&R Block receive in the preparation business?

Mr. WEINBERGER. Well, we derive income from the fees that are

paid.

Senator BAUCUS. Correct. Fees paid. Now, what about the whole

list? GAO has this whole list of side fees that are charged. Are you

saying GAO is incorrect in their analysis?

Mr. WEINBERGER. Well, I have not read the GAO report, so I cannot comment. But we do offer additional products and services, as

a convenience to our customer and as a profit-making enterprise

for the company. No one is required to take any of those products

unless he or she feels that it might——

Senator BAUCUS. Right. But there is a person in my office who

went through one of the preparers in the Free File Alliance. What

happened? Well, she went through it. Midway through, for an additional $25, you can get an upgrade. She did not want an upgrade,

she just wanted a return. It was blocked. She could not get anywhere because she did not want to pay $25 additional for an upgrade.

There are so many additional fees in the fine print at large here,

and it is just bothersome. It feels like people are getting taken for

a ride, often, when they try to fill these out.

Mr. WEINBERGER. Well, Senator, in the Free File Alliance, it is

a bedrock principle that a citizen should be able to file a Federal

income tax return without any cost, without any charge, and the

service cannot be conditioned on purchasing any other product or

service. The opportunities may exist, but there is no requirement

that anyone take those products or services.

Senator BAUCUS. It just intuitively, at a gut level, bothers me

that a person cannot deal directly with IRS, but has to go through

a middleman. Has to. Has to, if you file an electronic return. Has

to. I have no choice.

If I want to file electronically, I have to go through a middle person. It just seems wrong to me that I cannot just go directly to the

IRS website if I want to—I am not required to, but if I want to—

and file a return directly.

I just think that too often, to be honest about it, the tax preparation business does not want the IRS to offer true free tax filing because the tax preparation business wants to make money. That is

the honest answer here.

28

There may be a technical reason, but the real reason is, the industry goes to the IRS and says, no, we want to sign a contract

with you prohibiting taxpayers from filing directly, and the real

reason is, most people sign contracts because they want their business to make something out of it. That just bothers me, personally.

The CHAIRMAN. Senator Bunning?

Senator BUNNING. Thank you, Mr. Chairman.

Mr. DuMars, you indicated in your written testimony that returns filed through Free File are down nearly 21 percent, while

overall the number of returns filed electronically are up about 2

percent. Do you attribute this situation entirely to the changed income limitations on Free File or do you think there are other factors contributing to this trend?

Mr. DUMARS. I think there are additional factors.

Senator BUNNING. For instance?

Mr. DUMARS. For instance, last year when Free File launched in

January, we had front-page articles about the Free File program.

Particularly, there was one in USA Today, right on the front page.

You could not buy that coverage. That was the most outstanding

coverage. We had a bump in millions of returns to the program because of that.

This year, the best story we have gotten of any stories has been

a page 3 ‘‘Business Section’’ story, usually just a couple of paragraphs. It is a big difference between a front-page USA Today

story, which then ripples out throughout the Nation, to just having

it on page 3.

The problem is, it is becoming an old story. This is the fourth

year of the program. There is no new news, other than there was

some limitation. The limitation probably has some contribution to

that, but really, all the publicity we got last year really drove it up

significantly more than we expected.

Senator BUNNING. You also indicated that reaching the goal of 80

percent of returns filed electronically by 2007 will not be attained.

What does the IRS project that the percentage will likely be in

2007?

Mr. DUMARS. I do not have the exact numbers, but we are probably going to be closing in on 60 percent. We will get closer to that

by 2007.

Senator BUNNING. Rather than 80.

Mr. DUMARS. Rather than 80, on individual returns.

Senator BUNNING. Is there anything that is slowing down the

ability to reach the 80-percent goal, or do you think it was just set

too high to begin with?

Mr. DUMARS. I think at the time the goal was set, it was actually

a good thing to set it as high as it was, because I think it helped

drive us in that direction. I think to set very ambitious goals is actually positive for us, and it makes us focus and drive that way.

We are continuing to try to do everything we can to get as high

as possible by 2007 on the individual returns.

