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[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]

 AUDITS AND ATTITUDES: IS THE IRS HELPING OR HURTING SMALL BUSINESSES?

=======================================================================

                                HEARING

                               before the

        SUBCOMMITTEE ON ECONOMIC GROWTH, TAX AND CAPITAL ACCESS

                                 OF THE

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED FOURTEENTH CONGRESS

                             SECOND SESSION

                               __________

                              HEARING HELD
                             JUNE 22, 2016

                               __________

        
      
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]  
        
        
                               

            Small Business Committee Document Number 114-065
              Available via the GPO Website: www.fdsys.gov
 
 
 
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                   HOUSE COMMITTEE ON SMALL BUSINESS

                      STEVE CHABOT, Ohio, Chairman
                            STEVE KING, Iowa
                      BLAINE LUETKEMEYER, Missouri
                        RICHARD HANNA, New York
                         TIM HUELSKAMP, Kansas
                         CHRIS GIBSON, New York
                          DAVE BRAT, Virginia
             AUMUA AMATA COLEMAN RADEWAGEN, American Samoa
                        STEVE KNIGHT, California
                        CARLOS CURBELO, Florida
                         CRESENT HARDY, Nevada
               NYDIA VELAZQUEZ, New York, Ranking Member
                         YVETTE CLARK, New York
                          JUDY CHU, California
                        JANICE HAHN, California
                     DONALD PAYNE, JR., New Jersey
                          GRACE MENG, New York
                       BRENDA LAWRENCE, Michigan
                       ALMA ADAMS, North Carolina
                      SETH MOULTON, Massachusetts
                           MARK TAKAI, Hawaii

                   Kevin Fitzpatrick, Staff Director
                       Jan Oliver, Chief Counsel
                  Michael Day, Minority Staff Director
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                            C O N T E N T S

                           OPENING STATEMENTS

                                                                   Page
Hon. Tim Huelskamp...............................................     1
Hon. Judy Chu....................................................     1

                               WITNESSES

Mr. Pete Sepp, President, National Taxpayers Union, Washington, 
  DC.............................................................     3
Mr. Lee Davenport, Member, Electronic Tax Administration Advisory 
  Committee (ETAAC), Washington, DC..............................     4
Mr. Roger Harris, President & COO, Padgett Business Services, 
  Athens, GA.....................................................     6
Ms. Emily Peterson-Cassin, Project Coordinator, Bright Lines, 
  Washington, DC, testifying on behalf of Public Citizen.........     8

                                APPENDIX

Prepared Statements:
    Mr. Pete Sepp, President, National Taxpayers Union, 
      Washington, DC.............................................    18
    Mr. Lee Davenport, Member, Electronic Tax Administration 
      Advisory Committee (ETAAC), Washington, DC.................    38
    Mr. Roger Harris, President & COO, Padgett Business Services, 
      Athens, GA.................................................    41
    Ms. Emily Peterson-Cassin, Project Coordinator, Bright Lines, 
      Washington, DC, testifying on behalf of Public Citizen.....    47
Questions for the Record:
    None.
Answers for the Record:
    None.
Additional Material for the Record:
    None.
 
 AUDITS AND ATTITUDES: IS THE IRS HELPING OR HURTING SMALL BUSINESSES?

                              ----------                              

                        WEDNESDAY, JUNE 22, 2016

                  House of Representatives,
               Committee on Small Business,
                   Subcommittee on Economic Growth,
                                    Tax and Capital Access,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 10:00 a.m., in 
Room 2360, Rayburn House Office Building, Hon. Tim Huelskamp 
[chairman of the Subcommittee] presiding.
    Present: Representatives Huelskamp, Chabot, Radewagen, and 
Chu.
    Chairman HUELSKAMP. Good morning. Thank you all for being 
with us today. I call this hearing to order.
    Whether we want to or not, each and every one of us has a 
relationship with the IRS. Benjamin Franklin famously said, 
``In this world, nothing can be said to be certain except death 
and taxes.''
    In the administration of the tax code, the IRS has dual 
roles, collection and enforcement. Small businesses have a 
right to be treated fairly on both counts. Unfortunately, that 
is not always the case. Many can appreciate that the IRS is a 
tough job to do; however, the best outcomes will result from 
the IRS and taxpayers working together to improve voluntary 
compliance and efficiently allocate resources.
    The Small Business Committee has heard from a number of 
small businesses that have been harmed in one way or another by 
the IRS. In at least two cases, aggressive audits have resulted 
in these companies actually closing their doors.
    Today's hearing will focus on some of the ways the IRS can 
proactively work with small business taxpayers to improve 
communication and compliance, as well as on some things the IRS 
needs to do differently.
    I would like to thank our witnesses for coming today. I 
look forward to your testimony.
    I now yield to the ranking member for her opening remarks.
    Ms. CHU. Thank you, Mr. Chairman.
    One of the focuses of this Subcommittee is to ensure that 
small businesses are given the tools to comply with regulations 
without increasing their costs. This is particularly true when 
it comes to taxes and interacting with the Internal Revenue 
Service.
    In the past, when small businesses have testified before 
the Committee, they have told us that complexity and 
uncertainty create difficulty when filing tax returns. Many 
business owners worry that one simple mistake can lead to a 
costly and timely audit, and at a time when many businesses are 
striving to expand and hire additional employees, every hour 
and dollar counts.
    As a result of IRS procedures and administrative 
challenges, small firms must devote greater resources towards 
accounts and lawyers to properly report income and pay taxes. 
Over a quarter of small businesses in the 2015 National Small 
Business Association's Taxation Survey stated that they spent 
over $10,000 on tax compliance, and another 8 percent stated 
that they employ an outside tax expert to handle tax issues.
    Unlike larger, multinational corporations, the time spent 
by small businesses in complying with tax laws is much more 
costly, impacting business expansion, job growth, economic 
prosperity, and growth of small businesses. They should not 
also have to face intense scrutiny from the IRS through 
business audits and inadequate IRS compliance with the 
Regulatory Flexibility Act. Nevertheless, small firms cite 
filing hardships, aggressive auditing, and collection 
procedures as confusing as to how a new regulation will affect 
their business.
    Seeing as our nation's fiscal constraints are an ongoing 
priority, I understand that closing the $450 billion tax gap is 
critical to our long-term prosperity, but so are small 
businesses. Any effort to increase tax compliance must be done 
in a way that is responsible, fair, and not disproportionately 
burdensome to small firms.
    Today's hearing will give us a better grasp of the scope 
and collection techniques regarding small business audits. This 
hearing also allows us to examine what is being done to 
minimize IRS regulatory procedural burdens for small entities. 
I believe that this information is even more important right 
now as the agency seeks to be more efficient due to financial 
realities. The fact of the matter remains that the IRS cannot 
review and modify the procedures impacting small businesses if 
Congress continues to cut their budget every year. These 
actions have weakened the IRS's ability to enforce the nation's 
tax laws while also providing sufficient customer service for 
our small businesses. With the proper tools, America's small 
firms can sustain the economic growth currently underway by 
investing in their operations without fear of an audit and 
confusing regulations.
    With that, I would like to thank the witnesses for being 
here today. I yield back.
    Chairman HUELSKAMP. Thank you for that opening statement.
    A quick summary again on timing. First, if Committee 
members have an opening statement prepared, I ask that it be 
submitted for the record.
    I would like to take a moment to explain the timing lights 
for you. You will each have 5 minutes to deliver your 
testimony. The light will start at green. When you have 1 
minute remaining, the light will turn yellow. Finally, at the 
end of 5 minutes it will turn red. I ask that you kindly adhere 
to that time limit.
    Our first witness this morning is Mr. Pete Sepp, president 
of the National Taxpayers Union here in Washington, D.C. Mr. 
Sepp first started with the NTU in 1988. Currently, he 
supervises their government affairs, public relations, and 
development activities. Mr. Sepp has testified before Congress 
on a wide range of tax-related issues and has also been a guest 
on several nationally broadcast radio and television programs.
    Mr. Sepp, you have 5 minutes, and you may begin.

