U.S. GOVERNMENT PUBLISHING OFFICE

WASHINGTON :

For sale by the Superintendent of Documents, U.S. Government Publishing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

23–767 2017

IRS PUTS SMALL BUSINESSES THROUGH AUDIT

WRINGER

HEARING

BEFORE THE

COMMITTEE ON SMALL BUSINESS

UNITED STATES

HOUSE OF REPRESENTATIVES

ONE HUNDRED FOURTEENTH CONGRESS

SECOND SESSION

HEARING HELD

SEPTEMBER 14, 2016

Small Business Committee Document Number 114–072

Available via the GPO Website: www.fdsys.gov

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 F:\DOCS\23767.TXT DEBBIECongress.#13

with DISTILLER
(II)

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

WARREN DAVIDSON, Ohio

NYDIA VELA ́ ZQUEZ, 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

KEVIN FITZPATRICK, Staff Director

JAN OLIVER, Chief Counsel

ADAM MINEHARDT, Minority Staff Director

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 F:\DOCS\23767.TXT DEBBIE with DISTILLER
(III)

C O N T E N T S

OPENING STATEMENTS

Page

Hon. Steve Chabot ................................................................................................... 1

Hon. Alma Adams .................................................................................................... 2

WITNESSES

Ms. Kathy Petronchak, Director of IRS Practice and Procedure, alliantgroup,

LP, Houston, TX ................................................................................................... 4

Mr. Warren Hudak, President, Hudak & Company, Lemoyne, PA, testifying

on behalf of the National Association of Enrolled Agents ................................ 5

Mr. Don Williamson, Executive Director, Kogod Tax Policy Center, American

University, Washington, DC ............................................................................... 7

Ms. Jennifer E. Breen, Partner, Morgan, Lewis & Bockius LLP, Washington,

DC, testifying on behalf of the American Bar Association Section of Taxation ...................................................................................................................... 8

APPENDIX

Prepared Statements:

Ms. Kathy Petronchak, Director of IRS Practice and Procedure,

alliantgroup, LP, Houston, TX ..................................................................... 19

Mr. Warren Hudak, President, Hudak & Company, Lemoyne, PA, testifying on behalf of the National Association of Enrolled Agents ............... 27

Mr. Don Williamson, Executive Director, Kogod Tax Policy Center, American University, Washington, DC ................................................................ 32

Ms. Jennifer E. Breen, Partner, Morgan, Lewis & Bockius LLP, Washington, DC, testifying on behalf of the American Bar Association Section of Taxation ............................................................................................. 38

Questions for the Record:

None.

Answers for the Record:

None.

Additional Material for the Record:

None.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00003 Fmt 5904 Sfmt 0486 F:\DOCS\23767.TXT DEBBIE with DISTILLER
SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00004 Fmt 5904 Sfmt 0486 F:\DOCS\23767.TXT DEBBIE with DISTILLER
(1)

IRS PUTS SMALL BUSINESSES THROUGH

AUDIT WRINGER

WEDNESDAY, SEPTEMBER 14, 2016

HOUSE OF REPRESENTATIVES,

COMMITTEE ON SMALL BUSINESS,

Washington, DC.

The Committee met, pursuant to call, at 11:00 a.m., in Room

2360, Rayburn House Office Building. Hon. Steve Chabot [chairman of the Committee] presiding.

Present: Representatives Chabot, Luetkemeyer, Hanna,

Huelskamp, Gibson, Hardy, Kelly, Davidson, and Adams.

Chairman CHABOT. Good morning. The Committee will come to

order. We thank everyone for being here. Special thanks to our witnesses who have taken time away from their busy schedules to be

here with us today.

We are here today to follow up on the June hearing held by our

Subcommittee on Economic Growth, Tax, and Capital Access. In

that hearing, we laid out many systemic problems within the IRS

that are harming small businesses, including burdensome regulations, poor communication, and overly aggressive audits. Today, we

are focusing specifically on IRS audits and how small businesses

are treated, and often mistreated, during that process.

Members of this Committee regularly hear from constituents

about the IRS, and these constituents are not calling us to tell us

what a great job the IRS is doing generally. They are calling because they are desperate and frustrated, and they have good reason

to be oftentimes. I know members of this Committee have heard

from constituents who were audited so aggressively by the IRS that

they had to actually close their doors. Others are engaged in protracted audits that seem like vague fishing expeditions with no end

in sight. Most are hindered in their ability to actually run their

businesses because endless document demands from the IRS require so much of their time and resources. In many cases, small

businesses simply cannot afford to hire a professional to deal with

the demands of an audit.

The IRS has an obligation to provide small businesses with clarity and to treat all taxpayers with fairness and respect. The agency

has failed repeatedly in meeting this obligation to the people it is

supposed to be serving.

I do not need to tell you that a business forced to close its doors

can no longer pay taxes. It also cannot hire employees and create

economic growth in that community. Our current system is working oftentimes against small businesses when it should be working

for them. The IRS must do better.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
2

Today, we will be examining some of the issues and problems

with the current exam process. We will also be exploring some possible solutions.

I am looking forward to hearing from all of our witnesses here

today, and I would now like to yield to the ranking member, Ms.

Adams, for her opening statement.

Ms. ADAMS. Thank you, Mr. Chair, for holding this valuable

hearing, which follows up on the Subcommittee on Economic

Growth, Tax, and Capital Access hearing held in June. During that

hearing there was testimony from several witnesses about the difficulties associated with a tax audit. While tax audits serve an important purpose in the IRS’ role to enforce and collect taxes, the

auditing process can be confusing and intimidating for small business owners.

As we all know, our tax code is complex, resulting in simple and

innocent mistakes, mistakes that should not be met with a timeconsuming and costly audit. However, audits do serve an important

purpose. They are the primary tool used by the IRS in its effort to

reduce the tax gap, which is caused by nonfiling, underreporting,

and underpayment. In total, the gap is over $450 billion, even with

voluntary compliance at 84 percent. This lost revenue is unacceptably high, but because of IRS enforcement actions, like audits, an

additional $50 billion is recovered. The recovery of this amount

proves just how important audits can be, but it should not come at

the expense of our Nation’s job creators. Rather, the IRS should be

tasked with doing all that they can to improve voluntary compliance before audits are required.

Working with the taxpayer to correct mistakes is quintessential

to a thriving tax system. Accordingly, the IRS has made strides to

improve its relationship with taxpayers through increased customer service and outreach. Yet improvements can always be

made.

Today’s hearing will give us another opportunity to learn what

enhancements can be performed and modifications made to auditing techniques to reduce the burden on small business owners.

These recommendations are critical to improving tax compliance

and closing the tax gap. They also serve a very important purpose

in assisting small firms. We often hear reports of small employers

closing their doors due to an audit. They just could not recover

from the process or the expense. In many cases, the owner’s energy

is shifted from maintaining or growing the businesses toward meeting IRS demands to substantiate records. This problem is compounded by that of the great financial cost of hiring an outside professional, which many businesses do when facing an audit. Such

burden makes it essential to understand how the IRS’ primary collection tool, audits, impact a small business who is attempting to

comply with complex rules. While a small employer has a duty to

pay taxes and keep an efficient recordkeeping system, the IRS also

owes a duty to that taxpayer to conduct the audit in a manner

which is clear, ensure the employer understands his rights or her

rights during an audit, and to prevent harming the small business

from aggressive tactics. So I look forward to learning more about

the auditing process and what we can do to help both the IRS modSBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
3

ify and update its practices and small business taxpayers do a better job by complying and recordkeeping.

So I would like to thank the witnesses today for the time that

they are taking out from their busy schedules to testify.

Thank you very much, Mr. Chair. I yield back.

Chairman CHABOT. Thank you. The gentlelady yields back.

And I would now like to explain our timing rules here. And before that, Committee members who may have opening statements,

we would ask that they submit them for the record.

We operate under the 5-minute rule. You will each get 5 minutes

to testify. We take 5 minutes to ask questions, and there is a lighting system to assist you. The green light will be on for 4 minutes

and then the yellow light will be on for a minute to let you know

that you have got about a minute to go, and then the red light will

come on. And if you can stop near that I will appreciate it. We will

give you a little time, but not a whole lot.

And I would now like to introduce our very distinguished panel

here this morning. Our first witness is Kathy Petronchak, who is

director of the IRS Practices and Procedures for alliantgroup in

Houston, Texas. In that capacity, she provides advisory assistance

on a wide range of issues related to IRS procedures and represents

clients before the IRS. Ms. Petronchak previously had a 29-year career with the IRS in various positions, most recently serving as

commissioner for the Small Business/Self-Employed Division. We

welcome you here and appreciate your testimony.

Our second witness will be Warren Hudak, president of Hudak

and Company in Lemoyne, Pennsylvania. Hudak and Company is

a small business that provides comprehensive tax services to other

small businesses. Mr. Hudak is an enrolled agent and CPA and has

owned Hudak and Company for the last 20 years. And we welcome

and appreciate your testimony this morning, Mr. Hudak.

Our third witness today is Don Williamson, executive director of

the Kogod Tax Policy Center, Kogod School of Business at American University. Professor Williamson teaches a number of subjects

related to taxation. He is also a partner in LaMonaca and

Williamson, a small Falls Church, Virginia, firm that specializes in

accounting, auditing, and tax preparation for small businesses, and

we thank you for being here this morning.

And I would now like to yield to our Ranking Member for the introduction of our final witness.

Ms. ADAMS. Thank you, Mr. Chair.

It is my pleasure to introduce Ms. Jennifer Breen. Ms. Breen is

a partner at Morgan Lewis where she concentrates on tax controversy and planning matters with an emphasis on audits and IRS

administrative proceedings. Before joining Morgan Lewis, she

worked at Mattel, Inc., PricewaterhouseCoopers, and as a lawyer

with the IRS Office of Chief Counsel. She received her juris doctorate from the University of Houston Law Center. Welcome, Ms.