We are also pushing as hard as we can on the business returns

as well. Actually, I think we are seeing their pent-up demand. We

just did not have the software out and available until the last couple of years. So, actually, those two sides of it are moving about

as well as we could expect.

29

Senator BUNNING. When do you think we will reach 80 percent?

Mr. DUMARS. The projections are showing somewhere in the

2010 to 2011 time frame. But it is hard to know.

Senator BUNNING. So you are suggesting we move the time

frame?

Mr. DUMARS. I would not do it just yet. Let us keep pushing. Let

us keep pushing as hard as possible.

Senator BUNNING. But it is easier to do it up front than it is in

a crisis situation where you cannot get to the goal, and all of a sudden you say, oh, my God, we are not going to make it, you have

to change it.

Mr. DUMARS. Yes. I do like the pressure, though.

Senator BUNNING. Yes. Well, maybe this group up here at this

table does not.

Mr. DUMARS. All right.

Senator BUNNING. We have enough pressure on other things. For

instance, immigration.

Mr. Weinberger, you indicated that the do-it-yourself tax preparation with software is growing quite a bit, but that the majority

of e-filers returns are completed by paid and volunteer return preparers. Can you give us an idea of what types of taxpayers choose

one versus the other?

Mr. WEINBERGER. Well, often it is taxpayers who have more complicated returns who seek a return preparer, although in some

cases it may be a 1040-A filer who takes the Earned Income Tax

Credit. The Taxpayer Advocate, in numerous reports, has pointed

out that that highly beneficial program is also a very complex program to administer.

Senator BUNNING. Are there demographic groups that would

tend to use the do-it-yourself software, while other groups tend to

use paid preparers?

Mr. WEINBERGER. Yes. I think there are studies on that, but I

am not conversant with them.

Senator BUNNING. Is your firm?

Mr. WEINBERGER. Yes. I would be happy to provide that.

Senator BUNNING. Can you furnish that information to us?

Mr. WEINBERGER. Yes, sir.

[The information appears in the appendix.]

Senator BUNNING. That is all the time I have, Mr. Chairman.

The CHAIRMAN. Thank you. I just have a couple of questions to

ask.

I am going to go to Mr. Weinberger. The tax software preparation industry continues to lobby actively against permitting the IRS

to develop an Internet portal and means by which American taxpayers could file their returns electronically without using software

developed by the industry.

At this point, it seems that the industry should be sufficiently

mature in its development that it would focus on value-added services. It also seems that the Federal Government should regard the

offering of direct Internet filing just as States do, and as you have

heard Senator Baucus refer to.

For the purpose of this discussion, I would like to set aside the

notion of return-free filing and focus your responses exclusively

upon direct Internet filing.

30

Do you view the IRS’s development of a portal in which taxpayers could merely use fillable forms and blank screens, including

basic computational calculators for common, but difficult issues like

the Earned Income Credit, AMT, and taxation of Social Security

benefits as a conflict of interest or inappropriate competition to the

private sector?

Does your response change if the system is more interactive, not

simply fillable forms? Do you have any recommendations on how

the government could partner with the private sector on these initiatives?

Mr. WEINBERGER. Well, that is a complex question with lots of

parts. Let me take a few of them. I do not know that the tax software industry has weighed in against a direct filing portal. As Mr.

DuMars has testified, there are a number of technical issues embedded in the way in which, historically, the IRS has developed its

systems.

I think there was also a GAO report, in about 1997, as I recall,

about a cyber-file program that the IRS was exploring at the time

that found significant security issues related to the program. I

think possibly for that, or cost reasons, the exploration was pulled

back.

As a private-sector company, we prefer not to have competition

from the Federal Government in terms of the Federal Government

preparing tax returns for individuals, and we do feel that there can

be a conflict of interest in terms of how a return is prepared in

gray areas. That is why many tax clients come to a paid preparer,

for counsel, and also to have someone on their side in terms of

dealing with the government.

Those are issues that have to be weighed carefully by Congress

in the balance in terms of both cost, in terms of policy, in terms

of whether the preparation of a tax return is a core governmental

function.