 STATEMENTS OF PETE SEPP, PRESIDENT, NATIONAL TAXPAYERS UNION; 
 LEE DAVENPORT, MEMBER, ELECTRONIC TAX ADMINISTRATION ADVISORY 
 COMMITTEE; ROGER HARRIS, PRESIDENT AND COO, PADGETT BUSINESS 
 SERVICES; EMILY PETERSON-CASSIN, PROJECT COORDINATOR, BRIGHT 
                             LINES

                     STATEMENT OF PETE SEPP

    Mr. SEPP. Mr. Chairman, Madam Ranking Member, I am honored 
to be here to discuss a central feature of our tax system, the 
examination process. Back in 1988, my organization, National 
Taxpayers Union, led a transpartisan coalition, which included 
American Civil Liberties Union and National Council of La Raza, 
business organizations, taxpayer groups, all on behalf of a 
taxpayer bill of rights. There have been subsequent coalitions, 
subsequent pieces of legislation, but one interesting facet of 
this process has been a lack of focus on improving 
examinations. They tended to focus instead on making reforms to 
the collection process. There is a wide range of problems that 
have been identified in the small business community that still 
need to be addressed, particularly pertaining to examinations.
    I call them ``fear factors.'' One major fear factor has to 
do with the complexity of the tax system itself and the 
uncertainty that brings. The Ranking Member of the Full 
Committee, Congresswoman Velazquez, said this very eloquently 
in 2013. I quote, ``Many business owners worry that one simple 
mistake can lead to a costly and timely audit and at a time 
when many businesses are striving to expand, every dollar and 
hour counts.'' Quite true.
    I also think we have to worry about intimidation tactics 
used against small businesses. We are witnessing right now a 
counter and paradoxical trend of speed up audits where 
businesses are getting audit notices and being asked to respond 
almost immediately to whether they want to even appeal. They do 
not even have time to consider the central issues of the audit 
itself. On the other hand, there are ``slow-down'' audits where 
the procedure drags on and on. Interest keeps accruing through 
no fault of the taxpayer and abatement of that interest is a 
very difficult matter to resolve indeed.
    We also have the question of opportunity costs. When you 
look at very small businesses, under $100,000 in receipts, they 
tend to have a tax liability after examination, an additional 
tax of less than $10,000. They could easily rack up that much 
in legal and audit representation costs. Many if not most of 
them decide, in my opinion, not to fight it. That is why the 
audit appeal rate is so low. It hovers between 5 and 7 percent 
annually.
    When they have these problems, the remedies in court remain 
pitifully small. The cap on attorney fees that they can recover 
if they prevail in court nowhere near matches the amount that 
they actually need to spend to prove their position.
    There are other problems on the horizon. We are part of a 
coalition called the Coalition for Effective and Efficient Tax 
Administration involving more than a dozen associations 
representing thousands of businesses. We are identifying 
problems in the large business and international division with 
issuing designated summonses and designating cases for 
litigation, tactics which are normally supposed to be reserved 
for a very small number of uncooperative taxpayers or broad 
ranging, and they are being applied in consistently greater 
fashion and with more force, and the threat is being wielded to 
compel taxpayers into accepting the IRS's position. That is 
going to be a major problem for smaller businesses down the 
road. Taxpayer experts and litigation representatives, like 
Daniel Pilla, who has been before Congress in the past, has 
said he fully expects those kinds of tactics to migrate into 
the small business area and the self-employed area sooner or 
later.
    There is the issue that is being discussed in Committee 
markup for the Financial Services and General Government Bill. 
One of your colleagues, Congressman Katko, is offering an 
amendment to block the IRS from hiring private outside counsel 
to participate deeply in the examination process. Essentially, 
farming out audits.
    Now, this is currently applying to large business, the IRS 
hiring thousand-dollar-an-hour attorneys. You could easily see 
$300, $400 an hour attorneys working on small business 
liabilities. It happens because the IRS may consider the hazard 
of litigation in an appeal situation. They do not have to 
consider the cost of that litigation versus the tax due. So we 
have a volatile situation here.
    We need to enact reforms ranging from S. 2809 by Senator 
Portman, which would address some of the CEETA Coalition's 
concerns, and the Small Business Taxpayer Bill of Rights, H.R. 
1828, to reviewing the taxpayer advocates' most serious 
problems affecting small businesses, and coming together in a 
bipartisan fashion to address the factors of lack of trust, 
lack of certainty, and lack of remedies for small businesses in 
the audit process. We did it in 1988 and 1998. We can do it 
again. Thank you.
    Chairman HUELSKAMP. Thank you, Mr. Sepp. We appreciate your 
testimony.
    Our next witness is Mr. Lee Davenport, member of the 
Electronic Tax Administration Advisory Committee here in 
Washington, D.C. Mr. Davenport is in his third year as a member 
of the Advisory Committee, which serves as a public forum to 
discuss electronic tax administration issues. He is principal 
of Davenport Consulting, which provides business consulting and 
private financing services. He was also the architect of 
Myfreetaxes.com, which assists those who earn less than $62,000 
per year to file their state and federal taxes for free.
    Mr. Davenport, thank you for being here today. You may 
begin.

                   STATEMENT OF LEE DAVENPORT

    Mr. DAVENPORT. Thank you. Chairman, I thank you for holding 
today's hearing on how the IRS could help small businesses. 
Twenty-eight million small businesses in America are a 
cornerstone to our economy. Small businesses account for over 
half of all U.S. sales and 55 percent of all jobs, and they pay 
significant amounts of income, employment, and excise taxes 
into the U.S. Treasury.
    Helping small businesses easily file and pay their taxes is 
a critical mission of the IRS Electronic Tax Administration 
Advisory Committee, ETAAC. ETAAC was formed by law in 1998 to 
make strategic recommendations to Congress on how to improve 
tax administration and better serve taxpayers, including small 
business taxpayers through electronic means. In short, we are 
objective, digital, strategy consultants to the IRS.
    The Committee believes that modernizing the IRS taxpayer 
service communication platform is an urgent and strategic 
priority for the IRS. In the 2015 tax season, the IRS was in 
its fourth consecutive year of budget reductions and IRS 
service levels plummeted. IRS answered only 38 percent of its 
calls from taxpayers. IRS has been unable to modernize its tax 
service platform to move away from traditional paper and phone 
interactions. A current phone and paper taxpayer service 
platform is also not the preferred choice of the IRS or the 
many taxpayers who expect secure online services.
    Along with this issue is a lack of transparency with the 
IRS. For most taxpayers, the information the IRS has about them 
is a complete mystery. It is not easy for taxpayers to access 
and understand their tax information on file with the IRS, 
their previous tax-related interactions, or their tax 
compliance obligations.
    For small business taxpayers, this issue is even more 
critical because small businesses are more likely to complete 
multiple year-round transactions with the IRS. In many cases, 
when there is a compliance issue, small business taxpayers find 
out through a surprising IRS notice after they file, or even 
more stressful, an audit that can take months or years to 
resolve. For all types of taxpayers, accessing and using their 
information to proactively comply is almost entirely out of the 
question in our current system.
    The Committee believes that a key solution to these 
problems is a more digitally-enabled, modernized IRS that 
better equips taxpayers with information on how they can 
proactively comply, rather than solely focusing on detecting 
and enforcing compliance.
    In the past 3 years, ETAAC has provided recommendations 
based on a simple vision of how the IRS could serve taxpayers. 
The vision allows taxpayers to fully understand their tax 
obligations, to have transparent access to their tax 
information status with the IRS, and effectively and securely 
interact with their tax administrator on the way they want to 
be served, in the way they want to be served.
    The end state is a tax system that is less burdensome. It 
is a tax system that relies less on reactive measures, such as 
audits, and more on preventative and educational measures for 
taxpayers to remain proactively compliant. There are two 
challenges the IRS faces in achieving this vision.
    First, the current tax system is designed to be reactive. 
It does not leverage tax information to help taxpayers meet 
their obligations.
    Second, the IRS cannot quickly develop and implement its 
digital roadmap, including online accounts to address the needs 
of preferences of taxpayers. Our last two reports to Congress 
explain this dilemma and provide recommendations to overcome 
these challenges. In our 2015 report to Congress, we 
recommended that the IRS accelerate its digital taxpayer 
service strategy; that is, develop and implement secure online 
accounts for all business and individual taxpayers. We know 
that businesses are much more likely to use a tax professional 
for tax filing compliance needs. Online accounts for these tax 
professionals should be a priority. ETAAC advocates for the IRS 
to commit to quickly developing online accounts for business 
taxpayers and the tax professionals who serve them, and we 
encourage the Committee to do the same.
    In our most recent 2016 report, which actually comes out 
today, ETAAC addresses the lookback tax system that centers on 
post-filing programs that detect current noncompliance. We 
challenge Congress and the IRS to move to a system that 
verifies taxpayer identities and tax return information before 
accepting the return.
    A system that uses information statements, such as forms 
1099 and W-2 to verify taxpayer tax return information is 
essential to fighting fraud and reducing the taxpayer burden. 
The IRS should support taxpayers in filing accurate returns, 
giving them full electronic access to their tax account 
information at the time of filing. This proactive system would 
verify accuracy upfront and reduce audits, particularly those 
on small businesses.
    ETAAC is pleased with the IRS's first steps in its digital 
service plans. IRS released an initial draft of the Future 
State Initiative in January of this year that specifically 
incorporated ETAAC recommendations from the past 3 years. The 
initiative specifically contemplates small business taxpayers 
and their needs. ETAAC endorses this digital service component 
of the Future State plans, and we clearly identified the urgent 
need for small businesses. The IRS needs to accelerate online 
accounts for businesses and tax professionals.
    On behalf of the entire ETAAC, I thank you for inviting us 
to testify on this important topic.
    Chairman HUELSKAMP. Thank you, Mr. Davenport. We appreciate 
your testimony and your service on the Advisory Committee.
    Our third witness this morning is Mr. Roger Harris, 
President and COO of Padgett Business Services in Athens, 
Georgia. Mr. Harris has served twice as Chairman of the 
Internal Revenue Advisory Council, and has previously testified 
before this Committee, as well as before the Senate Small 
Business Committee. He has been named one of Accounting Today's 
Top 100 People. Mr. Harris, you have 5 minutes.