Breen.

Chairman CHABOT. Welcome, Ms. Breen.

And Ms. Petronchak, you are recognized for 5 minutes.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
4

STATEMENTS OF KATHY PETRONCHAK, DIRECTOR OF IRS

PRACTICES AND PROCEDURES, ALLIANTGROUP, LP; WARREN HUDAK, PRESIDENT, HUDAK & COMPANY; DON

WILLIAMSON, EXECUTIVE DIRECTOR, KOGOD TAX POLICY

CENTER, AMERICAN UNIVERSITY; JENNIFER E. BREEN,

PARTNER, MORGAN, LEWIS & BOCKIUS LLP

STATEMENT OF KATHY PETRONCHAK

Ms. PETRONCHAK. Chairman Chabot and Ranking Member

Adams, thank you for inviting me to testify. It is an honor to provide comments today for your hearing.

I interact with small businesses in my work with alliantgroup,

a tax consulting firm that ensures small and midsize businesses

are able to avail themselves of the tax benefits provided by Congress. I also spent almost 29 years at the IRS, and so this gives

me a unique perspective into the examination process. My testimony focuses on challenges that small businesses face and what

the IRS can do to improve the examination process.

Before I go into specifics, let me just say that much of the problem we see today is exacerbated by a lack of adequate funding for

the IRS, a trend that needs to change. With respect to the IRS

exam process, we believe there is some inconsistent treatment of

small versus large businesses, as well as differing procedures being

used in audits of these businesses. It is important to remember

that America’s small businesses have needs, interests, and resources that may differ significantly from those of larger businesses. However, some of the procedures utilized in large business

audits, as outlined in my testimony, provide added transparency

that would bring greater fairness to the small business examination.

I raised five issues in my testimony. I would like to briefly focus

on two of those issues: specialist assistance and third-party contacts.

With regard to the first issue of specialist assistance, in an IRS

audit there are instances when specialists are needed. While this

assistance is necessary, the process is often mysterious and the taxpayer is left in the dark regarding who is making decisions. Our

experience includes situations where a revenue agent who lacks expertise may rely on a technical specialist to make the decision in

an examination, and due to staffing levels, the specialist may not

have adequate time to fully assist, so revenue agents have only

consultations with them. In some cases, the taxpayer is not aware

that this has occurred or has not had an opportunity to discuss the

specialist’s technical conclusions. My firm has encountered situations in which the taxpayer did not know this assistance happened

until a FOIA request was made in preparation for appeals.

Another recent experience creates a greater concern. We recently

encountered a case in which the agent told our client that he was

going to sustain a majority of the tax credit at issue. However, the

agent then told our client he had to have a technical specialist review his final report. Weeks later, the agent told us that the specialist had directed him to allow little of the tax credit. The agent’s

manager informed us that he did not have the authority to reverse

the specialist’s decision, and when a conference call was requested

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00008 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
5

with these specialists, we were advised that they would not participate. This behavior is particularly troublesome if the specialist is

making the ultimate decision. The ideal situation is where the taxpayer is aware that a specialist is assigned and has access to that

individual.

The second issue I want to address is third-party contacts. The

IRS often reaches out to third parties that are not under audit, but

who may have needed information on the audited taxpayer. Such

contacts are permitted in certain circumstances, but the IRS must

give the taxpayer reasonable notice.

We are seeing increased use of questionable third-party contacts.

In our experience, it appears the IRS is increasingly using these

contacts when they already have the information, and other times

when they have not, as required, first requested the information

from the taxpayer. The IRS seems reckless in its third-party contacts, disregarding the adverse impact on the business of the taxpayer as the IRS tells customers, vendors, former employees, and

others that it is examining the taxpayer.

This trend has been noticed by others doing IRS oversight. The

National Taxpayer Advocate, in its 2015 annual report to Congress,

raises a number of points, including that the IRS is not always effective in providing notice to taxpayers, oftentimes only providing

them Publication 1, Your Rights as a Taxpayer, at the beginning

of the exam and not at or anywhere near the date of a third-party

contact. The practice of issuing third-party contacts should be

modified to ensure notice and an opportunity to respond prior to

the time a third-party contact is to actually be initiated.

In closing, I commend the Committee for its work on oversight

and ensuring that small businesses receive fair treatment and good

service from the IRS, and alliantgroup looks forward to working

with the Committee to further improve tax administration.

Chairman CHABOT. Thank you very much.

Mr. Hudak, you are recognized for 5 minutes.

STATEMENT OF WARREN HUDAK

Mr. HUDAK. Chairman Chabot, Ranking Member Adams, members of the House Small Business Committee.

Chairman CHABOT. You might want to pull that mic down just

a little bit. There you go. Thanks.

Mr. HUDAK. I was thanking everyone for the invitation today.

Chairman CHABOT. Sure.

Mr. HUDAK. My firm provides comprehensive tax services, including tax preparation, planning, and representation before the

IRS. We work with all categories of small business: sole proprietors, partnerships, and S-corporations. Our representation services

include audits, negotiating installment agreements, offers-in-compromise, collection due process hearings, appeals, and penalty

abatements.

Today, I share with you my perspectives, and I participate here

on behalf of the National Association of Enrolled Agents.

Over the last 5 years, we have witnessed a significant shift in

the number and quality of IRS audits. This shift has coincided with

a dramatic decrease in funding. We, too, have seen the quality of

audits go down with the funding.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
6

In short, the agency is struggling to rely more on automated and

faceless decisions based less on field audits and many on just

scrubbing of third-party information.

Importantly, IRS examinations range from simple issuance of an

IRS notice asking for clarification of a single item, but oftentimes

that leads to unintended consequences, the runaway audit that was

mentioned earlier. As resources dwindled, we have seen that increase in techniques. For instance, 1099Ks. We recently had a client who triggered an audit because their revenue that they reported did not coincide with the 1099K. They had an entity change

during the course of the year, had two entities and properly reported all income on both entities. Once that was presented to the

auditor inside a very short period of time, in 5 minutes, the auditor

was satisfied that all of the income was reported within IRS tolerances. But that did not stop. It turned into a 6-month audit with

requests from third parties and infringement on the interests of the

client for their ability to have privacy.

There seems to be more and more of a win-win culture for the

IRS. It is not to get at the actual correct tax, but the maximum

tax. In a recent call with the IRS, we had presented a Rev. Proc.

to them to abate a penalty. Before I could even get the words ‘‘Rev.

Proc.’’ out, they said, ‘‘we have it’’, and they accomplished the task.

When asked why do you not offer this to other taxpayers when

they call in, they said, we do not want to lead the customer. And

that was a problem. Why is the IRS in these terms not being more

helpful? Why are they not making them aware of the provisions of

the code to allow them to comply with the law in the best interest

of the taxpayer? Why would it be always the best interest of the

government maximizing revenue?

Training does make a difference. Increasingly, we are finding requests for things outside the scope of the audit, and we have forced

audits into appeals to allow us the latitude of a fresh, independent

look. Many of our clients come to us after there is a controversy,

and what we find is at that point in time they are under the misguided impression that the IRS is there to assist them and represent them.

And that leads me to really my closing. The Taxpayer Bill of

Rights is an awesome, awesome law. It would clear up a lot of the

problems we have in the audit. Along with the Pledge of Allegiance,

the ITS agents when they get up in the morning should recite the

Taxpayer Bill of Rights. Nina Olson in the Taxpayers Office did an

awesome job in advocating for that. She deserves all the credit in

the world for accomplishing that. For small businesses in audits

and compliance, we really should have more safe harbors, like the

home office deduction. That was incredible. It simplified the recordkeeping and, quite frankly, you are probably collecting close to the

right amount of revenue.

Training in the IRS’ future state we are so excited about, but we

want to be cautious. To my earlier comment, with the IRS’s future

state, during that taxpayer interaction online, at some point during

that interaction we have to be careful to be clear that the IRS is

not their representative. Thank you.

Chairman CHABOT. Thank you very much.

Mr. Williamson, you are recognized for 5 minutes.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
7

STATEMENT OF DON WILLIAMSON

Mr. WILLIAMSON. Chairman Chabot, Ranking Member Adams,

and members of the Committee, thank you for the opportunity to

testify on the issues small businesses confront when they are audited by the Internal Revenue Services.

My name is Don Williamson, and I am a professor of taxation at

American University’s Kogod School of Business, where for the past

32 years I have been the director of the school’s Masters in Taxation program, and for the past 27 years have had my own tax

preparation and tax planning practice, LaMonaca and Williamson,

CPAs, in Falls Church, Virginia, which specializes in representing

small businesses and their individual owners before the Internal

Revenue Service.

Mr. Chairman, the majority of small business audits are conducted by correspondence. While this approach may work when the

taxpayer has failed to report income reported to the Internal Revenue Service by third parties on Form 1099s, problems arise when

the IRS is seeking verification of or more detail about the information on the return itself. In these cases, taxpayers’ written responses to notices often sit at the IRS processing centers for

months until assigned to an auditor. The auditor will often find the

taxpayer’s response to be insufficient, setting off a new round of

correspondence, consuming yet several more months.

Furthermore, because small business owners usually rely upon

enrolled agents, CPAs, or attorneys when they are contacted by the

IRS, significant costs arise for even insignificant inquiries, such

that many business owners simply concede to a proposed adjustment and opt to pay the extra tax.