Mr. DuMars has testified that the administration view is that it

is not a core governmental function, but certainly I would view enforcement of the tax code and collection of taxes as a core governmental function.

So, there is a distinction in terms of what the government can

do best and what the private sector can do best. Through the last

10 presidents, beginning with President Eisenhower, it has been

the policy of the U.S. Government not to compete with its citizens,

except in those instances where the private sector cannot perform

the function well.

That was embedded in OMB Circular A–76 and was an important factor, I think, in the government’s willingness to agree with

the private sector to form this unusual private/public partnership,

which is the Free File Alliance.

The CHAIRMAN. All right.

My last question is for Mr. DuMars. If we would decide that it

would be appropriate to develop a means of electronic filing via the

IRS at the Federal level, do you think it would be possible to develop a partnership with the States?

What issues should be considered to ensure that taxpayers would

be able to undertake a coordinated filing effort at the Federal and

State level, especially given that the States are so far out ahead

31

of the Federal Government? I think we have 21 States providing

some form of direct electronic filing for their constituents.

Mr. DUMARS. I think the one thing to know on the State issues

is we have been making progress, actually working with the Free

File Alliance, on adding more State capabilities over time.

That is one of the things we do after each filing season: we review that process, try to work on that and see what we can do to

bring them in to work with the Free File Alliance and make it

available through the Alliance membership. Today, there are three

members who offer free State returns. We are looking at possibly

others in the future.

The one thing that the Free File Alliance has been open to is

meeting with the States directly to work on solving that problem,

which is very much a lower-cost solution, something we can put in

place relatively quickly.

The one thing I think we need to consider is, what are the tradeoffs we would have to make in investments on our back-end processing versus something like this where this is going to be a very

expensive endeavor? I think that is the one thing.

We still have a lot of work and there are a lot of challenges in

our back-end processing, and we see some of those challenges every

day during the filing season. Where do we go with our modernization program, especially around e-file itself?

We have gone into the business returns. We need to move into

the individual space. That is going to require significant investment, and that is going to provide a lot of benefit to taxpayers once

it is done. So, those are the issues that worry me; what do we take

away from to do something like this? That is the thing I think we

need to consider.

The CHAIRMAN. Senator Baucus, do you have another question?

Senator BAUCUS. I am just curious. Do corporations file electronically today directly with the IRS?

Mr. DUMARS. Some do.

Senator BAUCUS. Can you characterize which do?

Mr. DUMARS. The very largest, typically the top 50 of the very

large corporations. Actually, some have developed their own software, for instance, and they will submit in the very largest returns

that we receive directly.

Senator BAUCUS. Can a corporation, if it wants to, file directly?

Mr. DUMARS. By developing their own software?

Senator BAUCUS. Yes. Let us go to the other end. Let us say that

I am a closely-held corporation, a Sub S corporation. Can I go directly to irs.gov and file directly?

Mr. DUMARS. Not to irs.gov. What they have done is, the ones

who are doing it have purchased software, and then with that software they have asked for direct access. Those are also very large

corporations. Or they have developed their own software and they

have worked with us to develop a link into us. It does not go

through irs.gov, it goes through our registry user portal, or e-services area.

Senator BAUCUS. Right. But say I am a corporation. Do I have

to hire a preparer if I file electronically?

Mr. DUMARS. Do you have to hire——

32

Senator BAUCUS. Do I have to go through a preparer? Today, as

an individual, filing an individual return, I have to go through a

preparer if I am going to file electronically.

Mr. DUMARS. Or buy a software package.

Senator BAUCUS. Or buy a software package.

Mr. DUMARS. Right. The vast majority of large corporations will

buy a software package. They use a ‘‘preparer,’’ which is usually a

major CPA firm. Then there are a few that want to be able to file

directly using either the software they spent a significant investment to build themselves, or software that they spent a significant

investment to purchase.

Senator BAUCUS. But corporations may file directly with irs.gov.

Mr. DUMARS. Right, under this process.

Senator BAUCUS. Although individuals cannot.

Mr. DUMARS. Right. This is the back-end processing part I was

speaking about. This is the newest part of our modernized e-file

program for the business returns.