                   STATEMENT OF ROGER HARRIS

    Mr. HARRIS. Thank you, Mr. Chairman, and Ranking Member 
Chu. It is a pleasure to be here today.
    To give you a little background, Padgett Business Services 
provides accounting, tax, and payroll services to small 
businesses. We are currently celebrating our 50th year and have 
over 200 offices throughout the United States.
    We define a small business as someone with less than 20 
employees. Now, a lot of people consider that to be a ``mom-
and-pop'' type business, but I would remind those people that 
almost 90 percent of people who have employees would fit that 
definition, so it is a very powerful part of our economy.
    Our history and our relationship with our clients gives us 
a good perspective to comment on the interactions that small 
businesses have with the IRS and, in our case, their 
representative. Specifically as it relates to audits, no 
taxpayer, be it an individual or small business, ever wants to 
receive a notice that they are being audited. But in a 
voluntary tax system like we have, there is an element of 
enforcement that must be present. So, if you are successful and 
stay in business long enough, there is a good possibility you 
are going to interact with the IRS in some form of audit or 
some sort of correspondence.
    Currently, the IRS really executes two different types of 
audits on small business. The one that seems to be most 
prevalent and continues to increase over the years is the 
correspondence audit. Now, the idea behind a correspondence 
audit is that some computer or some person somewhere in the 
bureaucracy selects what appears to be some simpler issues and 
the small business owner is notified by mail, as the name 
indicates, and they are to respond to that notice about the 
specific issues in question. In theory, this is a very good 
system and I think it is partly the reason that we are seeing 
more and more of these is for the better use of IRS resources. 
It eliminates face to face, which is intended, again, I think, 
to minimize the cost and burden that a small business owner or 
their representative might face.
    Unfortunately, it does not work always as intended. First 
and foremost, sometimes the tax code is a little more 
complicated than it might seem, and what looks like a simple 
issue that can be very easily dealt with through correspondence 
really has more complicated pieces in it than may be on the 
surface. Sometimes that lack of face-to-face is a disadvantage, 
not an advantage, because the small business owner or their 
representative may feels like they are just talking to the 
bureaucracy and they do not really know where their information 
is and what is being done with it, and if there is something 
that needs to be questioned explained, there is not a real 
convenient process to do that.
    The thing that we probably hear the most as a criticism of 
correspondence audit through our company and our experiences, 
is that there is an inconsistency in the quality of this 
unknown person responding from the IRS. In many instances it is 
almost as if they do not know the issue as well as the 
representative or the taxpayer does. Eventually, you really do 
need to move to a face-to-face environment to get the issue 
resolved. So, in many instances, what starts as a 
correspondence audit can only be resolved if it moves to some 
sort of face-to-face contact.
    We understand that correspondence audits are probably going 
to continue to be the preferred method of auditing small 
businesses, but if that is the case, I think there are three 
areas that the IRS needs to focus on and address.
    First of all, they need to do a better job of selecting the 
issues that work in this type of environment, so if it is going 
to be done through correspondence, it is an issue that can be 
resolved through corespondence. Secondly, they need to have 
more consistency and better training of their employees. And 
finally, I think something that is very important is they need 
to develop a tracking system. It is interesting to us that 
FedEx or UPS can track packages all the way through the 
delivery process, but the IRS cannot allow a taxpayer or a 
representative to track the status of their information in 
their audit. There needs to be better tracking of the 
information as it is submitted and as it is going through the 
process.
    The audits that I think we all associate with the IRS are 
field audits where people come out and spend time either at the 
small business owner's place of business or the 
representative's place of business. The good news for that is 
you tend to get a more trained and better qualified IRS 
representative. The bad news is those audits can last days, 
weeks, months, and sometimes years, and the cost of those are 
almost exclusively the burden of the small business owner. 
Again, they are necessary evils because they can be very costly 
and very expensive.
    I agree almost completely with some of the comments of Mr. 
Davenport as we move forward with online accounts. The IRS is 
setting up individual accounts, which I commend them for. 
However, there is a vast need for business accounts and 
practitioner accounts. Currently, about 70 percent of small 
business owners have some sort of relationship with a 
practitioner, and, therefore, you need to give access to 
accounts to the people who would be most likely to use them. 
Unless you operate as a Schedule C, if you are a partnership or 
a corporation, there are no accounts right now, but I think we 
need those accounts as well.
    Finally, even on the individual accounts, which I think are 
a step in the right direction, and I certainly understand the 
challenges of identity theft that the service is facing, but 
right now the service says that the way to authenticate those 
accounts today, by their own admission, are only successful 30 
percent of the time. If we are going to have individual 
accounts, they need to be something that the average person can 
actually access when needed.
    So with that, I see my time is up, again, thank you for 
allowing me to being here, and I look forward to your 
questions.
    Chairman HUELSKAMP. Thank you, Mr. Harris, we appreciate 
your testimony.
    I now yield to our Ranking Member for the introduction of 
the final witness.
    Ms. CHU. It is my pleasure to introduce Ms. Emily Peterson-
Cassin. Ms. Cassin is the Coordinator of Public Citizen's 
Bright Lines Project. The Bright Lines Project was founded in 
2008 and worked to change the big test that currently defines 
political activity for nonprofits. Before joining Public 
Citizen, she worked as an attorney in ERISA litigation and in 
indigent representation. She received her juris doctorate from 
Georgetown University Law School.
    Welcome, Ms. Peterson-Cassin.
    Chairman HUELSKAMP. I thank the Ranking Member for that 
introduction.
    Ms. Peterson-Cassin, you may begin.