These problems were most recently illustrated in my own practice where a client living in Texas was contacted by the IRS Philadelphia Service Center regarding the income and expenses claimed

on his Schedule C. The letter did not provide the name of any person at the IRS to contact and simply requested copies of all the taxpayer’s books and records. The taxpayer, at considerable cost of

time and professional fees, assembled the requested information in

large boxes which were mailed to the address requested. After 4

months, the client received a one-page letter with the attached

page statement declaring the taxpayer’s business was a hobby, resulting in a substantial proposed assessment of tax, interest, and

penalties. At that point, my client had already incurred substantial

fees in responding to the initial request for information, and I

frankly advised him that taking the matter to the appeals division

would cost even more. Nevertheless, my client insisted that I file

a protest showing that his business was not a hobby. After several

more months and several letters, while I was able to transfer the

case from Philadelphia to the Appeals Office in Texas where the

taxpayer resides, we received yet another letter asking again for a

complete record of all the taxpayer’s travel and entertainment expenses with schedules reconciling the individual expenses to the totals on the return, documentation which we had already provided.

Nevertheless, we again began to prepare new schedules, cross-referencing each receipt to the totals on the return. However, before

we could complete the work, the client received a one-paragraph

letter dropping the case. As a result of this exercise that lasted for

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
8

almost a year, the client incurred professional fees that exceeded

the initial adjustment in tax proposed by the IRS having not contested the matter.

The substantial cost of this case not only to the taxpayer but indeed to the IRS itself illustrates the limits of correspondence audits. Because most correspondence audits initially have one point

of contact at the IRS to discuss the matter, taxpayers and their

representatives simply hope they are providing the correct information. At the very least, the IRS must better facilitate the internal

tracking of correspondence audits and end the process of courtesy

disconnects when a taxpayer is on hold for more than 45 minutes

when calling the IRS. In addition, the IRS should consider assigning a case to an arbiter if the taxpayer requests such an assignment at the time of first contact.

Finally, if the IRS can significantly improve its online capabilities, and more importantly its security over its online functions,

taxpayers could respond to email communications with specific IRS

personnel.

Thank you for the opportunity to testify today, and I look forward to working with the Committee on this critical problem of tax

administration.

Chairman CHABOT. Thank you very much.

Ms. Breen, you are recognized for 5 minutes.

STATEMENT OF JENNIFER E. BREEN

Ms. BREEN. Thank you. Thank you for the invitation today to

discuss the IRS’s approach to the audits of small business taxpayers.

My name is Jennifer Breen, and I am the vice chair of the Administrative Practice Committee of the American Bar Association

Section on Taxation. I am also a partner with the law firm of Morgan, Lewis and Bockius, where I represent taxpayers before the Internal Revenue Service in audits and appeals.

I am here today on behalf of the ABA Tax Section, so my testimony today should not be construed as representing the policies of

the larger association.

In the IRS’ 2015 fiscal year, it closed approximately 1.3 million

examinations, of which over 300,000 were examinations of small

business returns. The audits of these small businesses were conducted by the IRS’ SBSE, or Small Business/Self-Employed Division.

When SBSE determines that a return warrants an audit, it is

sorted for one of two possible types of audit: a correspondence audit

or a field audit. Of the examinations completed in 2015 for small

businesses, over half were correspondence audits. A correspondence

audit is one that is conducted exclusively by mail. The service center or campus will first mail a standard boilerplate letter to the

taxpayer to notify them that they have been selected for examination and to provide them with a list of documents that they will

need to provide to be verified. Now, these notices are computer-generated. There is virtually no customization with respect to the taxpayer, the taxpayer’s business, or the issues that may have been

the reason that it was selected for examination in the first place.

This initial generic request will require the taxpayer to provide a

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
9

variety of records to the IRS, such as the work papers that were

used to prepare the return, the taxpayer’s general ledger, bank

statements, canceled checks, and deposit slips. A taxpayer must respond within 30 days. They must mail the requested documentation to a general address that is listed on the notice, and should

the taxpayer have any questions regarding the initial letter, they

are directed to call a general number or write to a general address.

Once a taxpayer responds, the correspondence is then placed in a

queue and then will be assigned to a campus examiner. This process can take months, and sometimes taxpayers are forced to resend

the correspondence that they originally sent as the information

that was mailed cannot be located by the IRS.

Unfortunately, in many examinations, the quality of a taxpayer’s

response to the requests that are made by the IRS, as well as the

agent’s understanding of the position that has been taken by the

taxpayer, is impacted by the fact that all the discussions between

the two parties are held exclusively through correspondence.

Now, field audits, on the other hand, are generally conducted

through direct contact with the taxpayer through a combination of

face-to-face meetings, telephone calls, and written correspondence.

Now, at the outset of one of these audits, the taxpayer will be provided with a request for documents that the agent has identified

for review. Now, while these requests are often customized, they

also contain boilerplate items that agents are required to seek regardless of the issues that the agent has identified and regardless

of the type of business that the taxpayer is operating.

Regardless of the type of the examination that a small business

taxpayer receives, establishing good accounting and recordkeeping

will help a taxpayer prepare for an examination should one arise.

Now, if one does, it is important to thoroughly and timely review

all notices and requests for information that you receive from the

service. While the IRS outlines the examination process on its

website and in the various publications, for taxpayers, this process

can be confusing. Taxpayers are often unsure about what to expect

and how to proceed.

Unlike the large business and international, the LB&I Division,

SB/SE does not have a public examination process policy statement

whereby the division provides an organizational approach for examinations from first contact through the final stages of an issue

resolution, nor does it have directives requiring discussions with

taxpayers around certain examination procedures, such as the

issuance of requests for information or documents.

Now, last year, the IRS, including the SB/SE, announced its Future State Initiative. Through this initiative, SB/SE has indicated

that it is looking for ways to find better and more efficient manners

of doing business. It has identified possible changes to include the

use of digital notifications, possibly examination at earlier stages

shortly after returns are filed, the use of limited issue examinations based upon specific aspects of a taxpayer’s return, and the

ability for taxpayers and their representatives to exchange information electronically with an agent during the examination process.

Now, examinations do provide the IRS with an important tool to

identify noncompliance. Efforts such as these that have been idenSBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
10

tified should lead to improvements in the process and help the IRS

examine taxpayers more effectively and efficiently.

Thank you for the opportunity to be here today and to provide

the Committee with this information.

Chairman CHABOT. Thank you very much. We appreciate the

testimony of all the members of the panel here. And I recognize

myself for 5 minutes to begin the questioning.

I will start with you, Ms. Petronchak, if I can.

You mentioned that one of your clients did not even know that

a specialist was advising on the audit until a FOIA request was

made. How and why would a taxpayer ever need to file a FOIA request to receive information related to their own audit? That

sounds pretty outrageous to me.

Ms. PETRONCHAK. That is a good question. Let me try to be

brief in answering it.

Chairman CHABOT. Take as much time as you need.

Ms. PETRONCHAK. A strategy used by some controversy professionals would be to file a FOIA request to ensure that they have

all the information from a case file, particularly, you know, if they

want to ensure they are adequately representing their client in an

appeal. So that may be a large issue. Or SB/SE’s work papers are

not quite as thorough as those used by the large business division,

so they have a lot of lead sheets. So trying to get all the information and understanding from a file, exactly who they were talking

to and how they came to conclusions would be very important. And

they would not get the file unless they asked for it.

Chairman CHABOT. Okay. All right. Thank you very much.

Mr. Hudak, I will turn to you at this point. What would you identify as the single biggest problem with the IRS exam program as

it relates to small businesses, and how would you address it? If

there are two, which one? You can take two if you like.

Mr. HUDAK. Well, that is a good question. I think third-party

contact is a big ideal. Increasingly, we are seeing blanket requests

to banks, blanket requests to third-parties. We are also seeing an

increased number of improper contact with taxpayers. When a

properly executed power of attorney is stopping by to drop off something, the taxpayer says, well, you should give that to my representative. He said, no, that is okay. You can have it. And the

question is what was discussed? That is a big problem.

But increasingly, the IRS will be using this future state concept

where you get a notice, the taxpayer is encouraged to create an online account, and they chat or banter back and forth with the IRS.

And if you look at the taxpayer advocates’ foldouts on that process

and what it looks like, one comes to the realization at some point

during that, the taxpayer gets the feeling they are being represented by the IRS and that is simply not the case. And there is

some concern with the IRS’s future state as it pertains to representation.

I think it can be satisfied in a number of ways. I know NAEA,

National Association of Enrolled Agents, has asked to bring back

the ability to execute powers of attorney online. We did that before.

I think the Office of Chief Counsel seems to think there is a way

to do that safely and with confidence.

Chairman CHABOT. Thank you very much.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00014 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
11

I guess similar to that, if I could go back into my earlier career

of practicing law, I used to handle all kinds of stuff, but one thing

was in the domestic relations area. In Ohio, we have divorces and

dissolutions. And a dissolution is basically the parties coming in,

they usually come in together, but you cannot represent as an attorney both parties. You have to be clear. They have to sign saying,

you know, I know he represents this person and not this person.

You have the right to get another attorney. So I could see it is very

significant for folks to know that the IRS is not necessarily your

friend, maybe you instinctively know that when you are born as an

American, but certainly, when you are dealing with them, you want

to make sure you realize they are not representing you.

Mr. Williamson, I will turn to you at this point. What are some

of the most persistent concerns you have encountered in your representation of small businesses in the conduct of the exam process?

And I know you already dealt with some of them in your statement

and if you want to expand upon those.

Mr. WILLIAMSON. Thank you. It is basically time. This is what

really frustrates my clients. In the testimony I gave to you, we

were looking at a very simple exchange of information. Had I been

able to speak with someone, even on the telephone, I am sure I

could have settled this scenario I just described to you in minutes;

instead, it took a year. And so that is what really frustrates clients

is time.

Also, in small business audits, the agent will show up, begin the

audit, walk away and you do not see them for 6 months. And then

suddenly you have presented to you an extension of a statute of

limitations.

So my clients want to do business and they want to do it efficiently and as quickly as possible, and they do not need an IRS

audit hanging over their heads for 18 months to 2 years when

something could be settled very quickly.

