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

            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

                               __________

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                            

            Small Business Committee Document Number 114-072
              Available via the GPO Website: www.fdsys.gov
              
   
   
   
   
   
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                   HOUSE COMMITTEE ON SMALL BUSINESS

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

                   Kevin Fitzpatrick, Staff Director
                       Jan Oliver, Chief Counsel
                Adam Minehardt, Minority Staff Director
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                            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.

 
            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.
    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 time-consuming 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 modify 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.

 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 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.
    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.

                  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 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 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 
identified 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.
    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?
    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 investment, 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 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 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.
    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 fact-finding, 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 computer-generated 
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.
    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 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.]
    
    
    
    
                            A P P E N D I X

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    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.

    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 audits 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.

    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 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.
                     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 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.
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    \1\ The 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.
    \2\ SB/SE also has enforcement responsibility for estate, gift, 
fiduciary, excise and most employment tax returns.

    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\
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    \3\ The IRS operates on a fiscal year running from October 1 
through September 30.
    \4\ Statistics 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.

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

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                    The Examination Process

    I. Selection for Examination \8\
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    \8\ This 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.

    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.
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    \9\ DIF, 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.

    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.
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    \10\ See IRM 4.1.5, Classification and Case Building, for more 
detailed information regarding the classification process.
    \11\ The 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.
    \12\ GAO, 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).

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    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 over half, were conducted as a 
correspondence audit and the remainder were conducted as a 
field audit.\13\
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    \13\ Statistics from the IRS 2015 fiscal year, Internal Revenue 
Service Data Book, 2015, Publication 55B, March 2016.

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          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\
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    \14\ GAO, 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.

    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.
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    \15\ Generally, 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.

    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 
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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 further 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\
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    \16\ This 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.

    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 
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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 (``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.
---------------------------------------------------------------------------
    \17\ GAO, 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.
    \18\ Similar 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.

    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 to a correspondence audit and over half of the 
examinations resulted in no change.\19\
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    \19\ Statistics from the IRS 2015 fiscal year, Internal Revenue 
Service Data Book, 2015, Publication 55B, March 2016.

    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.
---------------------------------------------------------------------------
    \20\ See Publication 594, The IRS Collection Process, for more 
information regarding these options.

    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.

    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.
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    \21\ ``Future State Initiative'' Internal Revenue Service, February 
22, 2016. https://www.irs.gov/uac/newsroom/future-state-initiative 
(September 11, 2016).

    Thank you for affording me the opportunity to be here today 
to provide the Committee with this information. I look forward 
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to your questions.

                                 [all]
```