               STATEMENT OF EMILY PETERSON-CASSIN

    Ms. PETERSON-CASSIN. Thank you. Mr. Chairman, Madam Ranking 
Member, thank you for the opportunity to testify today.
    My name is Emily Peterson-Cassin. I am the Bright Lines 
Project coordinator at Public Citizen Congress Watch. Public 
Citizen is a national, nonprofit, public interest organization, 
with more than 400,000 members and supporters.
    For 45 years, we have successfully advocated for stronger 
health safety, consumer protection, and other rules, as well as 
for a robust regulatory system that curtails corporate 
wrongdoing and advances the public interest. My own work at 
Public Citizen is to coordinate the Bright Lines Project, an 
expert team of attorneys and nonprofit partners working for an 
improved definition of political activity for all nonprofits.
    I do not need to tell this Committee how important small 
business is to our economy and our society. Congress can, and 
should, protect small business by ensuring a clear, predictable 
framework of tax rules and regulations. Rules that are easy to 
follow and enforce allow small businesses to thrive, while 
minimizing opportunities to abuse the tax system.
    The IRS should be doing more to ensure that small 
businesses can easily comply with the regulations already in 
existence, and work to improve its ability to provide accurate 
and timely guidance. The Bright Lines project focuses on 
nonprofits, advocating for a definition of political activity 
that increases civic participation and creates objective 
standards for the IRS to follow when enforcing the law. Clear 
rules are just as important for a small business. Indeed, 
nonprofits can be likened to small businesses with a social 
mission. At the same time, it is important to recognize the 
benefits to small business and our society of having a safe and 
healthy workforce made possible by sensible government 
regulation.
    Regulation is also essential for opening up new markets for 
small businesses and helps incentivize innovation in safer and 
cleaner technologies. Regulations make our country stronger, 
safer, cleaner, healthier, and more fair to small business.
    The regulatory system must not operate to give large 
corporations an unfair advantage by delaying important 
regulations or muddying the rulemaking process. Making the 
rulemaking process too complicated for commonsense regulations 
harms small businesses rather than helps them. The analysis 
required under SBREFA, for example, can delay the already 
laborious rulemaking process for months. A recent GAO report, 
which investigated the slow process of rulemaking at OSHA, 
found that it takes 8 extra months of work for OSHA to prepare 
for the SBREFA panel. In addition, small business analysis 
should be narrowly targeted to benefit small business.
    Though the advisory panel component of SBREFA legislation 
often results in unnecessary delays to needed regulations, 
other aspects of the law do help small businesses comply with 
regulations and could be expended to be even more helpful. 
Supporting and expanding the Small Business Ombudsman and 
Compliance Assistance programs is a sensible way to give 
direct, tangible help to small business.
    The information the IRS provides to business taxpayers is 
essential to increasing compliance and decreasing hassle for 
small business. However, funding cuts to the IRS in the past 
few years has made that assistance more difficult to provide. 
Since fiscal year 2010, the IRS's funding has been drastically 
cut again and again. Consequences of those cuts have led to 
reductions in staff available to assist taxpayers and in the 
training available to that staff. An IRS staff that is 
adequately knowledgeable and available to small business 
taxpayers makes filing taxes easier and prevents compliance 
problems from compounding. Yet, over and over, the IRS is 
unfairly attacked and prevented from fulfilling its mission. 
Therefore, it is essential that the IRS is fully funded.
    It is in our nation's interest that small businesses are 
able to grow and thrive in a society that protects health and 
safety and ensures that the market operates fairly to 
businesses of all sizes. Small changes to SBREFA, fully funding 
the IRS, and ensuring a predictable rulemaking process will 
ensure that the playing field is level for small business.
    Again, it is an honor to come before you today, and I look 
forward to your questions.
    Chairman HUELSKAMP. Thank you, Ms. Peterson-Cassin. I 
appreciate your testimony. We will begin with questions.
    I would first like to direct a question to Mr. Harris. I 
appreciate your experience as a practitioner. Looking at this 
and after a correspondence audit, what do we really know how 
the IRS determines who is going to be audited? The New York 
Times article contends they have a secret algorithm. What is 
your experience or your best guess in what is occurring over 
there?
    Mr. HARRIS. They have what they call a DIF score. Tax 
returns are scored and compared to some norms of other returns 
and their prior returns, which, I guess, is the most common 
way. They also at times target specific issues where they see 
problems either in a tax part of a law or taxpayer behavior. 
Sometimes they are just random. They do some audits that are 
for research purposes, and those are done randomly and are done 
in great depth and detail. Quite honestly, sometimes you just 
do not know why you are selected. You see some returns that you 
think, wow, I do not know why that one is not getting an audit 
and one that looks fairly simple gets one, so, I think there 
are a lot of different reasons. I am not sure anybody knows 
them all.
    Chairman HUELSKAMP. Another question for Mr. Sepp about the 
auditors. How are they currently held accountable when they 
make errors that might cause a catastrophic result for 
taxpayers and/or small businesses?
    Mr. SEPP. There are some methods by which taxpayers can see 
redress if the IRS either loses documentation or if, perhaps, a 
math error on an examiner's part is discovered. That was 
something brought up to me in an interview I conducted with a 
tax professional. Interestingly, the IRS issues millions of 
math correction error notices on its own. Sometimes the IRS's 
own staff make mistakes in the calculation of a tax. The 
problem is, beyond going to appeals, and assuming the taxpayer 
even understands his or her appeal rights, getting into tax 
court or district court is a very expensive proposition. One of 
the elements of H.R. 1828, the Small Business Taxpayer Bill of 
Rights, would begin a pilot program for alternative dispute 
resolution in small business tax cases. That was an idea that 
had been developed by an IRS Reform Commission some 30 years 
ago, or 20 years ago I should say, and it is a good idea now. I 
think we should move forward with it.
    Chairman HUELSKAMP. With a tax appeal rate of 5 to 7 
percent, is this because businesses are a function of being 
scared as well as not knowing, or not worth the price of entry? 
There is a lot of discussion about large corporations that will 
draw audits for years. For a small business with 20 folks or 
less a couple days is a major crippling factor on their 
business if they are shut down or have to spend all their time 
with an auditor on an appeal.
    Mr. SEPP. Yes, absolutely. Some professionals have reported 
to me, just the basic misunderstanding, that when taxpayers 
receive the so-called 30-day letter with an RAR, the report of 
the examiner, as to the issues and the position of the IRS, 
they think it is a bill. They think they have to pay it.
    Chairman HUELSKAMP. Who would they call?
    Mr. SEPP. It is very difficult sometimes. That is a problem 
the Taxpayer Advocate has pointed out, that there needs to be a 
single point-of-contact with a phone number that a citizen 
under examination can get in touch with. The IRS has 
interpreted that mandate in a very fluid fashion, and that is 
not very helpful.
    Chairman HUELSKAMP. Mr. Davenport, what is your sense of 
volume of audit activity? Could that be diminished, and more 
targeted, and more efficient? You filed recommendations for the 
council you are on. Can you describe that a little bit more, 
how we could actually make it more efficient and better 
allocate the resources? Thoughts on that?
    Mr. DAVENPORT. I do not know if I can speak to the volume 
of the audits and their current status. I think that they would 
be increased. You would have more efficiency in the system if 
you allowed the small businesses to transparently see 
information that is on file. If the IRS presented to you an 
electronic account or a format, that they could say this is 
what we have for you. These are the kinds of things we are 
going to be talking about.
    As was previously mentioned, they could track the audit 
process, the paperwork through the entire cycle of the audit. 
Their interactions are, as I mentioned, largely unaccountable 
for, so you can change hands of the audit process several 
times. You can speak with people on one issue or event in the 
IRS and then speak with another person in another department. 
They do not have a way to be able to speak knowledgeably about 
all the information held in one place at one time, and I think 
it would improve dramatically.
    Chairman HUELSKAMP. They have, certainly, some type of 
internal processes, but are taxpayers not privy to those? Or if 
they ask who is looking at it next or who looked at it, where 
it is, what do they tell a small business man or woman that is 
appealing? Where is the appeal? Will they even answer that 
question?
    Mr. DAVENPORT. I think it would require several lengthy 
responses back and forth. I think putting all the information 
we have into the same place and having an important and dynamic 
conversation about the information that we have at the same 
time would be fair and transparent for both the filer and the 
service.
    Chairman HUELSKAMP. Well, thank you. I appreciate that.
    Next, I would like to recognize the ranking member for her 
5 minutes of questions.
    Ms. CHU. Thank you, Mr. Chair.
    Ms. Peterson-Cassin, the Regulatory Flexibility Act, or 
RegFlex, was passed by Congress and mandates that Federal 
agencies consider the potential economic impact of Federal 
regulations on small entities. In fact, it was this Committee 
that created the RegFlex Act over 25 years ago. How can the 
lack of RegFlex compliance from the IRS impact the ability of 
small businesses to adjust according to a new regulation?
    Ms. PETERSON-CASSIN. Well, clarity and predictability are 
essential to a good regulatory system to any regulation that 
comes out. It makes compliance easier and it makes enforcement 
easier. Small businesses want to comply with regulations, and 
when they do not know when the regulations are coming out, what 
the regulations will be, whether the regulations are going to 
affect them, it is impossible to comply. Furthermore, 
compliance problems, once they start, have a tendency to 
compound, which leads to a lot of the problems with difficult 
audits that we have been discussing previously.
    Ms. CHU. Well, this Regulatory Flexibility Act, RegFlex, 
and the Small Business Regulatory Enforcement Fairness Act, 
were designed with small business compliance in mind. What are 
the most advantageous aspects of these laws and could these 
tools be extended to further assist small firms?
    Ms. PETERSON-CASSIN. Absolutely. The best thing these laws 
do is to provide direct tangible assistance to small 
businesses, including creating small business ombudsmen. Most 
agencies already have one, including Treasury. Those ombudsmen 
are there to answer questions, provide guides, and help small 
businesses comply with existing procedures. But the program 
should be expanded to include more outreach, make sure that 
small businesses know that those resources are available and 
can be found easily. There should also be best practices 
guidelines on how to do that outreach. More compliance 
assistance and making that assistance meaningful will have 
enormous benefits, and remove burdens also to small businesses.
    Ms. CHU. Absolutely. Now I would like to ask you about the 
significant budget cuts at the IRS. The IRS has had significant 
budget cuts and it has resulted in limited resources. Is it 
realistic to think that the IRS can appropriately and 
efficiently perform all the duties it has been tasked to do 
while also reviewing the modified problem areas, like the price 
of audit on taxpayer accounts? How can increasing the IRS 
budget, and therefore increasing personnel, address many of the 
problems we are hearing about today?
    Ms. PETERSON-CASSIN. An answer to your first question, 
unfortunately, I do not think it is realistic at all to expect 
the IRS to carry out its vast mission of enforcing the tax code 
with the cuts that have been in place. Since 2010, as Mr. 
Davenport mentioned, the IRS has lost about 17,000 full-time 
employees, including 5,000 from enforcement. As we have been 
hearing, audits are an imperfect tool. Increasing compliance 
assistance and guidance, before the problems compound, makes 
those audits easier, and increasing the training available to 
staff through adequate funding would decrease the problems that 
those audits cause as well.
    Ms. CHU. How about increasing personnel and increasing the 
budget? What could that do to address these problems that we 
are hearing about?
    Ms. PETERSON-CASSIN. That is exactly right. I mean, the 
most obvious thing that the IRS can do to increase its 
compliance is answer their phones. As Mr. Davenport mentioned, 
he cited the statistic that the IRS has a 38 percent service 
level on their phones. That is obviously unacceptable. When 
they do get more funding, as they did, they got a little bit of 
funding in 2015 to address that problem, the service level goes 
up. In fact, when that extra funding came up, they were able to 
hire 1,000 temporary workers and increase the phone level 
service to about 70 percent. Now, that is not even talking 
about the first thing I do when I have a problem or I have a 
question, which is go to the internet. The IRS needs that extra 
funding in order to create easy-to-find compliance guides so 
that small businesses do not have to wonder what they are 
supposed to be doing. They should be able to find those answers 
right away. More funding will make sure that happens.
    Ms. CHU. Thank you. I yield back.
    Chairman HUELSKAMP. Thank you. Next, I would like to 
recognize Mrs. Radewagen for her 5 minutes of questions.
    Mrs. RADEWAGEN. Thank you, Mr. Chairman. I, too, would like 