Chairman CHABOT. My time has almost run out here, but you

mentioned before about the person who was being audited and contested it and by the time they got to the end of it, all the expenses

they had far exceeded the amount that the IRS said that they

owed, which was wrong. But so you are in a situation where even

when you win, you lose.

Mr. WILLIAMSON. You are absolutely right. I cannot tell you

how often a client will receive a notice for a few hundred dollars

and he contacted me to get a power of attorney to exchange information. He will pay it.

Chairman CHABOT. Yeah. It should not be like that. It absolutely should not. And thank you for shedding some light on that.

My time has expired. The ranking member is recognized for 5

minutes.

Ms. ADAMS. Thank you, Mr. Chair.

Small businesses are the backbone of America. They are the entrepreneurs and the job creators that are necessary to stimulate

our economy. We know that tax compliance is burdensome, both

from a financial and administrative perspective. So in order to be

adequately prepared in case of an audit, what is the best practice

for a small business when it comes to tax records? Ms. Breen?

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
12

Ms. BREEN. Yes. So as I mentioned a moment ago, I think one

of the keys is good accounting and recordkeeping. But I think that

it is also important to maintain those records in real time. Tax returns are prepared after the close of the year, and oftentimes,

many months after the close of the taxable year. And so it is important that as expenses and items of income are accounted for or recorded, the documentation to support that is kept in real time.

When an audit occurs, it often can occur up to 2 to 3 years after

the expenditure or the item of income was received. And so, therefore, it becomes even harder for a taxpayer to pull together those

records. So it is important that those records are maintained in

real time and in a way that a taxpayer can access them quickly

should an audit occur.

Ms. ADAMS. Thank you.

Ms. Breen, audits are the primary collection tool for the IRS in

their effort to close the tax gap. So what makes this the most attractive tool for the IRS, and how successful is it at recovering unpaid taxes?

Ms. BREEN. Well, I think that it is the most successful tool because it does bring success. And if we look at the statistics that the

IRS releases each year about the filing season, last year the IRS

reported that in 2015, over 25 billion in total recommended taxes

were determined pursuant to that audit cycle, and of that 25 billion, approximately 4 billion was associated with small businesses.

As part of the IRS LB&I and SBSE future state, the other operating divisions are announcing other types of treatment streams, so

ways that they could identify noncompliance or seek to enforce

compliance in other ways outside of the traditional audit. If those

are successful, we may see those expand into the SBSE Small Business Division as well.

Ms. ADAMS. Thank you.

The idea of individualized taxpayer accounts seems to be a popular notion. How could prioritizing accounts of enrolled agents,

CPAs, and tax attorneys be helpful to small business clients as it

pertains to tax filing and auditing?

Ms. BREEN. Well, the IRS has identified the need to expand its

use of technology as a way to enhance the use in examinations and

the way that it interacts with the taxpayer. And one of those ways

would be to allow taxpayers and their representatives to exchange

information electronically with the IRS. Now, these types of abilities could improve the communication between the two parties, and

it could help to minimize some of the delays or missing documentation that sometimes occurs when you are communicating with the

IRS and something I think that when any of us are communicating

with the IRS we want to try to avoid.

Ms. ADAMS. Okay. Because data security is extremely important, considering the hack of IRS accounts, can you address how we

can keep these accounts safe, particularly when these professionals

are responsible for assisting small business clients?

Ms. BREEN. Absolutely. I think that it is indisputable that

cybersecurity and fraud detection are integral to the IRS’s mission

of enforcement and service to American taxpayers. The ABA tax

section has consistently supported adequate funding of the IRS. We

believe that improvements are needed that require substantial inSBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
13

vestment, and we encourage Congress to provide that sufficient

funding so that the service can implement those very important

initiatives in the use of technology to better service taxpayers.

Ms. ADAMS. All right. I am going to yield back my time, Mr.

Chair. Thank you.

Chairman CHABOT. Mr. Gibson?

Mr. GIBSON. Thanks, Mr. Chairman. I appreciate the panelists.

I must say I am somewhat concerned by some of the testimony

to date so I want to follow up, particularly with regard to due process. It was mentioned in one example we had a case where a specialist provided insight. The IRS said, well, this is the determination and there is really nothing that I can do about it. My question

explicitly is where are we now in terms of current law on due process? And what recommendations would you have? So to put a finer

point on the question, can the individual, can the small business,

for example, call for a face-to-face meeting with all the parties

where they can sit down with records and actually sort through?

Is that within the Bill of Rights? I mean, is that within the current

state of play that a small business owner can call for such a meeting?

Mr. WILLIAMSON. No. Basically, in my case that I recited to

you, there was no right for me to sit down with someone from the

Internal Revenue Service and go through these documents until I

got to the Appeals Division, and then they did assign an appeals

officer. Until then, in these correspondence audits it is pretty much

back and forth. Now, indeed, after a while in a correspondence

audit there will be someone assigned to the case at the service center, but good luck trying to reach them.

Ms. PETRONCHAK. Congressman, I would say that in the Taxpayer Bill of Rights, it talks about the right to be informed. So

maybe it does not go far enough in the Bill of Rights for the situation I described in my testimony. And I used ‘‘specialist’’ generically. It could be a counsel employee who is advising the agent. It

could be a subject matter expert in LB&I from an issue practice

group. It could be an engineer or it could be a technical specialist

within SBSE. Whoever that is that is working on the case, it

should be more transparent to the taxpayer and they should be at

those face-to-face meetings.

Recently, I was at a client site. We were having a meeting, and

the SBSE agents were doing great jobs interviewing the taxpayer

about issues, but there was a specialist that had been involved in

the examination, and my understanding is that the specialist, he

could not come to the interview. Now, I think it would have been

helpful for that specialist to be at the interview to follow up and

ask the pertinent questions in making a final decision on that case.

Mr. GIBSON. So to understand, there is not clarity at this point

as to what the legal definition of ‘‘informed’’ means. That is what

I am hearing from the panel at this point.

Ms. PETRONCHAK. I would agree with that. I am not aware of

it.

Mr. HUDAK. I would agree with that. Very much so. I do believe

that the Taxpayer Bill of Rights, though, is a document that has

to be asserted. And if the representative is not involved and the

practitioner is not involved, oftentimes the Taxpayer Bill of Rights

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
14

are not being asserted. The IRS is not offering this. It has to be

asserted from the taxpayer or the representative.

Mr. GIBSON. Thank you. And to follow up on your original testimony, which I heard very loud and clear, so if you have a small

business owner, they are working really hard hours, they are just

trying to survive and flourish, and they get this notification of

audit, is it clear when they receive that that they have the right

to counsel? In other words, the IRS is not their advocate in this,

is that clear?

Mr. HUDAK. There is an insert. To the extent they understand

the notice in the first place, yes, they are notified. But they are

scared. Their records are usually a mess because they are behind

a grill 12 hours and at the end of the day they have got to reconcile

their tips in their credit card machine. Oftentimes it just does not

happen. It is not that they do not care. It has nothing to do with

that. It has everything to do with this unique nature of a small

business.

And I alluded to the safe harbor with the home office deduction.

We need to do more things like that to relieve these burdens off

of small businesses.

Mr. GIBSON. I had one other question, too. It was concerning to

me with regard to the notification of third parties. It can be intimidating. It can be friends and colleagues. Is there some kind of provision now for notification at the end of this that there has been

a closed case and there have been no discrepancies found?

Ms. PETRONCHAK. Congressman, I would say at the end of a

case, yes. I think Jennifer addressed in her testimony there are reports at the end. But with regards to the——

Mr. GIBSON. But third parties though were notified?

Ms. PETRONCHAK. The third party does not get that. It only

goes to the taxpayer.

Mr. GIBSON. So the onus is really on the taxpayer to say, look,

I know you got contacted, but I was cleared. You know, there were

no issues. Does the taxpayer get a full listing of all the third-parties that were contacted?

Ms. PETRONCHAK. They can request a list. I think in the Taxpayers Advocate’s Report she addresses the notification process and

the requirements in the law that periodically a list should be provided. The IRS has chosen not to provide that periodic list. So unless a taxpayer requests a list, they do not get one.

Mr. GIBSON. And I see my time has expired. Thank you, Mr.

Chair.

Chairman CHABOT. Mr. Davidson?

Mr. DAVIDSON. Thank you, Mr. Chairman. Thank you for the

witnesses who could be here today. It is just an honor to talk with

you about concerns small businesses have in interacting with the

IRS.

I spent a lot of time as a small business owner myself, and would

like to continue our track record of not being audited by the IRS,

as I think all small business owners would like to do.

When that does happen, you have all addressed some concerns

about how that process is for the small business owner. And I am

curious if you have been able to discern how the IRS is measuring

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
15

the auditors? What are the metrics? Does anyone have that answer?

Ms. PETRONCHAK. Congressman, it has been a while since I

looked at it, but I think in their performance elements they are

measured on their taxpayer relations, their technical knowledge of

a case, and how they conduct the audit. So it would be subjective

things that a manager reviews and how they are evaluated.

Mr. WILLIAMSON. Technically, since the 1990s and some of the

scenarios that arose in the 1990s, they made a big deal out of it

is not a race to how much revenue each agent can collect versus

the other agents. It is how quickly you can settle your cases and

how efficient you are, and not how much revenue you have gained.

It is my understanding. I have not been on the other side of the

table myself to know these things.

Ms. BREEN. Historically, there were also metrics about case closures. So agents were evaluated on the number of cases they could

get closed, and currency was something that was very important.

The IRS with its future state has announced perhaps it is stepping

away from closure as a metric and looking more to cases that have

been opened.

Mr. DAVIDSON. Okay. Thanks for that.

Can anyone answer what the average cost in terms of dollars,

hours, and duration an audit is for a small business?