Senator BAUCUS. So, Mr. Weinberger, what is the theoretical difference between corporations versus individuals and whether or not

IRS is competing with the private sector, or whether there is a bias

against the taxpayer? On the one hand, corporations can file directly, individuals cannot.

Your response, I took it, was generally in the context of, preparers should not compete with Uncle Sam. Second, preparers are

really in the business to help the taxpayer. Preparers are on the

taxpayers’ side against the government. Those are the two basic

answers you gave. So my question is to what degree those two

basic answers also apply to corporate returns.

Mr. WEINBERGER. Well, I am not familiar enough, I think, with

the corporate return filing setting. I would point out, though, the

IRS derives considerable benefit from competitive market forces

and the private software industry creating innovative products and

being at the cutting edge technologically in terms of what they are

producing, and finding new ways to assist taxpayers in easing the

burden of tax filing. I think that has some considerable advantages

over a one-size-fits-all model, which also has some considerable security risks.

Senator BAUCUS. Well, let us just probe that a little bit. If I buy

Turbo Tax, for example, that is kind of a one-size-fits-all. Turbo

Tax markets to a lot of different individuals.

Why can the IRS not then contract out with software companies,

software development companies, to develop—put out for competitive bid, different developers have different products, different

ways of doing things.

IRS could then select the best, or a series of several, for example,

and still that enables me as a taxpayer to file directly with the IRS

if I want to. I just do not like paying all these additional fees,

frankly. I do not like all the stuff I have to go through as a taxpayer when I deal with a preparer. I want to just deal directly.

So why should the government not take advantage of the free enterprise creative juices of the software development industry and

purchase software so that IRS can then set up a website where I

can file?

33

Mr. WEINBERGER. Well, if the government picked a winner, so to

speak, in that competition and made it a sole-source provider and

the rest of the software industry withered, the government would

lose the competitive pressures which lead to innovation.

Senator BAUCUS. Well, wait a minute. That is not a fair answer.

You are assuming in your answer by saying if you sole-source there

would be a lock on it. Look at the defense industry. The defense

industry wants to spread out a little bit so there is not a lock, for

good reasons. Why would the same not apply here? I am talking

about DoD.

Mr. WEINBERGER. Yes. In terms of your hypothetical, I was making an assumption, and that was that the government would select

one software company to be its provider.

Senator BAUCUS. Or several, I said.

Mr. WEINBERGER. In that model, I think it would reduce innovation, but it would preserve some element of it.

Senator BAUCUS. All right.

Now, again, my favorite example of a paper return. Does your

reason for preparers apply equally to paper returns as it does to

electronic filing? Your answer, or your response was, well, to be on

the side of the taxpayer. Are you saying, therefore, I should not be

able to file a paper return directly, that I should have to go

through a preparer? Are you saying that?

Mr. WEINBERGER. No.

Senator BAUCUS. Then why should I have to go through a preparer to file electronically?

Mr. WEINBERGER. That is the current IRS rule.

Senator BAUCUS. No, no. I am asking the policy reason. What is

the policy reason?

Mr. WEINBERGER. Policy reason? There is no policy reason. I

think that you could very well have the government permit direct

filing. I think that there are a number of technical issues and security issues related to it, and cost issues.

Senator BAUCUS. But from a policy perspective, you see no difference?

Mr. WEINBERGER. No.

Senator BAUCUS. Thank you.

Mr. WEINBERGER. But I may think of one. [Laughter.]

Senator BAUCUS. You may. I suspect you will.

Mr. WEINBERGER. All right.

Senator BAUCUS. And you can raise your hand if you come up

with one. [Laughter.]

Mr. DuMars, just briefly, if I might.

The CHAIRMAN. Go ahead.

Senator BAUCUS. Thank you.

My question is, what is the IRS doing about the problem that

GAO just reported? I mean, that sounds pretty dramatic.

Mr. DUMARS. And it is a very large problem, one that we are

very concerned about. But it is one we have to look into. We will

definitely take their information and we definitely will research

this.

But what are the trade-offs we have to make to go after this

versus the other jobs that everyone wants us to do, and what are

34

the costs and what is the resource allocation we are going to need

to actually do that?