to welcome the panel. Thank you for appearing today.
    Mr. Davenport, you talk about a system that verifies 
taxpayer identities and tax return information before the IRS 
accepts a return. How would this work in practice?
    Mr. DAVENPORT. In my mind there are a few things that would 
have to change. There are some regulations in place now to 
bring in information returns in earlier, much earlier. 
Information now from the 1099s and the W-2 passes through 
Social Security and then gets to the IRS sometime around the 
summer or late summer. If information was to arrive earlier and 
it would be usable by the IRS, searchable and cross-matched, we 
could better identify information that was included on those 
information statements, like W-2s and 1099s, and use it to 
verify, authenticate the individual.
    I think there is some movement in the spending bill this 
year, the IRS will start issuing refundable credits on February 
17th this year. This has some negative impacts for the system, 
but if you move back the date the refunds come out and you move 
up the date information comes in, you have a better chance of 
matching that information, and then knowing who the individual 
is and if they are getting the right number.
    This is not to stop me stealing his information at a coffee 
shop; this is to stop the 500,000 returns and refunds that are 
issued improperly to people who do not exist. They are phantom 
corporations that have filed for millions of people.
    Mrs. RADEWAGEN. Given the IRS cybersecurity challenges, as 
well as those of taxpayer identity theft and refund fraud, how 
do we ensure that the taxpayer online portals you recommend are 
secure?
    Mr. DAVENPORT. Security is an evolving thing. Even 3, 4 
years ago, we thought security questions were lightyears ahead 
of where we are. Now you can find that stuff on Ancestry.com 
and this is a pretty common thing that we think the status of 
evolving authentication, for me knowing who an individual is, 
the computer must be smarter than we are and those are powered 
by people and people have to make the decisions, and 
cybersecurity is a big deal. Right? So if we can improve that, 
if we can know who they are and if we can master information, 
we will have a better chance of making those payments 
correctly.
    The thing is now I can choose to interact with the IRS on 
the schedule I want. I can come in and out of the system at any 
point. I can file and not file next year and no one will know 
the better. We will know later, years later, but if we were to 
create an online system that I could match my information the 
employer sent me. I am a small business owner, if I got 1099s 
in the mail, as did the IRS, and if I could actually see what 
was there, what they had, what I had, in a prefiling season I 
could know my compliance was going to be right and I was going 
to file the right return. I could submit my return through an 
online account. They would send me a note, we received your 
return today. Thank you very much. We are going to drop your 
refund in your account today. Is that okay? Well, if it was not 
me or that was not my return I would say no and we would stop 
immediately.
    I think there are some security concerns around how to do 
it, but does it need to be done? It absolutely has to be done.
    Mrs. RADEWAGEN. Okay. I am running out of time here.
    I wanted to ask Mr. Sepp, the current audit process seems 
to be a bit of a mess based on a number of issues you 
identified: lack of centralized management, lack of 
transparency, flawed IDR process, et cetera. But it appears 
that many of these issues could be resolved administratively 
within IRS. What recommendations would you make to the agency 
to make the process work as intended?
    Mr. SEPP. Some of these recommendations are being made by 
the Coalition for Effective and Efficient Tax Administration, 
but I think they apply not only to the large business and 
international division but small business and self-employed. 
There needs to be more centralized case management and points 
of contact. There needs to be much more consultation between 
the auditors and the audited about deadlines for information 
document requests, about timelines for completion of the audit, 
and about issues identified in the audit. I would echo the 
testimony of those here who say we need better training of IRS 
staff to focus more intently on the issues and to refrain from 
tactics such as designated summons or threatening to designate 
cases for litigation or hiring outside firms. Those kinds of 
issues, again, are eventually going to migrate into the small 
business community in some form or another. We need to address 
those now.
    Mrs. RADEWAGEN. Thank you, Mr. Chairman. I yield back.
    Chairman HUELSKAMP. I have a feeling we may have some 
members streaming in from other committees, and I have a couple 
of additional questions and the members will have another round 
of questions.
    Mr. Sepp, you did mention the option of farming out audits, 
which is a new concept to me. I understand the current system 
where we actually do in most States, if not all, participate in 
assisting the IRS in tax administration. But the current 
system, farming out audits to hire private companies are 
perhaps conflicts of interest? Describe why that should be 
allowed or your opinion on the IRS doing that. Apparently, it 
is doing it on a number of cases.
    Mr. SEPP. Well, certainly, National Taxpayers Union has in 
the past supported allowing the private sector to deliver 
services more efficiently and effective than government, but 
you have to draw a line. This is an inherently governmental 
function involving sensitive information and very sensitive 
issues. When a business is involved, of course, anything that 
gets made public can affect the reputation of the business, its 
ability to attract capital and the like.
    This issue was first raised when the Internal Revenue 
Service retained Quinn Emanuel in an investigation, an audit of 
a very large firm, and this has led to concerns on the Senate 
Finance Committee side of all kinds of things. We have privacy 
issues, we have whether this is worth the expense. We also have 
the issue of whether this is something that reinforces the 
intimidation factor when you have attorneys at over $1,000 per 
hour participating in the examinations. We are not talking 
about appearing as expert witnesses about issues that the 
examiners within the IRS might need help with, but rather, 
deposing witnesses. That could be very troubling.
    Chairman HUELSKAMP. Is this a new route for the IRS? Or 
have they been doing this for a long time?
    Mr. SEPP. No. It is very recent. Very recent. We are 
essentially ahead of the curve here in our ability to curtail 
this practice before it becomes commonplace. As I mentioned, 
one of your colleagues, Congressman Katko, is already offering 
an amendment regarding this. Senator Portman's legislation has 
a somewhat different approach to curtailing the practice, but 
we need to get on this as quickly as possible.
    Chairman HUELSKAMP. It seems very shocking to me and I was 
actually in a different type of regulatory setting of 
environmental regulations with the idea we would bring in a 
competing firm to help enforce or decide what permits their 
competitive firm gets and it is just beyond unbelievable the 
IRS would do this as well.
    Ms. Peterson-Cassin, you said you had experience in the 
nonprofit world as well, and there have been a lot of 
discussions in the last few years in trying to figure out who 
gets targeted for audits or selection of special scrutiny, 
which has come under a lot of discussion lately. Can you 
provide an insight? Should the IRS be using special words they 
target, or how do they pick these out in the nonprofit world 
for this tax-exempt status, which of course raised plenty of 
concerns, I think, by many folks. Can you describe what they 
should have done, what you think they did?
    Ms. PETERSON-CASSIN. Absolutely. What happened in that case 
is that the laws governing what political activity is for 
nonprofits are so vague that they are not only hard for 
nonprofits of all stripes to comply with, but they are also 
very, very difficult to enforce. This is exactly the discussion 
we have been having. Compliance and enforcement are two sides 
of the same coin.
    So I liken it to a speed limit sign that says do not go too 
fast. When the rule is that vague, there are going to be plenty 
of people who do go too fast for whatever reason. Then there 
are going to be even more people, in fact, the most common 
thing we hear from nonprofits is they just do not engage. They 
restrict themselves from things that they could be doing, could 
be participating in, could be furthering their mission, and 
they say we are too afraid. We are too afraid and we are not 
going to do it. The Bright Lines project exists to make that 
clear so that everyone can be on the same page.
    Chairman HUELSKAMP. In my conversations with the 
Commissioner, there are things that he told me they could do 
that no one in their right mind in the nonprofit world would 
even try to do because they know they are going to be hit on 
the wrist or even worse. How do you know what you know? How do 
you find out? Now we are in the middle of just trying to figure 
out what exactly they were doing in Cincinnati, which is the 
subject of other hearings of other committees, so I appreciate 
that insight.
    Ms. Chu, did you have any additional questions?
    Ms. CHU. Yes. Mr. Davenport, I was intrigued by the 
recommendations of the Electronic Tax Administration Advisory 
Committee. Electronic signatures is just such a basic common 
sense idea and would allow small business owners to save time 
and money when filing their taxes electronically. How could 
such a simple administrative change create efficiency for small 
businesses and the IRS?
    Mr. DAVENPORT. You hit on a multiyear problem and I think 
this has come out of ERSAC before as well, but it is the way 
the form line 40-ES, the employment form for small businesses, 
it is a form that is filed quarterly and their employment taxes 
paid. It is administratively much easier to go to the form, 
print the form itself, sign it, and then scan it back than it 
is to create an electronic account to do this. It is a simple 
fix, but, you know, if we talk about the 80 percent goal to get 
electronic filing above 80 percent, which is going to charter 
ETAAC in 1998, we are close in most categories: individual 
filings, 87 percent of individual taxpayers; businesses are 
below 80 percent, just below 80 percent, because the 94X 
series, which there are 20-something million of these forms 
that come in every year, only about 37 percent of them come in 
electronically. It is something that the IRS has formed a 
working group on, they did that when I was in my first year in 
ETAAC. They formed a working group in e-services. They will 
make recommendations, and they expect to implement those 
recommendations in fiscal year 2018. And so you can see the arc 
for change is not as agile as you would expect in the private 
sector, but I do think that we are going to see some changes in 
that soon because it is honestly just an easier thing to do 
than not to do.
    Ms. CHU. What makes implementing these changes so difficult 
for the IRS? Why is it taking so long? Also, are there any 
downfalls to allowing electronic signature, such as fraud or ID 
theft?
    Mr. DAVENPORT. I think one of the things they are dealing 
with is that an individual must authenticate for a business, on 
behalf of a business, and as a Schedule C filer. There are 
millions of Schedule C filers, it is no problem for me to 
authenticate myself with my own social, but to do so on behalf 
of a business, you have to share your own personal identity on 
behalf of a business as a business owner, and sometimes as 
businesses grow, that information then has to pass to internal 
accounting services or external folks.
    Again, it may just be an administrative thing that can 
change, that we can fix the system and make it easier, but I 
think they have to think about authentication as a whole 
strategy. That is just kind of wound up in it. I would probably 
defer to Mr. Harris, he may have strategies.
    Mr. HARRIS. No, I think your comments are true. We need to 
move to more electronic filing capabilities, and I think the 
service, if I was going to be critical, it is the old saying, 
``The enemy of good is perfect.'' At some point we need to 
begin to allow businesses--there is always a reason not to do 
something. We need to start trying to find a reason to do 
something.
    Ms. CHU. Mr. Harris, collecting tax debt is possible 
through flexible collection tools and can be an efficient way 
of helping these individuals, yet these tools are rarely 
utilized by the IRS and instead tax liens, levies, and seizures 
are used. What makes liens and levies, which are much harsher 
points of collection, the preferred method for IRS agents?
    Mr. HARRIS. I really have no idea why it would be the 
preferred method because it is the most cumbersome method. It 
creates the most difficulties. I guess if you have exhausted 
every other tool. As you said, there are plenty of 
opportunities through any collection process through the use of 
installment agreements or offers in compromise or just paying 
the tab, it should be in all cases the place of last resort. If 
it moves up anywhere beyond that, then something in the system 
has not gone as intended because, again, that should be the 
last thing anyone gets to because that has the most severe 
impact of all on a small business owner.
    Ms. CHU. I yield back since I think votes have been called.
    Chairman HUELSKAMP. Are there votes this early? I did not 
know that, so I appreciate that. We got sidelined with another 
Committee, so I would like to thank all of you witnesses for 
participating today. You have raised a number of issues and 
potential solutions--I like hearing solutions--that require 
some serious attention at the IRS. It seems we have a lot more 
work to do in this area but this hearing is a good start.
    I know the Full Committee and this Subcommittee will follow 
up with the IRS and other stakeholders on the issues raised 
today. You have not heard the last from us. It is important 
that these issues and other related concerns are identified, 
addressed, and corrected.
    I ask unanimous consent that members have 5 legislative 
days to submit statements and supporting materials for the 
record. Without objection, so ordered.
    This hearing is now adjourned.
    [Whereupon, at 11:28 a.m., the Subcommittee was adjourned.]
    