Mr. WILLIAMSON. Congressman, as I said in my testimony, I

cannot specifically say so many dollars. I will simply say it is excessive. If we can communicate with the Internal Revenue Service and

show them in my cases here are the books, here are the records,

what questions do you have, let us settle them today, I do not have

to have a case on my desk for a year. Nine out of 10 of my cases

is simply documentation, and I can show the IRS the documentation if I can have the meeting or have the telephone call and we

can look at things together.

Mr. DAVIDSON. Okay. And now, there are increasingly other

factors linked besides just tax compliance for small businesses, and

of particular note is Obamacare. And in Congress’ appropriations

to the IRS, we historically have not funded the IRS specifically to

enforce Obamacare audits, but the IRS has diverted a significant

amount of money to do that. How has that impacted the audit process for small businesses? And how does that relate to the IRS’ explanations for their ability to turn these things around in a timely

manner?

Mr. WILLIAMSON. Obamacare and the returns that are required with it in the 8000 series have only been around for a couple of years, so I do not think you have an audit history where you

can determine how much time is being spent and how the returns

are being selected based upon the forms that the taxpayer is filing

with respect to their payments of medical care insurance. So we

are just not there yet to get a handle on how onerous the audits

will be of issues dealing with Obamacare.

Mr. DAVIDSON. In fiscal year 2015, the IRS spent $462 million

of its budget on Obamacare enforcement, so somebody must be getting enforced.

Mr. WILLIAMSON. Somebody is.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
16

Ms. PETRONCHAK. Congressman, the only thing I can say is

when the laws are passed, usually I found that it was a couple of

years before you started seeing revenue agents addressing specific

issues when the laws were passed; however, there is a lot of work

up front with computer systems or counsel and guidance that go

into it, so I can only guess that maybe that is where the money

went.

But to Mr. Williamson’s point, it usually is a few years before

you actually start seeing examination activity related to that.

Mr. DAVIDSON. Just one last question.

I thought it was interesting to say, hey, you actually have to go

through the process and note a request, you know, a copy of other

parties that have been notified. From the small business perspective, are there any other things that we might say, hey, this just

ought to be standard practice that you would advise?

Ms. PETRONCHAK. I will start. Obviously, the third-party contact process needs to be looked at closely, and I think Ms. Olson’s

views on those speak well to that. I do not know if the Committee

can look at it.

The other thing, I would not want to lose fact—on the fact-finding part. I mean, we have talked about we send in documents or

correspondence; they get lost. But the interactions and the factfinding, I think the IRS in looking at their future state needs to

make sure they stay focused on face-to-face interactions with the

taxpayer and does not move to too much online interaction and expect that to take care of everything.

Mr. DAVIDSON. Thank you. My time has expired.

Chairman CHABOT. Ms. Petronchak, you mentioned in your testimony that the IRS is understaffed, underfunded. There is a

theme here, because the common complaint is not directed at their

behavior, necessarily, although there is that. What it sounds like

is they have moved to make their systems accommodate themselves

in a way that reflects their ability to respond. By that I mean I am

listening to this and I am thinking that they barely can keep up.

I mean, if I was them trying to defend them here I would say give

us what we need to do this and we can make sure that the special

people are there and we can answer our phone in less than 45 minutes you said, Mr. Williamson, and that we did not get computergenerated things or letters in the mail that were essentially a list

of everything, send us everything you have and maybe we will get

back to you.

So I would like, just to be fair in this because we do not have

anybody from the IRS here, I would like to ask what you think

about that conjecture, if it is wrong, and do you think that—how

much of this do you think is driven by resources as opposed to

other things that we have talked about?

Mr. WILLIAMSON. Let me just chime in. I want to emphasize,

and I think most of the panelists will agree with me on this, the

professionalism of the individual agents we do business with is

very high and I commend them for that. I think what they have

tried to do is in trying to be more efficient, they become less efficient. And my case was an example of that. Had we just had some

communication one-on-one, I think we could have settled my case

really in minutes rather than a year.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
17

Chairman CHABOT. What would they say about that, though?

Mr. WILLIAMSON. I do not know what they would say about it.

Chairman CHABOT. It has got to be aggravating for them to get

a box of paper in the mail and have to read it all.

Mr. WILLIAMSON. You will have to ask them. I agree wholeheartedly, sir. No question about it. The hours it took us to put this

together to me would be much easier for us just to sit down with

somebody.

Ms. BREEN. I think the IRS has made statements over and over

again that it has a commitment to looking for ways to handle audits more efficiently and effectively. And at the same time, the IRS

has been publicly stating that it is doing less with less. That is why

the ABA tax section does support adequate funding.

On the other hand, you have got small businesses who are also

trying to do more with less in many instances. With the IRS’s new

future state, I think as a practitioner, I would hope that the initiatives that they are coming up with and putting together would create an opportunity for clearer and more effective communication

between taxpayers and the IRS and more focused and efficient audits. I think in that way, both America’s small businesses and the

IRS can go do the jobs that they want to go do.

Chairman CHABOT. It sounds like they are building walls,

though, as well. Responding to somebody, writing to someone in a

paragraph and asking for essentially maybe hundreds or thousands

of pages, it is easy to do on one end, but it is impossible to respond

to on the other.

Ms. BREEN. Absolutely. And many instances where the letters

that are sent to taxpayers that contain that perhaps brief or cryptic

information or request is computer-generated. So no human being

is actually looking at that letter or looking at that return once it

is first selected and saying, hey, let us look at X, Y, and Z, and let

us ask these very specific questions to the taxpayer.

Chairman CHABOT. So you think it has been dumbed down to

the point where it is easier to ask a big question that requires a

lot of work than ask a simple question that requires homework?

Ms. BREEN. I think because the computer is issuing these letters in the beginning, it is giving you a boilerplate list. Taxpayers

have no idea what it is they are supposed to give. They do the best

they can. They send it in and hope that someone looks at it.

Chairman CHABOT. What do you think? You were there 29, 28

years?

Ms. PETRONCHAK. Yeah, I was.

Chairman CHABOT. You must have made a lot of enemies in

that time.

Ms. PETRONCHAK. Yeah, I am sure. You know, most people

like revenue agents. I think they said most of them are professional.

You know, there are cultural problems at the IRS. It is not all

funding. Yes, funding would help. They could do things, maybe

they need training. Third-party contacts is a cultural issue. They

could do something with training, revising their procedures for that

to fix it.

I talked about the use of specialists. Yes, more specialists would

help them if they really want to have a specialist on a case devote

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
18

their resources, but maybe they work fewer cases if they do not

have a specialist and it requires that type of resource, instead of

opening it up and not being fair to taxpayers during that exam.

Mr. HUDAK. We have heard a lot of comments from NAEA’s

members about disappearing auditors going away on detail, going

away on training, disappearing for 6 months. Increasingly, they are

working from home, telecommuting. The question is, with the security, I understand they are doing to keep costs down, but at the end

of the day, you know, they are carrying taxpayer information home

with them and there is a concern there. But I think it is all being

driven by the same budget issue that we have been discussing

today.

Chairman CHABOT. Well, thank you for that. I appreciate it.

I want to thank everybody for being here today. We have heard

a number of problems. Some might describe it as an epidemic to

small business; the exam process that is. These issues need to be

addressed, and I hope that today’s hearing is a good first step in

our ensuring that that happens.

I want to thank you all again for being here. I appreciate the effort of our distinguished panel in bringing these issues to light.

Sunshine is essential for change. All too frequently, taxpayers are

hesitant to take the IRS to task publicly for fear their situation

may actually get worse. I cannot blame them for that. So these

problems persist. Creating an environment where we can identify,

discuss, and take these issues head-on is a key goal of this Committee. And I especially want to thank our witnesses again for

working to achieve that goal.

If there are no comments, ma’am, would you like to have a closing statement?

Ms. ADAMS. Just to thank you all very much. It has been very

insightful. And I would appreciate the opportunity to hear from

you.

Chairman CHABOT. Thank you. This Committee hearing is adjourned.

[Whereupon, at 12:04 p.m., the Committee was adjourned.]

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 F:\DOCS\23767.TXT DEBBIE with DISTILLER
19

A P P E N D I X


Insert offset folio 19 here 23767.001

SBREP-219A with DISTILLER
20


Insert offset folio 20 here 23767.002

SBREP-219A with DISTILLER
21


Insert offset folio 21 here 23767.003

SBREP-219A with DISTILLER
22


Insert offset folio 22 here 23767.004

SBREP-219A with DISTILLER
23


Insert offset folio 23 here 23767.005

SBREP-219A with DISTILLER
24


Insert offset folio 24 here 23767.006

SBREP-219A with DISTILLER
25


Insert offset folio 25 here 23767.007

SBREP-219A with DISTILLER
26


Insert offset folio 26 here 23767.008

SBREP-219A with DISTILLER
27


Insert offset folio 27 here 23767.009

SBREP-219A with DISTILLER
28


Insert offset folio 28 here 23767.010

SBREP-219A with DISTILLER
29


Insert offset folio 29 here 23767.011

SBREP-219A with DISTILLER
30


Insert offset folio 30 here 23767.012

SBREP-219A with DISTILLER
31


Insert offset folio 31 here 23767.013

SBREP-219A with DISTILLER
32


Insert offset folio 32 here 23767.014

SBREP-219A with DISTILLER
33

Chairman Chabot, Ranking Member Velazquez and Members of

the Committee, thank you for the opportunity to testify on the

issues small businesses confront when they are audited by the Internal Revenue Service.

My name is Don Williamson and I am a professor of taxation at

American University’s Kogod School of Business where for the past

thirty-two years I have been the Director of the School’s Masters

in Taxation degree program. The MST program at American University offers graduate courses in federal taxation to accountants

and small business owners who wish to expand their knowledge of

our nation’s tax laws. Our course offerings include not only traditional classes in subject areas such as the taxation of corporations

and partnerships, international taxation and tax policy but also

more specialized areas of the tax law such as IRS practice and procedure that address the issues of this hearing regarding the IRS

examination of small business tax returns.