Senator BAUCUS. Are you telling us that you may not be doing

anything about all of this because it is a resource question?

Mr. DUMARS. No.

Senator BAUCUS. Well, that is kind of how it sounded.

Mr. DUMARS. Sorry. That is not what I meant. We are looking

at this. We constantly have programs to look at this. However, how

much more resource do we have available to go after it in the

broader sense that maybe you are considering versus other things

you want us to go after in a very broad sense as well, around compliance and around these areas?

We do look at them through different programs that we have,

through our CI group and through other groups within IRS. But as

I say, it is something we need to research a lot on what just occurred and find out more about it.

Senator BAUCUS. How many preparer penalties did the IRS assert last year?

Mr. DUMARS. I have no knowledge of this.

Senator BAUCUS. Could you provide that for the committee,

please?

Mr. DUMARS. Yes, we could.

Senator BAUCUS. How many disciplinary actions did the IRS Office of Professional Responsibility take last year?

Mr. DUMARS. I will have to get that from them as well.

Senator BAUCUS. All right. And any relevant additional information would be helpful as well.

[The information appears in the appendix.]

Senator BAUCUS. Do you want to raise your hand, Mr. Weinberger? [Laughter.]

Mr. WEINBERGER. I would be happy to provide something, Senator.

Senator BAUCUS. All right.

[The information appears in the appendix.]

Senator BAUCUS. I am through, Mr. Chairman.

The CHAIRMAN. All right.

Senator BAUCUS. Although I might say that I am a little bit concerned about all of this, as I know you are, too.

The CHAIRMAN. I would think, in addition to your question that

Mr. DuMars answered about what the IRS is doing, now it is too

late to do it for this year, but for next year, maybe around January

1, or when you get into tax season, they should make public some

of the information that the Government Accountability Office

found.

They found that not one single tax return was filed the same, or

accurately. Then we have these instances in which people say certain income does not have to be reported.

If we know that tax preparers are giving that information out,

the IRS knows it, it seems to me the IRS would put out as many

press releases as you can and get as many public service announcements as you can saying, taxpayer, for your own interests, you

ought to be concerned about these things. And do not let somebody

pull the wool over your eyes.

35

You are paying them to give you the information, make sure you

get it, so the government can at least be notifying people that there

are real problems like this out here, and they are pretty deep-seated based upon what we have heard today.

In addition to that, I do not generally make a summation at the

end of a hearing, but I would like to say a couple of things.

First of all, we have had some eye-opening testimony today.

Clearly, there is much that can be done to make life easier for our

taxpayers. I just suggested one thing that the IRS might do a year

from now.

We need to take steps to ensure that, when a taxpayer uses a

preparer, they can trust that that preparer be a knowledgeable professional who is going to do the right thing and put the interests

of the taxpayer first. That preparer needs to be of the mind that

it is his duty to make sure that the taxpayer pays the right amount

of money, not one penny more, not one penny less.

Now, we have heard discussions also about taxpayer privacy.

This is an issue that Senator Baucus and I hear a lot about. I am

concerned about trends suggesting that tax preparers are interested in selling taxpayer information to make a fast buck rather

than as proprietary information that should be held in confidence

by a trusted advisor. It seems that we need to change the focus of

paid preparers from selling to advising.

Further, it is my hope that, in consultation with Senator Baucus

and other members of the committee, that we can look to the near

future for a time to reconsider the Good Government legislation

that has been referred to.

We have developed this to address many of the issues discussed

today. We should take some time to incorporate into that legislation new issues considered in the hearing today, including the impropriety of peace-of-mind audit insurance and the development of

additional means of electronic filing.

The IRS needs to have an aggressive game plan to increase electronic filing in the near future. We really need to consider whether

to have the IRS provide a basic means of electronic filing should

be seen as an extension of its obligations to the taxpayer to provide

them with forms and instruction.

The tax code, of course, is complex enough without making it

harder for working families. We should continue to look at how we

can partner with the private sector and the IRS to make this happen.

There should be plenty of room for the software industry to continue to provide value-added services, and I think you have heard

Senator Baucus speak very eloquently on that very point.