    
    
    
                            A P P E N D I X
                            
                            
                            
  
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]                          
                            
                            
                        Prepared remarked from the

          IRS Electronic Tax Administration Advisory Committee

    Chairman, thank you for holding today's hearing on how the 
IRS can help small businesses. The 28 million small businesses 
in America are a cornerstone to our economy. According to the 
Small Business Administration and the IRS, small businesses 
account for over half of all US sales and 55% of all jobs. They 
pay significant amounts of income, employment, and excise taxes 
to the US Treasury.

    Helping small businesses easily file and pay their taxes is 
a critical mission of the IRS Electronic Tax Administration 
Advisory Committee, or ETAAC. ETAAC was formed by law in 1998 
to make strategic recommendations to Congress on how to improve 
tax administration and better serve taxpayers--including small 
business taxpayers--through electronic means. In short, we are 
objective digital strategy consultants to the IRS. Recently, 
the committee has sharpened its focus on how the IRS could make 
the tax system less reactive and intrusive by providing 
taxpayers with digital access to their tax information and a 
better understanding of their compliance requirements.

    The committee believes that modernizing the IRS taxpayer 
service platform is an urgent, strategic priority for the IRS. 
In the 2015 tax season, the IRS was in its fourth consecutive 
year of budget reductions, and IRS service levels plummeted. 
The IRS answered only 38% of its calls from taxpayers. The IRS 
has been unable to modernize its taxpayer-service platform to 
move away from traditional paper and phone interactions. The 
current phone and paper taxpayer-service platform is also not 
the preferred choice of the IRS or the many taxpayers who 
expect secure online services.
    Aligned with this issue is a lack of transparency with the 
IRS. For most taxpayers, the information the IRS has about them 
is a mystery. It's not easy for taxpayers to access and 
understand their tax information on file with the IRS, their 
previous tax-related interactions or their tax compliance 
obligations. For small-business taxpayers, this issue is even 
more critical, because small businesses are more likely to 
complete multiple year-round transactions with the IRS. In many 
cases, when there is a compliance issue, small-business 
taxpayers find out with a surprising IRS notice after they 
file, or--even more stressful--an audit that can take months or 
years to resolve. For all types of taxpayers, accessing and 
using their tax information to proactively comply is almost 
entirely out of the question in the current system.