In addition to my academic work, for the past 27 years I have

had my own tax preparation and tax planning practice, LaMonaca

& Williamson, CPAs, in Falls Church, Virginia which specializes in

the tax issues facing small businesses and their individual owners.

LaMonaca & Williamson prepares hundreds of tax returns of small

businesses as well as representing such taxpayers daily before the

IRS examination, appeals and collection divisions, thereby making

me uniquely qualified to speak with you today.

I. Complexity of the Law Contributes to Time Consuming,

Unproductive Return Examination

Over the course of my tenure as an academic and tax practitioner I have seen with dismay the Internal Revenue Code grow in

complexity, becoming intrusive and pervasive in its reach and incomprehensible to all but those who devote their careers to its

study.

This complexity arises, in part, from the now annual amendments to the Internal Revenue Code that have a profound, even

paralyzing, effect on small businesses that impedes their efficient

operation and obstructs their ability to grow and create jobs. In

fact, since 2001, there have been approximately 5,000 amendments

to various sections of the Internal Revenue Code—about one per

day on average. Consequently, not only small business persons, but

even their tax advisers are overwhelmed by the complexity resulting in steady increases in fees advisers charge to their small business clients.

The National Taxpayer Advocate estimates that each year small

businesses spend approximately 2.5 billion hours preparing tax returns or otherwise responding to IRS inquiries about the preparation of their returns, the equivalent of 1.25 million full-time jobs.

In meeting these requirements 70% of small businesses employ tax

professionals to prepare their returns and represent their interests

before the IRS at a cost of more than $16 billion for the services

of attorneys, accountants and other professionals.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00037 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
34

In addition to waste time and resources, there is the practical reality that it is impossible today to be knowledgeable in the entirety

of our tax law. Professionals must specialize in areas (e.g., corporations, partnership, employee benefits, etc.). As a result, small businesses find that they must employ a team of tax advisers to prepare their returns and ultimately represent their interests if the

returns are audited. Our own Kogod study of more than 40,000

self-employed small business owners, which we conducted earlier

this year together with our research on the sharing economy, found

that more than 44% of our respondents paid more than $200 for

assistance in preparing their annual taxes. While generating a lucrative ‘‘cottage industry’’ for tax professionals, small businesses—

who comprise more than 99% of all businesses—suffer from burdensome tax compliance requirements that require professionals

advice and divert time and resources away from activities encourages business growth and create jobs.

In fact, a survey conducted by the National Federation of Independent Business found that CPAs, attorneys, enrolled agents and

other tax specialists not only prepared, at least in part, over 90%

of all tax returns filed by small businesses but were also retained

to represent small businesses when they were selected for IRS

audit. When small business owners believe they are unable to file

their own tax returns, represent their own interests before the IRS

or simply contact the IRS by telephone without being subject to a

‘‘courtesy disconnect’’ after remaining on hold for 30 minutes, resentment towards the ‘‘system’’ arises, creating a cynicism and disrespect toward our tax law that will only foster non-compliance and

ultimately fraud.

II. Why Target Small Businesses for IRS Examination?

As part of the tussle over tax rates and appropriate deductions

that create an overly complex statute, tax collection and enforcement accomplished by IRS audits of tax returns remain a necessary

and appropriate tool needed to enforce our tax laws. But in deciding what taxpayers to select for audit, the IRS needs to recognize

that on an hourly basis of IRS auditor time, the agency collects far

more revenue from large corporations with higher taxable incomes

than from small and medium size businesses with lower incomes.

But, nevertheless, the highest number of audits for 2014 of individual tax returns with business income was in the lowest range

of business returns, i.e. $200,000 to $400,000, amounting to 50% of

all audits of upper income individual returns. Indeed, the chances

of a Schedule C being audited are almost twice as great as a small

corporation being audited. This evidence seemingly indicates that

small proprietorships are in the audit crosshairs.

One reason the IRS appears to disproportionately target small

business taxpayers is the view that small businesses receive most

of their income in cash, which can be particularly difficult to identify and easily misreported. The IRS has done multiple studies on

the tax gap, i.e., the difference in the amount of taxes imposed and

the amount of taxes paid every year, and concluded that where information reporting or tax withholding is not imposed, there is a

63% net misreporting rate of income. As a result, the IRS uses auSBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00038 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
35

dits of small businesses and their owners to find unreported income. But, both the IRS and taxpayers agree such exercises are

time-consuming and imperfect with the IRS collecting just $7.3 billion from audits last year—its lowest in 13 years.

Most audits are not random, i.e. the IRS has a secret algorithm

for determining how likely each taxpayers is to have unreported income. Employing this calculus, the IRS has concluded that small

businesses are less likely to be paying their fair share of taxes relative to much larger enterprises, a surprising conclusion in light of

frequent press reports of multi-national corporations allocating billions of dollars of profits to no or low tax jurisdictions to avoid U.S.

income taxation.

In short, use of IRS resources disproportionately targeting small

businesses, regardless of the degree of misreported income by a

few, is both an inefficient use of IRS resources and unfair to the

vast majority of small businesses that properly report all their income while generating more growth and creating more jobs than

any other sector of our economy.

III. Unwinding the Wringer

The excessive time and expense of auditing small businesses is,

in part, due to the difficulty the IRS has in conducting examinations of tax returns when specific personnel are not assigned to a

taxpayer’s case. While audits are often conducted by correspondence, they can also be performed by IRS personnel who go to the

taxpayer’s business or ask the taxpayer to come to the local IRS

office. The majority of small business audits are conducted by correspondence. If the issue involves adjustments based on third-party

income reporting documents, e.g. Form 1099s, where the taxpayer

failed to report income, the matter can be promptly settled by the

taxpayer paying the tax on the omitted income plus paying interest

on the deficiency. Penalties are often not imposed.

However, problems begin when there is a disagreement over the

proposed adjustment or the IRS is seeking verification of the information on the return. In these cases, taxpayer responses to written

notices often sit at IRS processing centers for weeks or even

months until assigned to an auditor. Once a taxpayer’s response is

actually reviewed by an IRS auditor, it is often the case that the

auditor will often find the taxpayer’s response to be insufficient setting off a new round of correspondence consuming several more

weeks or months. Rather than this exchange of letters that inevitably must be made by certified mail to ensure receipt by the IRS,

a meeting, or even simply a telephone call, with someone at the

IRS assigned to the case could often settle the matter in a few minutes.

Furthermore, because small business owners rely upon enrolled

agents, CPAs or attorneys when they are contacted by the IRS, significant costs arise for even insignificant inquiries. In fact, many

small business owners simply conclude that the cost of their time

and professional fees is not worth the effort to dispute the proposed

adjustment and opt simply to pay the extra tax—rather than continue to fight.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00039 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
36

Because most correspondence audits have is no point of contact

at the IRS to discuss the matter, taxpayers and their representatives simply hope they are providing the correct information. At the

very least the IRS must better facilitate the tracking of correspondence audits so taxpayers may receive more prompt service. In addition, IRS should consider assigning cases to an auditor or perhaps

a group of auditors if the taxpayer requests such an assignment at

the time of first contact. Perhaps, if the IRS can significantly improve its online capacity, and, more importantly, its security over

its online functions, taxpayers could respond to e-mail communications with specific IRS personnel.

IV. Inefficient Conduct of Audits—A Case Study

Ironically, small businesses which are more likely to be audited

are less likely to have the resources to respond to inquiries and assemble evidence to support or explain their tax returns. In addition, individual taxpayers continue to have an almost illogical fear

associated with being selected for an audit resulting in a strained

relationship between taxpayers and an agency simply seeking to

verify the information reported on a tax return. Finally, the impersonal approach by the IRS in correspondence audits, apparently

due to the lack of personnel to conduct the examinations, makes for

a frustrating and inefficient exercise.

These problems were illustrated most recently, in my own practice, where a small business client living in Texas was contacted

by the IRS Philadelphia service center to explain the income and

expenses claimed on his Schedule C. The letter did not provide the

name of any person at the IRS to contract to discuss the audit and

simply requested copies of all the taxpayer’s books and records.

With no way to understand what specific items on the return were

under examination, the taxpayer, at considerably cost of time and

professional fees, assembled the requested information in three

large boxes which were mailed to the address requested.

After four months, the client received a one page letter with an

attached one page statement of explanation declaring the taxpayer’s business was a ‘‘hobby’’ and therefore the net operating loss

claimed on the return was disallowed resulting in a substantial

proposed assessment of taxes, interest and penalty. At that point,

my client had already incurred fees of several thousand dollars in

responding to the request for information; and I frankly advised

him that taking the matter to the Appeals Division would cost even

more. Nevertheless, my client insisted that I file a protest showing

that his business was not a hobby.

After several more months and several letters where I was able

to have the Appeals Office in Texas rather than Philadelphia hear

the case, we received another letter asking again for a complete

copy of all the taxpayer’s travel and entertainment expenses with

schedules reconciling the individual expenses incurred to the totals

on the return, documentation which we had already provided. I

called the Appeals Officer assigned to the case and explained that

we had already supplied the examination division with this information. The Appeals Officer insisted we supply the information in

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00040 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
37

even greater detail than we had the first time. Therefore, we again

began to prepare new schedules cross-referencing each receipt to

the totals on the returns. However, before we could complete the

work, the client received a one paragraph letter dropping the case.

As a result of this exercise that lasted for almost a year, the client

incurred professional fees that exceeded the initial adjustment in

tax proposed by the IRS had he not contested the matter.

The substantial cost of this case, not only to the taxpayer but

also the IRS itself, illustrates the limits of correspondence audits.

Had an IRS employee in Philadelphia been assigned to this case,

the matter would have been resolved in a few weeks rather than

a year. So often audits of small businesses and individuals are resolved by simply having documentation to support the items

claimed on the return. In this case the taxpayer had the documentation and I am confident the entire matter would have been

closed with one face-to-face meeting.