Finally, on an issue directed toward the IRS, and hoping to get

Ms. Olson’s help on something that we did not discuss today, I

hope you will take back a message that my patience is wearing

thin on the issue of offers-and-compromise and effective tax administration.

I have asked the Secretary and the Commissioner for a response

to this matter. It is important to my constituents, many of them

hit by the incentive stock option AMT.

Now, I happen to know that you share my concerns on this and

have been fighting a good fight in this area. However, I have heard

36

nothing from Treasury in response to that request, and I am not

pleased with what appears to be the thinking, that, rather than responding to that question, Treasury hopes that this will go away,

I believe. I see no reason why the IRS cannot put a pilot program

together in this area and see what the reaction is from practitioners and taxpayers rather than just simply doing nothing for

fear of some unknown.

Do you have anything you want to say in closing?

Senator BAUCUS. Yes. Thank you, Mr. Chairman. I think this has

been a very instructive hearing. I thank the GAO. I mean, you

have done a great job. I take my hat off to all of you at GAO. You

work hard and you perform a real public service. You are trusted.

You are truly nonpartisan.

It is one of the few anchors around here that we can rely on for

getting good, solid, honest, objective analysis on various problems,

and I personally just thank you very, very much. I think I speak

for all of the Congress, and probably most of the American people,

in saying that.

Mr. BROSTEK. Thank you very much.

Senator BAUCUS. You bet. I just urge you, you have our trust, so

obviously go the extra mile to keep it. We rely on you a lot, and

just thank you very, very much.

Second, Mr. Chairman, you referred to the Good Government

bill, which I think is good legislation. I thank Senator Bingaman

for introducing it; you and I are both co-sponsors of that legislation.

I think it is good, and we should follow up with it.

I also, frankly, think that we should outlaw insurance on tax

preparation. I mean, if taxpayers rely upon tax preparers, why

should tax preparers then sell insurance? I think that is wrong. It

just does not make much sense to me. People should not have to

pay extra.

I also hope that the IRS follows up with information that they

are gleaning from this hearing, but also information that GAO is

giving to them, because there has to be adequate enforcement here.

I have full confidence that the IRS will take this very seriously and

enforce the law.

I also think, Mr. Chairman, that the IRS could keep this committee apprised of actions that it takes against preparers, based to

some degree on information that has come out of this hearing, but

just generally. I mean, Mr. DuMars said he would send some information to us. I look forward—I know you do, too—to that information.

It is important in the individual context, this hearing, but it is also important in the larger context. We have about a $340 billion

a year tax gap. That is, income taxes that people owe, legally are

due, but are not paying. It is huge. It is $340 billion every year. About half of that is on the indi- vidual side, about $170 billion of income taxes that individuals

owe, are legally owed, and are not paying.

This preparation business is part of the problem. I mean, the degree to which the preparers are encouraging people to not report

cash income, to overstate deductions, to get bigger refunds back, et

cetera, contributes to the tax gap. Therefore, it undermines public

confidence. It is also a tax on other Americans who are being fair.

37

I think most preparers do a good job. That is my personal experience, and I think we should remember that. But there are too

many preparers who are not doing a good job, way too many. I just

urge the industry to really clean up its act or it is going to suffer

even greater consequences.

The tax gap, too, is important on a world agenda. The greater

the tax gap, the greater the need to borrow money from overseas

to finance the government’s necessary services. Who is buying our

treasuries to finance government services? China, Japan, lots of

other countries.

So, preparers could provide a real service here to individual

Americans who want to pay their taxes, not more than they have

to, but pay what they should, but also helping to close down the

tax gap. It is not easy to close the tax gap.

There are lots of reasons why we have it. But this is one way,

among many, many, that will help contribute to closing down the

tax gap, if the preparing industry just does a better job than it has

thus far. I know they will try, and I hope they are successful.

Thank you, Mr. Chairman.

The CHAIRMAN. Yes. Let me thank each of you for your testimony

and being patient through 2 hours of hearing. We appreciate it

very much. Thank you very much.

The hearing is adjourned.

[Whereupon, at 12:13 p.m., the hearing was concluded.]

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