    The committee believes that a key solution these problems 
is a more digitally enabled, modernized IRS that better equips 
taxpayers with information on how they can proactively comply, 
rather than solely focusing on detecting and enforcing 
compliance.

    In the past three years, ETAAC has provided recommendations 
based on a single vision of how the IRS should serve taxpayers. 
This vision allows taxpayers to:

           Fully understand their tax obligations,

           Have transparent access to their tax 
        information and status with the IRS, and

           Effectively and securely interact with their 
        tax administrator in the way that they want to be 
        served

    The end state is a tax system that is less burdensome. It 
is a tax system that relies less on reactive measures, such as 
audits, and more on preventative and educational measures for 
taxpayers to remain proactively compliant.

           First, the current tax system is designed to 
        be reactive, and does not leverage tax information to 
        help taxpayers meet their tax obligations, and

           Second, the IRS cannot quickly develop and 
        implement its digital roadmap, including online 
        accounts, to address the needs and preferences of 
        taxpayers.

    Our last two reports to Congress explain this dilemma and 
provide recommendations to overcome these challenges.

    In ETAAC's 2015 report to Congress, we recommended that the 
IRS accelerate its digital taxpayer-service strategy--that is, 
develop secure online accounts for all business and individual 
taxpayers. Taxpayers should have secure digital access to their 
tax information, and they should be equipped with comprehensive 
tools to interact effectively with the IRS online.

    In the report, we directly addressed key problems in the 
IRS strategy that affect small businesses, and we advocated for 
an expedited release of online accounts and tools for 
businesses--still not a stated IRS priority.

    Additionally, we know that businesses are much more likely 
to use a tax professional for tax filing and compliance needs. 
Online accounts for these tax professionals should be a 
priority. In the current IRS digital plan, online accounts for 
business taxpayers and their tax professionals arrive much 
later. ETAAC advocates for the IRS to commit to quickly 
developing online accounts for business taxpayers and the tax 
professionals who serve them, and we encourage this committee 
to do the same.

    In our most recent 2016 report, ETAAC addresses the ``look-
back'' tax system that centers on post-filing programs that 
detect and correct noncompliance. We challenge Congress and the 
IRS to move to a system that verifies taxpayer identities and 
tax return information before accepting a return.

    A system that uses information statements, such as Forms 
1099 and W-2, to verify taxpayers and their tax return 
information is essential to fighting fraud and reducing 
taxpayer burden. The IRS should support taxpayers in filing 
accurate returns by giving them full electronic access to their 
tax account information at the time of filing. This proactive 
system would verify accuracy upfront and reduce audits, 
particularly those on small-business taxpayers.

    ETAAC has been pleased with the IRS' first steps in its 
digital service plans. The IRS released an initial draft of its 
Future State Initiative in January of this year. The initiative 
specifically contemplates small-business taxpayers and their 
needs. However, the delivery date of these digital capabilities 
is unknown.

    Many of the ETAAC's recommendations from the past three 
years are incorporated into the IRS Future State Initiative's 
digital plans. ETAAC endorse4s the digital-service components 
of the IRS' Future State plan, and we have advocated to 
Congress that the IRS should accelerate these plans. Our 
recommendations clearly identify the urgent needs of small 
businesses. The IRS needs to accelerate online accounts for 
businesses and tax professionals.

    On behalf of the entire ETAAC, thank you for inviting us to 
testify on this important topic.

    For more information on ETAAC's recommendations to the IRS, 
and those impacting small businesses, please see the 
committee's recent reports at https://www.irs.gov/uac/
electronic-tax-administration-advisory-committee-etaac-annual-
reports.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    Good morning, I am Roger Harris, President and Chief 
Operating Officer of Padgett Business Services. I have been a 
tax practitioner for over 40 years and have served on the 
Internal Revenue Service Advisory Council for four years and 
was its Chair for two of those years. I believe this experience 
gives me a balanced approach to small business taxation--I have 
had the opportunity to see what works and what doesn't work in 
the real world.

    For nearly fifty years, Padgett Business Services has been 
providing accounting, income tax planning and preparation, 
payroll and payroll tax services to thousands of small business 
owners through our network of over 200 offices across the 
United States. Our clients generally have 20 or fewer employees 
and are what some people would consider ``mom & pop'' 
businesses; however, based on recent studies almost 90% of all 
firms that have employees operate in our target market.

    Internal Revenue Service Audits of Small Businesses

    Padgett's business model brings us in contact with our 
clients throughout the year, not just during filing season. We 
assist our clients in establishing good accounting, 
recordkeeping and tax processing. This ongoing communication 
allows us to understand these small business owners well beyond 
just knowing their numbers. Our strong belief is the best way 
to survive an audit is to do everything within your means to 
never have one. Enforcement being a prerequisite for our tax 
system to work, there is a real possibility for all small 
business owners to one-day experience the pleasure of an IRS 
audit. Because of that possibility the second best way to get 
through the process is to have a clear, traceable record of 
financial transactions and of course to keep and organize 
receipts and invoices. A disciplined approach throughout the 
year generally results in less trouble with the tax man--local, 
state and federal.

    In those occasions where audits do arise, either for 
established clients or individuals new to the small business 
world, it's important to have a broad overview of the process.

    In general, there are two kinds of audits: Correspondence 
and Field. According to IRS data for 2014, the IRS conducted 
just over 291,000 Field Audits and over 950,000 Correspondence 
Audits. Both of these numbers have dropped considerably since 
their peak in 2010 of 391,000 and 1.173 million, respectively. 
Because Correspondence Audits tend to focus on more moderate 
income tax returns, and more basic issues that should not 
require a face to face meeting, mom-and-pop small businesses 
are much more likely to experience these than actually sitting 
across from an IRS auditor.

    Correspondence Audits, known within the IRS as Campus 
examinations, are the most basic type of audit and are 
conducted--as the name implies--by mail. They are usually 
triggered by software that compares returns against common 
trends and selects those that might be considered outliers.

    Field Audits typically occur when the IRS suspects major 
violations or they are part of an IRS research program. IRS 
auditors may ask that taxpayers come to their offices, but they 
typically visit the place of business at least once during the 
process.

    The vast majority of small business audits are 
Correspondence Audits. While they are intended to cover only 
simple issues, because of the IRS's focus on efficiency, they 
can be frightening to small business taxpayers, as well as 
being time consuming and expensive. In some circumstances when 
things go wrong, they can be devastating to a business.

    For a Correspondence Audit, the IRS will mail small 
business taxpayers either a Letter 566 or a CP 2000 notice. 566 
letters advise taxpayers that their returns have been selected 
for examination and will list documents such as receipts needed 
to verify positions on returns. The CP 2000 notice will contain 
adjustments based on third-party documents associated with the 
return. A taxpayer typically must respond within 30 days.

    If taxpayers agree with a notice, they simply sign the 
letter and return it with a check made out to the US Treasury; 
the problem arise usually when there is a dispute.

    When responses from taxpayers arrive at the Examination 
center, they sit in a queue at the IRS processing center for 
weeks or even months depending on the backlog--causing great 
anxiety on the part of taxpayers. Eventually, files are 
assigned to auditors. If all goes well, taxpayers will receive 
letters thanking them for their responses and telling them 
nothing more is needed. Sometimes, for whatever reasons, 
taxpayers do not receive these acknowledgements, forcing them 
or their representatives to hunt down their case files or to 
keep resending them.

    As expected a good number of these responses are denied by 
auditors due either to the quality of the records or because of 
a dispute over a matter of law. While many people believe tax 
law is black and white the reality is most areas are gray. This 
graying requires the law to be applied to the facts and 
circumstances that exist and are specific to that small 
business. Sometimes it is difficult to understand all of the 
facts and circumstances when the discussion is by 
correspondence.