IV. Conclusion

The burden of compliance costs, including the often unnecessary

examination of small business tax returns, arises not only because

of the complexity of the tax law but also because of basic inefficiencies in the selection of returns for audit and the conduct of the examinations themselves. Because of these inefficiencies, small businesses have had to turn over responsibilities for the audit of their

returns to tax professionals whose fees have made it necessary for

taxpayers to concede possibly incorrect IRS adjustments. By revisiting its approach to the conduct of correspondence audits, the IRS

can make such examinations more efficient thereby raising additional revenue for the government and lessen the burden on the tax

paying community that is the fastest growing sector of our economy.

* * *

Thank you for the opportunity to testify today and the Kogod Tax

Policy Center looks forward to working with the Committee on this

critical problem of tax administration.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00041 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
38

STATEMENT OF JENNIFER E. BREEN

ON BEHALF OF THE

AMERICAN BAR ASSOCIATION SECTION OF TAXATION

BEFORE THE

COMMITTEE ON SMALL BUSINESS

OF THE

UNITED STATES HOUSE OF REPRESENTATIVES

FOR THE HEARING ON

IRS AUDITS OF SMALL BUSINESSES

SEPTEMBER 14, 2016

Good morning, my name is Jennifer Breen, and I am honored to

be here today. I have been a tax practitioner for over fifteen years

and have spent time as an attorney for the Internal Revenue Service (the ‘‘IRS’’), in-house as a member of a corporate tax department, and as an outside advisor to taxpayers. I am currently a tax

partner with the law firm of Morgan, Lewis & Bockius, LLP, in

Washington, D.C., where my practice includes representing taxpayers involved in examinations before the IRS.

I appear before you today in my capacity as Vice Chair for the

Administrative Practice Committee of the American Bar Association Section of Taxation. This statement is presented on behalf of

the Section of Taxation. It has not been approved by the House of

Delegates or the Board of Governors of the American Bar Association. Accordingly, it should not be construed as representing the

policy of the Association.

The Section on Taxation appreciates the opportunity to appear

before you today to discuss examinations of small business taxpayers by the IRS, and it is honored to serve as a resource to the

Committee on this topic.

American Bar Association Section of Taxation

The Section of Taxation is comprised of more than 17,000 members. Our members include attorneys who work in law firms, corporations and other businesses entities, government, non-profit organizations, academia, accounting firms, and other multidisciplinary organizations.

Our members provide advice on virtually every substantive and

procedural area of the tax law, and interact regularly with the IRS

and other government agencies and offices responsible for administering and enforcing such laws. Many of our members, including

myself, have served in positions at the IRS, the Department of the

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00042 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
39

1The IRM states the mission of SB/SE is ‘‘to help small business and self-employed taxpayers

understand and meet their tax obligations, while applying the tax law with integrity and fairness to all.’’ IRM 1.1.16.1.1.

2SB/SE also has enforcement responsibility for estate, gift, fiduciary, excise and most employment tax returns.

3The IRS operates on a fiscal year running from October 1 through September 30.

4Statistics from the IRS 2015 fiscal year, Internal Revenue Service Data Book, 2015, Publication 55B, March 2016. For purposes of the numbers contained herein as they pertain to small

business returns, the following categories of returns were included: 1) individual income tax returns reporting Schedule C business activity with positive income of $1,000,000 or less and

small corporations with total assets of under $10,000,000. These numbers do not include partnership returns, as the data presented by the IRS to date does not distinguish between large

and small business partnerships for the IRS’s 2015 fiscal year.

5 Id.

6 Id.

7Tax Gap Estimates for Tax Years 2008-2010, Internal Revenue Service, April 2016.

Treasury, the Tax Division of the Department of Justice, and the

Congressional tax writing committees.

Examinations of Small Business Taxpayers: A Background

The IRS’s Small Business/Self-Employed Division (‘‘SB/SE’’) is

one of four IRS operating divisions. It has responsibility for approximately 57 million taxpayers, including 41 million self-employed individuals and 9 million small corporations (those having

$10 million or less in assets) 1. SB/SE’s enforcement responsibilities

include examining individual and business tax returns to detect

misreporting 2. Examinations, or ‘‘audits’’ as they are often called,

consist of a review of a taxpayer’s books, records, and other data

to ascertain the correctness of any return or to make a return

where one was not made by the taxpayer. Examinations are authorized by Internal Revenue Code section 7602, which gives the

Secretary of the Department of the Treasury, the IRS’s parent

agency, authority to conduct such examinations.

In the IRS’s 2015 fiscal year 3, the IRS closed approximately 1.3

million examinations.4 Of those examinations, over 300,000 were

examinations of small business returns, with the majority of those

returns reflecting a total income of under $1,000,000, and over

200,000 of these returns reflecting income of under $200,000.5

These audits resulted in over $4 billion of the $25 billion in total

recommended additional taxes across all IRS examinations during

the 2015 fiscal year.6

Examinations provide the IRS with an important tool to identify

noncompliance in reporting tax obligations and help to enhance voluntary reporting compliance. In so doing, examinations help to reduce the ‘‘tax gap,’’which is defined as the amount of tax liability

that is not paid voluntarily and timely. Earlier this year, the IRS

estimated that the gross tax gap for the 2008-2010 time period (the

most current estimates available) was $458 billion and that $52 billion would eventually be collected, resulting in a net tax gap of

$406 billion.7

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00043 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
40

8This testimony focuses on the general processes utilized by the SB/SE operating division of

the IRS, as it is the division responsible for conducting examinations of small business taxpayers. Other operating divisions, such as the Large Business & International (‘‘LB&I’’) division,

may utilize different or additional processes not addressed herein.

9DIF, as referenced in the IRS’s procedures manual, the Internal Revenue Manual (‘‘IRM’’),

is a mathematical technique used to score income tax returns for examination potential. These

formulas were developed based upon National Research Program data. Each return measured

under DIF receives a DIF score by assigning weights to certain basic return characteristics.

Generally, returns with the highest DIF scores are screened for examination potential. The DIF

formulas are confidential in nature and for official use only. See IRM 4.1.3.2.

10See IRM 4.1.5, Classification and Case Building, for more detailed information regarding

the classification process.

11The criteria that classifiers use to decide what issues should be sent for audit are generally

set forth in IRM 4.1.5 and IRM 4.19.11.

12GAO, IRS Return Selection: Certain Internal Controls for Audits in the Small Business and

Self-Employed Division Should be Strengthened, GAO-16-103: Published December 16, 2015

(Publically Released January 13, 2016).

The Examination Process

I. Selection for Examination 8

After a return is filed, SB/SE uses a variety of methods to identify whether a return should be identified for potential examination. These methods include the use of a computer scoring program

(called the ‘‘Discriminant Index Function’’ or ‘‘DIF’’ 9) and other

methods, such as internal and external referrals, the use of data

matching (where the information reported to the IRS from third

parties is matched against the information reported by the taxpayer), and random identification. Many of the methods used by

the IRS use some form of automation to determine which returns

should be selected, and most, but not all, involve some form of

manual review to further evaluate which returns have audit potential. These selection methods create a pool of returns that the IRS

has identified for possible audit.

Revenue Agents and other IRS employees then conduct a review

of the pooled returns in a procedure known as ‘‘classification’’.10

During the classification procedure, an employee determines

whether a return warrants an audit through a review of the information reported on the return.11 During this stage, the taxpayer is

not notified of the potential for selection, and if the employee

classifying the return finds no issues, the IRS will take no further

action on the return at that time. The returns that are identified

during this process as warranting further review then become

available to assign for examination. The IRS reviews more returns

than are selected for audit to ensure that it has enough returns

that are available for examination when staff become available to

be assigned to an examination.12 Due to limited resources, the IRS

will only examine a limited number of the returns filed, making the

classifier’s role critical to ensure resources are used effectively.

II. The Examination

During the classification process outlined above, returns selected

for potential examination are also sorted for one of two types of

possible audit, a ‘‘Correspondence Audit’’ or a ‘‘Field Audit,’’ based

upon guidelines set forth by the IRS. Both of these examinations

are discussed in detail below. Of the over 300,000 examinations

completed for small businesses in 2015, approximately 160,000, or

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00044 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
41

13Statistics from the IRS 2015 fiscal year, Internal Revenue Service Data Book, 2015, Publication 55B, March 2016.

14GAO, IRS Return Selection: Certain Internal Controls for Audits in the Small Business and

Self-Employed Division Should be Strengthened, GAO-16-103: Published December 16, 2015.

Publically Released January 13, 2016.

15Generally, the first request seeks general records including the following: chart of accounts;

Year-end workpapers which reconcile the taxpayer’s books to the tax return; adjusted closing

trail balance; year-end adjusting journal entries and closing entries, the general ledger; bank

statements, duplicate deposit slips and canceled checks for all bank accounts; and copies of financial statements.

over half, were conducted as a correspondence audit and the remainder were conducted as a field audit.13

A. Correspondence Audits

Correspondence audits, also called ‘‘Campus Examinations,’’ are

the most basic type of audit and are conducted exclusively by mail.

These examinations are conducted through one of four ‘‘campus’’ locations, commonly referred to as ‘‘service centers,’’ that are located

in Brookhaven, New York; Cincinnati, Ohio; Memphis, Tennessee;

and Ogden, Utah.