    Unfortunately, it is not uncommon for a small business 
taxpayer to fail to respond to the original correspondence from 
the IRS in a timely manner. If taxpayers do not respond, the 
IRS issues a second notice, and if there still is no response, 
it will issue statutory notices of deficiency, known as a ``90-
day letter.'' At the end of that time, the IRS ``assesses'' the 
tax, including penalties and interest. Assessment establishes 
that taxpayers legally owe the amounts in question and then the 
cases are move over to collections.

    The problems associated with the audit process for small 
businesses can range from the mundane to the Kafkaesque. First, 
even the simplest correspondence audits consume time and focus 
for business owners to find, gather and mail the requested 
records to the auditor. The IRS often states ``but, it is up to 
taxpayers to keep proper records.'' This is correct but it 
doesn't make it any less burdensome. Even for the most 
organized among us, it takes time to locate and organize the 
correct documents. In addition to time requirements, the small 
business owner is usually under a great deal of stress. For 
many taxpayers this is their first dealing with the IRS in this 
way. Their minds wander to the horror stories they have all 
heard and they wonder how bad will this be and can I do this 
without help?

    Second, over 70 percent of small business owners rely on 
enrolled agents, CPAs or attorneys when they are contacted by 
the IRS. Because of this, even mundane correspondence audits 
can have significant cost, even for small disputes the cost of 
representation can easily exceed the taxes in question. Many 
business owners do the math and decide to just pay the extra 
tax instead of fighting it. For those instances when small 
businesses respond to correspondence audit notices and auditors 
reject their records or legal position, outside practitioner 
costs can quickly add up to thousands of dollars. Longer more 
complex field audits can be even more cost prohibitive for 
taxpayers.

    Another problem area for taxpayers that cost both time and 
money is when responses are seemingly lost or delayed in the 
system. The deadlines come and go and taxpayers believe that 
they have responded. The nature of the Correspondence Audit 
process is that it is almost wholly automated. If the computer 
at the examination campus does not know taxpayers have 
responded it continues to send out notices, deadlines will 
continue to not be met, as the IRS claim marches inevitably 
into assessment and collection. The IRS seems to have gotten 
better over the years at tracking cases but approximately a 
million cases go through Campus Examination centers each year. 
Cases can either be lost, not processed correctly, or they are 
not submitted in a timely manner. It is important to keep in 
mind that there is no one point of contact taxpayers or their 
representatives can call at the center to track down a 
particular case. This lack of a responsible human being within 
the bureaucracy is often the most frustrating aspect of the 
Correspondence Audit.

    A similar problem, except on the taxpayer side, is the non-
receipt of notices because taxpayers have moved, or for 
whatever reason are not receiving them. Taxpayers are 
blissfully ignorant. And on top of that the computer processing 
correspondence audits is blissfully ignorant as well, belching 
out notice after notice until cases end up in collections. 
Taxpayers can first learn they have a problem when their 
business checking accounts are frozen or another collection 
action has been taken. Once again unwinding these cases can be 
particularly time consuming and expensive.

    Finally, our franchise owners have experienced inconsistent 
quality in personnel. It is readily apparent that older more 
experienced auditors have the benefits of more training, a 
deeper understanding of the law, and more real life experience 
to guide them. Younger personnel only have a basic 
understanding of the law or do not have the experience that 
only time can provide. This lack of experience can cause 
delays, or even worse an incorrect determination. There has 
been a long term practice of allowing more complicated 
Correspondence Audits to be transferred to a local area office 
at the request of taxpayers. It has become very difficult to 
have these transfers approved. Similarly, requests to speak to 
managers and referrals to appeals can be ignored. The IRS is 
clearly experiencing a shortage of personnel and suffering from 
a lack of training.

    The small business taxpayer is also at the mercy of the 
knowledge and experience of their tax preparer or 
representative. Additionally, a less qualified tax preparer may 
be the very reason the small business owner finds themselves in 
the mess they find themselves in.

    At the end of the day no matter if it's the small business 
taxpayer, the tax practitioner, or the individual from the IRS, 
the cost of an extended process will be paid by the small 
business owner.

    So, what can the IRS improve even within the constraints of 
fewer resources? We believe they better facilitate the tracking 
of cases. If Federal Express can manage millions of packages 
all over the world, it seems that the IRS could come up with 
some sort of bar code or other tracking system that would allow 
both the IRS and the taxpayers to track correspondence 
responding to notices and the status of their cases. Most 
importantly, the IRS may need to be willing to assign cases 
earlier to an auditor or a team of auditors if the taxpayer 
believes such a request is in their best interest. And finally, 
leading to my next discussion, the IRS needs to drive a large 
part of the Correspondent Audit communications to the interest.

    IRS Future State Vision for Small Businesses and 
Practitioners

    The IRS vision for Future State could provide significant 
relief to many of the problems associated with Correspondence 
Audits. A taxpayer receiving one of these notices could simply 
activate an individual account through IRS.GOV, view their 
status online, scan the requested documents and email them to 
the examination campus, and respond to any follow ups. All of 
these communications would be done through a secure email 
system that would track all communications. If taxpayers are 
required to make payments, they can do so through their 
accounts or enter into installment agreements all online. We 
believe strongly that Future State accounts could provide their 
greatest return on investment in managing Correspondence 
Audits.

    Unfortunately, like most things there is good news and bad 
news. First, IRS plans to roll out online applications for 
individual taxpayers over the next year or so. Similar accounts 
for practitioners, however, will not be available for at least 
a year or two beyond that. It is important to keep in mind that 
over 70 percent of small businesses choose to have an enrolled 
agent, CPA or lawyer deal with notices from the IRS. This means 
that most small businesses will effectively be stuck in the 
current snail-mail process.

    Another considerable problem has to do with authentication. 
In order to access these accounts, taxpayers must provide 
information associated with their tax returns, their account 
numbers for a loan or credit cards, and cell phone numbers 
associated with their name and social security number. 
Unfortunately, for taxpayers who have not filed a tax return, 
or do not have loans or credit cards, or have cell phones 
provide by work or a family member, they will be effectively 
locked out of their own accounts. The IRS estimates that only 
30 percent of taxpayers will be able to authenticate themselves 
and use their accounts. Currently, unlike a typical financial 
institution, there is no 800 line planned that taxpayers could 
use to authenticate themselves over the phone.

    Additionally, the agency has no real plans for providing 
business level accounts. Luckily, most sole proprietors or LLCs 
filing a schedule C will be able to use the individual 
accounts. More complex small businesses organized as C 
corporations or partnerships will not have access to these 
accounts.

    Generally, because of the real threat of online hackers, 
the IRS is creating a very high authentication barrier to 
access online accounts. The reality is, however, that most 
taxpayers will rarely, if ever, need access to their accounts. 
They will try once, with 70 percent of the time failing to gain 
access, and then picking up the phone or using the U.S. Mail as 
their primary method of contract. While practitioners and 
businesses, both of whom have many more interactions with the 
agency, will do whatever it takes to go through the 
authentication juggernaut in order to access the accounts.

    Additionally, in the case of practitioners, they are well 
known to the IRS, having registered for a PTIN and a Central 
Authorization File number. Further, if necessary, the IRS could 
require a one time in-person authentication similar to the 
FAA's PreCheck system.

    In short, as the IRS moves forward with online accounts, it 
must include access by practitioners--enrolled agents, CPAs, 
and attorneys--and businesses in order for the strategy to be 
successful. The agency needs to find practical methods to 
authenticate Circular 230 practitioners and to authorize them 
to solve their clients' problems. Any solution that omits 
practitioners fails to recognize many taxpayers benefit from 
representation because they (a) do not want to represent 
themselves, (b) recognize they are not proficient enough to 
represent themselves, or (c) are afraid to engage with IRS 
enforcement staff. Forcing a portal to face taxpayers only will 
place taxpayers with practitioners at a disadvantage, as a 
result, practitioners will continue to be parked on phone 
lines, and it will significantly impede taxpayers' rights to be 
represented before the agency.

    We urge the Internal Revenue Service to consider four 
important policies:

          1. Develop robust individual and practitioner online 
        accounts at he same time.

          2. Allow Circular 230 practitioners to execute and 
        file authorizations electronically and immediately 
        represent those clients.

          3. Allow the use of electronic signatures for all 
        power of attorney and disclosure authorization forms.

          4. More expeditiously to provide access to business 
        accounts.

    Thank you for this opportunity to testify today and Padgett 
Business Services looks forward to working with the Committee 
on this crucial area of tax administration.

                                 [all]
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