Once a return has been selected for a correspondence audit, an

IRS analyst will review the return to ensure it adheres to the selection rules embedded in the automated processes, and then the return is assigned to a campus through automated processes. Generally, this means there is no further review by a manager or oversight group to determine whether to assign, hold, or screen out returns.14

Once assigned to a campus, examinations are initiated by a

standard boilerplate letter, the ‘‘initial contact letter,’’ which is

mailed to the taxpayer to notify them that they have been selected

for examination, provide them with a list of items to be verified,

and with a copy of IRS’s Publication 3498-A, The Examination

Process (Audits by Mail). As these notices are computer generated,

there is virtually no customization with respect to the taxpayer, the

taxpayer’s business activities, or the possible issues that have triggered the examination. Rather, the initial request is generic in nature and requires the taxpayer to provide a variety of records to

the IRS.15 A taxpayer must respond within 30 days by mailing copies of the requested documentation to a general address for the

campus conducting the examination. Should a taxpayer have any

questions regarding this initial letter, they are directed to call a

general number or write to the campus’s general address, as the

case not yet been assigned to a specific campus examiner at this

point in the process.

Once a taxpayer responds, the correspondence is placed in a

queue to be assigned to a campus examiner, who will notify the

taxpayer that the response was received. This process can take

months, often due to the number of cases in the queue. Sometimes,

a taxpayer is forced to resend the correspondence as the original

information mailed cannot be located by the IRS.

In some instances, after submitting the requested information,

taxpayers will receive notification that nothing more is needed and

that their examination is being closed with no changes. However,

in many instances, the examiner will contact the taxpayer with furSBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00045 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
42

16This testimony focuses on the general processes utilized by the SB/SE operating division

of the IRS, as it is the division responsible for conducting examination of small business taxpayers. Other operating divisions, such as LB&I, utilize different or additional processes not addressed here.

17GAO, IRS Return Selection: Certain Internal Controls for Audits in the Small Business and

Self-Employed Division Should be Strengthened, GAO-16-103: Published December 16, 2015.

Publically Released January 13, 2016.

ther issues or requests due to the records provided or a dispute

over a matter of law. Unfortunately, in many examinations, the

qualify of the taxpayer’s response to the requests made by the IRS,

as well as the agent’s understanding of the position taken by the

taxpayer, is impacted by the fact that all discussions between the

two parties are undertaken through correspondence and limited

telephonic communication (if any), rather than face-to-face conversations.

If a taxpayer fails to respond at any point in the process, the IRS

will send a second notice. If it receives no reply at that time, the

IRS will then issue a statutory notice of deficiency, also known as

a ‘‘90-day letter.’’ At the end of 90 days, the IRS will assess the tax,

and any penalties and interest associated therewith and send a Notice and Demand for payment, unless the taxpayer petitions the

Tax Court for a redetermination of the asserted deficiency.

As a whole, the IRS conducted the majority of its 2015 audits,

72.6 percent, via correspondence. As noted above, with respect to

small businesses, over half of these audits were done via correspondence. For some types of small business taxpayers, this percentage is even higher. For example, of the nearly 170,000 small

business taxpayers reporting gross receipts of under $100,000 that

underwent an audit in 2015, more than 65% underwent a correspondence audit.

B. Field Audits 16

Field audits are generally conducted through direct contact with

the taxpayer or the taxpayer’s representative through a combination of face-to-face meetings, telephone calls, and written correspondence. SB/SE conducts these types of examinations through

field offices located in seven regional areas across the United

States. When classifying a return to determine whether to identify

it for a potential field audit, the employee considers whether the

issue would likely require an on-site inspection of a taxpayer’s

books, records, or assets, whether extensive time is anticipated to

complete an audit, and whether the issues appear complex. In such

instances, IRS guidance recommends that a field audit should be

considered over one conducted via correspondence.

For cases that are referred to the field for examination, the inventory provided to each office is generally reviewed by a group

manager, who has the discretion to assign, hold, or screen out returns for audit based upon resource constraints or priority of the

workload.17 The group manager then assigns each case to an agent

who will conduct the examination. Once assigned, the agent will

notify the taxpayer that its return has been selected for examination and will provide it with a list of documents the agent has identified for review through an Information Document Request

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00046 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
43

18Similar to the boilerplate requests made in a correspondence audit, the first request in a

field audit generally seeks general records including the following: chart of accounts; year-end

workpapers which reconcile the taxpayer’s books to the tax return; adjusted closing trail balance; year-end adjusting journal entries and closing entries, the general ledger; bank statements, duplicate deposit slips and canceled checks for all bank accounts; and copies of financial

statements. In addition, this request also usually seeks all related returns. For example, if the

taxpayer under audit is a partner in a partnership, the initial request will seek copies of the

partnership’s returns, or if the taxpayer under audit is a partnership, the initial request will

seek copies of all of the partner’s returns as well.

(‘‘IDR’’). While these lists are often customized with documents the

agent has identified as required based upon his or her preliminary

review of the return, this request also contains boilerplate items

agents are required to seek regardless of the issue or issues the

agent has identified for examination or the nature of the taxpayer’s

business.18 The letter will suggest a date and time for the first

meeting with the taxpayer or the taxpayer’s representative, at

which the taxpayer is expected to produce the records requests for

the agent’s review.

At the outset of the examination, and generally at the first meeting with the taxpayer, the agent will also spend time asking the

taxpayer a series of questions. Some of these questions will have

been customized through the agent’s development of the case. However, often these questions are boilerplate and are required by SB/

SE guidelines for procedures and techniques that should be used

in every examination, regardless of the issues or type of taxpayer

involved.

After the agent has reviewed the initial information and met

with the taxpayer, in some instances, taxpayers will receive notification from the examiner that nothing more is needed and that

their examination is being closed with no changes. However, in

many instances, the examiner will contact the taxpayer with further issues he or she has identified or for additional documents to

be requested through subsequent IDRs.

C. Completion of an Audit

Both correspondence and field audits can be concluded in one of

three ways: as a ‘‘No Change,’’ as ‘‘Agreed,’’ or as ‘‘Unagreed.’’

A No Change resolution means that during the examination the

taxpayer was able to substantiate that all of the items being reviewed on the return were correctly reported and the examination

results in no changes. While the IRS did not tabulate data reflecting the total percentage of No Change examinations that occurred

in 2015, it did report statistics as broken down by specific types of

taxpayers. In nearly every instance of small business taxpayer examinations, No Changes occurred more frequently in cases for

which a correspondence audit was conducted. Additionally, for

some groups of small business taxpayers, the likelihood of completing a correspondence examination that resulted in no changes

was high. For example, of the 13,684 business returns with total

positive income of under $200,000 and total gross receipts of over

$200,000 that were selected for examination, 2,135 were subjected

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00047 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
44

19Statistics from the IRS 2015 fiscal year, Internal Revenue Service Data Book, 2015, Publication 55B, March 2016.

20See Publication 594, The IRS Collection Process, for more information regarding these options.

to a correspondence audit and over half of the examinations resulted in no change.19

An examination that has concluded as Agreed means the IRS has

proposed changes and the taxpayer understands and agrees with

the changes. If a taxpayer agrees with the audit findings, the taxpayer will be asked to sign the examination report or a similar

form, depending on the type of audit conducted. If money is owed,

the taxpayer will be required to make a payment or seek to utilize

one of the payment options offered by the IRS, if one is available.20

Of the over 300,000 small business cases closed in 2015, roughly

4% closed in agreement.

Finally, cases that are closed as Unagreed are those where the

IRS has proposed changes with which the taxpayer has disagreed.

If the taxpayer does not agree with the findings, a conference with

a manager may be requested for further review, the taxpayer may

seek review by the IRS Office of Appeals or may seek to use of the

IRS’s Appeals Mediation Programs.

Conclusion

In 2015, the IRS examined a total of approximately 1.4 million

tax returns, and a large part of these returns were associated with

small businesses across the United States. Although the experience

of an examination by the IRS can require time and attention and

cause uncertainty for the taxpayer, examinations are an important

tool for the IRS to identify noncompliance in reporting tax obligations, help to reduce the tax gap, and enhance voluntary reporting

compliance.

The IRS outlines the examination process on its website and in

Publication 556, Examination of Returns, Appeal Rights, and

Claims for Refund, for taxpayers who have never experienced an

examination. The examination process nevertheless can be confusing and time consuming. Consequently, taxpayers often are unsure about what to expect and how to proceed. Unlike the Large

Business and International (‘‘LB&I’’) Division, SB/SE does not have

a public ‘‘Examination Process’’ statement whereby the Division

provides an organizations approach for examinations from the first

contact through the final stages of issue resolutions, nor does not

have directives requiring discussions with taxpayers around certain

examination procedures, such as the issuance of IDRs.

Regardless of the type of examination a small business taxpayer

experiences, establishing good accounting and recordkeeping will

help a taxpayer prepare for an examination, should one arise, and

help to put the taxpayer in a position to effectively and efficiently

respond to any issues raised by the examiner. Good record keeping

is not enough, however. It is also important to be cooperative and

responsive to all IRS notices and requests for information.

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00048 Fmt 6602 Sfmt 6602 F:\DOCS\23767.TXT DEBBIE with DISTILLER
45

21 ‘‘Future State Initiative’’ Internal Revenue Service, February 22, 2016. https://www.irs.gov/

uac/newsroom/future-state-initiative (September 11, 2016).

Last year, the IRS, including SB/SE, announced its ‘‘Future State

Initiative.’’ 21 Through this initiative, SB/SE has indicated that it

is looking for ways to find better and more efficient ways of doing

business, including using technology to transform the examination

process. It has identified possible changes to include the use of digital notifications of possible examination at early stages shortly

after filing, the use of limited-issue examinations based upon specific aspects of a taxpayer’s return, and the ability for taxpayers

and their representatives to exchange necessary information electronically with an agent during an examination. Efforts such as

these should lead to improvements in the examination process and

help the IRS examine taxpayers more effectively and efficiently.

Thank you for affording me the opportunity to be here today to

provide the Committee with this information. I look forward to

your questions.

Æ

SBREP-219A VerDate Mar 15 2010 10:45 Feb 16, 2017 Jkt 000000 PO 00000 Frm 00049 Fmt 6602 Sfmt 6011 F:\DOCS\23767.TXT DEBBIE with DISTILLER